The UK Government’s ambitious plan to double its defence budget took a blow yesterday after the financial markets reacted to the Chancellor Kwasi Kwarteng’s 30 point ‘mini-budget’ announced on Friday 23 September and the pound fell to a new low against the dollar.
Prime Minister Liz Truss, during her recent campaign for leadership of the Conservative Party, pledged a multi-billion pound increase in defence spending that would raise the military budget to 3% of GDP. Under existing conditions that translated to raising military spending from £48bn to £100bn by 2030, Defence Secretary Ben Wallace was reported to have said on Sunday 25 September.
“23% of MoD funds currently allocated for platform acquisitions have been awarded to US suppliers”
However, on Monday 26 September the value of the pound fell to its lowest ever level recorded against the US dollar, with investors withdrawing over concerns about the sustainability the UK’s public finances. At its lowest the dollar value of the UK economy dropped 13% below where it had sat when Liz Truss became Prime Minister three weeks ago, without significant signs of recovery.
“This budget was already ambitious in the current fiscal environment, even prior to the currency devaluation we’re seeing today,” said Madeline Wilde, defence and security analyst at GlobalData. “If the devaluation problems continue in the longer term, then there is propensity for both ongoing and planned procurement programs to suffer.”
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Later on Monday the Bank of England said it would ‘not hesitate’ to increase interest rates to stabilise inflation but stopped short of suggesting an emergency rate hike to stabilise the pound, in a statement intended to stabilise markets and halt further investor flight. This may reassure the markets of the UK’s monetary discipline in the face of inflationary trends, but the implications for outstanding defence contracts can be severe. “Even if the Bank of England increases interest rates in response to the crisis, the enormous growth rate set out by the defence minister will be difficult to meet,” continued Wild.
“If the pound remains weak against the dollar in the longer term, it could result in US contenders being too expensive”
Changes to interest rates have implications for long term equipment plans, inflating prices and increasing the cost of programmes that have been planned. “Many ongoing procurement programmes for large platforms are governed by multi-year contracts, thus spreading the cost but making them vulnerable to fiscal changes,” said Wilde. The increase in pressures on the state’s budget may be counter-productive at a time when the Treasury is attempting to demonstrate financial soundness. “The British government is already borrowing a huge amount; to nearly double the defence budget by 2030 will have a significant impact on state spending as a whole.”
A reduction in the value of the pound can be expected to give a competitive edge to UK exporters in the defence industry, but as the currency’s purchasing power drops the Ministry of Defence’s (MoD) current purchasing plans with US companies becomes too costly. “The weakening of the pound against the US dollar will make it harder for the UK government to fund the £100 billion 2030 defence budget that was recommitted by Defence Minister Ben Wallace yesterday.”
Through the next ten years, 23% of MoD funds currently allocated for platform acquisitions have been awarded to US suppliers, according to GlobalData. “For planned programmes, if the pound remains weak against the dollar in the longer term, it could result in US contenders being too expensive,” said Wilde.