A growing number of zombie companies – that are neither flourishing nor dead - as a result of low interest rates, spells bad news for economic growth and productivity.
One in five companies on the S&P 500, are said to be zombie companies, also known as the “living dead”. These are indebted businesses that generate only enough cash to cover their costs and service the interest on their loans, but not to pay off the debt itself.
When interest rates are low these largely inefficient, failing and bloated companies just manage to generate enough revenue to service their debt. A rise in zombie companies in Japan in the late 1990s and early 2000s, when the country’s interest rates had been low for some time, is an example of this.
But economies would be better served if these poor performing companies failed. Creative destruction is the idea that companies that don’t do well should not survive as they are a drag on productivity, a poor allocation of labour and skills, and they stifle innovation.
In this current low interest rate environment, we can expect large companies to keep getting larger – and possibly more inefficient – as they can access cheap and substantial pools or credit to buy small and nimble upcoming competitors.
Under current circumstances, we will see more zombie companies in the United States (US) as borrowing money has never been cheaper. Central banks and governments have pumped money into the financial system and committed to low interest rates for longer to support economies through the impact of the Coronavirus pandemic.
Low interest rates and low credit spreads will result in more corporate zombies surviving than probably should.
The existence of a growing number of zombie companies will deter governments from raising interest rates too much as these companies could not afford to service their debt, which could spark a wave of defaults across economies.
An increase in less efficient companies that do not make way for smaller, more nimble businesses, will be a contributor to lower economic growth. As central banks around the world have committed to lower rates for longer – at least the next couple of years – we can expect economic growth to remain subdued.