UK borrowing: Where does the government borrow money from? National debt and deficit meanings explained

The Conservative Party’s economic record is likely to be a key battleground in the upcoming UK general election, where Rishi Sunak and Keir Starmer will go head-to-head at the ballot box
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With a UK general election likely to be only months away, the Conservative Party’s track record in government is likely to come in for greater scrutiny. One key battleground it will have to fight Keir Starmer’s Labour Party on is the economy.

The state in which the current party of government has left the nation’s finances has been particularly contentious over the past 12 months, particularly due to Liz Truss’s brief term as Prime Minister. Truss and her Chancellor Kwasi Kwarteng’s swathe of unfunded tax cuts not only drove up mortgage costs, but it also hiked the cost of public borrowing as it spooked the markets.

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It has left her successor Rishi Sunak with a mountain to climb if he is going to secure another term in Downing Street. In a bid to take control of the narrative earlier this year, he announced five priorities for 2023 - all of which are currently hanging in the balance.

One of these pledges was to reduce the national debt. However, with the UK’s budget deficit hitting £139.2 billion in the 2022/23 tax year - the fourth highest total on record - and borrowing continuing to remain elevated compared to historical levels, the PM may struggle to fulfil his promise.

But where does the UK borrow money from - and what does public borrowing mean in practice?

What does borrowing mean?

Every year, the government raises money through taxes which are usually set out in an annual Parliamentary event known as the Budget.

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It uses this money to fund public services, invest in infrastructure and pay for the welfare state, amongst other things. If the government spends more money than it raises through taxation and other income, it has to ‘borrow’ to cover the deficit - i.e. the gap between the money it has and the money it needs.

The UK government borrows money to fund public spending (image: Getty Images)The UK government borrows money to fund public spending (image: Getty Images)
The UK government borrows money to fund public spending (image: Getty Images)

Should a deficit repeatedly appear on the public’s balance sheet over a period of time, it becomes known as the national debt. But while you will often hear politicians compare the nation’s finances to the budget of, say, a business or a household, they work in a different way.

For example, debt can be very long-term - as much as 55 years - and can come with cheap interest rates, meaning the economic gains created by the borrowing may pay off the extra costs of servicing the debt over time. The International Monetary Fund (IMF) describes it as “an important way for governments to finance investments in growth and development”.

Running deficits and gaining debt can also be politically useful, as a government could become unpopular if it raises taxes too much. And, if a recession occurs - an event which can reduce the amount of money taxation provides - a government is likely to increase borrowing to fund public services.

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Problems mainly arise if a country defaults on its debt, i.e. cannot or will not pay it back. Building up too much national debt over time is also harmful, as it increases the amount of interest the governmenth as to pay out. If this happens, it tends to mean it becomes more expensive to borrow and economic output may be impacted.

Where does the UK borrow money from?

The money the UK borrows comes from the private sector, usually financial institutions like pension funds and banks. It raises this cash from bonds - also known as gilts.

These are basically promises to pay the lender back with interest over a certain period of time, with the bulk of this cash repaid on the final date of the bond. The payments before the end of the bond’s lifespan tend to consist of interest.

Overall, the private sector views these loans as a low-risk way of investing. This is because they guarantee regular repayments over what is often a long period of time.

Government spending is usually funded by a mix of taxation and borrowing (image: AFP/Getty images)Government spending is usually funded by a mix of taxation and borrowing (image: AFP/Getty images)
Government spending is usually funded by a mix of taxation and borrowing (image: AFP/Getty images)
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But they do carry some risk, as inflation can wipe out interest if the bond is not index-linked. Likewise, at the government’s end, issuing bonds (i.e. borrowing) becomes more expensive if inflation is high as investors will want to make a return in exchange for their cash. The index-linked bonds it issues are also likely to become more expensive when inflation is high.

Sometimes, the Bank of England (the public body in charge of the UK’s currency) buys them through a process known as quantitative easing - essentially printing money. This activity aims to boost spending and investment with the hope that it will heighten UK economic output. The central bank was forced to embark on a massive bond-buying exercise in the aftermath of Liz Truss and Kwasi Kwarteng’s disastrous mini budget in a bid to prop up pension funds.

What do the latest UK borrowing statistics show?

The Office for National Statistics (ONS) releases government borrowing figures on a monthly, quarterly and annual basis. The latest figures show the situation as of July 2023.

What they show is that the government borrowed £4.3 billion over the course of the month. This amount was lower than the £4.9 billion that many economists had been expecting, and well below the £6 billion forecast by the Office for Budget Responsibility (OBR). But it still came in as the fifth highest figure on record for the month of July.

The Bank of England sometimes funds government borrowing through quantitative easing (image: AFP/Getty Images)The Bank of England sometimes funds government borrowing through quantitative easing (image: AFP/Getty Images)
The Bank of England sometimes funds government borrowing through quantitative easing (image: AFP/Getty Images)
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It means net public debt stands at £2.58 trillion, equivalent to 98.5% of the UK’s gross domestic product (GDP) and 1.9% higher than a year earlier. While there is no good or bad figure when it comes to how the national debt compares to GDP, the figures mean the debtpile is sitting close to a 62-year high.

The bad news for Sunak and his Chancellor Jeremy Hunt is that interest payments on this debt have soared as a result of the record inflation and political turmoil we have seen over the last year. The UK had to pay £7.7 billion in interest in July – £1.5 billion more than a year earlier and the highest amount for July since records began in 1997.

With it being so expensive to borrow, the government is unlikely to promise any major public spending packages or tax cuts ahead of the next general election, according to analysts at Pantheon Macroeconomics and Capital Economics. This thinking appears to have been confirmed by Hunt’s reaction to the news on 22 August, with the Chancellor saying: “As inflation slows, it’s vital that we don’t alter our course and continue to act responsibly with the public finances. Only by sticking to our plan will we halve inflation, grow the economy and reduce debt.”

But Sir Keir Starmer said the government could not pretend that “everything is fine” based solely on the lower-than-expected borrowing figures. He said: “I don’t think the government is in a position to pretend that they’re handling the economy well, when the lived experience across the country is so very different to their rhetoric.”

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