Coronavirus: Government debt, an explainer

The Government’s debt may exceed £2 trillion by the end of this year. Over £200 billion of new borrowing could be needed. Much of this will be due to the coronavirus pandemic.

In this Insight we look at the basics of what government debt is, how it is funded and who it is owed to. We pick out some of the key issues arising from the coronavirus pandemic.

What is government debt?

When the Government spends more than it receives in taxes and other revenues it has to borrow. This is sometimes referred to as the Government’s budget deficit. Broadly speaking the Government’s debt is the accumulation of its outstanding past borrowing.

Will UK government debt increase?

The Government will need to borrow more during the coronavirus pandemic. Money is needed to finance its interventions to support workers and the economy, including providing loans to businesses. It will also need to borrow more because the slowing economy will increase Government spending and decrease its tax revenues.

Where has the Government borrowed from?

Over 85% of the Government’s total debt has been raised by selling gilts and bills, mainly to financial institutions (more on this later). Just under 10% is from National Savings and Investments (NS&I). NS&I is the Government-owned savings bank. It offers savings products, such as premium bonds, to the public. Other sources make up the remainder.

What are gilts and bills?

Gilts and bills are ways of loaning money to the Government. They are auctioned by the Debt Management Office (DMO). The DMO is the Government’s debt management agency. The sale of gilts and bills finances the Government’s borrowing.

A buyer of a gilt lends the Government money for a specified length of time. This is known as the gilt’s maturity. In return the holder of the gilt receives an interest payment, known as the coupon payment every six months for the duration of the loan.

When a gilt matures the Government pays the original amount loaned back to the holder of the gilt. The holder at maturity may not be the original buyer. Gilts are often traded on secondary markets by investors, pension funds and other institutions.

The DMO also sells Treasury bills, but a much smaller proportion of the Government’s borrowing is raised through these. Treasury bills are short term loans to Government of less than a year.

So the DMO sells gilts and bills just to finance the deficit?

Not quite. During the year some gilts and bills will mature and the Government will have to pay the original loan back. The DMO will often need to issue more gilts and bills to pay back these loans. This means that the stock of debt changes in two ways: the Government’s new borrowing is added, and old maturing debt is rolled over.

Even before the coronavirus outbreak, the UK Government planned to borrow over £160 billion this year: £60 billion to finance the difference between its annual spending and tax receipts and nearly £100 billion to pay back previous debt.

More must now be raised to deal with the costs of coronavirus. The DMO will hold more auctions than previously planned in April 2020. The auctions will aim to raise £45 billion largely through the sale of gilts at various maturities. According to the Institute for Fiscal Studies, £45 billion is more than was raised during any month of the 2007-2009 financial crisis.

Who owns gilts and bills?

Insurance companies and pension funds are the biggest holders of gilts and bills with around 32% of the total value. A further 28% are held overseas.

Since 2009 the Bank of England has become a large holder of debt – by September 2019 it held 23% of the value. The Bank of England has been purchasing gilts as part of its quantitative easing programme which aimed to provide a boost to the economy following the 2007-2009 financial crisis.

The Bank is returning to this approach in response to the coronavirus. It’s expanding its quantitative easing programme by around £200 billion (taking the total value of assets it can own to £645 billion). Most of the £200 billion will be spent on Government gilts, which are being bought from investors. The Bank is not buying gilts directly from the DMO. The Bank will then hold over 30% of Government gilts and bills.

What interest does Government pay on its debt?

The Government pays different rates of interest depending on, amongst other things, the type of debt, it’s maturity and the rate at which markets were willing to lend to it when the auction happened.

The Bank of England’s gilt purchases mean debt interest costs are lower than they would otherwise have been. The effective interest rate paid on this debt is the Bank’s main interest rate – known as Bank Rate – which is lower than the interest rate due on the gilts. Box 1 of the Library briefing Coronavirus: Effect on the economy and public finances explains further.

Steps taken recently by the Bank of England support lower debt interest costs. The £200 billion of Government gilts being purchased by the Bank will effectively be refinanced at the lower Bank Rate. The Bank’s decision to cut Bank Rate to 0.1% (from 0.75%), immediately lowers the effective interest the Government pays on gilts held by the Bank.

Isn’t it currently cheap for the Government to borrow?

Going into the coronavirus outbreak, markets were willing to lend to the Government at historically low rates. The Government was set to take advantage of the low rates and borrow for investment spending.

There was speculation – and some signs – that the coronavirus crisis might lead to markets increasing the price at which they would lend to the Government. However, this fear seems to have subsided. Markets continue to invest in gilts which are seen as some of the safest assets around. The Bank of England’s purchases have helped to increase demand for gilts.

Further reading

Coronavirus: Effect on the economy and public finances, House of Commons Library

Government borrowing, debt and debt interest: statistics, House of Commons Library

The budget deficit: a short guide, House of Commons Library

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About the author: Matthew Keep is a researcher specialising in the public finances at the House of Commons Library.

Photo:  “Bull Ring Market’s” by Ell Brown is licensed under CC BY 2.0