Focus: Mr Brown can't go to town

IN THE WEEK after the general election last May, Gordon Brown had a meeting at No 10 with Tony Blair. The new Chancellor of the Exchequer's nails were even more bitten than usual as he walked into Downing Street. He had just completed his first proper analysis of the economy, and realised that there would be trouble ahead. "The first year will be fine," he told the Prime Minister as they sat down to their coffee, "but things are going to get a lot more difficult after that."

Last week Mr Brown's prediction came true. He was forced to slash his forecast for the rate at which the British economy will grow next year. This could put the Government's lavish spending programme and thousands of jobs at risk. At the time of the Budget in March, the Treasury accounted for its generous distribution of funds to schools and hospitals by forecasting growth of between 1.75 and 2.25 per cent next year. Now, the Chancellor expects growth of around 1 per cent, meaning he will not only get less in tax receipts but must pay out more in welfare support. According to the Institute of Fiscal Studies, the gap translates into a black hole in the Government's finances of nearly pounds 15bn over the next three years.

In simple terms this means that Mr Brown has to do one of three things to compensate - cut spending, raise taxes, or increase public borrowing. In fact the Treasury insists there is enough surplus money around to do none of these in the short term. But this assumes that the crisis will sort itself out pretty quickly. If the rest of the world continues to plunge into recession - as a quarter of it already has - then the British economy has little hope of turning around on its own, and the Government will have to take one of these "tough choices".

This is crunch time for the Iron Chancellor. He may have got his wish of 0.25 per cent cut in interest rates - announced on Thursday by the Bank of England's Monetary Policy Committee after a series of heavy hints by the Treasury - but the difficulty is not over yet. This week the Government's round-up of independent economic forecasts will predict growth of only 1.1 per cent next year; economists at Goldman Sachs are already warning that it could be as low as 0.5 per cent, while those at JP Morgan believe that the country will go into recession in the first half of 1999.

MINISTERS ALSO fear that the unemployment figures out this week will bring more bad news. Even if the recent round of job losses has not yet impacted on the statistics, it will do so soon because longer dole queues are an inevitable consequence of a slowdown in the economy. The presentation- obsessed Government is so worried about the public relations nightmare ahead that it has privately set up a new strategy for co-ordinating the announcement of job losses so that it can publicise positive stories about factories opening at the same time.

In his 18 months as Chancellor Mr Brown has never faced a challenge on this scale. For the first time he is in a situation where circumstances are largely beyond his control. Until now, his difficult decisions - for example, the cut in lone-parent benefit - have been either announced by somebody else or combined with some apparent act of generosity. Neither option is open to him now. Nobody is suggesting that the global financial crisis is Mr Brown's fault, but that doesn't mean he won't have to take responsibility if the British economy slumps. In bad times, all chancellors tend to become isolated. If things work out, he'll have to share the credit with the Prime Minister; if they don't, Mr Blair can wash his hands of the whole thing and blame his money man. "This is Gordon's first big test," one member of the Government says. "Since the election he's taken responsibility for very few things that have been really unpopular - he has either passed the buck or spun his way out of trouble. He can no longer do that."

It was with some trepidation that the "Treasury FC" - as the football- loving Mr Brown, his press secretary, Charlie Whelan, and his economic adviser Ed Balls are nicknamed - flew to Washington last weekend for talks with other world economic leaders. As Bill McDonough, president of the New York Federal Reserve, said when he arrived for the meetings of the International Monetary Fund and the World Bank, those present were facing the "most serious financial crisis since the Second World War".

Mr Balls had already been out to the US the week before to lay the groundwork with the Americans - he had discussed with them the idea of a global regulator as a way of preventing future crises, and agreed on the importance of interest-rate cuts. It had also become clear that economies around the world were slowing down and that the Chancellor would have to come clean about the reduction in the growth forecasts for Britain.

Mr Brown had discussed the matter with Mr Blair at the Labour Party conference in Blackpool. The Prime Minister had agreed that the Government could not ignore the facts and would have to revise its estimates, however embarrassing that might be. Both men tried to prepare the ground by warning of "tough times" ahead in their conference speeches.

The timing was crucial. After speaking to Mr Blair from Washington, Mr Brown decided that he should set out his stall on Tuesday. He cancelled the previous night's trip to a bar to watch a recording of the Arsenal- Newcastle football match in order to prepare. But his announcement came less than 24 hours before the Monetary Policy Committee was due to decide on the future of interest rates, and it left him open to criticism that he was trying to "bounce" the experts into a cut. The Chancellor deliberately underplayed his statement, saying that "slower world growth makes it inevitable that growth in Britain next year will be more moderate".

ACCORDING TO the Institute of Fiscal Studies, every percentage point by which growth falls next year will mean a loss of pounds 2bn to the Government in 1999-2000, pounds 6bn in the following year and pounds 8 billion in the year after that. As a proportion of the Government's income of pounds 400bn, these are not huge figures but they are significant. The Treasury argues that they can be countered by the "cushion" put in place for just this situation: the surplus (tax receipts minus spending) is predicted to be around pounds 7bn next year, then pounds 10bn and pounds 13bn in subsequent years. But these figures will be lower if growth slows down and could be wiped out altogether if it does not pick up again. Carl Emmerson, research economist at the IFS, says: "The question is, is the cushion enough? If the slowdown only lasts one year then that is not a problem, but if it is more prolonged and deeper than expected then the Government is in difficulty."

David Walton, economist at Goldman Sachs, also warned that eating into the surplus would reduce the Chancellor's flexibility in future. "He has pretty much used up his room for manoeuvre. He's said this is the amount of money we have got, he has committed it, and hasn't left that much in reserve." David Heathcoat Amory, shadow chief secretary to the Treasury, believes Mr Brown will inevitably have to put up taxes or increase borrowing. "The Iron Chancellor is rusting," he says.

Tony Blair is certainly worried about the economy - Downing Street insiders say it occupied most of his thoughts while he was on holiday during the summer. But it is Mr Brown who has most to lose. The longest anyone this century has survived as Chancellor of the Exchequer is Lloyd George, who was in the post seven years and two months. It was possible to imagine Gordon Brown breaking that record. Now you might not want to bet on it.