Former chancellor Rishi Sunak is up against Leader of the Commons Penny Mordaunt to become the UK PM. Dear Readers, According to the latest reports, Boris Johnson has pulled out of the messy race for the next Prime Minister of the United Kingdom. Many believe that Rishi Sunak is set to enter 10 Downing Street. But even if that is true, the UK is likely to remain in the throes of a political and economic crisis. How it started It all started when the Liz Truss government presented its “mini-Budget”. In it, she and her chancellor (read finance minister) Kwasi Kwarteng — and it was strictly between them because she later admitted that she never involved the rest of the cabinet members — decided to follow through on a radical plan of increasing government spending and cutting government taxes in a bid to kickstart UK’s stagnant growth while also providing relief to people from high inflation. However, the plan backfired — spectacularly. In fact, it almost created a financial meltdown in the UK. Read this, this, and this to know more. As spectacular as the failure was, it was not altogether unexpected. Rishi Sunak, the man Truss beat in the leadership battle to succeed Boris Johnson as the Prime Minister, had repeatedly warned against going for “unfunded” tax cuts and spending increases. “Borrowing your way out of inflation is not a plan; it’s a fairytale,” said Sunak during one of the debates. Sunak was right. The only quibble one could have with him was to label it a fairytale because it turned out to be a nightmare. Such a dreaded one at that, that it not only cost Kwasi Kwarteng his job but also nipped the Truss premiership in the bud; she is now the shortest-serving PM in the three centuries that the position has been formally held. The nature of the political challenge Now there is a messy succession battle underway. As of early Monday morning, India time, Boris Johnson, the disgraced PM who was booted out in July for attending a party during the Covid lockdown in 2020 (and then lying about it), had decided to abort his bid to run against Sunak and Penny Mordaunt. And while that makes, on paper at least, Sunak, who has a huge lead over Mordaunt, the clear favourite to be UK’s next PM, no one will be surprised if Mordaunt springs a surprise. That’s because while Sunak is seen as a no-nonsense and competent economic policymaker — exactly the kind the UK needs right now — he is not white and, as this viral exchange over a UK radio channel suggests, there might be some reservations among the general public over his taking over as UK’s first non-white PM. Not to mention the fact that he would be the second replacement to the PM’s post by the Tories in their bid to hold on to the 2019 election mandate, and that is seen by many in the UK as a farce on democracy; the Truss experiment clearly being the tragedy. In other words, even if Sunak wins, which seems to be the most likely scenario, the fate of the Conservative party is still on the line. That’s not just because of the economic crisis, which Truss set in motion, but also because of the political crisis of credibility (or the lack of it) that the Tories face. Nature of economic crisis Regardless of who becomes the PM, the nature of the economic challenge is quite daunting. Here are some of the key findings of the analysis done by the Institute of Fiscal Studies (in the UK): 1. In the near term, the key challenge facing the UK economy is the terms-of-trade shock – an increase in the price of imports relative to exports. These effects are boosting inflation, but crimping domestic income. We expect these effects to weigh heavily on demand across both the household and corporate sectors over the coming year… The key policy question is how this loss is allocated. 2. For households, the looming cost shock will hit those least able to bear it…In the medium term, sharp increases in mortgage costs may push any consumer recovery into 2024. 3. The weakness on the supply side of the UK economy is now an urgent concern. While output is 2.6% short of its pre-COVID trend, we estimate current excess demand in the order of 1.4% of GDP. 4. Unemployment is expected to rise in the near term as demand falls. 5. Inflation is expected to rise further and, even though it is expected to fall from its peak (close to12%), it will likely stay high throughout 2023. But it is what the IFS report states towards the end that is most worrisome for any British policymaker. “Policy faces a tricky trade-off steering between the risk of a self-propagating recession on the one hand and the risk of de-anchoring inflation on the other,” states. Simply put, on the one hand, there is the cost of living crisis with retail inflation in double digits. On the other is the problem of stalled economic growth, which, in turn, leads to lower revenues and higher debts. The trouble is as the government curbs spending in a bid to contain inflation, it will further drag down economic growth. And any efforts to boost growth by keeping interest rates low and expanding government spending will likely worsen inflation and further reduce people’s purchasing power. In the coming week, it would be interesting to see what policy response is chosen by Rishi Sunak or Penny Mordaunt, whoever becomes the UK PM. 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