Last week, Katy Balls and I interviewed Rishi Sunak for the Christmas issue of The Spectator (out today) and his comments on debt have caused some interest in today’s newspapers. As ever with such interviews, there’s only so much you can squeeze into two pages but I thought it worth elaborating on his position today. I suspect it will come to define the political debate next year: yes, 2020 was a year of almighty splurge. Sunak has borrowed more in ten months than Gordon Brown did in ten years: but there was a pandemic. The question is how you get that back to normal.
For a surprising number of Tories, it’s a question of 'whether' you get it back to normal. Why not let debt rip? Let it go from today’s 100 per cent of GDP to 120 per cent or even 150 per cent? Surely all that matters is the repayments – and they’re at a postwar low. Interest rates are 0.3 per cent now, less then a tenth of historically normal rates.
To some, a 'modern monetary theory' is in the air: there is so much (Asian) cash looking for a safe home that governments are, in effect, being paid to keep it. The signs are that this is a long-term trend that will last for the rest of this decade: what Sajid Javid called 'low for long'. So is this a gamechanger, that ought to change fundamentally what we think about public finances? In other words, should the Tories learn to stop worrying and love the national debt?
Sunak’s position on this is pretty clear.
'It is clearly not sustainable to borrow at these levels. I don’t think morally, economically or politically it would be right,’ he says. ‘Running a structural deficit years into the future, with debt rising? That’s not building up the resilience you need to deal with the future shock that will come along, and someone else will be sitting in my chair. We now have had two of these things in a decade: who knows what the next shock will look like?’
You can call this Sunakism: a belief that it’s suicidal for any government to depend on high borrowing and low interest rates, because those rates could surge at any time. This, to Sunak, is the risk: interest rates could easily treble, and knock the government finances for six.
‘Are you or anyone else going to guarantee me that, for the duration of this parliament, rates might not go back to one per cent? There is this very large QE thing that’s going on. No one has done that before. There are plenty of smart investors who are also thinking about the risks of inflation over the next 12 months. Because we are now so levered, small changes have huge cash implications. If I have to come up with £10-£20 billion a year in a few years’ time because things have changed — well, that’s a lot of money.’
These figures are interesting: why £10 to £20 billion? A decade ago, this would have been seen as crazy talk. Interest rates were low when the OBR started doing its ‘ready reckoner’ in 2011 – so it started to point out what would happen should this change. A one percentage point rise in gilt rates, it said, would cost £500 million a year. A one-point rise in short rates costs £900m. And a one-point rise in inflation: £1.9 billion (a lot of UK debt is linked to inflation, making the Treasury very vulnerable to its return).
But to look at these figures now (Tab 3.23 here), you can see what is terrifying Sunak. The one-point rise in gilt rates costs £5.2bn in the pre-election year of 2023/24, ten times what it cost a decade ago. A one-point rise in the short rates would cost £12bn, a one-point rise in inflation £5.9bn. Put together: £22.9bn. And let’s remember that’s just for a one-point rise: in a financial crisis, you could be dealing with a two or even three-point rise, so the figure could easily treble. A £30bn to £40bn bill can be conjured up with just a small rise in rates.
Here’s what Sunak told us next:
'Of course, no Chancellor can afford to run the risk of having a £30-40 billion extra call on our spending every year. That’s a huge amount of money, so we want to try and minimise that. We have a large financial system, compared to many of our competitor countries, although our debt maturity is twice as long: about 15 years versus seven. We have a large amount of inflation-linked debt as well and we are not a reserve currency like the US. We don’t quite have the same size of balance sheet as the EU. A lot of people will say oh look at what’s going on in the US. I’d just say the US is in a different situation to us. It’s a far less open economy and it is fundamentally a reserve currency.'
He wonders what happens if today’s spending decisions mean a 2024 debt-induced fiscal crisis: how can the Tories, then, fight an election posing as the party of fiscal credibility?
'I do think that’s important between now and 2024 we’ve got to have a view on what we think the right economic dividing line between us and the opposition. Buying into the argument that there is simply no constraint on borrowing and debt won’t jive with most people’s common sense. Certainly not in Yorkshire! I think, politically, it is very problematic.'
To what extent does he think the outlook has changed?
'We can debate what’s the level that [interest rates] will be at sustainably. But there seems to be a broadly strong economic consensus that they will remain lower for a while. Now, this changes the sustainable amount of borrowing you can do every year – so you can afford to run a slightly higher deficit every year and still have debt coming down.'
So how high is a ‘sustainable’ deficit at lower interest rates? I asked him if he’d be happy with a deficit of five per cent. 'No! Gosh,' he replied.
'Roughly, on the current growth trajectory, you can run up to just shy of a three per cent deficit, probably 2.5 per cent to three per cent. Somewhere in that range, it depends on your assumptions, and still have [national] debt on a declining trajectory. That’s what the low interest rate environment gives you.'
So he will keep borrowing.
'I think we should take advantage of that. To invest in things that will enhance our long-term productivity: that’s exactly what the government is doing. That’s a sensible use of that space. But that has to come within a framework of still having a mind on what we just talked about: lower-tax economies derived from economies where spending is under control. We need to have a strong dividing line with the Labour party politically. And economically, a large structural deficit once you’ve recovered from a crisis: I don't think is a sustainable place to be.'