Crédito y Caución expects a further improvement in United Kingdom

2008 and 2009 witnessed spectacular year-on-year increases in corporate insolvencies IN THE United Kingdom: of 24.2% and 22.8% respectively. However, since last year, business failures have begun to decrease markedly, and this is consistent with the improvement in economic stability and a stabilisation of credit market conditions. In Q3 of 2010 the number of insolvencies in England and Wales decreased 13.9% year-on-year and 2.2% on the previous quarter: to 3,974 cases For the whole of 2010 Crédito y Caución expects a 15% year-on-year decrease.

For this year Credito y Caución forecast another, albeit more moderate, decrease in insolvency of 5%, signalling a gradual adjustment away from the unusually high level seen in 2009. However, with around 15,000 insolvencies expected in 2010, the number will still be much higher than the 2007 pre-crisis level of 12,500.

December 2010´s median expected default frequency [EDF] for UK listed companies continued the moderating trend of recent months, dropping 8 basis points on Novembers figure, to 61 basis points. Overall, Crédito y Caución has seen a 30 basis points reduction throughout 2010, with corporate EDF reaching its lowest level for more than two years. This improvement is due mainly to a rise in equity prices and a simultaneous reduction in market volatility. However, despite this overall improvement, the current levels of default conditions are well above their long-term average, with listed UK companies still facing significantly higher default risks than in earlier years.

Main economic developments

In the third quarter of 2010, the UK Gross Domestic Product grew 0.7% quarter-on-quarter [2.7% year-on-year] after a 1.1% growth in Q2 of 2010.

However, according to a preliminary estimate by the UK Office for National Statistics [ONS], in Q4 of 2010 GDP declined by 0.5% on the previous quarter, with adverse weather conditions significantly affecting output. Construction output decreased by 3.3% and services, which account for about 75% of British GDP, by 0.5%. Output from business services and finance fell 0.7%, after zero growth in the third quarter, while manufacturing output continued to increase [1.4%], making the largest contribution to growth.

The GDP drop in Q4 is something of a surprise, since earlier forecasts suggested that growth in that quarter would be around 0.5% on Q3. Overall, British GDP is expected to have grown 1.4% year-on-year in 2010, compared to earlier estimates of between 1.7% and 1.8%.

GDP forecasts for 2011 vary, depending upon their source, but generally the expectation is for continued growth, but at a slower rate. Independent growth forecasts average around 2%, although  very recently the OECD has forecast growth of 1.7%.

As a consequence of the credit crisis and governmental investment in stimulus measures, the fiscal deficit rose to 10.1% of GDP in 2010, with public debt increasing sharply since 2009. The governments aim is to cut the fiscal deficit to 1.9% of GDP by 2015, to avoid adverse sentiment by international financial markets. Comprehensive austerity measures and tax rises are designed to save GBP 80 billion and to bring in an additional GBP 30 billion by 2015. In the process, more than 300,000 jobs in the public sector will be lost, but the governments belief is that a revival in the private sector will create job opportunities to compensate for this.

However, there is pressure on the government to soften its fiscal tightening. For instance, the outgoing head of the Confederation of British Industry [CBI], Sir Richard Lambert, recently warned that cutting spending may exacerbate the situation by dampening demand, and that what needed to be put in place is a strategy for growth that will reduce the budget deficit while boosting demand.

While growth declined, inflationary pressures are increasing. Throughout 2010, consumer price inflation was above 3% [exceeding the Bank of Englands target rate of 2%], and actually increased to 3.7% in December 2010 from 3.3% in November. Behind this rise were higher food and fuel prices, with petrol prices in December exceeding the record price seen in May 2010, with diesel prices following the same trend.

Consumer prices are expected to increase further - to 4%-5% - over the next few months, as a result of Januarys rise in VAT, from 17.5% to 20%, introduced to help tackle the budget deficit. However, the Bank of England is maintaining its benchmark interest rate at 0.5% for the time being, expecting inflation to decrease substantially in the course of the year. The Bank of England still wants to keep in place its monetary policy of low interest rates as this helps to mitigate the effects of fiscal tightening.

Private consumption growth slowed to 0.3% quarter-on-quarter in Q3, after a stronger performance in the previous quarter. However, it was 2% higher than Q3 of 2009.

According to the British Retail Consortium/KPMG Retail Price Monitor, the value of UK retail sales decreased 0.3% year-on-year in December 2010 on a like-for-like basis [in December 2009 they had increased 4.2%]. Total sales rose by 1.5% [against a 6% increase in December 2009], but this growth was generated by additional floor space being created in shops.

This disappointing result can be attributed not just to Decembers adverse weather conditions but also probably to higher inflation. While food sales growth slowed only slightly, in Q4 of 2010 the non-food retail sector suffered a drop of 0.8% year-on-year, with consumers´ worries about unemployment and income discouraging large purchases.

Credito y Caución expects additional pressure on future household spending due to the rise in consumer price inflation, triggered by the VAT increase, higher fuel prices, fiscal tightening and the rising jobless rate. According to ONS, in the three months to November unemployment in Britain increased by 0.2% [49,000] on the previous quarter - to 7.9% - reaching 2.5 million, driven mainly by job losses in the public sector resulting from the governments spending cuts.

Therefore, it comes as no surprise that consumer confidence declined in the course of 2010 and remains depressed, reflecting uncertainty over the UK economic outlook and the employment situation.

Nevertheless, business confidence in the manufacturing sector has recovered comprehensively since mid-2009. After falling 10.7% in 2009, since then manufacturing production has recorded positive growth rates in every quarter. Overall, manufacturing production grew 3.8% year-on-year in 2010, while services grew by 1.2%.

Manufacturing is also the main driver of British export performance, with the latest available figures showing that exports of goods increased 12.2% year-on-year between January and September 2010, compared to a rise in the export of services of just 0.8%. British manufacturers have profited from a weakening sterling exchange rate and, according to the ONS, the volume of exports of goods [excluding oil and erratic items such as aircraft that may skew the figures] rose 3.4% in November 2010 on the previous month, while imports increased 0.3%. However, the overall deficit on the trade in goods and services increased to GBP 4.1 billion in November, with imports still growing faster than exports.

Exports are likely to continue to help sustain economic growth in 2011, as British businesses seek to take advantage of trade with emerging markets. With the slowdown of growth in the Eurozone, it is even more important that the 7% of UK trade currently channelled towards the leading emerging markets [China, India, Brazil, Russia, Mexico, Indonesia, and Turkey] is significantly increased.

Exports aside, Crédito y Caución expects business investment to contribute to growth. Companies have already increased their capital spending - up 8.9% year-on-year between January and September 2010 - and this promises even higher business investment this year.