A rebalancing and divergent world is hard for business to call

It could go either way…

The EY ITEM Club Winter forecast is optimistic about the UK’s ability to withstand the problems in the global economy in 2016. The EY ITEM Club expects continued consumer spending, reasonable export performance in developed markets and business investment to offset any negative effects from the challenges for the world economy emanating from emerging markets.

Chart of UK: Contributions to GDP growth
UK: Contributions to GDP growth

…so it is important to balance ambition…

The reality is that the global economy remains dynamic and uncertain but most importantly there are likely to be a significant divergence in performance between countries and regions.

Divergence means that there will be both opportunities and risks. The start of a new year is the ideal time to review existing plans and business models to ensure that the appropriate level of ambition is in place. Based on the specifics of the EY ITEM Club assessment of both the UK and global economies, the key areas for focus are:

  • Geographic focus: with the outlook for emerging markets remaining challenging, UK corporates should review their portfolios to ensure they are giving adequate focus to the improving economic prospects in the developed world such as the US and the EU. By contrast, a blanket approach to emerging markets would be the wrong strategy. Attention should be given on selecting the specific opportunities in countries less exposed to exports to China and commodity sales. India certainly merits review in this context.
  • Understanding the changing consumer landscape: consumer spending is expected to remain strong but levels of income growth are likely to vary by segment. The national living wage will benefit lower earners in the main whereas mid-income employees may see technology eroding their bargaining power. Understanding the variations will be crucial in shaping corporate investment and resource allocation plans.
  • Margins are likely to come under increasing pressure with the introduction of the National Living Wage, increasing average earnings and an eventual rise in interest rates. Businesses should review their business models and ensure their investment plans incorporate sufficient resources to drive productivity enhancing change. This could be the year when technology delivers on its promise to transform business activity more widely than has been the case to date as the availability of cheap labour starts to decline and capital begins to look relatively more attractive.
  • UK regions: The UK Government has embarked on a programme to devolve economic decision-making power to the UK regions. This will create new opportunities and the recent EY report on the UK region and city economic forecast is a good starting point for identifying what these might be.

…with risk management.

While the EY ITEM Club believe the UK is well placed to ride out the global storm, there are obvious risks to this view and hence a clear risk management plan should be high on the corporate agenda. Key areas are:

  • China: the impact of a significant slowdown – which would impact both commodity and trade activity and hence businesses either directly or indirectly exposed to this activity. The slowdown in Brazil illustrates how sharp a slowdown could be.
  • Geo-political risk: if there was an unexpected spike in oil prices for example, this might well impact countries less exposed to China such as the US and the Eurozone. Companies should consider how their trade activity, both sales and supply chain might be exposed to sudden shifts.
  • Currencies are likely to remain hard to forecast in this complex global economy as monetary policy divergences play a major role in shaping relative currency strength. The future level of sterling in particular is especially hard to predict.
  • UK domestic activity could slow and Government could easily find its finances under strain if tax receipts fail to meet expectations. This will have obvious implications for businesses that deal with the public sector but all parts of the economy could feel the impact if taxes have to rise.
  • Brexit will loom ever larger in 2016 although the impact remains hard to assess, it is sensible to begin to think through what the options might mean.

Scenario planning could help shed some light on the right balance of activity.

Scenario planning was all the rage when I was a boy but it has fallen out of favour in recent times. Given the risks identified above, now might be the moment to revisit this technique. In particular, it offers the possibility to scale the potential impact of some of the risks relating these to the business plan and hence providing guidance on the scale and allocation of resources to risk management.

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