Credit Crunch Implications For Irish Business
Author:
Joe Carr
The Credit Crunch –Implications For Irish Business
By Joe Carr
The changed economic climate, and the causes of this change, has generated much discussion in the recent past. The impact of economic difficulties can be seen in many areas: below target results for Q4 2007 and Q1 2008, with some specific sectors suffering more than others; increasing difficulty for businesses seeking funding; declining consumer sentiment; and cash flow has come under significant strain. However dark this scenario sounds, it is part of the story only. Just as we need to be realistic about the new challenges we face, Irish businesses should also be realistic about the advantages we enjoy as we face into the new environment.
Examining this changed environment, I realised the scale and implication of what had happened. Considering Ireland’s specific situation, I see some cause for optimism. There is light at the end of the tunnel, if we act pragmatically.
What happened?
First let me give the briefest of synopses of what did actually happen. Prior to the emergence of the credit crunch last summer, the situation which gave rise to the crisis was building for some time. In the US there was an enormous boom in lending, interest rates were at an historic low and the proportion of subprime borrowers on variable rate mortgages on loan books was increasing significantly - with total subprime lending amounting to $1.4 trillion. The security held by these borrowers was of poor quality and was extremely vulnerable to market forces. The subprime loans were not isolated from the rest of the financial world as they were packaged and repackaged repeatedly until the risk profiles of the products were so well mixed with those of other instruments that investors did not identify the risk attaching to the instruments they were buying.
Once the subprime borrowers began to default in significant numbers the whole house of cards started to collapse and the contagion spread to all asset back securities, and ultimately into other asset classes, both in the U.S. and across the Atlantic to Europe where investors had invested heavily in the repackaged securities.
Confidence was severely shaken, banks incurred heavy losses and reduced or stopped lending, credit dried up and so investment virtually came to a halt. This was matched by significant reductions in equity values, led by declining Financial Stock prices. Combined with rising food and oil prices, and higher interest rates, the real economy began to feel the effects.
This chain of events highlighted some major fault lines in the market system. Obviously there were flaws in the subprime lending model, but beyond that there were other fault lines which should be managed in future. The assumption of ‘rational man’ did not seem to apply in the pre-crunch climate, the amount of lending undertaken, which was obviously beyond the reach of the borrowers involved, was staggering. The levels of leverage reached by some of the financial institutions would never be supported by the average business model. There was an excessive amount of opportunistic trading taking place which may have distorted the market. The market was and still is vulnerable to a few mega-firms which float in the world economy like great oil tankers, the sinking of any one of them carrying potentially huge implications for the global economic environment. The other major fault line, unrelated to the subprime issue but unhappily coinciding with its onset, which is now showing its effects is the over dependence on the limited supply of fossil fuels.
How long until we’re back on track?
The question many are now asking is how long will it now take for economies, markets, and business to get back on the growth track. A study of previous bubbles shows that the aftermath can continue for quite some time.
I think it likely in this case that we will continue to feel the effects for a period of up to three years from now. I think it is important, however, that we don’t bury our heads in the sand in the face of this new reality., We should acknowledge the challenges and meet them head on through realistic and prudent planning. Volatile and difficult times provide opportunities to some; downward cycles always end with the beginning of another positive cycle.
What should be done?
I believe that public policy and business planning need to work in harmony to meet the challenges that we now face. Despite the global changes which have occurred the Irish economy is still healthy is in a relatively better state post crunch than both the US and the G7. The Mazars Business Environment Health Index, which scores the health of an economy on five criteria (unemployment, growth, inflation, growth in private consumption expenditure and level of government debt) shows Ireland scoring 76 out of a possible 100, where both the US and G7 countries scored 60.
Of particular note is our healthy position in regard to national debt, by comparison with both the US and G7 comparators. Ireland holds a relatively low level of national debt and therefore has the capacity to borrow for investment. But investment must be directed with care, taking into account the changed environment. Borrowing and investment plans should be reviewed accordingly.
A more balanced geographic spread of our dependence on world economies would leave us less exposed in the future to local fluctuations in areas such as the US and the UK. We have already been successful in reducing our dependence on the UK economy quite dramatically since accession to the European Union. In 1973 the UK represented 55% of our export markets, in 2006 that figure was 17%. In light of the recent rejection of the Lisbon Treaty, this statistic clearly shows the importance of our full participation in the EU.
Supporting key sectors where we have a strong base will focus our energy and help us gain competitive advantage in key areas so that we can compete more effectively. As a small economy specialisation is a must if we are to gain competitive advantage against larger nations. Technological convergence appears to be a key opportunity on the horizon for Ireland. We are strong in fields where these opportunities are emerging - life sciences, pharma, ICT and food production. Our small size means that all of the leading companies which we have in these areas are within close proximity to one another, allowing for ease of access for collaborative projects. Public policy should continue to focus investment on the areas of research and innovation which have not been undertaken by private industry since they might not generate immediate return, but which are vital to establishing Ireland as a presence in this field.
Similarly in financial services, if we are to achieve the employment levels predicted by the recent ESRI report, we need to continue to place ourselves at the forefront of innovation and excellence. Increased efforts in this area will no doubt attract more competition from abroad but the sector has been shown to be robust by comparison with some other countries and we have a sound base to on which we can build.
As a final comment on the public policy area, it is important to deal with the issue of confidence. The availability of appropriate knowledge is critical in helping to manage the issue of confidence which has proved to be a fundamental factor in the recent financial and market crisis. It would be useful to have some kind of public address to government (and to all of us) from an authority, much like the formal system that underpins the quarterly letter from the governor of the Bank of England to the British government of the day. I call it a ‘national dashboard’ that would give citizens, businesses, workers and politicians a clear indication of the current phase of the economic cycle, based on timely data, domestic and international. It could be published quarterly and would provide a basis for informed debate (including by legislators) and comment as well as rational decision-making by consumers, business and government.
As business leaders, this too is a time for careful evaluation of our businesses and organisations If not already at hand, it is time to undertake a detailed activity based costing (ABC) analysis of your business and where necessary to align cost bases with likely future revenue levels under the new market conditions. Unless you can clearly and rationally demonstrate otherwise, assume that your current market is unlikely to grow in real terms over the next 12-24 months, and in some sectors, it may be prudent to assume that there may be a decline in business. I am not, however, advising arbitrary cost cutting - in fact the opposite is true. All parts of your business must contribute. You need to prioritise the protection of your most profitable customers, activities, people and teams if the business is to succeed. Equally it is imperative to identify those activities in the business that have no potential to yield a positive business result for the foreseeable future, and on that basis don’t be afraid to make hard decisions.
Listen to your customers. What they wanted 12 months ago may be very different from what they expect today. Reflecting changing tastes and demand is key. Focus on innovation, knowledge and advantage - in a tighter market competition is tougher and complacency will lead to failure.
Finally, treat cash like gold dust and stay flexible. Don’t just have a plan but have several different plans depending on how the market develops, this of course also means that you must keep your eyes wide open to see any changes quickly and be prepared to act on them effectively.
The challenges and advantages of a small economy
It is true that Ireland is a small and very open economy. We have strong dependencies on some of the markets worst hit by the recent changes, the US and the UK. The drop in the value of the dollar has put pressure on SMEs trying to sell into these markets, while those who are competing locally with imports from those markets are under more pressure from more competitively priced imports. We have neither the critical mass nor the standing to act unilaterally to counter the present phase of the business cycle. Things like manipulating the interest rate and the exchange rate are off limits with membership of the Euro zone and the ECB’s focus – as with the Bank of England – is on inflation and squeezing it.
Our size, however, is something that I see that we can use to our advantage in the current climate. Being smaller, we can be more agile; we have strong businesses here and a strong economy to support them. We can look at the huge opportunity that is the emerging markets for new business to help sustain us through this period and add more geographic balance to reduce our dependence on the US and UK markets. If we focus our energies on those opportunities which offer reward, we can and will get through this phase of volatility.
On an individual level too, businesses need to extend the geography of your ambition. If you operate within a town or region, then you need to look nationally; if you operate nationally then you need to look internationally. The focus must be on specialising in the few things that you do well and excelling at them. This will be your key to competing on a bigger stage.
Key messages
The key points to take on board are that this storm is bigger than those of our recent past but we are in a stronger position to weather it than we have been at any time in the past. It is likely that it will take 3 years to get through this period of volatility and return to a steady state of recurrent growth. It is apparent that the psychology of confidence is fundamental to our economic cycles, but the availability of transparent economic information will greatly help to mitigate the type of market reaction we have seen. There is a new world economic order, in which the emerging economies will play a much greater role in our future economic and business success. Fossil fuels are now a key economic issue and energy management will be a new area of focus at all levels - for public policy, business management and personally. Finally it is now clear that we need to review and perhaps re-write our plans both nationally and at a corporate level - some of the basic assumptions which we used before may no longer apply.
Finally, I believe that this cycle, like all cycles, will pass. Those that are pragmatic and focused will enjoy success, even in these most difficult of times.