The UK Public Finances
As the UK public purse strings continue to tighten, there are challenges and opportunities ahead for those in the private sector
As the coalition government looks to deal with the current level of borrowing and restore health to the national coffers, the much-publicised public spending cutbacks will have a downstream impact on the private sector. Many suppliers to the public sector are likely to experience reductions in the volume and value of goods and services purchased by the state and face tougher procurement hurdles. Others, including outsourcers and restructuring specialists, will be well placed to help government departments, agencies and their contracted suppliers find new ways to deliver public services in more efficient ways and for lower cost.
Public sector finances are under some of the most intense pressure since the end of the Second World War. In June, the government announced both an immediate programme of savings to the tune of £6bn and then, in the Emergency Budget, that by 2014/15 public spending will be cut by £99bn from a current level of public spending this year of about £700bn.
Per the recent HM Treasury near-cash projections set out in the June Budget document, this £700bn spending for 2010-11 breaks down as follows:
||Public Order and Safety
||Personal Social Service
||Housing and Environment
||Industry, Agriculture and Employment
In addition, there is £73bn of spending that does not fit within the categories listed above and a further £44bn of debt interest.
The spending is forecast to be largely – but not by any means totally - funded by government receipts of £548bn comprising:
||Business rates and Council Tax
||Other taxes, duties, interest
The shortfall of receipts to spending is to be made up through borrowing.
Whilst some limited areas of public expenditure are to be protected –including health and international development – very significant cuts are expected across government departments. The level of cuts for these departments have been estimated by some commentators to be, on average, 25%, whilst others are saying as much as 40%. The precise cuts by department would become clearer when the Comprehensive Spending Review is published on 20th October 2010.
Impact of cutbacks on the private sector
The scale of these spending cuts carries widespread implications for both the public and private sectors, including lending institutions. First is the impact on public sector bodies themselves and how restructuring professionals can help public sector bodies face up to levels of cuts against a backdrop of 12 years’ continuous growth in scale and budgets. The challenge here is to look for ways to maintain the quality and safety of front line services while reducing the overall cost of administration.
The second and critical element to the budget cuts is that the public sector spends more than £220bn a year on a diverse range of goods and services bought from across the UK private sector. As departments seek to rein in expenditure there will be a consequent impact on private sector suppliers. The interdependence of public and private sector activity cannot be underestimated. The government procures items such as defence equipment, transportation, IT, office equipment, legal services, stationery, food, pharmaceuticals and many other types of goods and services.
There are also many organisations who supply to the suppliers of government bodies, setting up a chain of consequences from the Treasury down to sole traders. For organisations that have structured the DNA of their businesses to match the workings of the public sector or major public sector suppliers, spending cuts could result in short-term reductions in profitability and longer-term business failure. The challenge here is to ensure that the reduction in public sector spending does not damage the recovery of the UK economy through downstream private sector implications and further damage to the UK financial services sector through loan defaults.
Looking in more detail at the likely ways in which spending cuts will be implemented suggests that spending on projects, goods and services will be widely curtailed, which means that certain expenditure planned under the previous government will be curtailed in the very near future and related projects will be cancelled. The Building Schools for the Future programme is an early casualty of this type of cut. In addition to the simple cuts, there will be an immediate tightening of public sector procurement processes meaning that private sector providers can expect a more rigid and demanding procurement system both in terms of approach and available rates for delivering on public sector contracts. Processes such as e-auctions are likely to be more prevalent. The government’s expectations are clear – the private sector must provide better value for money through lower margins for public sector contracts. Achieving an overall spending reduction of £99bn by 2014/15 will require a gradual step-up in savings made over the coming four years. 20th October will be a key date in understanding how those savings will be achieved.
Survey of local councillors expectations of service cuts
Paul Brice, a KPMG restructuring partner, comments: “Although many private sector suppliers to the public sector will experience tough times during this round of cuts, we see some providers
benefiting if the government seeks to deliver services in different and more economical ways. We may see a greater trend toward outsourcing and we may see an increase in transactions and arrangements with the private sector structured in novel ways.”
The position for lenders
Lending institutions are likely to see additional balance-sheet risk as a result of public sector spending cuts. To address this risk, lenders should seek to monitor very closely the trading performance and outlook scenarios of their corporate clients with significant interests in or reliance on the public sector. This could well include a contract-by-contract review in some cases to see what the downstream impact of any changes or spending reductions could be. Looking at the terms of each contract should give a clear picture of the scale and likelihood of financial risks involved as a result of contract termination, deferral, re-pricing or invoked penalty clauses.
This type of portfolio exposure review should happen very regularly as changes to the viability of public sector contracts and whole businesses can happen quickly. Lenders should be alert to wholesale reduction in a client’s revenue through losing contracts and marginal reductions in turnover through pricing and procurement adjustments.
Conversely, lenders will also need to be on the lookout for opportunities for growth and investment. For outsourcers and those offering commercialisation programmes, there may be increased activity during the cutback period.
Lenders will need to keep a close eye on the fortunes of sectors under threat of shrinkage in public expenditure I.e. facilities management and recruitment, and those sectors where fresh opportunities for growth may arise i.e. manage services. In addition to daily news-streams - particularly the trade press for each sector - the government's own publications, such as the Comprehensive Spending Review, will be an important source of information to monitor the likely fortunes of sectors, segments and specific organisations.
- The public sector deficit must be addressed through reduced expenditure and increased receipts.
- There will be downstream impact on private sector suppliers both directly and indirectly along the supply chain.
- Although there is more detail of the government’s spending strategy to come in October this year, all areas of public spending will be affected to some extent and departments are having to make spending choices right now.
- Lenders to the private sector may benefit from close portfolio and market monitoring – being a leading supplier to the public sector may no longer be the prize it once was.
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