The Welsh economy looks to be turning the corner, but the recovery is still fragile, according to business rescue, recovery and restructuring specialist Begbies Traynor.

In its latest Red Flag update, which monitors the warning signs of companies in distress, Begbies Traynor reports that in Wales the number of companies experiencing significant or critical financial problems has fallen year on year, although there has been a slight increase compared with the final quarter of 2009.

In the first quarter of 2010, there were 6,088 companies facing significant or critical difficulties, compared with 5,400 in the last quarter of 2009 and 7,208 in the first quarter of last year.

Companies with "Significant Problems" are those with either a court action and/or average, poor, very poor insolvent or out date accounts. Companies with "Critical Problems" are those with county court judgments totalling £5,000 or more and/or wind-up petition related actions.

Nationally, there are more than 160,000 companies experiencing significant or critical financial distress. Between them they owe more than £55bn to creditors, suppliers and service providers.

Begbies Traynor says part of the rise in critical problems reflects a shift in trade creditor behaviour, with an increasing numbers willing to take court action against their debtors.

The remainder of the increase could be attributed to the normal seasonal uplift.

David Hill, a partner at Begbies Traynor in Cardiff, said: “While the economy appears to be showing positive signs of recovery, the magnitude of the liabilities still at risk of default represents a serious risk to creditors, indicating the potential far-reaching impact of these levels of distress. It is this ripple effect which represents a real threat to a sustained economic recovery.

“Faced with these risks, and a growing need to bolster their own funding for the recovery phase, trade creditors are increasingly seizing the opportunity to take action against their debtors in order to raise much needed working capital. This shift in behaviour heralds a new phase in the cycle, putting businesses experiencing financial problems at greater risk of failure.”

Interest rates will also have a role to play, with the latest Reuters poll of more than 50 financial institutions predicting a rise of one per cent over the next 12 months, thereby tripling current base rate, with some banks forecasting a rise of as much as 1.5 per cent.

David Hill said: “Low interest rates have been one of the principal reasons why business failures have not yet reached the peak levels many feared this savage recession would cause. A rise may tip more struggling businesses over the edge later in the year and through into 2011, especially in the embattled but vital SME sector which cannot afford the protection of sophisticated interest rate hedging.”

Red Flag reveals that the last three months marks the second consecutive quarter of increases in the number of problem companies. In Q3 2009, a total of 134,000 were reported as experiencing critical or significant problems.

These figures are lower than early 2009 as economic stimulus and government support measures have provided support for companies that may have otherwise found it impossible to survive.

However, Begbies Traynor says that its experience of previous recessions shows that the recovery phase of the economic cycle has represented the greatest challenge to vulnerable SMEs, meaning that the inevitable withdrawal of Government support will need to be handled sensitively to ensure a soft landing.

The sectors worst affected in the first quarter of 2010 include construction, in which companies experiencing significant or critical financial problems were up 30 per cent, professional services up 19 per cent, property services up 42 per cent, recruitment up 18 per cent and retail up 19 per cent on the previous quarter. Sharp rises in input costs coupled with one of the worst winters for decades combined to make this a particularly difficult period across a number of sectors.