Debt distress

2 November 2023 by Michael Roberts


Last week, Zambia reached a deal for relief on nearly $4bn owed to private bondholders, raising hopes that a protracted debt restructuring by Africa’s second-largest copper producer was nearing its end. It had taken three years to get a ‘rescheduling’ of the debt. But it has not gone away, it’s just a little smaller and the servicing cost is a little lower.



This is just one example of the increasing rate of debt distress that the poorer countries of the world have got into in the last decade, particularly after the end of the pandemic.

Many of these indebted countries are rich in natural resources and have young labour forces available for work. But they do not prosper because commodity prices for their exports are set for them by the international forces of the multi-nationals and trading Market activities
trading
Buying and selling of financial instruments such as shares, futures, derivatives, options, and warrants conducted in the hope of making a short-term profit.
companies. And world trade growth, particularly in resource commodities Commodities The goods exchanged on the commodities market, traditionally raw materials such as metals and fuels, and cereals. , is now contracting. For example, copper prices are down 25% in the last 12 months.

Debt owed by poor countries to the rich ones has been rising fast.

Even though interest rates Interest rates When A lends money to B, B repays the amount lent by A (the capital) as well as a supplementary sum known as interest, so that A has an interest in agreeing to this financial operation. The interest is determined by the interest rate, which may be high or low. To take a very simple example: if A borrows 100 million dollars for 10 years at a fixed interest rate of 5%, the first year he will repay a tenth of the capital initially borrowed (10 million dollars) plus 5% of the capital owed, i.e. 5 million dollars, that is a total of 15 million dollars. In the second year, he will again repay 10% of the capital borrowed, but the 5% now only applies to the remaining 90 million dollars still due, i.e. 4.5 million dollars, or a total of 14.5 million dollars. And so on, until the tenth year when he will repay the last 10 million dollars, plus 5% of that remaining 10 million dollars, i.e. 0.5 million dollars, giving a total of 10.5 million dollars. Over 10 years, the total amount repaid will come to 127.5 million dollars. The repayment of the capital is not usually made in equal instalments. In the initial years, the repayment concerns mainly the interest, and the proportion of capital repaid increases over the years. In this case, if repayments are stopped, the capital still due is higher…

The nominal interest rate is the rate at which the loan is contracted. The real interest rate is the nominal rate reduced by the rate of inflation.
on borrowing remained relatively low during the 2010s, debt servicing costs also mounted.

And since the global inflationary spike from 2021, interest Interest An amount paid in remuneration of an investment or received by a lender. Interest is calculated on the amount of the capital invested or borrowed, the duration of the operation and the rate that has been set. rates on debt, particularly dollar-denominated debt, have risen sharply and the burden of ‘servicing’ that debt has rocketed.

But it is not just in the so-called Global South that debt distress is rising. In the Global North, both the capitalist sector and governments face rising debt levels and costs in financing that debt.

High interest rates are already starting to batter US companies, in an economy that is doing better than any other major advanced capitalist economy. Charles Schwab estimates that borrowing costs for some firms doubled or nearly tripled in 2023 compared to previous years, taking a heavy toll on corporate balance Balance End of year statement of a company’s assets (what the company possesses) and liabilities (what it owes). In other words, the assets provide information about how the funds collected by the company have been used; and the liabilities, about the origins of those funds. sheets. Effective yields for below-investment grade corporate debt (the debt held by the weakest companies) have soared to 9% this month, according to the ICE BofA US High Yield Yield The income return on an investment. This refers to the interest or dividends received from a security and is usually expressed annually as a percentage based on the investment’s cost, its current market value or its face value. Index. Interest costs at US companies rose by 22% in the first quarter of 2023 compared to a year earlier.

As a result, according to S&P Global, 459 companies have filed for bankruptcy as of the end of August, surpassing the total number of bankruptcy filings recorded in 2021 and 2022.

According to Deutsche Bank, total US loan defaults could rise to 11.3% of outstanding debt, only slightly lower from the all-time-high of 12% seen during the Great Recession.

The concern is that higher rates will start to hit home from 2025 when large swathes of outstanding debt come up for renewal. The chart below shows the debt schedule of the Russell 2000 (the top 2000 companies in the US). As these firms begin to roll over their outstanding debts at significantly higher rates, defaults will pick up.

That brings us back to the so-called ‘zombie’ companies. In several previous posts, I have discussed the rise of these zombies – namely companies that do not get enough profit Profit The positive gain yielded from a company’s activity. Net profit is profit after tax. Distributable profit is the part of the net profit which can be distributed to the shareholders. to service their existing debt and so survive only by borrowing yet more.

BIS Bank for International Settlements
BIS
The BIS is an international organization founded in 1930 charged with fostering international monetary and financial cooperation. It also acts as a bank for central banks. At present, 60 national central banks and the ECB are members.

http://www.bis.org/about/
economists have also discerned a new category of vulnerable companies in the major economies, which they have designated as ‘fallen angels’. These are firms on the cusp of losing their ‘investment-grade’ credit status because they have accumulated more debt than they can handle. So they are vulnerable to ‘downgrades’ in their credit status, which would sharply raise their debt servicing costs.

Estimates of zombification vary. Goldman Sachs reckoned that 13% of US-listed companies “could be considered” zombies. But the Federal Reserve FED
Federal Reserve
Officially, Federal Reserve System, is the United States’ central bank created in 1913 by the ’Federal Reserve Act’, also called the ’Owen-Glass Act’, after a series of banking crises, particularly the ’Bank Panic’ of 1907.

FED – decentralized central bank : http://www.federalreserve.gov/
found that only roughly 10% of public firms were zombie companies in 2019 using slightly more rigorous criteria. Alternatively, Deutsche Bank found that over 25% of US companies were zombies in 2020 a rise from 6% in 2000. A recent study of 4.5 million company records by Kearney from around 70,000 listed companies from 154 industries and 152 countries found that the number of zombie businesses had risen by 10% since 2021 to almost 2,000 (that would be just 3%).

If corporate defaults rise, then this will put renewed pressure on the creditors, namely the banks. There has already been a banking crisis last March that led to several small banks going under and the rest bailed out by over $100bn of emergency funding by government regulators. I have already highlighted the hidden danger of credit held by so-called ‘shadow banks’, non-banking institutions that have lent large amounts for speculative financial investments.

And it is not just the corporate sector that is coming under debt servicing pressure. So is the public sector. The US government has spent $659billion so far this year paying off the interest on its debt, as the Federal Reserve’s rate hikes dramatically raised the federal government’s cost of borrowing. It’s this slow-burn rise in debt costs and the high rate of interest on government bonds that has led to US stock market investors to start to sell. The US stock market has fallen over 10% in the last few months as the cost of borrowing has risen.

What can be done? The official answer was provided by Gita Gopinath, deputy MD at the IMF IMF
International Monetary Fund
Along with the World Bank, the IMF was founded on the day the Bretton Woods Agreements were signed. Its first mission was to support the new system of standard exchange rates.

When the Bretton Wood fixed rates system came to an end in 1971, the main function of the IMF became that of being both policeman and fireman for global capital: it acts as policeman when it enforces its Structural Adjustment Policies and as fireman when it steps in to help out governments in risk of defaulting on debt repayments.

As for the World Bank, a weighted voting system operates: depending on the amount paid as contribution by each member state. 85% of the votes is required to modify the IMF Charter (which means that the USA with 17,68% % of the votes has a de facto veto on any change).

The institution is dominated by five countries: the United States (16,74%), Japan (6,23%), Germany (5,81%), France (4,29%) and the UK (4,29%).
The other 183 member countries are divided into groups led by one country. The most important one (6,57% of the votes) is led by Belgium. The least important group of countries (1,55% of the votes) is led by Gabon and brings together African countries.

http://imf.org
, in a recent article in the FT. Debt must be reduced, central banks must keep interest rates up (‘tight monetary policy’) and governments must reduce deficits (fiscal austerity).

Gopinath: “With record-high debt levels, higher for longer interest rates, and growth prospects at their weakest in two decades, restraint is required — even for reserve currency issuers. Indeed, the US has some of the largest deficits, at 8 per cent this year and expected to average 7 per cent over the next few years. At these rates, general government net interest payments in the US would grow from 8 per cent of revenues ($486bn) in 2019 to 12 per cent ($1.27tn) in 2028. Given the centrality of the US to global financing conditions, putting its fiscal house in order is paramount — for itself and others, who are getting hit by rising rates and weaker currencies.”

And how is this to be done? Well, “entitlement reforms are inescapable” says Gopinath. That means raising retirement pension contributions and the age threshold; and cutting public services. “Many EMDEs need to reduce the footprint of state-owned enterprises, which strain the public purse and often fail to deliver effectively.” That means privatisation. And “we need to be candid: for many industrial policies, these conditions are simply not met.” That means productive development must be sacrificed for fiscal and monetary probity. Gopinath claimed that putting “fiscal houses in order is essential to ensure governments can deliver for their people.”

But is this not the wrong way round? If there were planned investment in productive sectors and government services globally, economic growth would rise, our ‘fiscal house’ would then be in order and debt distress would disappear.


Michael Roberts

worked in the City of London as an economist for over 40 years. He has closely observed the machinations of global capitalism from within the dragon’s den. At the same time, he was a political activist in the labour movement for decades. Since retiring, he has written several books. The Great Recession – a Marxist view (2009); The Long Depression (2016); Marx 200: a review of Marx’s economics (2018): and jointly with Guglielmo Carchedi as editors of World in Crisis (2018). He has published numerous papers in various academic economic journals and articles in leftist publications.
He blogs at thenextrecession.wordpress.com

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