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T O P SECRET
Copy No
28
C P ( 7 6 ) 111
22 N o v e m b e r 1976
CABINET
IMF NEGOTIATIONS
M e m o r a n d u m b y t h a C h a n c e l l o r of t h * E x c h e q u e r
BACKGROUND
1.
In t h i s p a p e r I put b e f o r e m y c o l l e a g u e s m y c o n s i d e r e d a s s e s s m e n t
of t h e p r o s p e c t b e f o r e u s , a n d of t h e m e a s u r e s w h i c h t h a t p r o s p e c t r e q u i r e s
us to take,
2.
I t £s c l e a r f r o m t h e l a t e s t s h o r t - t e r m f o r e c a s t s t h a t a t t h e p r e s e n t
p l a n n e d l e v e l s sf e x p e n d i t u r e a n d t a x a t i o n w e s h a l l f a c e v e r y s e v e r e
financing p r o b l e m s over the next y e a r o r t w o , both at h o m e and a b r o a d .
The
l a t e s t f o r e c a s t for the public s e c t o r b o r r o w i n g r e q u i r e m e n t (PSBR) in
1 9 7 7 - 7 8 i s b e t w e e n £ 1 0 ^ b i l l i o n a n d £11 b i l l i o n ; a n d t h e f o r e c a s t d e f i c i t on
t h e c u r r e n t a c c o u n t of t h e b a l a n c e of p a y m e n t s n e x t y e a r i s £ 1 . 6 b i l l i o n t o
w h i c h w e m u s t a d d t h e d e f i c i t of £1*4 b i l l i o n on c a p i t a l a c c o u n t , m a k i n g a
t o t a l of a b o u t £ 3 b i l l i o n .
Unless we take action to d e a l with this situation,
w e f a c e a f u r t h e r s l i d e I n t h e s t e r l i n g p a r i t y a n d a n u n c o n t r o l l e d g r o w t h of
t h e m o n e y s u p p l y - a n d b o t h of t h e s e would r e f u e l t h e e n g i n e of i n f l a t i o n .
F u r t h e r m o r e , d o m e s t i c a l l y , w e s h o u l d f a c e t h e c o n t i n u i n g p r o s p e c t of h i g h
i n t e r e s t r a t e s , r e s t r i c t i o n s on bank lending and continuing d a m a g e t o o u r
industrial policy.
3,
At p r e s e n t we a r e holding o u r own w e l l in both t h e foreign e x c h a n g e
and the gilt-edged m a r k e t s .
This owes much to the fact m a t people know
we h a v e t h e I n t e r n a t i o n a l M o n e t a r y F u n d ( I M F ) t e a m h e r e - a n d t o t h e
expectations which that h a s c r e a t e d .
H o w e v e r , we cannot e x p e c t
c o n f i d e n c e t o c o n t i n u e u n c h e c k e d , if w e d o n o t a c t f a i r l y s o o n t o m e e t t h o s e
expectations.
T h e r e s e r v e s a t e n d - N o v e m b e r w i l l b e j u s t o v e r $ 5 b i l l i o n of
which $1.6 billion in gold and S p e c i a l D r a w i n g R i g h t s i s not liquid.
Of t h e
r e m a i n i n g $ 3 , 4 billion, $1.6 billion h a s to be r e p a i d on 9 D e c e m b e r , leaving
$1.8 billion.
T h i s i s why we m u s t r e a c h a g r e e m e n t with the' I M F .
If w e
f a i l o r if t h e r e i s w h a t t h e m a r k e t s r e g a r d a s o m i n o u s d e l a y , t h e e x c h a n g e
r a t e will slide - p e r h a p s plunge - and we will not have the r e s e r v e s t o stop i t .
4.
Having considered all the possibilities, I a m convinced that we need
t o m a k e a significant adjustment in fiscal policy, to m e e t the situation.
And
it Is c l e a r f r o m m y d i s c u s s i o n s with t h e m t h a t the IMF t e a m h e r e s h a r e t h a t
judgment,,
I M F DISCUSSIONS
5,
In a l l d i s c u s s i o n s s o f a r t h e F u n d h a v e e m p h a s i s e d t h a t t h e i r
o v e r r i d i n g c o n c e r n 1B t o s e e a m a r k e d i m p r o v e m e n t i n t h e U n i t e d K i n g d o m ^
e x p o r t p e r f o r m a n c e and a s u s t a i n e d p r o g r a m m e for e c o n o m i c r e c o v e r y over
the next two y e a r s .
T h e y h a v e b e e n a t p a i n s t o p o i n t o u t t h a t t h e y s e e it a s
n o p a r t of t h e i r f u n c t i o n t o d i c t a t e p o l i c i e s t o t h e U n i t e d K i n g d o m G o v e r n m e n t .
G i v e n t h e l i m i t e d s c o p e of o u r n e g o t i a t i n g a u t h o r i t y , h o w e v e r , t h e y h a v e , a t '
o u r r e q u e s t . I n d i c a t e d a n u m b e r of o b j e c t i v e s w h i c h t h e y b e l i e v e w e s h o u l d ,
need t o adopt in o r d e r t o p e r s u a d e the B o a r d and our m a i n c r e d i t o r s that our
p o l i c i e s a r e v i a b l e ; and have e x p r e s s e d p r e f e r e n c e s about the m o s t effective
m e a n s of a c h i e v i n g t h o s e o b j e c t i v e s .
6,
The Fund t e a m accept that, given the social and political s t r a i n s
Involved in a too r a p i d a d j u s t m e n t , the p r e s e n t i m b a l a n c e In t h e e c o n o m y
c a n n o t b e e l i m i n a t e d In l e s s t h a n t w o y e a r s .
This is to be w e l c o m e d .
They
a r e c o n v i n c e d , h o w e v e r , t h a t if c o n f i d e n c e i s t o b e r e s t o r e d , o u r a l m s s h o u l d
b e t o w o r k t o w a r d s t a r g e t s f o r 1 9 7 8 - 7 ? of £ 5 b i l l i o n f o r d o m e s t i c c r e d i t
expansion which leads to £67 billion for the PSBR.
Provided early action
was taken t o validate a credible path to those f i g u r e s , and provided the m i x
of p o l i c i e s w a s s u c h a s t o s u s t a i n c o n f i d e n c e , t h e y w o u l d e n v i s a g e t h a t w e
t h e n h a d a good p r o s p e c t of a c h i e v i n g a n o u t p u t g r o w t h r a t e of a b o u t l £ p e r
cent i n 1977-78 and 4 p e r c e n t i n 1978-79.
On t h e s e a s s u m p t i o n s , a n d
a s s u m i n g that confidence will allow i n t e r e s t r a t e s t o c o m e down, t h e / see the
n e e d f o r a f i s c a l a d j u s t m e n t f o r 1 9 7 8 - 7 9 of f 3 - £ 4 b i l l i o n a t 1976 S u r v e y
prices.
T h e i r confidence that we s h a l l achieve a 4 p e r cent growth r a t e in
1978-79 a f t e r s u c h a s u b s t a n t i a l f i s c a l a d j u s t m e n t r e s t s on a n expectation
that, by allowing the exchange r a t e to d e p r e c i a t e in line with o u r p r e s e n t
s t a t e of c o m p e t i t i v e n e s s , w e s h a l l a c h i e v e a l a r g e e x p a n s i o n in o u r n e t
exports that y e a r , and that.Industrial investment will be rising strongly.
To
the extent t h a t t h e s e e x p e c a t i o n s a r e not r e a l i s e d , the Fund would be
p r e p a r e d to contemplate some d e m a r c a t i o n f r o m the PSBR t a r g e t .
7.
In d i s c u s s i o n with officials, the F u n d t e a m o r i g i n a l l y a r g u e d t h a t , t o
have m a x i m u m effect, this adjustment should be achieved solely through
savings on public e x p e n d i t u r e .
T h e y a c k n o w l e d g e t h a t tht* i s a m a t t e r f o r
the G o v e r n m e n t t o d e c i d e , but a r g u e t h a t the a d j u s t m e n t would need t o b e
m o r e s e v e r e if p u b l i c e x p e n d i t u r e w e r e n o t t h e m a i n s o u r c e of s a v i n g s .
8,
F o r 1 9 7 7 - 7 8 t h e F u n d t e a m b e l i e v e s t r o n g l y t h a t w e Bhould not riBk
losing the chance t o r e s t o r e confidence by doing too l i t t l e .
They argue that
t h e r e w o u l d b e d i s p r o p o r t i o n a t e b e n e f i t s if w e s e t a t a r g e t b e l o w t h e l e v e l of
£9 billion which I announced in July.
They a r e , t h e r e f o r e , looking for a
P S B R of a b o u t £ 8 ^ b i l l i o n t o b e a c h i e v e d pi?Uim.*'ily b y m e a n s of p u b l i c
expenditure savings,
ASSESSMENT
9,
T h e s c o p e of a c t i o n r e q u i r e d m u s t i n e v i t a b l y b e a m a t t e r of j u d g ­
ment.
I h a v e a l r e a d y p e r s u a d e d t h e I M F ta%m t o r e d n e e I t s i n i t i a l d e m a n d
f o r p u b l i c e x p e n d i t u r e c u t s in t h e c o m i n g y e a r a n d w i l l c o n t i n u e t o
n e g o t i a t e v e r y t o u g h l y o n t h e s c a l e of t h e a c t i o n r e q u i r e d n o w t o a f f e c t t h e
outcome In 1978-79.
10.
In m y j u d g m e n t , h o w e v e r , t h e b r o a d s c a l e of t h e a c t i o n t h e y n o w
/
s u g g e s t i s a b o u t r i g h t if w e a c c e p t t h e i r v i e w of t h e p a t t e r n of g r o w t h i n t h e ,
next two y e a r s .
I n a n y c a s e w e n e e d t o t a k e a c t i o n on t h i s s c a l e t o r e s t o r e *
c o n f i d e n c e a n d r e - e s t a b l i s h c o n t r o l of o u r c u r r e n c y .
T h e b u l k of t h i s
a c t i o n should b e t a k e n through r e d u c t i o n s in public e x p e n d i t u r e , but t h e s e
might need to be supplemented by s o m e further i n c r e a s e s In taxation,
p a r t i c u l a r l y f o r 1 9 7 8 - 7 9 , if t h e f o r e c a s t s t h e I M F h a v e a c c e p t e d a s a b a s i s
for t h e i r s u g g e s t i o n s p r o v e t o b e c o r r e c t .
If on t h e o t h e r h a n d . t h e P S B R
p r e d i c t i o n s w h i c h h a v e b e e n t a k e n a s a b a s e p r o v e t o b e t o o p e s s i m i s t i c , it
m a y b e p o s s i b l e t o m a k e s o m e r e d u c t i o n s In d i r e c t t a x a t i o n w i t h o u t m i s s i n g
the new PSBR t a r g e t s .
M o r e o v e r , t h e I M F staff h a v e a g r e e d t h a t if t h e
g r o w t h of n a t i o n a l o u t p u t i n 1 9 7 8 - 7 9 w e r e t o p r o v e l o w e r t h a n t h e y a s s u m e ,
a l a r g e r PSBR t a r g e t for that y e a r could be envisaged.
PUBLIC EXPENDITURE
11.
I n c o n s i d e r i n g h o w b i g t h e p u b l i c e x p e n d i t u r e c o m p o n e n t of a p a c k a g e
should b e , m y c o l l e a g u e s w i l l n a t u r a l l y w i s h t o k n o w what would b e involved.
A s a g r e e d e a r l i e r o n , w o r k h a s b e e n c a r r i e d out b y o f f i c i a l s of t h e T r e a s u r y
and the D e p a r t m e n t s concerned on reductions which might b e technically
p o s s i b l e , s t a r t i n g in t h e p e r i o d i m m e d i a t e l y a h e a d .
This can be completed
a n d c i r c u l a t e d i n t h e l i g h t of o u r d i s c u s s i o n .
Meanwhile I will Indicate
b r i e f l y t h e k i n d of o p t i o n s I n v o l v e d .
12.
T h e f u l l l i s t of p o s s i b i l i t i e s w h i c h h a s b e e n d r a w n u p , f r o m w h i c h a
s p e c i f i c s e t of m e a s u r e s c o u l d b e c o n s t r u c t e d , c o u l d p r o d u c e s a v i n g s of a b o u t
£ 3 b i l l i o n i n a f u l l y e a r if a l l of t h e m w e r e a d o p t e d .
T h i s would involve a
m o r a t o r i u m f o r a f u l l y e a r of a l l p u b l i c s e c t o r c o n s t r u c t i o n p r o j e c t s n o t
a l r e a d y c o m m i t t e d , excluding the nationalised I n d u s t r i e s but including
housing.
T h i s w o u l d a c c o u n t f o r a b o u t o n e - t h i r d of t h e £ 3 b i l l i o n .
It
w o u l d a l s o r e q u i r e t h e t o t a l c a n c e l l a t i o n of u p r a t l n g s of s o c i a l s e c u r i t y
benefits and public s e c t o r p e n s i o n s n e x t y e a r , and In addition i t would
r e q u i r e f u r t h e r s p e c i f i c s a v i n g s i n a w i d e r a n g e of p r o g r a m m e s i n c l u d i n g
health, education, aid, defence and Industrial support.
Such m e a s u r e s
would b e t e c h n i c a l l y f e a s i b l e but politically v e r y difficult to a c c e p t .
13.
W e c a n n o t b e s u r e i n a d v a n c e of a d e t a i l e d n e g o t i a t i o n h o w f a r w e may­
h a v e t o go on public e x p e n d i t u r e t o m e e t the F u n d 6 o b j e c t i v e s , but I think
w e m u s t i n a n y c a s e b e p r e p a r e d t o m a k e s a v i n g s of £ 1 ^ b i l l i o n i n 1 9 7 7 - 7 8 ,
r i s i n g b y a f u r t h e r £ ^ b i l l i o n t o £ 2 b i l l i o n i n 1 9 7 8 - 7 9 a t 1976 S u r v e y p r i c e s .
I n m y j u d g m e n t s a v i n g s of t h i s s i z e a r e t h e m i n i m u m n e c e s s a r y t o g i v e u s a
r e a s o n a b l e p r o s p e c t of c a r r y i n g t h r o u g h t h e F u n d n e g o t i a t i o n s t o a
s u c c e s s f u l conclusion, and t o r e - e s t a b l i s h confidence in the m a r k e t s .
My
o f f i c i a l s h a v e a l r e a d y d o n e s o m e w o r k o n i l l u s t r a t i v e p a c k a g e s of d i f f e r e n t
m a g n i t u d e s , t h e l a r g e s t of w h i c h w o u l d m e e t t h i s r e q u i r e m e n t .
A n y of t h e s e
i l l u s t r a t i v e p a c k a g e s would involve s o m e a c t i o n , b u t l e s s d r a s t i c , on a l l t h e
i t e m s which I h a v e a l r e a d y m e n t i o n e d , eg s o m e p a u s e In n e w c o n s t r u c t i o n
'
c o m m i t m e n t s , b u t f a i l i n g s h o r t of a 12 m o n t h s m o r a t o r i t u n a c r o s s t h e b o a r d j
a n d s o m e s a v i n g on b e n e f i t s a n d p u b l i c s e r v i c e p e n s i o n s , b u t n o t a t o t a l
c a n c e l l a t i o n of t h e n e x t u p r a t i n g s .
T h e h i g h e r l e v e l of s a v i n g s i n t h e
s e c o n d y e a r w o u l d l a r g e l y b e s e c u r e d b y t h e c a r r y - t h r o u g h of t h e f i r s t - y e a r
m e a s u r e s , s o m e of w h i r h w o u l d h a v e a n i n c r e a s i n g e f f e c t ; b u t s o m e of t h e
o t h e r f i r s t - y e a r m e a s u r e s would not c a r r y t h r o u g h in full, s o t h a t s o m e
additional action would be r e q u i r e d t o achieve t h e l a r g e r total i n 1978-79.
1
14.
T h u s , a m o n g other o p t i o n s , we should have t o c o n s i d e r s u b s t a n t i a l
f u r t h e r e c o n o m i e s In t h e h o u s i n g p r o g r a m m e f o r t h a t y e a r , p r o b a b l y b y a
r e d u c t i o n i n t h e l e v e l of n e w c o u n c i l h o u s e c o n s t r u c t i o n a n d / o r l e g i s l a t i o n t o
allow for a m a r k e d r e a l i n c r e a s e in local authority r e n t s .
Another possible
Bource of s a v i n g s w o u l d b e a f u r t h e r s u b s t a n t i a l r e d u c t i o n i n d e f e n c e
e x p e n d i t u r e beyond t h a t in the i l l u s t r a t i v e p a c k a g e s ; t h i s would r e q u i r e
a n o t h e r D e f e n c e R e v i e w a n d r e c o n s i d e r a t i o n of o u r d e f e n c e c o m m i t m e n t s .
B u t t h e n e e d for s u c h a d d i t i o n a l s a v i n g s i n t h e s e p r o g r a m m e s i n 1978-79
w i l l b e s i g n i f i c a n t l y r e d u c e d if m y c o l l e a g u e s a c c e p t m y p r o p o s a l s , w h i c h
I intend s h o r t l y to b r i n g t o Cabinet, for encouraging a shift t o f o r e i g n
c u r r e n c y f i n a n c i n g of e x p o r t c r e d i t b y a r r a n g e m e n t s w h i c h w o u l d i n c l u d e a
r a i s i n g of i n t e r e s t r a t e s f o r s t e r l i n g - f i n a n c e d e x p o r t c r e d i t .
15.
C h a n g e s i n t h e p l a n n e d l e v e l of b e n e f i t s a n d p u b l i c s e c t o r p e n s i o n s
would r e q u i r e l e g i s l a t i o n .
In t h e f o r m e r c a s e t h e r e q u i r e d p r o v i s i o n s c o u l d
be added to the Social Security (Miscellaneous P r o v i s i o n s ) Bill which is due
to be introduced this week.
The b a s i c idea put f o r w a r d for o u r
consideration is that the statutory r e q u i r e m e n t for m a n d a t o r y upratings
should b e r e p e a l e d o r suspended, and r e p l a c e d by a d i s c r e t i o n a r y p o w e r .
The s a m e a p p r o a c h would be adopted t o public s e r v i c e p e n s i o n s and wonld
affect not only the Civil S e r v i c e b u t a l s o l o c a l a u t h o r i t i e s , the Health
S e r v i c e , t h e p o l i c e , t h e a r m e d f o r c e s , M e m b e r s of P a r l i a m e n t a n d t h e
judges.
The implications for t h e nationalised i n d u s t r i e s would a l s o have to
be examined.
16.
A d e c i s i o n on t h i s l e g i s l a t i o n w i l l b e c r u c i a l t o t h e p a c k a g e a s &
whole.
W e n e e d t o c o n s i d e r a c t i o n o n t h e s e l i n e s n o t m e r e l y f o r t h e s a k e of
the e x p e n d i t u r e r e d u c t i o n s involved but a l s o in o r d e r to d e a l with the
s i t u a t i o n i n w h i c h r e a l l i v i n g s t a n d a r d s of t h o s e o n b e n e f i t o r p e n s i o n s a r e
b e i n g m a i n t a i n e d o r e v e n i n c r e a s e d w h i l e t h e r e a l w a g e s of t h o s e a t w o r k a r e
being squeezed.
NEXT STEPS
17.
W e m u s t t a k e d e c i s i o n s on t h e m a i n i s s u e s w i t h o u t f u r t h e r d e l a y .
Drawings under the June $ 5 . 3 billion standby have t o b e repaid by
9 December.
I t 1B n o t n e c e s s a r y f o r u s t o d r a w m o n e y f r o m t h e F u n d b y
t h a t d a t e , b u t i t i s of v i t a l i m p o r t a n c e t h a t w e s h o u l d b e a b l e t o i n d i c a t e b y
t h e n at l e a s t t h a t we have r e a c h e d a f i r m u n d e r s t a n d i n g with t h e F u n d .
T h e r e a r e f u r t h e r s t a g e s of c o n s u l t a t i o n t o b e c a r r i e d o u t , m a i n l y w i t h t h e
G r o u p of T e n c o u n t r i e s w h o w i l l b e a s k e d t o p u t u p t h e m o n e y f o r t h e F u n d
d r a w i n g , after the t a l k s in London a r e c o m p l e t e d .
P r o g r e s s in the talks has
b e e n s l o w l a r g e l y b e c a u s e of o u r o w n i n a b i l i t y u n t i l n o w t o m a k e c o n c r e t e
proposals.
If w e a r e t o m e e t t h e t i m e t a b l e i t i s n o w e s s e n t i a l t h a t w e s h o u l d
c o m e t o a n u n d e r s t a n d i n g w i t h t h e F u n d t h i s w e e k o n t h e m a i n e l e m e n t s of a
programme.
18.
D e t a i l s of t h e a g r e e m e n t w i t h t h e F u n d c a n b e f i l l e d o u t l a t e r , b u t
t h i s w e e k ' s d e c i s i o n s w i l l h a v e t o c o v e r t h e s i z e of t h e P S B R a n d t h e g r o w t h
of t h e m o n e y s u p p l y i n b o t h 1 9 7 7 - 7 8 a n d 1 9 7 8 - 7 9 ( a l t h o u g h b o t h w o u l d b e
contingent on e c o n o m i c c i r c u m s t a n c e s in t h o s e y e a r s and subject t o r e v i e w )
a n d t h e s i z e of t h e p u b l i c e x p e n d i t u r e e l e m e n t i n t h e a d j u s t m e n t .
CONCLUSION
19.
I r e c o g n i s e t h a t I a m facing m y c o l l e a g u e s with e x t r e m e l y difficult
d e c i s i o n s , b u t I b e l i e v e we a l s o h a v e a n o p p o r t u n i t y t o e s t a b l i s h a v i a b l e p a t h
to recovery over a two-year period.
M o r e o v e r , if n e g o t i a t i o n s w i t h t h e I M F
a r e successfully concluded, we shall have obtained international e n d o r s e m e n t
of t h e v a l i d i t y of o u r p o l i c i e s a n d of t h e r e c o v e r y a t w h i c h t h e y a i m .
This
e n d o r s e m e n t In itself should p r o v i d e a n invaluable b o o s t t o confidence both at
h o m e and a b r o a d .
20.
It i s i n t h i s b e l i e f i h a t I m a k e
the following r e c o m m e n d a t i o n s :
i,
I s h o u l d b e a u t h o r i s e d f o r t h w i t h t o d i s c u s s with, t h e F u n d ,
without c o m m i t m e n t , packages designed to m e e t t h e i r PSBR
r e q u i r e m e n t s , w i t h a p u b l i c e x p e n d i t u r e c o m p o n e n t of £ 1 ^ b i l l i o n i n
1977-78, rising by a further £ f billion to £2 billion in 1978-79; and an
appropriate tax component.
At the s a m e t i m e work should be
c a r r i e d f o r w a r d o n t h e p r e p a r a t i o n of d o c u m e n t s f o r a n a g r e e m e n t
with the F u n d .
ii.
The L o r d P r i v y Seal should be Invited to bring before a s a s
a m a t t e r of u r g e n c y a p a p e r d e a l i n g w i t h t h e q u e s t i o n of a n
amendment to the Pensions (Increase) Act.
iii.
I should b e invited t o a r r a n g e , in consultation with the
S e c r e t a r y of S t a t e f o r S o c i a l S e r v i c e s , f o r a m o r e d e t a i l e d p a p e r t o
b e p r e p a r e d o n t h e I m p l i c a t i o n s of a m e n d i n g t h e e x i s t i n g s o c i a l
security legislation.
T h i s p a p e r would a l s o indicate t h e p r o b l e m s
involved in taxing s h o r t - t e r m benefits.
iv.
T h e S e c r e t a r y of S t a t e f o r t h e E n v i r o n m e n t , i n c o n s u l t a t i o n
with the Chief S e c r e t a r y , T r e a s u r y , should b e invited t o b r i n g
f o r w a r d a p a p e r on p o l i c y o p t i o n s a r i s i n g f r o m t h e H o u s i n g P o l i c y
Review.
The p a p e r s under i i . , iii. and iv. should be available for
meeting.
D W H
Treasury Chambers
22 N o v e m b e r 1976
6
our next
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