The UK is currently ‘drowning’ in debt – is there a realistic solution?

This is a brief look at the factors affecting, and being affected by the UK economic crisis, covering areas such as global debt ownership, UK credit rating, the UK tax avoidance scandal and exchange rates.


What is national debt?

Every year the Government spends more money than it can tax, so it plugs the gap by selling bonds to investors at home and abroad. These bonds – known as gilts – have to be repaid in full, with interest. Added together, the unpaid loans make up the UK National Debt. Or to put it into a diagrammatic equation:

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Due to the increasing budget deficit, national debt is steadily increasing by approximately £121bn per annum, equivalent to £2.3bn per week. I should point out here that the terms deficit and surplus are used as in clubs and societies to describe the essential profit or loss of the organisation.

[Supporting video: http://www.bbc.co.uk/news/business-26289940]

Simon Rose (Save Our Savers) also goes on to mention that he in fact believes the UK is heading towards a state which will require a Government National Unity – a type of government usually adopted in times of war and national emergency.

UK vs Foreign Ownership

Overseas investors, who buy UK gilts, are comprised of a few different sources;

  • Foreign investment trusts / pension funds
  • Foreign banks
  • Foreign individuals who want to buy UK gilts

The Good

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“These figures show that the UK remains a world-leading business destination as well as the growing confidence and trust that foreign investors have in UK businesses.”

Nick Baird (Chief Executive for UK Trade & Investment) 

The Bad

Several European countries experienced difficulties, when foreign investors held significant holdings of government debt. When foreign investors became concerned about the liquidity and solvency of countries like Greece, they sold their holdings, causing capital flight and rising bond yields.

The Aa1 Bombshell

In February 2013, Moody’s, one of the main world credit rating agencies, downgraded the UK from its AAA credit rating – the highest credit rating possible.

Moody’s decision to lower the UK’s status is based on a perception of sharply rising government debt and the large-scale use of quantitative easing (some £375bn has been artificially pumped into the economy by the Bank of England).

“The reputation of credit agencies has not been strong since the financial crisis; many other countries are in the same boat as the UK, with large-scale quantitative easing in the US, Japan and elsewhere”

Michael Izza, ICAEW Chief Executive

The UK has a good track record of not defaulting on debt – UK gilts are seen as a secure investment. Therefore, despite a low rate of return, people are willing to buy. However, due the decrease in the credit rating, this may deter future foreign investors as their investment is no longer as secure as it had used to be.

For all the doom and gloom surrounding the Aa1 rating, we need to remember that Aa1 is still very high (it is, in fact, the same as France and the US).

Who’s really in charge?

It was reported in 2013 that external based companies i.e. outside of the UK, were actively avoiding paying corporation tax, along with other taxes – totalling to a staggering £35bn. This figure does not include taxes owed to the government accumulated from aggressive tax avoidance schemes by other sectors and organisations.

Companies such as Amazon®, Starbucks and Google all use offshore accounts, whether it be in Luxembourg or Ireland for lower and more favourable tax rates. Although this may seem morally unjust, it is unfortunately legal under current UK legislation.

In 2013, after being heavily attacked in the media, Vodaphone released a defence statement which included the following;

“As the UK government wants more investment in UK infrastructure and jobs, it allows all businesses to claim relief for the cost of assets used in the business against their profits when determining their corporation tax bills. The government also provides relief to all businesses for the cost of interest on their debts to UK banks and financial institutions. Vodafone is no different to any other UK business.”

Vodaphone™ [on the tax avoidance scandal]

I believe that this is a fundamental issue that needs to be resolved before further cuts are made to areas such as welfare spending. However, the government has little say in comparison to these large corporations, as without even their relatively small contribution to the UK tax revenue stream and provision for international trade, the UK would be in an even greater state of debt.

 How much is it worth?

The pound Sterling is relatively stable. A big issue for foreign investors is the value of the Pound. If the value of the Pound falls sharply, then their investment will effectively decline in value. Inflation in the UK is slightly higher than other competitors, but generally, inflation is under control and the Pound is reasonably stable.

The value of the pound against the euro and the dollar is falling, and has been doing so for some time – the exchange rate currently being a mere £1 : $1.65 : €1.2. This could be seen as a bad thing, making it harder for British businesses to import into the UK, which would cause possible greater debt due to a decrease in revenue/profit tax from decreased sales. The value of the pound looks as though it will continue to decline, as investors move their money into currencies used by countries with better growth prospects. Therefore the issue surrounding the value of the pound i.e. is it worth trying to increase, must be considered when trying to encourage economic growth – via internal or external trade and investment.

 Is there a solution?

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(Pettinger, 2013)

As you can see from the pie chart above, it is evident why the government has made so many cuts to pensions, welfare, education and the National Health Service as they are the four largest sectors for government spending.

But what are the solutions advocated by the conservative and labour parties? The conservative party promotes cuts to public spending, whilst the labour party encourages economic expansion.

Conclusion

In conclusion, I believe that there is shared responsibility for the UK debt. Without wealthy foreign investors and government efforts to reduce the budget deficit, the state of our national debt would only get drastically worse.

However, the inconsistency in government plans to reduce the deficit and the lack of ethics by multinational corporations seems to be, for the time being, the prevalent situation.

Therefore, I believe that UK and EU international trade guidelines should be made stricter, for example, having a legal requirement for an international organisation to have a UK bank account if trading in the UK – which is supported by the survey I undertook.

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NOTE: All figures used in this article were correct as of March 2013.

Food for thought…

“HMRC holds back from using the full range of sanctions at its disposal. It pursues tax owed by the smaller businesses but seems to lose its nerve when it comes to mounting prosecutions against multinational corporations”  

Margaret Hodge MP

Reference List

Pettinger, T. (2013) Who owns uk debt? [online] Retrieved from: http://www.economicshelp.org/blog/1407/economics/who-owns-government-debt/ [Accessed: 16 Mar 2014]

For more information, visit;

Foreign investment: http://www.cityam.com/article/1380157581/global-britain

Moody’s downgrade: http://realbusiness.co.uk/article/18066-moodys-british-downgrade-the-sme-impact

Government spending: http://www.economicshelp.org/blog/142/economics/what-does-the-government-spend-its-money-on/

Tax avoidance scandal: http://www.theguardian.com/politics/2013/dec/19/hmrc-lost-nerve-tax-avoiders-mps

Featured image courtesy of http://www.hollins.edu/academics/economics/images/economicsMain.jpg

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