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Last Updated:  Thursday, 3 April, 2003, 16:26 GMT 17:26 UK
The chancellor's challenge
Jenny Scott
By Jenny Scott
BBC business correspondent

On 9 April Chancellor Gordon Brown will announce his Budget for 2003/2004. But a global economic downturn and the costs of war will make it difficult for him to balance the books.

Revising down growth forecasts is becoming something of a habit for Gordon Brown.

Chancellor Gordon Brown arriving at Downing Street for a war cabinet meeting
A faltering economy and the cost of war weigh on Gordon Brown's mind
The forthcoming budget will probably see the chancellor swallowing his pride once again, and admitting that he read the economy wrong.

The forecasts made by the Treasury only last November are already looking too optimistic. Back then, Mr Brown expected the economy to grow by between 2.5% and 3% this year - independent analysts are pencilling in just 1.9% to 2.4%.

Gloomy backdrop

The chancellor's usual trick when he's forced to cut near-term forecasts, is to make up the lost ground by boosting growth expectations in future years.

UK GDP growth - and conflicting Treasury and analysts' forecasts

But he'll struggle to do that this time. The Treasury is already counting on growth of 3% to 3.5% in 2004 - economists say it will be more like 2.6%.

So why the gloomy backdrop? The war can take some of the blame, but not all of it. It creates uncertainty which stops businesses from investing and us from spending.

It also plays havoc with the price of oil - a sustained war could keep prices high, adding to firms' costs and subtracting from their profits.

The stockmarket also stands little chance of a solid recovery while war prevails.

Don't blame the war

But even if the conflict was to end tomorrow, it wouldn't mean an instant cure for all the economy's ills.

Growth was faltering before the war, and chances are it will continue to falter after it.

Firstly, there is the apparent slowdown in consumption. Fears of a housing market collapse, expectations of slower future income growth and a build-up of debt looks to be curbing our appetite for spending.

It's by far the most significant part of the economy - accounting for around 60% - so any deceleration will be keenly felt.

Secondly, the global economy continues to struggle. Growth in the United States is fragile as is that in the eurozone, Britain's largest trading partner.

That has hampered British exports - they've fallen in five out of the past six quarters.

The recent fall in the pound will help by making exports cheaper, but that will take some time to feed through - and it's still no substitute for a surge in world demand.

Counting the shortfall

UK budget deficit forecasts

Investment in the economy - or rather the lack of it - has also ambushed Mr Brown's growth forecasts. He expected fixed investment to rise by around 6.5% this year, a figure that's looking wildly optimistic.

Government spending is about the only part of the economy that's contributing to growth as expected.

The limp economic backdrop means the chancellor will almost certainly receive less tax revenue than he was counting on. Central government revenues rose 1.5% in the first 11 months of the 2002/03 fiscal year, compared with a pre-budget forecast of 2.2% for the year as a whole.

It's not much in percentage terms, but given total revenues of more than 400bn, it soon adds up in absolute terms.

Higher taxes?

The judgement Mr Brown has to make is whether that shortfall is entirely down to the disappointment in growth, or whether it reflects a change in the relationship between growth and tax revenues.

If it's the former, he can afford to let borrowing take the strain and simply pay the money back when the good times return.

If it's the latter, the chancellor will need to reassess his revenue projections for years to come.

If he wants to carry on spending at the current rate, that means one thing - higher taxes.

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