Contributors to Euromoney’s risk survey foresee a bumpy ride ahead for investors in the British Isles.
Prime minister Boris Johnson survived a no-confidence vote on Monday, but he could only claim a pyrrhic victory, with 148 (41%) of his own serving MPs opting to oust him.
For Johnson and his allies, it is time to put the crisis behind them and get on with policymaking, but for others it is just the beginning.
Many believe the party-gate scandal to be a matter of principle, regardless of whether they voted for Brexit or not. Many are also fearing the consequences of allowing Johnson to carry on, given that there are also questions over his government’s performance.
Two tricky by-elections lie ahead, in Wakefield (West Yorkshire) and Tiverton and Honiton (Devon), to be held concurrently on June 23, both of which were triggered by the resignation of two disgraced Conservative MPs.
An investigation by the Commons Select Committee of Privileges into whether Johnson lied to Parliament will publish its findings after the summer recess. If it decides that he knowingly did so, he will be in contempt of parliament and in breach of the ministerial code.
This is normally a resigning matter, but do not bank on it where Johnson is concerned.
Euromoney survey contributor Peter Dixon, an independent economist, says the confidence vote only made explicit what had been long known – that the Conservative government is divided and it lacks any clear policy goals other than its own survival.
“The size of the backbench rebellion has severely weakened the government and it will now face calls from competing factions to implement a range of potentially contradictory policies,” he says.
“One group wants to cut taxes to help consumers struggling in the face of higher inflation, but this will come at a cost to already-stretched public services, which is increasingly a cause for voter concern.”
Graziano Brady, an economist at AM Best Rating Services, says the vote means the government will struggle to push through any controversial legislation “since backbenchers have little incentive to vote with a government whose days are likely numbered”.
Johnson’s penchant for spending his way out of recession was underlined just after the vote when he announced new plans to support vulnerable groups and support the housing market.
There are also signs that a rising number of Conservative MPs recognise the damage that Brexit is inflicting on the economy- Peter Dixon
At Prime Minister’s Questions, a request from one of his MPs to cancel the delayed and vastly overbudget HS2 – the high-speed train mega project – was given typical short shrift from a PM with a passion for grandiose designs.
That and the weakening economy, not to mention additional spending to mitigate the effects of spiralling energy prices, could easily put the government’s fiscal targets off track.
“There are also signs that a rising number of Conservative MPs recognise the damage that Brexit is inflicting on the economy, which does not bode well for political unity,” Dixon says, adding: “In the coming months, it is thus likely that the government will be distracted by political infighting, which will heighten risks to the economy.”
Some of the survey’s experts had already factored in these risks, but for others it warrants a downgrading that will likely see the UK’s total risk score slide further in the Q2 forecasting round, the results of which will be available in early July.
Bruce Morley, a lecturer in the department of economics at the University of Bath, says the government is less stable as a result and that it will probably lead to an increase in government spending to placate MPs. “This will increase the annual debt-to-GDP ratio to above 100%, further reducing the UK’s stability and growth prospects,” he says.
Morley says the UK will be perceived as riskier by international investors.
This could weaken the pound against other main currencies, exacerbating the inflationary problems, and monetary policy will have to become tighter as a result, with interest rates rising at an increased rate.
“This will have negative repercussions for economic growth and the property market,” he says.
So far this year, the UK’s risks have increased more than any other G10 country, pushing it down four places in the global risk rankings, to 36th.
All bar one of the various political, economic and structural risk indicators have been downgraded, notably government stability, government finances and industrial relations in each of the respective categories.
That means the UK is now at the bottom of tier two, below Poland, and is in danger of falling into tier three, commensurate with Spain:
The economic risks are becoming patently clear. In April, annual inflation measured by the consumer price index – including owner occupiers’ housing – accelerated to 7.8% from 6.2% in March. Consumer confidence has slumped alarmingly all year.
What is more, forecasts published by the OECD, while indicating that GDP will grow by 3.6% in real terms this year, point to stagnation in 2023, with GDP at a standstill.
Inflation is seen soaring to more than 10% at the end of this year on the back of escalating energy prices, and labour market and supply-chain constraints, averaging some 8.8% in 2022 and 7.4% in 2023.
Only Russia, affected by sanctions, is expected to fare worse than the UK among all the G20 leading economies in terms of growth. The UK will also have the worst inflation in the G20 apart from those affected by currency crises – Argentina, Turkey and Russia.
In reality, though, with borrowing rates rising and consumers cutting back –already affecting retail sales – the situation could be much worse, bearing in mind, too, the tendency for forecasters to get their predictions wrong.
A breakdown in the proper functioning of the provisions of the Good Friday Agreement is an undervalued risk- Graziano Brady
Dixon notes that in the light of high inflation, there are already signs of increased union militancy in response to the cost of living crisis, notably in the public transport sector with a series of strikes planned.
“Whilst a rerun of the 1970s [higher inflation and crippling strikes] is not on the cards, the public policy debate will become increasingly fractious, as could relations with the EU as the government continues to make noises about the Northern Ireland protocol.
“Looking ahead to the winter, energy security is likely to be high on the agenda as global prices remain high, and there is a non-zero risk that some form of rationing may become necessary, although this is less of a risk than in some other European countries.”
Fhaheen Khan, senior economist at Make UK, the manufacturers’ organization, notes that some energy-intensive industries are reducing activity to save on their bills and that businesses they are in contact with say the worst is yet to come regarding energy costs.
Khan goes on to mention that the zero-Covid policy in China is another risk. By shutting or reducing the activity of shipping ports, specifically in Shanghai, it has reduced access to critical parts and components that UK businesses rely on to finish goods production.
“More specifically, the UK automotive sub-sector is reporting further drops in production due to a fall in access to semi-conductors,” he says.
The UK is facing many risks ranging from uncontrolled inflation (with social instability) and a real-estate (property) market crash to energy security problems and the risk of becoming dragged into a war against Russia.
However, most experts are concerned more by the realistic prospect of conflict developing over the Northern Ireland protocol.
For AM Best’s Brady, this is likely to result in “spiralling negative consequences”, which have the potential to be “unmanageable”.
If the government legislates away its obligations under the protocol and does not backtrack, Brady fears a trade war with the EU is inevitable, exacerbating inflation and resulting in a worsening of the UK’s risk score.
“I also believe a breakdown in the proper functioning of the provisions of the Good Friday Agreement is an undervalued risk,” he says. “Northern Ireland was already without (local) government for two years between 2017 and 2019, and tensions have only increased since then, which may leave Northern Ireland without a functioning executive for another good number of years.”
Manufacturers in the UK have reported to us that the mere suggestion of Article 16 triggering is turning EU customers away from UK businesses- Fhaheen Khan
Indefinite direct rule from London is not a sustainable solution, Brady adds, so a change to the institutional arrangements may be necessary, but that entails risk of restarting conflict in the region.
“These considerations will also negatively affect my scoring unless a de-escalatory solution is found,” he says.
Make UK’s Khan says the Northern Ireland protocol is resulting in several challenges for UK industry, despite no real movement in the likelihood of triggering Article 16.
“Manufacturers in the UK have reported to us that the mere suggestion of Article 16 triggering is turning EU customers away from UK businesses, which is having a negative impact on trade,” he says. “This will likely reduce our expectations for economic growth this quarter via a fall in exports to our biggest market.”
The impact of Brexit is not fully known yet, says Khan, in terms of investor attractiveness. Some companies will find new opportunities in the UK. However, there seems to be a change in attitude that global corporations have taken with subsidiaries they own in the UK.
“Businesses here have reported that it is becoming increasingly difficult to get parent organizations based abroad to invest in UK production because they see the rest of the world as a more attractive place to further their operations,” he says. “This is a direct response to Brexit by these companies.”
Dixon adds that the UK has not suffered as badly as an investment location as the pessimists believed post-Brexit, but it will be a “constant struggle to remain competitive”. This will not be helped by the planned rise in corporate taxes in 2023, something which the University of Bath’s Morley also alludes to.
All is not lost. Khan notes that the UK Treasury is currently reviewing the tax-based government incentives in place that are used to increase private-sector investment in training, capital, and research and development (R&D).
The UK boasts a strong R&D tax-credit system, he says, but a below-average capital allowances regime and an apprenticeship levy that has failed to meet its objectives to solve the skills crisis.
R&D tax credits make the UK an attractive country to invest in innovation, but relatively weaker capital allowances make the UK less attractive to invest in fixed capital.
“However, the Treasury is considering some bold changes to the latter, such as full expensing policies that do not exist anywhere in the G7, with the potential to make the UK a prime location for foreign investment,” says Khan. “Its effectiveness will depend on what types of capital qualify and ease of access for particularly small businesses.”
There will likely be some bold moves from the government to restore confidence, but with the public finances stretched, monetary policy tightening and Johnson in the driving seat, investors could still be in for a bumpy ride.