With Mario Draghi praising the European economy in his quarterly speech at the European Parliament, albeit conceding that inflation is still too low for the ECB to remove its unprecedented monetary support, one would be left with the impression of a slow, steady European recovery, also explaining the recent record inflow into European stocks. Alas, as is often the case, the full story is just below the surface. And it is here that a big problem is emerging.
According to the 2017 European Payment Report compiled annually by Swedish debt collector Intrum Justitia AB, a growing number of small and medium-sized businesses in Europe have complained they face excessive delays in being paid for their work, with large parts of the sector seeking tougher laws to address the problem. First discussed by Bloomberg, the Justitia report reveals that 61% of the 10,468 small and medium-sized companies surveyed say they’ve been asked by counterparties to accept longer payment delays than they feel comfortable with. This is a staggering increase of over 30% in just one year: in 2016, that figure was 46%.
The surge is non-payments is perplexing as it takes place at a time when Europe is said to be actively recovering, with GDP rising, unemployment sliding, PMI surveys at or near post-crisis highs, and confidence at near record levels. The development is also “a growing concern” according to Intrum Justitia’s Chief Executive Officer Mikael Ericson, who told Bloomberg “this clearly significantly affects both growth and investments in European companies.”
Even more surprising, in 2011 the EU adopted the "Late Payment Directive" and said Europe’s whole economy is “negatively affected by late payment” and that “for Europe’s valued SMEs, any disruption to cash flow can mean the difference between solvency and bankruptcy.”
As such, the survey suggests that - among other things - Europe isn’t living up to its goal of protecting smaller companies from the liquidity issues they face when payment doesn’t arrive. It also suggests that there has been a sharp decline in liquidity within the supply chain, usually a harbinger of recessionary economic conditions, and hardly the environment in which a central bank sees "recovery." Quit the opposite.
As Bloomberg adds, a large number of firms surveyed said they want tougher payment rules to combat what Intrum Justitia describes as a “deteriorating payment culture.” Some 40% of businesses would welcome new legislation while about 30% want new voluntary-based codes of conduct.
Going back to the Late Payment Directive, it explicitly advises enterprises to pay their invoices within 60 days “unless they expressly agree otherwise and provided it is not grossly unfair.” Public authorities have to pay for the goods and services they procure within 30 days (or in very exceptional circumstances, 60 days). But the public sector, especially in Greece, stands out for particularly slow payment of its bills. The European public sector’s average payment time rose to 41 days in the 2017 survey, from 36 last year. In Greece, the average payment time for public authorities is 103 days while in Italy and Portugal, it’s 98 days. Ericson says those numbers “should be troubling news to European governments, as their own authorities hinder efforts to stimulate growth and job creation.”
But the most troubling finding of the survey is that low interest rates - the only policy crutch that has been somewhat effective in Europe in recent years, even if it meant the ECB's balance sheet is now the largest in the world - have lost their effectiveness, and only 13% of firms surveyed said low borrowing costs have led to an increase in their investments, with 81% reporting no change.
Justitia’s CEO Ericson concludes that with 4 of 5 companies saying low rates aren’t encouraging more investment, "it’s now all about cash flows" and that “ensuring stable cash flows early on” is now “more important” than investing in growth.
There are two major concerns emerging from the survey findings: first, as Ericson's data suggest, the flow of cash within Europe's businesses is rapidly declining, leading to surging receivables and non-payments. Second, while low rates may no longer stimulate businesses, it is certain that rising rates will adversely impact them and further exacerbate this troubling trend, which unless remedied immediately may culminate with mass corporate defaults. Finally, small and medium businesses are the bedrock of any stable "developed" economy. If Europe's SMEs are signaling a cash flow alarm, how is it possible to claim a European recovery is taking place?