Dec 14, 2020 - Economy

Pandemic-era debt could spawn new global wave of "zombie firms"

Reproduced from BofA Global Research; Note: Banks included are Federal Reserve, European Central Bank, Bank of Japan, Bank of England, Bank of Canada and Reserve Bank of Australia; Chart: Axios Visuals

Fears are mounting that a massive growth in debt and the current policy environment — described as "monetary policymaking on steroids," by Michael Arone, chief investment strategist for State Street Global Advisors, earlier this year — could be producing a new global wave of "zombie firms," a new G30 report by top economists and central bankers warns.

What it means: "The term 'zombie firms' was coined to refer to firms propped up by Japanese banks during Japan’s so-called 'Lost Decade,' following the collapse in 2001 of the Japanese asset price bubble," according to the report.

  • "Multiple studies suggest these firms contributed to Japan’s economic stagnation by distorting market competition and depressing profits and investments in healthy firms."

Why it matters: "[O]verburdening of the corporate sector with debt in the response to Covid-19 could create a new wave of zombie firms, with harmful consequences for the prospects of economic recovery."

  • "As interest rates stay low and governments continue to support struggling firms, the risk of zombie firms increases."

Between the lines: We may already be seeing this happen. The G30 report comes on the heels of the BIS' latest quarterly review, which noted that a "divergence in the assessments of corporate vulnerabilities may be emerging."

  • The review pointed out that while equity prices were reaching record highs and credit spreads had compressed, banks have significantly tightened their standards and cut back lending.
  • Investors' search for yield and central banks' gargantuan easing programs "appeared to underpin these contrasting developments."

The bottom line: The G30 report quoted Piyush Gupta, CEO of Singapore-based DBS bank, who expects the issue of zombie firms to be a particular challenge among small and midsized businesses. He predicts a wave of defaults that will add pressure to the financial sector.

  • Policymakers will soon need to ask themselves a serious question, he says: “Do you keep...using public finances to support companies or do you let creative destruction happen?"
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