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Governments around the world hope that the imminent arrival of several promising vaccines heralds an end to the coronavirus pandemic. Any economic recovery, however, will be hampered — in some cases seriously — by the very measures politicians have used to sustain companies through the height of the crisis. Support measures, in the form of loans and grants, as well as monetary stimulus have helped to keep businesses alive. While these measures have proven a much-needed lifeline, they mask the grim reality building up: a mountain of corporate debt. Once state support is switched off, many businesses will be unable to bear the debt they took on to survive.
The financial strain will be felt by companies in all sectors — those that were in good shape before coronavirus and those that were already burdened by debt. By July, US companies owed a record $10tn, equivalent to 49 per cent of economic output. Adding in other forms of corporate debt, including to partnerships and small businesses, raised that figure to $17tn. The picture is similar in the UK, where a provisional analysis in May by the trade organisation TheCityUK found unsustainable debt by private companies could reach up to £105bn by March 2021. The Office for National Statistics warned last month that 43 per cent of companies were running on less than six months’ cash reserves.
Current low interest rates will help to sustain corporate debt in the short-term but the risk is that higher leverage could make companies more vulnerable to sudden interest rate rises or earnings shocks. The risk of recession could also be prolonged by businesses that are overburdened by debt — they will be unable to recruit or invest. In the first instance, where they can, companies should use the market to repair their balance sheets. One example is Rolls-Royce, the aero-engine maker, whose revenues collapsed as airlines grounded aircraft and which raised £2bn through a rights issue.
Governments will need to consider measures to support market solutions — especially given the high risk of failures among medium and smaller-scale enterprises. Concerns have already been raised of a concentration of market power among larger companies. A flexible approach towards bankruptcy procedures is important; companies need breathing space to restructure their debts. The goal must be to eliminate debt overhangs without eliminating productive activity. The German government, for example, has suspended the duty to file for insolvency for some companies until the end of this year.
There may also be a need for more direct action by policymakers. Debt-for-equity swaps are one route and would allow governments to receive a stake in a company on the basis of previous support. Another approach would be through the active injection of equity using a public wealth fund. Germany has created a €100bn economic stabilisation fund with the power to take direct equity stakes in stricken companies. Both approaches would require an operationally independent institution with experienced management. Strict conditions would have to be set — it will be important to head off concerns over a repeat of the 2008 bank bailouts.
Thanks to the pandemic, governments are playing a larger role in the economy. This might go against traditional free market thinking. Private investors should normally be able and willing to back viable companies. But given the scale of today’s crisis, government-sponsored structures that keep fundamentally healthy businesses alive — and give taxpayers the chance of a return — are worth considering.