Global corporate insolvencies are forecast to increase by 26% in 2020 as the coronavirus pandemic pushes the world economy into recession
With pressure eased around US-China trade talks and a bottoming out of the global manufacturing rut, the year started out relatively positively. However, the Covid-19 pandemic has snuffed out nascent hopes of a recovery. Global GDP is forecast to contract 4.5% year-on-year, which makes this recession worse in magnitude than the 2009 Great Recession. China is the only major market expected to escape a recession. Being ahead of the epidemic curve, China felt the largest economic impact in Q1 of 2020, while in Q2, the economic activity rebounded, by 3.2% year-on-year. For most other regions the brunt of the recession has been felt in Q2. A recovery can be expected in the second half of 2020 assuming lockdown measures are gradually unwound. This also creates a positive ‘carryover effect’ for 2021. The recovery in 2021 is uncertain. It depends on the development and administration of a vaccine or, alternatively, a state of the world in which the effects of social distancing on economic activities are largely overcome.
The depth of the economic contraction varies per country depending on various factors. First of all, the economic contraction is forecast to be highest in countries with longer and more stringent lockdown measures. These lockdowns prevent the production and consumption of products and services. On top of that, demand may fall as workers lose their income, and economic uncertainty increases the propensity to save. Italy, France and Spain are severely affected by the virus and have implemented long and stringent lockdowns. These countries are all seeing a strong GDP contraction in 2020.
Second, sectoral composition matters. Countries in Southern Europe such as Spain, Italy, France, Portugal and Greece are more exposed to the current crisis, as their economic activity is highly dependent on tourism and service activities restricted by the coronavirus outbreak. Out of this group of countries, Greece exhibits the best outlook, as it has, until now, been more successful in containing the spread of the virus.
On the other hand, countries in Northern Europe are generally expected to have lower contractions. Germany, Denmark, Austria and the Netherlands are less dependent on tourism and have fared better in containing new infections, with their economies seeming to adapt better to social distancing restrictions.
Sweden has experienced the lowest GDP contraction of all the countries we analysed. This is because the government is steering for a policy of ‘heard immunity’ by letting the virus spread more freely. As a result, fewer economic activities are restricted. Despite the relatively light approach, the Swedish economy will still enter a recession this year. One reason is that people, especially those in risk groups such as elderly, voluntarily refrain from certain consumption. For instance, they choose not to go to cafes and restaurants, as this carries the risk of becoming infected. Another reason that Sweden hasn’t been able to entirely avoid a recession is that it is exposed through trade and financial linkages to the negative shock coming from the rest of Europe.
The United Kingdom stands out as the country in Northern Europe with the highest GDP contraction. Like in Sweden, the UK government initially steered for a policy of ‘heard immunity’. However, the economy was forced into a stringent lockdown as it became apparent that the medical system could not cope with the country’s high infection rate. What further complicates the situation is that the economy suffers from high Brexit uncertainty. The UK and the European Union are trying to work out a deal on a future political and trade relationship before the end of this year, but it is highly uncertain if this can be attained.
Outside of Europe, the United States, Japan and Australia have a more positive outlook than most European countries. The United States, although severely affected by Covid-19 infections (with the number of new cases still rising in July), has restricted economic activity less. Moreover, the population is likely to have restricted consumption less than in Europe, as the US administration sent weaker signals regarding the severity of the crisis.
Australia ranks among the best performing developed countries. It is a leading example for the successful containment of new infections, but the Australian economy is still vulnerable due to high exposure of tourism and export services to South-East Asia.
Lastly, Japan is relatively more vulnerable than the previous two countries, as its mixed approach of strict restrictions at the beginning of the crisis followed by a premature relaxation and a second significant surge in infections will both take a toll on economic activity. GDP in Japan is expected to show a 6% contraction in 2020. We expect a partial recovery in 2021 (2.8% growth), as the resurgence of infections will weigh on domestic and overseas spending.
A surprising decrease in insolvencies in the first half of 2020
The insolvency figures recorded in the first half of 2020 exhibit a peculiar decreasing behaviour. Figure 1 shows that most countries experienced fewer insolvencies than in the same period of the previous year. Most notably, the UK, Spain and France exhibit Year-to-Date (YTD) figures ranging from -20% to -40%. These large declines are at odds with the depth of the recession, especially since these countries are among the hardest hit by the crisis.
Two types of policies in particular are responsible for the discrepancy between GDP and insolvency development in the first half of 2020.
Insolvency regime changes
First, most countries made changes to the insolvency regime to protect companies from going bankrupt. These measures include temporary suspensions of insolvency applications (making them inadmissible) in bankruptcy courts, preventing creditors from starting an insolvency procedure, or raising the debt threshold for a bankruptcy notice. These temporary relief measures vary in duration across countries, with virtually all of them ending between May and December 2020, except a few that have no end date at all.
A number of countries including Belgium, Italy and Spain, have enacted laws that temporarily freeze insolvency proceedings or declare bankruptcies inadmissible. This means creditors are not allowed to appeal in court for the bankruptcy of a firm that is not able to honour its payment obligations.
Other countries, such as Singapore and Australia, have increased the debt threshold for companies to be declared bankrupt. A third group of countries including the Netherlands, Sweden, Denmark, Ireland, the United Kingdom and the United States have not made major changes to their insolvency regimes as a response to Covid-19. However, in the case of the Netherlands and the UK, the insolvency regime is subject to a larger overhaul that may affect the pattern of insolvencies going forward. In the Netherlands, for instance, it will be easier to force a company restructuring upon creditors, which may lead to fewer bankruptcies. But the changes to insolvency regimes in the Netherlands and the UK should be seen as separate from the coronavirus as they were initiated before the outbreak.
Governments are thus temporarily changing the insolvency framework to prevent a rise in insolvencies this early in the crisis. However, the measures are temporary, and in virtually all countries the relaxation measures end in Q2 or Q3 of 2020.
Second, governments and central banks across the world have taken measures to counteract the economic effects and to support small businesses. For instance, the Federal Reserve in the US and the Bank of England started lending programmes for Small and Medium Enterprises (SMEs). However, the most direct support for businesses has come from governments. These fiscal measures are aimed at providing companies breathing space after their liquidity position has come under pressure from a decline in revenues.
According to the IMF, the government support can be classified into three categories. First, the ‘above the line’ measures, which include wage subsidy schemes, temporary tax suspensions, social assistance, and direct grants made to small enterprises and self-employed. All of these immediately result in higher budget deficits. The second type of measure classified as ‘below the line’ generally involves the creation of assets, such as loans or equity injections to firms. These have little or no upfront impact on the deficit, but may increase government debt. Lastly, government guarantees, which usually have no upfront impact on the deficit or debt, but create a contingent liability, with the government exposed to calls on guarantees.
We believe that the most effective measures in the short run are direct spending (‘above the line’) and tax break measures. These can be direct subsidies to cover the worker’s wage bill and other fixed costs, such as rent and interest rate payments, or can involve a temporary suspension of corporate taxes. Several European countries such as Germany, the Netherlands, the UK, Denmark, and France, but also non-European countries such as Australia and Japan, have taken measures of this kind. Other European countries such as Austria, Belgium, Spain and Italy focused more on social assistance measures, such as unemployment benefits, short-term work compensation and benefits for temporary layoffs. Social assistance measures may have a positive effect on insolvencies, albeit a more indirect one, as they do not directly contribute to the firm’s liquidity position, but underpin household spending.
Fiscal measures had their biggest impact in the second quarter of 2020, when the lockdowns were most stringent. Governments in Germany, the Netherlands, France and Australia have explicitly mentioned that measures will be extended beyond the second quarter. In the European Union, there is also a common EUR 750 billion recovery fund that redistributes funds from countries that fared better through the pandemic to the ones that fared worse. All of this signals that the economic relief packages are likely to be extended throughout 2020.
The United States has opted for a mix of policies, including a form of wage subsidies to companies committing to keep their employees for a given period through the Paycheck Protection Program (PPP). A separate government scheme is aimed at providing loans and guarantees to companies. These measures could explain why there were relatively few insolvencies in the US in the first half of 2020, despite bankruptcy courts that were still largely functioning. At the moment of the writing of this report, the United States Congress was debating extension of the PPP relief package.
While effective in the short run, direct spending and tax reduction measures (‘above the line’ measures) are unlikely to prevent a rise in insolvencies in the longer term. Even if these packages cover costs incurred by companies, they will not cover persistent losses of profits. Capital owners of affected sectors will ultimately have no choice but to file for insolvency and reallocate their remaining capital to more promising sectors. The fiscal packages related to the coronavirus crisis also weigh heavily on the government budget, which may threaten to become unsustainable if continued too long. Some Southern European countries, most notably Italy and Greece, already have a high government debt. The budgetary space there to continue stimulus packages of this magnitude is limited.
A surge in insolvencies in H2 of 2020
We expect to see much higher bankruptcy figures in the second half of 2020. Figure 2 reproduces our insolvency forecasts for the full-year 2020. We forecast a 26% rise in global insolvencies. This forecast is based on the assumption of a gradual phasing out of the fiscal stimulus measures and a reopening of bankruptcy courts and proceedings. As mentioned before, temporary relaxation of insolvency laws ends in either Q2 or Q3 of 2020 for most countries. Fiscal measures may be extended throughout 2020 and even well into 2021, but are likely to be phased out, as they weigh heavily on the government budget.
All major regions will be confronted with an increase in insolvencies. Across countries there is a wide range of insolvency projections, depending on the severity of the economic contraction and the insolvency elasticity - the percent responsiveness of insolvencies to a one percent GDP change. This varies across countries due to differences in economic structure and institutional factors, such as type of insolvency regime.
The lowest increases in insolvencies are all found in Europe. In Germany, France, Austria, Belgium, Switzerland and Italy, insolvencies are likely to go up by percentages ranging from 6% to 20%. The economic contraction in these countries is generally lower - Belgium and Italy are exceptions – and they have a lower responsiveness of insolvencies to GDP. As mentioned before, there are often institutional reasons behind a lower insolvency elasticity. In Germany, for instance, legislation does not encourage struggling companies to file for insolvency, but instead encourages restructuring. On the other hand, Italy also has a relatively low historical elasticity of insolvencies to economic cycles, but for different reasons: the insolvency procedures are lengthy and costly, and thus most struggling firms prefer to liquidate outside the court through the so-called pre-bankruptcy composition agreements with creditors.
Among the economies with large increases in insolvencies are Turkey, the United States, Hong Kong SAR, and in Europe, Portugal, the Netherlands and Spain. For all of these countries, we expect a sizeable economic contraction that mostly explains the large increase in insolvencies. However, there are also country specific factors that matter. In Turkey and Portugal, we give a lower weight to the effectiveness of the fiscal response in preventing insolvencies, as this has limited focus on providing liquidity to firms. In the United States, although the recession is not expected to be as deep as in the Southern European countries, insolvencies are highly responsive to fluctuations in economic activity. Moreover, the effectiveness and the scale of the PPP program are likely to remain lower than in the European countries which provided generous liquidity assistance through wage subsidies.
In the case of Portugal, Spain and the UK, the large increase in insolvencies is largely attributed to the severe economic contraction. But, notably for Spain and the UK, insolvencies are forecast to increase less than during the Great Recession of 2009. We believe that this outcome is more likely to materialize, given some important changes in the insolvency procedure implemented since then. In the UK, the recent insolvency reform from June includes the temporary suspension of the wrongful trade provision that could result in accounting company directors being charged with a civil offence when a firm enters into financial difficulty. In Spain the reforms enacted in 2014 were designed to incentivize companies experiencing difficulties to apply for a restructuring plan as opposed to opting for liquidation. Before this reform, the insolvency procedure was generally unattractive to both debtors and creditors because it was lengthy and costly. Moreover, there is evidence that in order to avoid insolvencies, companies preferred to take on additional debt through mortgages, a practice that most likely contributed to the amplification of the increase in the insolvency numbers during the Great Recession when the housing market collapsed. We think that the current changes in legislation will weaken the link between the housing market and insolvencies, as attractive restructuring options will limit the need to finance liquidity through mortgages. Additionally, there are not yet signs of a severe downturn in the housing market in Spain. This further limits the stress on companies that may still depend on this form of financing.
Finally, the Netherlands is expected to experience a large increase in insolvencies, even though the economic contraction is smaller than in most other countries. The high sensitivity of insolvencies to economic conditions explains why insolvencies are expected to experience a considerable jump. This high insolvency elasticity has its roots in the legal framework. Companies with financial difficulties often prefer to apply for insolvency and re-start activity under another entity. Restructuring options cannot be enforced upon creditors and therefore are used less frequently.
A mixed picture in 2021
Our baseline forecast assumes that the global lockdown measures are gradually eased throughout the second half of 2020. Economic recovery is further boosted, as a vaccine becomes available in Q1 of 2021 or, alternatively, a state of the world emerges in which the effects of social distancing on economic activities are largely overcome. Our baseline scenario is that of a GDP recovery in all countries in 2021. This implies that monetary policy and fiscal policy can be gradually tightened in 2021. The assumption that the pandemic will be successfully countered is an important one, but also a very uncertain one. This is due to the fact that starting in July, many countries started experiencing a renewed rise in Covid-19 cases. This may necessitate more stringent social distancing measures, which could change the outlook dramatically.
Figure 3 shows the insolvency forecasts for 2021. Again, there is a wide range of insolvency projections. In some countries there is an increase in the level of insolvencies coming from a delay of registrations caused by the temporary suspension of court proceedings in 2020. This is the case for Spain, Australia, Canada, France, Switzerland, Norway and Finland – countries that are forecast to experience the highest increases in 2021. For Sweden and the Netherlands, the relatively weaker economic growth in 2021 following the milder contraction in 2020, coupled with the withdrawal of the fiscal support packages, leads to a slight increase in insolvencies in 2021.
Among the countries with the strongest decline in insolvencies in 2021 are Southern European countries, including Greece, Portugal and Italy. All benefit from a relatively strong economic recovery. Greece is a special case, as it has registered a downward trend in insolvencies in recent years, likely caused by reforms that make it easier to restructure a company without involvement of a bankruptcy court. We consider the 2020 increase in insolvencies in Greece a temporary deviation from this trend, and expect the previous downward trend to resume in 2021. Greece is also the only country with a cumulative decrease in insolvencies between 2019 and 2021 (Figure 4). Not only in Southern Europe, but also outside this region a number of countries display a strong percentual decline in insolvencies in 2021. Examples are New Zealand and the Czech Republic. These countries are also expected to benefit from a relatively strong economic recovery in 2021, which pushes down the insolvency level compared to 2020.
Despite the fact that overall all markets we see a slight decline in insolvencies in 2021, we emphasize that this is relative to the average level of insolvencies in 2020. Comparing the insolvency level in 2021 to the level before the Covid-19 recession (2019), we still see 2021 insolvencies are 25% higher. Thus, we caution that the level of insolvency risk will still remain more elevated than before the coronavirus crisis as a result of only a minor economic recovery in 2021.
Theo Smid, economist
+31 20 553 2169
Iulian Ciobica, economist
+31 20 553 2121
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