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Chapter 4a

Fiscal Strategy: The Next Three Years

1. Excluding windfall tax receipts and associated spending.

2. Includes accruals adjustment for the capital uplift on the redemption of the 2½ per cent 2001 index-linked gilt.

Table 4.5: Current and capital budgets

1. Excluding windfall tax receipts and associated spending.

2. Includes accruals adjustment for the capital uplift on the redemption of the 2½ per cent 2001 index-linked gilt.

3. Total tax receipts and social security contributions net of tax credits.

4. General government net borrowing. The Maastricht definition does not exclude the windfall tax and associated spending.

4.3.5 CYCLICALLY-ADJUSTED BUDGET DEFICITS

Experience has shown that serious mistakes can occur if purely cyclical improvements in the public finances are treated as if they represented structural improvements, or if a structural deterioration is thought to be merely a cyclical effect. The Government therefore pays particular attention to cyclically-adjusted indicators of the public sector accounts.

Table 4.6 shows cyclically-adjusted measures of government borrowing. As in the March 1998 Budget figures, these are based on a judgement that the economy was on trend, on average, in the first half of 1997. With the economy assumed to remain close to trend, there is relatively little difference between the actual and cyclically-adjusted measures of borrowing.

Following the policy tightening implemented in the Budget last July, the fiscal position has improved considerably. Indeed, the fiscal stance, measured by the change in cyclically-adjusted public sector net borrowing, tightened by more than 2 per cent of GDP in 1997-98, the largest fiscal tightening since 1981. This provided valuable support to monetary policy at a critical point in the cycle. The March Budget locked in that tightening: cyclically-adjusted public sector net borrowing is expected to fall further, bringing the fiscal position into structural balance in 1999-2000. Thereafter, small structural surpluses are recorded, with actual public sector net borrowing remaining close to balance and maintaining a stable path for the public finances into the medium term.

Should output growth over the next few years differ appreciably from what has been assumed, then the outlook for the public finances could be significantly different. However, whatever the path of output growth, the cyclically-adjusted measures provide a broad guide to the underlying state of the public finances and whether policy remains consistent with the fiscal rules.

Table 4.6: Budget balances1

1 Excluding windfall tax receipts and associated spending.

The need to adopt a prudent approach is highlighted by considering what might happen if the assessment of the cyclical position proved to be optimistic. As in the July 1997 and March 1998 Budgets, cyclically-adjusted measures have been calculated on two different assumptions for trend output:

• the first central case is based on the assessment that output was on trend on average in the first half of 1997; and
• the second cautious case assumes that output is 1½ per cent further above trend than this.

The second case represents a cautious view of the economy, but is within the range of possible outcomes. Chart 4.2 shows that on this deliberately cautious assessment of the cyclical position, the underlying state of the public finances is consistent with meeting the golden rule over the economic cycle but that the margin for error would be limited. In particular, the cyclically-adjusted surplus on current budget would average less than ¼ per cent of GDP a year over the period 1997-98 to 2003-04. This underlines the case for caution.

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4.3.6 ASSESSMENT AGAINST THE FISCAL RULES

The Government is well placed to meet its two fiscal rules and the terms of the EU Stability and Growth Pact.

The surplus on current budget and public sector net borrowing are forecast to improve further in 1999-2000; and more so on the cyclically-adjusted measures shown in Table 4.7, which take account of the effects of relatively slow growth in 1998-99. The surplus on current budget is projected to increase steadily over the medium-term. Public sector net borrowing remains low, with the current surplus offset by the increased provision for capital spending during the transitional phase of the Investing in Britain Fund.

Table 4.7: Progress against the golden rule

1 Excluding windfall tax receipts and associated spending.

More specifically:

• the golden rule will be met if the public sector current budget avoids a deficit on average over the economic cycle. The current budget, which is estimated to have been marginally in surplus last year, is projected to remain in surplus. At just over 1 per cent of GDP, on average, between 1997-98 and 2003-04, the surplus allows some margin for uncertainty. It also increases the scope for meeting priority public investment while avoiding an increase in the public debt ratio. The cyclically-adjusted surplus is, on average, slightly larger;
  
• net public sector debt is projected to fall steadily, to below 40 per cent of GDP from 2000-01 onwards (see Chart 4.1). This level of debt is prudent. Debt interest savings will provide more money for the Government's priorities, and especially for investment; and
  
• the projections are consistent with the terms of the EU Stability and Growth Pact.

The strict application of the fiscal rules and the total spending limits announced in this Report places the Government in a good position to meet the golden rule over the current cycle. This is in sharp contrast to the past where the public finances have been allowed to deteriorate as a result of persistent current deficits. For example, over the last economic cycle, 1985-86 to 1996-97, the public sector current budget was on average in deficit by over 1½ per cent of GDP.

The Government's fiscal strategy also places the public finances in a sound position relative to other major European countries. In particular, Chart 4.3 shows that by 1999-2000 the UK's general government net borrowing is expected to be well below that of both France and Germany and nearly 2 per cent of GDP lower than the European average. This represents a substantial turn around since 1993 when the UK's net borrowing, as a share of GDP, was more than double that of Germany.

4.3.7 DEALING WITH UNCERTAINTY

Projections of the public finances are highly uncertain. This is largely because public spending and revenue projections depend heavily on economic growth and trends in other economic variables, which are themselves uncertain. In addition, the demand for public spending can vary unpredictably due to evolving needs and opportunities. Trends in effective tax rates are also difficult to predict accurately. These uncertainties are reflected in past forecasting errors. Over the past ten years, the average absolute error for year-ahead forecasts of the PSBR was 0.9 per cent of GDP. Forecasts further ahead were considerably less accurate. The Government's reforms to monetary and fiscal policy will act to reduce the volatility stemming from errors in macroeconomic policy settings. However, unexpected shocks due to other influences, such as developments in the world economy, will continue to impact on the British economy.

The projections and policy stance need to take these uncertainties into account to ensure that the key public finance aggregates remain consistent with prudent financial management and our European commitments (under the Stability and Growth Pact). Past experience has demonstrated how difficult and painful it can be to restore the public finances to a respectable position once control has been lost.

This is why the Government has based its fiscal projections on cautious assumptions, audited by the National Audit Office.
This is also why the Government is committed to taking steps to best ensure that the golden rule is met and that public debt as a proportion of national income is kept at a stable and prudent level, over the economic cycle. By adopting a prudent approach, errors in the short-term projections should not be allowed to accumulate into a significant structural deterioration in the fiscal position. The public can have confidence that the public finances will be managed responsibly and in a way that will position Britain well to meet the challenges of the future.

ANNEX 4A: TIME-SERIES FOR KEY FISCAL AGGREGATES

Table A1 sets out historical series for the main public finances aggregates.

Table 4A.1: Series of government expenditure and receipts and budget balances

1 Excluding windfall tax receipts and associated spending.

2 On UK national accounts definition prior to 1991-92 and a Maastricht basis thereafter.

3 Figures are only available on a consistent basis for the years shown.

Table 4A.2: Series of public debt and net wealth

1 End-March debt as per cent of GDP in four quarters centred on end-March.

2 Definition on a Maastricht basis: per cent of GDP, year ending in March.

3 End-December net wealth as per cent of GDP in four quarters centred on end-December.

ANNEX 4B: FINANCING POLICY

The 1998-99 Debt Management Report, published in March, set out how the Government intended to finance its borrowing requirement for the current financial year. Table 4B.1 updates the financing arithmetic for 1998-99 to allow for the latest forecast of the central government net cash requirement (formerly the CGBR) for 1998-99, and for the 1997-98 outturn.

The financing requirement in 1998-99 is now expected to be £12.1 billion. This is £3.1 billion lower than the requirement published in the Debt Management Report. The revised financing requirement is expected to be net from gilt sales of £11.6 billion and a net contribution from National Savings of £0.5 billion.

Financing policy will be carried out on the basis set out in the Debt Management Report, subject to changes to the remit announced on 11 June 1998, to accommodate the revised gilt sales requirement.

Table 4B.1: Financing requirement (£ billion)

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Economic and Fiscal Strategy 1998 index page