European companies’ reluctance to borrow in the wake of the financial crisis may restrain investment and demand and lead to a “protracted” period of weak economic growth, the European Commission said.
“Balance-sheet adjustments can have important macroeconomic consequences following periods of corporate over- indebtedness, strong business cycle downturns, stock market declines and losses in potential output,” the European Union’s executive arm said today in a report. “Investment tends to fall during the adjustment phase,” which “reduces domestic demand in the economy and hence slows output growth.”
Companies’ efforts to lower borrowings could take about eight years, the Brussels-based commission said, citing studies of 31 previous episodes. The EU advises governments to resolve remaining problems at banks to prevent a shortage of credit, which may force companies to cut costs and lower their growth.
“Problems related to a lack of liquidity and difficulties in tapping wholesale funding have not disappeared altogether,” the commission said. “Addressing remaining problems in the banking sector is essential for laying a solid foundation for the recovery.”
Small and medium-sized companies should also consider using equity capital to fund investments, the commission said.
“Given that banking crises tend to weigh particularly on smaller companies, for which bank lending is the main source of external funds, measures aimed at facilitating access to equity markets by SME’s would be useful,” the commission said.
The commission on Sept. 13 forecast the region’s economic growth would show a more “moderate” pace in the second half after 1 percent growth in the second quarter. It estimates expansion eased to 0.5 percent in the three months through September and forecasts that it will slow to 0.3 percent in the current quarter.
Europe’s services and manufacturing industries grew at the slowest pace in seven months in September and retail sales unexpectedly declined in August, adding to signs the region’s recovery is losing momentum as governments step up budget cuts. European Central Bank President Jean-Claude Trichet said last month that it’s not time to declare “victory” over the recession.
“The analysis of previous episodes of corporate balance sheet adjustment shows that they have been associated with sizeable negative macroeconomic consequences, including weak GDP growth due to lower investment rates and falls in labor compensation,” the commission said. Cuts in wages “place a drag on disposable income and, ultimately, private consumption,” it said.
Governments should use policies to boost potential growth, the commission said. Companies need better access to equity capital, taking away the need to lower costs by cutting investments and wages, it said.
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