Zombies will prevent interest rates from rising too high

For those who are afraid of zombies, the Bank for International Settlements (BIS) has some bad news: they’re on the rise. What’s more, many people may be working for zombies.

But on the flip side, zombies may spook central banks enough that they don’t raise interest rates too high.

Of course, the BIS is not in the business of chasing the kind of zombie that roars and roams aimlessly, with blood on its face and vacant eyes, in horror films. It is corporate zombies that the BIS has looked at, and it noticed they have risen as interest rates have fallen.

When is a company a zombie? No official definition exists, but zombie firms are those that cannot really afford their debt unless interest rates remain low.

In a paper about the causes and consequences of the rise in zombie companies, the BIS applied two criteria to identify them.

The first criterion is an interest coverage ratio that has been below one for the last three consecutive years in a company that is at least 10 years old. Depending on the sector and the market, young companies need some time to raise their profits and cover their debt servicing.

The second criterion is a low expected future growth potential, which basically means that the zombie’s state is not a temporary one.

The economists created two measures, a more “stringent” one and a more “relaxed” one, to identify zombie firms.

“Both zombie measures suggest that the prevalence of zombies has increased significantly since the 1980s,” the BIS research says.

Zombie firms are on the rise

Zombie firms are on the rise. Source: BIS

Zombie firms’ share increased on average to around 12% of total companies from around 2% in the case of the broad definition of zombie, and to around 6% from 1% in the narrow definition.

But this increase was not gradual. A pattern emerged in which the increase of zombie firms was directly linked to the falls in interest rates. This is logical, after all: if interest rates were to increase, these companies would not have been able to pay their debts at all and would have had to close.

The probability of a zombie remaining in the same state the following year (rather than either recovering, or going bankrupt) has increased to 85% in 2016 from 60% in the late 1980s for the broad measure in the BIS study, and to 70% from 40% for the narrow measure.

“Lower rates boost aggregate demand and raise employment and investment in the short run. But the higher prevalence of zombies they leave behind misallocate resources and weigh on productivity growth,” the BIS researchers warn.

“Should this effect be strong enough to reduce growth, it could even depress interest rates further.”

Zombie firms could yet hinder the central banks’ efforts to bring interest rates back to normal after a decade of “extraordinary” monetary easing. Don’t bank on much higher rates from here, then.