Staying Afloat: New Measures to Support European Businesses

IMF Blog, March 2, 2021

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Much of Europe began 2021 with new lockdowns and weak economic activity while effective vaccines started to be rolled out.
Government programs aimed at supporting lives and livelihoods provided critical lifelines, preserved the structure of the economy, and preserved the income of workers.
The massive policy support saved millions of European firms, accounting for over 30 million jobs.
As pandemic measures expire (for example, loan repayment moratoria), bankruptcies could rise, leading to a surge in unemployment and nonperforming loans.
To support a rebound and strong recovery in 2021, emergency programs and lifelines will need to be maintained, but they also need to adapt from liquidity provision toward strengthening equity.

Analysis covers 26 European countries (of which 21 are EU members).
Without policy support, the share of illiquid firms in Europe would have more than doubled and the share of insolvent firms would have almost doubled by end-2020.
Public support is estimated to have filled 60 percent of European firms’ liquidity needs because of the COVID-19 shock, but only 30 percent of the equity shortfalls (the extent to which firms’ debt exceeds their assets).
Even with this scale of support, the share of insolvent firms as a share of total firms is estimated to have increased by 6 percentage points.
Equity shortfalls are largest for micro firms and small businesses:
- Current policies absorb only one quarter of the equity gaps for micro and small firms.
- For larger corporations, current policies absorb over two fifths of the equity gaps.
Without additional equity support, some 15 million jobs are at risk.
About 2 to 3 percent of GDP will be needed to close the equity gap and provide firms sufficient equity so they would no longer be in difficulty, focusing only on the firms that were solvent before COVID-19.
Both private and public sector action is required.

Liquidity support cannot address equity shortfalls; policymakers must shift from debt-increasing liquidity support to providing more equity support for firms with good prospects after the pandemic.
Implementation challenges:
- Public sector is not well placed to assess viability of a large number of small businesses or to monitor their performance.
- Risks of adverse selection (support more attractive for bad than good firms) and moral hazard (firms mismanaging their business after receiving state support).
- Targeting support accurately is critical but difficult; more accurate targeting tends to be more complicated, reducing take-up and timeliness.
- Ensuring private sector participation is a key difficulty.
Key principles to address these challenges:
- Involve banks that know their clients and routinely assess business plans to help address adverse selection.
- Incentivize private investors to contribute equity to mitigate moral hazard.
- Ensure adequate contributions and burden sharing by investors.

France:
- Proposed program of participatory, subordinated loans envisions a central role for banks in selecting viable firms and retaining a share of these loans on their books—ensuring “skin in the game.”
Italy:
- Program for small and medium-sized enterprises encourages private equity injections by tax incentives and caps the government’s contribution to a fraction of the private investors’ capital increase, with private investors required to remain invested for some years.
Ireland:
- Support scheme for small businesses requires adequate contributions and burden sharing by investors; Enterprise Ireland assesses firms’ plans to restore long-term viability with the help of market appraisals.

Healthier firms will forestall a return of “doom loops” between Europe’s real and financial sectors.
Healthier firms will create more jobs.
Policies to support displaced workers should include upskilling, training, and job search programs to help them find new jobs in expanding sectors.
Countries will need to invest in the green and digital transitions to boost resilience and productivity.
A shift from liquidity to equity support, enhanced out-of-court debt restructurings, and improved insolvency regimes are needed to enable restructuring or liquidation where appropriate and to ensure a strong and lasting recovery after the pandemic.

Staying Afloat: New Measures to Support European Businesses — Alfred Kammer, Laura Papi, March 2, 2021

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