A collective sigh of relief echoed across the country following Statistics NZ’s 20 April announcement that annual inflation has dropped to 6.7%, mirroring a global trend where the USA, UK, and Australia also experienced declining or stabilising inflation rates. However, following the RBNZ’s 50-point OCR hike earlier this month, New Zealand’s fate remains uncertain. With interest rates predicted to hit a staggering 14-year high by mid-2023, many borrowers are yet to experience the full effects of recent rate hikes.

Is a recession inevitable?

The economy shrank by a larger-than-anticipated 0.6% in the last quarter of 2022, marking the second consecutive quarter of weaker growth. The manufacturing sector experienced the sharpest decline, dropping by 1.9%, while retail, recreation, and transport/logistics sectors also dropped. Slower growth comes as no surprise, considering the global economic challenges that have loomed since 2019.

While a recession may not be inevitable, the ongoing challenges of soaring interest rates and persisting inflation are set to test the resilience of New Zealand's economy as fixed-term borrowing rolls over in 2023, and company liquidations surge to levels unseen since 2020.[1]

However, the challenges of the last three years mean that New Zealand businesses have had to emphasise cost management and efficiency, leading to the adoption of lean processes and resource optimisation. Consequently, many New Zealand businesses have become more resilient and competitive, putting them in a strong position to ride out a recession and make the most of any opportunities. “Businesses have become more agile and are used to responding to the environment,” says Corporate and Commercial Partner, Andrew Matthews. “The focus is on what they need to do next to adapt.”

Expert predictions are that if recession happens, it may not hit too hard. The New Zealand tech sector started tightening its belt months ago, taking account of what was happening overseas, but they didn’t have to react as severely as their peers in the US. The construction sector is often seen as the canary in the coal mine but, with the reconstruction efforts required following the January flooding and Cyclone Gabrielle, the outlook for it seems more positive. Rising interest rates and high inflation are likely to impact retail spending, and we’ve seen some evidence of this recently, with online retailer Ezibuy recently going into receivership and some recent earnings reports.

Outside New Zealand, the International Monetary Fund is warning that a third of the global economy could be in recession in 2023, with growth expected to slow in China and the USA. The recent collapse of three US banks and Credit Suisse sent jitters through the banking sector in the USA, Asia, and Europe and intensified concerns about the worldwide economy's health.

What would recession mean for New Zealand businesses?

Tightening economic conditions mean New Zealand businesses should be on the lookout for opportunities. Andrew Matthews says that a recession provides robust companies with opportunities to emerge as market leaders and benefit from opportunities for growth. Businesses with adequate cash reserves will be in a strong position to capture market share, grow their customer base, and enhance profitability. “Those who are match fit to compete and win, should see good gains. Others will look for ways to pivot - often more receptive to partnerships or acquisitions, enabling companies to broaden their offerings, access new markets, and boost efficiency and skillsets.”

The current economic climate is unusual, because the slowdown in growth has not yet led to higher unemployment as a result of New Zealand’s tight labour market, albeit we’re starting to see evidence of that changing.

How can businesses prepare?

Businesses are horizon-scanning and looking to prepare, both offensively and defensively.

Employment

With workforce having been such a critical area of attention over the past years, and the potential for significant change here, this is an area where we expect there will be focus. The current economic and labour conditions are presenting three key challenges for employers:

• Inflationary pressure on wage expectations
• Recruiting and retaining top talent to position themselves for a strong recovery
• Right-sizing and optimising workforce structures to business needs.

“Companies should have a plan to ensure they retain key employees, otherwise they risk losing them to competitors,” says Employment Partner, Rebecca Rendle. “If remuneration increases or retention bonuses are not immediately viable for businesses, they can explore other non-financial ways to retain staff, such as flexible working arrangements, additional training and mentoring opportunities, long-term incentives or enhanced employee benefits.”

Businesses needing to downsize or restructure must ensure that they develop a robust business case to support change proposals, as simply referring to ‘economic downturn’ or a recession will be insufficient on its own. Acting in good faith and following fair consultation and selection processes will assist to avoid costly mistakes.

Finances

As the economic climate becomes more uncertain, we’re seeing businesses closely monitor key financial metrics, watching out for declining revenues, margin squeeze, increasing accounts receivable, and growing inventory levels. Well-prepared businesses are spotting warning signs early and adapting their strategies accordingly - trading relationships are key. Businesses with upcoming financing needs are looking to lock finance in early, with rising interest rates reducing finance availability and increasing its cost.

“Businesses at risk of breaching their financial covenants (particularly leverage and interest cover ratios) should talk to their bank early and work out a plan together to see the business through, says Banking & Finance Partner, Dominic Toomey. “Proactive communication with lenders can help businesses renegotiate loan terms, explore alternative financing options, or access support programs. We’re expecting banks to be more active in their management, and this will be a change for a number of businesses who had been given leniency through the COVID period - our sense is that leniency is running out.”

Businesses should also keep in close contact with legal and accounting advisors to plan an early response to financial challenges.

Trading Relationships

Supply chain participants are likely to be squeezed as cost efficiencies and management of working capital are targeted. Terms of trade will be important, and actively managing those slipping outside of them. Concerns about counter-party risk are increasing, and we’re seeing increased demand for security arrangements, particularly in service-related sectors where taking physical security is more challenging.

"During these uncertain times, it is essential for businesses to prioritise and strengthen their trading relationships. As supply chain participants face increasing pressures, it's crucial to actively manage terms of trade and mitigate counter-party risks," says Corporate and Commercial Partner, Anastasiya Gutorova. "By diligently assessing and implementing security measures, even in service-related sectors, businesses can navigate the challenges ahead and maintain stability in their trading partnerships, ultimately driving growth and success in the long run."

The way forward

The Reserve Bank’s 50 point interest rate hike on 5 April came as a big surprise, as most commentators were expecting a 25-point rise. Given the drop in the rate of inflation, all eyes are now on the May and July OCR announcements to see whether this will be enough to prevent further interest rate rises. Andrew Matthews believes the Reserve Bank is looking to deliver shock to change behaviour from expectation. “We think that this will see businesses even more focussed on taking proactive steps to prepare for the challenges and seize opportunities that emerge.”