25 February 2021
British Recovery Bonds
Nice Idea – Needs a Tweak
by Frank O’Nomics
Underwhelmed seems to be the general reaction to Sir Keir Starmer’s “big idea”. Perhaps its because the press have had other issues on which to focus, but the column inches given to Sir Keir’s British Recovery Bonds idea have been pitifully small. It might also be that the Bond is seen as lacking significance, or just that many think it a bad idea – and there are a number of serious potential deficiencies. Nevertheless, while it might be a little niche as a vote winner, an adjustment to the nature of the bonds could still leave the proposal with some merit.
One of the reasons for the scant coverage of the proposals was that there was a lack of detail as to structure and size. Recent research has shown that, while savers have salted as much as £125bn away over the last 12 months, only 10% of this is likely to be spent after we emerge from lockdown. It makes sense for the government to try to tap into these increased personal reserves. A British Recovery Bond could offer greater security to savers and at the same time generate money that could be invested in industry and skills to help undo the damage caused by the pandemic. A bond offering a return over inflation might be too risky for the government if prices get out of hand, and those offering a return linked to GDP too confusing for many savers, so a conventional bond offering a fixed rate would seem to be most likely. There are precedents for this, with bonds offered to finance both wars and, more recently, bonds that were offered just to pensioners. The Labour Party’s version is similar to that floated by the Centre for Policy Studies who recently suggested raising funds on a more targeted basis as a way of helping turn around the economy in Northern Ireland.
Money to rebuild the economy plus a better deal for savers – sounds like a win double. Sadly not, with the big issue being cost. The high level of savings, together with £875bn of quantitative easing, has meant that the government has had very little difficulty raising cash at a very cheap level for some time. They can issue 2-year gilts and only pay interest of 0.03% and even out to 30 years the cost is only 1.3%. Getting savers to commit their money for longer than 3-5 years will be very difficult and the government is only likely to be able to secure these funds if they can beat the best rates available from banks. There is a very fine line here – the bonds could either raise nothing or could generate many billions. When National Savings and Investments (the likely provider of the new bonds) was the best rate in the market last year, it took in £69bn in just 9 months, before it slashed its rates and £26bn went straight back out. To be the best current bond would mean paying at least 1.5%. For every £1bn of Recovery Bonds issued at this rate the government will be paying at least £10mn per annum more than it needs to. If the product attracted £100bn, and it could, the cost to the taxpayer could be in excess of £1bn per year.
Such a cost might be worth it if the money was being channeled into areas that most need it. If the funds are being allocated to investment and infrastructure that would not ordinarily find it easy to raise capital, that could be very positive. However, there is no reason why the government can’t raise hypothecated debt for these purposes via standard gilt issuance. After all, they have just embarked on a programme of green funding via this method. On the other side of the equation – the savers who would benefit – the concept of need is somewhat stretched. As we have already discussed, the pool of savings exists because people do not intend to spend the money. By definition, the programme is not targeting the group that most need additional cash, those who have little to no savings.
Having said all of this, there is still one category of saver that does need help and that would benefit from the creation of a British Recovery Bond. While the charity sector is cash-strapped overall, most do need to retain a certain amount of their precious reserves in cash. Some of the larger charities choose to run large investment portfolios, but the majority cannot tolerate any risk. To have the facility to put money into a higher yielding government-backed bond, that is suitably liquid, could provide help for charities at a time when every penny has become very valuable. If the money raised were directed towards projects that provide employment and training, this would also prove attractive to those charities that have to ensure that their cash management fulfills stringent ESG criteria.
The government cannot rely on quantitative easing keeping its borrowing costs low forever, and the additional sources of funds that Recovery Bonds would tap could ultimately prove useful. However, if the product merely serves to reward those that don’t need it by generating funds that could easily be raised much more cheaply, there seems little point. If the idea is to gain traction once fleshed out in the next Labour Party manifesto, it will need careful thought.