One of the headaches that governments and central banks have during this coronavirus pandemic is the significant increase in corporate debt. Several businesses have had to borrow to remain in operation. This has happened not just in Malta but also abroad. This increase in debt has come on top of one very important development.

Over the last 10 years, borrowing by the business sector had already increased substantially. This occurred for two reasons. The first is that the financial and economic crisis triggered in 2008, and which continued in subsequent years, had already forced businesses to borrow. A great part of that debt remains unpaid. This may not have occurred in Malta as we managed to weather that international economic recession well.

The second reason is that the loose monetary policy adopted by central banks, with interest rates at all-time lows for quite a long period of time, encouraged businesses to borrow even more. Therefore, when (with the news of the vaccine, it will now become a question of when and not if) the pandemic is brought under control and the new normal evolves, the balance sheet of most businesses may not look so healthy.

This poses a number of challenges to governments, central banks and credit institutions. Three weeks ago I wrote about the new normal for the banking sector. However, this focused more on the banks themselves, rather than the impact of all the credit they have extended over the last years.

Governments, central banks and credit institutions are in a catch-22 situation

On the one hand, businesses cannot continue relying on government support through subsidies or delayed payments  but, on the other hand, many of them cannot survive without such support, at least until their national economy picks up momentum. Again, on the one hand, banks need to protect their balance sheets and the interests of their depositors but, on the other hand, are expected to continue to provide liquidity to economic players.

Until the major economies do pick up momentum, inflation is unlikely to get anywhere the two per cent target set by most central banks. With inflation staying well below two per cent, it is unlikely that interest rates would be increased. Moreover, if there is a credit crunch caused by the banking sector’s exposure to non-performing loans, central banks would need to intervene to provide li­qui­dity. However, there would be a limit to such an intervention.

The increase in public sector debt was welcomed in most countries because of the support that it provided to the economy. There has been talk that this new public debt may not need to be paid back for a number of years. Nevertheless, there will come a time when fiscal policy cannot be as expansionary as it has been in recent months. Yet we know that voters will not accept to bear again the brunt of any austere fiscal policies, as they did at the time of the last international economic recession.

As such, governments, central banks and credit institutions are in a catch-22 situation. The short-term situation requires them to continue supporting businesses directly and indirectly, but the need for sustainability requires them to take a medium- to long-term perspective.

This means that the timing of any decisions is critical. However, the elephant in the room remains the sheer size of corporate debt and its upward trajectory, with little to show for in terms of economic growth.