Financial Planning
Financial Planning
Uncertainty principles By Grant Williams, Risk Underwriting Director, Coface UK THE UK ECONOMY HAS BEEN OUT-PERFORMING ITS competitors for some time and CFOs have reasons to be optimistic in the light of strong consumer spending and a modest revival of some of our export markets. However, the jittery financial and commodities markets show that the global recovery is far from secure and UK companies cannot afford any complacency about trading risk. China’s surprise devaluation of the yuan in August heightened fears about the health of the world’s second largest economy which precipitated a plunge in stock markets around the world. It was a powerful reminder of the uncertainties that continue to blight confidence in the global recovery and hamper trade. According to the World Trade Organisation (WTO)1, the volume of global trade grew by just 0.7 per cent in the first three months of 2015, slower than the previous six months. In 2014, the 2.8% rise in world trade barely exceeded the increase in world GDP. Prospects for future growth could be undermined by a faltering China, as well as geopolitical tensions in the Middle East and Eastern Europe.
Domestic bliss Against this rather gloomy background, the performance of the UK economy stands out from the crowd: the ONS reports that GDP in the second quarter of 2015 was 2.6% higher than the same quarter last year2. This recovery has been made in Britain and almost entirely driven by consumer spending, which accounts for well over half of GDP. A combination of rising wages, low inflation and interest rates and falling unemployment have boosted confidence and encouraged people to indulge themselves – spending in shops, restaurants and car
showrooms has risen significantly this year. Reassuringly, the optimism of consumers is spreading to UK businesses: levels of business investment in the first quarter of 2015 were up 5.7% compared with the same period in 20143. But UK companies are not immune from trading risk. Higher wage bills and the downward pressure on prices have been good for consumers, but have squeezed profit margins for many companies and made it harder to maintain a healthy cash flow position. In this climate, there is always a temptation for business customers to bolster their own cash flow at the expense of their suppliers and this can be reflected in an increase in the number of overdue payments. Another factor is the extent of over-trading and overstocking. These are traditional risks for bullish companies in a recovering economy and the last two years have been no exception. Over-ambitious growth projections have had to be revised when sales have fallen short of expectation or promised contracts have been delayed. There was a sharp increase in the number of companies that issued profit warnings in late 2014, taking the annual total to a six-year high according to Ernst and Young4. In terms of insolvency-related claims, levels are still lower than in 2013 but there have been some notable failures in, for example, the construction sector this year which indicate fragility in this sector and beyond. For example, in March 2015, GB Group Holdings and GB Building Solutions went into administration despite leading a high profile project to build a £32m hotel in the centre of Leeds. The company said it was unable to survive “short-term working capital issues” after reportedly becoming embroiled in legal disputes. The Association of British Insurers (ABI) reported that trade credit insurers provided more than £11 million of cover for goods and services supplied on credit to GB Building Solutions Limited5 but several subcontractors are known to have been caught in the fallout.
Export trade risk The UK economy appears in rude health compared with its G7 competitors but we remain a net importer (the value of imports exceeded exports by £9.2bn in June 20156). The reluctance of UK businesses to consider overseas trade is a familiar concern, however external factors are also making it harder to rebalance the economy. These include the stuttering recovery of some of the UK’s key export markets, the strength of sterling against the euro, and the political and economic turmoil afflicting high-profile economies that had previously been seen as good prospects, notably Brazil and Russia. Most dramatically, the nosedive in the value of Chinese stocks on 24 August – the Shanghai Composite lost 8.5% of its value, the worst single day fall in eight years – caused panic in Europe, the USA and Asia although most equity markets outside China have since rebounded. Although it feels like an unpromising climate for
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overseas trade, exporting still makes considerable financial sense, provided CFOs implement sensible precautions to limit their companies’ exposure to risk. Arguably the greater risk lies in being reliant on domestic sales when it is unlikely that UK consumers will spend at the same rate when cheap credit is no longer available. As ever, thorough market research is the cornerstone of any risk management process. The following overview of company default risk in the UK’s key markets is based on the latest country risk evaluation. The current risk grade is given in brackets and ranges from A1 (very low risk) to D (very high risk). The UK is currently rated A2 (low risk).
China’s shadow banking system. The risk assessment has already been downgraded accordingly.
USA (country risk assessment: A1) The United States was the UK’s top non-EU trade partner in June 20156, accounting for UK exports worth £4.4bn (17% of the total). Sustained growth is expected this year driven by business investment and household consumption which has been stimulated by low interest rates and an improving labour market. An expected rise in interest rates could be postponed in the light of events in China.
The views expressed and the Country Risk Assessments in this article are those of Coface, a global leader in credit management solutions, as at August 2015.
Trading places Recent events may have dampened appetite for overseas risk but nor does it make sense for companies to invest all their hopes in the reviving UK economy. Instead, the most successful companies in the next few years will be those with a healthy balance of domestic and export sales. It’s time to move on from the BRIC era and find new markets with the potential for dynamic growth and a burgeoning population of middle-class consumers.
References 1
2015 https://www.wto.org/english/news_e/news15_e/stts_24jun15_e.htm 2
The Eurozone The UK’s exports to Europe increased slightly in June 2015 compared with the previous month and accounted for 45% of our total exports according to HMRC6 although this has been as high as 51% in the last 18 months. Germany (A1) and Spain (A4) have performed better but growth has been sluggish in Italy (B) and virtually non-existent in France (A3). Recent assessments have upgraded the Czech Republic to A3 and Portugal to A4 after both showed signs of recovery. There are concerns that financial tensions arising from the Greek debt crisis and the slowdown in China have the potential to hamper dynamic growth. In addition, the beneficial effects of low oil prices, the depreciating euro and quantitative easing are only temporary. Household debt and unemployment rates remain very high, especially in Spain.
Gross Domestic Product: Preliminary Estimate, Quarter 2 (Apr to June) 2015, ONS, 28 July 2015 http://www.ons.gov.uk/ons/rel/gva/gross-domestic-product--preliminaryestimate/q2-2015/index.html
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Business Investment Quarter 1 (Jan to Mar) 2015 - Revised Results, ONS, 30 June 2015 http://www.ons.gov.uk/ons/rel/bus-invest/business-investment/q1-2015--revised-results/index.html
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Analysis of UK Profit Warnings Q4 2014, Q1 2015 and Q2 2015, Ernst and Young website http://www.ey.com/UK/en/Issues/Capital-and-transactions/Restructuring/ EY-profit-warnings-past-issues
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ABI responds to GB Group Holdings Limited and GB Building Solutions Limited’s appointment of administrators, ABI, 10 March 2015 https://www.abi.org.uk/News/News-updates/2015/03/ABI-responds-toGB-Group-and-GB-Building-Solutions-Limited-administration
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China (A4) The market crash burst an unsustainable stock market bubble but it also highlights some more serious problems for the world’s second-largest importer of goods and commercial services that the Government is trying to address. After 20 years of rapid annual growth (10.0% pa between 1993 and 2013), China’s economy is decelerating but it is still far from recessionary. The slowdown will have the biggest impact on hard commodity exporters, especially in Latin America, Africa and the Middle East. More advanced economies are less vulnerable although some UK exporters will feel a chill if Chinese consumers decide to reduce their spending in the short-term. Within China, the sectors most affected by the slowdown will be those with sizeable overcapacities and low profitability, such as cement or steel production, linked to construction. The high level of private sector debt is another concern and there has been a rise in the number of non-performing loans although actual figures are difficult to determine given the size of
World trade registers modest growth in first quarter of 2015, WTO, 24 June
UK Overseas trade statistics, HMRC, 7 August 2015 https://www.uktradeinfo.com/Statistics/OverseasTradeStatistics/Pages/ OTS.aspx
Author information Grant Williams is Risk Underwriting Director at Coface UK, part of the Coface Group, a global leader in credit management solutions. Coface’s credit insurance, business information and collection services enable companies to protect themselves against the risk of financial default by their domestic and overseas buyers: clients have access to information about the financial health of 65 million companies worldwide. Coface publishes quarterly assessments of country risk for 158 countries. Its regular Country Risk Conferences bring together economists, policy experts, researchers and business leaders to review major economic trends and an outlook for the world economy.
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