Virus threat adds further twist to UK’s fiscal puzzle

Virus threat adds further twist to UK’s fiscal puzzle

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UK Chancellor of the Exchequer Rishi Sunak. (Reuters)

New UK Chancellor of the Exchequer Rishi Sunak is making final preparations for his first annual budget speech on Wednesday. Less than a month into his big job, Sunak will be keen to impress, but it could be a baptism of fire, especially with the looming coronavirus pandemic.
As UK cases climbed into triple figures, British Prime Minister Boris Johnson said on Friday that the virus is likely to spread significantly. UK strategy is to continue to limit the number of people becoming infected, but Johnson warned that a dramatic rise in the number of cases is now likely. Officials are stepping up preparations for the delay phase of the government’s strategy by trying to push back the peak infection point of the virus, ideally to warmer months.
The uncertainty that coronavirus is bringing to the nation’s politics and economics means that some key fiscal decisions will be kicked out of the budget until later this year. One early sign of this is that Sunak will reportedly abandon a planned announcement of the government’s long-awaited national infrastructure strategy to invest about £100 billion ($130 billion) by 2050. The budget statement is still likely to give the go-ahead for high-profile, expensive infrastructure, but there will be a delay in the overall strategy (and the billions to support it), part of Johnson’s so-called “infrastructure revolution” to “level up” regional disparities.
While the economic impact of the spread of the virus is hard to quantify at this stage, a dampening effect is certain. The effects will be felt not just in the havoc on financial markets but also through potentially significant falls in tax revenue to the exchequer. As a result, markets are anticipating that the Bank of England could cut interest rates as early as this month, though not necessarily as much as the half a percentage point reduction that the US Federal Reserve took in recent days.
Yet it is not only coronavirus and the prospect of a more relaxed monetary policy that may force some key fiscal decisions to be deferred from the budget. With Brexit negotiations resuming this month, the virus has struck at a time of wider economic and political flux.
Last week, after Brussels set out its own priorities, the UK unveiled its negotiating strategy to try to secure a trade deal with the EU. While there is overlap between the two positions, the time-frames are already exceptionally tight, with London saying that it will walk away from trade talks in June unless there is a “broad outline” of a comprehensive deal that can be “rapidly finalized” by September.
While at least an interim UK-EU deal (or potentially a set of sector-relevant deals) may still be the most likely outcome this year, there is a now a growing chance of the talks collapsing. To this end, the UK said this month that it has resumed preparations to end the transition period for “no trade deal” on World Trade Organization terms.
A key factor that will influence the boldness of Sunak’s budget will be whether, at a time of political and economic flux, he can renege on the fiscal rules put in place by his predecessor Sajid Javid, whose unexpected departure last month surprised Westminster. Javid recently warned his successor against this course of action, saying that “it would not be right to pass the bill for our day-to-day consumption to our children and grandchildren.”
Yet the problem for Sunak going into budget day is that the increasingly uncertain economic backdrop limits scope for big spending initiatives unless he drops the Conservative manifesto commitment to balance the budget within three years. Indeed, the Institute for Fiscal Studies think tank forecast last month that, even without any new commitments, the government will run a deficit.

A key factor that will influence the boldness of Rishi Sunak’s budget will be whether he can renege on the fiscal rules put in place by his predecessor Sajid Javid.

Andrew Hammond

So, unless Sunak throws caution to the wind, Wednesday’s budget could focus on delivering a relatively small number of Tory manifesto pledges from last December’s election, postponing other key business until later this year. The chancellor may take this course of action because of a “window of opportunity” offered by other key fiscal events this autumn, including the end of the Comprehensive Spending Review (CBR) round, which will set levels of public spending for at least three years.
There is also a growing possibility of a second budget this autumn to ensure, post-CBR, that all the numbers add up by the end of the year, including from the delayed national infrastructure strategy. This will give Sunak the luxury of not just one, but at least two and potentially three set-piece fiscal occasions this year, allowing him to defer some major decisions to the autumn when there may be much more clarity over the economic and political outlook.

  • Andrew Hammond is an Associate at LSE IDEAS at the London School of Economics.
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