Incentivizing private investors to contribute equity mitigates moral hazard. Involving banks, which know their clients and routinely assess business plans, is an important principle that can help address adverse selection. Another difficulty is how to ensure that the private sector does its part. Mechanisms that target firms more accurately are likely to be more complicated, reducing take-up and timeliness of the aid. Targeting support-something that is hard to do-will be critical to avoid wasting taxpayers’ money and should be improved. This will involve avoiding that public support is more attractive for bad than good firms-adverse selection-and preventing firms from mismanaging their business once they have received state support-moral hazard. The public sector is not well placed to assess the viability of a large number of small businesses nor to monitor their performance. Individual countries are coming up with innovative equity programs, but they face many implementation challenges. Policymakers will have to move the dial from debt-increasing liquidity support to more equity support for those firms that have good prospects after the pandemic. Liquidity support cannot address equity shortfalls. Both private and public sector action is required. About 2 to 3 percent of GDP will be needed to close the equity gap and provide firms sufficient equity so they would no longer be in difficulty, focusing only on the firms that were solvent before COVID-19. Without additional equity support, some 15 million jobs are at risk. Equity shortfalls are largest for micro firms and small businesses, with current policies absorbing only one quarter of the equity gaps versus over two fifths for larger corporations. Even with this scale of support, the share of insolvent firms as a share of total firms is estimated to have increased by 6 percentage points. Public support so far is estimated to have filled 60 percent of European firms’ liquidity needs because of the COVID-19 shock, but only 30 percent of the equity shortfalls (the extent to which firms’ debt exceeds their assets). In a recent IMF staff study (see presentation here), which covers 26 European countries (of which 21 are EU members), we estimate that without policy support, the share of illiquid firms in Europe would have more than doubled and that of insolvent firms would have almost doubled by end-2020.īut many companies are still short of equity It allowed banks to extend loans rather than amplify the downturn by adding a credit crunch. Liquidity (ready cash) provided to companies prevented cascading bankruptcies. With containment measures preventing many firms from operating at full capacity or at all, government support programs-such as job retention schemes, which at their peak benefitted 54 million people-have been essential for businesses and people to survive. Europe now needs to gradually change the support to firms from providing liquidity toward strengthening their equity.Īlmost a year into the pandemic, many European companies, especially micro and small enterprises in high-contact sectors, continue to reel from the shock of COVID-19.
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