The Covid-19 crisis has shut down many sectors of the global economy. Companies in these sectors have no income while the lockdown is in place, but they are still paying salaries, rents and interest on debt. These expenses are often deferred — including through government-sponsored programs — but rarely reversed. The pause increases financial pressure on businesses, meaning that many previously healthy businesses may find themselves unable to reopen once the health crisis passes.
Governments have announced crisis response plans to prevent this possibility. A popular policy is that of loan guarantees which increase companies’ access to credit. For example, in March 2020, the UK government unveiled a £330 billion loan guarantee scheme, equivalent to 15% of the country’s GDP, to provide businesses with cash to pay salaries and other expenses. Similar approaches have been followed elsewhere, in both advanced and emerging economies.
These programs inject much-needed cash into businesses, but do not solve a bigger problem that is looming: insolvency. The gap between lower-than-expected revenues and the accumulation of debt – including new loans that businesses may have to repay – must be bridged. And it’s not just the case of retailers, travel agencies, airlines or hospitality or entertainment companies, where demand can only pick up gradually, even after the crisis. The Covid-19 crisis has exacerbated existing vulnerabilities in other sectors and will slow their recovery. As supply chains around the world are severely disrupted, trade in intermediate goods has collapsed. Some countries have imposed various trade restrictions to keep scarce resources at home. These restrictions have hurt several manufacturers, from automakers to furniture makers.
Something has to be done to keep businesses afloat. Two things, actually. First, governments must temporarily suspend bankruptcy proceedings, which often require the assets of illiquid companies to be transferred to their secured creditors, mainly banks. Several countries have just taken this step. For example, in France, bankruptcy law normally allows 45 days from when a debtor can no longer pay their debts until they file for bankruptcy. President Macron has decreed that companies will have three months after the end of the state of emergency (i.e., as things stand, until September 2020) to file for bankruptcy if necessary . The German parliament has adopted a temporary suspension of companies’ obligation to file for bankruptcy. The suspension is valid until September 2020, with an extension until March 2021 – a one-year deadline for companies to stand. Similar suspensions have taken place in Australia, India, Spain and the UK. Others will follow.
Second, governments can design a post-crisis recovery process, whereby they and all other creditors agree on a formula to reduce the corporate debt burden. Realistically, reduction means canceling some of the debt, as no amount of debt restructuring over time is likely to be enough. Governments have a hold on all other creditors because the latter will also be indebted to the Treasury either through overdue taxes or through participation in government bailouts.
Imagine, for example, that after painstaking calculations, economists arrive at a magic number – say 42 – of the forgiveness of outstanding debt (public and private) needed for the majority of businesses to reopen. The government applies the discount to all creditors and – voila! – the economy is picking up with a bang.
There are a few complications. First, some businesses would not be able to reopen even after such a large discount. These companies would follow the normal insolvency procedure and be reorganized or closed. Second, banks can argue that their claims take precedence over those of, say, owners. This is also the case by law in ordinary times. But these are not ordinary times. Also, banks are usually among the first to receive government bailouts. Recall the £37 billion bailout of Northern Rock by the UK government in 2007. Finally, the scale of this write-off may dwarf anything in recent memory. Parliaments must be ready for bold action.
Also by Erica Bosio and Simeon Djankov on support for the economy after coronavirus:
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Erica Bosio is a researcher at the World Bank Group, where her work focuses on public procurement. Previously, she worked in the arbitration and litigation department of Cleary Gottlieb Steen & Hamilton in Milan. She holds a master’s degree in law from Georgetown University and a law degree from the University of Turin (Italy).
Simeon Djankov is Policy Director of the Financial Markets Group at LSE and Senior Fellow at the Peterson Institute for International Economics (PIIE). He served as Deputy Prime Minister and Minister of Finance of Bulgaria from 2009 to 2013. Prior to his cabinet appointment, Djankov served as Chief Economist in the Finance and Private Sector Vice Presidency of the World Bank. He is the founder of the World Bank’s Doing Business project. He is author of Inside the Euro Crisis: An Eyewitness Account (2014) and lead author of World Development Report 2002. He is also co-editor of The Great Renaissance: Lessons from Capitalism’s Victory over Communism (2014).