Economic Review – Q4 2010
Weathering the storm
In the latest issue of the Deloitte Economic Review, our Economic Adviser, Roger Bootle, turns his attention to how companies will fare during the fiscal squeeze. He is, on the whole, optimistic, His main points are as follows:
- Companies may weather the coming fiscal storm rather better than households and the public sector. But they certainly won’t survive entirely unscathed.
- The corporate sector looks set to escape the direct effects of the coming tax and spending measures relatively lightly. Indeed, the main rate of corporation tax is set to fall from 28% to 24% over the next five years.
- But there are of all sorts of other ways in which companies will be affected by the fiscal squeeze. Most obviously, those private sector firms which supply goods and services directly to the public sector are set to suffer from the retrenchment in the latter’s spending.
- Meanwhile, other effects which hit the general level of demand and activity in the economy will also hit companies. One of the biggest is likely to come via the labour market, which will suffer from sharp falls in public sector employment.
- Coupled with weak pay growth in the public sector and the effect of the various personal tax increases, this will place a major squeeze on households’ disposable income. As a result, household spending may well contract again next year. Needless to say, that will be seriously bad news for companies either directly or indirectly connected to the consumer and retail sectors.
- Admittedly, the effects of the fiscal squeeze may not be entirely negative for companies. Potentially favourable effects include increased business and consumer confidence, looser than otherwise) monetary policy, a lower exchange rate, and less
“crowding out”. In the long-term, companies might gain access to parts of the economy previously dominated by the State.
- What’s more, there are some reasons to think that companies are in fairly good shape to deal with the adverse effects of the squeeze. Profitability has held up well during the recession and business insolvencies have been low. Meanwhile, the corporate sector’s balance sheet is rather less stretched than those of the household and public sectors.
- These factors offer some hope that business investment will continue to recover over the coming quarters. Nonetheless, given lingering credit constraints, fragile confidence and weak demand, it seems unlikely that companies will be able to offset the impact on the overall economy of weaker spending in the public and household sectors.
- Against that background, worries over the inflation outlook will gradually fade and the Bank of England's Monetary Policy Committee will provide further support in the form of a further bout of quantitative easing.
- But with the financial and banking system still in a state of disrepair, further monetary stimulus is unlikely to offset fully the effects of the fiscal squeeze and the weakness of the global economy. Accordingly, after GDP growth of around 1.5% this year, I now expect growth to slow to just 1.0% next year. What’s more, the dangers of a full-blown “double-dip” in the economy are rising.
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View other economic material from Roger Bootle, including his monthly economic updates.
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