Corporate Balance Sheets and Macroeconomic Policy

• Author: Dale F. Gray and Mark R. Stone
• Position: Formerly with the IMF's European II and Fiscal Affairs Departments/Senior Economist in the IMF's Asia and Pacific Department

The relationship between corporate balance sheets and a country's macroeconomy is receiving increased attention from policymakers in many countries, especially those most affected by the Asian crisis. How can policymakers assess problems in the corporate sector and prevent or ameliorate crises?

Traditionally, central banks and finance ministries have set their sights mainly on macroeconomic indicators and, to a lesser extent, on the financial sector. Today, new challenges to macroeconomic and structural policies are being posed in many countries by the combination of heavily indebted corporations and volatile capital flows, and by corporate restructuring. What analytical and operational tools can policymakers use to gauge the dimensions of the corporate sector problems that their countries face and, where necessary, to devise appropriate policies to prevent crises or resolve problems following them?

The links

The links between the corporate sector and the macroeconomy are two-way. First, macroeconomic developments can affect the health of the corporate sector, especially if corporations are highly leveraged (that is, if they carry large amounts of debt relative to equity) and do business in an environment that does not promote sound corporate governance.

* Changes in world interest rates and country risk premiums can sharply alter the cost of borrowing for corporations burdened by foreign debt.

* Rapid exchange rate depreciation can increase the debt-servicing costs of firms with large foreign debts, destabilize the corporate sector, and even threaten the viability of many firms.

* A high level of short-term corporate debt denominated in foreign currency increases the vulnerability of the macroeconomy to exchange rate depreciation and sudden capital outflows.

* The adverse impact of tight monetary policy and high interest rates on domestic demand and bank lending, which have been used to stem rapid exchange rate depreciation, is amplified by high corporate debt and can therefore worsen the corporate sector's financial situation.

Second, the corporate sector can affect the macroeconomy through the following links:

* The restructuring of overleveraged corporations struggling to stay afloat financially can magnify an economic downturn by triggering the rapid disposal of assets at "fire-sale" prices and prompting large investment contractions. In post-crisis Asia, the contribution of investment to real GDP in the highly leveraged countries is negative and very large (Table 1).

* A squeeze on credit to corporations arising from a shortfall of bank capital can force governments to divert their fiscal resources to bank recapitalization.

* If the corporate sector is tipped into insolvency, lower investment and the prolonged period needed for corporate restructuring can significantly impair growth.

[ SEE THE GRAPHIC AT THE ATTACHED RTF ]

Analytical approaches

Before the Asian crisis, analysis of the...