MNI INSIGHT: UK Fiscal Boost May Be 1% GDP, BOE Impact Limited

By David Robinson

     LONDON (MNI) - Additional fiscal stimulus in the UK's March 11 budget could

amount to 1% of gross domestic product, but the practical difficulties of

ramping up infrastructure projects may prevent it from having a decisive impact

on Bank of England interest rate decisions.

     According to a brief reference announcing new fiscal rules in the governing

Conservative Party's election manifesto, public sector net investment will be

restricted an average of no more than 3% of gross domestic product, and the

government would "reassess" debt sustainability plans if interest payments reach

6% of revenue. Full details will be provided by Chancellor of the Exchequer

Sajid Javid on budget day, but analysts expect final definitions of the rules to

maximise its room for manoeuvre.

     With public investment currently running at about 2% of GDP, there is room

for another additional 1%, Arno Hantzsche at the National Institute of Economic

and Social Research told MNI.

     "That would have to be financed by higher borrowing unless there is a

willingness to increase taxes significantly beyond what was there in the

manifesto," Hantzsche said, "A big paradigm shift when it comes to fiscal policy

relative to the last 10 years is that it now suggests that the fiscal framework

allows for higher borrowing in order to fund public investment."

     Previously, the government's rule had merely stipulated that it must

balance spending by the mid-2020s.

     But, while a 1-percentage-point fiscal boost would in theory more than

eliminate the slack in the economy - recently estimated by the Bank of England's

Monetary Policy Committee to be running at 0.25% of GDP -- in practice it can be

difficult to start spending on infrastructure quickly. Such plans tend to run

into obstacles including the need to meet environmental and planning standards,

which take time to deal with before work can begin, on top of the most basic

difficulty of identifying economically-viable projects to start with.

     --OFFSETTING EFFECT

     All else being equal, higher levels of activity would tend to make it more

likely for the Bank of England to run tighter monetary policy unless

infrastructure investment had an offsetting effect by adding to spare capacity

and supply growth. Lags in implementing spending programmes may, however, push

some of the stimulus effect beyond the two-to-three-year monetary policy

horizon, limiting its effect on the Bank's policy deliberations.

     The BOE is also unlikely to rapidly revise its estimates of spare capacity

and potential growth in light of the March Budget. Its annual supply-side stock

take was carried out this month.

     "The impact on the market economy very much depends on the current state of

the business cycle on the current amount of economic slack that there is in the

economy. We think that the macro-economic effect of higher investment would be

close to zero in the case of output being close to potential," Hantzsche said.

     The government could also provide fiscal stimulus other than via

infrastructure spending. The Conservative manifesto promises to raise the

threshold after which employees make national insurance contributions to

GBP9,500 from GBP8,788, potentially reducing the number of people who have to

pay NICs by 400,000.

     While the revamped investment-to-GDP restriction is a fairly clear cap, the

rule placing limits on interest payments offers more get-out clauses. A breach

of the latter would merely require the government to demonstrate that

debt-to-GDP was not on a rising path, an easier task than the previous fiscal

rule's insistence that it be falling. The government can also, as it determines

the precise wording of the rule, give itself more leeway by using net, rather

than gross, interest payments as a proportion of total revenues for the

calculation.

     The 6% ceiling would be over GBP50bln in 2020/21, rising to GBP56bln by

2023/2, on MNI calculations, using the most recent projections from the Office

for Budget Responsibility. Gross public sector debt interest for 2020/21 is

estimated at just over GBP40bln, and if the government excludes debt interest

payments to the BoE, debt interest would be closer to GBP30bln, leaving around

GBP20 billion headroom, or about 1% of GDP.

     "The key thing is that given low levels of interest rates it would take a

lot of investment to push up significantly the debt interest to revenue ratio so

the binding constraint for fiscal policy will be the ceiling on investment

rather than the debt/interest revenue ratio," James Smith, Research Director at

think tank the Resolution Foundation, told MNI.

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

[TOPICS: M$B$$$,M$E$$$,MC$$$$,MT$$$$,MX$$$$,MFB$$$,MGB$$$]