EDC identifies the top 10 global risks facing Canadian companies
- August 5, 2022
Export Development Canada (EDC) Economics has identified the challenges facing Canadian companies for the rest of the year, including rising inflation, the energy crunch and the continuation of the war in Ukraine.
1. Economic recession in developed markets
To stem rising inflation and, more importantly, rising inflation expectations, central banks in the United States, Canada and Europe are implementing aggressive interest rate hikes, with more anticipated in the coming months. The higher borrowing costs will dampen consumers’ ability to finance the purchase of new cars, homes, and other consumables. As consumer confidence weakens, it cascades to businesses and eventually leads to a slowdown in real economic activity. EDC Economics’ base-case scenario doesn’t reflect this risk given the strength of consumers and the tight labour market (unemployment rates are very low). The pace and size of the rate hikes could drive the U.S. economy and other advanced economies, like Canada, into recession.
2. Inflation, demand destruction and repricing of risk
While trying to navigate through a difficult situation, there’s a risk that major central banks could miscalculate the impact of monetary policy tightening in their prioritization of bringing inflation down over the impact on the financial sector. As interest rates move well above their neutral levels, a significant repricing of risk ensues, resulting in sizable negative impacts on financial markets. Corporations, that have fragile balance sheets coming out of the pandemic, face serious default risks as liquidity quickly dries up.
3. Supply chains and labour constraints
Complex supply chains had been honed over decades to be nimble and agile, but were thrown into disarray with the subsequent trade challenges between the U.S. and China, and the impact of COVID-19. Before supply chains were able to recover, the global economy was hit by lockdowns in China, a manufacturing powerhouse, and the war in Ukraine, which is impacting everything from grain to oil and gas. A tight labour market due to lower labour supply and immigration has put further pressure on all sectors. Extreme weather or another virus could easily disrupt supply chains over the coming year. In response, manufacturers have been boosting their inventories and going on a hiring spree to weather future shocks. An expected future trend of near-shoring or friend-shoring (operating supply chains only through partner countries) means that supply chains will remain in flux until manufacturers, retailers and other companies find alternatives and get used to the new reality of resiliency in lieu of efficiency.
4. The Russia-Ukraine conflict
The full-scale Russian invasion of Ukraine caught most of the world by surprise. The impact of the conflict itself and western-led sanctions on Russia have upended the supply chains of key commodities, including grains and energy. Higher food and energy prices are driving up inflation across the globe. While EDC Economics’ base-case scenario includes continued fighting confined to Ukraine, an escalation and expansion of the conflict beyond its borders remain a risk to the outlook. The war is directly impacting Canadian exports; in EDC’s latest Trade Confidence Index, more than one-third of survey respondents report experiencing challenges due to the ongoing conflict from acquiring inputs to contract delays.
5. Sovereign debt crisis
Over the past few decades, emerging markets have implemented important structural reforms such as adopting flexible exchange rates, which have made them more resilient to external shocks than in the 1980s and 1990s. Low interest rates and inflation have been key factors keeping troubled sovereigns and corporates afloat and borrowing at affordable rates. But as higher rates kick in and growth underperforms, there are heightened concerns of a potential new sovereign debt crisis.
With close to 50 countries now either in debt distress or at a high risk of it, and debt restructurings too slow to respond, the recent debt default by Sri Lanka is unlikely to be an isolated event. While EDC Economics’ base-case is that the risk of a systemic sovereign debt crisis remains unlikely, if it happened, the impacts would likely be felt across emerging economies. Developed markets, like peripheral European states, may face rising fiscal pressures, but have greater ability to absorb shocks.
6. Energy crunch
The war in Ukraine and subsequent sanctions on Russia’s energy exports have exacerbated an already-tight global energy market. High energy prices and their inflationary effects have increased economic uncertainty and social unrest across the globe. The energy crunch has also altered the geopolitical landscape, as countries seek alternative supplies of energy. In the medium and long term, sustained high energy prices will likely temper demand for petroleum products, accelerate the renewable energy transition, and shift the global energy trade’s centre of gravity from petrostates to electrostates. As a major oil producer and net energy exporter, in the short term, Canada is expected to benefit from surging energy prices, attracting more investment into the oil and gas sector.
7. Global food security
With the triple impact of inflation, persistent supply chain disruptions, and a war raging in Ukraine, one of the world’s major breadbaskets, modern global food supply has seldom been so insecure. As the costs and scarcity of both food and fertilizers rise, the effects are being felt by consumers and producers, and governments will be under pressure to intervene. For many emerging markets, the impacts could be catastrophic, given the limited ability of many consumers and governments to adjust to higher prices and new supply disruptions.
With no end in sight, the food security dilemma could very well unwind many economic and development gains made over the past decade and contribute to political unrest across much of the Global South. Export restrictions on food risk are becoming a mainstay of domestic policy in several major markets, as governments prioritize supply for their own countries at the expense of global trade. Such a scenario does present opportunities for Canadian agri-food exporters to help alleviate supply pressures if they have the capacity.
8. Climate regulation
International recognition for urgent action on climate and other environmental, social and governance (ESG) challenges has led to increased pressure on governments and industry to demonstrate stronger commitments in these areas. Transparent disclosure and proactive reporting are becoming the norm, with an increased focus on ties to executive compensation. In many cases, these commitments are moving from voluntary programs to regulatory requirements and prompting convergence around ESG standards and targets. While this is raising the cost of doing business across sectors, it also opens the opportunity to enhance returns and access cheaper credit. Going forward, performance in these areas will offer some a competitive advantage and price others out of the market. The risk is that many companies may not be ready for these changes or haven’t appropriately factored in transitional costs.
9. The unwinding of globalization
The war in Ukraine and the subsequent sanctions on Russia have put strains on supply chains and reoriented trade flows (e.g., energy going to China and India instead of Europe). The war is only the latest challenge to international trade flows, following the shocks of COVID-19 and the U.S.-China trade dispute before that. Together, these shocks are driving companies to finally act and prioritize secure trade over efficiency. To do so, they’re redesigning their supply chains by increasing suppliers, building up inventories and investing in vertical integration. Governments are also increasingly adopting industrial policies for “strategic” sectors to reduce their economic dependency. While the net effect may result in more resilient companies, the added costs are considerable and will likely be passed on to consumers and taxpayers. The end of globalization isn’t evident, but a transformation is happening and for a trading nation, like Canada, it’s important to understand how it’ll evolve.
10. Wave of corporate defaults
In addition to financial markets and sovereigns, corporates are another asset class to watch. While the global economy did recover in the second half of 2020 and 2021—it came at the cost of a marked increase in levels of corporate indebtedness. This was incentivized by generous government loan guarantees, as well as record-low borrowing costs, as central banks unleashed monetary stimulus by lowering interest rates. But the economic slowdown due to inflationary pressures, as well as supply chain issues, combined with tighter financial conditions, pose risks to corporates as investors turn sour on corporate debt and require higher compensation.
Easy access to credit markets has meant “zombie” companies—those that are economically unviable—have managed to survive without meeting profitability and productivity requirements by tapping banks and capital markets. By some estimates, one-fifth of America’s largest 3,000 public firms are considered “zombies.” With unfettered access to credit markets a thing of the past, the withdrawal of fiscal support and a slowing economy, the near-term risk of a wave of corporate defaults is something Canadian exporters should be prepared for.