Dealing with Debt

Market cycles come and go and the peaks and troughs of investment fortunes are as old as time. Putting money to work and sound investment is commended as far back as the parable of the talents in bible times. There are two main sources of new money that can help business to grow, create employment and improve earnings.

The first is equity, that is private capital invested into business, and the second is debt, money loaned usually from banks to invest where the return on investment is expected to exceed the interest costs and repay the loan.

Debt is really important because it can be a force for good in growing businesses, and improving products and services.

But debt that cannot easily be repaid and more seriously still, debt interest payments which can’t be met, can tip business, individuals and sometimes nations into deep trouble.

Absolute levels of debt and the cost of servicing them are big issues.

The news this morning that the UK saw an increase in the public finance borrowing requirement of £0.5bn in July versus a surplus of £0.8bn in the same month last year is a disappointment for the Chancellor. Over the last 6 months the borrowing requirement has been around £36bn, slightly higher than in 2012. Absolute debt is now £1,193.4bn.

 

Source: Guardian

Improving employment numbers and positive growth in house prices and sales should be helping tax receipts, so the lack of improvement in these numbers will disappoint.

The worry is if the markets do not believe the Coalition has this under control the cost of borrowing money for the UK will increase putting the public finances under even greater strain. This might have happened already were it not for the paucity of alternatives by way of stable sovereigns with sound public finances.

Why does it matter to Jersey? After all, Jersey doesn’t have any borrowing.

Firstly we are in the sterling zone so anything that happens to the UK from a monetary perspective has a strong impact on our economy.

Secondly we are principally a manager of money and not a lender as a jurisdiction.  We make our return through managing savings.

The margin, the difference between what we pay for savings and what we get back is compressed at historic lows. This depresses bank profits and therefore the money available for reinvestment and growth.

This is a temporary situation as interest rates have not been this low for this long for 300 years, at some stage they will normalise nearer to long term trends.

This could see rates increase by 2% - 3% from current levels. Whilst this will make debt more expensive to service it is likely savings rates will be higher, and retirement and investment incomes will increase.  Bank profits should also recover.

Mark Carney the Governor of the Bank of England has said that he does not expect to even consider raising interest rates until unemployment in the UK falls below 7%, it is currently 7.8% on a rolling three month average and 7.4% in June, so looks to be trending down. Employment numbers rose by 400,000 in June, the fastest rate of increase since 1992.

The markets are betting Mr Carney will not be able to hold interest rates down until 2016; a 2015 post-election increase could be on the cards.

This may be bad news for mortgage holders who have enjoyed all-time lows in borrowing costs but it will be good news for our finance industry and for Jersey.

 

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