MONEY TALKS: A Rescue Package That Risks Disaster

LONDON --The U.K. government's fiscal stimulus was launched with the good intention of rescuing the economy from what looks like becoming the biggest downturn since the Great Depression.

The risk is it does more ill than good.

A consensus has built among economists and politicians that fiscal stimulus is a necessary antidote to collapsing private sector confidence and consumption.

And that's what Britain's Chancellor Alistair Darling proposed to do by temporarily cutting the Value Added Tax by 2.5 percentage points to 15% as well as announcing some scattered spending schemes in his interim budget presentation. In all, he's looking to spend GBP20 billion, or 1% of GDP through 2010.

In the scale of things that's not a lot of bang. By contrast, U.S. President-elect Barack Obama is said to be mulling a $700 billion stimulus package, some 6% of U.S. GDP, for when he takes office.

But the already delicate state of U.K. public finances militates against any more. Already, it could be too much.

Darling said public sector net borrowing would rise to GBP78 billion in the 2008 fiscal year, ending in March 2009. It will then rise to GBP118 billion in the 2009 fiscal year, some 8.0% of GDP.

In all, Darling projected that public borrowing would rise some GBP300 billion over the coming five years, resulting in government debt of nearly 60% of GDP.

Given how wrong the government's projections have been thus far, the risk is that these numbers end up being much, much worse.

At these sort of levels of government debt, the gilts market starts to come under considerable strain. Under the government's own numbers, the stock of U.K. government debt over the coming few years will increase by half from the current GBP620 billion.

The IMF estimates the U.K. is running a current account deficit of 3.6% this year and expects 3.4% next year. That demands considerable capital inflows and therefore either considerable confidence by foreigners in the U.K. economy's prospects for coming out of this recession, or higher real interest rates.

The U.K.'s massive load of private sector debt, poor state of public finances coming into the recession, and heavy dependence on the financial sector for growth suggests the economy is particularly badly placed relative to other countries.

What's more, the U.K. will be seeking buyers of its debt at a time when most other major developed countries will as well. Working off IMF projections, there will be at least $2 trillion of net issuance from leading countries this year and next. And these projections are likely to be a significant underestimate.

This suggests the only way to flog those gilts will be with higher interest rates - and that will only make the U.K.'s already gloomy prospects gloomier.

(Alen Mattich is a senior reporter and has been writing a column on market strategy for seven years. He can be reached at +44-20-7842-9286 or by email: alen.mattich@dowjones.com)

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