HC Deb 14 April 1970 vol 799 cc1213-23

The record since devaluation

Two and a half years ago, our main economic task was to convert a large balance of payments deficit into a substantial surplus and then to maintain that surplus over a period of years until our short and medium-term debt had been repaid. Devaluation, by making our exports more competitive and more profit-able, was a necessary pre-condition of achieving these aims. But it could not be sufficient on its own. It was essential to devote a large part of the increase in our national output to additional exports and import replacement, and to manufacturing investment on which the longer-term health of our balance of payments depends.

To make sufficient resources available for these purposes it was necessary to restrain other elements of demand severely, and, in particular, personal consumption and public expenditure. This meant higher taxes, a strict pruning of public sector expenditure programmes, and a firm monetary policy.

Our policies on taxation and public expenditure have transformed the accounts of the public sector as a whole. A borrowing requirement of £1,956 million in the financial year 1967–68 was reduced to one of £450 million in 1968–69 and then replaced by a surplus of about £600 million in the financial year just ended. There has thus been a turn-round in the public sector accounts of about £2,550 million in these two years.

At the same time, our tight monetary policies—which are, in part, a reflection of the fiscal turn-round—have created conditions that have reinforced the restraint of home demand. Domestic credit contracted moderately in 1969, in contrast to large increases in 1967 and 1968.

Thus the turn-round has been massive in both the fiscal and the monetary fields. But it has not been excessive, considering the magnitude of the task which faced us just over two years ago. It has produced a decisive switch of resources in the direction that was needed, and with a growth performance that compares well with previous periods of balance of payments improvement—even though the improvement was on those occasions much more limited.

I shall give a few illustrative figures. These compare the middle two quarters of 1967—I choose this period to avoid the distorting effects of the dock strikes later in that year—with the last two quarters of 1969—the latest six-month period for which figures of national income and expenditure are available.

During this period of just over two years, the national product as a whole grew by about 6¼ per cent., roughly in line with the growth of productive potential. But exports of goods and services grew, in volume terms, by 24 per cent. This is twice the rate of growth of manufacturing production, which rose by 11 per cent.; nearly two and a half times the growth of imports of goods and services, which rose in real terms by about 10 per cent.; nearly four times the growth of the national product as a whole. Over the same period, manufacturing investment rose by about 13 per cent.

The large increase in exports was greatly helped by an abnormally rapid growth of world trade. But we should have been unable to take full advantage of this, and effect such a large switch of resources into the balance of payments and manufacturing investment, if the other elements of demand had not been effectively contained.

Personal consumption went up in real terms by less than 4 per cent. Public sector expenditure on goods and services—which includes investment by the nationalised industries, but, is of course, different from public expenditure as a whole which also includes certain other items, particularly transfer payments—fell by 2. per cent., and the two together rose by 2 per cent., only one-third as fast as the national product.

Thus, about a half of the increase in our national output during the last two years or so has been devoted to improving the balance of payments and raising the level of manufacturing investment.

The improvement in the balance of payments has been dramatic. For many years the British balance of payments was weak. Today, it is one of the strongest in the world. Last spring, I set a target for a surplus of £300 million on the basic balance—current and long-term capital—for the financial year 1969–70. The final outturn for the financial year will not be known until June, but in the first three quarters, up to December, our surplus, seasonally adjusted, was £451 million. For 1969–70 as a whole it is unlikely that the surplus was less than £550 million, and it may have been considerably larger.

During the early days after devaluation I set another target—a surplus at the rate of £500 million a year in the course of 1969. A year ago that target had come to be regarded by nearly everyone—perhaps including myself—as rash and unattainable. In fact that, too, was surpassed. In the last two quarters of 1969 our surplus was at an annual rate of £550 million on current account and £740 million on current and long-term capital account combined.

The March trade figures were published today, showing a moderate surplus. This gives us a surplus on visible trade for the first quarter of £36 million, better even than the two strong quarters which preceded it. It brings the visible surplus for the past nine months to £87 million. This is not only a transformation from the large deficits of a couple of years ago, but quite different from the traditional pattern of our trade, for visible surpluses have been earned in only two years since 1822.

Invisible earnings have also risen strongly. Net invisibles in 1969 were £524 million—more than double the figure for 1967. There were also favourable developments on the long-term capital account, though some of these were of an exceptional nature.

As a result, our current account was in surplus in 1969 by £366 million. Our basic surplus, despite a first quarter deficit, was £387 million, or £457 million after adjustment for Eurodollar borrowing for overseas investment. These are the largest positive figures ever recorded either for current account alone or for current and long-term capital account combined.

It is also appropriate to note the performance of the balance of payments for the past five years as a whole compared with that for the previous five years. For 1965 to 1969 inclusive, the aggregate basic deficit was £817 million. For 1960 to 1964, it was £1,161 million. The aggregate current account deficit in the last five years was £306 million; and, for the previous five years £436 million. There is, of course, the additional difference that the five years to 1964 ended in record deficit. The past five years have ended with a record surplus.

Debt repayment

I turn to the question of our short and medium-term debts. These reached their peak at the end of December, 1968. The total was then 8,071 million dollars, or £3,363 million. It was a formidable sum, but it bore no relationship to the wildly exaggerated figures which were bandied about in some quarters. As late as June of last year the right hon. Gentleman the Member for Stafford and Stone (Mr. Hugh Fraser), for example, was claiming that figures of this order were "infinitely lower" than the total we owed abroad by means of central bank and similar arrangements. He was infinitely wrong.

The true figure, indeed, could always be fairly closely calculated, after a short time-lag, by anyone who applied himself carefully and objectively to the published sources. At the time of the Budget last year we published figures of the balance of payments deficit and outflow which pointed to a broad measure of total debt of about £3,100 million. This, indeed, could have been inferred from the regular published series. Of course, there was concealment of short-run changes. At a time when pressure upon sterling was very severe, this was necessary in the national interest.

That time, I am glad to say, is now well past. I shall describe the position in full detail today, and thereafter publication will be resumed quarterly in arrears. The information about the use of central bank facilities will be published in the Bank of England Quarterly Bulletin, as it was up to March, 1966.

By short and medium-term debt I mean the assistance which we took from the I.M.F., central banks, and certain other institutions such as the Bank for International Settlements. I do not include longer-term obligations, details of which are always published and almost all of which were incurred before 1964. Since then, there have, in this category been two German offset loans and borrowing from the Ex-Im Bank to finance the purchase of U.S. military aircraft. The total of these loans since 1964 now outstanding is about £300 million. They have been exceeded during this period in a ratio of 8 to 1 by our private long-term investment abroad.

Nor, of course, do I include what are commonly called the sterling balances. These are liabilities, but of a very different character from our other debts, and they have been with us for a very long time. They are part of the working balances and reserves of the sterling area countries, and the working balances, too, to some limited extent, of those outside the sterling area who trade with us and with the sterling area. They are an important part of world liquidity, which, if not held in sterling, would have to be held in some other currency.

I thought that I detected on the part of the right hon. Member for Bexley (Mr. Heath) last autumn a tendency to suggest that repayment of genuine debt out of an increase in these balances ought not really to count. That would be a very perverse argument, for, in fact, a considerable part—just under one-third—of the debts we incurred since 1964 were because of a run-down of the sterling balances. It would certainly be totally inconsistent to count an increase in debt because of a run-down here, and not to count a reduction of debt because of a build-up.

In any event, the sterling balances of overseas countries at present are still significantly below—approximately £500 million below—their level at the end of the third quarter of 1964. These liabilities need to be reckoned alongside our much more substantial assets abroad, and our net overseas assets position is better than was the case 5½ years ago.

Having dealt with those two possible areas of confusion, I return to the central question of short and medium-term debt as always understood both here and abroad. At the end of 1968, as I have said, this amounted to £3,363 million. Our reserves then stood at £1,009 million. Our net adverse short and medium-term foreign exchange position was, therefore, £2,354 million.

In the first quarter of 1969, we repaid debt to the extent of £252 million. In the second quarter, we repaid another £93 million. This quarter included the intense bout of deutschemark speculation in May, but we nevertheless finished quite well up. The third quarter began well and I was able to announce in the middle of July that we had repaid almost 1 billion dollars—equivalent to over £400 million—of debt since the beginning of the year. By the end of the month, that is, July, 1969, we had exceeded that mark.

August and September were difficult months. French devaluation disturbed August. September was dominated by a new bout of deutschemark speculation, but we were able to ride it reasonably well, owing to the manifest turn in our own balance of payments. As a result, our net borrowing in the quarter amounted to only £43 million—a setback, but not a severe one.

In the last days of September and the early part of October the question of the parity of the deutschemark, which had overhung the world monetary scene for the previous 18 months, was satisfactorily settled—a tribute to the courage of the new German Government and the Bundesbank. This, together with the clear improvement in our own position, meant that the real turning point had arrived. In the fourth quarter we repaid £397 million of debt. The outturn for the year 1969 was a debt reduction of £699 million, accompanied by an increase in the reserves of £44 million.

Progress so far in 1970 has been even better. In addition to the currency inflow, we also received in January our allocation of £171 million of Special Drawing Rights. Using all these resources, we were able, by the end of March, to reduce debt by a further £1,010 million while adding another £76 million to the reserves.

In sum, therefore, we have improved our position by £1,829 million over the past 15 months. This means that our net adverse position has been reduced by over three-quarters from £2,354 million to £525 million. Our outstanding short and medium-term debt, expressed in dollars, as it usually is for purposes of foreign exchange dealing and selling, has come down from over 8 billion dollars, to under 4 billion dollars. Of the remaining debt, 2,400 million dollars is to the I.M.F., the first repayment of which is due to be made in June, 1971.

Assistance under short-term facilities of the swap variety is down from over 4 billion dollars to 800 million dollars—less than one-fifth of that outstanding at the end of 1968. The Fed. swap, which at 2,000 million dollars is our main line of central bank credit, is now completely clean and unused. I think that it can therefore be claimed that the statement I made in last year's Budget, that there was nothing insuperable about our debts, has been proved wholly true.

This improvement of over £1,800 million has occurred during a 15-month period when our balance of payments surplus, substantial though this is, has been of the order of only £500 million. Some hon. Members who used frequently, but not recently, to ask me questions about how many years' surplus would be necessary to redeem the debt may now understand why I always answered that I could attach little meaning to any direct arithmetical connection. This does, how-ever, raise the question, which may be in some hon. Members' minds, of "hot money".

I do not believe that much of the inflow has been of the kind that occurs purely to take temporary advantage of favourable interest rate comparisons. We discouraged movement of this kind by our own Bank Rate adjustment in early March which was followed by rather larger moves, in the opposite direction, by the Germans and Italians.

The major explanation of the currency inflow we have had so far, apart from the balance of payments surplus itself, has been an unwinding of leads and lags, the unfavourable flows against sterling that had built up over previous years. Indeed, these flows may by now have moved in our favour. The liquidity pressures at home have no doubt pulled in money from abroad, particularly where companies here have been able to adjust the cash-flow from subsidiary or related companies abroad in order to ease the cash difficulty of the heavy tax-paying season. There has also been some re-building of sterling balances to what the holders may well regard as more convenient and normal levels now that confidence in sterling has been restored.

My considered judgment is that for the most part the currency flows going beyond what we have earned by our surplus have been attributable to these factors, and that it would not be accurate to called this "hot money". To some extent there is a seasonal pattern, for example, of sterling balances, which are usually favourable in the first quarter of the year. There may also have been some further seasonal effect through the liquidity pressures of our revenue quarter.

For these reasons, we must expect that during the rest of the year the inflow of currency will be more closely related to what we actually earn by our surplus than in recent months. From time to time, because of the seasonal pattern, there may even be a temporary reversal of the flow. Such movements would not reflect any underlying change either in our own position or in confidence and need not disturb us, for we have proved our ability to repay debt at a very fast rate.

What is left is clearly manageable. We can afford to be slightly more relaxed on this front, but we shall continue to need a strong balance of payments, because our capacity to repay debt will henceforth be more directly related to that surplus; and because we shall continue to need, over the years ahead, to build up our reserves, which are still low by comparison with other major industrial countries.

Monetary policy in 1969–70

Monetary policy has played an important part in the transformation I have described. A year ago I stressed that fiscal and monetary policy would both be more effective if each was working in harmony with the other. The last 12 months have demonstrated that this is so.

The change from a very large Government borrowing requirement to a sizeable surplus on Government account is, of course, the result of decisions in the fields of public expenditure and of taxation, and is in that sense an element of fiscal policy. But the fact that the public sector has been in net financial surplus with the other sectors of the economy, and, therefore, a net repayer of debt, has had important implications for the liquidity of the system, and has also enhanced the effectiveness of Government debt management and the control of bank credit.

The past year has seen a powerful strengthening of the gilt-edged market. In the calendar year 1968, the authorities bought about £200 million of gilt-edged securities from the non-bank public. In the weeks following last year's Budget, rates were allowed to move up to levels which took the redemption yield on some stocks to nearly 10 per cent. Then, with the improvement in the trade figures, the gilt-edged market turned. Apart from a short-lived reversal after the devaluation of the French franc, the market continued firm and at times very strong.

The results, in terms of stock bought from or sold to the non-bank public, are these: in the first half of 1969, net purchases by the authorities from the public of somewhat over £80 million; in the second half of 1969, net sales to the non-bank public from the authorities of nearly £500 million. Figures for the first quarter of 1970 are not yet available, but over much of the quarter the demand for stock continued firm, if not at the exceptionally high levels of the last quarter of 1969.

The other main ingredient in monetary policy has been the control of bank lending. Towards the end of 1968 I asked the London clearing banks and the Scottish banks to reduce their lending in the categories covered by the ceiling to a level 2 percentage points lower than at the time of devaluation in November, 1967. These banks found the task difficult, though other banks were able to achieve the comparable target set for them—probably because the pressure on them was less severe.

At times during the past year it seemed that a rise in restricted bank credit was threatening to undermine the effectiveness of monetary policy. But by September the strength of the gilt-edged market, against the background of the continuing Government surplus, allowed us to take a less rigid view of the requirements for control of bank lending. By the end of the year, provided that the clearing banks themselves did not relax their efforts to restrain credit, it was no longer necessary to judge their achievement simply by success or failure in reaching the 98 per cent. ceiling. In fact, over the calendar year 1969, restricted lending by the banking system as a whole fell by about £40 million.

Our policies have, moreover, brought about a very marked and satisfactory change in the pattern of lending within the ceiling in favour of the categories to which we have given priority in the interests of the balance of payments. There was, alongside this, a substantial rise in the unrestricted categories of lending in 1969, notably in fixed rate guaranteed credit for exports and shipbuilding, and the total increase in bank lending to the private sector was about £600 million.

To sum up, then, monetary policy in 1969 was very tight by any standard. In a year in which the external transactions of the public sector were adding to the money supply, this increased by about £400 million, or under 3 per cent., compared with a rise of £987 million, or about 6½ per cent., in 1968, when the external transactions of the public sector were tending to reduce the money supply.

The figures for domestic credit expansion, which are not directly affected by the external transactions of the public sector, illustrate the tightness of monetary policy even more dramatically: domestic credit contracted by about £200 million in 1969, compared with an expansion of about £1,900 million in 1968. In the financial year 1969–70, for which the full data are not yet available, the contraction of domestic credit will have been greater than in the calendar year 1969. The expectation, expressed in my Letter of Intent to the I.M.F. last May, that domestic credit expansion in 1969–70 would be within a figure of £400 million, has thus been more than fulfilled.