Published: June 01, 2008
Following a decade and half of generally strong growth and benign economic conditions, the world is in the midst of a very serious financial crisis resulting in weaker global economic growth. The epicenter of this turmoil is the US and in particular the US consumer but the ripples have spread out around the world. However, the effects are not uniform: there are great differences in the fortunes of companies, markets and economies and this has profound implications for both cash management and overall working capital management.
The over-abundance of credit and the low inflation resulting from the introduction of India and China, in particular, into the world economy led to enormous imbalances. Indeed, the 11% or higher current account surplus is likely the biggest the world has ever seen and certainly the accumulated foreign reserves are unprecedented. The over abundance of credit led to booms in asset prices, with the final (perhaps?) boom being the US housing market. The unwinding of that bubble is leaving exposed over-indebted US consumers who will have to rebuild their collective balance sheet. This will leave the US with sluggish growth for several years.
For much of the developing world, though, growth remains robust in stark difference to previous cycles. The challenge here is inflation, especially of food and energy prices. The balance of the world’s economic power is shifting from the ‘West’ (or developed world) to the ‘East’ (or developing world). Economic growth in China is likely to slow from 11.5% in 2007 to 9.5% in 2008, India is likely to slow this year but accelerate next year, and Nigeria looks like growing more strongly in 2008 than in 2007. These economies are developing their own internal dynamics and are increasingly linked directly rather than to the US. The US is no longer China’s biggest trade partner. Trade between Africa and China has grown at more than 40% per annum for the last six years. They will be affected by the US slowdown but it will not be catastrophic.
As these economies grow they are increasingly consuming more resources, especially food and energy, so commodity prices have stayed high. To take oil as an example, 40% of the growth in consumption this year will come from China and India and 30% from the Gulf. Prices are rising because supply just cannot come on line quick enough after years of underinvestment.
The precipitous fall in market liquidity from the middle of 2007 was one of the most dramatic events of recent financial market history. This can be seen as the moment when markets started to differentiate again - the liquid banks, the creditworthy companies and the strong economies. The flight to quality meant the money going home to China, the Gulf and others - the sovereign wealth funds included. The liquidity situation in these markets remains ample in sharp contrast to the over-leveraged ‘West’.
Nonetheless all companies need to exhibit caution wherever they may be located and doing business since they will find it harder to pass on these cost increases to their clients and margins and profits will be squeezed. To survive, companies need to be more disciplined in managing their interest rate, commodity and foreign exchange exposures. They will need to anticipate future movements and have prudent hedging strategies in place linked directly to sales and purchase contracts. Corporates should also continually review the financial health of their buyers and suppliers and ensure that the terms of trade adequately protect them; if dealing on traditional documentary trade terms they should work closely with their bankers to ensure the documents are ‘clean’, giving no opportunity for rejection by the counterparties. Corporates that are on open terms should explore the buyer and supplier financing programmes and risk mitigation products that financial institutions can provide.
In this current environment it’s about securing sales and profit growth at an acceptable risk for the medium term and not taking short-sighted decisions that could cripple the business and reduce the options to compete effectively in the future. The corporates that will come out of this period of uncertainty stronger are those that overhaul their financial supply chains and find efficiency gains as well as mitigate their risks appropriately with their financial partners.
In the future it is possible that people will look back on 2007/8 as a turning point, a key period of acceleration of the trend of transfer of economic power from ‘West’ to ‘East’ merely reverses a recent aberration. For 18 out of the last 20 centuries, China was the world’s biggest economy and is well on the way to regaining that position. China, along with India, Brazil, the Gulf and other countries will come out of this crisis in a much stronger position relative to the US with all the opportunities that that entails.
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