The Chancellor has said that the current Pandemic has added around £450bn to total borrowing, taking the national debt past £2 trillion. Most of this borrowing is financed by issuing government debt or ‘gilts’. There are two main types of gilts – ‘fixed’ interest gilts which pay a fixed interest rate regardless of the rate of inflation and ‘index-linked’ gilts where the interest rate varies according to the level of inflation.
The government’s current strategy is massively tilted towards fixed gilts, with around 90% of next year’s £330bn of gilts coming through this route. Just 10% will come from index-linked gilts.
But Jon Camfield points out that the interest rate which the government has to pay on fixed gilts is currently much higher than on index-linked gilts, so a switch to issuing more index-linked gilts could save money. For example, current rates are:
• 20 year fixed interest gilt yields 1.4% pa
• 20 year index-linked gilt yield -2.1% pa (minus 2.1%) + inflation
Even if the inflation rate turned out to be 2.5%, this would still mean the taxpayer forking out 1% less per year than on a fixed rate gilt.
Given the size and duration of government borrowing, such differences, repeated year-after-year, could make a real difference.
Greater issuance of index-linked gilts would also be very well received by the nation’s pension funds who have to pay out pension promises which are themselves linked to inflation. There would be considerable demand from Defined Benefit pension schemes for index-linked gilts and this would further help the government to fund its borrowing at an affordable rate.
One reason why the government has held off issuing index-linked debt is for fear of exposure to future increases in inflation. But index-linked gilts can come with a cap, so that rising inflation can only have a limited effect, and the large majority of gilts would still be on a fixed interest basis. Continuing to limit the role of index-linked gilts comes at a price, and with huge annual borrowing that price is rising all the time.
Commenting, Jonathan Camfield said: “Britain’s pension schemes would be keen buyers of index-linked gilts and these could save the taxpayer money as well. With the government needing to borrow huge sums in the coming years it seems short-sighted not to issue more debt on an index-linked basis where the interest savings could be substantial. Issuing more index-linked gilts would be a win-win for the taxpayer, for pension funds and the members they serve”.
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