Despite the enthusiasm accompanying the Brexit deal and Covid-19 vaccination programme, analysts remain concerned.
The UK's Houses of Parliament are in for a shocking time
As 2020 drew to a close, the UK’s investor prospects were improving.
The ability to reach a deal with European partners to avoid a cliff-edge Brexit at the end of the transition period and the start of the mass vaccination programme gave financial markets a boost against the backdrop of a stronger economic outlook for 2021.
Bruce Morley, an economics lecturer at the University of Bath, underlined this positivity.
“It seems to me the risks to the UK economy have declined due to the trade deal with the EU producing a relatively smooth Brexit,” he said.
“Also, the start of the vaccination programme has hopefully meant the problems with the coronavirus will be coming to an end in a few months, [not to mention the fact] there is government stability.”
Prime minister Boris Johnson’s Conservative Party has a working majority of 87 seats in the House of Commons, taking into account the non-voting Speaker and deputies, and non-sitting Sinn Féin MPs, with no requirement to call a general election until May 2024.
Yet only days into the new year, the confidence in UK PLC is dissipating as another national lockdown has been implemented – delaying economic recovery – with concerns about the Brexit agreement, unemployment and fiscal metrics dominating, despite low borrowing rates ensuring debt servicing is manageable.
In December, the OECD was predicting that general government gross debt would rise from 117% of GDP in 2019 to 160% by 2022 under the assumption the general government deficit would narrow but remain large at 13.3% of GDP in 2021 and 8.8% in 2022, after having increased to an estimated 16.7% in 2020.
That compares with a deficit of just 2.4% of GDP in 2019, with the unemployment rate seen rising to 7.4% this year from 4.6% in 2020, before easing to 6.2% in 2022.
However, the new national lockdown – to be reviewed, but with no promise of being lifted, by mid-February – will invariably weaken the economy again, making it hard to achieve the OECD’s 4.2% GDP growth forecast for this year.
Clearly the race is on to vaccinate a sufficient share of the UK’s 67 million strong population to ease pressure on the National Health Service, with daily infections rising above 60,000 for the first time, worsened by the fact the new strain of the virus is more infectious.
My view on Brexit has always been that it would harm the British economy. However, the full extent will only become visible now and I am afraid it is worse than what everyone expected
- Christian Richter, Coventry University Knowledge Hub
In the meantime, economists are now anticipating a double-dip recession and are downgrading their GDP forecasts for 2021, despite the Brexit trade deal.
One of those is Philip Rush, founder and chief economist of Heteronomics, and a contributor to Euromoney’s risk survey, who unlike many of his peers – who are still anticipating growth – is predicting a 3% contraction for real GDP this year.
“The outlook has deteriorated over the past month to beneath even my already bottom-of-consensus forecast,” he says.
“Restrictive lockdown policy is causing permanent damage, irrespective of intentions, and public borrowing in 2021-22 will be higher than forecast, squeezing fiscal pressures further.”
Indeed, Rush believes the fiscal deficit will be near 10% of GDP again.
Survey contributor Johan Krijgsman of Krijgsman & Associates also paints a bleak picture.
“Currently, Covid is out of control,” he says. “Monetary policy is pushing on a string and with fiscal policy at full tilt it is difficult to see much extra support for economic growth coming from the public sector, notwithstanding the urging from international institutions, most recently the OECD.”
This is hardly doing anything for the UK’s risk rating. Preliminary results from Euromoney’s latest Q4 2020 country risk survey show the UK languishing at 34th out of 174 countries in the global risk rankings, on a total score of 63.3 out of a maximum 100 points, after having fallen 14 places during the past five years.
The score declined a little further in the final months of 2020 and it is not expected to show any imminent improvement, according to several of the survey’s contributors.
This puts the UK in the medium-risk, tier-three category, sandwiched between Poland and Lithuania, trailing several other European countries, including the Netherlands (eighth) in tier one, and tier-two countries Germany (12th) and France (28th).
Although the survey score for government stability has improved, other political factors have worsened, including the regulatory and policy environment.
Political and institutional risks cannot be overlooked, says Norbert Gaillard of NG Consulting.
“Boris Johnson’s leadership is increasingly challenged by Conservative MPs,” he says. “I don’t anticipate an early general election in 2021, but tensions within the Tory Party could increase uncertainty and worry foreign investors.
“Institutional risk is also quite high in the medium term. The possible independence of Scotland may undermine the prestige and the geopolitical influence of the UK.”
Time is running out as additional assets and jobs are likely to leave the UK in the next weeks- Norbert Gaillard of NG Consulting
Economic risk has also increased, notably the economic-GNP outlook and employment/unemployment indicators.
As Morley states: “I think the long-term risks are now higher for the UK economy due to the dramatic rise in government debt as a result of support during the coronavirus, with debt-to-GDP now above 100%.
“At this level I think it could negatively impact growth and economic stability. The UK needs a long-term plan to bring its debt down to more manageable levels.”
The Brexit deal is no remedy, either.
Heteronomics’ Rush says the economic damage is “small beer compared to the Covid-related catastrophe”, but the deal is a “skinny one focused on goods despite the fat legal text”.
With additional trade restrictions and no deal on services, it is worse than EU membership and it will weigh on GDP growth, with many experts anticipating the financial markets will come to that realization eventually.
A deal on financial services is crucial, stresses NG Consulting's Gaillard.
“In October 2020, Ernst & Young estimated that £1.2 trillion of assets and 7,500 jobs were moved from the UK to the EU between June 2016 and September 2020, and the City has just lost euro-denominated share trading business,” he says.
“As a result, Johnson must get an equivalence deal as soon as possible. I remain confident he will get it because some EU countries, especially Ireland, could experience serious disruption to financial services.”
Gaillard adds: “However, time is running out as additional assets and jobs are likely to leave the UK in the next weeks.”
The huge fiscal deficit and growing public debt are a notable concern for the medium-long term.
“The capacity of the present and next British governments to tap capital markets is contingent on the strength of the financial sector, which is underpinned by a good agreement on financial services,” he says.
In the meantime, the British authorities will have to re-industrialize the country and climb the global value chain, but Gaillard believes the task will be difficult.
Christian Richter, head of business school and a professor of economics at Coventry University Knowledge Hub, says: “My view on Brexit has always been that it would harm the British economy. To an extent, that was already priced into my reviews starting in 2016. However, the full extent will only become visible now and I am afraid it is worse than what everyone expected.”
“In essence, the Brexit deal is designed to fulfil Britain’s need of imports. What I mean by that is the closure of the border to France just before Christmas showed how dependent on Europe the British economy is."
He adds: “The Brexit deal will mitigate this to an extent, but European exporters will withdraw more and more from Britain. The consequences of this are worse than what was anticipated by many observers, including myself. Together with Covid-19, this creates a perfect storm where the final outcome is completely uncertain.”
Moreover, Krijgsman warns the healing of the scars left by the pandemic will take time.
“Reshoring, working from home, cautiousness about proximity and online shopping will be disruptive to many sectors,” he says.
“The eventual need to reduce some of the public sector largesse of 2020 and uncertain trade relations will also likely uncover more problems than we clearly see at present.”
Coventry University’s Richter also anticipates increased social tensions caused by the economic downturn and the possibility of the UK splitting up eventually.
“The so-called bumps on the road to Brexit may actually turn out to be lethal,” he warns.
However, perhaps the biggest salutary warning came during Johnson’s televised press briefing on Tuesday, when Chris Whitty, the chief medical officer for England, happened to mention that the Covid-19 risks would only ease gradually, along with the bigger bombshell the country might require restrictions to be reimposed next winter.