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Two senior S&P Global Ratings analysts explain why fears of a wave of sovereign, corporate, and household defaults and bankruptcies are overblown

Two senior S&P Global Ratings analysts explain why fears of a wave of sovereign, corporate, and household defaults and bankruptcies are overblown

By Terry Chan and Alexandra Dimitrijevic*

As countries, companies, and households confront the COVID-19 pandemic’s economic fallout, many market watchers are sounding the alarm about rapidly rising leverage worldwide. And for good reason: in an acceleration of a years-long trend, the debt-to-GDP ratio among these three sets of borrowers is set to swell by 14% this year, to a record 265%. But while this has raised the risk of insolvencies and defaults, particularly among corporations, S&P Global Ratings believes a near-term debt crisis is unlikely.

Given the higher leverage and a challenging operating environment, S&P has downgraded the credit ratings of roughly one-fifth of corporate and sovereign debt issuers globally, especially speculative-grade borrowers and those suffering the most from COVID-19’s economic effects. For corporate borrowers, insolvency risks are likely to increase if cash flows and earnings do not return to pre-pandemic trend levels before extraordinary fiscal stimulus is withdrawn.

In our view, the world is likely to experience a gradual, albeit choppy, economic recovery, assuming that accommodative financing conditions are maintained, in a lower for longer environment, and adjustments to spending and borrowing behaviour are made. Add to that a widely available COVID-19 vaccine by mid-2021, and global leverage should flatten out around 2023, with governments scaling back stimulus, firms slowly repairing their balance sheets, and households spending more conservatively.

But absolute debt levels are only part of the story. We must also – and more importantly – consider borrowers’ ability to repay. Today, unprecedented fiscal and monetary stimulus is keeping the liquidity tap open for firms through bond markets and bank loans. Borrowing costs are very favourable, and appear likely to remain so for a long time: we expect benchmark interest rates to remain historically low into 2023. Meanwhile, credit spreads have tightened from their March peak; as it stands, they are more sensitive to business-specific risks than market risks, particularly for the lowest-quality borrowers.

For the most part, the increased debt is intended to help create conditions for an economic recovery that improves borrowers’ future ability to repay. This is especially true for sovereigns, whose fiscal-stimulus measures aim to reduce the pandemic’s economic impact.

All sovereigns will emerge from the pandemic with a larger stock of debt. The most developed economies are likely to bear the largest share of increases. However, they are largely wealthy, with strong financial markets and substantial monetary flexibility, allowing them to sustain their overall creditworthiness thus far.

We assume that governments will reverse the trajectory of fiscal deficits as economies recover, stabilising debt dynamics. So far, S&P has not lowered the ratings of any G7 country. Speculative-grade sovereigns are more vulnerable to downgrades, given their inherently weaker finances and higher susceptibility to shocks. Most of the negative sovereign ratings actions over the last few months have been in this category.

For all sovereigns, much will depend over the next year on how the new debt is used. If it finances productive activity, boosts national income, and increases government revenues, it will ultimately be supportive of debt sustainability and current ratings levels. But if the economic recovery drags on for longer than expected, or if governments are unable to consolidate fiscal results towards pre-pandemic levels, negative pressure on the ratings will increase.

As for business, many large companies have so far used the proceeds from their newly acquired debt to add cash to their balance sheets as precautionary reserves or to refinance their existing liabilities. Overall, we estimate that US investment-grade nonfinancial firms have kept about three-quarters of the money they borrowed in the first half of 2020 on their balance sheets. In Europe, that figure is just over 50%.

This is not the case for firms at the lower end of the ratings scale or for small and medium-size companies, especially in the industries that have been directly affected by social-distancing rules and the pandemic-induced recession. Fighting to survive, they are borrowing to cover income shortfalls and working capital needs.

For households, the increase in the debt ratio has been driven in part by the decline in GDP. Households often take on more debt soon after facing income loss. But, in past downturns, households have soon adjusted to more conservative spending patterns, slowing down debt growth. Based on those experiences, we forecast that, after some incremental improvements next year, the global household debt-to-GDP ratio will stabilise around 66% at the end of 2023.

Of course, the shape of the post-pandemic recovery will affect how much and how quickly these three groups of borrowers can trim debt. In many cases, debt ratios will flatten only as a result of a GDP recovery, rather than a decrease in debt. And several factors – including additional waves of COVID-19, a delayed vaccine, increased interest rates, a sustained dramatic widening of credit spreads, continued debt growth, or a disappointing rebound in demand – could turn the recession into a W-shaped one.

Even if the recovery unfolds as expected, there will be no shortage of economic pain. Some sectors are running well below capacity, straining firms’ survival prospects and, by extension, employment and credit outcomes. As a result, the short-term outlook remains worrying, particularly for borrowers at the lower end of the credit scale or in vulnerable industries. Nonetheless, we can take some comfort from the analysis that a large-scale debt crisis may not be nearly as likely as many fear.


Terry Chan is Senior Research Fellow of Credit Research for the Asia-Pacific at S&P Global Ratings. Alexandra Dimitrijevic is Global Head of Research at S&P Global Ratings. Copyright: Project Syndicate, 2020, published here with permission.

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19 Comments

22
up

Can't trust anything S&P says! Six days before Lehman Brothers collapsed in the GFC, Standard & Poor's maintained the firm's investment-grade rating of "A". Take their views with a grain of salt.

The Covid economic crisis and restrictions are decimating businesses on a Global scale. There is no way we will be avoiding mass defaults and insolvencies as there is no quick solution to these Virus issues. Just look at Tourism reliant countries. Fiji, Bali, Hawaii, Thailand, Spain, Italy... All decimated. Look at whats happening to the big cities like London and New York. 49% of small businesses in San Francisco will not be reopening. Just one small piece of data out of a Tsunami of bad data out there on what is unfolding.

I would be surprised if a financial crisis is not sparked from all of this.

Exactly what I thought, as soon as I saw S&P stopped reading.

Credit/Financial crisis, is to be avoided this time - we just simply print more of it, most to the point to just keep the 'safe/secure feeling'; subsidy upon subsidy, deferral upon deferral, QE upon QE, grant upon grant, LSAP, FLP, No LVR, neg OCR. Imagine as the current Pandemic still on going, then suddenly NZ being hit by Tsunami, major earthquake - The steps will be the same, the future different? when eventually it goes to confidence crisis. Those with special skills in Healthcare are already migrate out slowly, NZ is not worth it.

The wave of defaults and bankruptcies coming will most likely be too great for the money printers. They can't print forever without consequences either.

ok, now we have been warned :) - let's see what next week brings (the US elections week btw) Are we expecting USA default this time ?

Default to whom ? You mean default to themselves with money that doesn't actually exist anyway ? So they are currently like $27 trillion dollars in the red but does it really matter ? Just hit the keyboard and make a few trillion more up in bonds. Do not see if it matters if its $50 trillion or even $100 trillion. The world needs to dump the USD as the reserve currency before they panic and with many other currencies already gone down the toilet they are all itching to get their hands on USD. Cannot believe how the USD is holding up, it should be parity with ours by now.

Heard that Zambia has defaulted on its bonds payment so may be the first crack in the dam (Check out 3 Gorges Dam as well - big cracks).

many large companies have so far used the proceeds from their newly acquired debt to add cash to their balance sheets as precautionary reserves or to refinance their existing liabilities. Overall, we estimate that US investment-grade nonfinancial firms have kept about three-quarters of the money they borrowed in the first half of 2020 on their balance sheets

Unbelievable.

households have soon adjusted to more conservative spending patterns,

More unbelievability. Who would possibly have foreseen all of that?

For the most part, the increased debt is intended to help create conditions for an economic recovery that improves borrowers’ future ability to repay. This is especially true for sovereigns, whose fiscal-stimulus measures aim to reduce the pandemic’s economic impact.

Demonstrably not true in New Zealand.

Average GDP growth in world biggest economy since 2009? 1.6% Little less than inflation.
meanwhile, what has debt done in USA?
Of course we are all going to repair our balance sheets.
Corporations have been buy back kings to goose share prices to leverage more on
Now investors in NZ doing it.
Western GDP rates have been at stall speed for over 10 years and debt continues to fail to goose them.
Interest rates no further to cut.
End game approaches. Debt has to be written off in large amounts.
S & P ignore counter party risk and leverage and all off balance chicanery that come to roost when shit hits fan.
Let us see in February when economic pain is max and countries like Argentina start defaulting.

Reminds me of Dec 2004 in Southern Thailand when the sea started receding and many people started joyfully walking towards the water rather than running for their lives. Since they had never experienced anything like it before they could not comprehend the danger.

Spin.

Preceded by panic.

10
up

We’re obviously about to have a debt crisis now that they come out and say this

Reminds me of this old classic https://andersen.sdu.dk/vaerk/hersholt/TheEmperorsNewClothes_e.html

"The swindlers at once asked for more money, more silk and gold thread, to get on with the weaving. But it all went into their pockets. Not a thread went into the looms, though they worked at their weaving as hard as ever."

World wide inept? or savvy? governance and their respective central bank to deal with worldwide pandemic. For much of the time so far, is to incite 'stability' albeit the economic structure lies on unstable structure. The next three years will be interesting times for us, on how to retain peoples 'confidence'. One thing is for sure, by law of nature, physics, economics etc. - When giving out resources, it's always means taking away from others - It is a nice assumptions by all to keep on printing numbers to compete with the same old limited resources, in the hope of just buying time/delaying towards future problems, How every govt can reach those 'balance' is the key here. But we knew the magic bullet for NZ... 'overseas' resources, that seek refuge here.

As far as I can see, the argument of this article is that a debt crisis is impossible because interest rates are so low.
I'm definitely not an economist but... isn't this completely ignoring the possibility that firms, individuals and governments can be *insolvent*? As in, it doesn't matter if you can roll debt over cheaply when everyone knows you have no income? Seems a bit disingenuous to say that's not a 'debt crisis' just because it isn't triggered by high interest rates.

don't worry , you understanding is right, they just try to pull in as many investors in the bubble as possible using all channels, call it bull trap. The more these kind of article you see per/day the closer the end

Old saying - were's there's a tip there's a tap.

Glad to see that many of us can see through the BS spouted by this ratings agency! Just surprised that Interest have printed it!