Governments should support viable firms and restructure indebted entities, IMF says

Corporate debt stood at $83tn, or 98 per cent of the world’s gross domestic product, at the end of 2020

The International Monetary Fund cut its world economic growth forecast for 2022 by 0.5 percentage point in January. Reuters

Governments must support firms that can survive the Covid-19 crisis and restructure or liquidate those that cannot, as interest rates rise and lead to an increase in companies' borrowing costs, the International Monetary Fund said.

Companies racked up record debt during the Covid-19 pandemic: corporate debt stood at $83 trillion, or 98 per cent of the world’s gross domestic product, at the end of 2020, the IMF said in a blog post on Wednesday. Advanced economies and China accounted for 90 per cent of the $8.9tn increase in 2020.

“Now that central banks are raising rates to check inflation, firms’ debt servicing costs will increase,” the Washington-based fund said. “Corporate vulnerabilities will be exposed as governments scale back the fiscal support that they extended to stricken firms at the height of the crisis.”

Last month, the IMF cut its world economic growth forecast for 2022 by 0.5 percentage point to 4.4 per cent because of rising inflation, supply chain disruptions, the Omicron variant and concerns related to China’s real estate sector.

The IMF said it observed the largest one-year debt surge since the Second World War in 2020, with global debt — both public and private — rising to $226tn.

Governments around the world must continue extending financial support to firms that can recover, but are unable to raise the private financing required to do so, while withdrawing support from companies that need to be restructured or liquidated.

“Effective insolvency systems make economies more resilient, productive and competitive,” the fund said. “Shoring up these systems is critical as there are shortcomings in many important areas at present and countries may need to tackle many cases at once. There is not much time to prepare.”

The IMF is using a new indicator to measure how far countries’ insolvency and restructuring systems are prepared for a crisis. Covering 60 economies that account for 91 per cent of the world’s GDP and 84 per cent of the global population across all continents, it shows countries’ preparedness to handle large-scale corporate crises.

“Across all levels of income, economies can do more to prepare for a corporate debt crisis,” the fund said. “Corporate vulnerabilities tend to be more pronounced in economies where our indicator shows that there are shortcomings in crisis preparedness.”

Low-income countries are the least prepared, according to various measures of readiness, to restructure, reorganise or liquidate troubled firms.

Two thirds of the emerging market economies whose corporate debt was more vulnerable to adverse economic conditions than average also had systems of crisis preparedness that were weaker than average, the IMF said.

Almost 40 per cent of advanced economies with vulnerable corporate debt had below-average crisis insolvency systems that could struggle in the case of a large number of restructurings.

“These countries should step up efforts to improve insolvency systems. But all countries can improve crisis preparedness,” the multilateral lender said.

The IMF offered recommendations that governments can put in place to support viable firms and the legal reforms they should undertake to facilitate debt restructuring, liquidation and the reorganisation of distressed companies.

Governments should set clear objectives to address specific market failures. They should include strong governance and transparency safeguards to mitigate risks and put in place clear exit plans.

Burden-sharing and debt-restructuring plans should make use of the access to information and skills of private creditors, it said. Public creditors should actively participate in debt restructuring.

Insolvency systems should be prepared to handle a large increase in cases, with each country facing different priorities in this area.

Countries with limited fiscal tools and ineffective insolvency systems should rely more on out-of-court or hybrid restructuring, where the courts play a limited role to support negotiations between debtors and major creditors.

They should also tackle deeper reforms over the medium term to improve legal and institutional frameworks.

Countries with fiscal space can provide continued support but should be mindful of the risks of moral hazard and “zombie” firms that survive only with state assistance, the IMF said.

“Policymakers should calibrate financial support and direct it efficiently to companies that are in need. They should also be prepared to restructure or liquidate badly scarred firms,” it added.

Updated: February 24, 2022, 5:44 AM