Toxic Covid debt may have to be writ­ten off, says OBR

Com­pa­nies of all sizes could go un­der due to the weight of bor­row­ing to get through cri­sis, it warns

The Daily Telegraph - Business - - Front Page - By Tim Wal­lace and Lucy Bur­ton

A MAS­SIVE write-off of toxic Covid debt may be the only way to save the econ­omy from stag­na­tion as thou­sands of busi­nesses strug­gle to sur­vive, the new head of the UK’s spend­ing watch­dog has warned.

Re­pay­ments on £45bn of tax­payer­backed loans could be linked to com­pa­nies’ rev­enue, said Richard Hughes of the Of­fice for Bud­get Re­spon­si­bil­ity (OBR) – with any money out­stand­ing af­ter a set time frame sim­ply can­celled.

Mr Hughes said that firms of all sizes may oth­er­wise drown due to the weight of debt bor­rowed to get through lock­down, de­rail­ing the re­cov­ery be­fore it even has a chance to be­gin.

Gov­ern­ment schemes such as the Bounce Back Loan pro­gramme have al­lowed busi­nesses to bor­row life­line cash from their bank, with tax­pay­ers cov­er­ing at least some of the lender’s losses if the money is not paid back.

How­ever, it is feared that this sup­port could switch from be­ing a vi­tal short-term boost to a long-term mill­stone as re­cov­ery be­gins in earnest.

Speak­ing to MPs on the Trea­sury se­lect com­mit­tee, Mr Hughes said: “The longer the cri­sis goes on for, the more likely it be­comes that gov­ern­ment­guar­an­teed loans be­come less of a fa­cil­i­ta­tor of the re­cov­ery and more of a bur­den, be­cause firms have built up large stocks of debt, which they will strug­gle to write off.

“The more that debt is a bur­den on com­pa­nies, the less they will in­vest.”

One so­lu­tion could be to turn the gov­ern­ment guar­an­tees into a stu­dent loan-type sys­tem, he said, with com­pa­nies pay­ing a share of their rev­enues over sev­eral years.

Those that have still not paid the loans back over a set pe­riod could have the rest writ­ten off. Mr Hughes sug­gested that 5pc of com­pa­nies’ rev­enues could be taken each year.

He said: “I’ve ad­vo­cated mak­ing the re­pay­ment of these debts earn­ingscon­tin­gent, so that firms aren’t be­ing asked to pay back more than a per­cent­age of their turnover in a given year, so these debts don’t be­come a bur­den on their abil­ity to in­vest.”

This would likely lead to multi­bil­lion-pound losses for the tax­payer, but Mr Hughes said that the state should ex­pect losses in any case.

Hong Kong of­fered guar­an­teed loans in the Sars out­break and around 10pc of bor­row­ers de­faulted on their debt.

He said: “Sars was a very short, sharp shock to the econ­omy of Hong Kong. This has al­ready proven to be a virus of longer du­ra­tion and greater sever­ity, so you would ex­pect more of those loans to be called.”

Busi­ness groups backed the idea for a stu­dent loan-type scheme but want it to be based on prof­its, not rev­enues.

City grandees, mean­while, are call­ing on the Gov­ern­ment to es­tab­lish a new body fo­cused on tack­ling the moun­tain of debt fac­ing com­pa­nies as a re­sult of coro­n­avirus.

Out­go­ing Lloyds chair­man Lord Black­well and Le­gal & Gen­eral chair­man Sir John King­man are among the fi­nanciers telling min­is­ters to set up a “UK Re­cov­ery Cor­po­ra­tion” to tackle a £36bn pile of toxic debt.

Their idea mir­rors UK Fi­nan­cial In­vest­ments, which was cre­ated af­ter the 2008 cri­sis to man­age tax­pay­ers’ in­volve­ment in bailed-out banks. Sir John is the body’s ex-chief ex­ec­u­tive.

In an­cient Rome, a gen­eral en­ter­ing the city in tri­umph af­ter cam­paigns on be­half of the em­pire would al­ways carry a slave in his char­iot. The slave’s job was to whis­per over and over the words “me­mento mori” in the com­man­der’s ear as he lapped up the adu­la­tion of the crowds: re­mem­ber, you are mor­tal.

Robert Chote, the out­go­ing chair­man of the Of­fice for Bud­get Re­spon­si­bil­ity, is far more in­de­pen­dently minded than a Ro­man slave. But he will of­fer his own

me­mento mori to Rishi Su­nak, the Chan­cel­lor, to­day in the watch­dog’s lat­est – and likely damn­ing – as­sess­ment of the risks posed by the pan­demic to the Gov­ern­ment’s own fis­cal sus­tain­abil­ity.

Su­nak is by far the most pop­u­lar mem­ber of a Cab­i­net de­cid­edly tepid in tal­ent and has rightly won plau­dits for his han­dling of Covid-19 as he de­ploys vast fis­cal fire­power. But in ful­fill­ing his pledge in the sum­mer state­ment that “we must, and we will, put our pub­lic fi­nances back on a sus­tain­able foot­ing” he will quickly find that there are no good op­tions. Al­ready the Chan­cel­lor looks a prisoner of a debt pile surg­ing to­wards 100pc of GDP.

Even be­fore the pan­demic, the OBR had tough words to say about Theresa May’s health spend­ing spree in 2018. This, on top of the ex­tra pres­sures brought about by an age­ing pop­u­la­tion re­quir­ing ex­tra health spend­ing, threat­ened to push the UK’s debt to GDP ra­tio to a mam­moth 282pc by 2068 if left un­ad­dressed. So how ex­actly does Su­nak deal with the newly swollen debt to achieve that sus­tain­abil­ity he cov­ets?

Let’s con­sider some op­tions: first, growth. Im­me­di­ately af­ter the Se­cond World War, the UK’s debt to GDP ra­tio stood at more than 200pc. But as re­build­ing be­gan, the coun­try em­barked on a 30-year run of sus­tained eco­nomic growth, vir­tu­ally full em­ploy­ment and ris­ing in­comes un­til the Bret­ton Woods con­sen­sus broke down in the Seven­ties. That, along with a bit of in­fla­tion, low­ered debts as a share of the econ­omy.

This time around things are dif­fer­ent. There is no wartime de­struc­tion to re­build and the con­tri­bu­tion of the baby boomers at the other end of their lives is a fis­cal hand­brake, as the pop­u­la­tion ages. The UK’s pro­duc­tiv­ity is­sues are the econ­omy’s chief run­ning sore since the global fi­nan­cial cri­sis, and other struc­tural fac­tors such as Brexit po­ten­tially weigh on labour sup­ply. Hence the Bank of Eng­land thinks the UK’s trend growth rate, ef­fec­tively the eco­nomic “speed limit”, is now around 1.1pc a year, less than half that of a decade or so ago. Covid-19 will raise un­em­ploy­ment and kill off com­pa­nies as well, so the sit­u­a­tion is un­likely to im­prove.

In­flat­ing the debt away also seems tricky as cen­tral bankers around the world have been des­per­ately hunt­ing for some in­fla­tion, any­where, for years. De­spite a surge in the money sup­ply to fight the pan­demic, ad­vanced economies are fight­ing sec­u­lar trends such as pop­u­la­tion age­ing and a glut of sav­ings push­ing down on equi­lib­rium in­ter­est rates. Even if such an ap­proach was fea­si­ble through some dra­matic tear­ing down of the mon­e­tary frame­work – for ex­am­ple, a move to overt mon­e­tary fi­nanc­ing and end­ing Bank of Eng­land in­de­pen­dence – then the ge­nie would be well and truly out of the bot­tle. At a point when the UK is sell­ing more than £400bn in gilts a year, and rolling over ex­ist­ing bor­row­ings, it seems out­landish not to ex­pect the bond mar­kets to ex­act a pre­mium pun­ish­ing enough to turn an eco­nomic catas­tro­phe into full-scale melt­down. Lest we for­get, higher in­fla­tion also puts up Gov­ern­ment spend­ing costs, as well as chip­ping away at pub­lic debt. Be­sides, a third of the UK’s debt is in­dex linked any­way, mak­ing it im­pos­si­ble to in­flate away.

That brings us to aus­ter­ity. A wide-rang­ing study by three Ital­ian econ­o­mists, Al­berto Alesina, Carlo

Favero and Francesco Gi­avazzi, put Key­ne­sian types on the back foot last year with their re­search of aus­ter­ity pro­grammes in 16 coun­tries. Their book con­cluded that spend­ing cuts were far less dam­ag­ing than tax rises, and not nec­es­sar­ily dam­ag­ing at the bal­lot box ei­ther; wit­ness Labour’s de­feat in 2015.

But in Boris John­son we have a Prime Min­is­ter who doesn’t even ut­ter the word. The PM’s love of a grand pro­jet, from ca­ble cars and (aborted) gar­den bridges to air­ports and even bridges to Ire­land, is one of his defin­ing char­ac­ter­is­tics. In any case the likely post-Covid un­em­ploy­ment cri­sis will need jobs – in­deed en­tire new in­dus­tries – to be cre­ated. The pri­vate sec­tor should lead, but the pub­lic sec­tor will have to pump-prime the in­vest­ment.

Af­ter Covid-19 and a brush with his own mor­tal­ity, forc­ing through pub­lic sec­tor pay squeezes would also be po­lit­i­cal sui­cide for the Prime Min­is­ter. Re­mem­ber Theresa May lec­tur­ing nurses that “there’s no magic money tree” in 2017, and be­ware. The end­ing of the triple lock on pen­sions seems a more prob­a­ble route, but again comes with po­lit­i­cal costs.

Let’s also rule out the can­cel­la­tion of the £735bn in bonds bought by the Bank of Eng­land over 11 years of quan­ti­ta­tive eas­ing. Tempt­ing though it may be, the Bank’s chief econ­o­mist Andy Hal­dane told The Daily Tele­graph in May the “op­tics of that are ab­so­lutely hor­rific”, adding: “I don’t think bankrupt­ing your cen­tral bank and hav­ing to re­cap­i­talise it is a good look right now.” Quite.

That leaves the last op­tion: fi­nan­cial re­pres­sion. More overt meth­ods such as cap­i­tal con­trols are off the ta­ble now Jeremy Cor­byn’s lead­er­ship is fad­ing into his­tory, but the like­li­hood is that do­mes­tic savers will be “un­der paid” for years to come. Be­sides the Bank of Eng­land’s QE pro­gramme, since the fi­nan­cial cri­sis our banks have been ef­fec­tively forced to hold big­ger stocks of highly liq­uid as­sets like sov­er­eign debt, again push­ing the Gov­ern­ment’s in­ter­est rate down. Don’t for­get the insurers who also have to buy safe as­sets like gilts to fill pen­sion deficits.

Against the rock bot­tom rates pro­duced, even low in­fla­tion would help ease the debt pile. All the more so if the Bank of Eng­land fol­lows the ex­am­ple of its Ja­panese coun­ter­part and adopts yield curve con­trol, buy­ing bonds to lower in­ter­est rates at the far end of the bor­row­ing curve.

It prom­ises to be a long, slow grind that will make savers poorer as a re­sult, but po­lit­i­cally, it is the least worst op­tion. Mean­while the Gov­ern­ment will have to pray that in­ter­est rates re­main low, as the OBR will of­fer a stark re­minder of what could hap­pen if they don’t.

Against these bru­tal debt dy­nam­ics, even an all-con­quer­ing Su­nak is go­ing to strug­gle.

Char­lotte Valeur, the chair­man of the In­sti­tute of Di­rec­tors, has pub­licly re­vealed in The Daily Tele­graph that she is autis­tic

Rishi Su­nak, the Chan­cel­lor, looks a prisoner of a debt pile surg­ing to­wards 100pc of GDP, with more to come

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