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A sign outside the Bank of Canada building in Ottawa on May 23, 2017. A study published by the Bank of Canada last year estimated that about 10 per cent of Canadian companies fit the narrower of the two common definitions of “zombie firm."Chris Wattie/Reuters

Whatever the shortcomings of the government support programs for Canadian business during the COVID-19 crisis, there’s hard evidence that those billions of dollars served their primary purpose: to keep companies from dying. But in doing so, those pandemic policies may be supporting a growing population of the undead.

Canada’s corporate sector might have a zombie problem.

“Zombie firms” is a term for companies that have been around for years (rather than recent startups) and are persistently unable to generate enough income to service their debts. These businesses pose a financial risk to lenders, and are, collectively, a drag on economic growth. And it looks like the pandemic, and the policy response by both the government and the Bank of Canada, have swollen the zombie ranks.

In a research note published by the Bank of Canada this week examining the financial health of Canadian companies more than a year into the pandemic, the authors noted that, remarkably, business failures have actually been below pre-COVID levels during the crisis. Way below, in fact. The latest statistics from the Office of the Superintendent of Bankruptcy Canada show that business insolvency filings in the 12 months that ended March 31 – a period entirely cloaked in pandemic – were down 30 per cent from the 12 months prior.

The report credited much of that success to government wage subsidies and loans, together with record-low interest rates furnished by the central bank. However, it cautioned that the insolvency declines may be evidence that those programs are propping up a significant number of companies that won’t be able to stand on their own two feet once the supports are removed.

“The extraordinary financial support provided to some firms over the past year makes it difficult to get an accurate read of the financial health of businesses. In particular, it is not clear whether firms that currently benefit from financial support are financially viable without these programs,” the report said.

“The decline in the number of business insolvency filings, despite the large economic downturn, may indicate a potential further ‘zombification’ of firms in Canada,” it said.

Zombie firms were already on the rise long before the pandemic; much of their growth has been linked to persistently low interest rates since the global financial crisis of 2008-09. Researchers have theorized that the low-rate environment has made it easier for zombie companies to stumble along by renewing or renegotiating their loans on more favourable terms, and taking on more cheap debt.

In Canada, the collapse of commodity prices in 2014-15 also fuelled a surge of zombies among the large population of resource-based companies. A study published by the Bank of Canada in February, 2020, estimated that about 10 per cent of Canadian companies fit the narrower of the two common definitions of “zombie firm” – nearly double the proportion across the world’s advanced economies.

One of the key concerns about these unviable businesses is a pretty obvious one: They are vulnerable to eventually defaulting on their debts. If that happens in large enough numbers, it becomes a risk to the broader financial system – the banks and bond markets that are exposed to these firms.

The Bank of Canada’s February, 2020, study calculated that Canada’s zombie firms, despite their relatively large numbers, were responsible for less than 2 per cent of the country’s corporate debt, stock market capitalization and employment. Therefore, the paper concluded, they weren’t big enough to pose a “significant vulnerability” to the financial system as a whole.

Still, with the Bank of Canada having pushed borrowing costs down and pledged to keep its interest rates at record lows until at least the second half of next year, the conditions are in place for the zombie population to continue growing, and for those firms that have already slipped into Zombieland to take on still more debt. That increases the exposure of lenders and markets to a potential surge in defaults over the next few years.

Perhaps the bigger issue with a growing zombie population is an economic one. These firms hinder productivity, because they tie up resources, labour and investment that would otherwise be deployed in much more productive firms. As Canada’s already large number of zombies grows, they form a dead zone for economic resources that poses a potentially meaningful drag on postpandemic growth potential.

None of this diminishes the vital roll played in the pandemic by fiscal and monetary measures to shield large numbers of healthy Canadian businesses from potential financial disaster. This, by extension, has unquestionably averted the kind of wide and deep economic scarring that might have crippled any recovery.

Still, it’s evident that we saved a lot of corporate duds in that process, and that will have consequences. Frankly, we may need to suffer a wave of zombie-firm insolvencies in the recovery phase, if we’re going to get over this particular pandemic hangover.

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