- We believe that the U.K. government's decision to hold a referendum on EU membership by 2017 indicates that economic policymaking could be at risk of being more exposed to party politics than we had previously anticipated, similar to the situation in the U.S. when we lowered that sovereign rating in 2011.
- A possible U.K. departure from the EU also raises questions about the financing of the economy's large twin deficits and high short-term external debt.
- We are therefore revising the outlook to negative from stable and affirming the 'AAA/A-1+' ratings on the U.K.
On June 12, 2015, Standard & Poor's Ratings Services revised its outlook on the United Kingdom to negative from stable. At the same time, we affirmed our unsolicited 'AAA/A-1+' long- and short-term sovereign credit ratings.
We also affirmed the 'AAA/A-1+' long- and short-term issuer credit ratings on the Bank of England (BoE) and the 'AAA/A-1+' ratings on the debt program of Network Rail Infrastructure Finance PLC. We have revised the outlook on the BoE to negative from stable.
The outlook revision reflects our view that the decision of the newly elected Conservative majority government to hold a referendum on the U.K.'s EU membership by 2017 represents a risk to growth prospects for the U.K.'s financial services and export sectors, as well as the wider economy. We believe a possible U.K. departure from the EU also raises questions about the financing of the U.K.'s large twin deficits and its high private short-term external debt.
It is also our view that the calling of a referendum on EU membership indicates that economic policymaking could be at risk of being more exposed to party politics than we had previously anticipated, similar to the situation in the U.S. when we lowered that sovereign rating in 2011. In the case of the U.K., we believe that the decision to propose a referendum, with all the economic risks that such a decision entails, was at least partly driven by the government's intention to contain the influence of the eurosceptic U.K. Independence Party (UKIP). We also believe that the referendum is aimed at strengthening unity inside the Conservative Party, which has a strong eurosceptic wing. The Conservatives now have a narrow 12-seat majority, having obtained 36.9% of the national vote in the May 7, 2015, general elections (up 0.8% compared with 2010,and displaying strong regional differentiation, with 41% in England and only 15% in Scotland).UKIP's 12.6% of the national vote (up by 9.5%) could suggest that this strategy has so far not been successful. While UKIP gained only a single seat, it ended second in 120 of the 650 national constituencies, overwhelmingly in England.
In our opinion, the outcome of the general election could make consensus-based policymaking more challenging. We believe that the results of the recent general elections could, moreover, complicate the post-referendum scenario in Scotland should the U.K. decide to leave the EU. Our understanding is that, as the newly elected U.K. government enters into negotiations with its EU partners for potential treaty change, the aim is to agree at the same time upon a constitutional settlement devolving wide-ranging powers to Scotland. We find these objectives ambitious and may well take precedence over other policy imperatives, such as how to address the supply bottlenecks in U.K. infrastructure and in the housing market (see "Building For Growth: Can The U.K. Close Its Infrastructure Investment Deficit?" published Nov. 17, 2014, on RatingsDirect).
In our opinion, there are important risks to the U.K.'s longer-term economic prospects should it leave the EU, with implications for external financing and the role of sterling as a reserve currency, although this would also depend on what sort of relationship with Europe and the single market the U.K. could negotiate were it to leave the EU. The U.K. benefits from its flexible open economy, which we judge to have prospered inside the EU. We believe the U.K.'s EU membership has enabled the economy to attract higher inflows of low-cost capital and skilled labor than it would have attracted without access to the single market. It is our view that significant net immigration into the U.K. over the past decade has improved the sovereign's economic and fiscal performance.
For purposes of determining external vulnerabilities, we assess that the U.K. benefits from a reserve currency, alongside the U.S. and Japan. This leads to a more supportive external assessment, despite the U.K.'s very high net external debt. Under our methodology, were sterling's share of allocated global central bank foreign currency reserve holdings to decline below 3%, then we would no longer classify it as a reserve currency (sterling's share was 3.8% as of year-end 2014, according to International Monetary Fund data, compared with 52.5% for the U.S. dollar, and 4.0% for the Japanese yen). The loss of sterling as a reserve currency could lead us to lower the 'AAA' rating on the U.K. by one notch.
Since it joined the European Community 42 years ago, the U.K. has attracted substantial foreign direct investment (FDI), solidifying its role as a global financial center. At an estimated $1.6 trillion (57% of GDP), the absolute stock of inward FDI (OECD data published December 2014, which excludes special-purpose entities and resident affiliates' equity in and lending to foreign parents) in the U.K. is the third-highest in the world, representing 6.3% of the global total, well above the U.K.'s 4% share of global GDP. High FDI inflows into the U.K. have increased the capital stock in an economy that stands out for its low share of investment in GDP. At an estimated 17% of GDP this year, the U.K.'s investment-to-GDP ratio is the lowest of 'AAA' rated sovereigns (see interactive sovereign risk indicators at www.spratings.com/sri ). This underscores the heightened importance of FDI inflows for the U.K.'s economic growth prospects. Two-thirds of all inbound FDI into the U.K. represents investment in the services sector, primarily into the financial services sector centered in the City of London. Whereas we believe that London will remain an important European financial center even in the case of an EU exit, investment decisions by financial firms in the future in favor of other destinations could depress growth and fiscal performance.
On a flow basis, net FDI is a major source of financing for the U.K.'s current account deficit, which has remained in deficit without interruption since 1984. Net FDI financed most of the U.K.'s 2014 current account deficit of 5.5% of GDP, which was the world's second-largest in absolute dollar terms.
When we revised our outlook on the 'AAA' rating on the U.K. to stable one year ago, we projected that the current account deficit would narrow during 2014. Instead, it has widened to unprecedented levels. While this partly reflects weak demand in the U.K.'s key European markets, the more important driver has been a shift of the net income component of the current account into a substantial deficit of $63 billion (or just over 2% of GDP). Temporary factors that have pushed up the net income deficit include large one-off fines paid to foreign governments by several of the U.K.'s banks and multinational corporations. The U.K. dividend and interest payments to the rest of the world have also increased, whereas earnings on investments abroad have declined since 2011, reflecting both the permanent reduction in U.K. banks' stock of investments abroad and the potentially temporary weaker performance of U.K. investments in the eurozone, due to a more lagged recovery across the channel, as well as foreign exchange effects.
We see the U.K.'s high external deficits as a vulnerability to the economy, particularly because we view a possible EU departure as a risk to non-debt financing sources. On our preferred external liquidity metric, the U.K. performs weaker than any other of the 129 sovereigns rated by Standard & Poor's: gross external financing needs as a share of the sum of current account receipts and usable foreign exchange reserves are expected to stand at 810% in 2015, compared with 336% for the U.S. and an 'AAA' median of 192% (see www.spratings.com/sri).
At 83% of GDP (2015 estimate), the U.K.'s net general government debt ratio is slightly higher than that of the U.S. (80%) and is the most elevated among all 'AAA' rated sovereigns (followed by Germany at 68%; the 'AAA' median stands at 23%, see www.spratings.com/sri). Since the 2008 financial shock to the U.K.'s fiscal position, consolidation has been substantial, and primarily in the form of cuts to general government expenditure, which as of last year was below 2008 levels as a percentage of GDP. For 2015, we project that the steady reduction in net public borrowing will continue, as the general government deficit is, according to our projections, in line to narrow to 4.2% of GDP from an estimated 5.7% of GDP in 2014 (on a calendar year basis). Our budgetary projection for 2015 (calendar year) has somewhat improved compared with what we published at this time last year, given the stimulus to receipts from recovering real wage growth.
At the same time, we see the government's target to reduce public-sector net borrowing from 4% of GDP during the fiscal year ending March 2016 to 2% of GDP by the fiscal year ending March 2017, as optimistic. We believe meeting this target will prove to be difficult given our understanding that most of the planned reduction is set to take place by reducing benefits and other current public expenditure, without touching health or pensions. We also expect that receipts from the oil and financial services sectors will not recover to pre-crisis levels. If the government sells its remaining stakes in Royal Bank of Scotland and Lloyds sooner than we expect, we could trim our forecasts for net general government debt by close to 2% of GDP.
The affirmation of the 'AAA' rating reflects our opinion that the U.K. continues to exhibit high labor- and product-market flexibility, and a wealthy and diversified economy. We view the U.K.'s monetary flexibility and the sterling's reserve currency status as key credit strengths. We also consider the transparency, strength, and stability of the U.K.'s civil institutions to be an enduring rating strength.
The negative outlook reflects our opinion that there is at least a one-in-three probability of a downgrade over the next two years. In our opinion, the process of holding a referendum on the U.K.'s membership of the EU is evidence of increasing risks to the effectiveness, stability, and predictability of the U.K.'s policymaking. This in turn could negatively affect sustainable public finances, balanced economic growth, and the response to economic or political shocks.
We could lower the ratings if we were to take the view that our concerns about the adverse shifts in the political environment had become more tangible, especially if we were to discern negative implications for investment and growth. Should we conclude that departure from the EU is likely over the medium term, we could lower the rating by potentially more than one notch, depending on the circumstances, such as the expected future relations with the EU. The ratings could also come under pressure if net general government debt reached 100% of GDP (compared with our current expectation that it will peak at about 82% in 2016), or if the sterling were to lose its reserve currency status, because we would view this as a weakening of the economy's ability to carry a net external liability position.
We could revise the outlook to stable should the policymaking environment display degrees of effectiveness, stability, and predictability similar to that in the past, and should economic growth remain robust, the sterling maintain its reserve currency status, and the U.K.'s large fiscal and external deficits continue to narrow. The outlook could also be revised to stable were net general government debt to decline below 80% of GDP faster than currently projected, for example due to government asset sales.
|United Kingdom Selected Indicators|
|Nominal GDP (bil. US$)||2,814||2,319||2,409||2,594||2,624||2,680||2,951||2,806||2,905||3,207||3,336|
|GDP per capita (US$)||45,888||37,581||38,820||41,554||41,799||42,450||46,513||43,965||45,245||49,641||51,339|
|Real GDP growth (%)||(0.3)||(4.3)||1.9||1.6||0.7||1.7||2.8||2.8||2.6||2.1||2.1|
|Real GDP per capita growth (%)||(0.9)||(4.9)||1.3||1.1||0.1||1.1||2.3||2.2||2.0||1.5||1.5|
|Change in general government debt/GDP (%)||9.2||12.8||13.8||8.2||5.9||4.4||5.9||4.4||3.2||2.7||2.2|
|General government balance/GDP (%)||(5.1)||(10.8)||(9.7)||(7.6)||(8.3)||(5.7)||(5.7)||(4.2)||(3.0)||(2.5)||(2.0)|
|General government debt/GDP (%)||51.8||65.8||76.4||81.8||85.8||87.3||89.4||89.4||88.5||87.7||86.5|
|Net general government debt/GDP (%)||46.5||59.2||70.8||75.0||79.2||80.5||82.8||82.9||82.2||81.5||80.3|
|General government interest expenditure/ revenues (%)||5.3||4.8||7.2||7.9||7.3||7.1||7.1||6.7||6.7||6.7||6.7|
|Other dc claims on resident non government sector/GDP (%)||200.2||201.3||191.0||175.5||166.8||155.9||141.3||139.1||137.4||136.1||134.7|
|CPI growth (%)||3.6||2.1||3.3||4.5||2.8||2.5||1.5||0.1||1.8||2.3||2.3|
|Gross external financing needs/CARs plus usable reserves (%)||824.0||1,092.4||911.9||842.9||929.2||895.3||845.3||853.2||819.3||779.4||738.6|
|Current account balance/GDP (%)||(3.7)||(2.8)||(2.6)||(1.7)||(3.7)||(4.4)||(5.5)||(4.6)||(3.5)||(3.1)||(2.4)|
|Current account balance/CARs (%)||(7.8)||(7.1)||(6.4)||(3.8)||(9.0)||(11.0)||(14.5)||(11.8)||(8.8)||(8.0)||(6.0)|
|Narrow net external debt/CARs (%)||216.9||347.4||461.2||423.5||451.0||489.9||488.1||514.7||499.6||451.5||416.2|
|Net external liabilities/ CARs (%)||(9.6)||34.7||15.0||9.6||35.8||60.8||48.9||62.4||66.7||68.8||69.6|
|Other depository corporations (dc) are financial corporations (other than the central bank) whose liabilities are included in the national definition of broad money. Gross external financing needs are defined as current account payments plus short-term external debt at the end of the prior year plus nonresident deposits at the end of the prior year plus long-term external debt maturing within the year. Narrow net external debt is defined as the stock of foreign and local currency public- and private-sector borrowings from nonresidents minus official reserves minus public-sector liquid assets held by nonresidents minus financial-sector loans to, deposits with, or investments in nonresident entities. A negative number indicates net external lending. CARs--Current account receipts. f--Forecast. The data and ratios above result from Standard & Poor's own calculations, drawing on national as well as international sources, reflecting Standard & Poor's independent view on the timeliness, coverage, accuracy, credibility, and usability of available information.|
Ratings Score Snapshot
|United Kingdom Ratings Score Snapshot|
|Key rating factors|
|Fiscal assessment: flexibility and performance||Neutral|
|Fiscal assessment: debt burden||Weakness|
|Standard & Poor's analysis of sovereign creditworthiness rests on its assessment and scoring of five key rating factors: (i) institutional assessment; (ii) economic assessment; (iii) external assessment; (iv) the average of fiscal flexibility and performance, and debt burden; and (v) monetary assessment. Each of the factors is assessed on a continuum spanning from 1 (strongest) to 6 (weakest). Section V.B of Standard & Poor's "Sovereign Rating Methodology," published on Dec. 23, 2014, summarizes how the various factors are combined to derive the sovereign foreign currency rating, while section V.C details how the scores are derived. The ratings score snapshot summarizes whether we consider that the individual rating factors listed in our methodology constitute a strength or a weakness to the sovereign credit profile, or whether we consider them to be neutral. The concepts of "strength", "neutral", or "weakness" are absolute, rather than in relation to sovereigns in a given rating category. Therefore, highly rated sovereigns will typically display more strengths, and lower rated sovereigns more weaknesses. In accordance with Standard & Poor's sovereign ratings methodology, a change in assessment of the aforementioned factors does not in all cases lead to a change in the rating, nor is a change in the rating necessarily predicated on changes in one or more of the assessments.|
Related Criteria And Research
- Criteria - Governments - Sovereigns: Sovereign Rating Methodology - December 23, 2014
- General Criteria: Methodology For Linking Short-Term And Long-Term Ratings For Corporate, Insurance, And Sovereign Issuers - May 07, 2013
- General Criteria: Methodology: Criteria For Determining Transfer And Convertibility Assessments - May 18, 2009
- Sovereign Risk Indicators, March 31, 2015. An interactive version is available at http://www.spratings.com/sri
In accordance with our relevant policies and procedures, the Rating Committee was composed of analysts that are qualified to vote in the committee, with sufficient experience to convey the appropriate level of knowledge and understanding of the methodology applicable (see 'Related Criteria And Research'). At the onset of the committee, the chair confirmed that the information provided to the Rating Committee by the primary analyst had been distributed in a timely manner and was sufficient for Committee members to make an informed decision. After the primary analyst gave opening remarks and explained the recommendation, the Committee discussed key rating factors and critical issues in accordance with the relevant criteria. Qualitative and quantitative risk factors were considered and discussed, looking at track-record and forecasts.
All rating factors were unchanged.
The chair ensured every voting member was given the opportunity to articulate his/her opinion. The chair or designee reviewed the draft report to ensure consistency with the Committee decision. The views and the decision of the rating committee are summarized in the above rationale and outlook. The weighting of all rating factors is described in the methodology used in this rating action (see 'Related Criteria and Research').
Ratings To From United Kingdom Sovereign credit rating Foreign and Local Currency |U^ AAA/Negative/A-1+ AAA/Stable/A-1+ Transfer & Convertibility Assessment T&C Assessment |U^ AAA AAA Senior Secured Local Currency [#1] AAA AAA Senior Unsecured Foreign Currency [#3] AAA AAA Local Currency [#4] [#5] AAA AAA Commercial Paper Local Currency [#2] A-1+ A-1+ Bank of England Sovereign credit rating Foreign and Local Currency AAA/Negative/A-1+ AAA/Stable/A-1+ Senior Unsecured Foreign Currency AAA AAA Short-Term Debt Foreign Currency A-1+ A-1+ CTRL Section 1 Finance PLC Senior Secured Local Currency AAA AAA LCR Finance PLC Senior Unsecured Local Currency AAA AAA Network Rail Infrastructure Finance PLC Senior Secured Foreign and Local Currency AAA AAA Commercial Paper Local Currency A-1+ A-1+ |U^ Unsolicited ratings with issuer participation and access to internal documents.  Dependent Participant(s): United Kingdom [#1] Issuer: Affordable Housing Finance PLC, OBLIGOR: United Kingdom [#2] Issuer: Bank of Scotland PLC, Guarantor: United Kingdom [#3] Issuer: Government of Turks and Caicos Islands, Guarantor: United Kingdom [#4] Issuer: Barclays Bank PLC, Guarantor: United Kingdom [#5] Issuer: Lloyds Bank PLC, Guarantor: United Kingdom
This unsolicited rating(s) was initiated by Standard & Poor's. It may be based solely on publicly available information and may or may not involve the participation of the issuer. Standard & Poor's has used information from sources believed to be reliable based on standards established in our Credit Ratings Information and Data Policy but does not guarantee the accuracy, adequacy, or completeness of any information used.
Complete ratings information is available to subscribers of RatingsDirect at www.globalcreditportal.com and at spcapitaliq.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column. Alternatively, call one of the following Standard & Poor's numbers: Client Support Europe (44) 20-7176-7176; London Press Office (44) 20-7176-3605; Paris (33) 1-4420-6708; Frankfurt (49) 69-33-999-225; Stockholm (46) 8-440-5914; or Moscow 7 (495) 783-4009.
|Primary Credit Analyst:||Frank Gill, Madrid (34) 91-788-7213;|
|Secondary Contacts:||Ravi Bhatia, London (44) 20-7176-7113;|
|Hugo C Foxwood, London (44) 20-7176-3781;|
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