As countries, businesses and households grapple with the economic fallout from the COVID-19 pandemic, many market watchers are sounding the alarm bells about the rapid rise in global debt. And for good reason: in an acceleration of a trend of several years, the debt-to-GDP ratio of these three groups of borrowers is expected to swell by 14% this year, reaching a record 265%. But while this has increased the risk of insolvency and default, especially among businesses, S&P Global Ratings believes a short-term debt crisis is unlikely.
Given the higher leverage and a challenging operating environment, S&P downgraded the credit ratings of approximately one-fifth of the world’s corporate and sovereign debt issuers, particularly speculative-grade borrowers and those who suffer the most from the economic effects of COVID-19. For corporate borrowers, insolvency risks are likely to increase if cash flow and profits do not return to pre-pandemic trend levels before the extraordinary fiscal stimulus measures are withdrawn.
In our view, the world is likely to experience a gradual, albeit choppy, economic recovery, assuming accommodative financing conditions are maintained, in a lower environment for longer, and adjustments are made to spending and borrowing behavior. . Add to that a widely available COVID-19 vaccine by mid-2021, and global leverage is expected to flatten around 2023, as governments slash stimulus, businesses slowly mending their balance sheets, and households spending. more carefully.
But absolute debt levels are only part of the story. We must also – and above all – consider the repayment capacity of borrowers. Today, unprecedented fiscal and monetary stimulus are keeping the liquidity tap open to businesses through bond markets and bank loans. Borrowing costs are very favorable and look set to stay that way for a long time to come: we expect benchmark interest rates to remain historically low until 2023. At the same time, credit spreads have tightened since their peak in March; as they stand, they are more sensitive to the risks specific to the company than to market risks, in particular for lower quality borrowers.
Essentially, the increase in debt aims to help create the conditions for an economic recovery that improves borrowers’ future repayment capacity. This is especially true for sovereigns, whose fiscal stimulus measures aim to reduce the economic impact of the pandemic.
All sovereigns will emerge from the pandemic with a larger stock of debt. The more developed economies are expected to bear the bulk of the increases. However, they are largely wealthy, with strong financial markets and substantial monetary flexibility, which allows them to maintain their overall creditworthiness so far.
We assume that governments will reverse the trajectory of budget deficits as economies recover, stabilizing debt dynamics. So far, S&P has not lowered the ratings of any G7 country. Speculative grade sovereigns are more vulnerable to downgrades, given their inherently weaker finances and greater sensitivity to shocks. Most stocks with negative sovereign ratings in recent months have been in this category.
For all sovereigns, a lot will depend next year on how the new debt is used. If it finances productive activity, increases national income, and increases government revenue, it will ultimately support debt sustainability and current rating levels. But if the economic recovery continues for longer than expected, or if governments are unable to consolidate fiscal performance to pre-pandemic levels, the negative pressure on ratings will increase.
As for companies, many large companies have so far used the proceeds of their newly acquired debt to add liquidity to their balance sheets as precautionary reserves or to refinance their existing liabilities. Overall, we estimate that premium U.S. non-financial firms kept about three-quarters of the money they borrowed in the first half of 2020 on their balance sheets. In Europe, this figure is just over 50%.
This is not the case for companies at the bottom of the rating scale or for small and medium-sized businesses, especially in sectors that have been directly affected by social distancing rules and the pandemic-induced recession. . Struggling to survive, they borrow to cover shortfalls and working capital needs.