UK’s Finances in Shambles?

A few days ago, credit rating agency Fitch thought it was necessary to warn UK of its deteriorating public finances. They said that they need to take a more proactive approach to tackling its deficit. As of now, UK’s deficit is standing at 11% of its GDP!

Traders seem to agree. In the past few weeks, the pound has taken a beating. The Cable, for one, is currently sitting trading around the 1.4600 handle, almost 1,500 pips lower from its opening price this year.

Right now, it’s not looking too hot for the UK. Recessions are usually accompanied by high unemployment and weak economic activity, as seen in the recent recession. In 2009, UK’s tax revenues dropped while welfare costs skyrocketed. These, in combination with the 20 billion GBP financial stimulus for UK’s banking sector last year, put the UK’s debt at extraordinarily high levels. In fact, among the members of the Organization of Cooperation and Development (OECD), UK had one of the largest budget deficits when it went into recession.

Golly, it does look like the UK’s budget needs a lot of work! According to the International Monetary Fund (IMF), UK’s debt is estimated to swell to 71.6% of its GDP this year but Fitch expects them to scale it down to 3% of their GDP within five years. Is that even possible?! That requires them to cut more than 12% of their debt each year!

Just this April, UK posted its largest monthly public deficit on record. It showed a shortfall of 10 billion GBP, larger than the 8.8 billion GBP deficit posted April last year. At this rate, the budget deficit could exceed the government forecast of 156 billion GBP for 2010.

On top of that, UK also has to pay interest on its debt and these interest payments currently amount to 42 billion GBP this year. To put that into perspective, Prime Minister David Cameron remarked that they spend more on interest payments on debt than on running schools in the entire UK! Given the pace of growth of their debt, Cameron projected that interest payments could balloon to 70 billion GBP each year. If that doesn’t burn a deep hole in the UK’s pockets, I don’t know what will!

Now that explains Fitch’s warning shot to the UK. Will the other ratings agencies join in on the fun?

A couple weeks before the elections, S&P and Moody’s both said that the result of the election would have no effect on their credit rating of the UK’s debt. Both agencies said that their ratings would be based on the government’s plans to help reduce the country’s debt.

However, just like what many people had speculated would happen, the elections resulted in a hung parliament. This was a cause for concern because many believed that without a majority party in place, it would make passing any debt reduction plans more difficult.

Now that the elections are over, I can’t help but laugh at those earlier statements made by Moody’s and S&P. Wouldn’t any fiscal consolidation plans be affected by how the government works together? In any case, we’ll know by the end of the year whether or not either of these ratings agencies plan to downgrade UK’s debt.

Before then though, I think we’ll have to wait before they actually send any warnings. After all, the new Prime Minister has only been in office for less than a month – his seat in Parliament ain’t even warmed up yet! Let’s give him and his Tories some time to work something out with the other parties so that hopefully, a sound fiscal plan can be put in place.