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Public finances vulnerable to shocks after Covid, says watchdog

The government faces an “increasingly risky” situation as debt has soared and the cost of Covid mounts, the fiscal watchdog says.

The Office for Budgetary Responsibility said government debt now stood at some £2.2 trillion or 99.2% of GDP – a rate not seen since the early 1960s.

Meanwhile, there were no plans to fund about £10bn a year of Covid spending on things like health and transport.

OBR boss Richard Hughes said chancellor faced a “difficult trade-off”.

“[He must decide where] to spend now to prevent the risks and threats that he knows about versus keeping his powder dry, keeping debt low, keeping borrowing low so that he can deal with the threats he can’t anticipate,” Mr Hughes told the BBC’s Today programme.

The UK economy contracted sharply last year as swathes of businesses closed in lockdown, but it is now recovering strongly.

However, the government bill for emergency measures such as the furlough scheme continues to climb, pushing up its debt pile by about 20%.

In its Fiscal Risks report, the OBR said Chancellor Rishi Sunak was trying to tackle this by cutting future non-Covid public spending and increasing corporation tax from 19% to 25%.

But it said there were no plans to cover ongoing pandemic-related costs such as:

  • Reducing a backlog of 3.5 million procedures in the NHS
  • Maintaining a test and trace capacity
  • Funding catch-up schooling
  • Supporting public transport after a sharp fall in passenger numbers.

Addressing these spending pressures could require cuts to other government departments, tax rises or looser rules on government borrowing, it added.

The report also warned of the rising costs of servicing the government’s debt, noting that it was “exposed” to future shocks such as rising inflation or interest rates.

The Bank of England has slashed the UK’s benchmark interest rate to 0.1% during the pandemic to support the economy.

But inflation is increasing quickly as the economy reopens and some fear the Bank will have to raise rates to control prices.

‘Once-in-a-century shocks’

Mr Hughes said the OBR expected inflationary pressures to be temporary, but the risks remained.

“We are two decades into the 21st Century and governments have already faced two once-in-a-century shocks – the 2008 financial crisis and the 2020 coronavirus pandemic,” he added.

“There are reasons to believe that these kind of shocks are becoming more frequent and more severe. And also that government finances are becoming increasingly exposed to these kinds of shocks.”

In its report, the OBR noted that cutting carbon emissions would also put pressure on the public finances, but it added that delaying action would be more costly.

It said its baseline scenario of early action to achieve net zero by 2050 would leave the UK’s debt mountain at 21% – or £469bn – of economic output (GDP) by 2050-51.

However, postponing action would leave that figure at 23%.

“While unmitigated climate change would spell disaster, the net fiscal costs of moving to net zero emissions by 2050 could be comparatively modest,” it said.

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