Eurozone - Winter edition (December 2011)
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21 Decembrie 2011 |
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ERNST & YOUNG S.R.L. |
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A test of nerve and confidence
Economics and politics are inseparable. Economic crises are a test, not only of political nerve, but also of business confidence. With the agreement on a tax and budget pact on December 9, known as the “fiscal compact”, European leaders have taken a step towards closer fiscal integration in the belief that providing a stronger authority framework will give greater credibility to the shared currency. Closer integration with greater authority and fiscal discipline is intended to generate greater certainty and hence confidence in the euro. There is much work still to do and even the leaders themselves do not believe that the accord will be finalized before March — a full 4 months away.
If a week is a long time in politics, it can seem an eternity to the financial markets who have an inherent and seemingly insatiable appetite for data and drama. Our forecast says that the Eurozone economy has probably already fallen back into a recession. Growth will only resume toward the end of next year, rising to 1.5%–2% in 2013–15, after just 0.1% for 2012. Unemployment will not fall below 10% until 2015. Even though 9 December brought an agreement on binding rules over tax and spending, and sanctions against countries that overspend, the recession will still be areality to tackle for business leaders in the near future. As governments, corporates, financial institutions and the European Union work to transform themselves, there is a real risk of severe disruptions to normal patterns of economic activity. Markets are extremely volatile and even seemingly minor events can cause significant reactions in this environment
The near future will therefore continue to be volatile and business leaders in the Eurozone need to take precautionary steps to minimize risks as well as see the opportunities when and where they are offered.
The Eurozone solution: austerity and growth
The elixir of economic growth is needed to find a lasting solution to the debt crisis. Certainly, the extreme weakness of European growth prospects will do nothing to encourage investment in the Eurozone economy — quite the opposite, in fact. The paradox is that the fiscal compact will impose increased austerity on national governments and reduce their ability to stimulate growth in their countries. Having a balanced lifestyle may be essential to a long and healthy life, but no one would argue that dieting is the happiest of experiences.
Our Winter 2011 forecast expects business investment to be on hold in 2012. This is severely disappointing given that large companies are holding very large cash balances. It would seem that many boards will again succumb to the temptations of buying back shares or holding cash reserves rather than investing in growth — either through investing locally in Europe or in rapid-growth markets elsewhere. Aversion to risk is now very strong in corporate boardrooms.
But as the Eurozone (and the UK) slides into a recession, the really vulnerable companies are in the small and medium-sized enterprise (SME) sector. Large businesses are better placed to see a recession through, thanks to their cash reserves; few SMEs have such luxury. They are very much more dependent on their banks for working capital and credit lifelines. In normal times, banks will lend to well-managed SMEs with good products and a strong client base, even when they run into temporary difficulties. But the near-term anxiety in the Eurozone means a credit tightening by banks, out of caution and risk aversion in some cases, and out of the necessity to strengthen their capital in others. The European Council agreed on 26 October that bank capital should be strengthened up to 9% of risk weighted assets. This is not a tough target for all banks, but it is for some. These are probably the ones that featured in the European Central Bank’s Q4 2011 lending survey as tightening their lending standards.
It is likely that banks will restrict their lending and their business, leading companies to secure financing for every possible situation. Therefore, both the availability of financing and the cost of capital will be a challenge. To respond to the decreased possibilities of accessing capital, companies need to replace some of their former credit lines with other sources of credit. This will create new markets and new market parties, through joint ventures, for example. Challenging times also create opportunities, so the strongest companies need to be active in taking advantage of cases that may appear. At the same time, when companies are looking for growth opportunities, they need to be ready for sustained cost reduction.
Rapid-growth markets can be a real help
If SMEs are badly hit by a credit crunch, there will be virtually no prospect of achieving a serious reduction in unemployment rates, nor of returning consumption to a rising trend. Our Winter 2011 forecast sees private consumption grinding to a halt. It concludes that the best hope of a growth stimulus lies in exports, above all to the emerging economies. The Ernst & Young Rapid-Growth Markets Forecast (issued in November 2011) expects an average 6% growth in 2012, with slightly more than 7% in Asia. India will lead the way with 8.7% growth a year for 2012–15, closelyfollowed by China with 8.5%. These numbers are a softening on this year’s performance for these countries and regions but highly valuable for the global economy and European businesses if they hold.
According to our Rapid-Growth Markets Forecast, advanced economies will be exporting 33% of all their exports to rapid-growth markets by 2020, equivalent to US$17.6 trillion, compared with US$9.3 trillion today. This should deliver some kind of boost to the Eurozone economy in the coming years and is why we expect Eurozone growth to recover to 2% by 2014–15. Rapid-growth markets are already becoming vital for some consumer products manufacturers, such as the beer, spirits and wine sector, whose products are in great demand from the rapidly growing middle classes in these countries. The IMF estimates indicate that 70% of world growth over the next few years will come from emerging markets, with China and India accounting for 40% of this growth.
In drawing attention to the opportunities in rapid-growth markets, we are not only thinking in terms of private sector markets. The public sector’s procurement needs should also be investigated and addressed by many companies beginning to feel the effects of the squeeze on spending in European countries.
The business wish list
One key growth factor is innovation and, although the EU has been very ambitious in this field, initiating many important projects to stimulate innovation, the question is: how can the EU innovation policy be more effective? It is interesting to note that the public sector investment in innovation in Europe is higher than anywhere else in the world, the shortfall is caused by a lack of private sector investment. In our latest report on EU innovation policy, Next generation innovation policy1, a number of thebusiness specialists interviewed state that they want to see more effective university-industry partnerships and technology transfer. They also think that the EU and national governments should do more to create demand for innovation. Another key issue they point out is the fact that the innovation policy is too fragmented at a national level and they want to see a stronger coordination of innovation policy at the EU level.
Respondents in our latest Entrepreneurship Barometer2 are content with parts of the markets conditions in the EU; for example, the sophisticated financial sector, the high-quality education and access to several wellestablished SME stock markets. However, respondents are negative about funding as well as regulatory channels, and they point out the remaining barriers to a single EU labor market as an obstacle for growth.
The demand for a European “growth-enhancing” policy is also reflected in Business Europe’s priorities:
- Full implementation of the services directive in the single market, together with developing e-commerce and the deployment of broadband networks
- Concluding the World Trade Organization’s Doha Round and strengthening transatlantic economic cooperation
- Closing the skills gap in science, technology, engineering and mathematics
- Employment policies that will reintegrate the 10 million long-term unemployed into the labor market and address the growing problem of youth unemployment.
- Leveraging the €200 billion investment needed in European energy infrastructure by 2020
Clearly there is a strong engagement and willingness among business to be part of the discussion on how to create real growth and build a future for Europe as a strong player in the global market.
In the meantime, boards have to review and implement their strategies for coping with low or zero growth in the Eurozone. European and US difficulties have enhanced the rise of Asia, and will continue to do so. Companies need to ensure that they have an eligible Asia strategy. We think that businesses with a strong Asia strategy and foothold will outperform their Europe- or US-focused competitors. Another opportunity for growth is technology that will drive productivity to public services, especially to care of the elderly.
The economic doldrums are a time for companies to seek to raise efficiencies, because it is often the case that quality companies take market share from weaker competitors during a downturn. Outsourcing inevitably comes up for review, although the argument is far from cut-and-dried between bringing certain functions and processes back into a company and maintaining outsourcing. The issue needs to be looked at on its merits and the advantages of existing arrangements either confirmed or questioned.
Investing for growth can be a winning strategy during a recession, and merger and acquisitions markets currently make very good propositions. There are bargains to be had: shares in Europe are trading on low price/earnings ratios — even on a 10-year average. Some analysts are predicting an M&A boom before long.
However, the near-term evolution of the financial markets very much depends on how the sovereign debt crisis unfolds. There are already some positives: The agreement reached on 9 December offers a platform for a strengthened integration and tightened fiscal policy. Greece and Italy have Governments of limited duration with mandates to reform public finances and administration, restructure labor and product markets, privatize state assets and adopt growth-enhancing structural policies. These Governments draw their political strength, asdo those in Portugal and Ireland, from a general, if reluctant, acceptance by their political classes that there are no viable alternative strategies consistent with remaining in the Eurozone. The next 12 months will be crucial for the future of the European single currency area. If the crisis eases, Europe will tread a route to recovery, and emerging markets and the global economy as a whole can look forward to stability and growth.
