26 February 2019
Signs of the global slowdown continue to accumulate. Manufacturing production is shrinking in several key economies, retail sales are disappointing, world trade is substantially losing steam and some countries are already in technical recession. The joint economic upturn across the globe we saw only a year ago has quickly turned around in a concerted growth slowdown. The global economy remains stuck in a ‘low growth, low inflation’ trap and there is an urgent need to replace the old ‘debt-led’ ways of the past by a ‘wage-led’ growth model where demand is supported by broad shared productivity gains.
Against this background of a global slowdown, the findings of the OECD report on “Corporate Bonds Markets in a Time of Unconventional Monetary Policy” http://www.oecd.org/newsroom/risks-rising-in-corporate-debt-market.htm are anything from comforting. Since the last financial crisis, non-financial companies have dramatically increased their borrowing in the form of corporate bonds. Corporate debt stock now stands at 13 trillion dollar, double the outstanding amount of 2008.
This is exposing corporations and economies to multiple vulnerabilities: In the next three years, 4 trillion of corporate debt will need to be repaid, with corporations in emerging economies even facing a refinancing need of more than two thirds (69%) of their outstanding debt by 2023. Moreover, the quality of corporate debt has suffered: Half of investment-grade bonds are now rated as BBB- bonds (compared to less than a third in 2008) and the use of special clauses protecting bondholders in the segment of non-investment grade bonds has gone down markedly. According to the OECD report, the erosion in quality is partly attributed to the considerable large volume of “leveraged loans” reached in the recent years: loans for private equity leverage buy out, mergers and acquisition and balance sheet restructuring.
Where is the money raised from this massive increase on corporate bond issuance going? Are businesses increasing investment in productive assets? The OECD report unfortunately does not offer a response to that question. Previous OECD reports however suggest that there no take up in corporate investments. By contrast, business “investments” in share buy-backs and in dividends are booming. Rather than investing in the real economy, business are taking advantage of the ultra-low bond yields to borrow heavily, “take the cash” and transferring it shareholders via buybacks.
What are the implications in the near future? The risk is that slowing momentum in economic growth interacts with high corporate debt to trigger a self-reinforcing negative spiral: Defaults will rise as over-leveraged companies face disappointing revenue flows and thus find it more difficult to service their debt. Financial markets will react by downgrading company ratings from low investment grade to junk grade, thus increasing default rates further as these businesses have to refinance their debt at higher interest rates or having severe difficulties in rolling over their debts. Meanwhile, in trying to correct their over indebtedness, corporations will cut back on investment plans, thus further amplifying the slowdown. The risk is thus that an initial growth slowdown eventually results in another balance-sheet recession, as was the case in 2008-2009.
Two key conclusions emerge: Central banks should take corporate financial vulnerability into due account when deciding on monetary policy : Given high corporate indebtedness, even a small increase in interest rates or just the scaling back of monetary policy support in the form of quantitative easing could trigger the default doom loop described above. Moreover, monetary policy makers should seriously reflect to replace unconditional support for financial markets with more targeted, more effective and equitable interventions, in particular with a ‘quantitative greening’ policy that supports public investment into a low carbon dioxide economy.
It is also fundamental to change policy gear in a structural way and to stop basing growth and demand dynamics on continuously increasing borrowing, most often for purely speculative short-term purposes. The old model of ‘debt-led’ bubbles urgently needs to be replaced by a model of long-term business models, wage-led growth in which corporate fund raising is designed to finance long-term productive assets – not speculative shareholder’s remuneration – and in which aggregate demand is supported by broadly shared productivity gains. Enforcing proper corporate governance rules that can prevent short termist board decisions, promoting collective bargaining coverage and restoring the role of trade unions as decisive actors in the labour market and society are key ingredients to do so.