22 Nov 2017

Boxed In? Hammond seeks to make what he can of challenging political and economic conditions

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If it were possible for a Chancellor not to deliver a Budget in a particular year, then Philip Hammond might well have concluded that November 2017 was a stellar time to exercise that option. Alas, he had no choice but to hold up his ministerial box for the cameras and head to the House of Commons.

It is rare for an occupant of 11 Downing Street to have to frame a set of policies in such challenging political and economic circumstances. Anything coherent at all would be something of a triumph. In these conditions, it was inevitable that the Budget would be seen as at best a mixed bag and open to the charge that it lacked an overarching strategy, a political theme, or even a mere snappy slogan.

It is worth spelling out just how difficult the conditions that this Chancellor faced and faces actually are. The Chancellor does not yet know whether the UK will secure agreement for an orderly exit from the European Union, followed by a transition deal that takes the country to a point in mid-2021 before the real economic departure will occur.

The chances are that, with Cabinet agreement earlier this week to double the financial ‘offer’ to the EU-27, such an accord will be reached at or shortly after the EU Council on 14 or 15 December, but there is still a degree of uncertainty there. His party does not have a secure majority in the House of Commons and while the Conservative-DUP agreement affords him a majority on the final vote on his Finance Bill, he is not certain of that support on any individual item.

The election in June exposed a shift from class-based to age-based voting, rooted in a sense of intergenerational unfairness, that he was expected to offer a response to. Electors are plainly weary of the austerity that has been at the core of UK fiscal policy for almost a decade now, and that is especially true for the one-fifth of all employees who work in the public sector. His personal relationship with the Prime Minister is fragile and there are a sizeable number of his MPs, cheered on by the likes of The Daily Mail, who would like to see him quit or fired and replaced by someone with more enthusiasm for post-Brexit Britain.

All of which might be manageable if the economy were in more robust condition. But, here as well, Mr Hammond knew he would have troubles. The Office of Budget Responsibility (OBR) was unlikely to offer him enhanced growth estimates. Revisions to productivity statistics (which are, apparently, even worse than previously thought) were certain to suggest downward pressure on short-term and medium-term tax revenues. Inflation is well above target, which has an impact on public spending. Real incomes are once again falling. Investment is on hold in many sectors of the economy (partly, but not exclusively, due to Brexit). Still, matters might be worse. At least he is not Robert Mugabe.

So, to put it in Bridge terms, having been asked to make three no trumps with about a dozen points across his two hands, what was the Chancellor seeking to achieve in the Budget he has just offered?

Amended austerity

Austerity may not have many fans in the country at large but it still has multiple champions in the Treasury. Having been forced to extend the moment at which the budget would be in balance from 2020 to 2022 a year ago and then having been obliged, in the Conservative manifesto in May, to put it back again to the dangerously distant date of 2025, Mr Hammond was desperate to avoid another revision to 2027 which would be close to political never-never land. The Treasury is all but paranoid that if it ever abandons the objective of a budget surplus by a specified date then it will lose control over spending and hence the deficit altogether. Mr Hammond therefore talked tough on the subject. The need for discipline here limited the boost that he could award to the NHS and to housing policy.

Yet the reality is that the credibility of even the new 2025 target is wearing thin. The OBR did the Chancellor no favours at all by downgrading its projections for economic growth for each of the next five years. In each case, the growth rate anticipated is well below that of historic trend levels. This is a strikingly more pessimistic set of numbers than, for instance, the Bank of England has suggested.

This means that rate of deficit reduction will slow down significantly. It is expected to fall from £49.9 billion in 2017/18 to £25.6 billion by 2022/23, or, put differently, by about half over six years. The idea that it will then be eliminated entirely by 2025 looks somewhat optimistic. Put bluntly, if the OBR turn out to be correct in this series of forecasts (and their track record with these estimates is poor) then there is little chance that the UK will witness a budget surplus of any note in the next decade.

This (unacknowledged) prospect might explain why the Chancellor put such weight on his assertion that the rate of debt to GDP would finally peak this year and decline thereafter. In a subtle way, he was offering an alternative definition of ‘success’ in terms of asserting his control over the public finances. Yet even this claim is a serious hostage to fortune. According to the OBR, the debt to GDP ratio will reach 86.5% in 2017/2018 (or more than double where it stood in 2007/2008) and will then fall by a miniscule 0.1% to 86.4% in 2018/2019 and edge down a little more to 86.1% a year later. It would not take much to move those numbers in the wrong direction, leaving Mr Hammond exposed. The best hope for the Chancellor is that the OBR has overestimated the Brexit effect on the economy and he might be in a position to return to the 2025 deadline at a later stage during this Parliament.

Bet on the future

The true medium-term salvation for the public finances would be if the UK significantly enhanced its growth prospects by being an early and successful adopter of transformative technologies. For that reason, a Conservative Chancellor has been willing to support more state intervention in the drive to enhance the chances of the UK leading the way in fields such as autonomous vehicles and artificial intelligence. The British Business Bank (an uneasy compromise at its birth between the now Sir Vince Cable, who strongly favoured it, and George Osborne, who was instinctively sceptical about it) now finds itself at the heart of the Government’s proposals following the Patient Capital Review and will be similarly integral to the White Paper on Industrial Strategy that will be launched on Monday.

This should be of particular interest to those in the venture capital and growth capital sectors. The BBB has received a substantial increase in funding and now has a wider set of vehicles with which to deploy capital. The Chancellor has not, at this stage, abandoned the idea of a continued relationship with the European Investment Bank and hence the European Investment Fund, but if that proves to be impossible to retain, the BBB is set for a further injection of cash in future Budgets.

The Patient Capital Review also produced a ‘carrot and stick’ outcome for EIS and VCTs, with the ceiling on investments being doubled alongside a tougher test to exclude pure capital preservation schemes. Much will depend on the definition of ‘knowledge-intensive’ investments but this could be a very interesting development. The same is true of an otherwise obscure line in the HMT documents that accompany the Budget which spoke of a desire to work closely with the industry to develop a long-term plan to assist the asset management industry which is recognised as an asset by Government.

In political terms (assuming that nothing unravels) this Budget was a successful exercise both for the Chancellor personally and the Cabinet as a whole. A new package to move the EU negotiations to the next stage has been agreed, some potentially difficult amendments to the EU (Withdrawal) Bill have been avoided and a Budget with an eye-catching announcement on stamp duty and first-time buyers has been framed. What the PM and her colleagues need now is a peaceful run to Christmas.

Tim Hames
Director General, BVCA


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