Europe’s Rate of Corporate Deleveraging Slows

The slow fall in European corporate indebtedness since the 2008 financial crisis will probably continue, but economic growth rather than debt repayment will be the main driver according to Fitch Ratings.

The credit ratings agency (CRA) estimates that European corporate net debt/gross domestic product (GDP) had dropped from its 2009 peak of 62.5% to 56.6% by the third quarter of 2014. This was, however, still high both by historical and international standards. US corporate net debt/GDP peaked at 42% in 2008 and fell to 35% at its lowest point.

The annual decline in corporate net debt/GDP slowed to 0.7 percentage points (pp) in 2014 from 2.5pp in 2013. Fitch regards the easing in the pace of corporate deleveraging as mildly positive for the growth outlook in Europe. It provides some immediate support and may also boost future growth potential if it enables corporates to increase investment, which tends to be the most variable component of their spending.

The CRA forecasts corporate financial balances to drop from an average surplus of 1.2% of GDP in 2010-2014 to 0.6% by end-2016. Surpluses allow corporates to make active debt repayments (i.e. pay down their net debt in nominal terms), so this will leave less headroom to do so. Economic growth will be more important in lowering corporate net debt/GDP in the medium term.

Within the aggregate numbers there are variations by country and type of borrower. Europe’s largest economies, with the exception of Spain and the UK, did not see large run-ups in corporate net debt before the crisis. In contrast, some smaller countries such as Portugal and Greece saw large build-ups of indebtedness that have yet to be corrected – in some cases, such as Ireland, this is due to the presence of multinational corporates (MNCs).

It is likely that indebtedness ratios in Portugal will start to fall more rapidly as corporates are no longer running significant deficits and the economy is growing.

A third group, including Spain and the UK, has seen a more pronounced cycle of debt build-up and deleveraging. Active debt repayment has mostly been limited to countries that saw pronounced boom-bust cycles of corporate indebtedness. For many countries in this group, corporate indebtedness was concentrated in the construction and real estate sectors.

Spain’s corporate sector moved from a 10% deficit in 2007 to a large and sustained surplus, which has averaged 2% of GDP over the past five years. The country has seen cumulative active corporate loan repayments worth more than 16% of GDP since 2009. Elsewhere, nominal GDP has been dominant in reducing the net debt ratio, or repayment and growth have both contributed as in the UK.

Spain’s experience illustrates how the greater financing constraints on Europe’s small and medium-sized enterprises (SMEs) have seen them reduce debt faster than larger corporates, which have often been able to substitute bond issuance for bank financing.

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