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UK Financial Crisis

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October 03, 2022

What is the issue?

A toxic mix of politics, inflation and higher interest rates is threatening the financial system in the U.K., sending a shock wave through global markets.

What about the status of the UK economy?

  • Historic inflation- Between February 2021 and August 2022, UK gas prices shot up higher than the prices experienced at any time in the past.
  • Stagnant growth- The UK’s economy has largely been stagnant since the global financial crisis of 2008.
  • Between 2007 and 2020, the UK’s GDP has grown from 2.73 trillion dollars to 2.89 trillion dollars.
  • Currency- The pound sterling has rapidly lost value against the dollar and fallen to a 37-year low.
  • Underinvestment- Britain has one of the lowest shares of investment in GDP of any of the rich economies of the world (15-16 %).
  • Covid pandemic- The UK economy has still not recovered to the pre-pandemic level.
  • Energy crisis- Europe as a result of Russia’s war on Ukraine and tensions in global gas markets worldwide is suffering an epic energy crisis.
  • Brexit- It has generated inefficiencies which will cost GDP, thus providing very little incentive for investment.
  • The Mini Budget- The announced measures are likely to require new government borrowing.
  • It has deepened anxiety about Britain’s public finances.

Recently, India overtook the UK as the fifth-largest economy.

nominalgdp

What did the new mini Budget announce?

  • Inflation targeting- To contain the inflation, a freeze on energy bills was announced.
  • According to the government, this will reduce inflation by as much as 5 % points.
  • Kick-starting the economy- The government has decided to scrap the 45% top rate for high earners.
  • These tax cuts will benefit all taxpayers (individuals and companies) to varying degrees.
  • The government’s idea is to leave people and companies with more money in their hands.
  • It is expected to boost consumer spending as well as incentivise businesses to invest in the economy, creating a virtuous cycle of rapid economic growth.

Why was the mini budget criticized?

  • Government borrowings- The package comprises about 5% of the country’s GDP.
  • The energy support and the weaker economic outlook will increase the borrowing.
  • Interest rates- Since, the UK’s economy is facing the prospects of stagflation, the interest rates will rise.
  • Economic growth- The markets are not convinced that growth will happen at the pace the government hopes for.
  • Investor confidence Investors doubt the UK government’s ability to pay back the money.
  • They are unwilling to lend money to the UK, which, in turn, is reflected in the selling of UK government bonds.
  • As a consequence, gilt yields are shooting through the roof.
  • Cost-of-living crisis - The mini-Budget may end up in the cost-of-living crisis in the UK.
  • Inflation- More money in the hands of the people could fuel spending and inflation.
  • Imports- The sharp weakening of the pound’s exchange rate will make imports (especially energy) costlier.
  • Inequality- The International Monetary Fund (IMF) is reported to have said that the new UK Budget would disproportionately benefit the wealthy, thereby increasing the inequality in Britain.
  • Reaganomics- The announced tax cuts have drawn comparisons to the tax policies of US President Ronald Reagan.
  • Starving the beast strategy- The idea is that if the expenses of corporations are reduced, the savings trickle down to the rest of the economy.
  • British Prime Minister Liz Truss said that her government will not reverse the economic plan despite the turmoil in the financial market.
  • Britain, once a glorious imperial power where, the sun never sets, is now a country, post Brexit, that’s fast losing its status, economically as well as geopolitically.

starvingthebeast

 

References

  1. https://indianexpress.com/article/explained/explained-economics/the-mess-in-the-uk-economy-and-why-the-govt-is-being-blamed-for-it-8178380/
  2. https://www.moneycontrol.com/news/photos/world/explainer-all-you-need-to-know-about-uks-economic-crisis-9255781-17.html
  3. https://indianexpress.com/article/explained/expert-explains-uk-financial-crisis-and-global-economic-outlook/

 

Quick facts

Stagflation- Stagflation is an economic condition that is caused by a combination of slow economic growth, high unemployment, and rising prices.

Gilts- Gilts are bonds that are issued by the British government and generally considered low-risk equivalent to U.S. Treasury securities.

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