International Monetary Fund (Hansard, 15 December 1977)

§ Mr. Healey

I have written to the Managing Director of the IMF, Mr. Witteveen, in the following terms:

In my letter of 15th December 1976, I described the programme adopted by the United Kingdom to strengthen the balance of payments over a three-year period, to create the conditions for a reduction in the high rates of inflation then prevailing, and to provide a basis for sustainable growth in output, employment, and living standards. During the first year of our stabilisation programme the confidence of the financial markets has returned, the external payments position has strengthened markedly and a decisive turn in the pace of inflation has been achieved.

2. The maintenance of the social contract with the trade union movement, which kept the growth of average earnings to 8 per cent. in the year ending July 1977, has been crucial to this success. The moderation of pay settlements, together with an improvement in our terms of trade and the pursuit of firm financial policies, has led to a marked slowing down in the growth of retail prices. The year-on-year rate of increase had already fallen from 17–7 per cent. in June to 14.1 per cent. in mid-October, and since the spring the underlying rate has been well below the annual rate. This justifies the expectation that the annual increase will fall below 10 per cent. by the middle of 1978.

3. The successful application of the system of cash limits and the use of the contingency reserve as a means of keeping expenditure within the published plans have helped to establish firm control over public spending. The ratio of public expenditure to national income has been reduced. Combined with buoyant revenues and a steady improvement of the finances of the public enterprise sector, this has helped to provide room for further tax reliefs, increased social benefits and assistance to the construction industry.

4. The return of confidence in sterling produced massive inflows of capital which have increased our foreign reserves to over $20 billion by the end of November. These inflows inevitably injected additional liquidity into the economy while exerting persistent upward pressure on the exchange rate. In presenting the 1977–78 Budget I stated the Government's intention of keeping Domestic Credit Expansion (DCE) in 1977–78 well within the limit of £7–7 billion set out in my letter of 15th December 1976 and of maintaining control of the growth of the money supply. The growth of sterling M3 in 1977–78 was forecast as being in the range 9–13 per cent. In recent months, the inflow of overseas funds was reaching the stage at which it was putting the control of the money supply at risk. The Government accordingly felt it necessary to change its intervention tactics in the exchange market in order to remove that risk and to maintain the counter-inflationary thrust of its monetary policies. Following this change short-term interest rates adjusted to a level appropriate to my domestic monetary objectives. The Government remains convinced of the need to provide a stable framework of financial policy on which to build an enduring recovery of the economy in the next year and beyond.

5. These major improvements in the economic situation during 1977 have not, as 321W yet, been accompanied by a resumption of significant economic growth. The fiscal measures announced in October 1977 were designed to strengthen the forces of recovery. Provided earnings can be held within the Government's objectives, growth of about 3 ½ per cent. per annum should be attainable between the second half of 1977 and the second half of 1978 and should be consistent with achieving a significant current account surplus in both 1977–78 and 1978–79. The benefits of North Sea oil will create the conditions in which it should be possible to maintain a surplus on the current account for a number of years. This will be needed to help meet the United Kingdom's external debt repayment obligations and to contribute to the financing of structural capital flows including those arising from export credit.

6. The scope for stimulating the economy further will depend to an important extent on the competitive performance of British industry and on the movement of costs and prices. The industrial strategy is intended to achieve a marked improvement in the trading performance of British industry at home and overseas. Measures to improve productivity, raise investment and encourage retraining are important and continuing aspects of Government policy, and they have the support of management and unions. We have however to take account of past increases in domestic costs higher than those of most other industrial countries and of the recent appreciation of sterling. Large improvements in performance cannot be achieved quickly and the burden of protecting the United Kingdom's competitiveness and thus employment will continue to fall squarely on the containment of domestic costs. We have therefore striven, in close consultation with the Trades Union Congress, and the Confederation of British Industry, to contain the growth of average earnings within limits which will secure the deceleration of inflation to single figures by the middle of next year and thereafter progressively approach the price performance of our competitors in world markets. We shall now be building on the successes so far achieved in countering inflation, and co-operating with our social partners over the next years in order to ensure an increase in employment and a rise in living standards. This is the only way in which we can by our own efforts bring about a significant and sustained reduction in our present unacceptably high level of unemployment.

7. In its approach to the exchange rate, the Government will follow a flexible policy, with the objectives of avoiding disruptive fluctuations in the rate, maintaining monetary guidelines and preserving the competitive position of British industry. In other policies which affect the exchange rate the Government will take account of these objectives.

8. The Government is determined to continue its firm control of public spending, and the counter-inflationary thrust of its monetary policies. It will maintain orderly conditions in financial markets. These will require both control over the money supply and moderation in DCE. DCE for the financial year so far has been well below the level which I originally envisaged: this has been associated with 322W the substantial inflows of overseas funds. This situation has ended with the change of exchange market tactics and I expect DCE to come back nearer to the levels envisaged earlier, and possibly to make up some of the earlier shortfall. Nevertheless, I expect DCE in 1977–78 and the first quarter of 1978–79 together to be within the total of £7 .7 billion earlier envisaged for 1977–78 alone. In addition, I expect the Public Sector Borowing Requirement for 197879 not to exceed the figure of £8 .6 billion referred to in paragraph 14 of my letter of 15th December 1976. I shall take account of these considerations in deciding whether the prospects for the economy, and particularly for wage settlements and prices, make it possible for me to give a stimulus to the economy in my Budget for 1978–79. During next May on the occasion of the normal Article VIII consultation I expect to review policies further with the Fund for the final period of the standby, which expires on 2nd January 1979 unless the Government decides before that date that continuation of the standby is no longer necessary.

9. The Government reiterates its intentions expressed in paragraph 24 of my letter of 15th December 1976 and, in particular, its firm opposition to generalised restrictions on trade, and does not intend to introduce restrictions on imports for balance of payments reasons. The Government has stated that it is prepared, in current economic circumstances, to consider the further use of temporary selective measures where particular industries which are viable in the long term are suffering serious injury as a result of increased imports. It remains the Government's intention to reduce such selective measures as exist as soon as circumstances permit.

10. The United Kingdom is determined to make its fullest contribution to the expansion of world trade. But its capacity to do so will depend on how fast other countries expand and on their willingness to maintain open markets and non-discriminatory trading arrangements.