Spring Budget 2023 and its impact on credit management

in this blog, Baker Ing's Chief Economic Advisor, Markus Kuger, gives his analysis of the recent Uk budget announcements and what its means for credit management.

Summary

• The Spring Budget contains limited handouts for consumers (more free childcare and longer energy bill support) and companies (100% expensing for capital expenditure, creation of investment zones).
• Corporation tax will go up for companies with annual profits higher than GBP50,000 and business rates still remain under review.
• Macroeconomic forecasts have improved in this Budget with growth revised upwards and inflation changed downwards.
• Despite this, living standards will still drop quickly this year with negative repercussions on the business and consumer sentiment.
• Despite the support measures announced in the Spring Budget, 2023 will remain challenging as the risk of late or non-payment is likely to rise, on top of the deterioration seen in 2022.

Policy measures aimed at supporting growth

While Kwasi Kwarteng’s Mini-Budget in September 2022 shocked markets and ultimately led to his and Prime Minister Liz Truss’ departure, the Spring Budget presented by Chancellor Jeremy Hunt on 15 March produced more positive news as it contained handouts for households and businesses in order to stimulate the ailing UK economy. While consumers will benefit from a continuation of the energy support package for an additional three months, more free childcare, higher pension allowances for well-earners and frozen alcohol and fuel duties, the support for the corporate sector was smaller.

The most noteworthy handout to businesses was the introduction of full 100% expensing for capital expenditure on qualifying plant and machinery for the next three years. This policy, aimed at increasing investment will mainly help businesses with large qualifying capital expenditure in excess of the annual investment allowance. Companies operating in sectors involving less plant and machinery spend (often found in the service sector which accounts for more than 70% of UK GDP), or businesses that are loss-making, will not benefit from the new policy though.

The second policy measures aimed at increasing gross fixed capital formation was the creation of 12 so called investment zones, a plan already included in Kwarteng’s Autumn Statement. In order to “drive business investment and level up”, the zones will be created in the West Midlands, Greater Manchester, the North-East, South Yorkshire, West Yorkshire, East Midlands, Teesside, and Liverpool. Scotland, Wales and Northern Ireland will also be home to a zone each and the ultimate location will be decided in consultation with the devolved governments. Each of the investment zones in England will have access to GBP80m (including tax reliefs and grants) over the next five years and local authorities will be able to tailor their plans around local circumstances. The proposals must credibly explain how partners in the local area will use the levers available to increase growth in priority sectors, identify private-sector match funding and use the local planning system to support growth. The zones will likely be linked to universities and leading research institutions and will enhance growth in five key sectors: life sciences, creative industries, digital technology, advanced manufacturing and green industries.

Reform to research and development tax relief, creative industry relief and extension of cultural reliefs as well as reduced paperwork for international traders also feature in the Budget but the effects will be limited.

However, the Budget also contained unwelcome news for companies. Most notably, the chancellor confirmed the rise in corporation tax, a measure that was flagged up long in advance. For companies with a taxable profit exceeding GBP250,000 per year, the rate will increase from currently 19% to then 25%. The rate will remain at 19% for companies with a profit of below GBP50,000 and businesses with profits between GBP50,000 and GBP250,000 will pay between 19% and 25%. No decisions have yet been made regarding business rates. Two consultations were recently closed and the government has promised to release the findings shortly. In addition, the Budget foresees the launch of two new consultations: one on providing ratepayers with more information on their business rates valuations, and the second on measures to combat avoidance and evasion. While business rates remain unchanged for the time being, it is clear that reform still ranks highly on the government agenda and changes can be expected in one of the next Budgets.

Revised set of macroeconomic forecasts show improvements

For credit risk professionals the policy changes announced by the chancellor are probably of limited importance. However, the Budget also contained a set of new macroeconomic forecasts which are interesting from a credit risk perspective. Positively, the macroeconomic outlook has improved over the past months. The Office for Budget Responsibility (OBR, a non-departmental public body established in 2010 to provide independent economic forecasts) now predicts the UK economy to avoid a recession and to shrink by 0.2% only this year, compared with the previous forecast of -1.4%. Main driver behind this improvement is the moderation of energy prices which will also have a positive effect on government finances. Instead of borrowing GBP170bn in 2022-23 (as previously forecasted), the government deficit will come in at a lower GBP152bn while for the next financial year, borrowing will be GBP8.5bn smaller than initially anticipated. Over the medium term, the chancellor also expects slightly improved government finances: in 2027-28, government borrowing will stand at GBP50bn, down from a previously forecasted GBP70bn. Despite the lower borrowing, government debt will remain at a high level of around 95% of GDP, making the government vulnerable to higher debt refinancing costs (which have already risen over the past year).

Chart: Real GDP Growth Forecasts OBR

Problematically, even with the revised set of GDP forecasts, the UK will be the slowest growing G7 economy this year and the average annual growth rate for the UK economy for 2020-28 will come in at just 1%, compared with the 2.8% recorded before the global financial crisis in 2008-09. While pre-Covid real GDP levels in the UK will finally be reached again in mid-2024, six months earlier than expected in the last Budget, this is later than in any other G7 economy (which are already exceeding Q4 2019 outputs). For consumers, the normalisation in energy prices and the extended government support is welcome news but nonetheless, real disposable income per capita (which measures living standards) is projected to drop by a cumulative 5.7% over 2022-23 and 2023-24. This is 1.4 percentage points lower than previously feared but it is still the largest two-year fall since the start of this data series in 1956-57. As a consequence, households will continue to reduce non-discretionary spending this year with negative repercussions on domestic demand.

Positively for the interest rate outlook, the OBR’s inflation forecast was also updated: after having peaked at above 11% in Q4 2022, consumer price inflation will slow down to 2.9% in Q4 2023, according to the latest set of projections. While still slightly above the Bank of England’s (BoE) 2.0% inflation target, it would be the lowest rate since Q3 2021. Easing energy price inflation, a slowing economy and the response to the sharp monetary tightening cycle the BoE had embarked on over the past quarters all play a part in this drop inflationary pressures. While the BoE will likely rise interest rates a few more times this year, the speed and the magnitude of the tightening cycle will certainly drop. The key policy rate stood at 0.1% until December 2021 and has since been hiked ten times to currently 4%. Markets are pricing in a terminal rate of 4.5%, reached by mid-2023.

Chart: Inflation Forecasts OBR

From a credit risk perspective, 2023 will be a challenging year, despite the drop in inflation and the better than expected real GDP growth. Consumer price increases will outperform nominal wage growth for the next quarters, thereby leading to a drop in disposable income. Consumer confidence has improved in late 2022 before dropping again in early 2023 and the levels recorded are still low, indicating widespread pessimism amongst households which will impact adversely on their willingness to spend. UK business confidence indicators (such as the Purchasing Managers’ Index) have improved in February but still indicate challenges ahead (such as a drop in new order inflow in the manufacturing sector).

The challenging operating conditions in 2023 will adversely impact on the number of business failures. Worryingly, 2022 already saw a stark increase in liquidations in England and Wales, according to the government’s Insolvency Service. One in 202 active companies (equivalent to 49.5 per 10,000 active companies) entered insolvency proceedings last year, up from 32.9 per 10,000 active companies in 2021 and the highest ratio since Q3 2015. Overall, 22,109 company insolvencies were registered in England and Wales last year (Scotland and Northern Ireland also recorded increases), up by 57% and the highest reading since 2009.

Chart: Registered Company Insolvencies in England and Wales

Source: Insolvency Service

For 2023, another increase in the number of business failures is likely as low growth, reduced government support on the energy cost front for companies and comparatively high interest rates will all create headwinds for companies’ cash flow and profitability. Carrying out frequent counterparty risk assessments and teaming up with trusted advisors is recommended against this backdrop.

by COL