The Treasury’s Dilemma

In an address to the nation on Sunday, the Prime Minister attempted to shed light on how the lockdown might be modified over the coming weeks, unveiling a three-step plan to ease restrictions. Johnson also alluded to the considerable challenge facing the Government in absence of a vaccine – how to restart the economy without allowing the virus to re-emerge.

Number 10 will be acutely aware of the precarious situation many businesses find themselves in. Although the Job Retention Scheme has been a success, other elements of the Treasury’s rescue package have had a limited impact. To say the coronavirus business interruption loan scheme (CBILS) has suffered from teething problems is an understatement. Recent data from the British Chambers of Commerce reveals an approval rate of just 13%. Meanwhile, in the same sample, 51% of surveyed firms have less than 3 months of cash flow in reserve. Even after the addition of 100% state guaranteed ‘Bounce Back Loans’, the economic picture looks bleak.

Figures released by the Bank of England last week indicate a fall in GDP of 14% this year, with an unpreceded Q2 contraction of 25%. In terms of demand, payments data show a reduction in household consumption of 30% since March, while the Bank’s Decision Maker Panel expects companies’ sales to be down 45% in Q2. All of this means early projections of a ‘V shaped’ recovery look overly optimistic, with economists now regarding the letter U as a more accurate depiction.

The problem facing the Government is that without immunity, lifting the lockdown measures in a way that stops the economic decline is extremely difficult. Germany offers the best illustration yet of the delicate balancing act needed. After various states began to reopen shops, schools and even churches, its reproductive rate increased to 1, threatening the country’s initial success in containing the virus.

This reality will necessitate a gradual approach here in the UK, with certain forms of social distancing remaining in place for some time. Some restrictions might be lifted, yet in order to keep the virus suppressed, businesses will have to adapt to a new reality.

The problem is that many companies will struggle to pull this off successfully. The misery of the high street is already well documented, how will retailers cope when footfall is limited to just a handful of people per shop? In aviation, some have discussed the possibility of removing the middle seats in aircraft, yet is this really a commercially viable option for airlines?  What about restaurants? How will owners afford rent when the requirement to space-out tables cuts capacity, and therefore revenue in half? For many businesses, although costs will return, their income won’t.

If the need to operate in accordance with social distancing wasn’t difficult enough, firms also have to contend with a frightened public, who’ve obligingly followed the Government’s demand of staying at home, protecting the NHS and saving lives. Even officials have been surprised at the level of compliance. A YouGov survey commissioned by The Times found that 28 per cent of people do not want any aspect of the lockdown eased even if all five tests have been met. Worryingly for business, only 22 per cent want more shops to open. These statistics show just how successful Government messaging has been in persuading people to self-isolate. The new challenge will be restoring people’s confidence to a level where they feel comfortable resuming old spending habits.

All of this means that unless the Treasury retains certain aspects of its support measures, and tapers them correctly, the pain currently soothed by Government is merely being postponed for businesses. The timing around support withdrawal will therefore be crucial. For example, removed too early, and the job retention scheme risks becoming a waiting room for unemployment. Similarly, end access to grants prematurely, and smaller companies may decide to fold rather than take on large amounts of debt.

Another issue confronting the Chancellor is the cost of these measures, which appear to be extraordinarily high. According to the Office for Budget Responsibility (OBR), the support package’s cost in aggregate has already exceeded £100bn, even without including the Government’s CBILS liability. This has the potential to take borrowing close to £300bn in 2020, leaving the public finances in a vulnerable condition. To contextualise these numbers, the OBR forecasts the size of the budget deficit in 2020-21 to surpass anything seen since the Second World War, dwarfing even 2009-10.

Unsurprisingly this has unnerved many in the Treasury, with reports emerging last week of pressure to wind down the measures. This is both understandable and concerning, as while the support should be constantly reviewed, its untimely removal would cost the exchequer more in the long-term. After all, if the economy is in freefall, the debt burden increases without the government borrowing another penny.

All of this presents the Treasury with a dilemma. If it opts for a speedy return to business as usual, the quicker it can withdraw taxpayer support. However, this risks a second wave of the virus. Conversely, restarting the economy gradually may prevent the transmission rate increasing, yet will cost the taxpayer far more in prolonged support as company revenues take longer to return. What is clear is that the Government faces no easy options. The course taken over the coming months will be a careful balancing act, and in all likelihood determine the extent of the virus’s re-emergence, the strength of any recovery, and the damage inflicted to the public finances.

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