Boom, Gloom and the New Normal

The 2012-14 Budget period offers great opportunities, as well as great challenges.

Will companies continue to focus on short-term developments in financial markets? Michael Porter’s Shared Value concept instead offers us a powerful model for creating future growth.

Will policymakers stop focusing on the 24 hour news cycle and instead begin to set out the bigger picture? We need a vision for the future, and a clear idea of how to get there.

Are these decisions hard to take? No.

Has the world the resources to start in this new direction? Yes.

Would we enjoy the challenge? Yes

Can we start today? Yes.

We all know that companies are going to have to set difficult budgets for the next few years. They will also have to deal with continued uncertainty. We cannot rely on wise and all-seeing policymakers to lead us forward. They may well decide to do more of the things, such as Quantitative Easing, that will make the situation worse instead of better.

But larger companies, in particular, could also start to examine how to expand long-term R&D. And every company could add a future dimension to its Budget in respect of the opportunities that will arise from the new markets being created by today’s demographic and societal changes:

• Nearly a third of the Western population is now in the 55+ age bracket. They have the incredible benefit of an extra decade of life expectancy, compared to previous generations. And they have money – maybe not a lot, but enough to buy useful products and services. Yet they remain woefully underserved and often unrecognised by most companies.

• People in emerging economies are starting to move out of poverty in large numbers. This ‘bottom of the pyramid’ market represents a wonderful opportunity to develop new products and services. Millions now have some money to spend for the first time in their lives.

The great megatrends of the future also offer vast opportunities for future growth. These involve the need to increase food production, improve water availability and reduce carbon footprint. They are vitally important, and also offer the potential for profitable future growth. So, of course, do the opportunities associated with increasing life expectancy.

Companies therefore have a clear choice as we move into the Budget period. The blog believes a New Normal lies ahead, as it is describing in its new Boom, Gloom and the New Normal eBook, co-authored with John Richardson.

Winners will accept the challenges that it offers, and begin to move in a new direction. Losers, however, will remain frozen in the headlights, unable to take the first steps that will lead them to success.

Collectively, as the world’s 3rd largest industry, chemical companies have enormous potential to do good at this most difficult time. But progress depends on each of us as individuals being prepared to adopt a positive outlook in the face of the problems with which we are surrounded.

As always, of course, the blog will be delighted to help any company that wishes to accept the challenges that offered by the transition to the New Normal. It is confident that they will discover a potential to be successful beyond their wildest dreams.

Its the ‘big picture’ issues that we need to watch these days, no longer detailed forecasts of individual product growth rates. They are driving chemical product sales in every major region.

The chart above from the Financial Times highlights Europe’s drive towards austerity. Long gone are the days of the 2009 G20 meeting, when everyone focused on stimulus spending. This year, austerity packages will hit household income in most countries:

• Greeks lose 14% of their income, €5600 ($7600)
• Ireland and Portugal lose 5%
• Spain loses 5%, and Italy 3%
• Even the average German household will lose 1%

And, of course, Europe will likely see bigger cuts next year, and higher taxes, to help pay for current deficits.

Equally, there are no easy ‘solutions’ to today’s crisis. Recapitalising Europe’s banks, the most urgent task, will mean banks lending less – as higher reserve levels will reduce their lending ability. That will push some businesses into bankruptcy.

Similarly, Greece’s default will hit French and German banks hard. So they will need even more capital. If they don’t have enough, then the market will worry more about their lending to Spain and Italy. But this could easily become a vicious circle – if France puts in a lot of capital to protect its banks, then it could lose its own AAA rating.

And, of course, there is also the political dimension. Instead of trying to lead the debate, France and Germany have tried to put off the hard decisions. President Sarkozy faces election next year, and Chancellor Merkel in 2013. They now fear, probably rightly, that voters will throw them out if they agree to pass more money to Southern Europe.

Equally, as with President Obama in the USA, neither leader really seems to understand the economic issues involved. Instead, they all continue to defer to the same advisers whose policies have led to the current crisis.

Sadly, therefore, it seems the only real area of doubt about the outlook is around just how bad the downturn will be, and how long it will last.

The Asian Development Bank (ADB) says Asian governments ‘are caught in the pincer grips of slowing growth and rising inflation’. Whilst the cost of subsidies is ballooning. India, for example, will spend $42.5bn in oil subsidies this year, ‘six times the entire education budget’. As the ADB notes, `increased food and energy subsidies erode fiscal ability to provide social protection and support for a slowing economy and reduce funds available for development.’
In a perfect world, Asian governments would abandon subsidies and instead spend their money on critical areas for future growth, such as education and infrastructure. But they ‘missed the opportunity in the good times to change the subsidies’ according to former IMF head Rodrigo de Rato. Now they risk riots if they allow fuel and food prices to rise.
Thus the ADB forecasts that inflation will continue to rise, whilst growth slows. It expects just 7.6% growth this year, and 6.3% inflation, compared to 8.4% growth and 3.2% inflation between 2004-7. This will squeeze chemical demand – already Hong Kong companies expect to close 20,000 plants in the Guangdong area this year due to ‘higher wages and fuel prices’.

Fuel subsidies are set to double this year to at least $100bn, according to the head of the International Energy Agency (IEA), Nobuo Tanaka. This is in spite of the fact that some countries such as Taiwan have recently abolished subsidies, whilst others such as Indonesia have reduced them significantly. But for every subsidy withdrawn, a new one seems to appear. Yesterday Chile, which imports almost all its oil, announced that it would start to subsidise. Equally, some Western governments are toying with the idea of reducing existing fuel taxes. This has already become an issue in the US Presidential campaign, as well as in many European countries. And of course, it amounts to the same thing as an outright subsidy, as it means today’s higher prices are not being passed on.
The problem is one of ‘chicken and egg’. Once some governments start to subsidise, prices get out of line with costs. So demand increases. In turn, with supply tight, world market prices increase for everyone else, and so the pressure for more or new subsidies increases. The ironic thing is that energy subsidies themselves, whether direct or indirect, benefit the rich and not the poor. The International Monetary Fund has recently calculated that the top 20% of households receive 42% of a country’s total subsidy. This is because wealthy people consume more energy. The poorest people only receive 10% of the benefit.
Subsidies are therefore a very wasteful use of resources. But I doubt that will stop governments from using them. And energy-intensive industries such as chemicals will end up paying the bill.

Last month, I noted the suggestion by leading bankers that interest rates would probably rise by the end of May. The rationale for this view was that the bigger, stronger banks seemed to have got fed up with subsidising the rates being charged via LIBOR (London Inter-Bank Offer Rate) to weaker banks. And sure enough, LIBOR closed on Friday at 2.68%, well above the 2.0% rate set by the US Federal Reserve.
LIBOR may sound like an obscure part of the banking system, but it is the main benchmark for $347 trillion of global borrowing. So its rise will affect borrowers all around the world – both companies and individuals. Equally, government bond rates have risen between 0.2% and 0.5% during May in all the main financial centres, as investors worry about the impact of higher energy and food prices on inflation.
These higher interest rates are bound to slow demand for many chemical products. They will also make life more difficult for highly-leveraged companies.