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The second in this series looks at financial management in the face of an economic uncertainty.

With both the World Bank and International Monetary Fund (IMF)[1] issuing a warning of a growing risk of global recession, CEOs need to be thinking and planning ahead for the impacts of global liquidity from rising interest rates, the risk of depreciating Ringgit against global currencies, and the slowing down of major economies. If global liquidity does tighten, companies will see several ramifications on their financial positions and their ability to raise debt.

The higher cost of financing will impact profit margins that may affect debt service capabilities and dividends as well as increase banks’ reluctance to advance new funds for growth. With escalating risks arising from recession, banks would be expected to increase debt service coverage ratios, which, in turn, may see companies with a reduced capacity to raise debt or require increased debt amortization to mitigate the risks for banks. Increased costs, amortization and reduced borrowing capacity will impact cashflow, and as a result companies may need to source other forms of finance.

Lesser quality borrowers may also find it progressively difficult to refinance existing debt as financiers braving the increased funding costs and limited liquidity take safer bets on less risky customers. Difficulty in refinancing with new or even existing bankers can lead to default, or, at the very least, higher restructuring costs as banks demand stricter covenants and monitoring requirements. Increased liquidity may limit available sources of funds in the market, and therefore borrowers that have expiring facilities in the near term might need to consider exploring other options.

Borrowers with international currency exposures need to conduct stress tests to understand the impact of a depreciating Ringgit on their cash flow and balance sheet covenants. Global banks with exposure to local currencies may be reluctant to continue offering facilities to customers where the local currency is at a risk of depreciating. Further, a depreciating Ringgit will impact bank covenants that focus on debt ratios like Debt/EBIDA, PBIT/Interest.

With increasingly many financial institutions pledging to a net-zero commitment, industries and ancillary services that produce fossil fuels, other high-emitting business sectors, as well as those that impact natural forests and indigenous communities may see a reduced appetite from these financiers. Banks are seeking to reduce their Scope 3 emissions on environmental, social and governance (ESG)[2] and rebalance their industry priorities so as to reflect their commitment to the pledge.

CEOs must anticipate these complications and strategize pre-emptive measures to successfully navigate the turbulence caused by the looming recession

[1] IMF, World Bank warn of global recession risk, The Star, 12 October 2022

[2] Scope 3 inventory guidance, United States Environmental Protection Agency (EPA), 12 May 2022

By Guy Edwards, Executive Director – Restructuring Services, KPMG Deal Advisory