Interesting input from the Jupiter Independent Funds Team below received on Friday evening 15/05/2020:
Jupiter Independent Funds Team
Data this week revealed the extent to which the government’s response to Covid-19 has left its financial projections in tatters. UK GDP in the first quarter declined by 2%, and in the month of March alone by 6%, but both only include one week of the lockdown. Second quarter figures to the end of June are likely to be closer to those projected by the Bank of England and The Office of Budget Responsibility, both of which see the economy shrinking by around 25%-30% over those three months.
As cash flows to the Treasury reduce significantly (PAYE, business rate and VAT deferrals for companies, reduced duty income from fuel sales, air fares and property transactions, lower VAT receipts from retailers etc) but outgoings increase rapidly (e.g. the furlough and business interruption loan schemes), the Chancellor’s estimated 2020 budget deficit has blown out from £55bn at the time of the Budget in early March to £340bn and possibly even up to half a trillion pounds only 9 weeks later. The current furlough scheme to cover the 80% of the salaries of 7m employees (capped at £2500pm per person) costing £14bn per month is already more than the £12.5bn the Chancellor initially set aside in the Budget for his total Covid-19 lifeboat plan.
We crossed the Rubicon last week in another sense too: that was the point at which more than 50% of the UK’s adult population became financially reliant on the state, either as public sector employees, or because they’re on benefits, or, now, they’re beneficiaries of the furlough scheme. The public sector has a vital role to play in society, however as harsh an observation as it might be particularly in current circumstances, that sector is not economically productive. The private commercial and industrial sectors create economic wealth and generate growth: it becomes an uphill struggle for any economy to grow when only a minority of the population is able to contribute to wealth creation (which, in circularity, includes the ability to pay for public services).
Labour’s manifesto pledge in the 2019 election to nationalise Royal Mail, the utilities, rail companies and BT’s Open Reach, and paying out PFI contractors in public services, was forecast to cost £450bn over 5 years. That would have incurred structural, long-term debt which they planned to recoup principally through higher taxes. Our present predicament which has arrived in relative terms in the blink of an eye is of the same order of magnitude but with the additional substantial headwind of a thumping great recession, the biggest in nearly a century. Within the constraints of the virus, it is not difficult to see the economic and political imperative to get the nation back in to productive employment. The Chancellor must ensure that the substantial debt the government has taken on is temporary, or at least transitory, and not structural. The longer the debt sits on the government’s balance sheet, particularly in the absence of recovery or growth, the greater the risk the international ratings agencies which assess governments’ creditworthiness take a dim view of the prospects. In that event, our national debt faces the possibility of being downgraded which immediately pushes up the cost of financing, not only for the government itself but also companies and individuals (e.g. for mortgages, car financing and credit card interest), all when the economy is least able to afford it. It is easy then to create a downward spiral. There will be difficult choices to make about how best to reduce the debt burden including cost savings and tax. But ultimately, the best way is to recover and restore growth. The state has made significant interventions to protect livelihoods as well as lives; it must now ensure that it is equally willing to let go again to ensure as far as possible that the debt burden is indeed transitory and not structural. With Labour and the Unions urging a New Social Contract, repaying the ‘debt to society’, it may be easier said than done. Time will tell!
We are living in interesting (challenging) times now but the future, how we recover and what society will look like are being impacted on by this pandemic and the response of our politicians and the people. Hopefully, society will be fairer in future.
Jupiter Independent Funds Team manage the Merlin range of funds.
Steve Speed
18/05/2020