Budget Surplus to be Swallowed by Surging Cost of Debt Repayments

Above: File image of Chancellor Rishi Sunak. Image © Gov.uk.

The UK printed a budget surplus of £2.9BN in January 2022 aided by a surge in tax revenues with central government receipts totalling £91.6BN in January 2022, £8.6BN more than in January 2021.

However, the surplus was less than the market was expecting at £3.5BN and economists say recent improvements in the public finances will almost certainly be swallowed up by the increasing cost of debt repayments over coming months.

The ONS said much of the January surplus was driven by a jump in self-assessed Income Tax receipts which were at £18.4BN, an increase of £2.0BN.

"The fact that borrowing was negative this time exaggerates the improvement in the fiscal position – January tends to be a buoyant month for receipts thanks to the strength of PAYE income tax payments. Nonetheless this was the first repayment since the onset of the pandemic two years ago and the overall position is evolving favourably," says Philip Shaw, Economist at Investec.

But, of concern to Chancellor Rishi Sunak will be the inevitable rise in debt repayment costs that follow rising inflation.

Debt interest payments were £6.1BN in January, an increase of £4.5BN.

"The sharp rises in RPI inflation in recent months (to which index-linked gilts are pegged) pushed debt interest costs to £6.1BN in January, well above the OBR’s forecast of £3.6BN and last January’s £1.6BN," says Bethany Beckett, UK Economist at Capital Economics.

Source: Office for Budget Responsibility and Office for National Statistics - Public sector finances.

Capital Economics anticipates a rising repayment burden "for some time yet" as they forecast RPI inflation to keep climbing to a peak of 9.9% in April 2022 and to average 1.1 percentage points (ppts) above the OBR’s forecast in 2022/23 and 3.2 ppts above in 2023/24.

The UK government borrowed £138.5BN in the financial year-to-January 2022 which was the second-highest financial year-to-January borrowing since monthly records began in 1993.

But encouragingly borrowing is now roughly half of what it was this time one year ago (£140.2BN less).

Public sector net debt excluding public sector banks (PSND ex) was £2,317.6BN at the end of January 2022 which amounts to around 94.9% of gross domestic product (GDP), levels not seen since the early 1960s.

Looking at the 10 months of the 2021/22 financial year, government spending has fallen 4.9% on the corresponding period a year earlier with revenues coming in 15.6% higher.

Investec's Shaw says current trends point towards borrowing of £154BN this financial year, down on the £322BN borrowed last year.

The Office for Budget Responsibility (OBR) forecast at the time of last October's budget that the government was to borrow £183BN in 2021/22.

"With today’s figures continuing to build a case to expect a substantial undershoot, the government is likely to be on course to have sufficient resources to either cut taxes before the next election, to provide further help for households to manage their energy bills if it considers this to be necessary, or even a combination of both," says Shaw.

However, it looks almost certain that Sunak will still proceed with tax hikes in April when National Insurance Contributions from both employers and employees comes into effect.

Capital Economics says the current undershoot in borrowing will fall away in 2022/23 as higher inflation and interest rates may cause borrowing to overshoot the OBR’s forecast by £30BN.

The cost of financing Covid health measures is set to fall dramatically over coming months following a government announcement on Feb. 21 that all restrictions would be removed from Thursday 24 and free mass testing would end in April.

But Hoa Duong, economist at PwC, says the gains from this shift would be almost entirely swallowed up by the increased cost in servicing debt.

"England starts the new 'living with Covid-19' plan from Thursday 24 February. Further savings in Government spending are expected to follow as remaining financial support, such as the £500 support for self-isolation, is ending," says Doung.

"This could contribute to lessening the budget burden going forward but the net impact is likely to be minimal, especially when considering other expenditures. For example, a rise in interest payments on the Government’s record debt following the recent Bank rate hike would completely wipe out these savings in less than a month," he explains.