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Said Aminov
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А.Никольский
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30.07.2008 17:12:22
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Рубрики
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Современность; Политек;
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UK
Tight rein on inflation is crucial for UK industry
The UK government must control inflation if it is to give industry the chance to deliver the capabilities the armed forces need, argues Matthew Smith
With the UK a year into the global credit crunch and possibly already in a recession, Jane's views the country's defence industry as somewhat more resilient than other sectors of the economy.
This resilience has been a result of the relative lack of debt on UK defence companies' balance sheets and therefore reduced exposure to tightening credit conditions; revenues that are driven by government rather than consumer spending; medium-term revenue visibility through the fixed three-year government defence budget, set under the Comprehensive Spending Review (CSR); access to long-term government contracts; and access to export markets.
However, with the UK Treasury reporting in July that Consumer Price Inflation (CPI) had reached 3.8 per cent and producer output inflation 10 per cent, this access to a fixed defence budget presents its own problems; factors that were previously beneficial may become liabilities.
The 2007 CSR assumed that CPI would not exceed 2 per cent in 2007 and would subsequently remain at 2 per cent until 2010. A comparison of independent forecasts produced by the Treasury in July 2008 suggests that inflation will stay at around 3.6 per cent through to the end of 2008 before dropping to 2.4 per cent in 2009 - still 20 per cent above the inflation assumption. A longer-term inflation forecast published by the Treasury in May shows CPI staying stubbornly at 2.2 per cent until 2011.
Should inflation persistently remain above the level planned for in the CSR, it will erase the much-touted annual 1.5 per cent increase in real-terms defence spending currently programmed for the years through to 2010. This would effectively leave the UK Ministry of Defence (MoD) with a reduced budget in real terms at a time when all of its costs are rising.
The defence sector, like every other sector of manufacturing, is vulnerable to production cost increases. In most manufacturing industries, rises to production costs that occur through factors such as higher wage settlements (often driven by expectations of future inflation), increased supply costs for raw materials and high energy costs - according to the MoD, propulsion fuel is expected to increase by 23 per cent from 2007 to 2008 - usually translate into higher prices for customers.
In the case of defence, however, the parlous state of government finances and particularly the high level of public sector debt - which at 39.8 per cent of gross domestic product (GDP) in 2008 is just the tiniest whisker away from breaching one of the UK chancellor's 'Golden Rules' that public debt should not exceed 40 per cent of GDP - means that the three-year defence budget fixed by the 2007 CSR cannot be increased.
The MoD also has a history of over-optimistic programme spending assessments. According to the National Audit Office Major Projects Report for 2006-07, the MoD went GBP654 million (USD1.3 billion) over budget in 2006-07; and in 2008 the MoD's own Annual Report and Accounts admitted that it had missed its target for cost growth in 2007, with an in-year increase of GBP225 million in the equipment programme.
If prices rise but the budget stays the same there can be only one outcome: the MoD will not be able to procure as much defence equipment as it would like, or indeed has planned for.
The UK is already facing severe budgetary pressures partly because of the strain of operating in Afghanistan and Iraq. Even before this economic crisis erupted it was clear the MoD's finances were becoming over stretched: the MoD is required to make savings of GBP2.5 billion between 2007 and 2010 in addition to funding above-inflation wage rises, improving forces' housing and trying to rein in cost increases in the equipment budget.
The funding pressures appear particularly acute in the procurement budget, which, according to the MoD's Defence Plan 2008-12, will actually drop by GBP1 billion to GBP11.85 billion in 2008 (from GBP12.9 billion in 2007) and will remain under the 2007 level until 2011, although this is partly because of the inclusion of equipment procured through urgent operational requirements and funded by the Treasury reserve in previous years but not forecast for future years.
Jane's believes this is aggravated by an apparent reluctance within the government to make tough decisions about what programmes will have to give way, particularly as a substantial proportion of the defence budget in future years will be allocated towards funding several high-profile programmes: the Future Aircraft Carrier, Tranche 3 of Eurofighter, the Successor deterrent and the Future Rapid Effects System to name a few.
Despite this reluctance, it is becoming increasingly clear that something will have to give way as the MoD cannot continue indefinitely the current practice of 'salami slicing' the budget and making savings through low-profile capability reductions within programmes.
Rising inflation will add substantially to the MoD's equipment funding crises and dramatically ups the pressure to make major cuts. It is clear that the main threat to the UK's defence plan and its industrial base comes not just from lower-than-expected economic growth but from rising prices that will make vital equipment increasingly unaffordable to produce and therefore buy.
With less money in the government pot and inflation driving production costs upwards, defence companies will find their profit margins squeezed inexorably. In this situation one obvious solution is to take advantage of the weakening value of the Sterling and increase exports abroad. However, building market share in foreign markets is made problematic by the partisan and fractured nature of European spending and the broader economic slowdown facing the region.
In fact, industry faces a potential 'perfect storm' of rising costs and shrinking budgets where the prospect of programme cuts driven by cost inflation means that UK-based companies will face increasing competition for a smaller amount of procurement money.
It is therefore vital that the government does not underestimate the threat that high levels of inflation poses to the UK defence industrial base and that the Bank of England maintains its current caution over cutting interest rates. The government should focus its economic policy on controlling rising inflation and ensuring that economic conditions do not lead to it being priced out of its own defence market.
Matthew Smith is Jane's Defence Economics Analyst, London