Friday, January 15, 2016



The going gets tough

Businesses will feel assailed on all sides, warns ……Andrew Palmer

Bankers would not agree, but the good times for business didn't end with the financial crisis of 2008. Government and central banks pulled out the stops, sending shares higher and allowing firms to borrow money at historically low rates. China's massive stimulus gave more life to its expansion, pushing commodity prices higher again. With fragile labour markets putting downward pressure on wages, corporate profits soared: in 2014 the post-tax income of American firms reached heights not seen since 1929. In 2016 business will have to face up to the fact that the party is now truly over.

In 2016 there will be nowhere to hide

Start with China and the developing world. For years, businesses were able to soothe awkward worries about growth by talking to investors about their emerging-market strategy. All those people, all that potential middle-class consumption. The distribution of corporate revenues changed as a result: according to number-crunchers at McKinsey, in 1980 20% of global corporate revenues came from emerging markets; by 2013 it was 40%. Now the developing world seems much less alluring than it did. Growth rates have slowed there from 7.7% in 2010 to around 4.5% in 2015, with little or no improvement likely in 2016.

Companies are not like financial investors, yanking money out of regions one moment and shoving it back the next. Western executives will not quickly turn their backs on established markets like China and promising ones like India. But the focus of boardrooms will keep shifting westwards in 2016—to Europe, where an anaemic recovery will become more robust, and to America. Banks like HSBC and Standard Chartered, which boasted about their emerging-market franchises after the crisis, will squash the idea of moving their headquarters to Asia. More firms will discreetly leave parts of the developing world that have not quite paid off, aping the examples of Best Buy, an American electronics firm that closed down its Chinese operations in 2014, and Vivendi, a French media company which pulled out of Brazil in 2015. Western executives will talk of focusing on core markets.

Life in the rich world will also become more complicated in 2016, however. One reason is that Western businesses are not the only ones to be thinking differently about emerging markets: so too are firms from the developing world itself. As growth slows at home, these companies are looking abroad. China inevitably, is leading the charr. There was thought to be more outbound foreign investment by Chinese firms in 2015 than there was money coming the other way; deals included China National Chemical Corporation's buy-out of Pirelli, an Italian tyremaker; Ninebot's purchase of Segway, a rival maker of two-wheeled electric scooters; and an investment by Didi Kuaidi, a taxi-hailing app, in Lyft, an American rival to Uber. Expect much more of the same in 2016, including the first Chinese acquisition of a European bank. That will sharpen competition for assets, employees and customers.

A second source of discomfort will be the changing interest-rate environment. The long wait for the Federal Reserve and the Bank of England to raise rates will have ended in 2016. Many firms will be able to brush this off, but many won't. Even though rates will go up only gradually, changes in borrowing costs will be amplified at the bottom end of the credit scale. This is where borrowing has been most marked in recent years: four out of five new American issuers between 2012 and 2014 were classified as "junk" by ratings agencies. Analysts at Standard & Poor's expect the default rate among such borrowers in 2016 to be nearly double its 2014 mark; eyes will be on America's shale-oil producers, where low oil prices and high debt will prompt a shake-out.

Where's the silver lining?

In theory, rising interest rates have a large silver lining. They imply that economies are now strong enough to be generating inflationary pressures. After years of stagnating wages, that is good news for consumers and businesses alike. But new rules are likely to give a much harder shove than usual to wages in certain industries. In Britain a new "living wage" for workers aged 25 and over will come into force in April; in America campaigners for minimum-wage rises are winning battles for hefty jumps in pay. The arguments for mandating higher wages for low-paid workers are strong, but these rises are unusually steep and they will cause headaches in sectors like retailing and social care.

In the first half of this decade many companies were insulated from the economic travails around them. In 2016 there will be nowhere to hide. Emerging markets will be tougher and rich-world ones more competitive; labour costs will start to edge up, as will rock-bottom interest rates. The era of record corporate profits will start to fade. ■

Andrew Palmer: business-affairs editor, The Economist

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