On Feb. 13th of this year, Moody’s changed the rating outlook on the UK’s Aaa rating from Stable to Negative. Moody’s said at the time that:
“A combination of a rising medium-term debt trajectory and lower-than-expected trend economic growth would put into question the government's ability to retain its Aaa rating. The UK's outstanding debt places it amongst the most heavily indebted of its Aaa-rated peers, alongside the United States and France whose Aaa ratings also carry a negative outlook.”
On Nov. 14th, Moody’s stated that:
“We will need to assess the Aaa rating and negative outlook in the first few months of 2013, in light of what the government’s Autumn Statement reveals about the [government’s] assurances that the debt trajectory will stabilise and start to decline within the rating horizon.”
On Dec. 5th, HM Treasury published its Autumn Budget Statement which provided revised projections for government revenue, expenditure, borrowing requirements and debt trajectory for 2013-18. The UK Office for Budget Responsibility analyzed these projections and compared them with the coalition government’s 2010 “fiscal mandate”.
The OBR concluded as follows:
"We now expect Public Sector Net Debt (PSND) to peak at 80% of GDP in 2015-16, compared to a peak of 76% of GDP in 2014-15 in our March forecast. PSND is pushed higher as a share of GDP by weaker nominal GDP growth, higher net borrowing, and technical asset reclassifications. The Government now appears more likely than not to miss its ‘supplementary target’, which requires PSND to fall as a share of GDP between 2014-15 and 2015-16. We now predict that PSND will rise by 1% of GDP in 2015-16, falling by 0.8% a year later. In the absence of the reclassifications, we estimate that PSND would be stable as a share of GDP between 2015-16 and 2016-17, and then fall in 2017-18."
So it would appear that Moody’s will have to decide early next year whether to (1) confirm the UK’s Aaa rating with a stable outlook; (2) place the UK’s Aaa rating on review for possible downgrade; or (3) extend the negative outlook.
The somewhat negative conclusions of the OBR would seem to provide sufficient rationale for a review and subsequent downgrade to Aa1, which is what I expect.
I say this after having looked at the UK’s key statistics and ratios at HM Treasury, the Fed, Moody’s and the Economist. What I saw wasn’t very pretty. Admittedly, data is backward-looking. But there is no evidence to date of an inflection point in the key numbers having been achieved, and no reason to expect one anytime soon. When a simple extrapolation predicts a crisis, it is hard to accept a projection that includes an upside-down hockey stick in the out-years without a compelling story to go with it. That story depends on economic growth.
For the UK’s debt trajectory to correct, the UK will have to do more than trim expenditures--it will have to grow its economy in nominal terms in the high single-digits. Right now, UK nominal growth is far below take-off speed, and real growth is negative, that is to say, shrinking, which is not good for debt ratios. The fiscal deficit remains very large (7-8%, depending on who’s counting) despite three years of fiscal austerity.
The UK’s problem is the world’s problem: inadequate fiscal revenue growth, caused by an incompetent central bank that thinks that the welfare state can survive with revenue growth in the low single digits. Indeed, the coalition government has nothing to do with the problem, aside from tolerating Mervyn King and his bank’s incompetence. Central bank independence is second only to the monarchy as a British institution.
I will concede that the UK is the European equivalent of New York State, with vast unproductive regions supported by a volatile financial sector located on a single square mile. By living off the golden goose, other industries are neglected and suffer adverse terms of trade caused by an overvalued currency. The country’s fate is in the hands of the City, which hasn’t recovered from the crash.
But that doesn’t excuse the failure of the BofE to act appropriately during and after the crisis. If one were to rank central banks on their badness, I would place the BofE third, after the BOJ and the ECB, and ahead of the Fed which is only half-bad. Indeed if I am not mistaken, the genius Mr. King raised interest rates when the crash was gathering downward momentum, undoubtedly to prove his cojones and to ensure the bank’s “credibility”.
So I do not blame the government for the coming review and subsequent downgrade, but I think it’s coming. After removing France’s Aaa and placing the US Aaa on review for downgrade, it would be hard for Moody’s to argue that the UK’s rating is fine. Its numbers are as bad as those of France, and much worse than those of Canada and Australia (now a global paragon of sovereign creditworthiness).
The US’s Aaa is in Moody’s crosshairs now as well, since Moody’s review for downgrade is focusing on the ability of the ruling circles to achieve a decisive program of deficit reduction and debt-trajectory stabilization. That would of course be the fiscal cliff, which no one seems to be defending as a policy option. Assuming something wonderful doesn’t come out of the lame duck session, Moody’s will probably downgrade the US to Aa1 in the first quarter. While I think that would be a big mistake from an expected loss perspective, it would be consistent with Moody’s sovereign rating criteria.