United Kingdom: Risk Assessment
Country Risk Rating
Business Climate Rating
- Hydrocarbon production meeting three-quarters of energy needs
- Advanced sectors (aerospace, pharmaceuticals, and automotive)
- Low corporate taxes
- Uncertainties about the implementation and impact of the decision to leave the EU
- Economy's dependence on financial services
- High level of public debt
- Sizable private debt (especially property debt being 125% of disposable household income)
Uncertainties related to “Brexit” will weigh on short-term growth
Despite the unexpected decision in favour of leaving the European Union on 23 June, the British economy has proved resilient in the second half of 2016. Nevertheless, the uncertainty surrounding the exit terms will weigh on the economic outlook: private investment is not expected to contribute significantly to growth this year as investors adopt a wait-and-see attitude. Insolvencies should thus move in line with the slowdown in activity. However, exports could benefit from the sharp fall in the pound sterling against the dollar (more than 15% in the second half of 2016), hence a slightly positive contribution from foreign trade. In addition, a lower tax rate for companies is not excluded. Moreover, private consumption, the main driver of activity is expected to slow down due to the lower momentum of wage growth, a less buoyant labor market and rising inflation due to the depreciation of the pound sterling and the gradual rise in oil prices.
In this context of uncertainty and increased political risk in Europe, risks are many. A sharp depreciation of the pound against the dollar in 2017 is possible if the arrangement with the EU is less favorable than expected by markets. Moreover, new monetary easing measures are not excluded in case of a faster downturn than expected in activity, but that would weigh on the country's attractiveness. Volatility could prevail in the financial markets and a crisis of confidence could also lead to price correction in the property market. The sector is indeed showing poor performance and the risk of transfer to the banking sector is to be monitored because of the high number of SMEs with property as collateral. This risk is nevertheless limited, as banks are better capitalized since the crisis.
Budgetary consolidation is only party questioned
In November 2016, the Chancellor of the Exchequer decided not to opt for a massive stimulus plan (+0.1 percentage point of additional GDP growth in 2017) but the pace of budgetary consolidation should be less marked. Indeed, revenues should be less supported in connection with the slowdown in activity and spending should increase moderately, particularly those related to capital (the government should spend between 1 and 1.2 percentage point of GDP per year until 2020 in infrastructure). The establishment of the innovation and infrastructure fund allocating £23 million over a five-year period is not expected to solve the problems of low productivity. The rate cut should also help to limit interest payments on debt servicing and offset the effects of rising inflation. Furthermore, the objective of budgetary consolidation in 2020 was abandoned and the falling public debt/GDP ratio would not materialize until at least the 2020–2021 horizon. The country leaves room for maneuver to react to negative impact on growth.
After a record in 2016, the current account deficit is expected to narrow slightly in 2017, due to the lower momentum of imports linked to the expected slowdown in domestic demand, despite the increase in the price of imports due to the depreciation of the pound. In addition, this depreciation should support gains in price competitiveness and therefore exports, supported also by the demand made to the country. The strong weakening of investment income in 2016 should also weigh less on the current account in 2017 (more favorable returns).
The uncertain future of the United Kingdom
Prime Minister Theresa May wants the results of the referendum to be upheld and activation of Article 50 of the Lisbon Treaty governing the EU exit process before March 2017. However, the High Court in London ruled that Parliament should be consulted and the Supreme Court is expected to deliver its verdict early in 2017. Early elections are not excluded in the event of an unfavorable ruling.
In the event that the exit becomes effective in April 2019, the trade regime will be less open than in the past, and the migration policy should be more restrictive. Some highly integrated sectors in the EU, such as the pharmacy and automotive sectors, would be further hindered. Europe should take a hard line considering that, if the United Kingdom brings an end to free movement of European citizens, it will not have access to its single market, so as to prevent other European countries will follow suit. Indeed this would further destabilize the Union, already weakened politically (rise of populism).
While the Brexit issue divides, Scotland has announced its wish to remain in the EU (62% voted to remain in the EU) and Scottish Prime Minister Nicola Sturgeon wishes to hold a referendum on the country's independence.