What are the most dangerous global risks your company may face when doing business abroad? We asked two EDC experts, Country Risk Analyst Ian Tobman and Economist Andrea Gardella, to talk about the top three hazards and how they might affect both Canadian exporters and the global economy.
Brexit and EU collapse
Even the most enthusiastic advocates of Britain’s exit from the EU (the so-called Brexit) apparently didn’t expect to win the referendum, and didn’t plan for what might happen if they did. The post-vote situation is becoming a classic example of how unexpected events can lead to highly unpredictable economic consequences.
While Brexit’s immediate effects on Britain, the EU and the global economy haven’t (as yet) been the disaster that some predicted, the eventual impacts may be severe. The negotiations for the terms of Britain’s departure are still in the very early stages, and no one knows for sure whether it will be an amicable divorce or an acrimonious one. “However,” says Ian Tobman, “the uncertainty the Brexit vote has created is clouding an already wobbly macroeconomic outlook. This is already having an impact on investor plans and is expected to lower Canada’s UK-bound exports by as much as 8 per cent in 2017.”
Britain’s decision to leave has also revealed how the belief in a unified Europe with highly permeable national borders is fading. This pessimism may undermine the ratification, expansion and development of multilateral trade deals such as the Comprehensive Economic and Trade Agreement (CETA) between Canada and the EU, which is (or was) expected to open up new opportunities for Canadian exporters. And with Britain out of the EU, Canada would presumably have to negotiate a separate free trade agreement with the British government before our exporters would get freer access to the U.K. market.
Perhaps the worst-case risk is that Britain’s decision to leave the EU might influence other countries to do the same. This “EU collapse” scenario would have incalculable consequences for Canadian exporters to Europe, to say nothing of its effects on the global economy as a whole.
Italian banks and the Eurozone
The Italian banking crisis continues to threaten the stability of the Eurozone (the group of countries that use the euro as their common currency). “The IMF,” says Tobman, “estimates the total of Italy’s bad loans to be €360 billion, or about a third of the Eurozone’s total. Italian banks now require immediate capital injections to restore investor confidence, but under current EU banking rules, direct state assistance is not possible. Finding a solution is vital not only for Italy’s ailing banks but also for the sustainability of the Eurozone. This risk could actually have a more potent impact than Brexit.”
Andrea Gardella agrees. “The threat of an EU collapse and the Italian banking crisis are critical economic risks. Both would have a negative effect on the global economy, which in turn would shrink global demand for Canadian exports. Additionally, an EU collapse could affect Canadian direct investment in Europe.”
Economic crisis in China
The risk of a Chinese economic crisis remains serious even though the numbers released by Beijing have become somewhat less alarming. “Our view,” says Tobman, “is that this risk continues to be one of the highest. The Chinese government is trying to balance short-term growth with a transformation of the economy over the medium to long term. To do so, it’s using monetary and fiscal stimuli to buttress growth, but this is also increasing risks within the financial sector.”
If a Chinese economic crisis does occur, its effects on the Canadian economy and Canadian exporters could be substantial. We ship about $20 billion worth of goods directly to China every year and this volume would obviously diminish. But a Chinese slump could have still wider consequences for Canadian exporters—in a ripple effect, countries that use our goods to produce merchandise for China would also see their Chinese market shrink, so their demand for our products would diminish accordingly.
Increased U.S. regulation and protectionism
“The whiff of increased regulation and protectionism from across our southern border is undeniable,” says Tobman, “and the upcoming presidential election is making this a high-profile risk. While it’s likely that Congress would constrain the most extreme Presidential promises on the economy and trade, the fact remains that the United States is moving toward greater isolationism.”
For Canadian exporters, this would probably cause more aggressive U.S. responses to what the United States sees as unfair trade imbalances, such as the perennial softwood lumber dispute. Whether a U.S. government of either political stripe would move decisively toward protectionism (possibly in the form of renegotiating NAFTA) is a more difficult question to answer.
“If it did so,” says Gardella, “we could see a shift in the policies and regulations that the United States applies to trade and investments, all of which would likely be negative for Canadian companies. The business and trade environment would be less predictable and further protectionist legislation, like the current Buy America rules, could be introduced. Such measures would severely affect our companies’ competitiveness in the U.S. market.”
If Brexit or some other event triggered a collapse of the Eurozone and the EU, the effects would be more than economic. The regulatory and political impacts would also be profound, with Canadian exporters struggling to cope with the new national regulations and policies that would be replacing the formerly unified structures of the EU market. Doing business in Europe would be more expensive, complicated and slower than it is now, and could place the markets of the former EU beyond the reach of many Canadian companies.
Japan’s “debt bomb”
Japan’s economy is the third largest in the world, but it harbours a high-risk weakness in the form of a remorselessly expanding public debt. At the root of the problem is the country’s demography, whose low birthrate and low immigration rates are shrinking the working-age population at a disturbing clip. At the same time, the number of non-working retirees is escalating as the population ages. This group absorbs substantial services, such as pensions and healthcare, which are being financed by steadily increasing government/public debt. The concern is that, at some point, the country will no longer be able to service this debt and Japan will face a financial crisis.
“It’s been evident for some time,” says Tobman, “that Japan’s public debt, which is now above 250 per cent of GDP, is unsustainable. If the global perception of that risk were to change in the medium term, it could have a major impact on Japan’s financing needs, and a financial crisis in Japan would have global implications. With no new and conclusive policy moves expected in the foreseeable future, the likelihood of this risk will continue to grow.”
Two ways to deal with the risks
- Integrate risk management into your operations
Companies that are good at managing risk usually integrate risk assessment into their business operations and update their assessment regularly. Even smaller firms can formally assign someone from senior management to set up a process that will identify the top risks and find ways to deal with them. This person may be backed up by other company personnel, depending on the workload, and he or she should have the authority to bring in third-party risk experts when necessary. Once you’ve established how risk management will work within your company, you should make it part of your routine business activities.
- Distinguish between short-term and long-term risk
“It’s also very important,” says Gardella, “to differentiate between short-term risk effects and the potential impacts of risk over the longer term. Take the European situation, for example, in the context of Brexit. In the short term, there are economic risks such as a British drop in demand, which ultimately trickles down to affect Canadian exporters. But when you look at your longer-term risks in Britain and Europe, you need to examine the structural strengths of your particular sector in those places and decide whether and how your sector can sustain itself over the longer period. So I think it’s vital to look at short-term and long-term risk categories separately, and then weigh the short-term hazards against the opportunities offered by the medium and long term.”