Swallowing a Bitter Tonic

Under immense pressure from the U.S. and West Germany, the British Labor government reluctantly agreed last week to adopt a punishing package of spending cuts and tax hikes in exchange for a critically needed $3.9 billion loan from the International Monetary Fund. The agreement in principle, which will be announced within a week, was reached after a month of tense, sometimes stormy behind-the-scenes negotiations. The talks became so heated that at one point they threatened to provoke a full-scale British Cabinet revolt.

Essentially, Prime Minister James Callaghan agreed to take the politically explosive step of carving $5.8 billion out of Britain's $18 billion budget deficit over the next two years, largely by slashing government outlays. The Cabinet is considering draconian spending cuts, like a moratorium on all government construction. Ministers are further thinking about removing automatic cost-of-living increases from social security payments and civil service pensions, despite an inflation rate now running at almost 15%. Defense expenditures will be cut too (see THE WORLD), but not as sharply as social spending. Some British taxes will have to be raised. The levy most likely to be boosted is the value-added tax--a kind of super-comprehensive sales tax--which is already a substantial 8%.

Any attempt to cut back on Britain's social services will meet raucous opposition from left-wing Laborites in Parliament. But the leftists are not likely to gain enough support among opposing Liberals and Tories to have the spending cuts rejected. Britain does not have much choice. The pound has been in sharp decline through most of the year, dropping from $2.03 in January to $1.66 last week. Moreover, foreign debts are falling due. For example, about $1.6 billion must be paid this month on an earlier loan from the Group of Ten (industrial nations). Britain's creditors, including Arab sheiks and international bankers, have grown increasingly skeptical about its ability to pay its way. Thus, after Whitehall applied for a loan in September, the IMF decided it was time to impose stiff requirements as a condition for its investment.

A special IMF team was sent to London to study the situation and decide what the loan requirements should be. The team members, who lived in a hotel under false names, found anything but a country in the grip of austerity; one night they were turned away at two Soho restaurants because the tables were so crowded with customers. The IMF representatives at first wanted Britain to cut its deficit almost in half, to $9.9 billion in two years, but later settled for the $5.8 billion reduction. Yet, as TIME'S Frank Melville learned, when Chancellor of the Exchequer Denis Healey presented the package to the rest of the Cabinet, he was confronted with a wall of angry opposition from the right and the left.

To satisfy his ministers, Callaghan agreed to speak personally with U.S. President Gerald Ford and West German Chancellor Helmut Schmidt, whose countries will have to put up most of the money for the IMF loan. He spoke on the transatlantic telephone to Ford, and cornered Schmidt face to face at a European Community meeting in The Netherlands last week. Both men refused to budge on the conditions sought by the IMF. Some British Cabinet ministers were dazed at the news that Schmidt, a social democrat like the British Laborites, had been every bit as tough as Republican Ford.

Financial Help. Callaghan did get one sweetener from Ford and Schmidt: they agreed to provide financial help in easing the problem of sterling balances, which weaken the pound's stability. Sterling balances are pound deposits held in British banks by foreigners that can be withdrawn on a moment's notice; they are often dumped on foreign-exchange markets at the first sign of economic trouble. Callaghan, like many other Prime Ministers before him, wants to convert these volatile short-term deposits to long-term debts; precisely how this will be done and what kind of financial help the U.S. and West Germany will extend to accomplish it remain to be negotiated.

Despite that, Callaghan will have a tough job persuading British public opinion to buy his agreement. The main concern of his top aides is that the sharp cuts in public spending could reverse the willingness of British unions to negotiate a third stage of wage ceilings next year. For the past year and a half, union cooperation in holding down wages has been the foundation of Britain's anti-inflationary policy. That a Labor government should be forced to take that risk in order to satisfy foreign creditors is a true measure of how perilous Britain's situation has become.

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