Insolvencies: Here we go

Valerio Ranciaro Director General of SACE SRV and Chief Credit & Restructuring Officer of SACE, and Cinzia Guerrieri, Economist at SACE, look at the proverbial can that has been kicked down the road for a long time, and that finally looks as if will come to a rest – corporate insolvencies.

In the last three years the international macroeconomic context has been characterised by three extraordinary shocks: (i) the pandemic emergency, (ii) the Russian invasion of Ukraine and the consequent energy and food crisis, (iii) the return of sustained inflation and the end of ultra-expansive monetary policies.

In addition, extreme natural events linked to climate change have become increasingly frequent and widespread, generating strongly negative impacts. Some observers coined the term ‘permacrisis’ to identify a permanent state of high global uncertainty that weakened business confidence and economic activity.

During this period, however, there were also signals of resilience coming from international trade in goods (despite several disruptions along global value chains), household savings (partly accumulated during the lockdowns) and the companies’ adjustment capacity (thanks also to considerable fiscal support). These factors contributed to the rapid recovery of world GDP after the severe contraction in 2020, but at the cost of skyrocketing global public and private (especially corporate) debt.

In 2022 global GDP grew by 3%, just one percentage point lower than the forecasts made prior to the outbreak of the Russian-Ukraine war, along with a strong increase in global inflation (which hit almost 8% on annual basis) driven mainly by higher production costs. Central banks of advanced and emerging countries (led by the US and the Eurozone, but with significant exceptions such as China) accelerated the normalization of monetary policy, by rising the reference interest rates and reducing (or concluding) quantitative easing programmes. Consequently, global financing conditions have tightened with potential negative impacts on the credit cycle and, more generally, on the dynamics of world GDP during 2023.

According to the consensus for this year global economic prospects have in fact deteriorated, mostly due to the materialisation of the lagged effects of less favourable global financial conditions, in a context of fiscal support measures phasing-out and reduced purchasing power of household disposable income.

Preliminary data already show a reduction of bank loans to corporates and stricter credit conditions, although it will not be a credit crunch. In a baseline scenario, characterised by a significant probability of occurrence, the growth rate of global GDP in 2023 is expected to slow to +1.8% according to Oxford Economics[1]. If this forecast is confirmed, global GDP would record the slowest growth rate in recent history, after the contractions felt during the Global Financial Crisis and the pandemic.

In this scenario of a weak economic cycle, global inflation is estimated to lessen to 5.5%. Consumer price pressures are, in fact, expected to reduce, partly held back by a weaker push in demand and, at the same time, by the normalisation of commodities prices (although prices are still above the pre-pandemic period and remain volatile). There are, however, some signs of persistence in the core inflation rate – namely the rate excluding more volatile components such as energy and foodstuffs – reflecting the delayed indirect effects of the high prices of oil and natural gas observed last year, as well as the increase in nominal salaries occurring in robust labour markets.

Although monetary policy decisions will reduce the risks of sustained inflation in the medium term (in line with the objective of numerous Central Banks), at the same time it is plausible to expect an increase in short term financial vulnerabilities. The combination of rising interest rates, lower liquidity and less risk appetite of investors, along with the slowdown of economic activity, could have detrimental effects on highly indebted companies.

Global business insolvencies are indeed expected to increase remarkably on annual basis, although in terms of levels they will return just towards pre-pandemic ‘normal’ levels, after a period of substantial ‘freezing’ due to the extraordinary fiscal and regulatory support measures put into effect in the last three years. This scenario implies downside risks also for the banking sector, which may have to deal with an increase in non-performing loans and a reduction in asset quality in general.