Fitch: UK Faces Fiscal Continuity, Constitutional Uncertainty

The UK general election result reduces near-term uncertainty about fiscal policy, but raises long-term constitutional issues, Fitch Ratings says.

The narrow Conservative majority gives greater, but not complete, clarity on the future path of fiscal consolidation. Both the Conservative and Labour parties were committed to reducing the fiscal deficit in the next parliament, and supported the fiscal mandate set out in the Charter for Budget Stability. But the prospect of a hung parliament, to which opinion polls had been pointing throughout the campaign, and possibly a minority government, had raised the risk that making and implementing fiscal policy would become more difficult.

The Conservatives have said they aim to balance the cyclically adjusted current budget by 2017-2018, two years earlier than Labour's pre-election commitment, and using a different balance of revenue and spending measures. Consolidation therefore looks set to continue broadly in line with the March budget and Office for Budget Responsibility (OBR) projections. But certain details of the Conservative programme, such as the composition of planned welfare cuts, remain to be spelt out.

The fiscal mandate, particularly the five-year rolling deficit target, provides substantial flexibility, giving future governments the option to avoid pro-cyclical fiscal tightening in response to weaker economic conditions. But this flexibility may be hindered by pre-election commitments to protect large categories of spending and rule out rises in several major tax categories.

The OBR enhances fiscal transparency and credibility, increasing political incentives to correct budgetary imbalances. But missing or delaying targets for the cyclically adjusted current deficit could reduce fiscal credibility, in our view.

UK debt to GDP remains among the highest of 'AA' and 'AAA' category sovereigns. Further deficit reduction that resulted in a lower and steadily declining government debt ratio would support the UK rating at 'AA+'.

The election will increase pressures for lasting broader constitutional reform, particularly after the Scottish National Party won 56 seats in Scotland. Negotiations about devolution of fiscal responsibility to Scotland will further complicate the fiscal picture. The final arrangement is still unknown but Scotland's relatively small share of the UK economy (around 10%) means the resulting fiscal risks to the UK are likely to be manageable. The UK starts from a position of relative strength in fiscal policymaking. We would not expect the overall fiscal framework to be significantly weakened by further fiscal devolution.

But its slim majority could present a political challenge for the new administration as it seeks to implement its fiscal, UK constitutional, and European policy agenda. UK constitutional reform will need cross-party support, and the government could face internal dissent over Europe.

David Cameron has promised an "in-out" referendum on the UK's EU membership by the end of 2017, after a loosely defined renegotiation. A firm judgement on the sovereign credit impact of the UK leaving the EU (opinion polls indicate meaningful support for membership) is not possible at this stage, because the terms of the exit scenario are highly uncertain. Negotiating the shape of a UK exit would be lengthy and complicated, and a wide variety of outcomes are possible. This prolonged uncertainty could dent UK economic growth by weighing on confidence and investment.