Guide to Challenges in International Economics

This article is a part of a dossier

An article by: Riccardo Fallico
Miniature depicting a loan of money in the first bank in Genoa (Italy). The British Library (Genoa 1340 ca.)

In the 14th Century, the first “banks” appeared in the Italian cities of Florence, Venice, and Genoa. Already by the early 1500s, it was not unusual for sovereigns and merchants to turn to “bankers” for the financing needed to conduct military campaigns or business promotion. Christopher Columbus, for example, despite the political and economic support of the Spanish crown, had to resort to the Genoese bank Casa delle Compere e dei Banchi di San Giorgio, in which the Spanish sovereigns Ferdinand II of Aragon and Isabella of Castile themselves were clients. Columbus asked to borrow a portion of the amount needed to organize and conduct his voyage that led to the discovery of America. Under agreements between the Genoese navigator and the Spanish crown, Columbus was to personally pay half of the two million maravedis, the Spanish gold currency of the time, needed to finance the outfitting of the caravels. This is just one of many examples showing the very important role of lending in economic development. Over the years, the forms of lending have changed, diversified, and improved to adapt to the financial needs of borrowers. In addition to the issuance of pure bank loans, various forms of commercial loans have emerged, such as the letters of credit. Then came bonds among the financial instruments that gained great economic importance, not only because of their impact on a company’s ability to execute its commercial strategy, but also for their broader impact on the country’s economy.

Bonds and loans among the most common financial instruments

Both bonds and loans are financial instruments with fixed maturities, accrued interest, and requirements that the borrower repay the loan capital in full. Although bonds and loans have common features, as both generate capital, their effects are different. With a bond, the issuer receives money and promises to pay a certain amount of interest in exchange for the investment. Interest is paid at regular intervals set at the beginning of the investment period, and principal is usually repaid in a lump sum at maturity. Principal repayments and interest payments are generally not subject to renegotiation. However, when taking a loan, the borrower agrees to repay the principal plus interest in periodic installments over a certain period. When it comes to repaying loans, there can be a great deal of flexibility, with regard to the borrower’s ability to negotiate terms, payment amount, or timing with the lender. However, the interest rates paid to lenders on loans, due to the great customization of the product depending on customer needs, may in some cases involve higher interest payments compared to those of debt bonds. Moreover, the guarantees that a lender may ask for when giving out a loan may be much more binding and stringent than those that must be provided when issuing bonds. At the same time, a bank loan can be disbursed more quickly. Bond issuance procedures tend to be longer. Companies must first obtain a credit rating from a rating agency and find an underwriter or agent capable of independently placing the bonds on the market to sell them to interested investors.

Catastrophic consequences of the 2007-2009 global financial crisis

Given the lower costs, longer payment intervals, and fewer restrictions, bonds have become a very attractive instrument for companies to raise funds, very often combining them with a bank loan to be able to maximize financial leverage.

However, the catastrophic effects of the 2007-2009 global financial crisis have forced market operators to rethink the consequences that uncontrolled leverage expansion led to. The new imperative was to get out of the “vicious cycle of creating a new debt.” But good intentions have not been followed by concrete changes. According to the International Monetary Fund (IMF), the ratio of global corporate debt, excluding the debts of financial institutions, to global GDP rose from 75% to 98% between the end of 2008 and 2022. In absolute terms, it grew from $45 trillion to $88 trillion. Companies in emerging markets have increased their exposure by 250%, from $9 trillion to nearly $40 trillion of debt. For the most economically developed countries, the average increase was about 35%, rising from $36 trillion to $48 trillion. Looking at the corporate debt of individual nations, China turned out to be the country with the largest increase in its corporate debt over this period, from $4.38 trillion in 2008 to $27.74 trillion at the end of 2022. Among the most economically developed countries, the USA remains first in corporate debt (about $20 trillion), followed by Japan with $5 trillion and Great Britain with $2 trillion. On the other hand, Eurozone companies have accumulated a total debt of $14.63 trillion. Again, according to statistics for the end of 2022, China had a corporate debt to national GDP ratio of 158%, followed by Japan at 118% and the euro zone at 103%. The USA and Britain had 78% and 70% respectively, while the other BRICS countries – Brazil, India, and Russia – were below 72%.

From the perspective of individual companies, data released in March 2023 points to automotive giant Toyota as the company with the largest debt in the world worth $217 billion. Among the non-financial companies with the largest contribution to debt in the automotive industry were Volkswagen ($166 billion) and Ford Motor ($139 billion). U.S. telecommunications companies Verizon Communication ($151 billion), AT&T ($136 billion), and Germany’s Deutsche Telecom ($115 billion) were also present in this special ranking. Finally, also on the list is Electricité de France, a power company with a total accumulated debt of $108 billion. Among financial institutions, Deutsche Bank ($150 billion) and Softbank ($138 billion) were the most indebted.

Quality of corporate debt is a growing concern

While the mass of debt in circulation is very large, even greater concern is raised by the quality of the debt itself, which has deteriorated sharply in the recent past. According to Bank of America (BofA), private company debt created in the last five years alone totaled $1 trillion. Of this amount, 25% are high-yield bonds issued by companies rated below “investment grade,” i.e., at risk of default, and another 35% are syndicated bank loans involving various financial institutions offered to companies that are always rated below “investment grade.” Standard & Poors estimates that the share of bonds categorized as “investment grade” has fallen to about 76% from more than 90% in 2010. Bond issues are defined as speculative when they offer high yields but present an equally high risk of default. In 2023, they are up 53% from 2012 and now represent approximately 9% of the global bond market. According to the same American bank, $400 billion of corporate debt is considered potentially at risk of default, because it will only be refinanced at rates above 10%. However, another $150 billion is already considered to be at serious risk of default, where it is no longer possible to even consider refinancing it.

While alarms have often been sounded in the past that accumulating further debt could be an insurmountable obstacle for companies (as well as governments and households), monetary policies of quantitative easing and low interest rates have encouraged companies to continue building up their financial risks given the relatively low financing costs. However, the situation changed radically when leading central banks began to implement restrictive monetary policies to counteract the rapid rise in inflation rates. Thus, together with the increase in interest rates, the costs of financing and managing already contracted debts have increased and, on the one hand, partly served as a brake on the creation of new debts, but on the other hand, put many companies on the verge of bankruptcy. A study by the consulting firm Kearney, published in October 2022, revealed a rather discouraging situation: the debt of so-called “zombie” companies, i.e., those that require exogenous financial assistance to operate and are unable to repay the sum of their debts, amounted to $400 billion, while their number reached 5% of the total number of companies in the world. The persistence of high interest rates and the unfavorable economic environment hindered the improvement of the economic and financial situation of these companies to the point that in October 2023, statistics even spoke of a worsening situation: in the USA, the total number of “zombies” grew to 10%, while the EU, Italy, Greece, Portugal, and Spain had an average of 10% to 12% of “zombie” companies.

Risk of massive default by private companies is in focus

Due to the difficult financial and economic situation in 2023, the problems of default and ability by private companies to pay their debts have become increasingly important. In July 2023, Bloomberg reported that although the credit crisis at regional American banks in March of that year had been somewhat contained, nearly $600 billion in debt, both in the form of bank loans and bonds, loomed on the horizon, posing a high level of default risk. Real estate ($168 billion), pharmaceuticals ($63 billion), telecommunications ($62 billion), information technology services ($35 billion), and retail ($32 billion) were the industries with the greatest challenges.

According to other statistics published by Reuters at the end of 2023, the most indebted companies in Europe, the Middle East, and Africa had about $500 billion in debt maturing in the first half of 2024. It would have to be refinanced, given the already known difficulties of these same companies in repaying their loans and/or liabilities. Another $1.2 trillion is expected to be paid out by the end of 2025. Given the clearly unfavorable economic and financial circumstances, many market analysts are predicting an increase in insolvencies and bankruptcies. As early as August 2023, the UK Office for National Statistics said it had recorded a 19% increase in company bankruptcies in the UK compared to 2022. A month later, the Wilko store chain, founded in 1930, was forced to declare bankruptcy with outstanding debts of £625 million and the consequent loss of over 12,000 jobs. Even the United States cannot feel confident. In October 2023, Moody’s reported  that $1.87 trillion in American “junk” debt will mature between 2024 and 2028.

These huge masses of debt in circulation have become increasingly difficult to renegotiate and/or refinance to the point where the risk of default by private companies has increased significantly over the past two years. Standard & Poor’s Global Ratings in early 2024 presented statistics on defaults for 2023: 153 cases worldwide, the highest number since 2020, and an 80% increase from 2022. The highest number of cases are in the USA, 96 vs. “only” 37 in 2022, and in Europe, 30 cases vs. 17 in 2022. The hardest hit sectors are telecommunications, consumer goods, pharmaceuticals, and retail. According to Moody’s, the global default rate for companies with speculative ratings could rise to 5.6% in 2024 or even reach 13.7%, under the most pessimistic scenario. When it comes to the number of bankruptcy cases, the figures are even more ruthless: according to the Allianz Global Insolvency Index, the number of bankruptcy cases worldwide grew 21% in 2023 and will jump another 4% in 2024.

Bond market: issuance of high-yield instruments fell to its lowest level

The slowdown in new debt creation was recorded in the bond market, where high-yield bond issuance was slower in 2023 due to very high interest rates. High-yield bond issuance totaled about $90 billion from January through May 2023, the lowest in recent years, according to Reifinitiv, a company controlled by the London Stock Exchange (LSEG) that manages and provides financial data. Investment bank Morgan Stanley, however, has warned market participants in November 2023 that while companies holding high-yield bonds were able to meet their payment terms in 2023, an additional $125 billion worth of bonds must be redeemed in the first six months of 2024. The risk of delinquency increased, as refinancing rates were 120-250 basis points higher than before.

However, as of the second quarter of 2023, some of these concerns appear to have dissipated, as markets began to believe not so much in the global economic recovery, but in the possibility of interest rate cuts by major central banks, primarily by the Federal Reserve (Fed) and the European Central Bank (ECB). Economic and market operators, encouraged by a possible future change in monetary policy, have begun to return to the bond market. Reifinitiv reported that about $60 billion worth of bonds were issued in September 2023 in the United States, the first bond market in the world According to available estimates, 2023 could end with an offering of “investment grade” bonds totaling about $1.23 trillion. While the figure itself is very high, the volume, however, has not reached the 2021 or even 2020 figures of $1.45 trillion and $1.85 trillion respectively. A new surge in corporate debt issuance was also confirmed by BofA analysts in early February 2024. U.S. companies issued $190 billion in bonds in January, with another $160-170 billion expected in February.

Importance of refinement of debt market for global economic development

The liquid debt market can be an important factor in the development and stability of the economy, at least until there is a balance between the debt created and the underlying ability to repay it. These conditions effectively maximize the allocation of financial resources for lenders and equally effectively raise funds for borrowers. However, the policy of quantitative easing and low interest rates led to such a high surplus of cheap money supply that the loan offering mechanism “cracked.” First of all, companies that were already experiencing economic and financial difficulties managed to “survive” by refinancing their debts, essentially only pushing back the time horizon for repayment. In 2010, Moody’s in its report “USA. Speculative grade bank lines of credit maturing between 2011 and 2014: a refinancing wave is coming” threatened a wave of debt refinancing that U.S. companies would face in the wake of the 2008 financial crisis. It warned that sooner or later they will have to deal with the so-called “debt repayment wall,” i.e., the point at which it will no longer be possible to renegotiate terms and refinance existing debts. This has led to the expansion of risky segments of the credit market, which in turn has affected the credit quality of borrowers, underwriting standards, and investor protection. In 2023, the IMF confirmed in its presentation “Do Corporate Bond Shocks Affect Commercial Bank Lending?” that “excess bond premium shocks in the corporate bond market can trigger a reduction in commercial bank lending activity consistent with a tightening of loan supply.”

The imbalance in the debt market was then exacerbated by poor allocation of financial resources, so much so that already in a 2020 report, the Boston Federal Reserve, analyzing the financial health of U.S. companies, excluding financial institutions, revealed how the accumulated financial leverage was not only not generating the profits needed to repay the debt itself, but was becoming a boomerang, hitting the stability of the companies themselves in the event of future economic and financial shocks.


Riccardo Fallico