RUTH SUNDERLAND: Coronavirus raises the potentially explosive problem of dodgy corporate debt
Charting the right economic course through the coronavirus is almost as difficult as calibrating the right medical response.
The two, of course, are linked.
The aim for policymakers is to prevent what we all hope is a temporary crisis from causing long lasting damage to the economy by sending good firms to the wall and costing people their jobs and their savings.
The terrifying falls in the FTSE 100 last week are an early warning. Despite a bounce on Friday, the index is still down around 28 per cent from the start of the year.
‘It is not inevitable at this stage that the epidemic will trigger a meltdown, but if it does, the most likely transmission mechanism is a tsunami of corporate debt’, says Ruth Sunderland
That is a brutal blow for savers and pensioners, even for those whose losses are ‘only’ on paper because they don’t need the money right now.
Yes, values will recover, but it could take a long time. Boris Johnson, on scientific advice, has been slower than his counterparts in other countries to take actions such as shutting down schools and banning public gatherings.
Regardless of the Government’s attempts to spread the impact of the virus, however, companies and organisations are doing it anyway, pre-empting official orders. This is perfectly rational from the point of view of the people running schools, care homes and the like, because there is an asymmetry of risk.
They are more afraid of being blamed if the virus claims victims than they are of a possible financial hit down the line caused by being over-zealous.
But the consequences of shutting down normal activity prematurely or needlessly are real. Our economy is skewed towards services and leisure activities which could judder to a halt due to social isolation.
Growth this year will be the weakest since the financial crisis and we haven’t even thought about the upheaval of Brexit, which has not gone away.
Never waste a crisis, the saying goes, so what can we learn?
The coronavirus has exposed the fault-lines in businesses, economies and societies just as ruthlessly as it has sought out its human prey. The fine-tuned efficiency and the ultra-low costs about which firms routinely boast are now revealed as vulnerabilities. Just-in-time supply chains mean companies do not, as they did in the past, have surplus stocks to fall back on.
Despite a bounce on Friday, the FTSE 100 is still down around 28% from the start of the year
Firms that despised ‘overmanning’ and have cut staff numbers to the bone are now fretting about how they will cope with minimal cover for sickness or absence.
Where once managers liked to have a prudent cushion against bad times, many businesses have been operating with only the tiniest margin for error. This is certainly the case when it comes to borrowing.
As the banks have reduced their gearing, companies have ramped theirs to the hilt so there is now the huge and potentially explosive problem of dodgy corporate debt.
As coronavirus hits their earnings, many will find themselves in trouble regardless of how low rates fall. Those taking an old-fashioned approach of no debt, such as the Sunderland-based Hays Travel group that took over Thomas Cook, may find themselves better placed than rivals to survive.
The IMF has been warning for some time that there is around £15trillion of corporate debt at risk in leading countries which could turn toxic if there is a downturn even half as bad the financial crisis.
It is not inevitable at this stage that the epidemic will trigger a meltdown, but if it does, the most likely transmission mechanism is a tsunami of corporate debt.
The pandemic has laid bare the levels of complacency in modern economies, and the huge risks that have been allowed to build up largely unawares.
Only a matter of a few months ago, the idea that the whole world would be menaced by a deadly virus was the stuff of dystopian fiction. Covid-19 has exposed our arrogance, and our frailty.