Macroeconomics

The tragedy of the invasion of Ukraine by Russian troops has unfortunately continued over the past two weeks. We can only express our solidarity with those brave Ukrainians fighting for their freedom and our deep feelings for all who have lost their lives or their homes in this war. It remains the case that absolutely everything must be done to end the unnecessary death and suffering immediately.

In addition to the incredible human suffering, it must also be sadly recognised that the world will not simply return to the situation as it was before. The relationship between Russia and the West will never return to a basis of trust. Either way, the lifting of sanctions and normal trade relations will also take a long time. 

Similarly, the political balance is in serious jeopardy. It is completely unclear at this stage which way China and India and many other countries will turn. The possible lure of being able to obtain cheap raw materials as a result of Western sanctions or just to weaken and put pressure on their supposed political opponent, the US, could be very tempting. 

The big global corporations play down the importance of the markets in Russia and Ukraine. They point to their relatively small share of their global business. That may be true in some cases, but in others it looks completely different. Tourism in many countries may serve as an example.

In any case, one thing will now be unavoidable: a significant increase in inflation. It is completely irrelevant what position and views the leadership of the European Central Bank leadership expounds on this subject. The necessary basics, food and energy, are already significantly more expensive. Indirect effects, such as fertilisers, have not yet been taken into account, and if energy prices do not fall significantly very quickly, the effects on the prices of many products will be significant. This means that the disposable income of the broad masses will shift in a very significant way, with noticeable effects on consumption. Here, too, the effects will be stronger at regional levels than the global statistics will suggest. It is also relatively unhelpful to use the halving of growth forecasts for the global economy as an example.

At the moment, the financial markets are still reacting relatively calmly to the changing conditions. This is certainly welcome in view of the stability we need at the moment, but the day will come when the real situation will be reflected. As is well known, the financial markets always trade the future and not the present. Money always senses and seizes opportunities, knows no emotion and is therefore an unmistakable indicator of developments and their consequences.

Almost ignored is the Fed’s 0.25% interest rate hike, with the simultaneous announcement of more steps to follow in 2022. This would normally have immediately weighed on the markets and caused the dollar to rise, but this time led to rather smaller reactions and, unusually, to a weakening of the US dollar. After having risen to levels of $1.09 to the euro, and slightly below, it is moving more towards $1.11 after the interest rate decision.

Energy prices played yo-yo. Owing to the sanctions against Russia, oil prices were initially pushed up to almost $140 per barrel. A quick and strong correction followed, pushing prices back below $100. The situation was similar with gas because of its dependence on Russia. However, it must be mentioned very clearly here that there is no shortage of oil, even if Russia should fail as a supplier. This could be triggered by a supply stop, which is rather unlikely since Russia urgently needs the revenues from raw material exports, or by import stops by some Western countries.

Gold proved to be the usual safe haven only in the very short term. The price rose above the magic mark of $2,000 per ounce, only to stabilise below it again.

Leather Pipeline

In these times, one continues to feel uncomfortable reporting on such a terse matter as the leather pipeline. Nevertheless, life must go on for the majority of people; no one should simply pull the covers over their head and wait for the trouble to pass.

That is why it is probably all the more important in such times of crisis to keep a cool head and to study very carefully what effects the events are having on one’s own life and business. After just over two weeks of the world being turned upside down, it is probably too early to make long-term assessments. So let’s deal with what we already know today and what directly affects and concerns us in the leather industry at the moment.

Let’s start with the direct influences resulting from the war in Ukraine. First of all, the supply of raw materials from Ukraine has been either completely interrupted or at least severely affected. That is of crucial importance for very specific productions, above all in Italy. This is the case with light hides for the high-quality leathergoods sector, which came in large quantities and supplied a large number of the specialists in the Italian industry. Replacing these supplies quickly and at short notice with equivalent goods is not easy, especially because these hides were almost exclusively supplied in semi-finished state. Wherever suitable replacements were available in central Europe, the manufacturers acted to cover current contracts and to secure enough supply for existing sales commitments.

Quite noteworthy quantities also came from Russia, mainly supplying leather manufacturers in Italy and the Middle East. Some of the big names from Russia still had very large stands at the Lineapelle fair in Milan. They probably would have spared themselves the cost if they had known what was going to happen on 24 February. These supplies will also have to be replaced, but with their material, normal cattle hides, there is no problem in covering the quantities quickly from other sources. 

As a sales markets for leather products, the short-term effect is relatively small because deliveries to Russia and Ukraine have only been interrupted for a short time so far. On the other hand, there is of course the question of how much of the previous purchasing power of Russian consumers in particular will return after the considerable devaluation of the rouble. More difficult is the question of goods that have already been produced, which can now no longer be delivered and which, in addition to possible open invoices from previous deliveries, put a considerable strain on the suppliers’ liquidity. The question that is currently occupying many people is whether Chinese suppliers can replace the missing quantities that are no longer being delivered from the Western world at short notice owing to the sanctions. Here, too, we hear that some Chinese suppliers are currently waiting for payment from previous sales in Russia. This does not suggest that there is a clear solution at the moment as to how Chinese suppliers can fill the gap. In any case, one thing is certain from our point of view: owing to the devaluation of the rouble and reduced purchasing power in Russia, the focus there will be on much cheaper consumer goods.

Another sector that has been significantly affected by the war is automotive. While the big car companies play down the importance of the Russian market for their overall business (exceptions accepted), the supply of important parts from Ukraine and the supply of raw materials from Russia is a weighty factor. Car companies are trying to play down the impact and point to possible replacement supplies from other regions, but it is relatively unlikely, at least in the short term, that semiconductors and other components can be replaced quickly and without difficulty.

Many production lines have been shut down. Something that is worth mentioning in this regard is that all premium manufacturers quite explicitly state that their high-margin, high-priced models (and these are the ones most likely to be equipped with leather) will definitely and without any restriction be given priority in production. Thus, we can assume that there might be a negative impact on leather demand, but that it will be rather less than many people fear. If we take a look at the production and sales figures for luxury cars in 2021, it quickly becomes clear that even last year the decline in automotive leather demand in Europe was much lower than the production figures would suggest.

Another direct influence on leather production is, of course, the massive increase in costs for chemicals and energy. Transport costs, and here we are no longer talking about sea transport to overseas destinations but lorry transport within Europe, have also become much more expensive. At the moment, there is still a massive dispute about how to compensate for these increases, but it will be some time before they are actually implemented and have an effect, and in the meantime the leather producers will have to compensate for these differences first.

In addition to the direct issues and effects caused by the war situation, another influencing factor has faded into the background without actually disappearing. The sharp rise in the number of infections caused by covid-19 is no longer leading to tighter lockdowns in Europe, but worker absences due to illness and the resulting quarantines are nevertheless putting a strain on production. In many factories, production cannot be run at full capacity at the moment because there are not enough workers available.

This is affecting the situation in China to a much greater extent at the moment. At the moment, the number of infections caused by the omicron variant is increasing. Even though the numbers are very low compared to all other countries, the zero-covid policy of the Chinese government is an extremely big obstacle. The official information about closures and impairment does not match what one hears directly from China. Even if only a few large cities have gone into complete lockdown, selective closures of districts can lead to a de facto shutdown of business and social activities in Shanghai. Due to the high pressure on the local authorities to keep the covid situation under control, there are also major problems with the transportation of goods. Many truck drivers do not want to or cannot carry out their normal deliveries to and from major ports if they want to avoid quarantine measures or have to comply with them. Officially, most of these restrictions are not publicised, but local sources report significant regional restrictions on transport and production.

It can be assumed that consultations with the Chinese government are in full swing at the moment on how to adopt a different strategy for dealing with the pandemic without losing face because of past decisions. To restrict the country and the economy is certainly not an option at the moment in view of the significantly weakening Chinese economy. Even if it is cynical, this is at the same time rather a signal that China cannot afford further economic sanctions at the moment as a result of  possible support for Russian aggression.

If we take into account that in a fortnight the first quarter of the year will already be over and that the production cycle in the leather industry usually tends to slow down then until the end of the summer, we must certainly advise caution with regard to the next few months, even without the geopolitical events.

Despite all the negatives, there is always something positive, and that is definitely the market for splits at the moment. In all sectors, whether for leather, collagen or gelatine, demand currently exceeds supply and it is therefore no surprise to anyone that all prices are moving upwards. In the case of lime splits, the somewhat declining production in Europe is playing a role, and in the case of splits for the leather industry, the search is on for the cheapest raw material due to the considerable pressure on prices. It is not foreseeable that this will change in the next few months, unless the price for cattle hides falls sharply again and collections and leather types for the coming seasons change again.

In the case of sheep skins, not much has changed, except that the leather industry in Turkey is of course very much influenced by the events in Russia and Ukraine. The full consequences cannot yet be seen, but those producers who sell to a large extent in Russia and Ukraine will be in serious trouble. For the others, who have concentrated more on the markets in western Europe, the Middle East and the US, the situation naturally looks much better and less problematic. Here the difficult part will only come in a few months, when the considerable devaluation of the Turkish lira and the resulting significant cost increases are reflected in the calculations. At the moment, of course, the export revenues from articles already manufactured are bringing a pleasant windfall profit.

In the current situation it is not appropriate to make any forecasts for the near future. The war could lead to a quickly changing environment. At this moment, meat producers are trying to pass on increased costs. Whether this is a sensible way of dealing with the situation is something they must ultimately decide for themselves and take responsibility for. If we put together the facts that are available now, we would come to the conclusion that the risks that lie ahead are significantly greater than the possible opportunities that can be derived from this crisis.

We wish all the people of Ukraine safety and peace and, above all, a speedy end to the threat to their lives and their homeland. The majority of the civilised world, and that includes many people in Russia, stands by their side.

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