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To stave off risks to recovery, policymakers should focus support on firms that can survive.

Dear maria, We just published a new blog—please find the full text below.  Governments Must Choose to Support or Restructure Heavily Indebted Firms (Image: IMF photos) By Ceyla Pazarbasioglu and Rhoda Weeks-Brown To stave off risks to recovery, policymakers should focus support on firms that can survive and prepare to restructure or liquidate those that cannot.  Companies entered the COVID-19 crisis with record debts they racked up after the global financial crisis when interest rates were low. Corporate debt stood at $83 trillion, or 98 percent of the world’s gross domestic product, at the end of 2020. Advanced economies and China accounted for 90 percent of the $8.9 trillion increase in 2020. Now that central banks are raising rates to check inflation, firms’ debt servicing costs will increase. Corporate vulnerabilities will be exposed as governments scale back the fiscal support that they extended to stricken firms at the height of the crisis. Governments face difficult decisions as they manage these risks to the economic recovery. They may need to continue providing financial support to firms that can recover (but cannot raise the private financing to do so) while withdrawing support from firms that are so badly scarred that they should be restructured or liquidated. Financial support should become more focused amid shrinking fiscal space. Effective insolvency systems make economies more resilient, productive, and competitive. Shoring up these systems is critical as there are shortcomings in many important areas at present and countries may need to tackle many cases at once. There is not much time to prepare. New IMF research takes stock of corporate vulnerabilities and assesses countries’ preparedness to handle large-scale restructuring. It proposes principles to guide the design of policy support for firms that can recover and to facilitate the restructuring of those that cannot. Measuring preparedness We use a new indicator to measure the extent to which countries’ insolvency and restructuring regimes are prepared for a crisis. Covering 60 economies that account for 91 percent of the world’s GDP and 84 percent of the global population across all continents and levels of development, this indicator offers a representative perspective on countries’ preparedness to handle large-scale corporate crises. The chart below summarizes the five sub-indicators for advanced, emerging market, and low-income economies. The whole dataset is available here. Corporate vulnerabilities tend to be more pronounced in economies where our indicator shows that there are shortcomings in crisis preparedness. Two-thirds of the emerging market economies whose corporate debt was more vulnerable to adverse economic conditions than the average country also had systems of crisis preparedness that were weaker than average. Almost 40 percent of advanced economies with vulnerable corporate debt had below-average crisis insolvency systems that could struggle in the event of a large number of restructurings. These countries should step up efforts to improve insolvency systems. But all countries can improve crisis preparedness. Many countries have continued to strengthen their insolvency systems, either with targeted reforms (Brazil, France, India, Korea, Turkey, and the United States) or with broad reforms affecting key elements of their systems (Germany, the Netherlands, and the United Kingdom). Policy principles What strategies should governments put in place to support viable firms and what legal reforms should they undertake to facilitate debt restructuring, liquidation, and reorganization of distressed companies? Policy support schemes should set clear objectives to address specific market failures. This was the case with Australia’s and Norway’s public support programs, for example. They should include strong governance and transparency safeguards to mitigate risks and put in place clear exit plans from the start. Burden-sharing and debt-restructuring plans should make use of the access to information and skills of private creditors, as was the case with Mexico during the peso crisis of the mid-1990s and France during the COVID-19 pandemic. Public creditors should actively participate in debt restructuring. Insolvency systems should be prepared to handle a large increase in cases, with each country facing different priorities in this area. Countries with limited fiscal space and ineffective insolvency systems should rely more on out-of-court or hybrid restructuring (where the courts play a limited role to support negotiations between debtors and major creditors, and which can be implemented relatively quickly). At the same time, they should tackle deeper reforms over the medium-term to improve legal and institutional frameworks. Countries with fiscal space can provide continued support but should be mindful of the risks of moral hazard and “zombie” firms that survive only with state assistance. Banks’ balance sheets should remain sound and transparent. Accounting and regulatory forbearance introduced to mitigate the economic impact of the pandemic have increased the potential for hidden nonperforming loans not reflected in banks’ balance sheets. Together with the rise in sovereign debt holdings, bank and government balance sheets have become increasingly intertwined—a phenomenon associated with debt crises. As forbearance ends, the reporting of asset quality should rely on transparent and consistent practices, aided by effective supervision and enforcement. Asset quality reviews can make balance sheets more transparent and support the market for distressed debt—especially after episodes of forbearance. At the same time, banks’ defenses may need to be shored up to absorb the losses from the crisis. Governments were right to support firms financially through the worst of the pandemic. They recognized the initial large premium on speed over precision and provided rapid support without distinguishing between enterprises that could be saved and those that should not. Now policymakers should calibrate financial support and direct it efficiently to companies that are in need. They should also be prepared to restructure or liquidate badly scarred firms. Jeff Kearns Managing Editor IMF Blog jkearns@IMF.org   Thank you again for your interest in IMF Blog. Read more of our latest content here. Take good care! The near-term growth outlook remains strong—but so too are inflationary pressures. United Kingdom UK Economy Rebounding Amid Growing Inflationary Pressures A masked commuter on the escalator at London's Holborn Underground Station. (IMF Photo/Jeff Moore) By the UK team, IMF European Department   Thanks to a rapid vaccination campaign and highly accommodative policies, the United Kingdom’s economic recovery has proceeded faster than expected. The near-term growth outlook remains strong—but so too are inflationary pressures. Monetary policy will need to tighten steadily to anchor inflation expectations and bring inflation back to target. Careful communication to counter expectations of a long cycle of rate hikes and high borrowing costs would help reduce the drag on growth in 2023. Fiscal policy could support this tightening cycle if planned consolidation was brought forward slightly. Despite the recovery, the pandemic and Brexit have magnified structural challenges and will leave some scars. The government has made significant progress in spelling out a comprehensive Plan for Growth, but structural issues such as regional inequality will require additional investment in transport infrastructure and digital connectivity. Meanwhile, enhanced retraining policies would support labor market transitions by helping workers find employment in expanding industries. In terms of climate, the Net Zero Strategy is a major step forward. The key to success lies in setting clearer and earlier incentives for the private sector to reduce emissions and removing barriers to greater green investment by the private and public sectors. Packages to compensate consumers for more expensive energy bills should focus on lower-income households; after these packages are phased out, they could be redesigned to support climate objectives. The financial system has been resilient. Corporate and household balance sheets have held up well, but the resilience of non-bank financial institutions and core financial markets could be better underpinned. Financial innovation such as fintech and green finance must be managed carefully. The primacy of financial stability should be maintained when pursuing post-Brexit regulatory reforms. (Click the image below to see a larger version) RELATED LINKS Read the Article IV Read the Financial Sector Assessment Program The United Kingdom and the IMF In exceptional times, monetary finance may provide helpful policy support but there are risks. Dear maria, We just published a new blog—please find the full text below.  Should Monetary Finance Remain Taboo? (Image: Sorbetto/iStock by Getty Images) By Itai Agur, Damien Capelle, Giovanni Dell’Ariccia, and Damiano Sandri In exceptional times, monetary finance may provide helpful policy support but there are risks. The severe economic challenges posed by the global financial crisis, and more recently the pandemic, sparked a debate on whether central banks should expand their unconventional monetary policy toolkit to include monetary finance—the financing of government via money creation. Monetary finance is often associated with Milton Friedman’s metaphor of a helicopter dropping money from the sky. Reflecting on the role of monetary policy during the Great Depression, the Nobel laureate argued that a permanent increase in the monetary base could stimulate aggregate demand even in a severe liquidity trap, that is when interest rates are at zero and prices are stagnant or declining. This increase could be transferred to households via tax cuts or other forms of government support. The 1970s struggle to contain inflation, and the many catastrophic episodes during which monetary policy became hostage to a country’s fiscal needs, however, made monetary finance taboo. Central banks’ success in lowering inflation was built on asserting their independence from fiscal authorities. The idea of financing fiscal deficits via money creation thus came to be seen as a mortal threat to central bank independence. Should monetary finance remain taboo? Or are there merits to recent calls for using this tool during times of severe crises? In a recent paper, we review the arguments in favor of and against monetary finance and provide some suggestive empirical evidence about the effects on inflation. For and against Proponents of monetary finance argue that it has a stronger effect on aggregate demand than a debt-financed fiscal stimulus. Because there is no increase in public debt, monetary finance does not need to be paid for with future tax hikes, making consumers more likely to spend. Monetary finance may also prevent self-fulfilling runs on government debt. If investors suddenly lose confidence in debt sustainability, the central bank may avert a default by partially monetizing debt. Importantly, if the central bank commits to this strategy—and does not abuse its power to monetize debt outside of self-fulfilling runs—investors are unlikely to lose confidence in the first place, without requiring the central bank to intervene. But even advocates of monetary finance will point out that there are very serious risks. The primary concern is that it may pave the way to fiscal dominance whereby monetary policy decisions are made subordinate to the fiscal needs of the government. The resulting loss of confidence in the central bank’s ability to keep inflation low and stable could lead to hyperinflation, as happened for example in the well-known case of Zimbabwe in 2007-08. Inflation risks We use two empirical approaches to provide a preliminary assessment of the inflationary risks. First, we analyze the association between the monetary base and inflation across several countries back to the 1950s. We find that a monetary expansion has modest effects on inflation in countries with strong central bank independence, low initial inflation, and small fiscal deficits. But the effects are much stronger if central bank independence is weak, inflation is high, and fiscal deficits are large. The analysis also detects considerable non-linear effects. While small expansions of the monetary base are associated with modest increases in inflation, large monetary expansions can have much stronger effects on inflation. Second, we examine whether unconventional monetary policy (UMP) announcements in response to the start of the COVID-19 pandemic in 2020 led to an increase in inflation expectations. The sample includes 49 advanced economies and emerging markets and developing economies (EMDEs) during the period between March and December 2020. Most countries embarked on asset purchases in secondary markets within the framework of quantitative easing (QE) programs. QE increases the monetary base, but unlike monetary finance, it is temporary as the central bank is expected to eventually unwind the assets it purchased. However, in several EMDEs, UMP programs included components of direct government financing through the purchase of government bonds in primary markets and the extension of loans and grants to the government, often with the explicit goal of providing fiscal support. These programs resemble forms of monetary finance. As the chart shows, we do not find evidence of systematic effects of UMP announcements on inflation expectations, even when we focus on direct government financing (DGF) programs in EMDEs. In interpreting these findings, it is important to note that these operations were relatively modest in size and were likely perceived as one-off interventions. Based on the review of the conceptual arguments in favor of and against monetary finance and considering our empirical findings, we see merit in further exploring the conditions under which monetary finance may or may not be appropriate in exceptional circumstances. However, possible experimentation with this tool should be modest and limited to countries with credible monetary frameworks, low inflation, and sustainable fiscal positions. Most importantly, possible monetary finance operations should be decided exclusively and independently by central banks with the sole goal of ensuring economic stability. This is admittedly a difficult standard to achieve. A difficulty seen by some as sufficient reason to ban monetary finance altogether. Indeed, in this context, departures from central bank independence can be very dangerous. History abounds with examples where the use of monetary finance under inappropriate circumstances had devastating effects on economies and livelihoods. Jeff Kearns Managing Editor IMF Blog jkearns@IMF.org   Thank you again for your interest in IMF Blog. Read more of our latest content here. Take good care!