Global Policy Forum

Britain Defends Austerity Drive Despite Downgrade Threat

Rating agency Moody’s Investor Service (Moody’s) warned the UK that it might downgrade the country’s triple-A credit rating because the “weaker macroeconomic environment” looks too challenging for the government’s deficit reducing efforts. Conservative finance minister (“chancellor of the exchequer”) Osborne is using this warning to argue that further debt reduction is of the essence and that further austerity measures are therefore critical for economic recovery. The commitment to “expansionary austerity” – the ideological belief that spending cuts and economic growth go hand-in-hand, even in a time of economic downturn – is more of a bet than a plan, as it has failed for all other European countries currently in crisis.

By Julia Werdiger

February 14, 2012

The British government came under more criticism on Tuesday for its far-reaching austerity program after Moody’s Investors Service warned that the country could be next in line to lose its AAA credit rating.

The opposition Labour Party and some business groups saw the threatened downgrade as evidence that the government’s deep spending cuts were hindering growth and called for a change of course. George Osborne, the chancellor of the Exchequer, defended the cuts and said the idea that he had abandoned growth was “nonsense.”

“This warning from Moody’s comes as something of a reality check to the U.K.,” said David Tinsley, an economist at BNP Paribas in London. “It serves as a reminder that the country does not have much room for any fiscal slippage if it is to keep its top credit rating.”

Moody’s also lowered its outlook for the Austrian and French economies to negative and cut the debt ratings of six other European countries, including Spain, Italy and Portugal.

Investors seemed to brush off the latest downgrades, however. Borrowing costs for Italy and Spain dropped Tuesday in successful debt auctions. Italy raised about 6 billion euros ($7.9 billion) in a bond sale that was 1.4 times oversubscribed, and at a substantially lower rate than the previous sale. Spain sold 5.4 billion euros’ worth of 12-month and 18-month bills, also paying less than at an earlier auction.

The warning on the British economy surprised the Treasury, which had repeatedly said that its ability to maintain its top credit score — even after the United States and France lost theirs — was an endorsement of the belt-tightening it began soon after the coalition of Conservatives and Liberal Democrats took office in May 2010.

Moody’s cited “the weaker macroeconomic environment, which will challenge the government’s efforts” to reduce the deficit, and “the high risk of further shocks within the currency union” as the main reasons for the change in Britain’s outlook. Mr. Osborne, who is expected to give his annual update on the economy next month, has already had to push back his initial goal of eliminating the budget deficit by 2015.

Moody’s said that Britain’s “outstanding debt places it amongst the most heavily indebted of its AAA-rated peers, alongside the United States and France, whose AAA ratings also carry a negative outlook.” The two countries, along with Austria, have already lost their AAA status with Standard & Poor’s, another rating agency.

Moody’s supported Britain’s efforts to reduce the deficit but noted that slower economic growth could threaten such plans.

Ed Balls, the Labour Party’s candidate for the top Treasury post, said he “consistently argued that the chancellor’s gamble — raising taxes and cutting spending too far and too fast — would backfire because without a balanced plan that promotes jobs and economic growth, the government will not succeed in getting the deficit down.”

“It is clear,” he added, “that austerity around the world alone doesn’t work.”

Mr. Osborne disagreed and said that Moody’s announcement was “a reality check for the whole political system that Britain has to deal with its debt.”


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