Governments Must Choose to Support or Restructure Heavily Indebted Firms
IMF Blog, February 23, 2022
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- Authors: Ceyla Pazarbasioglu, Rhoda Weeks-Brown
- Published: February 23, 2022
Key findings on corporate vulnerabilities and preparedness
- Corporate debt stood at $83 trillion, or 98 percent of the world’s gross domestic product, at the end of 2020.
- Advanced economies and China accounted for 90 percent of the $8.9 trillion increase in 2020.
- The IMF constructed a new indicator covering 60 economies that account for 91 percent of the world’s GDP and 84 percent of the global population to measure preparedness of insolvency and restructuring regimes for a crisis.
- Corporate vulnerabilities are more pronounced in economies with shortcomings in crisis preparedness:
- Two-thirds of the emerging market economies whose corporate debt was more vulnerable to adverse economic conditions than the average country also had systems of crisis preparedness that were weaker than average.
- Almost 40 percent of advanced economies with vulnerable corporate debt had below-average crisis insolvency systems that could struggle in the event of a large number of restructurings.
- Many countries have continued to strengthen insolvency systems through targeted reforms (Brazil, France, India, Korea, Turkey, and the United States) or broad reforms affecting key elements of their systems (Germany, the Netherlands, and the United Kingdom).
Risks identified
- Rising interest rates will increase firms’ debt servicing costs and expose corporate vulnerabilities as governments scale back fiscal support provided during the pandemic.
- Accounting and regulatory forbearance introduced during the pandemic have increased the potential for hidden nonperforming loans not reflected in banks’ balance sheets.
- The rise in sovereign debt holdings and greater intertwining of bank and government balance sheets are associated with debt crises.
- There is limited time to prepare; many countries may need to tackle large numbers of restructuring cases at once.
Policy principles and recommendations
- Targeted support and clear objectives:
- Policy support schemes should set clear objectives to address specific market failures.
- Support programs should include strong governance and transparency safeguards and clear exit plans from the start (examples cited: Australia’s and Norway’s public support programs).
- Distinguish between viable firms and non-viable firms:
- Continue providing financial support to firms that can recover but cannot raise private financing.
- Prepare to restructure or liquidate firms that are so badly scarred that they should not be sustained.
- Burden-sharing and use of private creditors:
- Debt-restructuring plans should utilize the information and skills of private creditors (examples cited: Mexico during the peso crisis of the mid-1990s and France during the COVID-19 pandemic).
- Public creditors should actively participate in debt restructuring.
- Insolvency system capacity and reform sequencing:
- Insolvency systems should be prepared for a large increase in cases, noting different country priorities.
- Countries with limited fiscal space and ineffective insolvency systems should rely more on out-of-court or hybrid restructuring mechanisms while pursuing deeper legal and institutional reforms over the medium-term.
- Countries with fiscal space can provide continued support but should guard against moral hazard and “zombie” firms surviving only with state assistance.
- Bank balance-sheet transparency and resilience:
- As forbearance ends, asset quality reporting should rely on transparent and consistent practices, aided by effective supervision and enforcement.
- Asset quality reviews can make balance sheets more transparent and support the market for distressed debt.
- Banks’ defenses may need shoring up to absorb losses from the crisis.
Strategic implications for policymakers
- Financial support should be more focused amid shrinking fiscal space and targeted to firms that can survive.
- Strengthening insolvency systems is critical to make economies more resilient, productive, and competitive.
- There is an urgent need to improve preparedness because many important areas of insolvency and restructuring policy currently show shortcomings.
Source: Ceyla Pazarbasioglu and Rhoda Weeks-Brown, Governments Must Choose to Support or Restructure Heavily Indebted Firms, February 23, 2022.
