What Sovereign Debt Means for Businesses

A few weeks ago, when discussing the issues that many MNCs may face in far-away markets like China, we emphasized the need to fully understand what your business is getting into as it attempts to amass customers around the world. While the discussion then mainly revolved around the risks that surround differing political and cultural norms, businesses that are looking to expand globally need to understand that there may be significant risks when entering markets that are politically and culturally similar to one's home country.

As we leave behind the worst financial crisis in a generation, a sovereign debt crisis looms large, particularly in Europe but also in several American states. While discussions about sovereign debt crisis are more often then not analyzed in political terms (as in, what does this mean for the incumbent government?), the reality is that such a crisis can have devastating effects on businesses. As the governments of PIGS (Portugal, Italy, Greece and Spain) attempt to control their ballooning and by now out of control debt issues, they are realizing that the only instruments at their disposal are a combination of increased taxes and decreased spending. The existence of the Euro means that countries in peril are not able to devalue their currency to increase exports (and therefore increasing GDP) nor are the able to inflate their debt away. Were these troubled economies able to devalue their currencies, the realities face by businesses that operate within their borders would be less onerous than it currently is. In fact, businesses that produce made-for-export goods would stand to profit greatly. However, as it stands, the prospect of increased taxes and spending cuts, while politically challenging is even worst news for businesses.

As taxes inevitably rise in debt-laden countries and social spending programmes are cut, the risk of a double-dip recession rises. However, the consequences of another recession, this time brought on by a sovereign debt crisis, stand to be far worse, far more wide-reaching and long-lasting than those of a traditional recession brought on by an aggregate decrease in demand. Increased taxes, for example, will mean a decrease in demand as the population sees its disposable income dwindle and will impact businesses' bottom line further as corporate taxes will surely also go up. Decreased spending, in turn, will also have a negative impact on people's disposable incomes but it will also have dire consequences for the country's long-term competitiveness as infrastructure, health-care and education spending decreases.