Page last updated at 18:53 GMT, Monday, 24 November 2008

Economic slowdown hits borrowing

By Steve Schifferes
Economics reporter, BBC News

Budget deficit

The Chancellor, Alistair Darling, admitted that the UK economy will contract by around 1% next year, after falling in the second half of 2008.

But he said that new government measures would lead to a recovery in the second half of 2009.

Mr Darling intends to inject 20bn, or around 1% of GDP, up to April 2010.

However, the extra spending will lead to a soaring budget deficit, which will reach 78bn by next year, and 128bn - or 8% of GDP - by 2010.

Soaring deficit

It would be the highest level of borrowing since modern records began in 1970 when the UK went cap in hand to the IMF for funding.

government debt

"This is a remarkable figure," said Robert Chote, head of the independent Institute for Fiscal Studies.

The budget deficit is to double next year, and increase by another 50% in the year after that. It is well above the 43bn deficit forecast just six months ago in the March Budget.

And overall government debt will rise rapidly from the current level of 40% of GDP to peak at nearly 60% by 2013/14 before the government believes it can stabilise the budget gap.

This is well above the government's self-imposed target of keeping debt below 40%, and will take public debt to over 1 trillion by the end of the period.

The key question will be whether financial markets will accept such a large increase in borrowing without increasing the interest rates on UK government debt.

That will be made more difficult by the fact that the government is abandoning the rules which have, in the past, reassured the markets.

"Even on the Treasury's possibly somewhat optimistic projections, the current budget is not expected to return to balance until 2015/16, which shows just how long and painful the process of getting the public finances back on track will be," says John Hawksworth of PricewaterhouseCoopers

Abandoning the rules

Mr Darling is "temporarily suspending" the fiscal rules that have governed spending up to now.

It would be "perverse and damaging" to stick to government borrowing rules in the current crisis but the chancellor said the books would be balanced again by 2015/16.

Instead, the government will introduce a temporary, more modest target "to improve the cyclically adjusted current budget each year, once the economy emerges from the downturn."

Mr Darling argued that the measures were necessary because of the severity of the world downturn.

"Every country is facing the impact of this crisis on their own economy," Mr Darling said.

But "monetary policy is not enough," he added.

The chancellor pointed out that the world banking system would suffer losses of $3 trillion as a result of the financial meltdown - triple the estimate made earlier in the year by the IMF.

"We are disappointed with the absence of a clearer framework of new fiscal rules," says CBI director general Richard Lambert.

Economic prospects

GDP forecast

Despite his revised forecast, Mr Darling has taken a more optimistic view of the UK economy than many independent forecasts.

He is expecting the UK economy to recover to a growth rate of 1.5% to 2% by 2010, and to return to its normal growth rate of 2.75% in subsequent years.

"Because of the wide-ranging measures I am announcing today, and the many strengths of the British economy, I am confident that the slowdown will be shallower and shorter than would have been the case," Mr Darling said.

But other forecasts suggest that the economic recovery will not begin until well into 2010, and that the economy could shrink by as much as 2% next year.

If the world economic recovery is indeed delayed, then even the grim budget forecasts made by the chancellor could be too optimistic.

Some economists argue that if Mr Darling's stimulus is not enough to turn around the economy, he will need a further stimulus package in the Budget.

"The economy still faces powerful contractionary forces in the shape of widespread recession abroad, and at home falling house prices and stock markets, blunted monetary policy as banks constrain lending and rock-bottom business and consumer confidence," says Andrew Smith, chief economist at KPMG.

"If this package fails to kick-start the economy, further expansionary measures can be expected in next year's budget proper."

Fiscal squeeze

The government is also planning a sharp cut in the rate of growth in public spending over the next few years.

Public spending is now expected to grow by just 1.2% per year, less than the growth rate of the economy as a whole, and a sharp decrease from the 1.8% previously planned.

This compares to an annual growth in public spending of around 3% under the previous Labour government.

In addition, the government has pencilled in 5bn in efficiency savings by 2011.

This spending slowdown is part of the plan to bring the public finances back into balance by 2015.

But it will not be enough on its own.

Tax rises

The government is also going to implement a very large shift in the tax burden in years to come.

Compared to tax giveaways of 19bn this year, the government is expecting to raise taxes by 20bn in four years' time.

The largest slice of tax increases will come from the 0.5% increase in National Insurance contributions, which will raise 4.7bn.

Taxes on the rich, including the 45% higher rate and restrictions on personal allowances, will add 2bn in tax revenues.

And, if growth is slower than predicted, there may have to be other tax increases in the pipeline.

Government debt

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