Europe’s zombie problem has only gotten worse

Good morning and welcome to Europe Express. It is not quite the zombie apocalypse horror fans are accustomed to, but the European Central Bank has some concerns regarding failing companies propped by government aid and cheap loans during the pandemic. We will explore what the warning from Frankfurt means and what can be done to stop the undead from multiplying.

We will also unpack the European Commission’s latest corporate tax agenda and its hopes that international pressure will help get EU ducks in a row — including countries that could readily pull the brakes on legislation.

Meanwhile, migration is creeping back on to the EU agenda, with record daily arrivals in one of Spain’s Moroccan enclaves and on the Italian island of Lampedusa. We will consider what this means for anti-immigration politicians in southern Europe.

Life support for the living dead

Even before the Covid-19 pandemic struck, Europe had thousands of companies that were the financial equivalent of the living dead, being kept alive by low interest rates and plentiful amounts of cheap debt, writes Martin Arnold in Frankfurt. 

The European Central Bank thinks this “zombie” problem has only become worse — partly because of its own actions — as the huge fiscal and monetary policy support launched to prop up the economy gave artificial life-support to many unviable companies.

This was one of the findings of the ECB’s twice-yearly financial stability review, in which the central bank warns of all the things that could threaten the financial system. The main body of the review will be published today, but the section on zombies was pre-released yesterday.

While not quite a mea culpa from the ECB, the bank does acknowledge that flooding the financial system with ultra-cheap money in response to the pandemic was likely to have multiplied the number of zombie companies roaming around the economic landscape.

“Firm-level, loan-level and supervisory data for euro area companies suggest that zombie firms may have temporarily benefited from loan schemes and accommodative credit conditions — but likely only to a modest degree,” the ECB wrote.

Defining a zombie company as one that has sub-zero returns on its assets, a low debt-servicing capacity and a negative net investment rate for more than two consecutive years, the ECB said the number of such companies had declined since the 2012 eurozone debt crisis.

It estimated that the share of total companies that met its definition of zombification had fallen from almost 6 per cent in 2013 to about 3.4 per cent in 2019, still well above the level of about 2 per cent before the 2008 financial crisis.

The economic impact of the pandemic and the policy response may have, at least temporarily, contributed to some degree of zombification

Government loan guarantees, furlough programmes, debt moratoria, tax relief and waivers on the need to file for insolvency in some countries all contributed to a fall in bankruptcies last year — despite a record postwar recession.

The central bank did not put a number on how many extra zombies were created. But it gave an idea, saying that before the pandemic hit, 8 per cent of companies were “quasi zombies”, with high debt levels and weak profitability, even if they were still just about viable.

“Zombification may lead to an inefficient capital allocation, but also poses medium-term risks to the financial system if risks are not properly priced,” the ECB warned.

Governments, it argued, need to shift to more targeted support that focused on saving viable companies — and let the zombies finally die.

Passive-aggressive tax plans

If there is one rule of thumb in the EU, it is that seeking the unanimous agreement needed for taxation matters is likely to be a non-starter. And yet the European Commission yesterday proved it remains undeterred, write Valentina Pop and Sam Fleming in Brussels.

The commission’s latest move was to reboot its long-stalled effort at creating more unified rules for taxing companies across the union, with the proposal of “Business in Europe: Framework for Income Taxation”, or BEFIT. This proposal, which will materialise by 2023, would create a common rule book across member states and a common tax base, reducing compliance costs and tax avoidance.

The effort comes alongside proposals to tackle abuse of shell companies as well as already-mooted plans for a digital tax pencilled in for mid-July. It is all ambitious stuff, but it hinges on unanimous agreement among the bloc’s 27 governments — something that has been decidedly elusive in the past.

That is also true of possible legislation to implement an upcoming international deal on corporate taxation at the OECD — if one happens.

Paolo Gentiloni, economics commissioner, raised hopes yesterday of a political agreement on this front by July. The OECD discussions revolve around two so-called pillars:

1. Redistributing profits of multinational companies so that more jurisdictions can get taxing rights 

2. A minimum tax for large companies. 

The commission is planning to put forward binding legislation on both points in a bid to ensure consistency and faster implementation across the bloc. 

These are bold proposals which suffer from a lack of courage in their enforcement

Experts immediately pointed out the risk that national vetoes could once again undermine attempts to create a fairer tax system across the EU.

One idea floated in response was an article of the EU Treaty that allows the use of majority voting instead. (Read more on what Article 116 is and how it can be used in this FT story from last year). 

“Plans for more tax justice are worth very little if they can be blocked by individual tax havens with a simple veto,” said Sven Giegold, a German Green MEP. “Public coffers are empty. We cannot afford to delay necessary reforms any longer. The commission must now move swiftly to apply Article 116 of the EU Treaty.”

But Gentiloni made it clear yesterday that the commission did not think Article 116 was suitable for its broader tax legislation ambitions, where unanimity must reign. “We need a very strong case of distortion of the single market” to make use of the article, he said. Gentiloni added that Brussels was working on specific cases, but refrained from giving details.

An EU official said earlier that the commission in any case didn’t feel the need to “aggressively push” governments on implementing OECD-inspired legislation, because international pressure, including from the Biden administration, might just do the trick. Definitely, maybe.

Migration is back

Europe’s failure to find a comprehensive solution to the thousands of migrants seeking to reach its territories has been exposed yet again, and could revive the fortunes of anti-immigrant politicians, write Miles Johnson in Rome and Valentina Pop in Brussels.

Spain deployed the army yesterday to secure the border of its north African enclave of Ceuta, after a record of about 6,000 people entered from Morocco on Monday.

In Italy, after a sharp fall during the lockdown period, the number of migrants and refugees arriving is also on the rise. Last week, more than 2,000 migrants arrived in Lampedusa, a small island off the coast of Sicily, in a 24-hour period — a level not seen since before the pandemic.

In Brussels, officials are trying to revive an ad hoc redistribution scheme. Ireland yesterday offered to take 10 refugees from Lampedusa, but sceptics such as Austria are unwilling to be moved on the issue.

“Austria is steering a very clear course: a distribution [of migrants] all over Europe is not an approach that will bring a solution,” Austrian EU affairs minister Karoline Edtstadler said in Brussels last week.

What will this mean for local politics?

In Spain, anti-immigrant opposition party Vox, which has been growing in popularity and is expected to join the local government in Madrid, immediately dispatched its leader Santiago Abascal to Ceuta late on Monday to criticise the alleged inaction of the Socialist government.

In Italy, Matteo Salvini could soon revive his recipe of daily Facebook tirades about illegal migrants arriving in Lampedusa. In the past, such diatribes have pushed his League party from polling in the low single digits to a point where he looked like a favourite to become prime minister.

Even though he changed tack during the pandemic and threw his fortunes in with Mario Draghi’s moderate national unity government, the old Salvini could return soon.

Meanwhile, his rising rival on the right, Giorgia Meloni, is picking up the anti-immigrant rhetoric baton. In the wake of the record arrivals in Lampedusa, Meloni has called on the government to put up a naval blockade. — exactly the kind of ideas Salvini used to put forward.

All attention in Italy and Europe has understandably been on the pandemic and EU recovery spending. The migration crisis of six years ago seems a long time ago. But the issue may again become the battleground that shapes the direction of politics in southern Europe.

Chart du jour: Airbus’s size advantage

European aviation company Airbus could beat out US rival Boeing as travel starts to reboot. New versions of smaller Airbus planes could prove more popular than Boeing’s larger jets for low-cost carriers on Atlantic routes. (More details here)

Three things to watch today

1. The European Central Bank publishes its financial stability review

2. European Commission vice-president Valdis Dombrovskis takes questions from MEPs on vaccine production and patent waivers

3. US secretary of state Antony Blinken meets Russian foreign minister Sergei Lavrov in Iceland

Notable, Quotable

They [regulators] are not keeping up with these fast-moving, innovative businesses

• EU politicians have piled blame on Lithuania for its lax financial oversight after the FT revealed a fintech company in the Baltic country funnelled millions of euros out of Wirecard before it collapsed last year.

• A report has shown that some Dutch municipalities have been spying on citizens to predict riots, supposedly without realising that doing so was illegal. (De Volkskrant)

• Former Romanian Social Democrat leader Liviu Dragnea, currently imprisoned for corruption, faces new charges for paying political favours to a businessman who secured him an invite to former president Donald Trump’s inauguration. (Balkan Insight)

• Andrea Orcel, one of Europe’s most influential bankers, is set to take on behemoth Santander in court today over his rescinded job offer to lead the bank. (Bloomberg)

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