Whitehall officials are concerned that the collapse of Thames Water could lead to a Truss-style lending crisis.

Whitehall officials are concerned that the financial collapse of Thames Water could lead to a spike in borrowing costs for the government, not seen since Liz Truss’ mini-budget chaos.

They are so concerned about the wider impact of borrowing costs on the UK, including utilities and infrastructure that they think Thames should be nationalised before the election.

Treasury officials and UK Debt Management Office officials fear that unless the UK’s largest water company is renationalised quickly, “prolonged uncertainty” about its fate will “damage UK plc in a sensitive period”, as elections are due in the UK and US this year.

The Guardian published details earlier this month of the government’s contingency plans to renationalise Thames through a special administrative body. The government could end up taking on the majority of the £15bn debt. Thames’ investors are refusing to invest more money in the struggling company due to a dispute with the water regulator Ofwat.

Under the plan, some lenders to the core operating company of the company could lose as much as 40% of their money. Officials believe that this is a delicate balance between managing the public’s outrage over the company’s failures while maintaining investor confidence in UK.

These contingency plans describe the risk of “contagion”, which could be triggered by the plight of Thames, and lead to a drop in confidence that would affect borrowing costs for all states.

After the Truss Mini-Budget in September 2022 UK borrowing costs soared as government bond markets fell into freefall. The Truss mini-budget in September 2022 spooked investors, and the value of UK debt instruments known as gilts plummeted.

This crisis added billions of pounds to the UK’s borrowing costs as investors demanded a higher price to lend to it. The UK’s borrowing cost increased by billions of pounds as investors refused to lend money to the country. Many mortgage offers were withdrawn overnight.

Jeremy Hunt reversed Kwarteng’s tax plans and stabilized debt markets. However, UK borrowing costs have crept back up in recent months due to geopolitical shocks including the Middle East Conflict.

Investors are wary of lending to the UK because of its growing debt and slow economic growth. The UK’s £2.7tn debt is about 98% GDP and will continue growing as the government borrows heavily to upgrade its ageing infrastructure of pipes, cables and water and power.

The International Monetary Fund (IMF), the global lender of final resort, warned that debt vulnerabilities in the UK continue to increase as inflation continues to rise. The IMF said that global bond yields would make it more difficult for borrowers to service their debt.

To fund its expenditure, the British government relies on investors, many of whom are foreign. These loans are in the form of gilts. As yields increase, the prices of these IOUs will fall. Higher yields are usually an indicator of risk.

Investors have traditionally viewed debt issued by regulated utilities, such as water companies, as a safe investment with a risk profile that is similar to gilts.

Whitehall is increasingly concerned that the longer the crisis at Thames continues, the more spillovers will occur. Thames has 16 million customers. Thames said that it had enough money to run its operating company for over a year.

One official said, “It comes at a moment of great political uncertainty in the United States and around the world.” This is not a matter that should be left unresolved. Investors are looking for clarity and certainty, even if it means a temporary pain.

A second official said that there was a real danger of spreading the disease from Thames.

Whitehall officials anticipate that any restructuring in which investors lose money on Thames’ water company will trigger legal action against both the government and Ofwat. Officials still prefer a quick renationalisation which forces lenders to take losses to a lengthy, drawn-out debate about the fate of Thames, which would impact the UK’s need to raise capital to fund infrastructure projects and its general debt issue.

The Debt Management Office, an arm of Treasury, is responsible to issue new UK debt. The body responded to the figures released last week, which showed that Hunt may need to lend more money than initially hoped. It announced an increase of £12.4bn in sales this year. The total amount of UK government debt expected to be sold this year is now £277.7bn.

The government refused to comment on the concerns of Treasury and DMO.

The Department for Environment, Food and Rural Affairs spokesperson said: “Water companies are commercial entities, so it would not be appropriate for the government to comment on Thames Water specifically.”

A recent sale of new bonds recorded the highest borrowing cost for a 30-year bond sold through a syndication – a grouping of lenders – since 2005.