European Commission pinpoints risks to UK public finances

26 Jan 16

A review by the European Commission has found that the public finances in the UK face a high level of risk due to increasing public sector debt levels forecast over the next decade.

In a review of fiscal sustainability, the commission warned that the UK public debt levels were likely to have hit around 88% of gross domestic product in 2015.

However, after a decline to 86% of GDP by 2020 it would increase to close to 90% of economic output by 2026, and would still be forecast to rise further beyond the forecast period. This, combined with the risk of reaching a much higher level triggered by potential shocks to nominal growth and interest rates, led the commission to assess that the UK had high short-term risks.

The review found the UK’s debt to GDP ratio could reach 100% of economic output in the modelling following a standard negative shock. As a result, the review said that “a very large set of jointly simulated shocks to growth, interest rates and the primary balance points to a probability above 40% of a debt ratio in 2020 greater than in 2015, which entails risks given the high starting level”.

“All in all, having regard to the different projection scenarios and main results, the UK presents a high risk in the medium term from a debt sustainability analysis perspective,” the review concluded.

Factoring in the impact of an ageing population into the likely path of public spending, the commission concluded that the UK would need to make a “fiscal adjustment” equivalent to 3.2% of GDP to ensure sustainability of public finances over the long run. This is based on calculating the reduction in spending, or increase in taxes, that would be needed in the five years from 2018 to reach a 60% debt-to-GDP ratio by 2030.

This “sizeable level” of adjustment is due to the projected impact of age-related public spending, which is a likely to require a 2.4% shift in fiscal policy in the long term to be offset. An unfavourable initial budgetary position also contributes to what it called the “substantial required adjustment”.

The UK is one of 11 countries deemed by the commission’s analysis to face high medium-term risks to fiscal sustainability. The others are Belgium, Ireland, Spain, France, Croatia, Italy, Portugal, Romania, Slovenia and Finland.

Publishing the review, Marco Buti, the commission’s director general of economic and financial affairs, said fiscal sustainability challenges were significantly lower in the EU today relative to the outset of the financial crisis.

“Significant challenges nonetheless remain over the medium term, mostly due to the public debt stocks cumulated during the crisis years, and over the long term, mostly related to the projected increase in age-related public spending,” he stated.

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