Would a hung parliament threaten the UK’s credit rating?

Labour’s slight revival in the opinion polls has the newspapers discussing the possibility of a hung parliament.  As Andrew Rawnsley says, a hung parliament would reflect the public mood:

People are sick of Labour but reluctant to swallow the Tories. That points to either a hung parliament or a Conservative victory with a narrow majority.

Or, as Henry Porter succinctly puts it:

The next election sometimes seems like a choice between root canal work and an operation for haemorrhoids.

A hung parliament is certainly a possibility, though we shouldn’t get too excited about the results of one poll. But, while hung parliaments make things interesting for political commentators, what might the effect be on the economy and, more specifically, on the UK’s credit rating?

Back in May, when Standard and Poors threatened to downgrade the UK’s credit rating, they did not do so just because the country has high levels of debt. The UK’s debt is no worse than that of any other major western economy. No, the reason they gave for picking on the UK was the lack of a clear plan to bring the rising deficit under control and reduce the level of debt over the long-term. As S&P’s spokesman said:

The outlook could be revised back to stable if comprehensive measures are implemented to place the public finances on a sustainable footing.

In other words, your credit rating will be fine if the next government bites the bullet by raising taxes and cutting spending to pay off the debt. The trouble is, both of these things are deeply unpopular and a government would need a strong mandate to do either, let alone both. A coalition government, or one with a weak majority, might lack the mandate to make the necessary tough decisions. More to the point, such a government would be perceived as weak by the ratings agencies and by investors. That might be enough to mess up our AAA credit rating.

The FT’s Alex Barker raised this scenario in an interview with Brian Coulton, Head of EMEA Sovereign Ratings at Fitch.

Q: The Fitch stable rating is based on the government articulating “a stronger fiscal consolidation program next year”. Do you expect that to happen regardless of who wins the election?

Yes. As we get into 2010 the downside risk of deflation will be significantly diminished and fiscal policy goals are expected to shift from stabilisation towards consolidation. It is a feature of large AAA sovereigns like the UK – which have exceptional near term funding flexibility – that they can “sequence” fiscal policy goals in this manner and act in the near term to prevent an unnecessarily deep recession. But the re-orientation does need to happen during 2010.

In other words, whoever wins the election will have to make definite commitments to reduce the deficit or they will be toast. But what if no-one wins the election?

Q: Is the likelihood of a hung parliament a factor in your calculations? Is it the election outcome that would most threaten the UK’s sovereign credit rating?

We detect a growing cross party consensus that fiscal adjustment needs to happen. A hung parliament could complicate the process of agreeing how this should be done but we do not believe it would lead to an impasse, unduly delaying the adjustment plans.

In other words, even a Lib-Con or Lib-Lab coalition will have to make definite commitments to reduce the deficit or they will be toast.

He has a point, of course. Whatever happens, the government’s sources of funding will dry up if it doesn’t make some tough decisions in the next couple of years. That will be true whether the next government is Tory, Labour, Lib Dem, Green, BNP or Monster Raving Loony.

That said, I still think a hung parliament would make investors nervous. OK we might get Vince Cable as Chancellor but it would still make the government look weak and unstable, especially if the horse-trading and coalition building went on for too long. It would be less of a problem in a country such as Germany which is used to coalition governments. In Britain, though, there is still the assumption that we are governed by a single party and our political system would take some time to adapt to the new circumstances.

Last week, in the pub, a colleague asked me what I thought would be the best election outcome for UK PLC. I was at bit of a loss because I can see potential advantages and disadvantages in both Labour and Tory proposals. That said, a hung parliament could well be the worst outcome of all. In tough times, rightly or wrongly, people seek certainty, especially from those in charge. A prime minister at the head of a coalition government, faced with the worst economic crisis for decades, would need to be an outstanding leader to meet these challenges while holding his troops and the country together. I’m not sure that there is anyone on the front benches capable of doing that.

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4 Responses to Would a hung parliament threaten the UK’s credit rating?

  1. Jim says:

    If the Tories were the largest party, but didn’t have a majority, they should proceed as if they did. Draw up a 5 year plan to cut the deficit, with tax rises and spending cuts, phased in. Then put it before the House and defy the others to vote it down, given that it would be very clear to all involved what the market reaction would be to a failure to confront the issue.

    I think the smaller parties would cave in, as would significant numbers of the LibDems and Labour. For the good of the country it needs to pass, and I think (or hope) that there are enough people in the LibDems and Labour who still realise what is in the country’s best interests must trump party politics.

  2. John says:

    Hasn’t the time come for all the smaller parties who work on the basis of policies to join together in a single message: Tory, Labour and Lib Dem, I will not vote for them again!

  3. Pingback: Freethinking Economist

  4. jameshigham says:

    The short answer is yes it would because it would further weaken our chances of blocking the predatory EU and once they have complete control [2012], that’s the end of the country’s credit.

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