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FEBRUARY 20, 2009

Bank Bailouts, Sinking Revenue Fray U.K.'s Ledger
By ALISTAIR MACDONALD and LAURENCE NORMAN

LONDON -- The combination of government bailouts and falling tax revenue combined Thursday to show the perilous state of the U.K.'s balance sheet.

The country's Office of National Statistics said two bailed-out banks -- Royal Bank of Scotland Group PLC and Lloyds Banking Group PLC -- have been classified as public-sector entities, moving as much as £1.5 trillion ($2.136 trillion) of liabilities to the country's balance sheet.

Meanwhile, the U.K. Treasury reported that tax receipts for January, usually a bumper month, dropped 10% from a year ago to £53.8 billion. Declines were across the board; corporate taxes contributed 20% less than a year earlier and value added tax revenue was down 10%, partly after the U.K. lowered this tax to help stimulate consumer spending. That resulted in the smallest January repayment of debt for the U.K. government in 14 years.

As a result, economists said, Treasury Chief Alistair Darling will have to increase his already massive borrowing forecasts for coming years. That could limit the government's ability to deliver further stimulus to the economy.

"Given the rate at which the U.K. public finances are deteriorating ... it is frankly anyone's guess as to how high the public deficits may go over the next couple of years," said Howard Archer, an economist at IHS Global Insight.

Mr. Archer expects worsening fiscal positions across Europe as tax revenue falls and governments have to spend to stimulate the economy, though he believes the U.K. will be one of the worst hit.

The U.K. isn't the only place where there is debate over classifying bailout recipients as public-sector entities. In the U.S., for example, the Bush administration kept Fannie Mae and Freddie Mac off the federal books, but the Obama administration is expected to decide soon whether to move the mortgage giants onto the federal budget, heaping huge sums on the federal deficit.

Prices of U.K. government bonds, or gilts, tumbled Thursday as concerns mounted over the state of the country's public finances, sending yields higher.

In the fiscal year to January, net public-sector borrowing stood at £67.2 billion, according to government figures, the highest figure since records began in 1993. That compares with £23.1 billion in the year-earlier period. The government has targeted borrowings of £78 billion for the fiscal year that ends April 5.

Government spending in January totaled £45.5 billion, up 6.6% from £42.7 billion a year earlier. That includes an increase of 15% to £13.5 billion in social benefits, such as unemployment insurance.

One large cost has been the attempts to bail out the banking system. That impact was underscored by the classification of RBS and Lloyds as public-sector entities, because the U.K. has effective control of the two banks via government bailouts. The statistics office estimates their liabilities are likely to more than double the government's current debt load, and at £1.5 trillion would equal the country's gross domestic product. The figures, which were expected, don't take into account the banks' assets.

The move won't affect the U.K.'s triple-A credit rating, Moody's Investors Service said.

But as the economy worsens and the government's efforts appear insufficient, economists expect more spending announcements when the Treasury unveils its budget in April.

Capping the grim news for the U.K. government, Bank of England Deputy Governor for Financial Stability John Gieve said that policy makers were taking "very seriously" the risk that the U.K. could experience a 10-year depression like Japan, even if it wasn't "inevitable."
—Sara Schaefer Muñoz and Natasha Brereton contributed to this article.