29 October 2021

Will the end of Covid support ‘fuel insolvencies’?


Following the withdrawal of government support measures to mitigate the economic effects of the pandemic, Dana Rădulescu, Partner, MPR Partners, examines the outlook for insolvency.

At the beginning of October, the main UK government support measures given to British businesses during the Covid-19 pandemic were withdrawn. Many now expect a wave of insolvencies to follow in the coming months. Credit insurer Euler Hermes estimates that these supports have helped to prevent 18,900 insolvencies, and predicts that the number of insolvencies will now rise by a fifth in the wake of their withdrawal.

According to government data, the number of companies becoming insolvent during 2020 fell by 27% compared to 2019 – the last year of normal pre-pandemic trading. This sharp fall in insolvencies manifestly suggests that government financial support kept some firms afloat, which would otherwise have become insolvent during 2020: a phenomenon that is likely to have continued this year. Therefore, we are likely to see a backlog of “zombie” companies, which would have become insolvent but for artificial support, now doing so.

 

Divergence in Europe

The coming wave of insolvencies is not, of course, limited to the UK. Right across Europe, governments are withdrawing pandemic support measures which helped businesses to survive. However, the anticipated level of insolvencies varies enormously. In Italy, for example, they are expected to surge by 68% in the next 12 months compared with pre-pandemic levels. This contrasts with a predicted increase of 4% in Germany and 23% in France.

Much uncertainty exists about the levels of insolvency which will materialise in the UK. Insolvency claim manager RSM anticipates a 60% rise in insolvencies, at best, but cautions that they could increase by as much as 135% in a worst-case scenario, potentially pushing the bankruptcy figure over the 30,000-mark. Much will depend on wider economic factors: increasing energy costs, supply problems and potentially higher interest rates.

There is fear that many fragile companies are still at a high risk of default: predominantly the pre-Covid-19 zombies kept afloat by emergency measures. In this scenario, the full economic consequences of the pandemic are yet to emerge. These zombie companies will not be the only ones impacted, however, as ongoing supply chain disruption and inflation are also anticipated to curtail growth. The ongoing negotiations with the EU over Northern Ireland and French access to UK fishing waters also present potential risks in terms of smooth EU market access, as France threatens sanctions. Nor can we be altogether confident that, notwithstanding the success of the vaccination programme, the pandemic won’t take a turn for the worse.

 

Spectre of inflation

Wage demands are rising rapidly as the spectre of inflation re-emerges. The Low Pay Commission recently recommended a 6.6% increase in the national living wage for workers over 23 years of age. Yet even this increase  will only just outpace inflation, which is predicted to run at around 5%. Such myriad cost pressures will clearly take a toll on many British businesses. On the plus side, not all UK government supports are being phased out. It recently announced the extension of its Recovery Loan Scheme by six months to 30 June 2022. Another lifeline for many struggling businesses is the government’s extension of the prohibition on commercial rent arrears evictions until 25 March 2022. However, the end of that protection could be the final nail in the coffin for many businesses – especially those which have racked up untenable levels of rent arrears. That too may trigger a large number of insolvencies in spring 2022.

The UK’s pandemic supports for business included a complex mix of tax reliefs, grants, government-backed loans and the furlough scheme, which helped keep people in employment while businesses were shut. The full impact of increased insolvencies on unemployment has therefore yet to materialise.

It may well be that government supports have prevented much economic damage, but they cannot have prevented all of it. To a certain extent, however, these supports will have merely delayed the inevitable economic impact of the pandemic. Automotive manufacturers, suppliers and energy sector companies are increasingly projected to be the most at risk of insolvency as the government’s Covid-19 support packages finally cease.

The particularly volatile nature of the energy market during 2021 – which bucked the trend of recent years – has generated significant and ever-increasing losses for the suppliers in the sector. It has also created the conditions for an increasing number of potential insolvencies. Fuel prices recently hit record levels with electricity prices set to follow suit, even as concerns rise about the adequacy of supply.

 

China problem

Growing supply chain problems have caused significant price fluctuations in oil, gas and copper, among other commodities. The impact is perhaps most notable in China, the world’s leading exporter of manufactured goods, creating the potential for large-scale payment problems, accentuated by a notable drop in worldwide consumption, which drives the global economic engine.

It is worrying to note that 72% of investors declare they do not have a risk plan for such a slump, while only 11% have developed a business continuity plan. In economies where over 70% of companies are SMEs, with relatively low financial resources and often rather limited economic know-how, the absence of a risk strategy and the lack of coherent plans for managing economic shocks will inevitably lead to further insolvencies.

The Institute of Fiscal Studies (IFS) recently published a paper which shows how the combined impact of Brexit and the pandemic are radically realigning the UK economy. It states: “A profound economic adjustment now looms. Many of the changes in patterns of household consumption during the pandemic appear increasingly persistent, and many firms now seem to be expecting and preparing for a different economy in the years ahead. Brexit compounds this challenge: early evidence points to the beginning of a period of acute structural change within UK trade.”

 

Acute structural change

The paper noted that the pain will not be evenly spread, with certain sectors likely to be particularly affected by the changes ahead. It warns: “Early evidence also now points to the beginning of a period of acute structural change within UK trade. Among goods, we expect the pivot away from EU suppliers and clients to accelerate. Services remain a more notable concern. Professional services exports into the EU have lagged in particular in recent years: exports of professional services to the EU were around 30% of the total in 2021Q1 versus 44% in 2016Q1. We expect these effects to worsen in the years ahead, meaning a likely net drop in overall UK services exports.”

Ultimately, the only certainly for the UK economy is uncertainty. The IFS predicts that “COVID-related scarring”, which it defines as the “permanent economic damage done by the pandemic”, could be that the UK economy is 2.5% smaller in 2024−25 than it otherwise would have been. It warns that much depends on the speed of recovery in the next 18 months and that “a slower recovery could mean larger hysteresis (the dependence of the state of an organisation on its history) effects and greater permanent losses.” Either way, there are challenging times ahead. As the withdrawal of Covid support dovetails with economic dislocation, business insolvencies in the UK are set to increase markedly.

 

Dana Radulescu

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