EU Aims to Dodge a Wave of Bankruptcies Coming Down the Track

When European Union leaders wrapped up 20 hours of talks to put the seal on a giant economic-aid package around dawn on Dec. 11, they didn’t head off to bed. They had one more topic that couldn’t wait: the damage done to corporate balance sheets.

Starting at 8 a.m., the leaders summoned the EU’s top economic policymakers to brief them on the state of the euro-area economy and how to avert the next catastrophe they could already see coming down the track, according to two officials familiar with the talks.

For more than 90 minutes, the leaders quizzed European Central Bank President Christine Lagarde over what happens when the time comes to pare back the extraordinary support for business, said the officials, who asked not to be identified because the meeting was private. They were concerned about a potential wave of corporate insolvencies sweeping through the banking sector and undermining the economic recovery, said the officials.

The ongoing struggle to vaccinate half a billion Europeans will be the main focus when leaders gather again for a videoconference starting Thursday. But they’ve also carved out time on Friday to assess the state of the economy together for the first time since December and officials charged with looking beyond the acute phase of the pandemic are scanning the corporate sector for danger.

“It is a very significant risk for us,” said Paschal Donohoe, the Irish minister who leads meetings of euro-area finance chiefs and was part of that summit discussion back in December.

EU Aims to Dodge a Wave of Bankruptcies Coming Down the Track

Since the start of pandemic, companies took on debt -- made affordable by state guarantees and central-bank stimulus -- to survive the lockdowns that reduced cash flow. Weaning them off this support could stretch their finances to the breaking point and spark a cycle of bankruptcies and jobs losses, compounding problems in the banking system.

According to the European Commission, the bloc’s executive arm, nearly a quarter of the companies in the EU would have struggled to keep up with financing payments last year without government support. The aid, mostly in the form of public guarantees, was eventually equivalent to 19% of the bloc’s output.

EU Aims to Dodge a Wave of Bankruptcies Coming Down the Track

The first step in moving beyond that life support will mean shifting to a more targeted form of support and with the region’s economic recovery plagued by uncertainty, governments are beginning to wrestle with a new dilemma: how they’ll decide which companies to keep alive as they gradually withdraw support.

“We need to take the right decisions to decisively tackle the insolvency challenges of the corporate sector in the next months and years with the social implications of our decisions at the forefront of our minds,” EU Economy Chief Paolo Gentiloni said last month. “We are dealing with jobs, workers and people. Not abstract entities.”

Spain’s government recently approved an 11 billion-euro ($13 billion) plan to help companies pay down debts accumulated during the pandemic. The package includes 7 billion euros for direct aid to companies and 4 billion euros to cover potential debt restructuring.

Paradoxically, the number of bankruptcies in the EU actually decreased last year compared to 2019, thanks in large part to the suspension of loan repayment requirements and the temporary relaxation of bankruptcy rules. In the third quarter of last year, 587 billion euros of loans received such extensions, about 60% of which were corporate obligations.

The share of euro-area corporate non-performing loans stood at 5.23% of total loans in the second quarter of 2020, according to the commission. But the volume is expected to rise across the EU once measures are unwound and firms start defaulting on their debt obligations.

The issue policymakers are grappling with is both economic and deeply political.

As long as the EU’s state subsidy rules remain looser to allow governments to help firms hit by the pandemic, those who can afford it may be able to provide deeper support for their domestic industry for longer. Those with more fiscal headroom like Germany may decide on granting more assistance to their companies, while France has already unveiled a state-guarantee plan to support businesses “whatever the cost.”

EU Aims to Dodge a Wave of Bankruptcies Coming Down the Track

As governments move into the next phase of recalibrating measures, finance ministries will be looking at three key things to decide which companies will need more support, Donohoe said in an interview.

The first is the impact of the pandemic on jobs, not just in general but across different industries. Some of the worst affected sectors, such as tourism, are among the biggest employers in several economies, particularly in southern Europe. That means that by focusing their support on these businesses governments will be able to do more to support jobs.

Governments will also be looking at the type of public health measures that are likely to stay in place in the medium term. While parts of the economy are already functioning or will open up soon as vaccinations progress, others may face curbs that stifle their activity for longer, especially those that really on bringing large numbers of people together.

EU Aims to Dodge a Wave of Bankruptcies Coming Down the Track

The final thing policymakers will be paying close attention is how bad the financial stress is within specific sectors. Certain firms are struggling more than others and channeling aid to those most in need will help to best avoid a dangerous spike in bad loans that would put extra pressure to the financial system.

That’s what officials are struggling with because the aid programs that are already in place are interfering with the usual signals.

“Our support measures are so broad they of themselves are playing a preventative role in suppressing a financial sector risk,” Donohoe said.

©2021 Bloomberg L.P.

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