Penned by Rajdeep Sil
INTRODUCTION :
On 26 September 2022, Liz Truss’s Govt presented its mini budget stating a 45 billion pound tax cut which will be financed by massive new borrowing. As soon as this news hit the street, the British Pound went for a nosedive & plunged to a historic low of $1.08 for every 1 British pound. This very well portrayed the crisis of faith that this decision has caused for the UK Govt.
In fact, the crisis had grown so bad that the Bank of England had to intervene & reverse its plan to sell off bonds and would instead start buying bonds to salvage a collapsing market.
In the defence of the decision to cut taxes for the country’s top earners, she states that this will ultimately help in reviving the shrinking economy in form of investments and drive the economic growth. However, sceptical investors offloaded the sterling & Govt debt, and bet against them.
REACTIONS OF THE MARKET :
While cutting taxes amid high inflation is not a new wonder that is being witnessed today. Rather during the early 1980’s, when Ronald Reagan was the US President, a similar stunt had caused the dollar to surge, which probably benefitted from its position as the global reserve currency & an otherwise robust global economy. But it looks like the complete opposite has happened in case of the UK Govt’s decision.
Citibank has classified this move as a “huge, unfunded gamble for the UK economy”, while many notable economist have described the Govt being driven solely by ideology without a clear roadmap of the what & the how of this decision.
Not only the currency market has been affected, but at the same time, this is likely to raise the cost of borrowing for the UK Govt as well.
THE IMPACT :
In the short term, the fall in value of the pound will make imports more expensive, which would further drive up the cost of living & inflation for the island nation which imports about half of its food & fuel as well as other staples. As a stabilisation measure, a rate hike by the Bank of England is likely to be the most natural outcome due to this action by the UK Govt.
However, the only silver lining in Britain’s fate is that, UK has the second lowest Debt-to-GDP ratio in the G7 nations, and unlike the emerging markets, the majority of the debt is denominated in the national currency. Thus an outright default is highly unlikely, even though British bonds have managed to make Greek & Italian debt to look like gold-plated.
But still, the bottom-line is that this move by the UK Govt is indeed a gamble, which is giving the investors cold feet. At the same time, this could prove to be a detrimental move for Liz Truss, considering her rating has also taken a beating along with the pounding of the pound.
Whether these radical economic reforms by the UK Govt actually serve their purpose or will it end up creating more trouble for the UK economy, only time will tell.
References
- https://www.bbc.com/news/business-63051702
- https://edition.cnn.com/2022/09/30/economy/uk-economy-what-next/index.html
- https://www.economicsobservatory.com/whats-happening-in-uk-markets-the-story-in-ten-charts#:~:text=The%20Bank%20of%20England%2C%20which,has%20not%20seen%20for%20decades.
- https://foreignpolicy.com/2022/09/28/liz-truss-britain-economy-markets/
- https://news.sky.com/story/whats-happening-with-the-uk-economy-12706998
- https://www.forbesindia.com/article/news/whats-happening-to-uks-economy-and-how-bank-of-england-is-trying-to-manage-it/80263/1
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