Illusion of stability: ‘Companies would constantly be expecting that their counterparty is actually insolvent,’ said FDP MP Stephan Thomae © Markus Schreiber/AP

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Concern is growing in Germany that a rule introduced as a part of the country’s emergency response to coronavirus is fuelling the creation of thousands of so-called zombie firms that could end up sapping the economy for years to come.

Under a government waiver introduced in March, German companies adversely affected by the pandemic do not have to file for insolvency. The rule was supposed to be phased out at the end of September, but justice minister Christine Lambrecht wants to extend it until next March.

The idea has proven controversial, however, with many saying it would be better to let weak companies go to the wall than keep them on artificial life-support. 

Jan-Marco Luczak, legal spokesman for Angela Merkel’s CDU/CSU, said the waiver was helping firms that would be in trouble even without coronavirus.

“It’s inappropriate to continue to hold the protective hand of the state over such companies,” he said. “That is neither in the interests of all other market participants, nor . . . of a company’s creditors.”

Chart showing how reduction in insolvencies in Europe fell during the pandemic

Zombie companies are those that are unable, in the long-term, to cover their debt-servicing costs from profits. The number of such “living dead” firms rose strongly in the decade after the financial crisis, as low interest rates encouraged them to saddle themselves with debt.

But economists fear the problem has been exacerbated by the policy response to coronavirus, which saw governments spend billions on job-retention schemes, cheap loans to struggling companies and bailouts for big firms threatened with bankruptcy.

Advocates of free-market capitalism say keeping companies afloat with government subsidies prevents “creative destruction”, the process described by economist Joseph Schumpeter in which insolvent companies that go belly-up make way for healthier newcomers.

Evidence is emerging that this process has slowed or even stopped in Germany. “Around 550,000 German companies — or about one in six — risk becoming a zombie firm,” said Patrik-Ludwig Hantzsch, head of economic research at Creditreform, a business data company.

Mr Hantzsch said the insolvency waiver had “over-fulfilled” its purpose. “It has created a situation where companies benefit that are not really entitled to — whose business models weren’t working, corona or no corona,” he said.

Experts fear that extending the moratorium will destroy trust in the market. “Companies would constantly be expecting that their counterparty is actually insolvent,” said Stephan Thomae, an MP for the opposition Free Democrats. An extension would “place a huge burden on economic activity”.

That view is supported by business leaders. Henrik Follmann, chief executive of chemicals company Follmann Chemie, said prolonging the waiver “is not a good idea — because trust goes down. You don’t know who you’re dealing with.”

“If a company is in bad financial trouble then there are different ways to save it here in Germany, if it has a good perspective in the future,” said Stefan Wolf, chief executive of car parts maker ElringKlinger. “If you do business with a company that finally goes bankrupt, it is a bad idea.” 

The waiver has already had a marked effect. Germany is experiencing its worst postwar recession, with the economy contracting by more than 10 per cent in the second quarter. Yet despite that, fewer companies are going bust than in normal times. Since the waiver was introduced in March, the number of companies filing for insolvency in local courts fell more than 13 per cent in April year-on-year and by almost 10 per cent in May. The federal statistics agency says it expects a decline of 29.1 per cent in July.

That “seems to suggest that some businesses may be interpreting the economic impact of the pandemic very broadly”, said Stefan Schneider, economist at Deutsche Bank.

The logic of extending the insolvency moratorium is clear: 2021 is an election year, and neither of the government parties — Ms Merkel’s CDU/CSU group or Ms Lambrecht’s Social Democrats — want to see a wave of bankruptcies sweeping over the country just as voters go to the polls, pushing up unemployment and sapping economic growth.

Ms Lambrecht has made clear that the waiver would only be extended for companies that have become “over-indebted” as a result of the coronavirus crisis. “Unlike insolvent companies, over-indebted ones have the chance to permanently avert insolvency,” she said. “These companies should then be able to use the additional time to exhaust all the possibilities for restructuring and refinancing.”

But some fear an extension will simply put off the inevitable wave of bankruptcies. “It is unlikely that all the companies that make use of this waiver possibility will be rescued completely,” said Manfred Stamer, an economist at the trade credit insurer Euler Hermes. “Many of them will fail once the waiver expires.” If the moratorium were extended, more insolvencies would simply be shifted into 2021, he said. 

Mr Schneider of Deutsche is also predicting that the number of businesses going bust will rise sharply after March if the waiver is extended. “But that is not all: there could also be a domino effect as even healthy companies are brought to their knees by mounting defaults of their clients and business partners,” he warned.

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