ECONOMY: Business as usual?

The economic landscape is rugged to say the least, unemployment is rising and the pound is down. So how should the industry attempt to navigate its way through 2010? Ron Emler reports.

Nobody is arguing that 2009 was not a very bad year for the British economy and that, at best, it has only just started to stagger up from the bottom of the trough. On the other hand, few commentators and forecasters are willing to predict when the patient will be making a strong recovery.

In the third quarter of the year, Britain’s gross domestic product fell by 0.4%, meaning that the economy had shrunk by almost 6% since the summer of 2008. While it is likely that the rot will have stopped in the final quarter, the pattern is undeniable. Britain was one of the first major economies to enter the recession, it was one of the most deeply affected and it is one of the last to start down the long road to recovery.

World trade shrank by about 10% in 2009, according to the World Trade Organisation, but now the US is rebounding, France and Germany are leading the recovery in Europe and Japan, long the sick man of Asia, is perking up.  

Why is Britain seemingly so weak? First because proportionately the economy is much more reliant on financial services, the sector worst hit by the credit crunch, and second because Britons had far higher levels of personal debt than in any other major economy. Since 1997, UK households had taken on an extra £1 trillion in debt to fund house purchases and personal spending. The financial bubble here was bigger in proportion to the size of the population, and despite Gordon Brown’s protestations, when it burst the bang was loudest.

The optimists argue that the underlying picture is not as bad as the pessimists paint. After all, growth is about to resume, albeit sluggishly, the level of unemployment has not soared to the three million-plus that many predicted, house prices have picked up, in turn buoying consumer confidence, and spending on the high street has been remarkably resilient. Perhaps the extra £200 billion pumped into the economy by the Bank of England really has cushioned Britain from an even worse experience.

On the contrary, argue the pessimists, look at the underlying trends and there are considerable grounds for unease.

First the level of government debt is mind-numbing. It comes into perspective with the realisation that before December’s pre-Budget report, it would have taken until 2035 for government debt as a share of gross domestic product to return to the 40% ceiling specified by the prime minister’s now abandoned “golden rules”.

Even Brown’s promise to halve the annual budget deficit of £200bn (not the national debt – that is now more than £1 trillion) by 2014 implies raising taxes savagely and/or slashing state spending. What about the pace of recovery? A consensus is gathering around the view that the British economy will grow by about 1% in 2010 but Mervyn King, the Bank of England’s governor, reckons it will be late 2011 before it has returned  to the level on the eve of the recession. In other words, it will be a further two years before Britain
has “recovered”.

True, the growth in unemployment has been less horrendous than most forecasters predicted, but the downtrend is far from over. The jobless total is unlikely to touch bottom for a further 12 months or so. As part of an inevitable cut in government spending, it is reckoned that up to 750,000 civil service jobs will have to go in the next 18 months, so the 3m+ unemployment forecast may still be correct.

For technical reasons (not least the fact that national indexes have been heavily distorted by the central London market and because few houses have been for sale since owners are waiting for a recovery) house prices are predicted to fall by a further 10% in 2010. That would take the peak-to-trough fall to about 35%. And while spending has held up remarkably well, there are good reasons why consumers are now expected to tighten the purse strings drastically – indeed there is strong evidence that the saving rate is rising as people attempt to reduce their indebtedness. Nearly two-thirds of companies now say that weak customer demand is hindering their own growth plans.

Surveys on behalf of the CBI and the British Chambers of Commerce suggest that about half of all companies are planning a pay freeze or to keep the increases in their wage bills below the rate of inflation, so even most people in work are going to be worse off in real terms in 2010. And that is before they are faced with the extra VAT being levied from 1 January or the ending of the stamp duty concessions designed to help first-time buyers.  

If that were not bad enough, consumers’ anxieties will heighten as Britain approaches the general election. They know that pain lies ahead whichever party ends up in power. There are rumblings from credit rating agencies that the British government’s debt is so high that our credit rating is in danger of being cut unless drastic measures are introduced, with all that implies for the public finances and the value of sterling. The OECD has already raised the spectre of a “public debt spiral”.  

Most commentators think that the fiscal squeeze will fall on the consumer, not businesses; some talk of the need to take an additional £70bn a year out of pockets and purses to make the national balance sheet look acceptable to the international lenders we need to finance the government’s debt.

To put that in perspective, each 1p increase in the basic and higher rates of income tax raises about £6.5 billion – equivalent to about 0.5% of household annual income. Will any political party dare to be so draconian?

Overall, the prospects for drinks producers and retailers are not encouraging. Capital Economics, the respected forecasting house, recently predicted that in real terms consumer spending on alcohol and tobacco will fall by 3% in 2010 and then 1.5% in 2011; thereafter it will remain flat for a further two years. In other words, the sector’s recovery will not start until 2014.

The effects are predictable. The rate of business failures will continue. As the trend towards consumption at home due to tight budgets proceeds successful independent retailers such as Majestic will take stronger hold of their niches in the market; less dynamic businesses will go under as the supermarkets tighten their stranglehold on the “commodity” sector of beer, wine and spirits retailing. First Quench will not be an isolated disaster. There will be more anguish for suppliers.

In the on-trade, the rate of pub closures has topped 50 a week. That will tail off because the weakest have already gone to the wall, leaving the more resilient survivors to cater for the market. Indeed, where a close rival has closed, some licensees will enjoy stronger trade. Even so, Ted Tuppen, the chief executive of Enterprise Inns, which has 7,400 pubs, said in November that ”trade will not be a lot easier next year even if the sun comes out and the recession ends”.  

Less gloomily, groups such as Mitchells & Butlers, JD Wetherspoon, Young’s and Fullers have all managed to increase profitability by investing in their facilities at the same time as cutting recurring costs to the bone. Their diverse business models have been tailored to their estates, showing that success across the on-trade spectrum is achievable.

Most businesses can take some optimism from the fact that they are unlikely to face extra interest costs in the coming year because, although inflation may tick up to about 4% by mid year for technical reasons, it will probably return to about 1% by next Christmas. That means that the Bank of England is expected to peg base rate to its present 0.5% until 2011. Even so, many businesses will still find it difficult to obtain funding.

The latest survey from the British Chambers of Commerce found that credit conditions had worsened since the summer. A third of all companies said loans were now even more difficult to obtain as banks impose tighter conditions.

For the drinks sector, the fate of sterling is crucial. Sterling’s trade weighted index was at a 12-year low in November, but during 2009 it did appreciate against the US dollar by about 7%. This was largely due to dollar weakness rather than any revival of confidence in sterling and there are hopes that the improvement will continue with sterling heading back towards $1.70. That would benefit major UK producers, especially the Scotch sector.

On the other side of the coin, the pound has slipped further against the euro during the past year (just ask British holidaymakers!) and there seems little reason to predict improvement. That has large implications for UK shippers and their European principals. Many continental houses did not increase their UK prices last year simply to protect their existing business in Britain. Can they absorb a further hit from the exchange rate?

Ironically, Pernod Ricard says it is not keen on sterling appreciating by much because of its large UK cost base, notably in Scotland.
The weak pound also presents problems for producers in Australia, New Zealand and South Africa, all of whose currencies have appreciated against sterling in the past year.

There is, however, one sector that may benefit from sterling’s weakness – tourism. Not only does the value of the pound make the UK attractive in absolute terms, but the improvement in near-term global growth prospects has increased the likelihood that more people will take overseas holidays.

That offers grounds for optimism among hoteliers and restaurateurs in the main centres such as London and Edinburgh as well as their suppliers. A good early summer would also boost “staycationing” – Britons taking a holiday in the UK.

Overall, though, 2010 will be a year in which the fit fight to maintain their leanness and profitability: the flabby will struggle to survive.