UK long term growth could well be damaged by its seeming inability to deleverage with sufficient speed.

Looking at the ten top ‘mature’ countries of the USA, Japan, Germany, France, the UK, Italy, Canada, Spain, Australia, and South Korea, the McKinsey Global Institute (MGI) says that, in the UK, the ratio of total debt to GDP has continued to rise up to the end of Q2 2011.

The MGI graph [1] shows how far out of step with the other countries the UK is and shows that we are now in Japanese territory when looking at debt as a proportion of GDP.

MGI says that, based on the Swedish and Finnish deleveraging episodes, there are six ‘critical markers of progress’ to be passed prior to an economic recovery:

  1. The financial services sector has stabilised and lending increasing.
  2. Structural reforms have taken place.
  3. Medium term debt reduction plans are both credible and implemented.
  4. Exports are up.
  5. Private investment has re-started.
  6. The housing market is stable and homes are being built.

According to MGI the USA is further along this roadmap of milestones than the others but that no country has yet passed them all.

MGI put total UK debt at 507% of GDP in mid 2011, up 30% on the end of 2008 and a huge 197% more than 2000’s 310%. For the UK, says McKinsey, deleveraging has only just begun much like most countries.

This compares to the US where MGI reckons that household are about a third to halfway through the process. But their government debt deleveraging is being held back by policymakers’ inability to make the required decisions.

Deleveraging in the United Kingdom and Spain is proceeding more slowly, and these countries could face many years of gradual debt reduction ahead.” Says MGI.

One of the factors pointed at for the UK is that banks have exercised ‘forbearance’ (also at the behest of government) on house repossessions so possibly obscuring the size of the mortgage debt problem. The Bank of England estimates that 12% of mortgaged homes are ‘in a forbearance process’. And with two thirds of them on a variable rate a real disaster could happen if rates started rising.

The United Kingdom therefore does not appear to be following the deleveraging path of Sweden. At the recent pace of debt reduction, we calculate that the ratio of UK household debt to disposable income would not return to its pre-bubble trend for up to a decade. Overall, the United Kingdom needs to steer a difficult course: reduce government deficits and encourage household debt reduction— without limiting GDP growth. The United Kingdom will need renewed investment by nonfinancial businesses to achieve this.” Concludes MGI on the UK.


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