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Managing risk: Focus on Europe
IN 2012 and 2013, harsh adjustment to a new fiscal reality will be unavoidable, regardless of the path eurozone politicians decide to embark on.
Yet according to Trevor Williams, chief economist for Lloyds Bank: “Right now, there is no crisis in Europe.”
“There has been much fire fighting to keep this at bay. Debt problems seemed to lessen along with the perception that it was an issue for these countries. If all that went away we would have a better economic profile than we have now,” he said.
Ismail Ertürk, senior lecturer in banking, at Manchester Business School, said that with Spain joining to the list of countries with severe financial problems in the eurozone its outlook is looking increasingly worse.
“The eurozone has failed to identify its underlying weaknesses from the very start and has tried to deal with the interconnected problems on a piece-meal manner.
“Since 2002 banks in the eurozone have become interconnected through their balance sheets and as a result French banks have huge exposures to the Italian banks, and German banks have huge exposures to the UK, Irish and Spanish banks.
“The UK, although outside the eurozone, has immense exposure to the eurozone economies because the UK banks have lent over the years to the banks and companies in Spain, Ireland and France.
“The European Central Bank’s injection of liquidity into the banking system in the eurozone has not helped and instead has just delayed the problems like those we are seeing in Spanish banking.”
Those countries (especially France and Germany) in the eurozone propping up the ones who are struggling will have to “play a nail biting waiting game” to see whether their exposures can be settled up.
The worst outcome for the eurozone would be if one or more countries were to exit. If Greece does exit, the obvious question is whether there will be a domino effect and market attention will turn towards Italy, Ireland, Spain, and Portugal.
“It would have implications for further economic upheaval. If some structural break occurs the second round effects on those not directly connected, such as the UK, would still be felt,” said Williams.
“There would be low growth but it would also affect policy response, with lower interest rates. Those countries that are not highly in debt can respond to that.”
There is talk of a two tier Europe, but Williams questions: “What do we mean by that term?
“A country may find it is in the EU but not the euro – would its obligations change? No. What we mean by that is not countries leaving or being ejected but some / countries moving closer to each other.
“The implications are that those countries most closely implicated will make decisions for them excluding others. The UK could be left out – we don’t yet know what the economic effect of that will be – it could be minimal.”
But Ertürk feels a breakup of the eurozone will have very negative, if not disastrous, impact on the UK businesses.
“A breakup means returning to national currencies in the eurozone. Therefore all euro denominated receivables and debt from the eurozone will be converted to weaker currencies causing some significant currency related losses to the UK economy. Given that UK exports to the eurozone are high, the overall impact is very likely to be severe,” he said.
The present state of affairs leaves treasurers in a vulnerable position. However, with an established, prudent risk framework, businesses can be proactive in identifying and mitigating potential risks.
Edward Massey, senior regional director for new business at Lloyds Bank, said a business should look at the quantum of risk relevant to the underlying business.
“How much of the balance sheet is in that currency – 10% or 50%? If, for example, 50% of your business is in Greece, that’s a big risk. The main risk we are interested in there is devaluation of the currency.”
Business should also look to see whether they have large exposure to the euro.
Massey said: “If you have invested £100m assets in Europe and they are reported in pounds sterling on your balance sheet, the original value of those assets will be diminished if you have to repatriate that. That sort of thing can really have a knock on impact to your balance sheets.”
Williams concludes: “While there is greater continued uncertainty, there is a risk that things will get worse rather than better. How should a business plan? Very carefully.”
But he adds, to end on a positive, business should be cognisant that there are still opportunities.
“Dislocation creates opportunities. For example, some of your competitors in those economies may be weakened, but be aware of the risks,” he said.
