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Crisis Management

“The Worst Is Not Over”: Trade Credit In Today’s World

A Q&A with Alexis Garatti, Head of Economic Research at Euler Hermes.

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FEI Daily: Which industries do you expect will file the greatest number of trade insurance claims as a result of the coronavirus outbreak and why?

Alexis Garatti: At the beginning, what seemed to be a crisis located only in China has rapidly become something with an international dimension. At the origin, the nature of risk was more related to supply chain disruption for those companies whose inputs depended on products coming from China. The second nature of this risk was related to companies exporting to China. It was the first stage of the crisis.

In the second stage, we had the realization that the risk was more than expected. We saw a significant decline of oil prices, which was the trigger for a sharp correction of the market. At this stage, this is another type of risk related to the stability of the energy sector and the stability of funding conditions.

Now we are in a third phase of the crisis, where different governments realizing that they will probably have to organize confinement strategies, similar with what China has organized or what Italy has organized. So, what was perceived as an external risk, supply chain issue at the beginning has now become now a domestic risk. Now there is, across the board, a rise in the general level of risk.

At the three stages of the crisis, you can easily see that every segment of the business is concerned by this elevation of the risks. Of course, there is no doubt that there is more exposure in term of risk in the energy sector, in the transportation sector, because we know that we have the situation of blockage and confinements, which will be detrimental to the business.

FEI Daily: Which industries do you feel are least prepared -- in terms of trade credit insurance coverage - and how do you think they will respond in this crisis?

Garatti: That's a very, very complex question.

We are all experiencing exceptional circumstances. Typically, in a crisis, the definition of that kind of exogeneous shock is the fact that you cannot anticipate where it comes from and what actors are the least prepared to those exceptional circumstances.

But, if you ask my opinion, I would say that every company that has a very high degree of leverage with an urgent need of cash in the short-term to finance its daily activity. These companies could be exposed to a significant tightening of its financing conditions both at a local and global level. We call this situation a seclusion crisis, i.e. the fact that there is an abrupt interruption of the circulation of goods, capital and people across the world.

Those companies are the most vulnerable when being confronted to a significant negative shock on their turnover. In that case, if you have been too complacent in the way you accumulate debt over the last few years, then it could be a day of reckoning for you.

FEI Daily: What are your expectations for insolvencies following this crisis?

Garatti: Initially, we were expecting, at the global level, a rise of 6%, but then, taking into account the last elements, and triple impact  of that crisis, we have estimated that the current shock has the potential to increase the level of global insolvencies in a range of 12%-14% in 2020.

For now, we are trying to finalize those estimates, but there is no doubt that many countries will experience a situation of recession and that we will see a significant rise of insolvencies for the fourth consecutive year in a raw. We had advocated for some time for cautiousness because, and this is an important message today, we entered into that crisis in a situation of fragility.

I’d guess you are perfectly aware of the negative impact of protectionism on global trade in 2019, amid multiple sources of social tensions and conflicts leading to a significant rise of political risk at the global level. The fact is that we entered into 2020, in a very fragile situation where the economy was afloat thanks to the support of central banks, thanks to different sorts of monetary policy stimulus, but now the fact is that today’s shock is very big and that central banks seem unable to smooth it efficiently. That's why we anticipate such an increase of insolvencies at the global level in 2020.

FEI Daily: What impact has the low investment return environment had on trade credit insurance?

Garatti: Based on our macro-economic analysis, and our close monitoring of companies, we were well prepared to navigate this particularly uncertain time. We had indeed identified the fact that we were in a fragile situation at the global level, characterized by high political risk, high leverage. We were aware that any type of shock would have the capacity to disrupt the system in general. In this context, low returns were announcing difficult times and incited us to be preemptively prudent.

FEI Daily: As you know, FEI members are CFOs and VPs of finance and controllers, treasurers, etc. What your big takeaways for them?

Garatti: The first thing is that the worst is not over. There is still a potential for downsides, both at the financial market level, and the economic level. The first half of 2020 will be characterized by a succession of a technical recession.

The second message is that we are still confident in the capacity of the economy to see a rebound from the second half of 2020, on the back of large stimuli both at fiscal and monetary levels. We still believe in a U-shape type of scenario. Despite this conviction, we still need to closely monitor the possibility of seeing a systemic risk materialize.