Ten percent of corporations survive only because central banks have kept real interest rates negative.
The BIS defines Zombie firms as those with a ratio of earnings before interest and taxes to interest expenses below one, with the firm aged 10 years or more.
In simple terms, Zombies are those firms that could not survive without a flow of cheap financing.
The above chart shows the median share of zombie firms across AU, BE, CA, CH, DE, DK, ES, FR, GB, IT, JP, NL, SE and US.
According to the BIS Quarterly Report one out of ten corporations in emerging and advanced countries is a "Zombie".
Let's dive into the report for more details.
The inability to come to grips with the financial cycle has been a key reason for the unsatisfactory performance of the global economy and limited room for policy manoeuvre.
Since 2007, productivity growth has slowed in both advanced economies and EMEs. One potential factor behind this decline is a persistent misallocation of capital and labour, as reflected by the growing share of unprofitable firms. Indeed, the share of zombie firms – whose interest expenses exceed earnings before interest and taxes – has increased significantly despite unusually low levels of interest rates.
Over the past 10 years, there has been a close positive correlation between the growth of corporate credit and investment. A build-up of corporate debt has financed investment in many economies, particularly in EMEs, including high investment rates in China. Turning financial cycles in these economies could therefore weigh on investment.
As with consumption, the level of debt can affect investment. Rising interest rates would push up debt service burdens in countries with high corporate debt.
Moreover, in EMEs with large shares of such debt in foreign currency, domestic currency depreciation could hurt investment. As mentioned before, an appreciation of funding currencies, mainly the US dollar, increases debt burdens where currency mismatches are present and tightens financial conditions (the exchange rate risktaking channel).
Empirical evidence suggests that a depreciation of EME currencies against the US dollar dampens investment significantly, offsetting to a large extent the positive impact of higher net exports.
End of the Rate Hike Cycle
For the above reasons, I believe the end of the global recovery is at hand.
And when the next bust happens, the last thing central banks will be doing is raising interest rates.