What happens when a once-in-a-century pandemic hits an economy “saddled with record levels of debt”? In 2008 the problem was household and banking debt. Today it is corporations, says Ruchir Sharma in The New York Times.
At roughly $16trn, US corporate debt is worth 75% of GDP, with the vehicle, hospitality and transport sectors looking especially vulnerable. One in six US firms do not generate enough cash flow to cover debt interest payments, says Sharma. They avoid bankruptcy only so long as they can secure cheap refinancing. Such zombies are “the natural spawn of a long period of record low interest rates”. Investors reaching for yield have been forced to put their money into bonds backed by ever riskier ventures.
It’s not just America. The world’s $74trn “ocean of corporate debt” contains many hidden perils, says The Economist. Data from the Institute of International Finance shows that global non-financial corporate debt rose from 84% of GDP in 2009 to 92% last year. In America, two-thirds of non-financial corporate bonds are rated as “junk”, or just above junk at “bbb”.
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A back of the envelope “cash-crunch stress test” suggests that almost one quarter of global listed firms outside China would run out of cash within six months should their sales fall by two-thirds. Europe’s unprofitable banks are a notable area of concern. If they are to get through the next few months then the world’s businesses will require a giant “bridging loan”.
The big fear is that contagion from corporate junk could infect the wider financial market, amplifying the ongoing shock and generating a repeat of the 2008 credit crunch. Such contagion would be a disaster at a time when businesses are tapping credit lines for emergency cash, says Robert Burgess on Bloomberg. On this score, however, there is room for optimism. The Fed’s emergency liquidity injection last weekend saw overnight funding costs for banks plunge on Monday after they spiked to levels not seen since 2008 at the end of last week. The Fed might not be able to put a floor under equities, but if it can ensure that the financial plumbing is working properly and that banks are happy to keep doing business with each other, then “a big worry” is “off the table”.
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