Government support for companies during the pandemic have been so effective that bankruptcies have barely budged despite the huge hit to the economy.
The biggest risk to a post-Covid economic recovery is expected to come from firms that have been kept alive during the pandemic but fail once those supports are withdrawn, or linger on as ‘zombies’, unable to invest and hire due to their crippling debts.
It is hard to estimate the damage done to small and medium firms. The Economic and Social Research Institute (ESRI) calculates that last year's March to June lockdown alone resulted in an SME revenue shortfall of between €6bn and €10bn.
The full-year figure is between €8bn and €15bn, according to the ESRI.
The Government is stepping up supports by expanding its Covid Restrictions Support Scheme – a welcome move – and liquidations are running at less than half the pace of 2011.
However, we may be missing the biggest solvency risk to the recovery. That may come from “healthy” firms who have survived the crisis without State aid, but who could fail in large numbers if credit conditions tighten as banks become wary of lending.
That’s the message from a study of 13 European economies published by the US National Bureau for Economic Research.
‘Healthy’ firms would take hardest hit if lending tightens.
While most attention has been on companies receiving government supports and the risks when those are wound down, this new research suggests that the business failures resulting from this are likely to be small and manageable.
“Even if pandemic loans come due, business failures remain modest and so do policy costs,” according to the research led by Pierre-Olivier Gourinchas of the University of California, Berkley.
The bigger risk, according to Mr Gourinchas’ research – conducted with economists from the Canadian central bank and the US Federal Reserve system – is that banks stop lending to the economy as a whole.
In this case, the rate of business failures would rise by almost 8.5 percentage points relative to normal times.
“Such a contraction would disproportionately impact ‘strong’ firms, i.e. firms that otherwise would not need fiscal support to survive Covid-19 in 2020,” the study showed.
“Even in that scenario, the large business failures would not arise from excessively generous 2020 policies that just delayed the inevitable. Instead, they would be a new blow, coming from the contraction of credit to the corporate sector.”
That would be a devastating hit to an economy that’s already on its knees.
State can provide partial loan guarantees to encourage lending and to keep interest costs in check.
The latest data shows that half a million people in Ireland are on pandemic payments because they can’t work.
If healthy firms go under, job losses in small firms – the backbone of employment here – will be amplified.
Smaller firms tend to have loans with shorter maturities that have to be rolled over more frequently; they pay more for their loans, and have to post more in collateral.
Banks are likely to charge a high risk premium through, or even to refuse to lend.
The only solution lies, again, with the State. It can provide partial loan guarantees to encourage lending and to keep interest costs in check.
By offering only partial guarantees rather than full ones, the State can ensure that banks don’t lend recklessly. By the same token, conditions would need to be attached to new loans to ensure that State-guaranteed debt was not used to repay existing borrowings.
These could be repaid with a temporary tax on future profits, Mr Gourinchas says.