Government borrowing costs have little to do with a country’s debt level but quite a lot to do with its perceived stability. That is why a country like Japan, whose debt as a proportion of GDP is one of the highest in the world, pays interest at 0.03 percent on its bonds. Oil rich countries like Russia, Venezuela and Nigeria, with much lower levels of debt, pay significantly higher rates of interest; 7.5 percent for Russia, over 10 percent for Venezuela and a staggering 16 percent for Nigeria.
Countries with governments that might do something bonkers are perceived as a much greater risk than those with populations that pay their taxes and elect moderate governments. Stable and boring countries are a lot less risky. Most stable and boring of all are the Swiss who charge investors a small fee for lending money to their government.
Source: Trading Economics
But occasionally, even countries perceived to be strong and stable do something a bit crazy, like elect a volatile and clearly incompetent president. It is unlikely that Donald Trump will be able to do any lasting damage. The checks and balances of the American state will see to that. The cost of servicing US government debt is still therefore relatively low when compared to much of the rest of the world. Nevertheless, the fact that they could put someone like Mr Trump in the White House at all makes Americans seem that bit less reliable than they once were. Consequently, compared to other safe-bet countries, US borrowing costs have crept up.
Historically, though, all government bond yields are low. In uncertain times, people look for safe places to park their money. Government bonds provide such safe places and the more people there are who want to lend money to a government, the less that governments has to pay to borrow. Therefore, though it may look perverse, as UK government debt has risen, the interest rates on that debt have fallen. Both are, to an extent, consequences of the recession. Government borrowing went up but so did the search for safe assets.
Should we, then, be worried about Moody’s downgrading the UK government’s credit rating? In the short-term probably not. Ratings don’t seem to make much immediate difference to government borrowing costs.
Nevertheless, Moody’s assessment of the UK was scathing:
Moody’s believes that the UK government’s decision to leave the EU Single Market and customs union as of 29 March 2019 will be negative for the country’s medium-term economic growth prospects. Aside from the direct impact on the UK’s credit profile, the loss of economic strength will further exacerbate pressures on fiscal consolidation.
Growth has slowed in recent months, with average quarterly growth of just 0.26% in the first two quarters, versus an average of 0.6% over the 2014-2016 period. Private consumption has slowed sharply and business investment has been weak since 2016, most likely linked to the Brexit-related uncertainty. While future years may see some recovery, Moody’s expects growth of just 1% in 2018 following 1.5% this year and 2.25% on average in recent years.
More importantly for the UK’s credit profile, Moody’s does not expect growth to recover to its historic trend rate over the coming years. The UK is a relatively open economy, and the EU is by far its largest trading partner. Research by the National Institute of Economic and Social Research (NIESR) suggests that leaving the Single Market will result in substantially lower trade in goods and services with the EU. In a similar vein, both the NIESR and the Bank of England estimate that private investment will be materially lower in the coming years than in a non-Brexit scenario.
Moody’s is no longer confident that the UK government will be able to secure a replacement free trade agreement with the EU which substantially mitigates the negative economic impact of Brexit. While the government seeks a “deep and comprehensive free trade agreement” with the EU, even such a best-case scenario would not award the same access to the EU Single Market that the UK currently enjoys. It would likely impose additional costs, raise the regulatory and administrative burden on UK businesses and put at risk the close-knit supply chains that link the UK and the EU. Also, free trade arrangements do not as a standard cover trade in services — which account for close to 40% of the UK’s exports to the EU and 80% of Gross Value Added in the economy — given the prevalence of non-tariff trade restrictions and the need to align regulations and standards. In Moody’s view, the differences of outlook between the UK and the EU suggest that the most likely outcome is now a rather more limited free trade agreement which may exclude services: the UK’s desire to pursue its own regulatory policies and to avoid the jurisdiction of the European Court of Justice will make finding an agreement on services challenging. Moreover, any free trade agreement will likely take years to negotiate, prolonging the current uncertainty for businesses.
Aside from the direct impact on the UK’s credit profile, weakening growth prospects are likely to exacerbate the government’s evident fiscal challenges. And this is likely to be happening during a period in which policymakers will be increasingly distracted by the twin challenges of sustaining a domestic political consensus on how to operationalise Brexit and reaching agreement with EU counterparts.
In other words, Brexit has made a bad situation worse. Although the rate the UK pays on its borrowing is low, it now has a lot more debt relative to GDP than it has had for several decades. Even small rises in the costs of refinancing that debt will put extra pressure on public finances.
As I said before the Scottish referendum, there is a lot to be said for living in a 300 year-old country with a reputation for political stability. Voting to leave the EU dented that reputation. The government’s poor handling of the aftermath and the antics of some of our government ministers haven’t done anything to repair the situation. Sure, it’s still unlikely that a British government will do anything completely mad but we don’t look as strong and stable as we once did. Over time, the cost of government borrowing is likely to reflect that.
It is ironic, then, that some of the politicians who told us in 2010 that if we didn’t control the public debt the bond markets would slaughter us, are the same politicians who have brought us to this pass. Some of them want us to go further and quit the EU without paying anything. They tell us that electing Jeremy Corbyn would make the UK like Venezuela. Yet unilaterally repudiating an international treaty would be more Venezuelish than anything a UK government has done in decades. It would be a sure-fire way of making us look like a basket-case.
The rest of the world thinks we are a bit crazy but, for now, seems to be giving the UK the benefit of the doubt. The Brexit vote was an uncharacteristic outburst from a usually sober and rational nation. Despite the ridiculous posturing of some of our politicians, people still believe that something sensible will be sorted out eventually. But the closer we get to the Brexit deadline without any meaningful progress, the more risky the country will start to look. Being volatile, bonkers and a bit maverick might look like fun but there is a price to be paid for it.