Risk aversion threatens to dampen economic recovery

 
Mark Gregory

AS THE great and the good of UK business congregate for the CBI’s Annual Conference today, the atmosphere is likely to be much more upbeat amongst business leaders compared to last year.

This is understandable. Business confidence in the UK has soared over the last 12 months and executives are now more confident about the economic outlook in the UK than at any time in the last two years, according to EY’s latest Capital Confidence Barometer.

This confidence appears to be based on solid foundations – the latest official GDP figures released by the Office for National Statistics (ONS), showed that economic output rose by 0.8 per cent between July and September.

And 84 per cent of the executives we interviewed for the barometer expect the UK economy to grow at between one per cent and three per cent in 2014, in line with other consensus forecasts.

This confidence is leading to a much more positive attitude towards the UK’s growth prospects and this confidence is likely to translate into M&A activity – a boon for the city as well as the UK.

Businesses have been stockpiling cash waiting for the right time to invest and the current confidence levels have historically signalled a pick-up in activity within six to 12 months.

LOW RISK STILL IN FAVOUR
However, despite these increasingly positive noises, doubts as to the speed and scale of any pick-up in activity loom large. The underlying sentiment from those executives polled is of a preference for low risk, incremental growth strategies with a focus on organic moves around core products and existing markets.

This is supported in part by the trend in PMI statistics for 2013. The surveys consistently report increasing levels of confidence but there remains a gap between actual output and the level that the higher confidence scores imply.

So with the economy growing – albeit slowly – and corporates awash with positive sentiment and healthier balance sheets, why is business being so cautious?

MORE CORPORATE GOVERNANCE
The most striking finding from our survey was the increased focus in the boardroom on risk management, regulation and especially corporate governance in the last six months.

The increased level of focus is a step change on an unprecedented scale.

These findings are easy to rationalise. Over the last six months business has witnessed the continuing work to increase the regulation of the banking sector, the international debate on taxation, several high-profile corruption allegations such as on Libor and Forex, and public interventions by politicians from all sides on UK energy policy. As an example, a number of energy companies have announced plans to put investment on hold.

The overall picture is one of increased political interference and hence greater political risk: weakening one of the key pillars of UK strength as perceived by inward investors in EY’s annual UK Attractiveness Survey.

This should act as a wake-up call to policy makers. Business confidence – although increasing – is still fragile and government needs to facilitate and not overburden corporates.

ENCOURAGING LONG TERM INVESTMENT
Policy needs to find the appropriate balance between risk and reward, it needs to be developed with an understanding of the potential impact on the economy and business, and to facilitate and encourage investment over the long term.

As examples, energy policy seems to require low end user prices, huge incremental investment and the use of higher cost technologies – this circle has to be squared.

Regulation of the banking sector must be balanced – some of the more beneficial lending such as to SMEs and start-ups is inherently more risky hence a strict risk averse regime will adversely impact priority areas. The UK recovery has started and confidence has improved.

But as the EY ITEM Club Autumn forecast highlighted, it will only be sustained if business investment follows the consumer upturn, creating the jobs and opportunity for wage growth that is necessary to support rising consumer debt.

Mark Gregory is EY’s chief economist