Stagnation haunts Osborne's growth gamble

LONDON Wed Nov 28, 2012 1:56pm GMT

Chancellor of the Exchequer George Osborne (C) arrives for a State Banquet for the Emir of Kuwait, Sheikh Sabah al-Ahmad al-Sabah at Windsor Castle November 27, 2012. REUTERS/Oli Scarff/Pool

Chancellor of the Exchequer George Osborne (C) arrives for a State Banquet for the Emir of Kuwait, Sheikh Sabah al-Ahmad al-Sabah at Windsor Castle November 27, 2012.

Credit: Reuters/Oli Scarff/Pool

LONDON (Reuters) - Chancellor George Osborne is expected to defend his faltering austerity plan next week as the only credible way of solving the government's biggest political problem - its failure to deliver a strong recovery.

No matter how Osborne presents the sums in his December 5 "Autumn statement", he cannot hide a simple fact: the stagnating economy has played havoc with his ambitious plans to cut Britain's debts before the next election in 2015.

In his economic statement to parliament, the Chancellor may even have to predict higher borrowing this year. This would be deeply embarrassing for a man who promised the Conservative-led coalition would virtually eliminate a record budget deficit by 2015, arguing that the previous Labour government let Britain's finances get out of control.

Osborne's supporters pin most of the blame on the euro zone debt crisis, and the International Monetary Fund says he is right to let some areas of spending rise while tackling the fundamental causes of heavy borrowing.

But his critics say austerity has disproportionately sapped demand and that he is running out of time to fix the economy soon enough for any benefits to be felt before the election. The Conservatives need an alternative "plan B" for the economy, they say.

"If they go on as they are, they face certain defeat," said Simon Lee, a lecturer in political economy at Hull University Hull. "The conclusive proof is that plan A is not working."

The failure of Prime Minister David Cameron's government to nurse the economy back to strong growth after the financial crisis has fuelled attacks from Labour, which polls show would regain power if an election were held now.

In a sign of the frustration, a handful of Conservatives have called for Osborne to be replaced before it is too late to turn the government's fortunes around.

HIGHER BORROWING?

Inheriting Britain's biggest budget deficit since World War Two, Osborne said he had to cut borrowing sharply to ensure bond investors would continue to lend to the government and to achieve a lasting recovery.

Conservative lawmaker Mark Garnier, a former fund manager who sits on a parliamentary committee scrutinising Treasury policy, urged Osborne to hold firm. "Stick with plan A," he said. "The key thing is to absolutely deliver the right message to the people who are financing running this government, which is the international bond market."

But weak tax receipts mean Osborne may have to admit borrowing will rise this year, which is likely to encourage those who argue that too much austerity is self-defeating.

The independent Office for Budget Responsibility, which makes the forecasts in Osborne's statements, may also predict he will fail to get public sector debt falling as a proportion of national output by 2015/16.

That in turn could endanger Britain's triple-A credit rating, which Osborne has promised to defend vigorously.

To reach the OBR's forecast of cutting borrowing to 120 billion pounds this year, the deficit must fall by 1.2 percent. It is now 7.4 percent higher than at the same time in 2011.

While Britain emerged from recession in the third quarter, Bank of England Governor Mervyn King has warned that growth will remain sluggish on a "long and winding" road to recovery.

"Looking out into future years, the key challenge for the Chancellor is that the budget 2012 forecasts were based on optimistic growth forecasts," said Rob Wood, an economist at Berenberg Bank. "It is likely they will have to revise that down, which will reduce tax receipt growth in the future as well, and therefore mean deficit overshoots are here to stay."

DEBT CRISIS

Battered by the euro zone crisis and drained by overdependence on troubled banks, the weak economy means Osborne may have to cut more spending or extend the period of austerity once again beyond the current 2016/17 to meet his targets.

"The choice would be when to announce that. Do you use the extra year and pencil in a further tightening for 2017/18 or does he go for something quicker than that?" said Gemma Tetlow, a programme director at the Institute of Fiscal Studies.

Neither is likely to go down well with voters hurt by austerity imposed by a government which is cast by critics as run by wealthy "posh boys" who are out of touch.

Osborne cannot risk repeating the blunders of his budget in March, a public relations disaster that taxed cheap hot food, hit the elderly, cut taxes for the highest earners and hurt the Conservatives' poll ratings.

Last month, Osborne said he supported infrastructure investment in railways, airports, power plants and communications but gave few clues on who would finance it.

There may be more announcements on cutting welfare spending and a move to assuage those who say the government has not asked the wealthy to do enough in the deficit reduction plan so far.

Much may depend on how proceeds from a Bank of England bond -buying programme are dealt with in the public finances. A decision to move to the Treasury 35 billion pounds made on the quantitative easing programme could buy Osborne more time to get the austerity plan back on track.

"Fortunately for the government, it could raid the piggy bank," Nomura economist Philip Rush said, predicting the windfall should "broadly offset the underlying fiscal deterioration over the next several years".

(Additional reporting by David Milliken and Mohammed Abbas; Editing by Guy Faulconbridge and David Stamp)