SHARES in Britain's smaller companies are likely to be the worst affected by a crackdown in spending by a UK government faced with a big budget deficit from bailing out the country's banks. Central and local government expenditure worth 73 billion pounds ($101 billion) to small companies last year, according to the Federation of Small Businesses (FSB), could be at risk as the UK government looks to rein in public spending in coming years. Total public spending is currently over 600 billion pounds, but the government has already signalled a proposed slowdown, with real spending rising by just 1.25 percent in 2011/12. The rate is paltry compared to the past decade, when public sector current expenditure has grown on average by 3.3 percent per annum. Between 2000/01 and 2005/06 it averaged 4.4 percent. “Government contracts have their worth on two levels: both financially and the reputational aspect of having the contract,” said FSB's head of public affairs Stephen Alambritis. “If those dry up, to try to clamber back on to a public procurement listing is going to be very difficult for small businesses as we come into recovery,” he said. Investors' concerns are reflected in the valuation of Britain's small-cap stock index, which has been hit hard in the current recession. The FTSE Small cap index nearly halved in value last year, is down by more than 12 percent so far in 2009, and the outlook remains tough. “Our view is that small/mid-caps should underperform large-caps in the early stages of a recovery,” said Eduardo Lecubarri, head of Small/Mid-Cap Strategy at JP Morgan. “As we come into recovery the larger businesses will be better prepared... they have the resources to win over buyers with cheaper bids,” said Alambritis. Among contracts already facing spending gaps and delays is the government's Building Schools for the Future (BSF) project, which the National Audit Office claims needs an additional 1 billion pounds a year in government funding. The start of a 350 million pound BSF contract in Salford and Wigan has already been delayed by over a year. IT company Redstone, which has shed almost 70 percent of its value since September 2008, is among the companies waiting for the Salford and Wigan IT infrastructure contract to be awarded. The company announced a drop in profits in December on the back of cancellations. Spending cuts “Peripheral projects such as IT upgrades are likely to be the first casualties” of public spending cuts, said David Page, economic analyst at Investec securities. Small-cap builders, real estate firms and roofers and scaffolders also will be hit, causing further stress for companies such as Taylor Wimpey, the shares of which have fallen over 60 percent since September 2008. The small-cap housebulider has already suffered land writedowns, while it saw completions, a fifth of which are in government-subsidized housing, fall by 35 percent in the first half of 2008. The transport sector also faces reduced spending. State-backed rail operator Network Rail recently accepted a 22 percent reduction in its budget for spending and investment over the next five years. These cuts will affect sub-contractors, such as engineer and support services group Babcock, which have been told 28 percent of their upgrades will be deferred over the next five years. Page says there will be few safe havens with cutbacks that will be more or less across the board. Fiscal double whammy Total public spending could reach 1.3 trillion pounds this year if the full extent of Britain's bank bailouts is realized, which as a percent of UK GDP will be at its highest since the last recession in the early 1990s. “Small businesses are concerned with the huge amounts of money being used to shore up the banks,” said Alambritis. The government will have to raise taxes or cut spending by 20 billion pounds a year by 2015 to meet its own targets for restoring public finances, according to the Institute for Fiscal Studies. “Once there are signs of recovery the government is likely to tighten fiscal policy quite sharply. Including tax increases to some extent on small business, but a lot of that will fall on the housing sector, which will have a demand impact on smaller businesses,” said Page. This would lead to further pressure on small companies' profit margins. “There is a concern that business taxes, national insurance contributions, corporation tax, capital gains and VAT may be targeted for increases,” said Alambritis.
