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Rising interest rates cast shadow over public finances

Author: ICAEW Insights

Published: 21 Jun 2023

The government may need to borrow more than they bargained for, as tax and other receipts lag behind inflation while public spending races ahead.

The monthly public sector finances for May 2023 were released by the Office for National Statistics (ONS) on Wednesday 21 June 2023. These reported a provisional deficit for the second month of the 2023/24 financial year of £20bn, bringing the total deficit for the two months to £43bn, £20bn more than in the previous year.

Alison Ring OBE FCA, Public Sector and Taxation Director for ICAEW, said: “Month two of the new financial year brought little respite for the Chancellor, as rising interest rates and inflation-linked debt drove central government debt interest costs 76% higher than before the pandemic, putting pressure on other areas of public spending. Added to the ongoing costs of the energy price guarantee, the combined deficit for April and May 2023 reached a total of £43bn, £20bn more than in the same period last year and the second highest deficit on record.

“The chancellor will also be concerned about tax and other receipts, as these are rising at a much slower pace than spending, suggesting he may need to borrow a lot more than expected in both this financial year and 2024/25. 

“While the level of public spending before interest is expected to improve once the energy price guarantee ends in July, rising interest rates cast a shadow over the public finances. This will worry a government keen on finding sufficient fiscal headroom to be able to deliver pre-election tax cuts.”

Month of May 2023

The provisional shortfall in taxes and other receipts compared with total managed expenditure for the month of May 2023 was £20bn, £11bn more than the £9bn deficit reported for the second month of the previous financial year (May 2022). This reflected a widening gap between tax and other receipts of £79bn and total managed expenditure of £99bn, up 4% and 15% respectively compared with May 2023.

Two months to May 2023

The provisional shortfall in taxes and other receipts compared with total managed expenditure for the two months to May 2023 was £43bn, £20bn more than the £23bn deficit reported for the first two months of the previous financial year (April and May 2022). This reflected a widening gap between tax and other receipts for the two months of £160bn and total managed expenditure of £203bn, up 5% and 15% respectively compared with April and May 2022.

The slow rate of rise in tax receipts is partly due to the abolition of the short-lived Health and Social Care Levy, but even so is much lower than might be expected considering the current rate of inflation. This is concerning given the much higher pace of growth in public spending.

Total managed expenditure of £203bn in the two months to May can be analysed between current expenditure excluding interest of £170bn (up £16bn or 10% over the same period in the previous year), interest of £24bn (up £8bn or 47%), and net investment of £9bn (up £3bn or 46%).

The increase in current expenditure excluding interest compared with the prior year has predominantly been driven by £7bn from the uprating of benefit payments, £5bn in higher central government staff costs and £3bn in central government procurement, in addition to £3bn in energy support scheme costs. 

The rise in interest costs of £8bn primarily relates to a £3bn or 18% increase in central government debt interest charges in the first two months of 2023/24 and a £5bn swing in net Bank of England debt interest payments. This arose from a combination of higher interest rates and the effect of the retail price index on inflation-linked gilts. 

The increase in net investment spending is too early in the financial year to diagnose trends, given that the timing of capital projects can have a significant effect on the reported numbers in individual months.

Public sector finance trends

Two months to May 2019 (£bn) May 2020 (£bn) May 2021 (£bn) May 2022 (£bn)  May 2023 (£bn)
 Receipts  130  111  135  153  160
 Expenditure  (129)  (186)  (158)  (154)  (170)
 Interest  (11)  (9)  (10)  (16)  (24)
 Net investment  (6)  (16)  (8)  (6)  (9)
 Deficit  (16)  (100)  (41)  (23)  (43)
 Other borrowing  (6)  (74)  (26)  3  8
 Debt movement  (22)  (174)  (67)  (20)  (35)
 Net debt  1,799  1,989  2,220  2,402  2,567
 Net debt/GDP  80.7%  93.9%  98.6%  97.0%  100.1%

Source: ONS, ‘Public sector finances, May 2023’

Caution is needed with respect to the numbers published by the ONS, which are expected to be repeatedly revised as estimates are refined and gaps in the underlying data are filled. The latest release saw the ONS revise the reported deficit for April 2023 down by £3bn from £26bn to £23bn as estimates of receipts were updated for better data.

Balance sheet metrics

Public sector net debt was £2,567bn at the end of May 2023, equivalent to 100.1% of GDP – the highest level since 1961 according to the ONS. However, it goes on to heavily caveat the number it is using for GDP, which is based on a forecast from earlier in the year that does not reflect more recent developments in the economy.

The debt movement since the start of the financial year was £35bn, comprising borrowing to fund the deficit for the two months of £43bn less £8bn in other net cash inflows as loan repayments and positive working capital movements exceeded new lending to students, businesses and others during the month.

Public sector net debt has risen by £752bn or 41% since 31 March 2020, reflecting the huge sums borrowed since the start of the pandemic.

Public sector net worth, the new balance sheet metric launched by the ONS this year, was -£617bn at 30 May 2023, a £39bn deterioration from the -£578bn now reported for March 2023. This comprised £1,604bn in non-financial assets, £1,027bn in non-liquid financial assets and £318bn in liquid financial assets less public sector gross debt of £2,885bn and other liabilities of £681bn. 

This new measure seeks to capture more assets and liabilities than the narrowly focused public sector net debt measure traditionally used to assess the financial position of the UK public sector. However, it still excludes unfunded employee pension liabilities that amounted to just over £2trn at 31 March 2020 according to the Whole of Government Accounts, although they are expected to be much lower at 31 March 2023 as discount rates have risen significantly since then.

Year to March 2023

The ONS also made its second revision to the provisional numbers for the financial year ended 31 March 2023, reducing the reported deficit by a further £3bn from £137bn to £134bn.

This is still one of the largest full-year deficits on record. It was £12bn more than in 2021/22, primarily because of energy support packages put in place to help households and businesses through the cost-of-living crisis, but £179bn lower than in 2020/21 during the first year of the pandemic. The 2022/23 deficit was £72bn more than the £62bn reported for the 2019/20 financial year, the most recent pre-pandemic pre-cost-of-living-crisis comparative period.

The numbers for the year ended 31 March 2023 will be continually revised over the next few months as year-end estimates are finalised, although the overall picture – of substantial red ink – is unlikely to change significantly.

For further information, read the public sector finances release for May 2023.

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