Life & Culture

Why we've escaped the euro storm - so far


One suspects that inside the Treasury the calamitous problems currently facing euroland are being watched more calmly than might be expected.

First, it demonstrated that the failure of Britain to pass Gordon Brown's five tests to join the euro back in 2003 was just as well given the battering that deficit nations inside the single currency area are taking.

Secondly, the turmoil in southern Europe - most notably Greece - during the election campaign demonstrated why no nation can delay steps to deal with budget deficits and debts. To do so risks the markets and the speculators treating the pound and UK bonds - gilt-edged stock - as a one-way bet.

In effect, the events in Greece, including the violent and tragic turmoil on the streets, reinforced the message that inaction - in the face of deficit and debts - is no answer.

Indeed, it will make it that much easier for new Prime Minister David Cameron to take the kind of decisive action on deficits and debt which was eschewed by departed Prime Minister Gordon Brown who staked his hold on power on preserving recovery.

Britain has organised its debt better than most

The reality is that Greece was in danger of turning into the 'Lehman Brothers' of the sovereign debt crisis. In much the same way as Lehman's collapse in September 2008 brought the credit market to a grinding halt, creating havoc for the global banking system, so the Greek tragedy has threatened the same.

The failure of the European Commission, EU leaders and the Frankfurt based European Central Bank to grasp the nettle early proved fatal. Even a joint EU-International Monetary Fund bail-out of $145bn failed to calm markets because of doubts about the political will in Greece to carry through its reforms.

The contamination from Greece to other southern European economies was swift.

The ratings agencies Standard & Poor's and Moody's, which play a significant role in setting the cost of credit, have downgraded much of the debt of Greece - which is now classified as junk - and that of Portugal and Spain too. They thus spread the crisis far and wide.

A small insight into how Britain's banks could be hurt came when 84 per cent state-owned Royal Bank of Scotland revealed it was setting aside £430m to cover potential losses of Greek loans, and HSBC said it was exposed to the tune of £1.5bn.

Yet Britain's banking exposure to Greece is just a fraction of that in Spain where, for instance, Barclays has a branch network.

Moreover, one of the big five banks on Britain's high street is Santander which has grown through the purchase of the branch networks of three former building societies the Abbey, Alliance & Leicester and Bradford & Bingley - the latter two victims of the credit crunch.

Santander in the UK has been set up as Financial Services Authority-regulated subsidiary and has been stress tested carefully. But it could never be totally immune if, for instance, the Spanish economy were to spin out of control.

It was this possibility which led the European Union finance ministers to draw up a £650 billion rescue for euroland in the early hours of last Monday morning (May 10).

The raw numbers about the British economy which face the new Prime Minister are not pretty. The European Commission has reminded Britain week that its deficit, currently at 12 per cent of national output (GDP), is higher than that of Greece and Ireland - two countries in the trauma ward.

In order to cover this deficit, Britain must repay £29bn of maturing bonds and issue new bonds to the eye-watering value of £187bn over the next 12 months. This is an unprecedented amount in peacetime.

The Commission forecasts that without more budgetary cuts or tax rises, Britain's national debt will rise to 87 per cent of GDP by the end of 2011.

So far the UK has escaped the worst of the typhoon affecting the Club Med nations. Among the main reasons is that Britain, unlike Greece, Portugal, Ireland and others, is not in the straitjacket of the single currency.

As the UK public finances and economy weakened over the last 18 months, the pound quietly has depreciated by 25 per cent against a basket of currencies.

This gives the UK the flexibility to export its way out of difficulty.

Another advantage is that Britain has a top notch credit rating as a borrower. Even in the immediate post Second World War period, the UK never reneged on its obligations. Greece has been a serial defaulter.

Despite the need to raise ever larger borrowing totals, Britain has organised its debt better than most. Much of it is long maturity, so it does not need renewing on a regular basis.

None of this can be taken for granted. The credit rating agencies are giving the new administration the benefit of the doubt. This almost certainly means they will want to see action to start trimming the deficit and the debt accumulation before the summer in an emergency budget.

During the campaign we heard a great deal about the need to find £40bn more of cuts if the deficit was to be cut in half by 2013-14. The first job of the new coalition government will be to flesh all of this out.

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