Insolvencies Are up, Hinting at Recession
Corporate insolvencies are on the rise, both in the United States and globally. Here’s what that says—and doesn’t say—about companies’ future prospects.
History has taught us that insolvencies act like the canary in the coal mine: Their rise typically precedes a recession. 2019 marks an inflection point of rising insolvencies in developed markets around the world, with Atradius economists predicting an increase of nearly 3 percent in 2019 and 1.2 percent in 2020. But this time, it’s not clear what the trend might foretell. Some of the major factors contributing to the current insolvency increase—notably, uncertainty over trade policy and Brexit—could be corrected during the next few months.
What is clear is that these are uncertain times, as business leaders everywhere anxiously await the next round of tariffs in the economic tit-for-tat between the United States and China. Brexit is another source of worry, as it’s anyone’s guess at this point how the final decision will play out.
Uncertainty is bad for business because it makes planning for the future difficult, leading executives to delay investments. This results in a self-inflicted spiral as businesses hold off on investments because of volatility, which leads to slower growth, higher unemployment, and increased insolvency activity—and then the process repeats.
U.S. Set to See Highest Increase in Insolvencies
Among developed markets tracked by Atradius economists, the United States is predicted to see the largest increase in corporate insolvencies, with a forecasted rise of 3.2 percent in 2019 and another 2 percent in 2020. The U.S.’s central role in global trade policy uncertainty is one factor in this outlook, as are high levels of corporate debt, the dollar’s strong position, and the unwinding of the pro-cyclical fiscal policy. In addition, factory output is on the decline and consumer confidence is down.
The retail sector is particularly hurting, with more than 12,000 stores expected to close in 2019. The U.S.-China trade war has been a major challenge, as many retailers source goods from China and are now getting hit with price increases. The latest escalation, for instance, included a 15 percent tariff on $300 billion of consumer goods from China that will go into effect next year. E-commerce is another problem, as many smaller retailers struggle to compete against giants like Amazon.
The U.S. agricultural industry is also struggling. U.S. farm bankruptcy filings rose 13 percent this year (as of July), a six-year high. Bad weather and retaliatory tariffs targeting agricultural products are contributing factors. Farm insolvencies have far-reaching implications for other players in the space, such as durable goods, machinery, and fertilizer companies.
Brexit Causes Insolvency Jump in Western Europe
Western Europe is forecasted to see the second-highest increase in insolvencies this year, with a predicted 2.7 percent increase in 2019. Slowing economic growth and lower global trade are two contributing factors, but widespread uncertainty surrounding Brexit is the major culprit there.
The United Kingdom is expected to see a 10 percent increase in insolvencies in 2019 and another 5 percent in 2020, which is the largest jump among Western European nations. Brexit remains an unpredictable and intractable mess. The continued deferment of the U.K.’s departure from the European Union (EU) has prevented the recovery of the pound sterling, kept inflation high, and discouraged businesses from making key investments. If the U.K. cannot execute a smooth transition out of the EU in the first half of 2020, and the period of uncertainty drags on, insolvencies could increase beyond this prediction. The turmoil isn’t contained to the U.K., as many EU countries have close trading relationships with the U.K.
Switzerland, another big contributor to Western Europe’s increase in insolvencies, is forecasted to see a 4 percent jump in 2019. Swiss insolvencies have been on the rise since 2015, following the Eurozone debt crisis and the scrapping of the Swiss franc’s ceiling against the euro. Global trade uncertainty plays a role; the Swiss franc is a safe-haven currency and demand is up. The construction and hospitality sectors will likely bear the brunt of Swiss insolvencies.
A Silver Lining
A recession could very well be on its way, but there are a few reasons for hope. For one, geopolitical issues are causing the most uncertainty at the moment, so they also provide an obvious path toward solving the problem. A resolution to the U.S.-China trade war and a smooth conclusion to the Brexit crisis would be positive for global growth, which would encourage business investments and prevent further insolvencies.
The Federal Reserve recently cut the target federal funds rate another 25 basis points (bps). Monetary policy typically takes between six months and a year to work through the system, so in the near future, the recent cut cycle should provide positive economic stimulus. The Fed also signaled they are pausing at the current interest rate levels as they observe the impact. Monetary or fiscal policy that is more accommodative than expected would also help stimulate growth and reduce insolvency expectations.
Another reason for hope is that the forecasted increase in insolvencies in the U.S. is not as dire as it may seem on the surface. In 2007, ahead of the Great Recession, insolvencies rose 15 to 20 percent. That’s significantly higher than the 3.2 percent increase expected for this year. Plus, the U.S. has accommodative bankruptcy laws compared with other developed markets, making it easy for companies to enter Chapter 11. In other markets, an insolvency means the business liquidates. In the U.S., it often represents a period of course-correcting for an organization that will continue to operate.
That said, however, the insolvencies trend certainly indicates some risks to global businesses. Corporate treasury and finance leaders should become knowledgeable about local legal rules and regulations so that they are prepared in the event that a trading partner goes bankrupt. Another option is trade credit insurance, which can protect an organization against delayed or missing payments and can also help companies navigate complex bankruptcy laws.