In an article with Ulrich Hege Professor of Toulouse School of Economics and Pierre Mella-Barral Professor of Toulouse Business School, Professor Bo Becker recently examined how corporate debt burdens threaten economic recovery after COVID-19.
Bo Becker is the Cevian Professor at the Department of Finance at the Stockholm School of Economics and works on corporate credit, insolvency and bankruptcy, credit cycles, and credit ratings as well as corporate governance. He is a Research Fellow of Center for Economic Policy Research, a Research Member of the European Corporate Governance Institute and previously served on the board of directors of the Swedish National Debt Office. In an interview, Bo Becker talked about growing corporate debt across Europe and elsewhere, Sweden’s readiness for a more online economy and policy response to COVID-19. He raised the importance of debt restructuring for a swift recovery after a COVID recession.
Corporate Debt: “At An All Time High”
Professor Becker starts by pointing out that corporate debt in Europe, and elsewhere, is at an all time high. This reflects long-term trends of decades of falling interest rates and inflation. It also reflects cyclical factors: a very long expansion and compressed credit spreads. As a result of the COVID-19 pandemic, corporate cash flows are deteriorating and collateral values are falling. This leads to a rapid deterioration in credit quality across the spectrum. Highly affected sectors include travel, leisure and retail. From a policy viewpoint, Becker observes that several recent initiatives aim to support corporations with short-term debt, adding that: “for example, the Riksbank has made up to 500 BSEK available to Swedish banks for lending to SMEs”. Collectively, corporate leverage, a rapidly deteriorating business cycle, and debt-focused policy will create a considerable need for debt restructuring in the next 18-24 months.
Sweden’s mitigation strategy: Impacts on the Economic Trajectory And Policy
According to Becker, it is likely that the development of health-related policy will impact the trajectory of the economy. Sweden has been less restrictive of movement than other countries. The extra flexibility these policies provide may ameliorate the economic impact to some extent. In contrast, if stronger measures have to be imposed later, this will change.
Professor Becker identifies three broad policy targets that appear common across countries: protecting employment, supporting distressed firms and encouraging aggregate demand. Here, commenting that: “The two first areas are non-controversial in principle, although designing effective policies ‘on the go’ is a challenge”. In contrast, he points out that aggregate demand stimulation may be premature. As people are not working, low demand is not restricting the economy. Increasing households’ financial resources will not impact demand if they cannot visit stores, restaurants, theaters and so on due to containment. He adds: “The time for stimulating demand may come, once restrictive containment policies are rolled back.” The strong fiscal position of the Swedish government is an advantage when designing policies, offering room to focus on urgent problems and not the government balance sheet, and giving staying power to policy.
The Need for Debt Restructuring Reform And Concrete Measures
Even if policymakers put health concerns first, planning for how to deal with unsustainable corporate debt burdens should start soon, in professor Becker’s view: “by taking steps now to limit the number of bankruptcies and business closures, we can speed up the recovery of the COVID recession”.
The bankruptcy court system has limited capacity. In the short run, Professor Becker therefore identifies that much restructuring will have to happen outside of bankruptcy courts. Public policy may be able to offer inducements for a smooth and efficient process. He underscores this point by adding: “Such measures may include reducing capital requirements for banks that write down excessive debt burdens or accept debt-for-equity swaps and offering tax inducements for debt write-downs. It is also important that out-of-court processes should be organized, fair and rapid.” He contrasts Swedish restructuring with the Norwegian system: “Norway has a more developed system for out-of-court debt restructuring. Sweden should learn from their example”.
From a long term perspective, Bo Becker points out that reforming European insolvency law to better handle insolvent firms with a viable business poses a key challenge. Notably, reforms in this area have been too slow: “We wasted one expansion cycle not getting reform done - let's make sure we don't waste another.” In relation to this, he emphasizes the importance of speed: “By working on reforms now, policies may be launched in time to matter.”
Finally, in light of the coronavirus outbreak, saving lives comes first. This will most likely impact the economic policy menu and depending on the duration even more so the need for debt restructuring: “If restrictive policies stay in place long or have to be re-imposed, the need for debt restructuring increases.”