Ruth Lea: Prepare for a taste of nasty medicine as Osborne seeks cure for our financial ills

The Chancellor gave a very clear steer on the overall shape of the

plans in his Emergency Budget in June. He started with Alistair Darling's public sector projections, which had already been tightened, and tightened some more – by 40bn by 2014-15 to be precise. He allowed for 8bn of the extra tightening by way of tax increases, principally the increase in the standard VAT rate to 20 per cent in January 2011, and chopped off 32bn from Darling's spending plans.

At that time, I was convinced this was broadly the right thing to do. There was a severe risk that, if George Osborne had not done this, the credit ratings agencies would have downgraded the rating of Government debt and interest rates would have risen. These higher interest rates could have stifled any recovery.

There are, of course, those who say the financial markets have far too much sway over policy-makers. But if you are borrowing one pound in every four pounds you are spending, as the Government is, then you are dependent on them and you have to take heed of them.

The spectre of the truly shocking public borrowing figures should haunt us all. Suffice to say the financial markets, and the ratings agencies, reacted positively to the plans outlined in the Emergency Budget.

There has been some, though admittedly not much, speculation that the plans may be relaxed and George Osborne may cut less than he announced at the time of the Budget. But such a move would undermine the market's confidence in the coalition Government's determination to correct the severe fiscal imbalances they inherited. He would be most unwise to do this – and I am almost certain he will not. There is, however, a possibility that he may tweak the year-by-year profile of the

tightening.

I am aware of no suggestions that the Chancellor might actually tighten his fiscal retrenchment policies. The probability that he would, thus increasing the risk of a double-dip, is vanishingly small. So, in conclusion, I expect little change to the Budget's overall fiscal profile in the 2010 Spending Review. And I think this is the right course of action.

But just how bad are the cuts and how will they affect the economy? Some perspective is needed. Surprisingly, given the gory talk, total spending is actually due to rise between the current financial year (2010-11) and 2014-15 by 40bn, or six per cent, in cash terms.

Even after allowing for inflation, it may only fall by four per cent over this four-year period – an average of one per cent annually. In the dog-fights that political debates are, these figures are rarely quoted (if ever?) so any sense of perspective is lost. Given this situation, the impact on the economy should be containable and a double dip, in which GDP falls again, seems most unlikely. The private sector would have to perform very badly indeed for this to happen. But, of course, spending cuts will slow the economy.

Looking at the departmental breakdown, while some budgets are likely to be relatively generously treated, others will fare much worse. Much worse.

Firstly, the NHS Budget has been ring-fenced. The NHS has an enormous budget. It is 122bn this year – 17.5 per cent of total spending. And this ring-fencing has significant implications for other departments.

Secondly, spending on international aid has also been ring-fenced.

Thirdly, it is unclear just how many further savings will be demanded by the Chancellor of the welfare budget. Welfare payments, social security benefits and tax credits, take even a greater share of the cake than the NHS. They amount to 193bn this year – nearly 28 per cent of total spending.

Finally, the debt interest payments on the soaring stock of government debt are exploding. In 2008-09, they were 30bn. By 2014-15, they are projected to be 63bn, compared with the present defence budget of 40bn. These rapidly rising debt interest payments are a testament to the poor handling of the public finances over the last decade. And they underline the need for the fiscal stringency now.

A combination of ring-fencing and debt interest payments imply thin gruel for the other budgets. Most are faced with at least 25 per cent cuts in real terms. It seems, however, that the Ministry of Defence may be partly spared, facing only seven per cent cuts, and education may similarly be given preferential treatment with only 10 per cent cuts.

But for the others, including the Business Department, Communities and Local Government, Energy and Climate Change, the Home Office, Department of Justice and Transport, the medicine will be very nasty indeed.