Maxime Lemerle | Head of Sector and Insolvency Research | Euler Hermes | mail me |


Business insolvencies are expected to increase by +2% in South Africa in 2019 (after +3% in 2018). This is the first outright deteriorations since 2009 and the global financial crisis.

This forecast mainly relies on:

  1. the level of GDP growth, which is expected to stay well below the desired levels at +1% in 2019 after +0.7% in 2018, and
  2. the business environment which remains clouded by ongoing structural rigidities.

External debt is now increasing (52% of GDP in 2018) and despite accumulation of FX reserves, some external liquidity indicators remain weak. The debt due ascended to 87% of FX reserves, as corporates (particularly state-owned ones) accumulated more USD debt, as a consequence of high debt costs in ZAR.

Factors

The South African business environment is clouded by ongoing structural rigidities, including uneasy labor relations and periodic disruptions to power supplies, and is compounded by at least four other factors:

  1. weak international commodity prices;
  2. slowdown in China, the country’s largest trading partner;
  3. drought conditions, with weakened agricultural output and a need to import maize and other foodstuffs; and
  4. uncertainties relating to U.S. monetary policy tightening. The GDP growth will stay well below necessary levels in 2019 (+1%, after +0.7% in 2018.

The ongoing deterioration of the business climate is also witnessed by the World Bank Doing Business 2019 survey which ranks South Africa 82 out of 190 economies (74th three years ago), just below Panama, Tunisia and Bhutan.

South Africa still keeps some aspects of an Advanced Economy, particularly on protection of minority investors (23rd) and paying taxes (46th) items. However recurrent power blackouts, difficulties to start a business (134th) and strong barriers to trade (143rd) are key bottlenecks. Barriers to domestic transactions and to register a property (106th) are among other key weaknesses.

Advanced economy

South Africa’s increase is in line with global insolvencies, which confirmed their upward trend from 2017 after seven consecutive years of sizable declines.

Indeed, our Global Insolvency Index which covers 43 countries totaling 83% of global GDP is to post a +10% y/y increase for 2018. Overall, we expect 20 countries of our sample to see in 2018 more insolvencies than in 2017.

Three factors explain this outcome:

  1. A weaker macroeconomic context for some countries;
  2. The implementation of new types of insolvency procedures and the cleaning of business registers through the official insolvency procedures in a few other countries;
  3. More significantly, the stronger willingness to use the insolvency framework in China.

Insolvencies will increase in 2019 because the pace of growth is too slow

In our view, the upside trend in insolvencies will continue in 2019 (+6% y/y). However, this outlook will reflect a universal reason: the soft landing of the global economy to a slower pace of growth at 3.0% in 2019 from 3.1% in 2018 and 3.2% in 2017.

We expect real GDP growth to soften in the US (from 2.9% in 2018 to 2.5% in 2019), the Eurozone (from 1.9% to 1.6%) and Asia (from 5.1% to 4.8%).

This lowering demand is increasing the vulnerability of companies with high-fixed costs and firms with larger inventories or issues in their working capital requirements. At the same time, the end of easy financing is increasing the vulnerability of debt intensive sectors and more globally, the vulnerability of the most indebted companies.

In fact, most economies, notably the developed ones, are expected to revert to and even cross their respective tempo of GDP growth, which has historically proved to be necessary to stabilise the level of insolvencies (+1.7% for Western Europe).

In other words, we expect economic growth to become gradually insufficient for a higher number of companies in a higher number of countries with regard to their production costs, (re)financing costs and structural challenges.

Structural rigidities

In this context, we foresee two out of three countries will post an increase in business insolvencies in 2019 (compared to three out of five in 2018) and one out of two countries to register more insolvencies in 2019 than observed in average over 2003-2007, before the financial crisis of 2008.

A major concern for the business environment is the ongoing structural rigidities, which includes uneasy labor relations, periodic disruptions to power supplies, and is compounded by at least four other factors:

  • Weak international commodity prices;
  • Slowdown in China, the country’s largest trade partner
  • Drought conditions, with weakened agricultural output and a need to import maize and other foodstuffs; and uncertainties relating to U.S. monetary policy tightening. GDP growth will stay well below necessary level in 2019 (+1%, after +0.7% in 2018).

It should be said that countries that exhibited dynamic business creation over the past years would face an extra volume of insolvencies due to young companies being too weak to survive: startups beware!

China to clean its zombie’ state-owned enterprises

The surge in insolvencies in China will keep driving up the regional (and global) insolvency figures.

Indeed, in 2018, business insolvencies continued on a huge double digit growth (estimated at +60%) according to the available non-official data, thus confirming the official pickup posted in 2017 (+74% to 6,257 cases according to the Supreme People’s Court of China).

We expect another double-digit increase of insolvencies in 2019 (+20%). Firstly, because of the ongoing softening and adjustments of the Chinese economy, notably with regard to credit growth, Belt and Road Initiative and international trade issues. Secondly and most importantly, Chinese authorities have decided to clean out its ‘zombie’ state-owned enterprises (exceeding 20,000 cases according to some studies).

All in all, this insolvency outlook calls for more selectivity and preventive actions such as stellar credit management practices by risk managers and business leaders worldwide. It also calls for a close monitoring of the political and policy-related risks which will nurture volatility all along 2019 even if we expect positive outcomes for most of them in our base line scenario,

– Ludovic Subran, Global Head of Macroeconomic Research at Allianz and Chief economist at Euler Hermes.


 

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