Could UK debt levels really rise to 300% of GDP by 2070?

There is intense speculation that the UK national debt could raise to 300% of GDP by 2070, as the gap between public service spending and tax income seems set to widen. When looking at the national debt, some figures are astounding and highlight the considerable interest the UK government is paying on national debt.

 

How much is the UK government borrowing at the moment?

 

Currently, the UK national debt is around £2.6 trillion, and in October 2023, the government borrowed £14.9 billion to cover a monthly funding shortfall. This is October's second-highest borrowing figure since records began in 1993.

 

In the 2022/23 financial year, the government borrowed £127.8 billion, £5 billion higher than the previous year. To put total borrowings into perspective, as of October 2023, the UK national debt stood at 97.8% of GDP - i.e. the value of all goods and services produced in the UK in a year.

 

Putting these figures into context, the UK government raises and spends around £1 trillion a year. Therefore, the minutest imbalance in the budget can lead to multibillion-pound shortfalls. Contrast this with the 1990s, which saw a Labour government reducing debt and running a budget surplus for several years and Margaret Thatcher reducing national debt to just 22% of GDP in the 1980s. However, towards the end of Tony Blair's tenure, national debt started to climb again and then more recently we had the financial crisis and Covid pandemic.

 

Money markets and UK borrowings

 

As we know, the government raises funds by issuing bonds to the money markets on which interest is paid. In December 2021, UK base rates stood at 0.1%, fast forward to today, and they stand at 5.25%. While money markets are obviously linked to base rates at the time, it is important to focus on money market rates for medium-term government bonds.

 

Looking back to the Liz Truss mini-budget on 23 September 2022 shows how an unbalanced budget can impact money markets. Figures suggest that during her disastrous seven-week premiership, a staggering £20 billion was blown on underfunded cuts and £10 billion added to debt interest charges as money market rates shot up. In recent times, interest has been significant, £20 billion in June 2022, £18 billion in December 2022 and £12.8 billion in June 2023.

 

The impact of inflation on debt

 

During periods of relatively high inflation, greater than interest rates, the real value of debt begins to fall. This is seen as transferring wealth from lenders to borrowers, but investors will eventually demand higher bond yields to counteract high inflation.

 

For example, if inflation was 10% and the interest rate on government bonds was 10%, the relative spending power would be maintained. If inflation was 10% and the rate on government bonds was 5%, this would create a 5% benefit for the borrower. The level of debt increases by 5% while relative spending power increases by 10%, leaving a deficit for the lender - they cannot maintain relative spending power.

 

US inflation in 1946 and 1947

 

One practical example would be the US, with inflation of 12.9% in 1946 and 11% in 1947. As inflation was well above the interest rate then, this reduced national debt as a percentage of GDP from 119% down to 92%. Inflation has not been constant over the years, so there will be periods of relatively low inflation and high interest rates, and vice versa.

 

Relative spending power

 

Due to high inflation, it is estimated that relative UK household spending power last experienced in 2021 will not be replicated until 2027. This means that household incomes have fallen in relative terms due to the cost of living crisis.

 

Could debt rise to 300% of GDP by 2070?

 

The Office for Budget Responsibility (OBR) believes that national debt as a percentage of GDP could rise to more than 300% by 2070. In basic terms, this means that the UK government will spend more for a prolonged period than it brings in. There are several factors to consider, such as:-

 

· An ageing population

· Reduced proportion of workers

· Reduced tax take

· Increased pension payments

 

It is safe to say that there are many challenges for the UK government in the short to medium term. In the longer term, unless an ongoing shift in the demographic of the UK population can be reversed there will be even greater financial challenges ahead.

 

Summary

 

As inflation dictates the cost of goods and services, it also contributes heavily to the rate of growth of the economy. If interest rates are lower than inflation, the relative spending power of debt is reduced, switching the benefit from lenders to borrowers. The best barometer for the state of any country’s balance sheet is debt as a percentage of GDP.

 

Earlier in 2023, the UK's national debt as a percentage of GDP stood at 104.1%. This compares to 123.3% for the USA, 143.7% for Italy, and 255.2% for Japan. Yes, there are challenges ahead, but other countries are in a much worse state than the UK.

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