Analysis: Tight rein on inflation is crucial for UK defence industry

Analysis: Tight rein on inflation is crucial for UK defence industry 25 July 2008: With the UK a year into the global credit crunch and possibly already in a recession, Jane's views the country's defence industry as somewhat more resilient than other sectors of the economy. This resilience has been due to the relative lack of debt on UK defence companies' balance sheets (and therefore reduced exposure to tightening credit conditions); revenues that are driven by government rather than consumer spending; medium-term revenue visibility through the fixed three-year government defence budget (set under the Comprehensive Spending Review - CSR); access to long-term government contracts; and access to export markets. However, with the UK treasury reporting in July that Consumer Price Inflation (CPI) inflation had reached 3.8 per cent and producer output inflation 10 per cent, this access to a fixed defence budget throws up its own problems and, factors that were previously beneficial, can become liabilities. The 2007 CSR assumed that CPI inflation would not exceed 2 per cent in 2007 and subsequently remain at 2 per cent until 2010. A comparison of independent forecasts produced by the treasury in July 2008 suggests inflation will stay at around 3.6 per cent through to the end of 2008 before dropping to 2.4 per cent in 2009: still 20 per cent above the inflation assumption. A longer-term inflation forecast published by the treasury in May shows CPI inflation staying stubbornly at 2.2 per cent until 2011. Should inflation persistently remain above the level planned for in the CSR, it will erase the much touted annual 1.5 per cent increase in real-terms defence spending currently programmed for the years through to 2010. This would effectively leave the UK Ministry of Defence (MoD) with a reduced budget in real terms at a time when all of its costs are rising.