Rise of Zombie Firms

The term “Zombie Firms” gained importance in media during 2008, for companies receiving bailouts from the US TARP (Troubled Asset Relief Program). It was first applied to Japanese firms when they needed support from Japanese banks after the collapse of the Japanese Asset Price Bubble in 1990s. The period came out be known as ‘Lost Decade’. Weak & failing firms were able to exist or survive only through the support of Japanese banks.

An economy with companies which need bailouts in order to operate or survive, or in other words, an indebted company which is able to repay the interest on its debts but unable to repay the principal. They do generate cash, after covering running costs and few fixed costs like wages, rates and rent, that is, they only have enough funds to service the interest on their loans, but not the debt itself. Banks act as their never- ending life support, for their continued existence. Over an extended period, they are unable to cover debt servicing costs from current profits. Zombies contribute on economic performance as they are less productive and ultimately their presence lowers investment in and employment at more productive firms.

After 2015-16, Chinese Stock Market Crash and the economic downturn in 2016, Chinese industrial companies like steel, aluminium, paper, etc. had developed gross over production capacity problems. National People’s Congress suggested to close or reorganise the state owned or public zombie industrial companies by 2020.

Lack of profitability over a long period of time may lead to a company not able to service its debts. Further, sometimes the young companies may need more time for investment projects to deliver the returned. For this reason only, low expected profitability is important, corporate restructuring or new investments may eventually increase profitability. Alternate way to identify a zombie, if its interest coverage ratio (ICR) has been less than one for at least three consecutive years and if it is at least 10 years old.

Under the so- called “Congestion effects”, Zombies are less productive and may crowd out growth of more productive firms by locking resources, which further leads to depression in prices of those firms’ products & raise their labour cost and their funding costs, by competing for resources. In the short run, less rates boost total demand and raise employment opportunities and investment, but the higher prevalence of zombies they leave behind misallocate resources and weigh on productivity growth. It is widely referred as a ticking time bomb that might trigger the next recession and bear market. According to Bank for International Settlements, 12% of companies across developed markets count as zombie firms, up from 8% in 2008.

Asia’s zombies mostly lie in India, Indonesia and South Korea. Over the period of time, India has emerged as the leader among Asian companies, when talk about zombie companies as per the report by Nikkei Asian Review. As per the report, India held the score with 617 zombies in 2018, followed by other countries like China with 431, South Korea with 371 and Taiwan with 327, whereas Japan has a relatively low number at 109 as Japanese companies tend to have low debt levels. To mark with few in India, many power companies of major conglomerates have loaded up on debt, including Adani Power, a member of Adani Group and Reliance Power, a unit of Reliance ADA Group, as quoted by Nikkei Asian Review.