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Debt will be a massive issue whoever takes power

By Conall Mac Coille

Published 05/05/2015

Thursday's election also promises to be one of the most unpredictable in recent memory
Thursday's election also promises to be one of the most unpredictable in recent memory

There is no doubt that the economy is in much better shape than before the last election in 2010, and in particular, the improvement in the labour market has been impressive.

The Conservatives have won many plaudits for dealing with the fallout from the financial mess it inherited from Labour, but the reality is little has been done to deal with the debt burden.

The UK economy was hit particularly hard during the global financial crisis, contracting by more than 6% between Q1 2008 and Q3 of 2009, when house prices fell 20% and public sector debt rose from more than 30% to 80% of GDP.

However, seven years on from the collapse of Royal Bank of Scotland and Lloyds, the economy has made great strides. Although there is still a lot of work to be done to remove the private household and public sector debt overhang, the UK has confounded many of its critics, though whoever wins the upcoming general election still faces a difficult task to get spending under control.

As the Chancellor highlighted in his budget speech on March 18, under his tutelage, the economy was the fastest-growing among the G7 members last year.

The major concern for investors is the possibility of a referendum on Britain's future role in Europe. David Cameron has pledged to hold a referendum by the end of 2017 if he wins a second term and in that scenario, it is likely that the UK would have to set up a series of bilateral agreements with its major trading partners to limit the impact an exit from the EU would have on trade.

However, debt will remain the Achilles heel of any new government. During the worst of the banking crisis, UK national debt ballooned from more than 30% of GDP to more than 80% today. This amounts to more than£1.3trn.

It is also worth pointing out that at 5% of nominal GDP, the UK's budget deficit is now one of the largest in the OECD. The current deficit is close to a record high and this has raised concerns that the recovery has become unbalanced and too reliant on domestic demand.

This election will focus investors' attention on the real challenges that still face the UK economy and the pound could be particularly vulnerable - historically, countries with large fiscal and current account deficits have been prone to currency instability, something the new government will try to avoid at all costs.

Thursday's election also promises to be one of the most unpredictable in recent memory.

The real possibility of a hung parliament could also create instability - longer term, the economic reality of a large deficit remains. The next government will be limited in what it can do to cut taxes or increase public spending if it is to put an end to a reliance on debt.

Conall Mac Coille is chief economist at stockbrokers Davy

Belfast Telegraph

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