Abstract
This paper examines the risks associated with an increase in non-financial corporate debt. It breaks down the sustainability of debt by sector and their resilience to financial shocks along standard sustainability metrics and improved measures of leverage that take into account the composition of debt. In doing so, it hopes to provide different parameters for authorities to create macroprudential policy.
The IMF’s April 2019, World Economic Outlook has highlighted concerns about the sustainability of the world’s non-financial corporate debt burden and its sustainability in the event of a major financial shock. The IMF’s warning comes on the heels of dramatic growth in corporate leverage in major global economies, with the United States and China especially vulnerable to debt-driven deleveraging in the corporate sector in the event of a major slowdown. Indeed, in the United States, the corporate debt to GDP level is well above 100% while in China and Europe it is above 150%.
While private debt to GDP ratios are an important indicator of financial stability, it cannot paint a full picture of the risks to a system. What is required is an alternative set of evaluations that presents us with a granular picture of sectoral indebtedness and can provide regulators a deeper understanding of systemic vulnerabilities created by overleveraging. Such a set of metrics would not simply look at debt to GDP as ex-post net variables but examine the gross flows that impact debt sustainability. More specifically, the analysis undertaken by most of the literature on corporate debt depends on a measure of the sustainability of the debt – or the ability of the firm to pay down its debt rather than the leverage embedded in the debt structure – or the immediate need for liquidity in the event of a downturn. This latter measurement is especially important as the 2008 financial crisis has shown us that over-dependence on net measures can blind regulators to global risks associated with particularly systemically important sectors.
This paper will attempt to take a first step toward building such a granular framework by examining the sustainability of American corporate debt through sustainability analysis of nonfinancial corporate sectors. This it argues does not displace but rather compliments traditional measures used by analysts that rely on aggregated and netted metrics. By examining sectoral debt composition based on both dimensions of corporate indebtedness, a mixed picture emerges. While some sectors show more resiliency to a downturn than standard analysis implies, other sectors, particularly within the utilities sector, show far greater exposure to profitability and interest rate shocks than commonly understood. It is important to note that while this paper evaluates the liquidity of non-financial corporate debt sectors in response to adverse events, it does not examine the ultimate holders of this debt and their liquidity requirements. Therefore, it does not provide us with a complete picture of the systemic vulnerabilities presented by these instruments.