Storm warning
by Stuart QualtroughLast year OPI explored whether the industry was teetering on the edge of a global recession. Here in a snapshot of the global economy, OPI analyses the current situation.
The clouds are still brewing, we seem closer now to a US recession than ever before - but what is the likely fallout for OP retailers and manufacturers across the globe?
The question at the end of last year was not if the recession would arrive, but when?
Now the official figures seem to reinforce the pessimistic outlook, but there remains some hope for the near future.
In the UK, the figures are worsening. Research released by Ernst & Young earlier this year revealed that profit warnings for the year to 31 December 2007 totalled 384, the highest yearly figure since 2001.
In Q4 of 2007, 107 profit warnings were issued by UK-quoted companies, the highest quarterly figure since the last quarter of 2001, and 22 percent more warnings than the same period last year. One in five of the warnings this quarter explicitly blamed the fallout from the US sub-prime mortgage crisis and the credit crunch. Moreover, the majority of profit warnings blaming the crunch came from outside of financial sectors. From construction to software and retail to support services, the message is clear: 2008 is set to be a tough year.
Keith McGregor, corporate restructuring partner at Ernst & Young, explains: "By the end of 2007, the question whether the impact of the credit crunch would spread beyond the financial sphere was answered by a wave of 'credit crunch' profit warnings from non-financial corporates. The UK economy will slow in 2008; the only question is by how much."
The highest warning sectors in Q4 were support services with 22 warnings, general retailers with 12, media with 10, software and computer services with nine and travel and leisure with eight. The highest warning FTSE sectors in 2007 were software & computer services and support services with 56 warnings each, followed by general retailers with 47.
The year ended as badly as it started for the general retail sector with it reporting 12 profit warnings for Q4 of 2007 and taking the annual total to a record breaking 47 profit warnings, the highest number in this sector since 1999 when Ernst & Young began recording profit warnings.
Andrew Wollaston, corporate restructuring partner at Ernst & Young, comments: "Early indications suggest that although Christmas wasn't a complete disaster, the cry of wolf was more justified than in previous years and the story this Christmas was the continuing polarisation between winners and losers.
"On the winners' side, department stores appear to have held up well, along with grocery sales, whilst games console retailers were buoyed by demand for the must-have present this Christmas. Chief amongst the losers, at Christmas and in 2007, were clothing, footwear and electrical retailers."
Trouble ahead
Weakening consumer confidence, sluggish retail spending, a stalling housing market, falling equity withdrawal and increasing credit card refusals do not bode well for retailers as they go into the traditional cash-hungry first quarter of the year.
According to retail insolvency expert Chris Laughton of UK accountancy firm Mercer & Hole: "Many people are predicting that the most likely to run into trouble are big ticket retailers selling discretionary products.
"I also think there are risks and that big-ticket, discretionary-spend retailers are in the front line.
"But so far 2008's prominent retail insolvencies in the UK have been in shoes (Stead & Simpson and Dolcis), books (The Works) and fashion (Elvi and Base Menswear).
"The common thread is undistinguished chains at the low end of the middle market being most at risk, with the credit crunch affecting future levels of retail spending and spending on non-essential delayable purchases. Differentiation and a nose for fickle customer demand remain the key factors for survival.
"The tally of retail failures is lower than it might have been. Restructuring takes longer because of the more complex stakeholder structures found now compared to five years ago, and some of the weaker players saw the New Year problems coming.
Together, these factors encouraged some retailers to start taking advice and acting early enough to avoid administration."
However, the early shoots of recovery are already beginning to show. Last month, Brady Dougan, CEO of Credit Suisse, stated that he believes the credit crunch could be over in as little as a few months.
Dougan believes that the tightening of credit has begun to ease slightly, although the underlying root causes that sparked off the sub-prime mortgage crisis and credit crunch have yet to be addressed.
Confident future
The US housing market could settle down in the middle of 2008, he went on to say, but it would be prudent for firms to assume the crisis lasts somewhat longer.
Globally, the crisis has cost financial institutions over $100 billion, with many estimating that the ultimate cost could be more than triple the losses already incurred.
When confidence returns to the markets, the financial situation will soon be back on track, Dougan believes.
Manufacturers and global OP retailers have recently been cashing in on the emerging economies of Eastern Europe and the former Soviet Union, which have been enjoying spectacular growth in recent years.
But the question on many commentators' lips is, will these fledging economies be robust enough to withstand the spreading global credit crunch and a possible recession in the US?
Most economists forecast growth in the region of 5.5 percent to 6 percent in 2008, which is slower than in 2007, but still considered impressive.
"This is still a fast-growing region with strong fundamentals," says Erik Berglof, the chief economist at the European Bank for Reconstruction and Development.
Despite the optimistic outlook for the whole region, some economists believe there remain a number of considerable risks for certain countries.
The International Monetary Fund (IMF) said in its influential November report on Europe that the risks were particularly high "for those countries that have been funding large current account imbalances with foreign bank borrowing".
The Baltics and Balkans remain particularly dependent on foreign capital to finance their huge current account deficits.
Current account balance is determined mostly by the difference between exports and imports of goods and services. In energy-rich Russia, which exports oil and gas, its current account surplus is estimated at 6 percent of GDP for 2007, while for Latvia, the deficit is almost 25 percent of GDP.
Neil Shearing, Emerging Europe economist at Capital Economics, says more than $300 billion of direct investment had been ploughed into emerging European economies since 2000.
"The Baltics and Balkans remain particularly dependent on foreign capital to finance their huge current account deficits," he adds.
Berglof identifies "high levels of current account deficits, high exposure to foreign borrowing and political uncertainties in some countries", but he believes the problems have already been recognised and steps are being undertaken to counter the threat.
But Shearing noticed that "given that the roots of this latest global slowdown lie in tighter credit conditions, it is impossible to ignore the impact of weaker capital inflows on regional prospects".
"Monetary policy faces the difficult challenge of balancing the risks of higher inflation and slower economic activity, although a possible softening of oil prices could moderate inflation pressures to some extent," the IMF commented in its latest World Economic Outlook.
Huge current account deficits and high inflation risks make some currency exchange rates overvalued.
Shearing says that the currencies of the Baltics and Balkans "remain vulnerable to a sharp dip in global recession".
"If a slump in global growth hits investor confidence hard, a disorderly devaluation cannot be ruled out," he adds. "This would almost certainly trigger a recession."
Economic problems in the US - a further slowdown or recession - are not expected to have a significant impact on Eastern Europe, as the world's biggest economy is not among the region's leading trade partners.
Looking east
Shearing says that exports to the eurozone reached 40 percent of GDP in some Eastern European countries, while for exports to the US, the figure stood at just 2 percent.
One of the reasons is that the performance of Eastern Europe will be largely determined by the eurozone economy.
However, countries of Central Europe look particularly exposed to a sharp slowdown in the eurozone: if growth in the single currency area dips to 1.5 percent, Hungary for example, could slip into recession.
The IMF said in its European report that "the broader financial system has continued to function well [in Western Europe, but] money and credit markets remain tight".
Some experts believe that Russia's economy performance will have a further effect on Europe's emerging markets.
Russian analysts say the influence of the credit crunch on Russia would be very limited as they expect the Russian government to use its huge stabilisation fund, which has been boosted by rising oil prices, if the liquidity situation deteriorates.
The important question is whether Western banks, which have been among the biggest investors in Eastern Europe, decide to reduce their involvement.
In the World Economic Outlook, IMF economists warned of a precarious situation that could occur should things get worse. The IMF wrote that "so far, foreign bank financing of credit in Eastern Europe has held up well, but this financing could be curtailed if the global situation deteriorates and there are tighter global funding conditions".
Nevertheless, most economists remain cautiously upbeat about the region's outlook for 2008, saying that most governments have been taking relevant steps to bring potentially dangerous economic developments under control.
