Year: 2010

The British government may find it hard to stick to a coherent strategy as ministries scramble to cut spending by up to 40 percent on Treasury orders.

Prime Minister David Cameron, who took office in May, says shrinking the record peacetime deficit from 11 percent of GDP to almost nothing within five years is the most urgent task for his Conservative-Liberal Democrat coalition government.

A spending review is under way and results will be announced on October 20. Cameron has likened the process to “the methodical turnaround of a failing business”, but there are many sceptics.

“Ministers are effectively flying blind, under orders to cut programmes by up to 40 percent but with confused guidance about their departments’ objectives,” said a recent report from the Centre for Social Justice (CSJ), a Conservative think tank.

Many fear that cuts will be made based on what is expedient for politicians or least difficult for civil servants to deliver, to the detriment of social and economic goals.

“At the moment there is not the sort of coordinated response needed across departments to deliver the government’s economic objectives,” Adrian Bailey, opposition legislator and chair of a parliamentary committee on business, told the Financial Times.

Alastair Newton, political analyst at Nomura, said the test would be whether the government scrapped low-priority programmes to ensure proper funding for high-priority ones, or whether it merely “salami-sliced” money from many programmes.

“I’m cautiously optimistic that we’re going to get some sensible prioritisation simply because the scale of the cuts is so big that you cannot salami-slice your way through,” he said.

Newton said the coalition appeared to be looking seriously for areas from which the public sector could pull back, but it would be hard for centre-right Conservatives to agree on that with their junior, centre-left Liberal Democrat partners.

“There is no such thing as the right solution here. There’s what they can get away with,” he said.

Sledgehammer
There are no obvious templates for what the government wants to do. The scale of the cuts dwarfs Britain’s two most recent austerity drives, after a 1976 IMF bailout and in the 1980s, under the leadership of then Prime Minister Margaret Thatcher.

There are also big differences with the much-admired Swedish and Canadian efforts in the 1990s. Britain is launching into these cuts at a time when growth in some of its key trading partners is weak and interest rates are at record lows, leaving little leeway for rate cuts to support growth.

The government has ring-fenced health, a move popular with voters which leaves one of the biggest items of public spending beyond the reach of the cuts, exposing other areas even more.

“Speculation will continue to mount about whether that ring fence can be maintained if it turns out to be politically challenging to make deep cuts in other sensitive areas,” said Sam Hill, fixed income strategist at Royal Bank of Canada.

Another concern is that cost-cutting in one area, such as layoffs or early retirement for public sector workers, could lead to extra spending in another, such as welfare bills.

Russell Jones, global head of fixed income strategy at Westpac, said the Treasury appeared to be “playing hardball” to push ministries to deliver wide-ranging cuts.

“This is not a subtle policy at the moment, it is a sledgehammer. The danger is it hurts the economy’s flexibility and underlying dynamism over the longer term,” he said.

The government is adamant that will not happen. Cameron has said that “governing for the long term” was a guiding principle of the spending review and tough decisions would be made.

“The truth is there will be some things that we genuinely value that will have to go,” he said in a recent column.

But early initiatives to cut spending have given a flavour of the difficulties ahead for the government.

In an embarrassing moment recently, Cameron’s office ruled out a proposal to scrap free milk for schoolchildren, deemed too politically toxic, at the very moment when a minister was busy defending the idea on live national television.

Germany’s RWE, Europe’s fifth-largest utility, warned government plans to introduce a nuclear fuel tax in Germany would keep a lid on its earnings and dividends for years to come.

The statement makes RWE the first utility to detail the effects of a tax on the fuels of nuclear power stations, which Berlin plans to claw back profits that power providers made by charging customers for carbon certificates they got for free.

“If this plan were to be implemented, it would curtail our earnings power considerably,” RWE Chief Executive Juergen Grossmann said in a statement.

Germany’s 17 nuclear power stations, operated by the country’s four largest utilities – RWE, E.ON, Energie Baden-Wuerttemberg and Vattenfall – have become a focal point of energy policy in Europe’s largest economy.

Plans by the government to introduce a tax on uranium and plutonium, the plants’ fuel, have infuriated utilities. A finance ministry draft law obtained by Reuters shows the government expects to raise €2.3bn ($2.96bn) annually between 2011 and 2014 with the tax.

“The group now has to review its medium-term goals up to and including 2013,” RWE said.

The company has predicted that recurrent net income – net income adjusted for extraordinary effects and the basis for calculating the dividend – would rise five percent on average each year through 2013.

It also has promised that dividends would remain at least stable through 2013, and that it would seek to pay out 50-60 percent of its recurrent net income as dividends.

RWE would also lower investments in assets such as new power plants if the tax was introduced, which could crimp its ability to compete with the combined GDF Suez and International Power.

The “regulatory uncertainty remains (the) main challenge for the share,” said Landesbank Baden-Wuerttemberg analyst Bernhard Jeggle.

Still, the company reiterated that recurrent net income and operating earnings would climb about five percent this year.

One of the highest emitters of carbon dioxide in Europe and beset by regulatory uncertainty, RWE trades at 8.3 times forward earnings, according to Thomson Reuters StarMine.

That is a 28 percent discount to 18 peers such as Italy’s Enel and France’s EDF.

Germany’s nuclear power stations, amongst the utilities’ most profitable large-scale power plants, are slated to be closed in the mid-2020s. But parts of the German coalition government and the power providers are aiming to extend their lifespan, saying they want to share the extra profits.

An extension will be decided as part of a broader concept for the future energy supply of Germany. But the fact that the government has yet to decide on such a concept was creating even more uncertainty for RWE, the company said.

Bank of Ireland plans to move away cautiously from state support by showing it can raise debt outside a government guarantee and gradually repay taxpayers’ funds over several years, it has announced.

Ireland’s biggest bank by market value has become the first major Irish bank to replenish its capital from partly private sources, an exercise which left the state with a 36 percent stake plus preference shares.

Its underlying operating profit fell by 32 percent in the first half of 2010 but it said tough conditions were set to stabilise or improve this year with the nascent recovery in its main markets Ireland and the UK.

Allied Irish Banks, still trying to raise the 7.4 billion euros ($9.73bn) of capital asked by regulators, last week said it needed continued government help and that the guarantee for bank liabilities should be kept beyond the current year-end expiry.

Bank of Ireland Chief Executive Richie Boucher said his bank could carefully move to regain its independence.

“With the recapitalisation we’ve done, the EU endorsement of our (restructuring) plan, us passing the stress tests leaves us with the capability to seek to get off the guarantee,” Boucher told journalists.

“That’s one of our very, very important strategic objectives,” Boucher added.

Boucher’s cautious optimism contrasted with fully nationalised Anglo Irish Bank, which recently said the government guarantee should be extended into next year and which has received EU approval for a fresh bailout of up to 10 billion euros.

Ireland’s bank guarantee scheme was introduced at the beginning of the global financial crisis in September 2008 and the EU has approved an extension until the end of 2010 for debt of over three months duration.

Bank of Ireland said it aimed gradually to pay back the state’s 1.7 billion euros worth of preference shares in the next three years, although it said it had no control over the 36 percent stake the government owns in ordinary shares.

Europe’s biggest travel firm TUI Travel said it expected its full-year profit to be at the lower end of expectations after trading was hit by uncertainty among British consumers following June’s emergency budget.

TUI Travel, in which Germany’s TUI AG holds a controlling stake of 57.5 percent, also said airspace closures as a result of the ash cloud from an Icelandic volcano had affected bookings and cost it a total of £105m ($168m).

“The strong booking trends experienced up until the volcanic ash disruption in mid-April and the subsequent rebound in early May were not sustained throughout the early summer period,” said Chief Executive Peter Long.

“This was particularly marked in the UK source market where trading was affected by further airspace closures, good weather and post election uncertainty regarding the emergency budget,” he added.

TUI Travel said bookings in Britain, its second biggest market, were down two percent over the last twelve weeks while a trend among customers to buy discounted holidays in the late bookings market has impacted the group’s profitability. Trading in the Netherlands was also weak with bookings down three percent.

The group said its biggest market, Germany, had seen strong growth in bookings, which were up 12 percent, but customers had been buying cheaper holidays which have a lower profit margin.

Long said it was difficult to predict how the later booking pattern will change over the next 12 to 18 months in light of the current economic environment.

Analysts forecasts for full-year EBIT (earnings before interest and taxation) range between £439m and £495m, according to a poll.

British construction group Morgan Sindall said growing demand for office buildings was helping to offset the impact of government spending cuts on its business, although the construction recession was not over yet.

“The commercial side is growing, but let’s not over exaggerate – it’s growing a bit but not as quickly as governments are spending less,” Executive Chairman John Morgan told reporters after the construction group reported a three percent fall in first-half profit.

Morgan, who co-founded Morgan Lovell in 1977 before it combined with William Sindall in 1994, said public sector work now accounts for about 50 percent of the group’s work, down from 60 percent.

Morgan Sindall, which fits out offices and builds schools and houses, said its order book had grown to £3.7bn ($5.9bn) from £3.2bn at the start of the year, although the outlook remained tough.

“It’s been challenging for a couple of years now and the recession in construction is not over yet,” Morgan said.

“If you look back at statements from Morgan Sindall or anyone else in the sector, you’ll see a challenging outlook, but to be honest the numbers are in line with expectations,” said Panmure Gordon analyst Andy Brown.

John Morgan said the group’s housing business, Lovell, could benefit from the woes of social housing repairs specialist Connaught, which is in crunch talks over funding after warning on profit.

Morgan Sindall said in its results statement that the outlook remained robust for new build social housing and refurbishment.

For the six months to end June, the group reported adjusted pretax profit of £23.1m, compared with £23.9m last year.

It maintained the interim dividend at 12 pence per share and increased its net cash balance 55 percent to £128m.