Coronavirus Might Spark a Business Debt Crisis, Economist Warns: 'Pockets of Vulnerability Could Blow Up'

An economist has warned that if the coronavirus health emergency causes enough damage to corporate finances then it could trigger a business debt crisis.

Simon MacAdam, a global economist at the consultancy Capital Economics, highlighted the risk in a note to clients sent out on Friday.

"Our current assumption is that the virus-related disruption is not severe enough to prompt a widespread business debt crisis," MacAdam wrote.

"But if the virus triggers a sharper drop in profits or a bigger rise in borrowing costs than we envisage, then these pockets of vulnerability could blow up.

"Although the global banking system appears to be better placed to deal with such turbulence now than at the time of the global financial crisis, at the very least this could exacerbate any virus-related global downturn."

New coronavirus cases are appearing across the world. More than 100,000 cases are now confirmed, according to a tracker compiled by Johns Hopkins University, and over 3,400 people have died as a result of contracting the disease.

Aggressive containment efforts in China, the world's second-largest economy, are causing widespread disruption to business and industry with economic repercussions for other countries.

Now, the intensification of containment efforts elsewhere amid a rising number and spread of cases worldwide is adding to the economic threat.

Stock markets have fallen sharply in response to recent coronavirus developments.

Investors are concerned about the scale of the potential impact on company bottom lines with demand shriveling, production ground to a halt in some places, and supply chains disrupted.

If the coronavirus outbreak drags on further into the year, and perhaps develops into a pandemic, analysts warn that the global economy may slip into recession.

Jeffrey Frankel, who served as chief economist to and then as a member of the Council of Economic Advisers during the Clinton administration, said corporate debt is a prominent concern amid the coronavirus issues.

"I think it is possible that the coronavirus might trigger a global recession, that financial volatility is part of that, and that corporate debt is particularly vulnerable," Frankel, James W. Harpel Professor of Capital Formation and Growth at Harvard Kennedy School, told Newsweek.

The global debt-to-GDP ratio for non-financial businesses—the size of their combined debt as a portion of their total output—is at a record-high 94 percent, Capital Economics said.

It climbed after the financial crisis as central banks slashed interest rates to all-time lows and ultra-loose monetary policy was deployed to heal wounded economies.

But MacAdam said there are structural reasons for this to have happened, such as the liberalization of financial sectors creating more competitive credit markets, and that aggregate figures do not give a detailed picture of what lies beneath.

MacAdam raised in his note four pockets of business debt where there is a high risk of issues emerging because of a worsening coronavirus situation and which could, in turn, create wider economic and financial problems.

One is the energy extraction industry's capacity to service its debt is historically weak. Any hit to energy commodity prices may complicate the ability of extraction firms to pay back their debts.

A second is the large amount of outstanding BBB-rated corporate debt, which is one credit rating above junk status. A widespread downgrade amid a coronavirus-related economic downturn "would impose hefty costs on borrowers and investors alike," MacAdams wrote.

Third is the financial sector's increasing exposure to leveraged loans, which means lending to corporate borrowers that are heavily indebted and non-investment grade. Those leveraged loans are often packaged up together and sold as investment products.

And four, the growing use of "questionable accounting practices" may be hiding the true debt levels of some companies who look like they have robust books.

"So, even though the overall non-financial business sector is not about to buckle under the weight of its debt, there are clearly parts that look vulnerable to a big drop in corporate profits or surge in borrowing costs," MacAdams wrote.

"The greater the virus-related disruption, the closer we will get to this tipping-point."

Mohammed El-Erian, chief economic adviser to the finance firm Allianz, wrote this week in the Financial Times that the large amount of investment-grade U.S. corporate debt is hanging over the market for high-yielding junk bonds "like a Damoclean sword."

"Much of it is now facing a considerably higher risk of downgrade, given the inevitable global economic slowdown caused by coronavirus," El-Erian wrote.

"The greater the movement down to junk status, the higher the risk of a waterfall of funding dislocations that makes everything worse, financially and economically."

The Federal Reserve sought to take pressure off the economy on Tuesday with an emergency rate cut of half a percentage point. Its federal funds rate is now at a target of 1 to 1.25 percent.

Federal Reserve Chairman Jerome Powell called it a "booster shot" to "help the U.S. economy keep strong in the face of new risks to the economic outlook."

coronavirus economy stock markets corporate debt crisis
A board on the floor of the New York Stock Exchange (NYSE) on March 3, 2020 in New York City, showing market losses amid concerns about the novel coronavirus and its potential impact on the global economy. Spencer Platt/Getty Images
Coronavirus Might Spark a Business Debt Crisis, Economist Warns: 'Pockets of Vulnerability Could Blow Up' | World