'Insolvency time bomb'

EDITORIAL: A report by an international trade insurance firm, suggesting that 'Covid-19 is creating an insolvency time bomb' and the number of companies going bust globally could rise by a about a third (35 percent) between 2019 and 2021, raises some important questions and threatens to wipe all the smiles off the faces of investors that have been riding the recent pro-risk sentiment in financial markets. A firm which provides insurance for international trade deals would know what it is talking about, especially when it says that this trend 'would be a record for its global insolvency index', and that about half the countries in the world would set new highs in bankruptcies. So far central banks have kept things from falling apart with different sorts of combinations of interest rate cuts and balance sheet expansion, hence the surprising optimism in capital markets, but with production and output levels still pretty tame the long term viability of this strategy is fast being called into question. Just last month the IMF (International Monetary Fund) expressed similar concerns, observing among other things that debt levels were rising and credit losses from insolvencies could seriously test the resilience of the banking sector in some countries.

It doesn't help, of course, that the virus is still spreading very fast in most countries, especially the world's biggest economy. That is why it is hardly a surprise that THE United States is set to witness the biggest increase in terms of companies going belly-up - 57 percent more than 2019. Over there hopes of a V-shaped recovery first gave way to a U-shaped recovery, where the upturn would have taken a little longer to come, but now fresh infection and death rates are stretching the time before the turnaround just too much for most companies to just sit around and wait for good times to return. And insolvency is hardly the most isolated business; oftentimes when companies go bust links are broken in long chains and all sorts of legal, financial and logistic troubles arise. It is also disruptive because a large number of firms are left unpaid or suddenly in need of new suppliers. And as the report rightly noted, "The larger the company filing for bankruptcy, the higher the risk of a domino effect." The US is likely to be followed by Brazil (45 percent increase over 2019), Britain (43 percent) and Spain (41 percent). China, the world's second largest economy, is expected to see a 20 percent jump in bankruptcies.

And this is hardly the worst case scenario. All this is despite all the fiscal and monetary support from governments and central banks. Such large, in fact, was the global financial response to the pandemic that it caused a historic decoupling between financial markets and economic prospects with investors betting that central banks would keep the ship afloat as long as needed. Central banks, on the other hand, would have surely bet, or at least hoped, that they would not have to throw money around for so long. But now they must find out yet more ingenious ways of keeping the system running, which will of course require time. Unfortunately, that is one luxury that hundreds of thousands of firms across the world that are the nuts and bolts of complex economic systems just do not have right now. And should central banks cut back and this manna from heaven stop now, just when there is a famine on the financial horizon, then an even grimmer fate awaits firms. According to the report, a premature withdrawal of support and policy measures could raise the number of insolvencies to the 40-45 percent range. And if the global economic recovery takes longer than expected, this number could even rise to as high as 85-95 percent.

These are worrying indications indeed. At risk is all that is central to the working of the global economy; everything from income, jobs, money-flow to large scale supply chains and global trade itself. After all, insolvencies can create financial pandemics of their own. Therefore, for these and a lot more reasons, it seems the world will see at least a few more doses of fiscal stimulus packages from governments and monetary concessions from central banks and hope that by then the recovery would at least be within sight. For now, though, the insolvency time bomb is ticking.

Copyright Business Recorder, 2020