Government borrowing is large but not yet a problem

Advanced country governments have found it easy to increase their borrowings at very low interest rates, but they can’t make a habit of borrowing such large sums.

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  1. Charles Stanley

Over the last three months, most governments have greatly increased their spending and suffered a major decline in tax revenues. There was always going to be a large cost from closing down many sectors as they pursued tough policies to limit the spread of the virus. As a result, government borrowing has risen dramatically. Some are now asking if this is sustainable? How will all this debt be repaid?

The good news is so far advanced country governments have found it easy to increase their borrowings at very low interest rates. In some cases, savers have been willing to pay the governments for the privilege of lending to them with negative rates on leading government bonds. It has also been possible for governments to borrow long if they wish, putting off the day when the debts have to be repaid.

Countries that retain the confidence of financial markets can look forward to rolling the debts over in due course, when they do fall due. Most countries allow their debt pile to be managed by the advantages of economic growth, gradually reducing the proportionate impact of past debts, rather than rushing to repay them.

It is true that the scale of these borrowings is unprecedented in peace time. It would be a good idea to get the deficits down to more manageable levels as soon as possible. If this is a one-off event with a very bad year, followed by progress in reducing the size of the deficit, that should work without undermining bond market confidence.

To help keep markets sweet about all this borrowing, the main central Banks are resolved to keep interest rates very low, and to offer plenty of support to bond prices in case investor appetite for all this debt starts to wane. The Charles Stanley base case assumes high borrowing for the current financial year assumes cut deficits next year – and assumes low interest rates are preserved. A surge in borrowing on this basis is affordable.

So how will the deficits be tamed? The best way is to promote the recovery in economies that all seek. The lost tax revenues should be rebuilt by encouraging more activity. Tax rises anytime soon would be likely to do more harm than good, delaying or damaging the very recovery that is needed to swell Treasury coffers.

As governments seek to rebuild confidence and persuade people to spend more, tax rises could tip them in the opposite direction. Promoting recovery is also the way to cut the extra spending. Much of the higher costs incurred by government has come in the form of employment subsidies or more spending on unemployment benefits. Getting people back to work is essential to righting the public finances, which cannot afford indefinitely to support a large proportion of the workforce financially.

We will be watching progress around the world in rebuilding tax receipts and cutting back on special measures spending, to cushion the downturn and tackle the virus. Beneficiaries of all this government largesse include medical supply and pharmaceutical companies who have seen increased official buying. Savers have been willing so far to help governments borrow colossal sums, as they accept the authorities have the power to keep interest rates low leaving them with little choice but to accept poor running returns. It important that we now start to see some progress in limiting special spending and increasing the tax take from recovering economies. This big surge in debt is affordable at current rates, on the assumption that governments do not start to make a habit of borrowing on this scale.

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