PricewaterhouseCoopers warns that ‘alarming’ level of debt may prove hard to deal with if interest rates increase
Britain’s economy is sitting on a timebomb of debt on course to break through the £10tn barrier within the next five years, according to a report out today charting the country’s two-decade long addiction to borrowing.
The study by consultancy group PwC found that property speculation by individuals and companies, coupled with an explosion of debt-financed City deals in the past decade, had resulted in the ratio of debt to national income more than doubling since the late 1980s.
It warned that “alarming” levels of debt reached since the turn of the millennium would prove hard to service if there was even a modest increase in interest rates from current emergency levels.
John Hawksworth, chief economist at PwC, said: “There is a timebomb effect from the huge amount of debt built up across all sectors of the economy.”
The PwC research showed that in 1987, the UK’s total debt for households, the City, non-financial companies and the government stood at 200% of gross domestic product, the amount the economy produces in one year. By 2009 debt stood at £7.5tn and was 540% of GDP.
“The UK’s addiction to debt has reached alarming levels during the past decade,” Hawksworth said. “The rise in debt of the financial sector from 46% of GDP in 1987 to 245% in 2009 is particularly striking as banks lent large amounts to the shadow banking sector and most financial institutions geared up in search of higher returns on equity.”
Even excluding the activities of banks and other financial institutions, gross UK debt almost doubled relative to GDP from just over 1.5 times national income in 1987 to around three times in 2009, with most of this increase coming from the private sector rather than the government.
Households borrowed more to buy houses, resulting in their debt burden rising from 63% of national output in 1987 to 110% of GDP by 2009. The non-financial corporate sector saw its debts rise from 45% to 122% of GDP over the same period, with more than half the current total related to commercial property.
“This is an addiction that it is going to be hard to get off,” Hawksworth said. “If we try to get off quickly in a ‘cold turkey’ way the consequence will be another huge recession.”
He said low interest rates had helped Britain cope with much higher debt levels, at least temporarily. Both nominal and real (inflation-adjusted) interest rates fell during the 1990s, while the recession of 2008-09 had seen them drop still further. “This has made it possible to service a larger debt stock relative to income levels, but current exceptionally low interest rates will not last forever and a large part of household and corporate lending remains exposed to possible future falls in residential and commercial property prices.”
According to the PwC study, a rise in bank rate from 0.5% to 3% would result in the cost of servicing UK debts climbing by 8% of GDP – around £120bn at current prices.
The coalition is seeking to make the economy less dependent on both private and public sector debt over the coming years, and Hawksworth said eventually Britain would have to face up to reality.
“Total debt in our main scenario is projected to top the symbolic figure of £10tn by 2015 at a time when GDP will still be less than £2tn. This is a very heavy burden of debt for the economy to continue to bear, particularly with interest rates likely to rise significantly at some point over the next five years or so,” Hawksworth said, noting that the Government’s fiscal squeeze should allow interest rates to remain lower for longer than they otherwise would.
“Private sector debt levels in the UK have reached historically unprecedented levels. Sooner or later, this will have to be addressed either through debt being run down sharply, which would risk triggering [risking] another recession, or more likely through a persistently heavy debt service burden that could dampen economic growth for decades to come. Either way, deleveraging will be a painful process for the UK that goes well beyond the immediate challenge of getting the public finances under control.”