Financial Planning
Financial Planning
Meeting the challenge of economic instability By Coface UK AS THE GLOBAL economy slows and markets grow increasingly volatile, the prospects for some star performers have deteriorated. This means CFOs will have an important role in steering their companies’ export strategy into safer territories and overseeing a rigorous approach to credit management. At the start of 2016, the outlook for the global economy could be as precarious as it was in the aftermath of the economic crash in 2008. After the crises in the US and Eurozone, it is now the turn of the emerging countries and China to feel the chill, while developed economies are experiencing a moderate recovery. In its report examining the world’s economic prospects for 20161, the UN observed: “More than seven years after the global financial crisis, policymakers around the world still face enormous challenges in stimulating investment and reviving global growth.” The report pointed to several factors hindering growth including macroeconomic uncertainties, low commodity prices and declining trade flows, exchange rate volatility, stagnant investment and diminishing productivity growth. These problems increase trade risk and spell uncertainty for companies which export but it would be short-sighted to exclude overseas markets and focus entirely on their domestic trade. After all, exporting is a proven way to increase sales and improve productivity, and the UK is not immune from the effects of economic instability. However, it does highlight the need for an informed approach to trade risk and a company-wide commitment to credit management.
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Trade risk Information A latest review of trading risk2 provides a useful digest for key UK markets. Based on a range of economic measures and global underwriting experience, the following country risk assessments use a seven-level ranking to indicate the risk of payment default. In ascending order of risk, these are: A1 (very low), A2, A3, A4, B, C and D (very high).
Improving risks The Eurozone In general, insiders predict a slightly higher growth of 1.7% (compared with 1.5% in 2015), fuelled by investment and consumption. This progress has been assisted by a gradual improvement in the job market, the weakness of the euro against the dollar and reduced energy costs. However, the situation varies from country to country: n France (A3) – the company failure rate has returned to pre-crisis levels as the economy grows but there has been some deterioration in the Ile-deFrance region, in which 24% of French companies are concentrated and suffered 21% of the total number of business insolvencies. Construction, textiles and services are the highest risk sectors. n Germany (A1) – household consumption should be spurred by wage growth and low unemployment but as a major exporter, the slowdown in China and difficulties faced by emerging markets could affect business investment and confidence. n Italy (B) – assessments have been revised to predict positive growth of 1.3% in 2016, buoyed by household consumption and the expectation of structural reforms. However, there are ongoing concerns including a large number of non-performing bank loans. n With the exception of Portugal (A4), business insolvencies have declined across the region, especially in the Netherlands (A2) and Spain (A4). n Despite the partial economic recovery in Spain, the country is still experiencing political instability following the inconclusive general election result in December 2015. It could be a similar story in Ireland (A3) where voters go to the polls this spring. n Greece (C) may not be front page news after its most recent bailout but it remains beset with economic and social problems, as reflected by the general strike in February. n The uncertain outcome of the British Government’s referendum on EU membership could be a destabilising factor for businesses, given the strong trade links between the Eurozone and the UK (A2).
Central Europe These countries have not been significantly affected by the debilitating combination of falling growth and increased indebtedness. Assessments have been upgraded for Hungary (B to A4) where it expects moderate growth of 2.5% this year. USA (A1) Outperformed the eurozone in 2015 although the rate of growth is expected to slow slightly this year. Private consumption will continue to be the largest contributor to US growth as real wages increase thanks to low inflation. Corporate insolvencies are falling and the sectors showing the best risks are automotive, textile and clothing, transport and chemicals. However, the energy sector has been hit by the fall in oil prices. Public debt remains worryingly high and accounted for 104.9% of GDP at the end of 2015. Finally, uncertainty over the presidential election in November could affect business confidence. India (A4) Alone among the once-heralded BRIC countries in achieving sustained and stable growth. The belief is that this will continue during 2016/17 as the economy benefits from the low level of commodity prices and the effects of the structural reforms initiated by Modi’s Government although there are signs that some initiatives, such as land reform, are running out of steam. Nevertheless, predictions for household consumption remain buoyant and the services sector will continue to underpin activity, especially the technology sector.
Deteriorating risks China (A4) The slowdown will continue, as will concerns over structural imbalances in its economy. Challenges for the Government include overcapacity in many industrial sectors, loss of competitiveness, high corporate debt and falling business confidence. Corporate debt now represents more than 160% of GDP. The suspension of the Chinese stock exchange in early January shows that market volatility is an ongoing risk. Brazil (downgraded to C, the second downgrade in a year) The outlook remains poor as Brazil sinks further into recession and political crisis. GDP has shrunk, inflation and unemployment are rising and the country has now been hit by a public health crisis caused by the Zika virus outbreak. Russia (C) Predictions are that the economy will shrink in 2016, hit by European sanctions, high interest rates and the depreciation of the Rouble which is correlated with oil prices. The success of a deal with OPEC to freeze oil production is not assured. Other emerging countries Factors such as slowing global growth, falling commodity prices and growing indebtedness have had a marked effect on many emerging economies, which has led to a downgrade in assessments. South Africa, Algeria and
Bahrain have been downgraded to B, while Zambia (C) and Namibia (A3) have been placed on negative watch. Geopolitical threats The bloody chaos in Syria is the most pressing threat to stability in the Middle East and beyond. It is a major factor in tensions between Saudi Arabia (A4) and newly confident Iran (D) as they vie for influence in the region. In addition, the conflict has become another flashpoint between the West and Russia and between Turkey and Russia; intensified the terrorist threat; and is a factor in the record levels of migration in 2015 which proved so contentious in Europe.
Holistic credit management Credit management is most effective when it is fully embedded in company culture but good credit management practice is not always actively championed within companies that offer trade credit, particularly when their focus is on growth. CFOs are ideally placed to promote credit management and ensure it is as much a priority for the MD and sales team as it is for financial professionals. It is essential that every employee appreciates the danger of bad debt and understands their responsibility to prevent it. References 1. World Economic Situation and Prospects 2016, UN, 2016 http://www.un.org/ en/development/desa/policy/wesp/wesp_current/2016wesp_full_en.pdf 2. Country risk barometer: key challenges of 2016, Coface, January 2016. www.cofaceuk.com/Economic-studies
Further information CFOs can find out more about the trading risks and opportunities for their business at the next Coface UK Country Risk Conference on the morning of Thursday 9 June 2016. This year, the Conference will focus on the UK economy, global recovery, cyber-security and geopolitical risk. To register your interest, email: crc_uk@coface.com
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