Insolvencies: Surge of failures expected

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By:
Peter Koh
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As economic growth slows in 2006, more businesses are expected to fail, with the biggest increases likely in Germany, Japan, the UK, and the US.

Global economic growth is forecast to slow to just 2.8% in 2006 from an estimated 3.2% in 2005 and a record 4% in 2004. This will have a strong impact on the number of business failures, which, according to Euler Hermes, a specialist insurer, will rise on average by 1% and by 4% in Germany, 3% in the UK and the US, and 2% in Japan.

“What we see is that the fluctuation of the global insolvency index more or less mirrors the fluctuation of world GDP,” says Philippe Brossard, head of research at Euler Hermes. “When world GDP dipped in 2001, the world insolvency index moved up strongly. Similarly, when the world economy picked up in 2004, we saw a sharp decline in the world insolvency index. The fluctuation of the insolvencies globally is symmetric to the GDP cycle.”

In order to compare business failures in countries that have substantially different insolvency rules, Euler Hermes has devised a Global Failures Index, a weighted index that looks at the changes in reported insolvencies in different countries.

Katrina effect

The expected rise in the global index is strongly influenced by the rise in business failures in the US. US insolvencies have been falling since 2001 – from 40,000 to 32,400 at the end of the second quarter of 2005, the lowest level for 25 years. But Katrina’s devastation of communities in the southeastern US is expected to have a big impact on local business failures. There was also a surge in Chapter 11 filings in the third quarter as companies rushed to declare bankruptcy before changes to the law, effective in October, that make bankruptcy proceedings more onerous for debtors.

Unmade in Japan

Despite a strong stock market and a promising recovery in Japan, insolvencies are expected to increase there too as growth might not reach expectations. In December, revised official figures showed that third-quarter growth in the Japanese economy was just 0.2% up on the previous quarter in real terms, with an annualized rate of 1%. The government had previously estimated quarterly growth of 0.4% for the third quarter and 1.7% annualized growth.

Globally the clothing, air transport and textiles sectors have the worst outlook for 2006. Euler Hermes identifies imminent insolvencies in the clothing industries of Belgium, France and Italy, and in the air transport sectors of Belgium, Canada and the US.