Published: December 15, 2022
The current macroeconomic backdrop is far from a fairy tale. With war raging in Ukraine, and major economies tipping into recession, treasurers are adapting to a world of rising interest rates and inflation, as well as spiralling energy and commodities costs. Meanwhile, supply chain disruptions, combined with growing ESG expectations, have thrust working capital efficiency back into the spotlight as corporates look to ensure they are in the best possible shape for the future.
Not too hot. Not too cold. But just right. This is how Goldilocks famously likes to take her porridge, according to a 19th-century British fairy tale. It’s also the basis for a perfect economic storm.
A Goldilocks economy is one that isn’t ‘too hot’ in terms of growth, as this could lead to inflation. Neither is it ‘too cold’ as this could lead to recession and high unemployment rates. Rather it is an economy that exhibits growth; but not too much. And these ‘just right’ economic conditions became something of a regular feature in the decade prior to the Covid-19 pandemic.
As Christian Keller, Head of Economics Research, Barclays Investment Bank, explains: “After the global financial crisis of 2008, there was a prolonged period of significant policy stimulus, driving interest rates down and asset prices up, all while inflation remained negligible. The Goldilocks economy, or certainly a form of it, became more or less the norm – until the health crisis hit. Soon, lockdowns across the world resulted in a significant shock to the global economy.”
Of course, the impact of the pandemic has been well documented, both in terms of human tragedy as well as economic losses. Treasury departments have also felt the heat. According to TMI and Barclays’ European Treasury Survey 2022, now in its third year, 31% of respondents believe that Covid-19 has significantly or very significantly impacted their treasury operations, and 42% say the same of their supply chains.
Thankfully, markets are now – by and large – looking beyond Covid. The major exception here is China, says Keller, where the zero-Covid policy remains problematic for economic growth and, after an initial rapid rebound, the recovery has slowed. “In addition, the possibility of a new Covid-19 strain remains a concern, but vaccines are being updated regularly and vaccination programmes have been a success in many areas, especially in Europe.”
Although the pandemic is now moving into the rear-view mirror for many, there have been several other unwelcome surprises for markets and corporate treasury teams in 2022. “First and foremost is Russia’s invasion of Ukraine,” notes Keller. As well as the human cost of the war, with many lives lost and at least 12 million[1] people displaced, the impact on businesses has been significant – with 27% of treasurers responding to the aforementioned survey noting that the impact of the conflict has either significantly or very significantly impacted their departments.
Supply chains have also been subject to further disruptions and breakages, on the back of the pressures already created by Covid-19 and lockdowns in China. And at the time of war being declared towards the end of February 2022, around 374,000 businesses worldwide were reliant on Russian suppliers and 241,000 used Ukrainian suppliers, according to Dun & Bradstreet[2]. What’s more, Russia and Ukraine accounted for circa 25% of the global trade in wheat and circa 80% of sunflower oil exports[3].
Source: TMI and Barclays’ European Treasury Survey 2022
Alongside the decreasing supply of many essential commodities, prices have increased – adding to the challenging operating environment. Helen Kelly, Head of Europe, Barclays Corporate Banking, comments: “With the majority of commodities being priced in US dollars, the level of market risk has increased significantly as a result of FX volatility and rising prices. Corporates with large commodities exposures are understandably reviewing their hedging activity in this area as a result.”
Not all corporates have significant direct exposures to commodity prices, but almost all are indirectly exposed in their supply chains – with prices being passed on through suppliers. Yet not all suppliers can instantly absorb increased prices for raw materials, so the role of supply chain finance (SCF) has become much more pivotal throughout the Ukraine crisis.
“Treasury teams at large buying organisations are looking for new ways to support their suppliers, while maintaining or improving their cash conversion cycle. SCF is an obvious choice here,” elaborates Kelly. “We are also seeing much more collaborative relationships between suppliers and their clients, as well as greater dialogue between treasury and procurement teams to ensure that everyone is on the same page – and being supported.”
This collaboration, she says, has been bolstered by digital processes and e-invoicing, which took off during the pandemic. “All parts of the supply chain, from physical to financial, are now better connected and more in sync. Nevertheless, there is still room for improvement, and further efficiencies may need to be found sooner rather than later if supply chain and commodity-related challenges persist alongside the war,” she warns.
However, by far the biggest economic knock-on effect of the war has been the exacerbation of the energy crisis. In 2021, before the conflict began, European energy prices had already risen by 600%[4]. In 2022, the crisis has deepened as geopolitical tensions raged.
Countries across Europe have enacted sanctions and trading bans against the country and attempted to reduce their use of Russian energy sources. In turn, Russia has significantly reduced, and in many cases, entirely halted gas supply.
Keller continues: “Several European nations, such as Germany and Italy, are therefore struggling to secure sufficient energy to cover basic needs.” The price of energy has also skyrocketed because it is being imported from other nations, such as Norway and Saudi Arabia, and in volatile currencies. “This means that for the first time in years, Germany is no longer running at a trade surplus and is instead carrying a negative trade balance – simply because the cost of importing energy is so significant,” explains Keller.
Potential energy blackouts are therefore on the cards. In turn, this could hamper business productivity and threaten GDP as factories face shutdowns. Some businesses with operations in Germany are even contemplating moving to the UK as a means to avoid these blackouts[5].
As a result, the need for energy transition has become much clearer – and more urgent for governments across the globe. But, as Kelly notes, this kind of fundamental shift will take time, effort, and significant financing. Keller agrees, adding that “even if the political will is there, the global transition to more renewable energy sources will remain a focus for decades to come as nation states, cities and companies alike move towards to the low-carbon economy. And despite the fact that ESG and net zero are high on the agenda of the majority of governments and corporates, there are numerous other distractions and priorities at present – including inflation, rising interest rates, and recession”.
This is not to say that treasurers cannot play their part, however. Kelly believes that, although they carry their own complexities, ESG considerations can be seamlessly integrated into financing deals and cash management activities. “Treasurers are well aware of the realities of climate change, and the appetite for sustainable solutions is growing, especially as energy transition moves ahead.”
In the short-term, however, the increased prices resulting from the energy crisis and supply chain issues are stoking inflation and rapidly driving up interest rates. And tight labour markets are only exacerbating matters. As Keller explains: “In the UK, and to a somewhat lesser extent, also in Europe, we are seeing low unemployment and relatively high increases in wages over a short period of time, and this is fuelling inflation.”
Initially, central banks watched from the sidelines, but they finally understood that this was not a temporary blip in inflation, says Keller. “We saw relatively early action from the Bank of England and then the US Fed, and both have continued to consistently raise rates – and will likely continue to do so in the months ahead. The European Central Bank was slower to react, but has been much more aggressive than anticipated in raising interest rates in recent months – with an unprecedented 75bps hike in September 2022 and another in November[6].”
Some treasurers are understandably becoming concerned of overtightening in monetary policy, and the prospect of recession. As Kelly explains: “Many treasurers, particularly those who are new to the profession, haven’t operated in an inflationary environment before. They are used to operating only in an artificially low or negative interest rate environment. So, the prospect of rapid rate rises is quite alien to them.” Nevertheless, Keller is adamant that rising rates and a mild recession is a much better prospect than runaway inflation.
While there may be some yield opportunities for treasurers on the back of these rate rises, Kelly calls for caution. “Rate rises are still lagging inflation, so in real terms yields are still negative. Treasurers’ attention would arguably be better focused on getting back to basics by concentrating on ways to optimise internal cash flows, rather than chasing yields in a recessionary environment.”
Large corporate groups often have pockets of trapped cash, she explains. “Though many corporates looked for – and found – internal efficiencies during the pandemic, there are still further improvements to be made. Cash forecasts are rarely perfect. And poor forecasting or poor visibility can lead to subsidiaries with unnecessarily high levels of internal borrowings, as well as superfluous cash buffers in other subsidiaries.” The crucial point here being that these internal inefficiencies carry a much greater cost in this environment, making it even more critical to iron out any wrinkles. “The business case for doing so is certainly there,” adds Kelly.
Entering a period of recession also triggers a need to reassess risk exposures and risk mitigation tools, continues Keller. “This covers everything from operational risk to market risk, counterparty risk, climate risk, technology risk, and people risk,” he elaborates. Kelly agrees adding that this is also the perfect time to review treasury policy. “The role of the treasurer has evolved so much from being ‘just a back-office function’ to being embedded in the business as a risk partner and adviser around financial outcomes. But treasury cannot perform those roles to the best of their ability without the right policy in place, or the right people, partners, or technology.”
On the latter point, she explains that tools such as AI-driven cash forecasting solutions, automated workflows, and real-time information delivered via open APIs can make a significant difference to treasury teams. This is especially true when operating in uncertain times, with limited human resources, and again “the business case for leveraging these tools is stronger than ever,” she says. “What’s more, even if corporate IT budgets are not quite there, the rapid digital shift driven by Covid-19 means that many suppliers now offer these kinds of tools within their platforms – with minimal resource requirements from a treasurer’s perspective.”
In summary, while 2022 may have marked the end of the Goldilocks era and opened up a new period of economic uncertainty and instability, there is still light at the end of the tunnel, since unpredictability in the market gives the treasurer an opportunity to shine. Uncertainty also gives them the mandate to seek opportunities for transformation – whether that be in the way they hedge, the investments they hold, the technology they leverage, the partners they rely on, or the talent they acquire – helping them to make greater strides towards their ‘happily ever after’.
Barclays Bank Ireland PLC is registered in Ireland. Registered Office: One Molesworth Street, Dublin 2, Ireland D02 RF29. Registered Number: 396330. A list of names and personal details of every director of the company is available for inspection to the public at the company’s registered office for a nominal fee. Barclays Bank Ireland PLC is regulated by the Central Bank of Ireland.
This article is intended only for an audience in Europe. Where readers are present in the UK it is only intended for persons who have professional experience in matters relating to investments, and any investment or investment activity to referred to within it are available only to such persons.
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