07/11/2023
Published in
El Confidencial
Germán López Espinosa
Full Professor Accounting Department of the University of Navarra and IESE Business School.
Last September, the IMF published its Global Debt Monitor, which showed that global debt in 2022 has been reduced by 10 percentage points of global GDP, from 248.1% to 238.1%. This represents a global debt level of $235 trillion. In the last two years, 2021 and 2022, global debt has been reduced by 20 percentage points, representing 66% of the large debt wave that occurred during the pandemic.
Private debt accounts for 146% of global GDPand is now virtually at pre-pandemic levels. However, public debt is at 92.4% of global GDP after two years of reduction, but is still above its 2019 level of 84.9%.
It is the more developed economies that are more indebted, since creditors have more confidence in their institutions and in the fulfillment of their commitments. A high level of debt increases the vulnerability of countries, companies and households in times of crisis, since the same level of debt is not interpreted in the same way when there is economic growth as when there is a recession. A high level of debt requires economic growth to be sustainable.
If we look at the evolution of the interest rate curve in the United States, it can be seen that since November 2022 investors are demanding higher subject interest on three-month Treasury bills than on the 10-year bond, which means that investors are wary of the short deadline and are predicting bad expectations. The Federal reservation Bank of New York publishes recession probabilities based on the yield curve, since empirically it has been an excellent leading indicator of future economic activity. It currently estimates that the probability of the U.S. being in recession by the end of January 2024 is 57.13%, and by the end of May 2024 it estimates a probability of 70.85%.
Faced with these expectations, investors and creditors are raising the level of monitoring of corporate debt, and are once again becoming more skeptical about companies' business plans and the financial sustainability of the debt of those companies that exceed certain thresholds.
One of the usual ratios, among others, used by the market to assess whether debt is sustainable is the net financial debt to ebitda ratio. High values of the ratio correspond to debt sustainability problems and low values indicate a high operating capacity to repay the net financial debt. This ratio depends on the sector, given the different optimal capital Structures at sector level, but in bank loan contracts, on average, it is usually used as a commitment (covenant) that the business or the group to which it belongs does not exceed 4, and if it does, the creditor can apply for the early repayment. This is a mechanism for the creditor to discipline the debtor.
The ratio in the industrial sector, with information available on companies listed on database Capital IQ globally, is currently 2.2, having been 4.4 during the pandemic and 2.7 in 2019. Therefore, it appears that the industrial sector has managed to reduce debt post-pandemic. However, in consumer companies such as fast food, entertainment, appliances, furniture, hotels, travel and cars, among others, that ratio rose to 5.2 in 2020 and is currently at 4.2, but still above the 3.4 they had before the pandemic, in 2019. If we take into account that the ratio has not fallen to pre-pandemic levels, that it is a procyclical sector and that part of household consumption is financed with debt, we can deduce that a change of cycle would put companies in this sector in difficulty.
On the other hand, we have the water, electricity and gas companies that did not need to take on debt in the pandemic, but with the investment opportunities that have arisen in this sector after the pandemic, their ratio has grown from 2.8 to 4.8, which increases their vulnerability if the prices of their services fall in the future.
A weaker status , given their greater financial constraints, can be found in medium and small companies that have not been able to refund the increase in debt derived from the status pandemic. If the recession crystallizes, a high ratio increases the vulnerability of business and puts employment at risk.
With the current expectations, companies have to maintain liquidity in order not to be vulnerable, knowing that amortizing debt in this status does not give you financial flexibility, since it does not assure you future banking credit . It is very important to anticipate the status and take corrective measures before it is too late and the ability to maneuver is less.