Certain companies are at risk of becoming insolvent as governments lift the pedal on fiscal support, a former member of the European Central Bank warned Tuesday.
Many governments have deployed massive fiscal stimulus to mitigate the economic fallout from Covid-19. In most cases, this has allowed firms to avoid bankruptcy and employees to have a job to return to once lockdowns are lifted. However, as this fiscal stimulus eases and without a fully-open economy, some companies will struggle to keep their doors open.
“When it comes to corporate solvency, trouble is ahead of us,” Benoit Coeure, who is now head of the Bank for International Settlements (BIS) Innovation Hub, told CNBC’s Karen Tso.
“We are going to see what are the underlying issues as governments gradually withdraw their support,” Coeure added.
In a report out Tuesday, the BIS warned that there are underlying financial fragilities despite some confidence among market participants in recent weeks regarding the reopening of many economies.
“A wave of downgrades has started, alongside concerns that losses might cause widespread defaults,” the BIS said in its annual economic report.
ECB President Christine Lagarde said Friday that the recovery “is going to be incomplete and might be transformational” as some businesses will struggle to survive and adapt to a new reality. On the other hand, she also said that other firms will emerge to address a changed reality.
Speaking to CNBC, Coeure said that addressing corporate solvency is a matter for national governments and not central banks.
“Maybe the challenge for central banks is to make sure that liquidity support … doesn’t move into solvency support, which is a fiscal function. So whenever needed, we need governments to be on top of this, not central banks,” he said.
Central bankers were very quick to respond to the crisis and ahead government action. In the U.S., for example, the Federal Reserve cut interest rates in the space of about two weeks in March. In Europe, the ECB designed a new quantitative easing program to keep borrowing costs low.
“There is a risk of what economists call fiscal dominance that is fiscal policy taking over monetary policy, there is also a risk of financial dominance that is central banks being too shy, because they fear they would harm markets or they would harm banks, and here you need safeguards. But the safeguards are very clear — that’s sustainable public finances and that’s good bank supervision and market supervision,” Coeure said.
However, as some countries reopen their economies, analysts have started considering what the recovery phase will look like, with some still expecting a V-shaped recovery.
Coeure said “it is clearly too early to tell how the recovery would look like,” warning that the Covid-19 crisis “could leave lasting scars.”