## 1fraea2021002

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---

### Emissions and Targets — overview, trajectory, and policy instruments
- France: one of the twenty biggest GHG contributors in absolute terms but a low-emission country when controlled for output; low-emission intensity largely explained by the higher share of nuclear power in energy generation.
- Relative to the EU average: higher GHG emission contribution from agriculture, buildings, and transport; lower from energy.
- National commitments: carbon neutrality by 2050; targets aligned with Paris Agreement 2015 and EU Green Deal.
- Sectoral multi-year targets set on a 5-year cycle through the National Low-Carbon Strategy (SNBC) and the Multiannual Energy Program (PPE).

Sectoral targets (relative to 2015, for 2030)
- Transport: reduce emissions by 30 percent between 2015 and 2030.
- Building sector: reduce emissions by 49 percent between 2015 and 2030.
- Agricultural sector: reduce emissions by 18 percent between 2015 and 2030.
- Non-ETS sectors: reduce emissions in the non-ETS sectors by 37 percent in 2030 relative to 2005.

Trajectory and shortfalls
- The first SNBC targets were not met; targets were revised up in the second SNBC (2019, adopted 2020), especially for transport and building-related emissions.
- Emissions are on track to meet 2020 commitments, but existing policies fall short of what is needed for the 2030 targets and carbon neutrality by 2050.
- Preliminary estimates: the COVID crisis could contribute to a drop in GHG emissions by about 9 percent relative to 2019 (two-thirds of which from lower transport emissions); this decline is expected to be temporary and partly reversible.

Recovery plan and green budgeting
- About one-third of Plan de Relance funds destined for the green transition, primarily targeting transport and buildings; funds for green transition in agriculture are limited.
- Government’s 2021 green budget exercise quantified the 2021 budget as:
  - EUR 38bn in environmentally friendly measures,
  - EUR 5bn of mixed character,
  - 10bn that are detrimental to the environment.
  - (Compared to EUR 30nb, EUR 5bn and EUR 11bn in 2020, respectively.)
- Government estimate: environmentally friendly measures of the Plan de Relance will reduce emissions on a cumulative basis by almost 30MtCO2eq by 2030 (close to 1 percentage point lower).
- France’s recovery package ranks highly in greenness among fiscal packages responding to COVID-19.

Environmental taxation and fiscal context
- France raised less than 2½ percent of GDP in fiscal revenues through environmental taxes, corresponding to about 5 percent of total tax revenues in 2018.
- Energy taxes as a fraction of the overall petrol price declined from 80 percent in 1995 to 63 percent in 2018; only 8 percent of the petrol price in 2018 is accounted for by the carbon-tax component.
- Effective carbon tax cost varies across sectors: estimated to be four times higher in transport than in the service sector, nine times higher compared to industry, and 15 times higher compared to agriculture.
- Domestic carbon tax on transport and building fuels is frozen at €45 ($53) per ton.

Policy recommendations and instruments
- Core recommendation: robust environmental taxation should be a key plank of the climate mitigation strategy.
- Carbon pricing:
  - Increasing carbon prices to €65 ($75) per ton by 2030 could raise revenues from carbon taxation to 0.7 percent of GDP in 2030.
  - Economic efficiency costs of such an increase are estimated to be minimal: 0.08 percent of GDP in 2030.
  - Domestic environmental benefits (including reductions in deaths related to local air pollution) are expected to more than offset efficiency costs.
  - Relying solely on carbon taxation to reach targets would require an unprecedented increase in the carbon tax, likely politically infeasible given limited coverage and the importance of atomic energy in France.
- Phase out subsidies and tax expenditures to brown energy sources (e.g., fuels used in agriculture and forestry, in road and non-road sectors) to better reflect emission costs.
- Use additional carbon-tax revenues to cushion impacts on the most vulnerable: resume carbon-price increases accompanied by measures addressing regressive effects and assistance to affected households.
- Complementary EU-level policies recommended to ensure a level playing field and bolster national measures.
- Power-sector option: surcharge on power (and industry) emissions so combined price with the EU ETS reaches a level consistent with economy-wide price of carbon (e.g., at least €65 per ton by 2030) to incentivize renewable power generation alongside any reduction in atomic energy reliance.

Transport — status and policy options
- Transport is the only sector with an emission increase over the last three decades; it accounts for a large share of the needed additional effort.
- Government objectives and projections:
  - Aim for 35 percent of new vehicles in 2030 to be electric vehicles (EVs).
  - Aim for full zero emissions vehicle sales by 2040.
- Feebate system: taxes polluting cars and subsidizes zero-emission cars at purchase; recovery plan increased fiscal incentives for cleaner cars.
- EV uptake: share of EV purchases rose from 5 percent in 2019 to about [10] percent in the first eight months of 2020; the share of EVs in the total existing fleet is still less than 1 percent.
- Policy options:
  - Integrate a revenue-neutral feebate into vehicle excises to provide continuous incentives for clean vehicles with no fiscal cost or tax burden on the average motorist.
  - Invest in charging stations to address network coverage concerns.

Buildings — status and policy options
- Building-sector emissions: initial SNBC emission-reduction targets were not met; potential for significant further reductions via renovation and retrofitting.
- Plan de Relance allocations for buildings:
  - EUR 4bn to improve energy efficiency of public buildings.
  - EUR 2bn to support private residential building renovations.
- Recommended focus and measures:
  - Prioritize deep retrofitting for buildings with the lowest energy performance where returns on investment are largest.
  - Develop a market for deep retrofits including advice, monitoring, financing, auditing, and investment in human capital.
  - Consider on-bill financing of energy efficiency investments and revenue-neutral energy-dependent housing taxation to address renter-owner obstacles.
  - Continued resource allocation needed to upscale housing stock and ensure electrification consistent with the government goal to end coal and oil heating by 2028.

Agriculture — status and policy options
- France has the largest emissions from agriculture in the EU; sector emissions have declined by less than 10 percent since 1990.
- Agricultural emissions profile:
  - Almost half of agricultural emissions derive from livestock.
  - About 10 percent derives from fuel usage.
  - The sector’s relative emission intensity per value added is among the highest globally and has increased since 2005.
- Plan de Relance includes measures to encourage a shift to less emission-intensive activities and supports re-forestation, but green funds for agriculture are limited.
- Possible additional measures:
  - Reduce emissions from livestock via demand management.
  - Eliminate fuel-related tax expenditures in agriculture.
  - Provide fiscal incentives (e.g., subsidize output in lower-emission farms with tax revenues levied on emission-intensive farms).
  - Consider incentivizing carbon sinks.

Renewable energy and power sector considerations
- France likely did not attain its 2020 renewable energy target of 23 percent (it stood at 17 percent in 2018 after an increase of some 8 percentage points since 2005) and is at the low end compared to peers.
- To reconcile net carbon neutrality with stated ambition to reduce reliance on atomic energy, accelerated adoption of renewable energy production is needed.
- Plan de Relance provides financial support for green hydrogen; significance uncertain given early stage of the technology.

### The Covid-19 crisis: corporate liquidity, solvency, and productivity impacts
- Corporate credit was already on an upward trajectory pre-crisis and spiked during the first half of 2020.
- Increased liquidity needs raised the corporate interest-to-income ratio.
- State guaranteed loans (PGE) enabled firms, especially SMEs, to meet liquidity needs but accelerated credit growth, accounting for 10 percent of total corporate sector loans within a short period.
- As of end-November, about 42 percent of PGE availability had been used (approximately €130 billion).
- Guaranteed PGE loans have a grace period of up to two years and can be reimbursed over up to six years.

Productivity dynamics (Melitz and Polanec (2015) decomposition with Levinsohn-Petrin (2003) productivity estimates)
- During the Global Financial Crisis (2008-2012) France experienced a productivity decline of -0.3 percent per year.
  - Within-firm adjustment contributed -0.52 percent.
  - Firm dynamism contributed +0.17 percent (exit contributed +0.15 percent; entry contributed +0.02 percent).
  - Inter-firm reallocation contributed +0.06 percent.
- Incumbent within-firm adjustment of -0.52 percent disaggregated:
  - -0.35 percent from non-zombie firms.
  - -0.17 percent from zombie firms.
- Zombies: firms aged ten years and above with interest coverage ratio below 1.5 for three successive years.
- Zombie SMEs represent 4 percent of all incumbent SMEs but their mean productivity loss is six-fold higher.
- Inter-firm reallocation (+0.06 percent) explained by positive allocative efficiency from non-zombie firms weighed down by negative allocative efficiency from zombie firms.

Credit allocation, PGE take-up, and insolvencies
- Early PGE take-up higher in regions with larger initial levels of bankruptcy.
- Aggregate insolvency rate dropped by 33 percent during the crisis in France (as of end-September).
  - Possible factors: loan-guarantee schemes refinancing non-viable companies, court closures, extension of insolvency registration deadlines.
- Regression (panel) findings (dependent variable = log of total insolvency filings in a region Jan–Sept 2019 vs 2020; standard errors clustered by region and time):
  - Column (1): PGE (log) * Post coefficient = -0.44*** (0.17)
  - Column (2): PGE + Aid (log) * Post coefficient = -0.45*** (0.17); PGE + Aid (log) * Post (separate) = -0.27* (0.16)
  - Column (3): PGE + Aid (log) * Post * High Share of low ICR coefficient = -0.19*** (0.06)
  - Covid Deaths (hundreds) coefficient = 0.02* (0.01) in all columns
  - Observations = 188; r2 = 0.35, 0.35, 0.37 across columns respectively
- Interpretation in text:
  - A 10 percent increase in state guaranteed loans reduces a region's bankruptcy filings by 4.5 percent (column 1).
  - Interaction with regions that have a high (above-median) share of low ICR firms shows an additional reduction in bankruptcy filings by 1.9 percent (relative effect, column 3).

Implications and risks
- Regions with higher take-up of state guaranteed loans experienced lower bankruptcy filings, but:
  - This could reflect temporary suppression of insolvencies with risk of a surge when government credit support schemes expire.
  - Alternatively, it could indicate refinancing of pre-crisis (technically) insolvent firms being kept afloat, risking increased presence of zombie firms that may congest capital allocation during recovery.
- Banque de France credit rating data: firms rated between excellent and fair comprised 9 percent of PGE beneficiaries but 42 percent of the total amount (rest distributed among fairly poor and below, or unrated firms).

Policy considerations and recommendations (corporate support)
- Broad-based liquidity credit support helped prevent disruption of credit supply but is not sustainable indefinitely; support will need to be narrowed and phased out.
- Temporarily support firm financing needs via equity-like instruments, well-targeted based on viability and need, to mitigate debt overhang and lower risk of costly defaults.
- Key features of a well-designed equity-like financing program:
  - Selectivity to mitigate adverse selection.
  - Pricing so that take-up is adequate.
  - Time-bound duration with a clear exit strategy for the government.
- Selectivity: support firms that are crisis-affected (having an equity need), viable before the crisis, and dynamic (conditionally viable after the crisis).
- Lessons: successful programs typically targeted viability and need, were of limited duration, and offered support beyond liquidity (e.g., guarantees on investment loans).

### Enhancing debt restructuring mechanisms — rationale, operational measures, and fiscal options
Rationale and evidence
- Delay of filing for bankruptcy may reflect distortions from debt overhang; debt-ridden firms may continue to under-invest and erode firm-value longer than is efficient.
- Brunnermeier and Krishnamurthy (2020): government resources toward reducing legal and financial costs of bankruptcy are unambiguously beneficial.
- Greenwood, Iverson and Thesmar (2020): court congestion and excess liquidation of small firms are key issues to resolve for robust recovery.
- France registers the highest rate of annual insolvencies worldwide (Euler Hermes, 2020), accounting for almost one third of total insolvencies in western Europe.
- An increase in insolvencies from the pandemic of about 50 percent could overwhelm court capacity.
- Liu, Garrido and DeLong (2020): corporate triaging processes and standardized approaches can accelerate insolvency resolution for SMEs.

Short-term operational measures
- Temporarily increase administrative capacity of France’s out-of-court restructuring mechanisms (mandat ad hoc and conciliation) to:
  - Prevent court-system overload.
  - Enable viable firms to restore financial health.
- Adopt corporate triaging to:
  - Distinguish businesses that can and cannot be restructured.
  - Wind down non-viable firms expeditiously.
  - Facilitate capital reallocation towards viable firms and avoid long-run scarring from debt overhang.

Medium-term fiscal measures (strengthening corporate equity)
- Reduce tax-bias towards debt to strengthen corporate equity, complementing the already legislated reduction in the Corporate Income Tax rate to 25 percent by 2022, through:
  - An interest deductibility rule based on a fixed debt-to-equity threshold (deny interest deductibility if debt-to-equity exceeds some fixed value).
  - An allowance for corporate equity, supplementing deductibility of interest with a similar deduction for the normal return on equity.
- De Mooij (2012) and Fatica et al. (2013) cited as comprehensive surveys on tax options to encourage equity.

Expected benefits and objectives
- Reduce delays in restructuring caused by debt overhang and private incentives to avoid bankruptcy.
- Prevent indiscriminate liquidation and preserve viable firms.
- Accelerate insolvency resolution for SMEs through standardized triaging and operational procedures.
- Encourage a shift from debt-financing to equity-financing, supporting market-based financing and corporate resilience.

*Source: IMF staff — "Climate Mitigation Policies in France" (section: 1. Emissions and Targets); 1fraea2021002 — Chapter: The Covid-19 crisis adversely affected the liquidity and solvency position of French corporates; 12. Enhancing debt restructuring mechanisms can complement the efficacy of solvency support initiatives.*

### 1. Emissions and Targets ________________________________________________________________ 9

### 1. Emissions and Targets

### Overview and introduction
- France is one of the twenty biggest GHG contributors worldwide in absolute terms but is a low-emission country when controlled for output; the low-emission intensity is largely explained by the higher share of nuclear power in energy generation.
- Relative to the EU average, France’s GHG emission contribution is higher from agriculture, buildings, and transport, but lower from energy.
- Through national legislation France committed to GHG emission targets including carbon neutrality by 2050 and targets aligned with multinational agreements (e.g., Paris Agreement 2015, EU Green Deal).

### Sectoral targets and emission trajectory
- Sectoral multi-year emission targets are set on a 5-year cycle through the National Low-Carbon Strategy (SNBC) and the Multiannual Energy Program (PPE).
- Targets (relative to 2015, for 2030):
  - Transport: reduce emissions by 30 percent between 2015 and 2030.
  - Building sector: reduce emissions by 49 percent between 2015 and 2030.
  - Agricultural sector: reduce emissions by 18 percent between 2015 and 2030.
- Non-ETS sectors: France is required to reduce emissions in the non-ETS sectors by 37 percent in 2030 relative to 2005.
- The first SNBC targets were not met; targets were revised up in the second SNBC (2019, adopted 2020), especially for transport and building-related emissions.
- Emissions are on track to meet 2020 commitments, but existing policies fall short of what is needed for the 2030 targets and carbon neutrality by 2050.
- Preliminary estimates suggest the COVID crisis could contribute to a drop in GHG emissions by about 9 percent relative to 2019 (two-thirds of which from lower transport emissions), but this decline is expected to be temporary and partly reversible.

### Recovery plan and green budgeting
- About one-third of the funds committed in the Plan de Relance is destined for the green transition, primarily targeting transport and buildings; funds for the green transition in agriculture are limited.
- The government’s annual green budget exercise quantified the 2021 budget as:
  - EUR 38bn in environmentally friendly measures,
  - EUR 5bn of mixed character,
  - 10bn that are detrimental to the environment.
  - (Compared to EUR 30nb, EUR 5bn and EUR 11bn in 2020, respectively.)
- The government estimates environmentally friendly measures of the Plan de Relance will reduce emissions on a cumulative basis by almost 30MtCO2eq by 2030 (close to 1 percentage point lower).
- France’s recovery package ranks highly in greenness among fiscal packages responding to COVID-19.

### Environmental taxation: current status and fiscal context
- France raised less than 2½ percent of GDP in fiscal revenues through environmental taxes, corresponding to about 5 percent of total tax revenues in 2018.
- Energy taxes as a fraction of the overall petrol price declined from 80 percent in 1995 to 63 percent in 2018; only 8 percent of the petrol price in 2018 is accounted for by the carbon-tax component.
- Effective carbon tax cost varies significantly across sectors: estimated to be four times higher in transport than in the service sector, nine times higher compared to industry, and 15 times higher compared to agriculture.
- The domestic carbon tax on transport and building fuels is frozen at €45 ($53) per ton.

### Policy considerations and recommended instruments
- Core recommendation: robust environmental taxation should be a key plank of the climate mitigation strategy.
- Carbon pricing:
  - Increasing carbon prices to €65 ($75) per ton by 2030 could raise revenues from carbon taxation to 0.7 percent of GDP in 2030.
  - Economic efficiency costs of such an increase are estimated to be minimal: 0.08 percent of GDP in 2030.
  - Domestic environmental benefits (including reductions in deaths related to local air pollution) are expected to more than offset efficiency costs.
  - Relying solely on carbon taxation to reach targets would require an unprecedented increase in the carbon tax, likely politically infeasible given limited coverage and the importance of atomic energy in France.
- Phasing out subsidies and tax expenditures to brown energy sources (e.g., fuels used in agriculture and forestry, in road and non-road sectors) to better reflect emission costs.
- Use additional carbon-tax revenues to cushion impacts on the most vulnerable: resuming carbon-price increases should be accompanied by measures addressing regressive effects and assistance to affected households.
- Complementary EU-level policies would help ensure a level playing field and bolster national measures.

### Transport
- Transport is the only sector with an emission increase over the last three decades; it accounts for a large share of the needed additional effort.
- Government objectives and projections:
  - Aim for 35 percent of new vehicles in 2030 to be electric vehicles (EVs).
  - Aim for full zero emissions vehicle sales by 2040.
- Feebate system: taxes polluting cars and subsidizes zero-emission cars at purchase; recovery plan increased fiscal incentives for cleaner cars.
- EV uptake: share of EV purchases rose from 5 percent in 2019 to about [10] percent in the first eight months of 2020; the share of EVs in the total existing fleet is still less than 1 percent.
- Policy options:
  - Integrate a revenue-neutral feebate into vehicle excises to provide continuous incentives for clean vehicles with no fiscal cost or tax burden on the average motorist.
  - Invest in charging stations to address network coverage concerns.

### Buildings
- Building-sector emissions: initial SNBC emission-reduction targets were not met; potential for significant further reductions via renovation and retrofitting.
- Plan de Relance allocations for buildings:
  - EUR 4bn to improve energy efficiency of public buildings.
  - EUR 2bn to support private residential building renovations.
- Recommended focus and measures:
  - Prioritize deep retrofitting for buildings with the lowest energy performance where returns on investment are largest.
  - Develop a market for deep retrofits including advice, monitoring, financing, auditing, and investment in human capital.
  - Consider on-bill financing of energy efficiency investments and revenue-neutral energy-dependent housing taxation to address renter-owner obstacles.
  - Continued resource allocation in future years is needed to upscale housing stock and ensure electrification consistent with the government goal to end coal and oil heating by 2028.

### Agriculture
- France has the largest emissions from agriculture in the EU; sector emissions have declined by less than 10 percent since 1990.
- Agricultural emissions profile:
  - Almost half of agricultural emissions derive from livestock.
  - About 10 percent derives from fuel usage.
  - The sector’s relative emission intensity per value added is among the highest globally and has increased since 2005.
- Plan de Relance includes measures to encourage a shift to less emission-intensive activities and supports re-forestation, but green funds for agriculture are limited.
- Possible additional measures:
  - Reduce emissions from livestock via demand management.
  - Eliminate fuel-related tax expenditures in agriculture.
  - Provide fiscal incentives (e.g., subsidize output in lower-emission farms with tax revenues levied on emission-intensive farms).
  - Consider incentivizing carbon sinks.

### Renewable energy and power sector considerations
- Despite progress in the power sector, France likely did not attain its 2020 renewable energy target of 23 percent (it stood at 17 percent in 2018 after an increase of some 8 percentage points since 2005) and is at the low end compared to peers.
- To reconcile net carbon neutrality with a stated ambition to reduce reliance on atomic energy, accelerated adoption of renewable energy production is needed.
- Financial support in the Plan de Relance for green hydrogen is provided, but significance is uncertain given the early stage of the technology.
- Policy option: surcharge on power (and industry) emissions so that the combined price with the EU ETS reaches a level consistent with the targeted economy-wide price of carbon (e.g., at least €65 per ton by 2030) to incentivize renewable power generation alongside any reduction in atomic energy reliance.

*Source: IMF staff — "Climate Mitigation Policies in France" (section: 1. Emissions and Targets).*

### 1.      The Covid-19 crisis adversely affected the

### 1fraea2021002 - 1.      The Covid-19 crisis adversely affected the

### Impact on corporate liquidity and solvency
- Corporate credit was already on an upward trajectory pre-crisis and spiked during the first half of 2020.
- Increased liquidity needs raised the corporate interest-to-income ratio.
- State guaranteed loans enabled firms, especially SMEs, to meet liquidity needs but accelerated credit growth, accounting for 10 percent of total corporate sector loans within a short period.
- As of end-November, about 42 percent of PGE availability had been used (approximately €130 billion).
- Guaranteed PGE loans have a grace period of up to two years and can be reimbursed over up to six years.

### Productivity dynamics and firm-level decomposition
- Aggregate productivity change is decomposed using the Melitz and Polanec (2015) method with Levinsohn-Petrin (2003) productivity estimates, separating continuing (C), entering (E), and exiting (X) firms (see Equation (1) in source).
- During the Global Financial Crisis (2008-2012) France experienced a productivity decline of -0.3 percent per year.
  - Within-firm adjustment contributed -0.52 percent.
  - Firm dynamism contributed +0.17 percent (exit contributed +0.15 percent; entry contributed +0.02 percent).
  - Inter-firm reallocation contributed +0.06 percent.
- Results are qualitatively comparable to findings for all French firms and other European countries.

### Role of excessive debt and zombie firms
- Zombies defined as firms aged ten years and above with interest coverage ratio below 1.5 for three successive years.
- Incumbent within-firm adjustment of -0.52 percent can be disaggregated into:
  - -0.35 percent from non-zombie firms.
  - -0.17 percent from zombie firms.
- Zombies SMEs represent 4 percent of all incumbent SMEs but their mean productivity loss is six-fold higher.
- Inter-firm reallocation (+0.06 percent) is explained by positive allocative efficiency from non-zombie firms weighed down by negative allocative efficiency from zombie firms.
- Evidence from Europe: firms with weaker pre-crisis balance sheets experienced persistent post-crisis productivity declines accounting for about one-third of within-firm slowdown (Duval et. al, 2020). Firms with higher leverage reduce investment (Kalemli-Ozcan et al., 2018). Firms entering the GFC with higher financial leverage experienced sharper investment declines (Demmou et. al., 2020).

### Credit allocation, PGE take-up, and firm exits during Covid-19
- Early PGE allocation patterns: take-up was higher in regions with larger initial levels of bankruptcy (regional analysis using Infogreffe insolvency registry and regional PGE take-up).
- Aggregate insolvency rate dropped by 33 percent during the crisis in France (as of end-September).
  - Possible factors: loan-guarantee schemes refinancing non-viable companies, court closures, extension of insolvency registration deadlines.
- Difference-in-difference specification (Equation (2)) relates regional insolvency filings to state-guaranteed loans (PGE), controlling for firm establishments and Covid-related deaths.
- Empirical regression findings (panel regression; dependent variable = log of total insolvency filings in a region Jan–Sept 2019 vs 2020; standard errors clustered by region and time):
  - Column (1): PGE (log) * Post coefficient = -0.44*** (0.17)
  - Column (2): PGE + Aid (log) * Post coefficient = -0.45*** (0.17); PGE + Aid (log) * Post (separate) = -0.27* (0.16)
  - Column (3): PGE + Aid (log) * Post * High Share of low ICR coefficient = -0.19*** (0.06)
  - Covid Deaths (hundreds) coefficient = 0.02* (0.01) in all columns
  - Observations = 188; r2 = 0.35, 0.35, 0.37 across columns respectively
- Interpretation of magnitudes stated in text:
  - A 10 percent increase in state guaranteed loans reduces a region's bankruptcy filings by 4.5 percent (column 1).
  - Interaction with regions that have a high (above-median) share of low ICR firms shows an additional reduction in bankruptcy filings by 1.9 percent (relative effect, column 3).

### Implications and risks
- Regions with higher take-up of state guaranteed loans experienced lower bankruptcy filings, but:
  - This could reflect temporary suppression of insolvencies with a risk of a surge when government credit support schemes expire.
  - Alternatively, it could indicate refinancing of pre-crisis (technically) insolvent firms being kept afloat, risking increased presence of zombie-firms that may congest capital allocation during recovery.
- Banque de France credit rating data: firms rated between excellent and fair comprised 9 percent of PGE beneficiaries but 42 percent of the total amount (rest distributed among fairly poor and below, or unrated firms).

### Policy considerations and recommendations
- Broad-based liquidity credit support helped prevent disruption of credit supply but is not sustainable indefinitely; support will need to be narrowed and phased out.
- Temporarily supporting firm financing needs via equity-like instruments, well-targeted based on viability and need, could mitigate debt overhang and lower risk of costly defaults.
- Key features of a well-designed equity-like financing program:
  - Selectivity to mitigate adverse selection.
  - Pricing so that take-up is adequate.
  - Time-bound duration with a clear exit strategy for the government.
- Selectivity considerations: support firms that are crisis-affected (having an equity need), viable before the crisis, and dynamic (conditionally viable after the crisis).
- Lessons from past programs:
  - Successful programs typically: targeted on viability and need, were of limited duration, and offered support beyond liquidity (e.g., guarantees on investment loans).
  - Examples with mixed or limited effectiveness: Korea (Oh et. al., 2009), Italian Fondo di Garanzia (Blasio et. al., 2017), French Sofaris and Oseo-Garantie (increased business creation and employment but raised default risk), Spain’s mutual guarantee (some benefits for VSMEs during recessions).

*International Monetary Fund — Chapter: The Covid-19 crisis adversely affected the liquidity and solvency position of French corporates (prepared by Manasa Patnam (EUR)).*

### 12.      Enhancing debt restructuring mechanisms can complement the efficacy of solvency

### 12.      Enhancing debt restructuring mechanisms can complement the efficacy of solvency support initiatives.

### Rationale and evidence
- A delay of filing for bankruptcy may reflect distortions from debt overhang: if the private costs of bankruptcy outweigh its social costs, debt-ridden firms may continue to under-invest and erode firm-value longer than is efficient, hoping for a recovery.
- Brunnermeier and Krishnamurthy (2020) show that government resources toward reducing the legal and financial costs of bankruptcy are unambiguously beneficial.
- Greenwood, Iverson and Thesmar (2020) identify court congestion and excess liquidation of small firms as two key issues to resolve to ensure a robust recovery of the corporate sector.
- France registers the highest rate of annual insolvencies worldwide (see Euler Hermes, 2020), accounting for almost one third of total insolvencies in western Europe.
- An increase in insolvencies from the pandemic of about 50 percent could overwhelm court capacity (see for e.g., Guerini et. al, 2020), risking indiscriminate firm liquidation.
- Liu, Garrido and DeLong (2020) discuss key operational features of a corporate triaging process and standardized approaches that can help accelerate the insolvency resolution for SMEs.

### Short-term operational measures (near term)
- Temporarily increase the administrative capacity of France’s out-of-court restructuring mechanisms (mandat ad hoc and conciliation) to:
  - Prevent court-system overload.
  - Enable viable firms to restore their financial health.
- Adopt corporate triaging to:
  - Distinguish between businesses that can and cannot be restructured.
  - Wind down non-viable firms expeditiously.
  - Facilitate capital reallocation towards viable firms and avoid long-run scarring from debt overhang.

### Medium-term fiscal measures (policy options to strengthen corporate equity)
- Reduce the tax-bias towards debt to strengthen corporate equity, complementing the already legislated reduction in the Corporate Income Tax rate to 25 percent by 2022, through:
  - An interest deductibility rule based on a fixed debt-to-equity threshold (i.e., denying interest deductibility if debt-to-equity exceeds some fixed value).
  - An allowance for corporate equity, which supplements deductibility of interest with a similar deduction for the normal return on equity.
- De Mooij (2012) and Fatica et al. (2013) provide comprehensive surveys on tax options to encourage equity.

### Expected benefits and objectives
- Reduce delays in restructuring caused by debt overhang and private incentives to avoid bankruptcy.
- Prevent indiscriminate liquidation and preserve viable firms.
- Accelerate insolvency resolution for SMEs through standardized triaging and operational procedures.
- Encourage a shift from debt-financing to equity-financing, supporting market-based financing and corporate resilience.

*Source: 1fraea2021002 — 12.      Enhancing debt restructuring mechanisms can complement the efficacy of solvency support initiatives.*

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_Source: https://www.imf.org/-/media/files/publications/cr/2021/english/1fraea2021002.pdf_