Construction, retail and travel companies are among the hardest hit in the latest raft of insolvencies, brought on by high interest rates, falling consumer spending and high material costs.
Bankruptcy filings have been on an upward trajectory since last year – filings have topped 10,000 over the past month, for the first time since 2013.
Data from ASIC demonstrates a similar story in terms of company administrations, with 10,497 filings in the 2023-2024 financial year compared to just 7,942 the year before and far outstripping the average of less than 5,000 the two years before that.
Insolvencies inevitable consequence
UNSW Business School, School of Economics Associate Professor Evgenia Dechter points to the extended period of high inflation – and thus high costs – as the predictable culprit.
“The present economic climate is characterised by low consumer confidence and low demand, which have a negative impact on business profitability,” Associate Professor Dechter said.
“High materials costs and high interest rates, which have raised the costs associated with debt servicing, further contribute to the increase in insolvencies.”
The issue is compounded by the high number of new business registrations since 2021, especially in smaller companies with less access to equity and financial tools.
Despite the higher numbers, ASIC says the ratio of companies entering administration is still lower than that of 2013 due to the boost in registrations.
“Given that more than half of new firms close business and exit within the first three years, it’s plausible to infer that a substantial proportion of these younger and smaller entities are now exiting due to insolvency,” Associate Professor Dechter explained.
“However, there is evidence that the unfavourable economic conditions also affect the more established firms.”
Hospitality, construction under pressure
Construction companies and hospitality businesses are feeling the squeeze particularly strongly, according to UNSW Business School, School of Economics Professor Richard Holden.
Major construction firms like Porter Davis Homes, Probuild and Dyldam have gone under, joined by a myriad of retail firms including Godfreys, Marquee Retail Group and The Body Shop’s UK parent, which threatens the future of its 100 Australian stores.
Australia’s culture of fixed-price construction contracts has made it particularly difficult for building companies, who are forced to eat any increases in material prices if the market shifts, like the nationwide timber shortage in 2022.
“That has been a fundamental driver of a lot of these bankruptcies – if you’re forced to complete the contract and can’t renegotiate it, you can lose a lot of money,” Professor Holden said.
“That pushes a lot of people to the wall.”
Lower consumer spending is the main culprit for the hospitality sector’s woes, as consumers cut back on non-essential spending to stay afloat.
The 2022-2023 financial year was a difficult one with 1,114 companies entering administration, but the last 12 months have been harder, with 1,576 companies entering administration.
“The more discretionary categories of spending tend to get cut back on, and for businesses in that sector, a large and sudden drop in demand can make it economically impossible to continue,” Professor Holden said.
The combination of inflation and the resulting increased interest rates have cut consumer confidence even as operational costs increase, lowering both demand for hospitality services and potential profit margins.
“These factors, compounded by the increased cost of servicing debt, have resulted in declining sales and diminished profitability within these industries,” Associate Professor Dechter said.
“Cross-industry spill-over and domino effects are likely to be present as well.”
Is more aggressive monetary policy needed?
The answer to that question is probably yes, according to Professor Holden.
“Our Reserve Bank has been less aggressive than other central banks in raising rates post-pandemic, a deliberate strategy to hang on to labour market gains,” he said.
“There are benefits to holding onto gains in the labour market, but there’s also the risk that inflation and interest rates stay higher for longer.”
Holden points to enthusiastic government budgetary spending as one of the incendiary elements of our current inflationary environment, describing them as “very expansionary”, which he says, “just puts fuel on the inflation fire.”
“If those governments want to do something to stop bankruptcies in these areas, they should stop spending so much money recklessly,” Holden cautions.