COVID-19 will create a new generation of zombie companies, followed by a wave of business defaults, a bank CEO says
- Piyush Gupta, group CEO of Singaporean lender DBS Bank, said that he expects COVID-19 to create a fresh generation of zombie companies, which will be followed by a wave of defaults.
- "Many companies will find that COVID-19 is not just a liquidity problem. It is eventually a solvency problem," he told CNBC.
- Governments around the world, Gupta said, need to decide whether to keep providing support to struggling businesses and risk them turning into zombie firms, or to withdraw support.
- "Do you keep putting money ... using public finances to support companies or do you let creative destruction happen a la Schumpeter?" Gupta asked.
- Gupta was referring to a concept by famed economist Josef Schumpeter who belongs to the school of thought of allowing entities fail to pave the way for the new and improved firms.
COVID-19 could cause a wave of businesses to default over the next two years as government's withdraw their stimulus measures, the CEO of Singaporean lender DBS Bank warned.
In an interview with CNBC's "Managing Asia," Piyush Gupta said: "Many companies will find that COVID-19 is not just a liquidity problem. It is eventually a solvency problem."
Gupta noted that many businesses have taken advantage of huge levels of government support in recent months, but once that support is withdrawn, they may struggle to get back to where they were before the pandemic.
Gupta also said that governments will ultimately need to decide whether to keep on propping up companies by providing stimulus or letting them fail.
"For a lot of companies that are not able to survive when you get to later in this year or next year you have the million dollar question of 'how do you deal with these zombie companies?'" he said.
"Do you keep putting money ... using public finances to support companies or do you let creative destruction happen a la Schumpeter?" Gupta asked.
Gupta was referring to the "creative destruction" concept, created by famed economist Josef Schumpeter, who posited the idea that older companies should be allowed to fail in order to pave the way for new and improved firms.
"I suspect things will be worse than people predict," Gupta concluded.
Gupta said that he thinks the most likely outcome is in line with Schumpeter's thinking, which he said "means that you'll start seeing a lot more default."
"You'll start seeing the problems spill over to the financial sector," he added.
Gupta said his bank has taken "draconian assumptions" at the scale businesses will default so its balance sheet is prepared.
"We think the scale of scope of the problems we may have over next 2 years between 2020 and 2021, could range anywhere between $3-5 billion," Gupta said.
He added: "In a typical year it is about $1 billion. I can see challenges which are 2-3 times which I would normally see."
Gupta also became the latest voice to downplay the suggestion that economies are likely to see a V-shaped recovery, adding that the shape of recovery could be anything in the "alphabet soup."
He said: "It is difficult to [gather] how sharp the recovery will be even 3-4 months into the crisis. A V-shape, an L-shape a U-shape, a W-shape, and because of that is in the hands of health, it is hard to figure out how quickly the recovery will kick in."
Many economists and analysts were banking on a V-shaped recovery earlier in the nascent recovery of the global economy, but this belief has begun to wane particularly in the wake of rising COVID-19 cases across the US.
The US surpassed its biggest single day-rise with more than 75,000 cases reported on Thursday. As recent as June 24 the record was 37,014, and the record has been broken 11 times in the last month alone.
Bank of America said earlier this month the US officially ended its V-shaped recovery and has entered a slower 'healing phase'.