THREATS TO BUSINESS INSOLVENCY IN TIMES OF OVERLAPPING CRISES [Part II]

 

 RECESSIONAS A FACTOR IN BUSINESS INSOLVENCY

 

The second threat is recession, whichrepresents the decline that occurs when productive capacities are not fully utilized, either because foreign orders are falling, demand for goods and services in the domestic market is falling, or both. [1] Several countries are facing this scenario today, including Germany, not only because the high energy prices caused by the war in Ukraine absorb much of people's purchasing power, but consumers  themselves  are running out of money as a result of inflation, which causes a change in consumption habits.

 

An example may better represent the difficulties faced.  Tobias Plaz no longer knows how he can continue to run his bakery business profitably in Germany. At the end of August he received a letter from his gas supplier. Instead of paying just under ten cents per kilowatt hour of gas, you now have to pay just under 35 cents. The company alone uses about 80,000 kilowatt hours of gas for heating and hot water. The billing of the gas supplier's monthly budget will increase from 721 to 2588 euros from October 1, 2022. This does not even include the energy costs of the furnace. But Plaz still has a gas contract in place under the old conditions until the end of the year.[2]

 

 An increase of 360% of light and gas as a result of the war in Ukraine, represents for most European countries a great challenge, beyond the measures of restriction of use that are being carried out.  The rise in energy and raw material costs cannot be absorbed by companies, which will have to pass them on to prices, playing on the inflationary spiral.  The problem is compounded by the fact that the recession is accompanied by constant inflation.

 

Specialists point out that the fire must be put out before it gets out of control. [3] That seems to be the slogan of the  countries affected by the gigantic inflation that travels the world and that reached historical highs in decades.   The United States and the United Kingdom with the  highest levels of the  last 40 years and Latin America, also under pressure from the escalating cost of living, force  the firefighters in charge of the fiscal and monetary policy of the countries to workat full speed.

A toxic mix of politics, inflation and higher interest rates is threatening the financial system in the UK, sending a shockwave through global markets and providing a warning to governments around the world of the dangers of the new economic era we are entering [4]                       

 What does high inflation have to do with an economic recession? [5] A lot. When inflation soars, central banks raise interest rates (the cost of borrowing) to discourage the purchase of goods or services. It is a policy that seeks to reduce consumption and investment in the hope that prices will fall. This mechanism controls inflation, but at the same time slows down economic growth that causes recession and is a threat to the solvency of companies.

It is rightly argued that yes and ait is quite difficult to choose the right interest rate for a single economy. How do you choose the right rate if your neighbors are also increasing theirs? When a central bank raises its interest rates, one way this curbs inflation is by appreciating the currency. Higher interest rates attract foreign investors, causing the exchange rate to rise. A stronger currency makes imports cheaper and reduces inflation. [6] This situation does not only affect governments, but its consequences spread throughout the business circuit conditioning companies.

 

          So, for example, driven by soaring gas prices, some companies that make steel, fertilizer and other raw materials are moving their operations to the United States, attracted by more stable energy prices and government support. This can cause certain changes in supply chains and in the business circuit. [7] Inflationin Europe is forecast to soar more than expected as recession nears the energy crisis.

The compensation with the increase in prices has a limit, and although governments provide aid packages to individuals, companies are left out of that benefit.  It warns that the theater of the current war between Russia and Ukraine is not limited to a geographical scope, but also attacks the economic systems of the countries, which is why it is rightly stated that the global economy is in intensive care. 

 

When the economic horizon is fraught with uncertainties, negative expectations impact medium-sized companies more significantly than large ones. Just look, for example, at what is happening in Spain, reported by the "middle market index" - who estimate that hiring will be frozen and investments will fall in the coming months. In other words, the scenario becomes complex, which sharpens decision-making in terms of entrepreneurship and risk-taking.[8]

 

Any prolongation of the crisis affects business productivity and interrupts the cycle of the economy, making it slower with lower demand for goods and services.  With the Fed rising borrowing costs, mortgage rates rising,  and the housing market slowing slow,  a  serious slowdown in activity portends.   If Americans don't feel good about the economy and purchases of durable goods like cars and furniture are slowing down, you can see the direction the economy will take in much of the world.[9]

 

TheBank of England said it would buy longer-term UK debt to help restore stability. Perhaps the financial situation in that country is giving an early warning of the dangers that other developed markets will also face.

 

The context of credit restriction that any recession entails adds a greater deterrent factor in companies that cannot service their debt or meet their commitments, especially of a fiscal or labor nature, in countries where the tax burden, the intervention of unions and the labor trial industry is very high (Argentina, among others). Thus, the company as an organization of goods and services, is cornered by the lack of liquidity and a certain degree of conflict, which prolonged in time exposes it to critical situations.

          As sales revenue and profits decline, the company will reduce hiring, freeze it completely, or proceed with layoffs. In an effort to reduce costs and improve the bottom line, you can stop buying new equipment, reduce research and development, and stop launching new products (a factor in revenue growth and market share).  Marketing and advertising expenses can also be reduced. These cost-cutting efforts will have an impact on other businesses, both large and small, that provide the goods and services used.[10]

             

          It is observed that recessions impact companies with a tightening of credit conditions.  To be sure, during the recession, standards for lending in the market tend to be stricter and lenders are more selective about the risks they are willing to take at any rate.  Even [11]regardless of size, the vast majority struggle to repay their debt, on which most depend to finance ongoing operations or ordinary draft.

 

        The recession will also affect the company's accounts receivable , inventory replenishment costs and  liquidity. Without neglecting to warn that it conditions consumers and the entire supply chain, which forces them to reconvert objectives. Customers who owe money may make payments more slowly, later, or not at all. Then, with reduced revenue, the affected business may be forced to pay its own bills more slowly, later, or in smaller increments than its original credit agreement required. [12]

 

       Making late or delinquent payments reduces the valuation of debt, bonds and the ability to obtain financing which, as noted, is very restricted in a recessionary context because cash flow decreases.   The company's ability to repay its debt (pay interest on money it has borrowed) can also be affected, resulting in default on bonds and other debts and further damaging the credit rating.  What if it is general and permanent over time, can cause insolvency.

       If somehow the curve of business insolvencies is not contained or flattened, and a sovereign debt crisis is added, the symbiosis will have a greater impact on the entire productive system, which the government must readjust if it intends to somehow get out of the state of shock or hypertrophy. Without firms, without innovation, productivity growth stops and the depression will deepen.   Any response that is sought, will depend to a large extent on the  endogenous conditions of the economy, but, according to specialists, a phased approach to temper this threat is recommended:

         In the first stage, relief measures should be used to prevent viable companies from being forced into insolvency prematurely and causing a knock-on effect. Without intervention, even normally effective frameworks could lead to systemic failure, in which a flood of insolvencies would trigger forced selloffs and cause asset prices to collapse.[13]

                

The top half of the front page of the Daily Mail  newspaper has a headline referring to the crash of 'Wall St. " describing the massive drop in the value of stocks,  on what became known as Black Thursday, October 24, 1929.

               These relief measures are extremely useful in emerging markets, where creditors often use the insolvency system as an instrument to collect debts, but which also has another side: it is the necessary alternative for companies to enter intensive therapy long enough to reorganize their liabilities in an orderly manner.

    

                   In the second stage, the main challenge is to respond to the growing number of companies that need an insolvency process to survive. In this phase, it is essential to ensure the smooth operation of the debt renegotiation and restructuring mechanisms in the appropriate legal areas with courts specialized in the subject, which provide a quick solution to the conflicts that business insolvency poses. If the legal framework is not dynamic enough to manage shortages, protect credit and respond quickly to economic reality, restructuring does not work.

 

              Finally, in the third stage, the emphasis should be on people facing financial difficulties after the crisis. This translates into a special procedure for individuals, consumers who must resort to a debt discharge system, not of the same entity as companies, but that if it allows them an adequate recovery to reintegrate into the circuit of business and consumption.

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[1]Henrik Böhme "Recession, the fearsome specter of economic contraction" in https://www.dw.com/es 18.09.2022

[2] Sabine Kinkartz "Is a wave of bankruptcies looming in Germany?"  https://www.dw.com/ 08.09.2022

[3] Cecilia Barria, Is inflation more harmful than recession...? https://www.lanacion.com.ar

[4] James Mackintosh, "Britain's financial disaster is a warning to the world" 1.10.2022 in www.wsj.com

[5] Cecilia Barria ob. cit.,

[6] Tooze, Adan Ob. cit.

[7] David Uberti, "High natural gas prices push European manufacturers to switch to the United States. https://www.wsj.com/ 21.09.2022

[8] Antonio, Lorenzo "73% of managers of medium-sized companies..." on ttps://www.eleconomista.es 3.09.2022

[9] Business week in https://www.nytimes.com/ 25.09.2022

[10] How does the recession affect businesses? https://lainversionhoy.com/ 25.01.2022

[11] How does the recession affect businesses? https://lainversionhoy.com/ 25.01.2022

[12] How does the recession affect businesses? https://lainversionhoy.com/ 25.01.2022

[13] Ceyla Pazarbasioglu and  Alfonso Garcia Blackberry Ob. cit.