Outlook: C&W's US exit leaves a company looking for a purpose

Sterling crossfire; Gas prices inflate
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Cable & Wireless yesterday delivered the promised "exit" from its troubled US operations, but only by putting them into Chapter 11 bankruptcy proceedings. This was the only way that Francesco Caio, the chief executive, was ever going to extricate himself from the acquisition-inspired mess left behind by his predecessor, Graham Wallace. Chapter 11 allows the US operation to renegotiate on more favourable terms the crippling rental contracts it had signed up to, as well as downsize the workforce more swiftly and at less cost.

Nobody in their right mind would have bought the business, with its chain of data processing centres, in its present state. Chapter 11 allows costs to be put on a more realistic basis, which in turn has attracted a purchaser, Gores Technology, willing to pay as much as $125m for the business.Even so it will cost £300m in cash before C&W is able to draw a line under the affair, on top of the £150m of cash "burn" the US chalked up in the first half. The only consolation is that the sums still add up to less than the £650m Mr Caio said he might have to spend before he could secure his exit.

Assuming all goes according to plan, what will C&W look like after the US operations have been shed? A bit of a hotch potch is the honest answer. The remnants of the original, colonial C&W are still to be found in an array of smallish telecom incumbents in the Solomon Islands, the Caribbean, Guernsey and Macau. The really big one, Hong Kong Telecom, has already been flogged off. All of them face varying degrees of new competition and a consequent onslaught on margins.

Then there are the still loss-making UK operations, the fruits of the Thatcher government's decision in the early 1980s to create an alternative to British Telecom. These still constitute the second largest telecom-munications network in Britain and, in theory, could be quite profitable if Mr Caio can get the formula right. But the biggest asset of all remains the company's £1.6bn cash mountain. Shareholders have seen the cash steadily eroded over the years through losses and hair-brained acquisitions. Mr Caio says profligacy is a thing of the past, but he will not entirely rule out using the cash for expansionary business purposes, rather than paying it back to shareholders. His case will need to be a compelling one to convince sceptical investors.

Sterling crossfire

The pound briefly hit an 11-year high against the dollar yesterday, its highest level since October 1992, the month after Britain's enforced withdrawal from the European Exchange Rate mechanism, yet this is more a story about dollar weakness than pound strength. The pound's effective exchange rate, measured against a basket of currencies weighted according to their importance in UK trade, has been falling steadily since early 2000. Since April this year it has stabilised within a range of 3 per cent.

The main currency play is between the dollar and the euro on the one hand, and the dollar and the yen on the other, with the pound left bobbing around somewhere in the middle. The pound is being pulled up by the euro and down by the dollar with a broadly neutral net effect. In theory, then, the effect on the UK economy of this battle of the currency titans should be only marginal. In practice, it is not as simple as that.

Most British trade is these days with the eurozone, so British industry should be benefiting from the strong euro in terms of more competitive exports and pricier imports. Unfortunately, demand in the eurozone is as flat as a pancake, so the boost isn't as great as it should be. Meanwhile, we are becoming less competitive against the really strong growth areas of the world, the US and the Far East. The Chinese renminbi is pegged outright to the US dollar, and so, in effect, are other peripheral Far Eastern currencies, which broadly track the dollar. The exception is the yen, but even here, deflation allows the Government to print money to throw at currency intervention, and thus keep the yen from rising too far against the dollar.

The European Central Bank's apparent willingness to tolerate a strong euro when growth in the eurozone is still so low, is regarded with complete bewilderment in the Far East, from where I have just returned. What the core euroland economies of France and Germany need is lower interest rates and a depreciating currency yet, relatively speaking, they are getting the reverse. Indeed the ECB has publicly threatened to raise interest rates as punishment for the flouting by Germany and France of the Stability and Growth Pact rules.

Europe hardly needs to take lessons from Japan in economic policy management. Most of the 1990s in Japan were characterised by economic mismanagement. Yet in the past two years Japan has shown itself willing to learn from past mistakes. Despite the dire state of the public finances, there's been no fiscal tightening nor does there seem likely to be for the foreseeable future. Interest rates are being held at zero, and the currency is being kept low through massive intervention. All this therapy is finally producing results in terms of a return to modest rates of growth.

None of these policies could be easily repeated in Europe, where the constraints of the single currency would prevent foreign exchange intervention on a similar scale or fiscal laxity of the magnitude practised in Japan. The growing stand-off between the ECB and its member governments is reminiscent of the paralysis in economic policy making that occurred in Japan in the 1990s as the Ministry of Finance pulled one way and the Bank of Japan the other.

The euro area has become the biggest loser in the game of competitive currency devaluation being played out between the US and the Far East, and the real curiosity is that the ECB doesn't even seem to realise it. Britain is caught in the crossfire.

Gas prices inflate

There must be a cold snap on the way. British Gas is raising its prices. True, its 2.5 million prepayment customers will not have to bear the increase until winter is over. But that is where the season of goodwill ends. Everyone else will find their bills going up by 6 per cent from January. And not just for gas. Electricity, which these days is generated substantially from gas, is going up by the same amount.

British Gas customers could always protest by switching to another supplier but that would not do much good since most of the competition has already raised prices. If you think that this is not the way a liberalised energy market was supposed to work then you would be right. Synchronised price rises smack of collusion, not competition.

The regulator Ofgem is already investigating price spikes in the wholesale gas market this autumn to establish whether shippers have been rigging the market. British Gas insists that shortages of supply are not to blame. Rather, the culprit is the interconnector between the UK and the Continent, where gas prices are index-linked to those of oil and have been rising in tandem. The interconnector has the effect of creating a single market price for wholesale gas, which is 15 per cent higher now than it was at the start of the year. Britain becomes a net importer in a year's time, leaving us even more hostage to what happens on the Continent.

Higher electricity bills also loom, and not just because the price of gas is rising. Electricity generators want more for their output in return for building new stations. Alternatively they will simply allow existing capacity to run down, forcing up prices anyway. Never mind, says the British Gas managing director, Mark Clare; you're still better off today in real terms than when the market was thrown open to competition in the mid-Nineties. Cold comfort for anyone with a house to heat this Christmas.