The scenario darkens

Michael Alan Hamlin

Posted on October 18, 2008

Acknowledging, understanding the crisis is the first step

No one doubts that the week of October 6 – 10 will go down in history, but no one is certain exactly why. Will it be remembered as the week the financial crisis went global with markets from the U.S. to the EU to Japan to China, India and Russia falling steeply? Or the week the crisis bottomed out? Or, will it be remembered as the week that global recession began in earnest?

Executives around the world polled in a McKinsey Quarterly survey taken October 3 – 6 would likely forecast the third possibility. Even before the extent of the global meltdown became clearer in the following days, a majority of respondents signified significantly darkened expectations for their economies. That was the week analysts were expecting the Dow to reach bottom at 9600. But by last Friday, it had fallen below 8500, and the S&P had recorded its biggest weekly decline since 1953.

The results of the survey showed that executives were evenly divided on whether the U.S. Treasury’s bailout of the industry would effectively restore liquidity to the financial markets. Tellingly, U.S. respondents were more skeptical than their global peers. No doubt both groups would be even more skeptical now. Before last week’s meltdown, 70% of respondents expected their countries’ economies to be substantially or moderately worse over the next three months. Only 16% thought they would be the same. Just 14% of respondents expected their economies to be substantially or moderately better.

The outlook among executives in developing markets – which includes Asia and Latin America – was marginally more positive. Twenty-three percent expected their economies to be substantially or moderately better three months from now. Sixteen percent said they would be the same. But 61% – about the same percentage as U.S. executives – said their economies would be worse.

Despite the gloomy forecast, more than two thirds of the respondents globally expect their workforces to remain the same (46%) or to grow (27%) over the next three months. Twenty-six percent expect their workforces to decrease. However, this suggests that 70% of the companies represented by respondents will freeze hiring or begin cutting the size of their workforces. As a result, there will be substantially fewer jobs available over the next three months and probably longer. After last week, it seems obvious that many more companies will be looking to at least stop hiring.

More executives in developing economies, despite being somewhat more optimistic overall before last week than other global executives, expected their workforces to stay the same (48%) or decrease (29%). Only 22% were confident that their workforces would increase. Although the survey did not provide results for respondents in the Philippines, analysts expect the business process outsourcing sectors to continue to expand, and to some extent, support sectors for the industry as well.

But that’s unlikely to be the case for other services sectors that have depended on consumer spending driven by overseas remittances to grow. Developments in Mexico provide a glimpse into likely developments in the Philippines. There, government is preparing to absorb workers who lose their jobs in the U.S. as a result of the downturn. Although demand is likely to remain strong for Filipino workers in critical sectors such as healthcare, many others are likely to find themselves looking for work.

If that happens, vulnerable industries in the Philippines include real estate, retail, dining and entertainment, finance and insurance, and automotive services as remittances slow. These sectors are also likely to be hampered as a result of tightening credit. Although the Banko Sentral ng Pilipinas appears intent on keeping interest rates low, lenders will be less willing to extend credit to buyers in vulnerable sectors such as consumer real estate. Expect defaults to rise as well. Manufacturing will be hit as the domestic market and export markets contract.

Corporations will also be squeezed everywhere, and particularly in developing markets. Fifty-five percent of all respondents to the survey said the cost of funds obtained in the past three months was higher, even when obtained from regular sources. Almost 70 percent of respondents in developing markets said the cost of funds has increased as banks fretted about loaning funds at all.

Manufacturing will be hit the worst by rising costs of funds, with 74% of global respondents indicating that the cost of funds has increased, but in financial services, 62% of respondents indicated as well that the cost of funds has risen. Because borrowed funds are used primarily for development initiatives (52%) tightening credit is another sign that commercial activity will moderate significantly. Forty-six percent of respondents use external funding to pay operating expenses, and these firms will be forced to undertake considerable belt tightening.

So the scenario has darkened significantly, and executives everywhere are clearly worried. While there is opportunity in crisis as I suggested last week, exploiting it requires acknowledging, understanding, and dealing with the crisis itself.

No Comments

Leave a response