Additional tax rises or spending cuts of around £20 billion, over and above current plans, will be needed by 2013/14 to close the fiscal gap, according to PwC’s latest UK Economic Outlook report.

PwC’s projections for the UK public finances (see Table 1 below) suggest that public borrowing could be close to the Treasury forecast in 2010/11.  Beyond that, however, the Treasury projections are based on sustaining average GDP growth of 3.25% from 2011/12 through to 2014/15, which is well above average independent forecasts which project average GDP growth over this period of only around 2.5% per annum.

Table 1: Comparison of HM Treasury (HMT) fiscal projections with PwC main scenario

John Hawksworth, head of macroeconomics, PricewaterhouseCoopers LLP said:

“Our projections are based on a more cautious view of medium-term growth potential than the Treasury.  We assume the same 5% of GDP permanent loss of output due to the recession as the Treasury, but assume that the underlying trend growth rate from 2008/9 onwards is 2.25% per annum, rather than the Treasury’s 2.75% central estimate and what they describe as a ‘cautious’ assumption of 2.5% used in their own public finance projections.

“We see public sector net borrowing remaining at around 5% of GDP in 2014/15, as compared to the latest Treasury forecast of a 4.4% budget deficit in that year.  Public borrowing in the medium term could therefore exceed the levels projected by the Treasury meaning that, with public debt heading to just above 80% of GDP in 2014/15, there could eventually be an adverse bond market reaction that would significantly push up the cost of servicing this rising debt.”

The report states that the fiscal gap could be closed through many possible combinations of additional tax rises and spending cuts starting from 2011/12 and building up to around £20 billion per annum (at 2009/10 GDP values) by 2013/14.  Table 2 below illustrates three possible options and sets out the implications both for total departmental spending (DEL) and for those areas of spending not identified as being protected from real cuts in the Pre-Budget Report (I.e. the NHS, schools, Sure Start and international aid).

Table 2: Alternative tax and public spending scenarios

Note: figures in square brackets indicate cumulative real spending cuts in the 3 years to 2013/14. Other spending figures are annual average real growth rates over this same period.

John Hawksworth, head of macroeconomics, PricewaterhouseCoopers LLP concluded:

“Depending on the mix of tax rises and spending cuts adopted, the scale of the cumulative real departmental spending cuts required in the three years to 2013/14 would be around 9-14%, while the real cuts in unprotected areas could vary from 17%-27%.  In practice, a spending squeeze towards the middle of the range might appear most plausible, supplemented by perhaps around £10 billion or so of additional tax increases.

“The details of this package will be for the next government to decide, but the bond markets and credit rating agencies will be looking for a credible medium-term fiscal consolidation plan to be announced soon after the next general election. 

“Whatever the precise package adopted, public spending is likely to be squeezed hard from 2011/12 onwards after a decade of relatively strong growth. Capital-intensive departments such as transport, housing and defence seem likely to be particularly hard hit in the next spending review.”

Moderate economic recovery projected, but risks still weighted to the downside

The report also outlines predictions showing modest average GDP growth of around 1% in 2010, picking up gradually to around 2.5% in 2011. The UK economy edged out of recession during the fourth quarter of 2009, but the level of GDP was still around 6% lower than its pre-recession peak although most recent business surveys point to a revival in activity during the latter part of 2009 and early 2010.  Consumer and business confidence has gradually become less negative over the past year and the housing market has shown signs of recovery.

John Hawksworth, head of macroeconomics, PricewaterhouseCoopers LLP said:

“The signs for economic recovery are promising but the extent of the good news should not be exaggerated as a large part of it may be due to the normal operation of the stock cycle.  The period of very sharp de-stocking has run its course, which will lead to an automatic recovery in orders and output levels in the short term, but the question is whether this upturn can be sustained.  This depends on stronger growth in exports and business investment since both consumer and government spending are likely to be constrained for some years to come.”

PwC’s main scenario (see Table 3 below) sees UK GDP rising by a relatively modest 1% in 2010, picking up to around 2.5% in 2011, but there could be pitfalls along this road to recovery as the effects of past monetary and fiscal stimulus fade.

Table 3: Comparison of projections for UK economy

The comparison of forecasts shows that the PwC main scenario is broadly similar to the latest average independent forecast, but less optimistic that the Treasury’s Budget forecast for 2011 (although similar for 2010). However, both our main scenario and the projections of others are subject to significant margins of uncertainty, as indicated by the alternative GDP growth scenarios shown in Figure 1 below.

“Risks to our growth forecasts are more balanced than a year ago, but may still be weighted somewhat to the downside.  We recommend that business should stress test their plans against the possibility of a ‘double dip’ recession which could result in a further fall in GDP in 2010-11.  This is not the most likely scenario, but there is probably a risk of around 25-30% of such a double dip scenario.  At the same time, the possibility of a stronger recovery can also not be ignored given recent relatively more positive survey data.”