There's an old Hollywood expression that comes to mind as the global financial crisis wears on into the New Year: it ain't show friends, it's show business.
Gulf companies may resort to pulling a Ukraine
There's an old Hollywood expression that comes to mind as the global financial crisis wears on into the New Year: it ain't show friends, it's show business. For this week's illustration, grab your mukluks and take a trip to Kiev, where the temperatures are dropping to minus 13 degrees Celsius - but mother Russia has kindly decided to turn off the gas. Where is the love? Russia's gas company, Gazprom, shut off gas supplies because it claims that Ukraine is behind on its gas bill, and hasn't paid its late fees to boot. That's generally what happens when you don't pay your bills to the utility, whether it's the mobile phone bill, or the power bill, or the cable bill.
The company doesn't call and ask apologetically if it would be just too horribly inconvenient to shut off your service for non-payment. They just shut it off. Oh, and you still owe the bill. The next call - assuming you still have a working phone - is from the collection agency. It gets more melodramatic, though, when governments are involved. It turns out in this case that a lot of Europe's gas moves via Ukraine, so no one in Euroland is very happy. And now Russia claims that Ukraine is siphoning off gas meant for paying customers, from Paris all the way to Istanbul. Then, just to up the ante, Russia says it wants to more than double what it charges for gas, even though oil prices have been falling faster than the rouble.
It doesn't help that Ukraine is in a financial doghouse, having already had to hit up the International Monetary Fund for a US$16.4 billion (Dh60.23bn) loan. And if you think Russia's own financial travails don't have something to do with Gazprom's decision to play baseball of very hard variety with its former comrades from defunct Soviet Socialist Republics Ukraine, then I've got a sauna in Reykjavik you might be interested in.
It's called leverage. So far in this crisis, we've heard a lot about a different kind of leverage, the kind that involves investing a little bit of cash together with an enormous amount of borrowed money in hopes of making sexy returns. Now the global economy is wracked by deleveraging, in which investors and financial institutions trying to rebuild their balance sheets hold on to their cash, depriving the global business community of working capital and throwing the global economy into a recession.
This year, welding the wallet shut promises to be the new black, when borrowers and customers use the power of non-payment to wrestle better deals out of creditors and suppliers. It is this kind of leverage that gave rise to the term "too big to fail". We've seen it modelled already in the case of financial institutions such as Citigroup, AIG, Amlak and Tamweel. These institutions arguably faced failure if they did not receive some form of government intervention.
In the coming year or two, however, we are likely to see more, smaller companies hit the skids. And even healthy companies may stop making payments or rendering service in order to extract deals that better reflect the darker economic climate. Last week's column alluded to this trend by introducing the threat of "strategic defaults", which is when an otherwise healthy borrower decides it is no longer in their business interest to service loans or honour contracts.
This is what happened following the dramatic climax of the Asian financial crisis in 1997 and 1998. After the breathtaking plunge in currencies and the near default of governments and failure of banks, corporate Asia went through a long and painstaking process of restructuring that dragged on for years. In many cases, this meant renegotiating contracts with contractors and suppliers that were written during boom times. The same thing is likely to happen around the world now, particularly in the Gulf, where many supply contracts were probably signed when raw materials were in shortage and prices were skyrocketing.
The best way to get a supplier to renegotiate an ironclad contract is not to ask nicely. It is to pull a Ukraine and simply stop paying. Sure the supplies stop coming, but so do the revenues that the supplier earns selling them. But the most laborious and politically difficult phase of this restructuring is between companies, their banks and other creditors. Typically, companies end up surrendering some or even all management control and creditors, in turn, end up agreeing to reschedule or defer debt repayments - or even to forgive some debt. Banks that do so end up writing down the value of those assets, taking what is known as a "haircut".
In countries with tried and tested bankruptcy laws this process can be relatively quick and dirty, even if overseen by court-appointed administrators. The result is a relatively speedy turnaround that ensures the company and the banks return to health as quickly as possible and resume their contributions to the economy. The problem comes in countries with untested bankruptcy systems. In Thailand and Indonesia, for example, bankruptcy laws proved weak and the courts either too corrupt or too overloaded to enforce them. This enabled big, politically connected borrowers to elude creditors for years. This can delay economic recovery and retard new investment.
The UAE has bankruptcy provisions written into its Commercial Transaction Law. But the law was written in 1993 and has yet to be tested by a major corporate insolvency, much less a major economic downturn. Lawyers and analysts worry that it still falls short of bankruptcy provisions in, say, the US, and that it is still too reliant on either amicable resolutions or time-consuming court procedures.
Now, before a deluge of cases hit the courts, may be the best time to re-examine the UAE's bankruptcy law and make sure such knotty restructuring disputes don't put a big chill on the country's economic recovery. firstname.lastname@example.org