Chancellor’s dilemma over the size of debt owned by foreigners

Balancing the books: Chancellor Rachel Reeves says she’ll take ‘difficult decisions’ to restore economic stability

Britain is increasingly in hock to foreign governments who own far more of the national debt than previously thought, The Mail on Sunday can reveal.

The news is a blow to Rachel Reeves as she prepares next month’s Budget, which is expected to raise wealth taxes to balance the books.

The Chancellor has vowed to take ‘difficult decisions to restore economic stability’ after claiming a ‘dire’ inheritance from her predecessor, Jeremy Hunt.

But experts fear the UK’s growing dependence on foreign powers, some of whom may be hostile, to pay its way in the world means the economy is even more vulnerable to future shocks.

It has also emerged that the Office for Budget Responsibility (OBR) – the independent forecaster who checks Reeves’ plans – mistakenly estimated how much of Britain’s £2.7 trillion debt pile was held by overseas governments. Foreign investors own 28 per cent of UK national debt – nearly twice the percentage of two decades ago. Most of it was thought to be held by private investors.

But OBR chairman Richard Hughes has revealed that foreign governments own more than half of it – about £430 billion. In a House of Lords Economics Affairs Committee report published last week, Hughes said these investors hold 16 per cent of all government debt, not the 2.9 per cent previously thought.

The OBR found out who really owned the debt when it contacted the International Monetary Fund.

The IMF said it had recently been told the figures provided to it by the Bank of England only captured central bank holders of gilts. Hence the huge error.

Hughes warned that ‘fickle and flighty’ foreign buyers of UK government debt lacked ‘home bias’, were susceptible ‘to geopolitical considerations in their portfolios’ and posed a ‘growing risk to the stability of the gilt market’. Gilts are government IOUs issued to UK pension funds, insurers and overseas investors to fund spending on public services such as schools and hospitals.

Public debt has ballooned in recent years to almost match the size of the economy’s annual output – or gross domestic product – as the Treasury borrowed billions to pay for lockdowns and a cost-of-living crisis. Soaring inflation also pushed the interest paid to government debt-holders to more than £100 billion a year – a similar sum to that spent on education.

Asked if foreign financing of the UK’s debt was really a problem, independent economist Julian Jessop said: ‘I think it is – it is relatively easy for foreigners to decide not to invest in the UK.’

Mohamed El-Erian, chief economic adviser at insurer Allianz, told peers that foreign holders of debt were like tourists.

‘The minute something goes wrong they head to the airport and get out,’ he said. ‘That is what tends to happen during shocks.’

The OBR has warned that an ageing population, and increased spending on defence and combating climate change, could push the UK’s ratio of debt to GDP from its current level of 99 per cent to 274 per cent in the next 50 years.

Hughes said taxes would have to rise or public spending would have to be cut ‘to keep the public finances on a sustainable level’.

The report came as the Labour government warned of painful choices to tackle a hotly-disputed £22 billion-a-year ‘black hole’ in the nation’s finances.

Analysts expect interest rates to stay at 5 per cent when the Bank of England’s Monetary Policy Committee meets this week, though two quarter point cuts are on the cards later this year.

The Bank is also expected to announce plans to sell another £100 billion of gilts it bought after the financial crisis in 2008 to shore up the economy.

Investor appetite for government debt is strong, with demand far outweighing supply during a recent gilts auction.

The decision over the how fast to sell gilts has big implications for the Government, as the Bank is losing billions on the deals, with losses covered by the Treasury.

The scale of the losses in the coming years will affect how much headroom Reeves has to meet her target of reducing the debt-to-GDP ratio.

The OBR and the Treasury were contacted for comment.