By: Swakrit Banik
Every economy goes through a rhythmic fluctuation in its real economic activity. This is something we know as a Business Cycle. Every country and corporate try to forecast the turning point of the business cycle because if predicted successfully, there is no limit to the insane amount of money one can make. Several economic variables indicate which stage of the business cycle the economy is moving towards, such as,
Lead indicators (like stock price, capital expenditure, and money growth rate, which turns in advance to the economy)
Lagging indicators (Economic variables which turn after the economy. These are used more as conformation like - unemployment, corporate profits, wage rate/unit, consumer price index etc.)
Coincident indicators (i.e. economic variables which turn with the economy, like GDP, inflation, personal income etc. These are not indicators but are more like a by-product of the economy's performance)
This brings me to the star word of today's time - "Inflation". It is an indicator of the high cost of living in a country, i.e. when the price of goods and services shoot up. Inflation is healthy for an economy, but, as they say -
"Too much of anything is good for nothing."
The United Kingdom (UK) has now been subjected to this. The temperature may have been cold in the UK, but inflation is only getting hotter and hotter. We all know inflation decreases during the recession and increases during the expansion phase. However, things are quite contradictory for the United Kingdom. The country is witnessing one of the worst economic crises in history, pushing the economy into a recession. On the other hand, inflation rates are at an all-time high and are expected to shoot up even further by the year end.
Well, all of this is because of three primary reasons:
The Russians have completely cut-off gas supply to the UK due to which the cost of electricity has almost shot up by 100% in the UK.
On top of the existing gas shortage, winter is incoming for Europe. So, energy consumption is likely to hit new peaks till December.
Even if Europe has 90% of its gas storage full as of September, it will take only 90 days to reach dangerously low levels.
So, a shortage of gas during a peak consumption time with no storage option has put energy prices at extreme levels. Secondly, the UK is now importing oil and gas from the USA and other countries. These countries are reaping the benefits from this situation by selling to the UK at a very expensive price. Hence, the cost of production and inflation levels have hit a record of 10.22%. Companies like Citi Bank estimates the inflation rates to go as high as 18.60% for the UK by January 2023.
This is where the ex-Prime Minister of the United Kingdom, Liz Truss, announced a Mini-Budget to tackle the energy and economic crisis in the UK. The pointers stated are so terrifying that it instantly shook the economy of the UK itself.
The standard practice is that power companies buy energy in the form of oil and gas, convert that into electricity and sell it at a higher cost to the consumers after booking their profits. But as soon as Russia cut off the gas supply, electricity costs soared because it is imported at a higher price. Thus, the price charged from consumers is also going up. But the Government of UK has set the maximum ceiling price at £520/MWh. So, now when the cost of electricity to power companies are at £1000/MWh, the citizens are paying £520/MWh only.
On top of that, the Mini-Budget states,
"Millions of households are set to get £400 wiped off their energy bill."
i.e. UK Government is providing a £400 discount to the citizens which will be paid by the government and whatever losses this powerhouse incurs during the coming two years will be set off from loans given by Banks. This price gap is applicable to every income group.
If seen from the public's point of view, it is beneficial for them. They don't have to bother with the energy bills even if the cost goes up. Then the question is - why is it a disaster?
Well, the answer to this is presented in the graph given by the National Institute of Economic and Social Research (NIESR).
The x-axis shows the class of people going from poor to rich. The first graph, which has the amount spent on energy on the y-axis, shows that the poorest segments of the UK spend approximately £2750 on energy, while the richest spend £5000. The second graph, on its y-axis shows, how much of their income is spent on electricity consumption. If we have a close look at how much it is in terms of their % income, the poor spend 8% of their income, while the rich spend only 3% of their income, even if they spend £5000.
In response, NIESR asserts that it is bad economics for the government to charge both rich and poor the same unit price for energy because the cost of energy represents such a small portion of wealthy people's income. For example, Mukesh Ambani spends close to ₹80Lacs/month for electricity consumption. He will pay the same price per unit as a normal middle-class household living in a 2 BHK apartment. So, for a household individual who pays ₹5000/month on electricity, it is around 8-10% of their income. Whereas for Ambani, it is not even 0.01% of his income. Because of such a scenario, there is
Extra power consumption in the UK
For this extra consumption, there is no extra revenue generation for the government.
So, even if the energy price in the UK is shooting up, people are required to pay no more than the ceiling price set by the government. Hence, power companies are suffering an abundance of loss, which will need loans and compensation from the government and Banks.
A simple solution to this problem is an implementation of a Variable Slab System - which is used in India, quite similar to the slab rate system we follow for taxation. Thus, because of such abrupt policies, the UK Govt. will be bearing the cost of £130 Billion (i.e. ₹1.20 Lac Crore) over the next 18 months in addition to the $3 Trillion (i.e. ₹246 Lac Crore) debt that they already have.
Now, the question that pops up is - How will the government get such a massive chunk of money?
Well, the answer is quite simple. The government will be issuing bonds and treasury bills. The problem here is that currently, the UK is heading towards a Bond crisis which has led to a Currency crisis, which will eventually lead to a Mortgage and Banking crisis. Thereby turning UK into complete economic turmoil.
The pound is depreciating at a very fast rate which is shaking the currency market. The foreign exchange rate of GBP (Great Britain Pound) is not in favour of the investors. So, even if the bond market is yielding a higher interest, the currency has depreciated to such an extent that now it has become a loss-loss situation for investors. As a result, they are quitting the UK market. This is further decreasing the demand for the pound, and as a result, the currency is depreciating further. As an importer of oil and gas, this is also spiking up the price of energy because a weaker GBP will result in an excess cash outflow, which is now an extremely unfavourable situation for the UK.
The government will have to borrow more money in order to compensate for these losses. This means more bonds will float into the market, which means demand for bonds will go down, and the interest rates for these bonds will go up, which will shoot up the cost of borrowing for UK Govt. Eventually, depreciating the currency further and will lead to a vicious cycle.
On top of that, they have also announced tax cuts which are expected to decrease government revenue by $45 Billion (₹24K Crore) till 2026 during a cash crunch situation.
Now, because of these policies, the UK government is raising the prices of other goods and services. This makes the inflation rate so high. The country now faces a price more than 10% higher than that of a year ago. It is for the first time that inflation has hit double digits in 40 years. Recession is a part of a business cycle, and every economy goes through this wave and UK is no different. But the question that arises now is - how is UK going to recover and what are the options left at their disposal?
The way I see things, the country is left with two options, i.e.
Either withdraw the sanctions imposed and resume getting oil and gas from Russia. This way, the root cause of all problems will be solved and eventually things will fall into place for UK.
Or deal with the complication of its economy by being dependent on the US and Gulf countries in the hope that things stay in their favour.
Well Written Article💯