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COMMUNITY UPDATE

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It was thought to be a ‘blood bath’ budget, and for some, the Chancellor of the Exchequer did not disappoint. Rises in taxes and cuts in public services were the main features of what was the most important budget in decades.

On 22nd June the new Chancellor, George Osborne, unveiled an emergency budget amid a fragile economy, rising unemployment and the Greek debt crisis, which was, and still is, shaking the foundations of European economies.
 
Indeed, according to Mark Spelman, Global Head of Strategy at Accenture, “Europe seems to have stumbled with a range of structural deficits epitomised by ‘the Greek Tragedy.’ The challenges of public sector deficits, low growth and high youth unemployment in Europe have made the continent look vulnerable and less relevant on the global stage. Fiscal consolidation has become the latest phrase to dominate the economics vocabulary over the past three months. The premise is that countries need clear budget deficit reduction plans in order to persuade fickle bond markets not to change sovereign debt ratings and push up the costs of financing the debt even further. Yet this argument has had to be balanced with the fear that reducing government spending too fast could choke off a weak recovery. This is still a major concern in Europe given the low projected growth rates of 1 to 1.5 per cent over the next two years.”

Concerned with the wider European context, the UK’s Coalition Government intends to balance the structural deficit by 2015, the end of the UK’s current administration, and create a balanced economy with spending, saving and exporting. According to the Chancellor, the budget “pays for the past, plans for the future and … gives confidence to the economy.”
 
Through, for example, cuts in corporation tax and extending the Entreprise Finance Scheme, the Coalition Government tells us that it is creating “a stable and consistent platform for private sector recovery.” 
 
However, consumers are central to a private sector recovery. An increase in VAT and increased unemployment mean less disposable income, causing businesses to consider the most effective way to boost their sales. Mark Riches, CEO of World Duty Free says, "The right solutions for business should always be driven by understanding their customers’ mentality. Reality will now begin to kick in - people still have high levels of personal debt, inflation is rising, VAT has increased and unemployment is high. Quite a cocktail. Consumers will be even more selective in how and with whom they spend their money. Businesses need to be best in class in their market, focus on their core business and continue to invest. There needs to be a new mentality in the boardroom - more of the same won't be good enough for the next two years, at least."
 
Sandra Macleod, Group CEO of reputation auditors, Echo Research says, "Expectations and sentiment matter - in markets as much as in relationships. The budget was seen to be brave, tackling the issues head on with no messing around, and not as bad as the corporate world had been led to believe.  With this, and in some quarters a slight sigh of relief, our expectations are being set low and tough - so anything better-than-expected will be seen to be a bonus. However, I am watching sentiment more closely now - the comment in the media and around no-frills breakfasts are about tough times ahead, belt tightening, long roads and double dips.  That mood is not a fertile one from which to grow and revitalise an economy - and the balance isn't right yet." 
 
Adam Chester, Head of UK Macroeconomic Research at Lloyds TSB Corporate Markets, believes that this austerity budget raises questions about where growth in the economy will come from as past growth came from capital markets and public spending. “In terms of the big picture, the Chancellor was true to his promise of ‘accelerated’ deficit reduction, announcing an additional net fiscal tightening of £40bn (or 2 per cent of GDP) over and above the £73bn pencilled in by Labour over the next five years. While this may be less than some had hoped for, given that the UK is starting its fiscal consolidation process in a relatively difficult position, we believe it strikes a reasonable balance between fiscal austerity and economic recovery. As widely expected, the majority of the tightening will occur through public spending cuts rather than tax increases. The ratio between these two rises from 60:40 over the next couple of years to 80:20 by 2014/2015. To achieve this fiscal squeeze, while at the same time protecting the NHS and overseas aid, many departments face real spending cuts of 25-30 per cent over the coming years. Although many of these cuts will be difficult to implement politically, the government’s decision to focus the reductions in current spending rather than capital investment is, we believe, a sensible one.”

We asked Dominic Swords, Business Economist at Henley Business School, to provide his insight into the budget and its impact on the economy and businesses. He says:
 
“I expect the UK will grow very slowly this year: not a double dip but not a dynamic bounce back for most people in society. The budget has actually delayed the recovery by a year - a year in which many will feel great hardship. The success of the budget will be in whether that short-term pain is out-weighed by a more robust and healthier recovery thereafter.     
 
“Last month’s emergency budget delivered by George Osborne was both significant and clever.  Significant for the dramatically new direction it has set out for the future of the UK and clever for the way in which funds were found to finance specific new activities.
 
“For the markets – in capital, currency and credit – it has been seen as something of a gamble.  While they liked the clarity of a plan, there are some comments that he may have overdone the size of the deficit reduction. The fact that the budget will actually lead to lower growth than previously forecast for 2010 with higher unemployment, a higher short-term fiscal deficit and will result in a net deficit of well below 3 per cent (the forecast is 1.7 per cent) of GDP in 2015 provide evidence for the size of his additional discretionary fiscal tightening.
 
“If you work in the public sector, the glass contains something of a spiked cocktail or at best some nasty tasting medicine.
 
“Over the last three years, public spending has been a major cushion to stimulate growth. But in the short-term, the forecasts for the rest of the year bring all the main contributors to growth (private consumption, business investment, net exports and public sector spending) down to fractions of a percentage. In fact, the expected 1.2 per cent expansion on which the budget was based for this year is largely dependent on a positive increase in inventories by companies over the next nine months. It will not take much for any of those small growth figures to turn negative. And, in the presence of major cuts in public spending, this is why the risk of a return to recession this year is increased.
 
“In juggling the government’s finances, the Chancellor has gained in stature. He found large sums from cuts in welfare and projected cuts in other areas of the public sector to fund essentially some tax reductions at the lower end of the income scale and for enterprise. His vision for the future is for an economy much more focused on the private sector with the potential for large parts of the public sector delivered by private companies but financed by the state – presumably at greater levels of efficiency than currently in order to achieve his targeted cuts.
 
“It is a vision which has its merits and also its disadvantages. Regardless of that debate, the real issue facing us is about the rate of the transition. Is it simply too quick? Is the removal of government as a borrower from financial markets plus the incentives provided by the budget enough to stimulate private business? The risk that the answer to that question is ‘no’ is very high.”
 
Criticaleye is encouraged by the Coalition Government’s approach to incentivising the growth of the private sector through SMEs. Cuts to both the Corporation Tax and Small Companies Tax will encourage high growth companies, the foundation of the British economy, to grow and provide much needed employment. The government has provided a plan for stability and encouragement for enterprise through a variety of schemes to incentivise innovation and regional growth, which is a very positive step towards recovery. 
 
Please get in touch if you have any comments about the issues in today's update. 
 
I hope to see you soon, 
 
Matthew