From pandemic-induced supply chain disruptions to the abrupt end of a prolonged period of low interest rates, the current economy faces few historical parallels. This tumultuous environment has led to operational challenges and increased risk for some businesses. Although businesses and the economy have continued to demonstrate resilience, various financial trends may give rise to more challenges.
In general, all regions have been feeling the pressure of higher interest rates and inflation. The economic and geopolitical implications of the war in Ukraine continue to weigh on global economic activity. However, despite slow growth and elevated risks, some recovery is underway and global inflation is expected to fall further in 2024, though it will likely continue to linger above pre-pandemic levels. The easing of COVID-19 supply chain disruptions and the cessation of China’s zero-COVID policy have supported commercial activity, and these tailwinds are expected to drive faster global recovery and facilitate growth.
Global inflation is trending down and seems likely to head even lower in the second half of 2023. Generally, price pressures from food, freight and energy around the world have eased. Labor markets remain tight, but underlying wage and inflation pressures have shown some signs of easing. According to business research firm Dun & Bradstreet’s Global Business Ranking, companies in the East Asia and Pacific regions have the highest risk of becoming inoperable, inactive or dormant over the next year, with over 50% of businesses in the highest risk categorization. In comparison, the highest risk categorization for all other regions remained between 2% and 4%. Industry-level risk is more consistent across regions, with the services and retail industries showing the highest risk globally.
In the United States, consumer prices are still impacted by inflation pressures that remain higher than the Federal Reserve’s target of 2%. There might be some imminent relief on this front, however, as headline prices rose by 3% in June, down from 4% in May and the lowest annual inflation rate since the third quarter of 2021. The federal funds rate is a greater challenge at this point. After the most recent hike in early May, this benchmark interest rate stands at a 16-year high of 5% to 5.25%, compared to almost zero in March 2022. Fed officials left interest rates unchanged in June after 10 consecutive rate hikes in 15 months, but they have not ruled out further increases later this year.
While certain economic conditions are trending in a positive direction for businesses, other factors will influence the business landscape in the coming months.
Trends in the Business Environment
Country-specific conditions have put various industries at greater risk. For example, in North America, high interest rates have created heightened risk for the financial services sector and related industries, as demonstrated by the failures of several midsized banks in the United States. As interest rates and inflation remain a major headache for U.S. businesses, financial institutions should be examining borrowing patterns to identify challenges and opportunities.
Dun & Bradstreet’s indicators regarding the financial health of small businesses tracked significant improvements in early 2022, reflecting early stages of small business recovery from COVID-19 in the United States, but have shown mixed signals more recently. The index dropped to a 12-year low during the height of COVID-19 and remained fairly flat throughout the various fluctuations of the pandemic. The economy’s health improved significantly in January 2022, but has since been curbed by the highest inflation rates in 40 years and the Federal Reserve’s tightening of interest rates.
The sectoral indices of the Dun & Bradstreet’s Small Business Health Index with the highest year-over-year declines are financial services, real estate and retail—industries related to interest rates or directly dependent on consumer spending. U.S. consumer spending remains supported by a tight labor market, although high prices and increases in interest rates are causing consumers to be more selective.
As small business health weakens, borrowing patterns of U.S. businesses are affected. Over the past two years, the number of commercial loan accounts opened by small businesses grew tremendously. This growth was supported by businesses securing pandemic relief, such as Paycheck Protection Program (PPP) loans, and other assistance grants from federal, state or local agencies. Since then, the number of open accounts has dropped to pre-pandemic levels.
Despite the modest addition of new open accounts or new businesses, the year-over-year growth in the amount of debt in open loan accounts remains considerably larger than the pre-pandemic benchmark. This signifies that businesses have ramped up the amounts borrowed from their existing accounts. At the same time, the growth in commercial credit card accounts has accelerated in the second half of 2022 after a drop in 2021. This has been accompanied by growth in the amounts borrowed.
Essentially, businesses have begun to feel the impact of high prices on their bottom line and have increased their borrowing through both loans and new commercial credit card accounts generally used for smaller, day-to-day expenses rather than large payments or one-time capital investments. Increased borrowing combined with a rising interest rate environment generally tends to ramp up payment delinquencies for loans and credit cards. However, based on a review by Dun & Bradstreet, this has not yet been the case. Furthermore, a strong jobs market coupled with pandemic savings drove a modest increase in consumer spending in the fourth quarter of 2022. Despite the positive signs, the U.S. business risk outlook is still likely to remain dependent on Federal Reserve rate decisions.
Considerations and Recommendations
Overall, Dun & Bradstreet’s indicators show a general trend toward near-term improvements, though some industries will experience more stress than others. The global economy continues to face unique macroeconomic conditions and, in addition to the ongoing tightness in the labor market, there are now a few more signs of underlying vitality. Although the impact of the tightening monetary policy isw not yet apparent, this might be a signal that businesses are experiencing some relief as the core measures of inflation begin to cool.
While inflation may continue to decrease in the second half of 2023, the U.S. economy will continue to experience turbulence for the foreseeable future. All three drivers of the economy—business, consumer and government—are facing headwinds that stand in the way of growth. The federal funds rate remains higher than it has been since 2007. Borrowing is more expensive now, which may be why the gross private domestic investment component of GDP declined by 12.5% in the first quarter of 2023. These trends will likely persist as credit conditions continue to tighten following the banking crisis.
With increasing constraints driven by the cash-flow squeeze, lower availability of capital and higher input prices, there will likely be an increase in forms of fraud like business identity theft and business misrepresentation, in which businesses make false statements that affect decisions regarding contracts or transactions. Indeed, in comparing Q1 2023 to Q1 2022, Dun & Bradstreet saw a 33% increase in business misrepresentation fraud in the United States, the United Kingdom, Canada and Ireland. In the United States alone, business misrepresentation increased 19%.
The U.S. economy seems to be headed toward a volatile period where economic growth remains lackluster, depending on how various risks are mitigated in the coming quarters. In the second half of 2023, companies should therefore be taking a hard look at how to navigate this challenging economic climate. Companies must look beyond short-term considerations and focus on long-term planning. The following best practices for treasury, finance and risk management leaders may help organizations navigate the short- and long-term uncertainty associated with this dynamic landscape:
- Understand your company’s starting point and its ecosystem. Take a holistic view of the business to evaluate its financial health, and the health of its vendors and suppliers. Be sure to understand the financial or operational risks. Further, make sure to understand your organization’s obligations and connections to customers, prospects and suppliers so that you can quickly scale back or change operations as needed in the face of further disruptions.
- Be prepared. Proactively identify risks and develop mitigation strategies and alternate plans. For example, consider whether your operations are stable enough to take on new engagements or initiatives. Without clarity and preparation, it is easier to miss opportunities and not see increased business risk.
- Maintain focus. During periods of economic uncertainty, it becomes more important than ever to keep informed about the potential impact on your business from unexpected events, shifts in regulatory requirements, changes to corporate policies or disruptive technologies. Continuously monitoring internal operations and external events will yield valuable insights. For businesses, this means staying focused on a long-term strategic plan.
- Remain agile. Nimbleness and openness to change can be corporate leaders’ biggest assets as they create a resilient, agile business. For example, an unexpected event such as a port closure may also present opportunities to pivot your supply chain operations. If your primary suppliers are impacted by this type of unexpected event, consider using an alternative supplier in an unaffected region of the world.