Hello Dear Reader,
This week, shall we shake off the sweet holiday laziness and dwell on economic concepts that are a little serious, a little frightening, but intriguing?
What Is a Zombie Company?
“Zombie companies” has become a term we meet often in the economic press over the past few years. Just as the word suggests, it describes firms that are neither dead nor alive: firms that, without securing new financial resources, have lost the ability to pay their debts and sustain themselves. These firms have to cover debt with debt. In truth they have already gone bankrupt. Their cash flow is not enough to pay the interest on their existing debt. Debt finances debt, and zombie companies cause capacity to be exceeded and productivity to fall.
Famous Zombie Companies
Researchers at the Bank for International Settlements note that in the economies of more than ten countries, the number of zombie companies, which had risen by 2% since the mid-1990s, has increased by 12% since the end of 2018. A sixfold increase in 29 years. In the United States alone, 16% of S&P companies are zombies. Giants such as Tesla, Netflix and General Motors are among them. Thanks to zero-interest borrowing policies and the ability to buy back their own shares on the stock market, the market value of their shares rises and they experience a virtual kind of growth.
The question to ask at this point is: how can these companies still take out loans and secure financial support with such poor financial data?
A study by the OECD explains how banks have helped zombie companies spread. According to that study, lending banks prefer to restructure non-performing loans and lend again — in the hope of perhaps saving the money — rather than classify a company's debt as non-performing.
Especially for firms large enough to be expected to create a domino effect, governments instruct banks to accommodate the indebted company and even, if necessary, to take a stake in it. This puts at risk the position of the public whose deposits are held at those banks.
The Damage to the Economy
The greatest damage zombie companies do to a national economy is that they endanger and consume the capital that could otherwise be channelled to productive and efficient companies. Low bank interest rates reduce borrowing costs and may push firms into taking excessive risk, which in the long run can grow lending to unsustainable levels. Because when borrowing rates return to normal, these firms will have no chance of surviving, and no economy can keep rates at that level indefinitely. In such a case, national economies will collapse in proportion to their zombie companies. If I say that the volume of zombie company loans in America is 1.6 trillion dollars, I think the gravity of the picture becomes clear.
What Can Be Done
To rescue zombie companies, their financial ratios must first be analysed thoroughly, existing problems identified with an objective eye, the debt position restructured, and solutions that increase cash flow put into effect urgently.
What matters, however, is taking the steps needed to improve, at the macro level, the economic conditions that create this situation. Instead of the economic rescue packages politicians keep producing to pump blood into big bosses, lasting reform, the revival of industry, higher production and the optimised use of financial resources are only a few of those steps.
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