Olaf Scholz, Rishi Sunak and Bruno Le Maire are showering firms with loans – about $140 billion so far, according to a Breakingviews analysis of German, British and French government data. As that figure rises, so does the risk that the three finance ministers inadvertently create a growth-sapping debt overhang.
Start with Sunak’s state-guaranteed loan schemes, under which $27 billion has been approved, mostly for pandemic-hit small- and medium-sized firms (SMEs). At over $3 billion a week, SMEs are accumulating debt at more than twice their usual rate. Since revenue and profit margins are plummeting, debt-to-EBITDA ratios must be surging.
It’s a similar story in Germany and France, where government-backed loans of an estimated $30 billion and $80 billion respectively have been approved, based on Breakingviews calculations including larger companies.
Soaring corporate leverage is preferable to soaring bankruptcies. But because the loans have to be repaid, governments aren’t absorbing the lockdown’s costs, as seems appropriate for such a large external shock. Instead, they’re just allowing firms to spread out the pain. That risks creating a debt overhang, which tends to drag down private-sector investment and economic growth, according to studies, including a 2019 European Central Bank paper.
One solution is to turn the debt into equity, creating a quasi-sovereign wealth fund. But it’s not clear why taxpayers should want a portfolio of crisis-hit retailers and restaurants. And calculating the valuations at which to make the switch would be an ordeal.
Better to sweeten the terms, potentially even writing off debt for firms that don’t bounce back quickly. Britain’s student loans provide a model: they only kick in when graduates earn 1,615 pounds a month, and the debt gets eliminated after 25 years. Scholz, Sunak and Le Maire could give firms the headroom to invest and grow by making repayments conditional on hitting pre-pandemic levels of earnings, fixing repayments at a small proportion of revenue and eliminating remaining debt after, say, a decade or less.
That would admittedly hit Treasury coffers: the debt so far is almost 1.5 per cent of GDP across Germany, France and Britain. Yet even that sum pales in comparison to the cost of a permanently less dynamic private sector.