Grant Thornton: our reaction to the Spending Review

Wednesday, October 20, 2010 | Posted by: Fiona Cullinan
Categories: Economy | Tags: economy, reaction, analysis, George Osborne, Budget, recovery, deficit, Stephen Gifford, CSR, risks, spending review

Credit: www.wordle.net

This afternoon, Chancellor George Osborne delivered the Comprehensive Spending Review, laying out his plans for dealing with the UK deficit. Here’s the reaction from accountants, economists and sector analysts at Grant Thornton - updated thoughout the day. Firstly, Stephen Gifford, Chief Economist gives an overview, followed by further comments on the impact on local authorities, education, support services, renewable energy, waste sector, property, construction, infrastructure and capital spending:

Useful links:

• Full-size Spending Review Wordle: created by Grant Thornton from the full HM Treasury full Spending Review document.
• Chancellor George Osborne’s speech in full.
• The Spending Review in pictures from HM Treasury’s Flickr.
• The Spending Review by region.

Stephen Gifford, Chief Economist at Grant Thornton, with an overview:

The Coalition Government continued their commitment to slash the huge budget deficit by announcing £83 billion of cuts in government spending, with the brunt of the cuts focused on welfare savings.

Today’s Spending Review is without doubt an economic and political gamble of huge proportions, with the emerging recovery across the economy now on a knife edge. 

But in many ways, the Chancellor has been forced to play this rather weak hand.  With confidence in the UK’s ability to pay its debts fading fast, the government had to respond with clear and decisive action to address the fiscal deficit. The Government has risen to the challenge but whether the austerity plan will work and bring back economic prosperity is far from certain.

A painful but more sustainable footing

The aggressive reduction in government spending will help to put the economy on a firmer footing over the longer term. Sound public finances will reassure the financial markets, keep market interest rates low and encourage the private sector to invest and create new jobs. 

In the short term, however, it is a bitter pill for us all to swallow and a particularly hard knock for the 490,000 employed in the public sector who will soon start to lose their jobs.  Consumer and business confidence will almost certainly be hit hard in the short term. Grant Thornton expects economic growth to be uncomfortably low over the next six months. 

Real risks remain

Most consumers and households will not be thinking about the benefits of these austerity measures. Instead, one of the main outcomes of the Spending Review will be an increase in the level and fear of unemployment.  This will put a large dent in consumer confidence, which is bad news for all considering that signs of improvement in the UK economy have only just begun.

The balance between current and capital spending cuts is a cause for concern. Maintaining investment in transport, schools and science is good news for both business and families.  But the increase of £2 billion in the capital spending over the last Budget will hardly do much to improve the productive capacity of the economy over the long-term.

Rebalancing the economy will take time

Addressing the deficit early will mean lower debt interest payments of £5 billion over the next three years, providing some limited scope to increase capital spending, vital for driving forward economic growth over the next three to five years.

The private sector will eventually create the jobs required to offset losses in the public sector.  New jobs will be created by the UK’s labour market adjusting and from new private sector activity being created through innovation and enterprise. But the process will take an inordinate amount of time.  Economic restructuring on this scale will take at least a decade if not more. 

Today’s Spending Review has confirmed what we have all been fearing for a while: UK households are in for a tough time. With likely salary freezes and the risk of rising inflation and taxes, any feel good factor is a distant prospect.

Nathan Goode, Energy Environment and Sustainability Partner for Grant Thornton UK LLP, on the renewable energy announcements:

£1bn to fund the Green Investment Bank in 2013/14
“Success of the Green Investment Bank will depend on the lending terms it offers to customers and the level of private sector support it is able to attract. We also need clarity on how long it will be before the new bank starts lending.”

£1bn public capital funding for Carbon Capture and Storage (CCS) demonstration projects. 
“Support for the CCS project is good news as if successful, it will both reduce CO2 emissions and help establish the UK as a world leader in the emerging CCS technology.”

£860 million for the Renewable Heat Incentive.
“This is a positive move as there had been some uncertainty around this subsidy. 
The subsidy will be funded by the Government rather than a complex energy levy so it is simple and transparent which is a good thing.”

No mention of the Feed in Tariffs (FITs)
“The Chancellor did not refer to the Feed in Tariffs so it is interesting that the accompanying speech notes stipulate that the tariffs will be rebalanced towards more cost effective technologies at the next formal review probably in 2014/15. This leaves open the possibility that Solar FITs will be reduced if they are too successful. This is a negative signal to investors in renewables as it insinuates the government may change the rules if the FITs are seen to be too successful.  If we are to hit our renewable energy targets, in the UK we will need to be seen as a good country with stable regulations to encourage global investors.”

Damian Dewhirst, Associate Director in Grant Thornton’s Government and Infrastructure Advisory service, on local authority announcements:

“The unexpected good news is for children and older people. The protection of spending on schools by the maintenance of Dedicated Schools Grant and for pre school children by the protection of Sure Start will ensure that early years provision and education will remain at the heart of local provision. The additional funding for adult social care totaling £2 billion from NHS and local authority budgets recognises the pressures of an aging population on the future demand for public services.

“The removal of ring-fencing for all other government spending will give local authorities real freedom, for the first time, to decide how money is to be spent. The downside to this is that the amount of money over which authorities can take decisions is to be reduced. This reduction may be by a greater amount than we had anticipated as a result of the good news for children and older people.

“Quite how far this reduction may go will not become clear until the business plans for the departments that fund local government are published next month. Only then will we get the detailed information about how the overall package of support to local government is made up. This will reveal whether the new found decision making freedoms are, in fact, simply a cloak for deep spending reductions and, if so, what the impact will be on individual local authorities.”

Neil Rutledge, Infrastructure Partner at Grant Thornton UK LLP, on infrastructure and capital spending:

“While government support for infrastructure over the Spending Review period has been confirmed at largely similar levels to those previously announced - involving a cut in overall capital expenditure from £59.5bn in 2010/11 to £45.6bn in 2013/14 - what is clear is that investment in certain sectors, particularly those supporting economic growth, such as transport, and the low carbon economy have been favoured at the expense of other areas, such as housing and other social infrastructure.

“Confirmation of the injection of £1bn of public capital to establish the Green Investment Bank and a green light for the introduction of a Renewable Heat Incentive with £860m of new funding further confirms the importance place by government on the low carbon agenda as a stimulus to growth.

“While next week’s eagerly anticipated National Infrastructure Framework from Infrastructure UK will provide more detail on the infrastructure schemes being supported, confirmation that a number of regional transport schemes such as the Mersey Gateway Bridge, will proceed will come as a relief to large parts of the construction industry.

“Against this backdrop, the previously announced cancellation of much of the Buildings Schools for the Future programme and the cancellation of seven waste PFI projects means that the spoils may fall unevenly.

“With the credit crunch still a significant feature in holding back private housing activity, the housebuilding industry will not find welcome confirmation of a fall in capital expenditure by the Department for Communities & Local Government for will fall from £6.8bn in 2010/11 to £1.8bn in 2013/14.  While not all of this relates to housing, it is clear that delivery of new social housing will depend upon new model which involve tenants bearing more of the burden.”

Nigel Mattravers, Director and Waste specialist within Government and Infrastructure Advisory at Grant Thornton UK LLP, on the impact on the waste sector:

“The announcements regarding waste management within the Spending Review send messages about the waste sector’s future.

“On the one hand there are positive statements of support for renewable projects through the renewable heat incentives (RHIs), feed in tariffs (FITs)and the Green Investment Bank. On the other there is the fact that support for seven of the ongoing waste PFIs has been with drawn.

“The effective support for renewable waste technologies, in particular anaerobic digestion, through RHIs and continued FITs had been generally expected but the effective withdrawal of support for some of the UK’s biggest waste schemes was not. This will have a dramatic impact on the current landscape of the waste industry. Although the announcement about Project Transform (Coventry,  Solihull and Warwickshire) was made some weeks ago the withdrawal of support for the North London Waste Authority (NLWA) project must be seen as a surprise. NLWA had long been seen as a flagship project for government and was seen as being critical to enable the UK to meet our diversion targets. What Defra is now saying is that support for these seven projects is being withdrawn as the UK no longer needs these projects to meet the EU 2020 targets for landfill diversion.

“How the individual authorities will react to this withdrawal of support at this stage is unknown particularly when many millions of pounds have been spent over many years to get to their current procurement. The question is: will they still be able to afford schemes that will enable them to meet their waste targets?

“For the 11 projects that will still receive government support, there will be relief but for other projects, and the waste industry as a whole, there will be great deal of uncertainty in the weeks to come.”

Karl Eddy, Head of Government and Infrastructure Advisory at Grant Thornton UK LLP, on local government cuts and opportunities:

“Within the high level numbers there were winners and losers.  Local government appeared to be one of the real losers within the settlement with cuts of 26% over the next four years with a net budget impact of 14% after Council Tax.  The only consolation would be the simplification of the financial controls and removal of ring-fencing of grants which should make for a more flexible and agile financing regime to be adopted. But will place responsibility for many of the hard choices on local government.

“Asset sales will play a part in protecting front line services and will be heavily dependent on the OBR’s economic forecast being achieved.  These are big caveats to achieving the outcomes.

“The sustained support for Big Society, should be the upside of smaller government.  The Chancellor is signalling a wider reshaping of government, its centre of gravity moving from top heavy Whitehall departments to localities.  This may result in more agile and focused services, delivered more effectively by the right combination of public, private and civil society organisations. 

“The focus on priorities to support economic activity remains.  The investment in green energy, skills and transport is welcome alongside the Regional Growth Fund announcements - harnessing enterprise and focusing on growth.  However, the spatial implications of such investment decisions may deliver a double whammy to those cities and towns already suffering from a reduction in public sector employment.”

David Shaw, Director in Grant Thornton UK LLP’s Government and Infrastructure Advisory services, on the Big Society aspect of the Spending Review:

“We welcome the sustained support of Big Society, which should be the upside of smaller government. The Chancellor is signalling a wider reshaping of government, its centre of gravity moving from top heavy Whitehall departments to localities. Local decision-making will better target scarce resources on the areas of greatest need and contribute to the activation of community resources. This will result in more agile and focussed services, delivered more effectively by the right combination of public, private and civil society organisations.

“The Spending Review promises a reduction in the bureaucratic burdens that tie up frontline professionals and deter new entrants from social enterprises, charities and SMEs. Currently front line organisations waste precious time and effort on labyrinthine bidding exercises and disproportionate monitoring. Therefore it is good news that we will see a shift from a top-down performance management culture to one which enables the front line to deliver and measures their outcomes rather than their inputs. 

“Ultimately, this agenda points to the devolution not just of service provision but also of prioritisation and commissioning. The real question is of accountability in the medium term as it may imply a new role for local authorities as more devolved accountability structures develop.”

Neil Rutledge, Government and Infrastructure Advisory Partner at Grant Thornton UK LLP, on the impact on support services:

“In the next 18 months support service providers will also be hit by rough and ready measures to cut spending across the public sector. By 2012, I expect the public sector to refocus on delivering quality services and getting value for money. Providers that can deliver cost effective support services should benefit disproportionately from this transition.

“In terms of subsectors in support services, the Spending Review is bad news for defence contractors who will be hit by the announced 8% reduction in the defence budget and the recent cancellation of the £14bn Defence Training Rationalisation project. On the other hand, the Spending Review announced a reform of the sentencing framework, which is good news for private sector providers offering to run programs that reduce reoffending.

“The fact that finance directors in government departments are increasingly held personally accountable to deliver savings should make it easier for support service providers to identify who to approach with offers that deliver such savings.

“The public sector clearly needs to adopt best business practice in procurement if it wants to achieve efficiency savings while providing the quality services expected by the taxpayer. This should particularly benefit large support service providers with the ability to provide economies of scale.

“Meanwhile, even smaller support service providers can benefit from a move to decentralization and localism, particularly if they are either highly specialized or innovative enough to deliver services at lower prices.

“I expect the support services sector to consolidate in the next couple of years as companies strive to make the most of opportunities generated by the pressing need for the public sector to cut costs.”

David Smith, Director in Grant Thornton UK LLP’s Government and Infrastructure Advisory service, on education:

Schools
“The small increase in direct funding is positive news for schools, although the re-distributional impact of the pupil premium will favour schools teaching poorer pupils. However, cuts in child welfare benefits and local government services may put pressure on families leading to greater pressures on schools to support disadvantaged pupils. Capital spend on schools falls by 60% as the BSF programme winds down leaving funding only for demographic pressure and major maintenance, so many schools may face increased operational costs.”

Higher Education
“If the recommendations of the Browne report are adopted, the swinging 40% cut to government core funding for teaching in universities is likely to be offset by higher tuition fees but this will put more of the financial burden on students and their families. Consequently, more students will demand degrees that lead to better job and income prospects rather than those simply providing personal development. The combination of differential fees and more selective students is likely to result in winners and losers but greater risk for all HE institutions.”

Further Education
“Further education will see a 25% cut in funding including an end to Train to Gain in favour of SME focused training. There will be more apprenticeships, with a student loan system for those over 25 and proposals for a training levy on employers. The transfer of funding from general taxation to targeted users and the focus on growth generation parallels changes in higher education.”

Phillips Woolley, Partner in Grant Thornton UK LLP’s Government and Infrastructure Advisory service, on real estate and assets:

“Local government expected the settlement to be very tough - and it is. Achieving a year on year saving of 7.1% for the next four years will be a massive challenge for councils and implementation will involve a large scale disposal of assets. Getting best value for those assets in the current market will be difficult and timing of disposals will be critical in both value and service terms.

“New capital funding to local government is falling sharply. We therefore anticipate new development will, to a large degree, rely on a combination of: localisation powers of recycling assets; public private partnerships; and using new tools to raise money. Therefore I am pleased to see the Government supports the establishment of public sector property vehicles aimed at delivering efficiency in the use of assets.

“The Government has applied a principle of supporting capital projects that it believes contribute to most to economic growth and a rebalancing of the economy, this has resulted in strong investment in transport and green projects. However, there are difficult cuts for social housing of around £5 billion. 

“The cuts run alongside a reform programme which may provide leverage for councils to innovate in order to continue investment albeit at a more modest level. New social tenants will pay 80 per cent of market rents, this extra income is forecast to raise £4.5 billion to fund the development of 150,000 new social homes over the next four years. 

“The removal of ring-fencing for all local authority revenue grants, a general promotion of localism and new mechanisms such as tax increment financing and housing revenue account changes are radical reforms, and give councils some additional tools to innovate.  We think councils will be keen to use these and quickly understand the potential to raise money for new housing and other capital facilities in their areas.”

Kathryn Hiddleston, Construction partner at business and financial advisors, Grant Thornton UK LLP, on the impact on the construction sector:

“On a positive note, the Government intends to increase the existing levels of capital spend by £2.3bn a year to 2014/15 to fund projects with long-term economic value. This includes over £10bn on nationwide high value transport maintenance and investment and more than £14bn for Network Rail investment. This is good news for the large scale civil contractors.

“Changes to social housing so that new tenants will pay 80% of market rents will help fund the development of 150,000 of new social homes over the next four years. Welcome news for a beleaguered house building market.

“However, where the Government gives with one hand it can take away with the other. The Government wants to devolve significant financial control to local authorities and - despite pledging to maintain significant funding for schools and hospitals - it is requiring local government to achieve savings year on year of 7.5% over the next four year at the same time as freezing Council Tax for 2011/12. All this will undoubtedly have a draconian effect on the number and value of projects available for regional builders.

“On a really positive note Mr Osborne announced an increase in the funding for adult apprenticeships by £250m a year by 2014/15. It is to be hoped that a large proportion of this will be directed towards developing skills for the construction industry.

“In conclusion, potential winners are the large scale civil contractors and social housing developers but the medium to small regional outfit may find that competition becomes even more keen for an ever-decreasing share of local council spend.”

Will McWilliams, Partner at Grant Thornton, on transport:

“The Government’s £30bn expenditure commitment to transport over the next four years recognises transport’s key role in supporting economic growth in the UK. In addition, the commitment to the capital’s Crossrail project together with Underground upgrades is very positive for London.

“Plans to extend the Midland Metro is excellent news as it will take it to the heart of the city centre. Continued investment in the Tyne & Wear Metro supports the key role that metro schemes play in the prosperity of our regional cities but this project was confirmed by the coalition government in June and was never likely to come under the axe.

“There was no specific mention of large rolling stock projects such as Thameslink or Intercity Express Programme with an implication that increased rail fares would support this investment on a more incremental basis.

“Overall, when Crossrail and revenue expenditure on the national road and rail network are taken into account there will still be significant pressure on local government transport expenditure and we estimate that 10% year on year transport expenditure reductions will be required at local government level.”

Bryan Higgins, Care Sector Manager at Grant Thornton UK LLP, on care home closures:

“The £14.4bn English adult social care budget needs another £4bn over the next four years to provide care for an additional 370,000 adults, but is getting only £2bn. Today’s Spending Review strikes a blow to the English adult private social care sector leaving it with a £2bn open wound.

“I expect to see an increase in the number of care homes that need to close down as a result of this Spending Review. The budget, which covers residential care and home care, leaves councils needing to increase care eligibility criteria and seek increased personal contributions towards costs. Rationing care could result in reduced care referrals and freezing or reducing the annual fees.

“Following the Spending Review, the outlook for the private social care sector is gloomy because care home occupancy levels have fallen for the last two years to around 88%. Moreover, last April’s average council fee increase was just 0.5%. This Spending Review announcement will therefore hasten occupancy falls, probably to an average of 85% with limited scope for fee increases only in the next four years.

“Compounding the problem of financial viability facing many care operators is this month’s 1% rise in the national minimum wage, as well as the increase in VAT to 20%. Moreover, new legislation will lead to higher management costs to ensure compliance.

“The despair will be felt hardest in those English regions already suffering low average occupancy and council fees - the north east and north west - although no region will be immune.”

More analysis to come on Grant Thornton Thinking Blogs.

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