Where does the government borrow money from? UK borrowing, national debt and deficit meanings explained

The new Prime Minister Liz Truss is likely to borrow more money to fund tax cuts and her cost of living plan

There has been a great deal of focus on the UK economy in recent months, what with predictions of an imminent recession and the economic turmoil caused during the Liz Truss administration.

With inflation denting consumer purchasing power and record high interest rates squeezing the property market and businesses, public finances look set to take a major hit over the next 12 months. At the same time, the government is still being scrutinised by the markets after Rishi Sunak’s predecessor announced a swathe of unfunded tax cuts and public spending that would have seen UK borrowing soar to what were described as unsustainable levels.

The Bank of England was forced to step in to prop up pension funds, as investors ditched the pound en masse. While the current Prime Minister and Chancellor Jeremy Hunt steadied the ship somewhat with their Autumn Budget back in November 2022, the UK looks destined to face higher taxes and broader cost of living challenges for some time yet.

News revealed today (Tuesday 24 January) increased the sense of gloom. The Office for National Statistics (ONS) said government borrowing climbed to £27.4 billion in December 2022 - the latest month we have data for.

But where does the UK borrow money from - and what does borrowing even mean?

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

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.

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.

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.

Government borrowing tends to be funded by the private sector (image: AFP/Getty Images)

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.

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.

Government spending is usually funded by a mix of taxation and borrowing (image: AFP/Getty images)

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 money 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 for the investor/lender over what is often a long period of time.

The Bank of England sometimes funds government borrowing through quantitative easing (image: AFP/Getty Images)

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 - aimed at boosting spending and investment and therefore, growing UK economic output. It 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?

According to December 2022 figures released by the ONS on Tuesday (24 January), the UK borrowed £27.4 billion - the highest figure for the month of December since records began in 1993. A major part of this total (around £7 billion) was down to government energy support schemes - namely the energy price guarantee and energy bills grants.

At the same time, interest on government debt hit £17.3 billion - the second-highest monthly total on record. Record inflation was cited as the main driver of what was an almost £10 billion month-on-month increase. However, with inflation having peaked and the energy support schemes either set to expire or become less generous, this figure is being viewed by some as a high water mark.

Some economists argue that the ONS figures are misleading, given the length of time interest payments are due over.