[The Editors' Verdict]Surging Zombie Companies: The Government's Choice

Kim Kyung-soo, Professor Emeritus at Sungkyunkwan University

Last month, the Financial Times (FT) introduced the results of a survey conducted by Oxford Economics targeting global companies. The biggest risk currently related to the novel coronavirus infection (COVID-19) is not a second pandemic (global outbreak) but the possibility of a financial crisis (20% chance within two years), and concerns about this are the key factor dampening corporate sentiment.

Financial crises typically occur during the boom-bust (overheating and bursting) cycle caused by credit cycles, but the likelihood is currently low. This is because regulations on the soundness of banks, the core of the financial system, have been significantly strengthened over the past decade. Rather, bank soundness regulations have shrunk proprietary (Prop) trading, causing banks to fail to properly perform their role as market makers, resulting in increased volatility in the repurchase agreement market and foreign exchange market. By imposing strong regulations on banks while leaving non-banks unchanged, the financial market has been distorted as a result.

In response to the COVID-19 pandemic, central banks worldwide, from the United States to Indonesia, have injected massive amounts of liquidity. Charlie Munger, Vice Chairman of Berkshire Hathaway, who made significant profits from large corporations in urgent need of cash during the 2008 crisis, lamented that he never received a single phone call. It is difficult to find large corporations in crisis due to lack of liquidity.

Instead, bankruptcy risks caused by companies whose debt exceeds assets due to blocked cash flow are surfacing. Even before the pandemic, the global economy was already showing a downward trend and corporate debt was increasing. According to the Bank for International Settlements (BIS), as of the end of March this year, the non-financial corporate debt of China (159% of GDP), Korea (105%), and the United States (78%) is at the highest level in the 21st century. Professor Edward Altman, who devised the Z-score, a financial soundness indicator for companies, predicted that a large wave of bankruptcies among U.S. companies, delayed by liquidity support, is imminent. In response to the increase in corporate defaults, banks can tighten credit regardless of the central bank's ultra-loose monetary policy stance. If corporate cash flow does not normalize at this time, the credit market will experience chronic stress and financial instability will worsen.

Recently, the Bank of Korea released data analyzing marginal companies (among approximately 23,500 externally audited companies, those with operating profit less than interest expenses for three consecutive years). Last year, marginal companies increased in wholesale and retail, automobile, electrical and electronics, and construction industries, reaching the highest level since statistics began in 2010 (14.8% of all companies).

The report also revealed that loans to marginal companies significantly decreased in the first half of this year. While the probability of default is expected to rise sharply due to declining sales, the proportion of marginal companies is expected to increase to over 21%, and their share of credit to over 22%. This suggests the possibility of financial instability if the real economy's recovery is delayed.

The Economist reported last March that measures taken by the German government to prevent corporate bankruptcies for employment stability resulted in better macroeconomic outcomes (unemployment and consumer spending) than other European Union (EU) member states, but also produced zombie companies dependent solely on government support, with one in six companies now at risk of becoming zombies. If true, the cost of stability is too high. Zombie companies surviving on credit and government support may have helped prevent bank failures and maintain employment, but on the other hand, they disrupted the corporate ecosystem and were the fundamental cause of Japan’s "Lost Decade" in the 1990s, The Economist assessed.

Although Korea has not suffered direct damage, the economic losses cannot be underestimated. This is because the Korean economy was already vulnerable when it faced the COVID-19 pandemic, as revealed by BIS data. When today’s and future stability conflict, it remains to be seen what choices the government will make.

Kyungsoo Kim, Professor Emeritus, Sungkyunkwan University

This content was produced with the assistance of AI translation services.