September 12, 2012 9:00 pm

Osborne faces debt-reduction challenge

Ed Miliband accused the government of “failing its own tests” after David Cameron refused to confirm that the coalition would stick to its fiscal mandate to start bringing down national debt by the end of this parliament.

The Labour leader was challenging the prime minister on speculation that the poor state of the economy would force the government to let its target slip, rather than announce yet more steep cuts in public spending. “Plan A is not working,” he said.

Some economists believe that George Osborne, the chancellor, will have to break the debt element of his fiscal mandate – the coalition’s guiding rule since the 2010 Budget – in his autumn statement on December 5.

The Treasury insists that Mr Osborne is “committed” to the coalition’s fiscal policy, but refuses to say whether the mandate is set in concrete, regardless of the state of the economy.

Mr Osborne will receive forecasts from the independent Office for Budget Responsibility in November, assessing whether he has a realistic chance of meeting his target of bringing down debt as a percentage of gross domestic product by 2015-16.

The Treasury insists that no decision has been taken and that recent data paint a complicated picture about the economy. Although it is in double-dip recession, jobs figures and receipts for income tax and value added tax have been stronger than many expected.

Some economists believe that Mr Osborne will stick to his rolling five-year plan to eliminate the structural deficit – extending the deadline by a year to 2018 – but let the supplementary promise to start cutting debt by 2015-16 slip.

Allan Monks, an economist at JPMorgan, said: “It’s very unlikely that you would get the sort of growth [by 2015-16] to get you out of jail.”

Indeed, in setting that target – which looked within reach based on OBR forecasts at the time – Mr Osborne may have bought himself a set of handcuffs. “It was always a bit puzzling why the ratio had to fall by that date,” said Mr Monks.

Michael Saunders, an economist at Citi, said that meeting both targets would require massive cuts in spending: “If he wants to hit the debt rule, he has to do tightening that is beyond what is politically possible.”

The fiscal plan calls for a reduction in spending equal to about 3 per cent of GDP spread over the next two fiscal years, and meeting the debt target would require slashing a further 1 per cent of GDP from spending by the 2015-16 fiscal year, said Mr Saunders.

The chancellor might concede that the secondary target could not be met, but blame it on the unexpected crisis in the eurozone. This could result in the loss of Britain’s AAA credit rating, Mr Saunders added. “There is no political way out. He will have to take the hit either way.”

Liberal Democrats are expected to urge Mr Osborne to show flexibility and not take more demand out of the economy at a time of weakness.

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