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Zombie firms on the march as rate hikes near: BIS

International markets have been buoyant in recent months as easy money policies won an additional reprieve, but a rise in so-called zombie firms shows a rise in interest rates could turn into a nightmare.

In its latest quarterly economic report, the Bank for International Settlements (BIS) said Sunday that the shift in outlook in monetary policy along with low inflation and economic expansion helped investors adopt a “risk-on” approach.

As investors took on risk by buying equities, markets soared to record highs.

“Despite subdued inflation in advanced economies, the global macro outlook was upbeat” as early data pointed to continued economic expansion in advanced economies, said the report.

“Market commentators label such an environment the Goldilocks scenario — where the economy is ‘not too hot, not too cold, but just right’.”

However the BIS, known as the central bank to central banks, also pointed to some worrying signs.

Despite the ultra-low interest rates “a growing share of firms face interest expenses exceeding earnings before interest and taxes — so-called ‘zombie’ firms”, the BIS warned.

Ultra-low rates have allowed these companies to keep operating but they would quickly feel the pain of higher interest payments.

It warned “in the event of a slowdown or an upward adjustment in interest rates, high debt service payments and default risk could pose challenges to corporates, and thereby create headwinds for GDP growth.”

It noted the share of such firms has risen especially sharply in the eurozone and Britain, where according to a table it now stands around 10 percent. The share stands at over 16 percent in the United States.

The author of one article in the BIS report, Claudio Borio, warned of a debt trap.

“Debt service ratios, for instance, are only so low because interest rates have been falling so much,” he said.

“There is a certain circularity in all this that points to the risk of a debt trap: the protracted decline in interest rates to unusually low levels, regardless of the strength of the underlying economy, creates the conditions that complicate their subsequent return to more normal levels.

Borio noted that US corporate debt is now considerably higher than it was pre-crisis, and that global debt levels in relation to GDP have continued to rise despite the financial crisis as countries borrowed to prop up economic activity.

“Against this backdrop, the increase in the percentage of … ‘zombie’ firms — does not bode well,” he said.