DISCLAIMER: The views expressed in this note are those of the author and do not necessarily reflect those of the European Investment Bank or the European Investment Fund.
Usefulness of the article: This article provides an update on the economic response to the coronavirus crisis. Initial data show the prevalence of credit guarantees, but also significant differences between countries. Recent impact assessments of European guarantee programs prior to the crisis also show divergences in the effectiveness of these policies. We therefore propose a number of ways to ensure their sustainability.
Summary:
· Public authorities in France and Europe have responded to the coronavirus crisis with unprecedented measures to support businesses. Among these, credit guarantees for businesses play a central role.
· We question their sustainability once the crisis is over, particularly in terms of differences between countries.
· The considerable amounts involved should prompt reflection on the objectives and on potential new mutualization efforts in Europe.
In the face of the challenges posed by the coronavirus, business support policies appear to be central, particularly credit guarantees for businesses. Their scale raises questions about long-term sustainability. In particular, questions arise about the relationship between different levels of sovereignty and the assessment of the long-term effectiveness of these measures.
1. The central role of credit guarantees in the response to the crisis
Initial data on the levels of spending and credit guarantees linked to crisis response policies show disparities in the levels of expenditure incurred. Here we present an initial assessment as of mid-April based on the lists of policies provided by the IMF[i] and the EIB (Figures 1 and 2). These are obviously very preliminary data[ii]. Nevertheless, such statistics provide an initial overview of the scale of the economic response announced by governments. The overall level of the economic response for the countries concerned, at almost 8% of their total GDP, roughly corresponds to the generally expected impact of the crisis on growth, which is also estimated to cost 8% of GDP (IMF, 2020). This cost stems mainly from lockdown measures, which affect individuals differently depending on their income (Figure 3). In addition, there is considerable disparity in the scale of the economic response between countries.
In terms of policy types, credit guarantees and direct loans, which are sometimes difficult to distinguish in the promises made by governments, account for more than a third of the amounts committed. By geographical area, credit guarantees are prevalent in Europe and the United States, while Japan favors subsidies. By mid-April, the United States had announced €469 billion in guaranteed loans, and European countries €1.36 trillion. The European Union had promised a pan-European fund of €25 billion, managed by the European Investment Bank, which could support up to €200 billion in loans to businesses and venture capital investments, guaranteed by all European countries according to their GDP weight.
Figure 1: Fiscal response to the coronavirus crisis by country, as a share of GDP, as of mid-April 2020, according to the IMF and EIB, author’s calculations[iii]
Figure 2: Fiscal response to the coronavirus crisis by policy and geographical area, in billions of euros, as of mid-April 2020, according to the IMF and EIB, author’s calculations
Figure 3: Workers able to work remotely by income bracket in the United States, according to Bergamini et al, 2020.
2. Impacts and limitations
Assessments of the impact of guarantees since the 2000s have been carried out, particularly at the European level (Brault and Signore, 2019). European credit guarantees have been in place since 1998 in many countries, with France and Italy receiving the highest volumes. These are portfolio guarantees that share the risk with the financial intermediary. The largest group of companies supported are sole proprietorships. The European Investment Fund’s guarantees had a positive impact on business growth and survival between 2002 and 2016. They increased companies’ assets, sales, and employment. The probability of bankruptcy also decreased. The bankruptcy rate of supported sole proprietorships remained low. The ratio of intangible assets to total assets, which gives an idea of the importance of innovation in the business model of companies, increased by one-third. These effects were greater for small and young businesses, which typically face more credit constraints, and for service businesses. The larger the loan guaranteed, the greater the impact. The impact is also positive for other programs evaluated by other researchers (Brault, 2019).
Limitations also appear. The effect on productivity is ambivalent. It was negative in the short term in Central, Eastern, and Southern Europe, but positive in France in the short and long term. Guarantees have no significant impact on profits. The overall impact is no greater for technology-intensive companies or in the knowledge economy. Broad-based credit guarantees are therefore not the most appropriate tools for these aspects. Other policies, particularly capital investment, would be more suitable.
Credit guarantees were designed in the 1980s to compensate for the difficulties SMEs faced in accessing bank credit and to promote the growth of young companies. However, the coronavirus crisis has given them a very different mission, namelyto prevent mass bankruptcies by smoothing the cost of the crisis over time. Data from the European Investment Fund on European credit guarantees in the Benelux countries, Italy, and the Nordic countries from 2002 to 2016 show a default rate of just under 5% for sole proprietorships, with a peak after 2008. However, in France, Bpifrance’s central scenario is currently 10% of bankruptcies (Sauvage, 2020). This could lead to a vicious circle between SME finances and public finances. The current high level of uncertainty therefore requires us to consider the long-term sustainability of these programs.
3. The future of credit guarantees after the coronavirus
Several solutions exist, each with its own set of advantages and disadvantages.
· Guaranteed loans could be extended. The risk for guarantors and the burden of « zombie » companies, which are able to repay the interest on these loans but not the principal, would increase. Guarantors, governments and banks, might prefer to defer principal repayments rather than face defaults, leading to an increase in the number of « zombie » companies. Some banks might refuse these extensions, prompting central banks to step in (Brunnermeier, 2020). Central bank corporate bond purchase programs could be extended to small businesses, whose debts would be securitized. However, there are questions about this possibility. The bond market for small businesses is underdeveloped. Holding the debts of a large number of small businesses, without a banking intermediary, would lead to a further shift by central banks towards a more interventionist mandate. In such a scenario, the question of the eligibility of loans for such a buyback would become an important political issue.
· The other solution is cancellation. The problem would be transferred to the state budget in a context of high debt. These cancellations could be partial and discretionary. The difficulty lies in deciding on effective criteria and convincing public opinion. Using environmental criteria, for example, to determine the survival of businesses is a politically difficult measure.
· Finally, guaranteed debts could be converted into capital held by the state. This conversion could be done immediately in the event of imminent default. Guaranteed debts could also be converted into convertible bonds that would combine repayment terms with the possibility for the state to return to the capital in the event of prolonged difficulties for the company. The challenge for the state would remain to spread the effects of the crisis over time, potentially reselling such holdings later, once the situation has recovered. If the crisis persists, the state could once again become a major asset holder, perhaps through sovereign wealth funds. This would profoundly change the current economic model of advanced economies.
In the absence of a long-term solution, the main danger is divergence between countries. Divergence between European regions and countries has recently increased in terms of public and private debt, investment, and productivity (IMF, 2019). Global private debt has doubled since 2008 (CODE, 2020), at a rate comparable to that of public debt. The debt of French non-financial companies could increase by almost a third this year (Ray, 2020). This rise in debt is associated with a decline in investment and productivity growth (Gebauer, 2017) and an increase in inequality (Wolf, 2020). However, countries with the highest levels of corporate debt generally have lower levels of credit guarantee commitments. The risk is increased divergence in defaults, investment, and productivity (Figure 4).
Figure 4: Credit guarantees and non-financial corporate debt (IMF data)
Given the limitations of public finances, European programs would be better placed to reduce these divergences. They make it possible to increase the number of guarantees in countries where national programs are more modest and their impact is more limited. European efforts to pool public debt, stimulus plans, and unemployment insurance are still in their infancy. European loan and credit guarantee programs have the advantage of benefiting from long experience and being immediately operational.
4. Long-term sustainability and assessments
The question of assessing the current sustainability of business support policies is crucial. Current credit is stimulated by accommodative monetary policies. However, simple financing through monetary expansion and guarantees alone seems unlikely to solve the problem of long-term economic recovery. During the 1950s and 1960s, credit control was used to select priority sectors for financing as part of a catch-up policy (Monnet, 2018). The inflation generated by this increase in credit was associated with an industrial planning policy internally and a protectionist policy externally (Brault, 2013). The combination of credit guarantees, promotion of the green economy, and carbon taxes at European borders has certain similarities with this policy. In the short term, the aim is to provide broad support to businesses in order to avoid systemic bankruptcies and smooth out the cost of the crisis over time. In the long term, the question is whether credit guarantees can be used to achieve other objectives, such as increasing productivity and protecting the environment—in other words, a complex strategy of development and catching up.
It is also a question of whether this policy is the most appropriate, or whether other policies, some of which have also been used to respond to the crisis, should be used as a complement or as an alternative. These include intergovernmental lending policies, limited or broader fiscal integration, direct subsidies to businesses and workers, and the creation of large sovereign wealth funds, among others (Bénassy-Quéré, 2020). In this context, the question of assessing the impact of guarantees is central.
The problem with assessing the impact of guarantees is that, until now, they have mainly been carried out retrospectively. Ex ante assessments of companies’ credit needs have focused mainly on evaluating credit constraints (Chen et al, 2018). An ex ante assessment now appears essential. Once this assessment has been carried out, it will be possible to compare the impacts of different policies in response to the crisis. Several institutions, including the OECD, the EIB, the EIF, and Bpifrance, have created platforms for discussion and evaluation of these policies in recent years. The task now is to scale up these efforts.
Conclusion
We have therefore shown that the issue of the sustainability of business support policies after the coronavirus crisis is closely linked to the issue of coordination between European national levels, both in terms of the implementation of these policies and their evaluation. The fiscal response to the crisis has involved very large sums of money in most countries. However, there are differences between major global regions and, within Europe, between countries, both in terms of the types of policy responses and the amounts committed and initial levels of debt. Loans and credit guarantees, which are the main policy for supporting businesses after the crisis, are long-term commitments—and risks. The risk is that of divergence in terms of business survival, debt, productivity, and investment. A vicious circle could develop between the credibility of corporate borrowing and the financial stability of states. In this context, the evolution and harmonization of business support policies must be anticipated in order to inform future choices.
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