Perspectives



Economic Review and Outlook: Implications for the UK

The government’s latest budget, published on March 19th, presented a number of interesting surprises, perhaps indicative of a growing confidence in government that the recovery from the global recession is on track and sustainable.

The surprises were mainly aimed at personal savers—major reforms for those with defined contribution pensions, for example, in terms of how they can access their fund on retirement, and greater tax exemptions for those who save. There was also a continued theme of tax breaks for companies that invest for future growth. Unfortunately, the budget was relatively light on new infrastructure announcements, which is symptomatic of the somewhat bumpy journey the infrastructure sector is experiencing in the UK—some highs, some lows, and many competitors, all of whom are waiting for the promised pipeline of projects contained in the £375 billion National Infrastructure Plan 2013.

UK Economic Performance

The UK’s quarter-by-quarter GDP growth from 2007 through to the end of 2013 is shown in Box 1. The improvement in growth figures is ahead of forecasts produced earlier this year and has been supported by higher consumer spending. Growth in the last quarter of the year dropped slightly (by 0.1 percent) compared with the previous quarter, but for the first calendar year since 2007 the UK experienced positive growth in each quarter of the year and ended the year with annual growth of 2.6 percent (the previous year growth was -0.2 percent).

The Office for Budget Responsibility (OBR) estimates growth figures as follows (Box 2):

  • 2014: 2.7 percent (up from 2.4 percent in the Autumn Statement 2013 and 1.8 percent in last year’s budget)
  • 2015: 2.3 percent (as last year’s budget and up from 2.2 percent in the Autumn Statement 2013)
  • 2016: 2.6 percent (down from 2.7 percent in last year’s budget)
  • 2017: 2.6 percent (down from 2.8 percent in last year’s budget)
  • 2018: 2.5 percent

The OBR expects employment to rise in every year of the forecast period, eventually reaching 31.4 million by 2018.

In contrast to last year, when inflation was 2.6 percent on budget day and forecast not to reach two percent until 2016, the OBR now expects inflation to be below target at 1.9 percent in 2014 and then to remain at two percent.

Public sector net borrowing is forecast to fall by half in 2014-15, from its peak in 2009-10. The OBR forecasts a small surplus in 2018-19. Borrowing for this year is estimated at £95.6 billion (2013-14) and is forecast to fall to £83.9 billion in 2014-15, £68.3 billion in 2015-16, £41.5 billion in 2016-17, and £17.8 billion in 2017-18.

It is understandable that there is renewed confidence on the basis of these forecasts, but the borrowing figures show that public sector net debt is still rising as a percentage of GDP, peaking at 78.7 percent of GDP in 2016 before falling thereafter, as shown in Box 3 on the following page.

Prospects for UK Infrastructure

There are many identified projects contained in the latest edition of the government’s National Infrastructure Plan 2013. The plan contains over £375 billion of infrastructure projects proposed for the next decade and beyond. These projects represent a mix of public and private sector investments in all infrastructure sectors.

There are some urgent requirements, particularly in the energy sector where the trilemma of security of supply, reducing carbon emissions, and affordability has yet to be satisfactorily resolved, although the Energy Act, which introduces significant market reforms, was passed in December of 2013. Many of these reforms depend upon secondary legislation which is working its way through the system and is anticipated to be complete by the end of 2014 or early 2015. The reforms comprise four policy instruments as follows:

  • Carbon price floor (to encourage investment in low-carbon generation);
  • Contracts for difference (enabling a fixed strike price to be paid to low-carbon generation developers);
  • Capacity mechanism (to support provision of back-up and peaking generation plant); and
  • Emissions performance standard (to limit emissions from fossil-fuelled generation).

The intent is to create an attractive platform for investment in new electricity infrastructure that can reduce emissions and provide security of supply. The problem is that over £110 billion1 of new investment is required this decade to meet the EU’s 2020 renewables directive and to replace and augment existing and retiring generating stations. That equates to higher bills for consumers and is causing a political storm with different parties as they each focus on reassuring electricity consumers on the cost of energy in the lead up to the next general election in May of 2015. The consequence of political debates is that they cause uncertainty; investors do not like uncertainty.

This may be why, at the same time as the budget was published, Infrastructure UK published a financing update to its National Infrastructure Plan 2013. The update focuses primarily on the opportunities within the infrastructure pipeline for investment in greenfield assets (i.e., new or replacement infrastructure). It also references the already active market in brownfield assets (more popular with many investors due to their lower risk profile, lower financing costs, and more predictable returns) and suggests that, in some cases, this brownfield investment could be used to support the financing of new infrastructure by recycling capital.

The update defines the nature and extent of the potential investment opportunity, with a particular focus on the period to 2020, and is intended as a reference point for an ongoing dialogue between the government and the investment community to understand the views of the investment community and inform the development of the National Infrastructure Plan 2013 as it continues to evolve.

However, the difficulties of solving the energy trilemma were illustrated by one announcement in the budget relating to the first electricity reform measure to be introduced, the carbon price floor. Whilst the government reaffirmed its commitment to growth in low-carbon technologies, it also announced a cap of the UK’s carbon price floor of £18 per ton from 2016-17 to 2019-20. The UK’s carbon price floor sets a rising trajectory for the carbon tax paid by electricity generators, which raises the cost of electricity. Its intention is to stimulate investment in low-carbon infrastructure by reducing the cost gap between low-carbon and carbon-emitting generators. The cap is designed to reduce the electricity price to consumers. The carbon price floor started in 2013 at £16 per ton (2011 prices) with a planned rise to £30 per ton by 2020, so an £18 per ton cap is quite significant.

The budget also sustained the drive on HS2 (the proposed new high speed rail line from London to Leeds and Manchester via Birmingham), with the government committing to review proposals to accelerating the route to Crewe, a major rail hub north of Birmingham, as well as reviewing the London Euston station and link to HS1 proposals. A hybrid bill for Phase 1 from London to Birmingham has been deposited with Parliament and will be debated this year. A hybrid bill will not only grant the government planning permission to build the HS2 network, but will also give the government powers to operate and maintain HS2 and its associated works, along with other more detailed planning matters relating to existing infrastructure affected by HS2.

 

Other budget announcements on infrastructure were relatively modest, relating mainly to provision of emergency funding to repair storm damaged assets, such as flood defense structures and roads, and to a number of regeneration initiatives, including release of surplus government property for redevelopment, a new garden city at Ebbsfleet in the Thames Estuary, and provision of funding for the redevelopment of housing estates in inner cities.

Conclusions

As has been stated before, there is a sense of optimism but it is not universal. Capital spending is on the rise and the importance of investment in national infrastructure projects is not lost on government. However, the challenges of reducing the public sector net debt combined with the reforms that are ongoing in the electricity and highway sectors are not helping increase the flow of infrastructure projects going through planning and consenting. There are also, of course, questions relating to finance and planning timescales in terms of moving individual projects forward.

Source: Matt Buck (Creative Commons)

There is also an added consideration. In my last EFR article (Volume 7, Issue 2, December 2013) I wrote that the European Academies Science Advisory Council had concluded that an increase in extreme weather throughout the continent would present major challenges to engineers and infrastructure owners. The turbulent three months that have followed—storm after storm hitting the UK from the Atlantic causing significant damage to rail and highways infrastructure, not to mention that, at one point, it seemed as if much of Southern England was underwater—created another challenge for government. Infrastructure resilience is critical to economic performance. It will be interesting to observe over the next decade whether the UK will take a more strategic approach to infrastructure resilience or whether it will rely on emergency funding for repair work as and when an extreme event occurs.

Note:

    1. Electricity market reform assumptions, Department of Energy and Climate Change 

Image Header Source: Shaun Dunmall (Creative Commons)