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from The Great Debate UK:

How will the privatisation of RBS and Lloyds affect gilt supply?

--Sam Hill is UK Fixed Income Strategist at RBC Capital Markets. The opinions expressed are his own.--

The return of RBS and Lloyds to the private sector is moving up the agenda but as the UK government prepares to set out the strategy for privatisation, the spotlight will, once again, fall on the gilt market and the public finances.

Equity injections approaching £70bn at the nadir of the financial crisis may have provided the banks with a lifeline, but the imprint on the UK’s public finances remains severe. Along with restructuring loans and compensating depositors for failures at other domestic and foreign financial institutions (e.g. Bradford and Bingley, Northern Rock, the Icelandic banks), recapitalising these banks required the government to turn to the gilt market for financing. In financial years 2008-09 and 2009-10 cash totalling £120bn was raised solely for these interventions. This was on top of the £240bn cash requirement needed to plug the rest of the budget deficit.

It was always intended that RBS and Lloyds should only have a temporary period of public ownership but the share prices have not recovered sufficiently to allow the government to fully break even on its investment. On examination though, £13.8bn of the cash raised for supporting Lloyds and RBS was recorded at the time as a permanent hit to the public finances, largely reflecting the loss on buying some shares above the prevailing market level, and should be deemed irreversible. The government therefore has the opportunity to stick to the break-even principle, by targeting privatisation proceeds sufficient to recover the portion of the intervention recorded as temporary. That amounts to £55.1bn, or a 61 pence target for Lloyds shares and 410 pence for RBS.

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