Surprise deficit raises risk of more UK austerity

LONDON Tue Aug 21, 2012 3:10pm EDT

A pile of one pound coins is seen in central London June 17, 2008. REUTERS/Toby Melville

A pile of one pound coins is seen in central London June 17, 2008.

Credit: Reuters/Toby Melville

LONDON (Reuters) - Britain's public finances veered further off track in July after a shortfall in corporation tax revenues and higher spending, putting the government's deficit goals in doubt and raising the prospect of more austerity on top of the planned spending cuts.

After nine months of recession, the unexpected deficit underscored the lack of scope for finance minister George Osborne to give a meaningful boost to the economy - which looked at increased risk of prolonged weakness on Tuesday as manufacturers reported a slump in orders.

The high deficit also casts doubt over the Conservative-led coalition's plan to defend Britain's top triple-A credit rating and hold down borrowing costs, and Osborne may soon face the unpleasant choice of more austerity or missing his goal to close the budget gap within five years.

The public sector finances excluding financial sector interventions - the government's preferred measure - showed a deficit of 557 million pounds ($875 million), compared with a 2.8 billion pound surplus in July 2011, the Office for National Statistics said on Tuesday.

"At this rate, borrowing for 2012/13 overall will massively overshoot the Office for Budget Responsibility's forecast," said Vicky Redwood, economist at Capital Economics.

"With the recovery falling well short of the OBR's expectations, we think that the government will struggle to cut borrowing at all next year either," she added.

Economists said borrowing could overshoot the planned 92 billion pounds for this fiscal year by more than 30 billion, if the public finances keep deteriorating at the current rate.

The coalition government of Conservatives and Liberal Democrats aims to cut the budget deficit to 5.8 percent of gross domestic product this year from 8.2 percent of GDP in the 2011/12 fiscal year, helped in part by a one-off boost from the transfer of Royal Mail pension assets to the public sector.

For the year to date, public sector net borrowing - excluding financial sector interventions, the Royal Mail boost and other one-offs - totaled 47.2 billion pounds, up 11.6 billion from 2011.

Including the Royal Mail transfer, borrowing for the fiscal year to date totals 16.9 billion pounds compared with 35.6 billion between April and July 2011.

NO ROOM

The coalition has made the reduction of Britain's record deficit the corner stone of its policies, but calls to soften the austerity drive have been growing due to the weak economy.

The recent Olympics have lifted Britons' spirits and may have made the country some money, but the economy remains stifled by business and consumer fears about the raging euro zone debt crisis.

A survey from the Confederation of British Industry showed that this month manufacturers recorded the worst decline in orders since December.

The finance ministry said that while it would continue to allow automatic stabilizers - mostly benefit payments and a lower tax take - to support the economy, Tuesday's figures showed there was no scope for deficit-financed spending.

"The government remains committed to the credible plan we have set out to deal with Britain's debts, and today's numbers emphasize how risky it would be to deliberately increase borrowing," a finance ministry spokesman said.

Britain's public finances are highly seasonal, and July typically shows a surplus due to inflows of income and corporation tax. However, this year the North Sea oil and gas output has been unusually low, hitting corporation tax revenue.

MISSED TARGET

The government had originally planned to eliminate the structural budget deficit by 2015 with a tough program of spending cuts and tax rises.

But the weak economy has forced it to extend the planned fiscal consolidation by another two years and Prime Minister David Cameron has warned austerity could last until 2020.

"We expect the Office for Budget Responsibility to revise up its forecast for borrowing and believe the government will eventually have to announce more fiscal measures in order to meet its fiscal mandate," Nomura economist Philip Rush said.

Last month, the International Monetary Fund said Britain could need to cut taxes or boost investment spending to support growth if the economy has not picked up by early next year.

However, the IMF also predicted that finance minister Osborne was likely to miss his secondary goal to ensure that the debt to GDP ratio starts falling after 2014/15.

So far, Osborne has focused on schemes to lower banks' funding costs to get credit flowing, as well as guarantees to support infrastructure investment without spending taxpayers' money directly. Measures to support house-building are expected next month.

Tuesday's data showed that government receipts in July fell 0.8 percent on the year, driven by a near 20 percent drop in corporation tax, while current spending grew 5.1 percent.

(Reporting by David Milliken and Sven Egenter; Editing by Ruth Pitchford)

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