As global trade recovers, accelerating input prices will increase European corporates’ financing needs by EUR70bn in 2021, the equivalent of a -3pp loss in margins. Suppliers’ delivery times in the manufacturing sector are back to levels last seen during the peak of the Covid-19 pandemic in 2020, while container prices have stood at a five-year high for two months. This coupled with the rise in commodity prices has brought input prices to highs similar to those seen in 2011. In this context, the key question remains the pricing power of European corporates to absorb increasing production costs. In our recent report, we showed that most sectors have limited pricing power, with the exception of consumer electronics, pharmaceuticals and airlines. This is also visible in the share of the rise in input prices absorbed by selling prices in the manufacturing sector since last fall (25% in the Eurozone against close to 60% in the US, see Figure 1). Hence, we estimate the cost of the rise in input prices at around EUR70bn for the main European countries (see Figure 2). Part of the rise can be compensated for by the excess cash that non-financial corporates have on their balance sheets thanks to generous state-support schemes. However, it could still be equivalent to a loss of -3pp of margins.

Figure 1 - Share of y/y increase in input prices covered by selling price increases in the manufacturing sector
Sources: national sources, Euler Hermes, Allianz Research
In this context, 2022 could bring a reality check for European non-financial corporates as the grace periods for Covid-19 debt are set to end, along with most state-support mechanisms. This is particularly important as most companies across advanced economies now have less buffers as their debt levels have increased faster compared to their margins over the past decade. The NFC debt-to-GDP ratio was already at a historically high level in France before the Covid-19 crisis. Going forward, the expected increase of low bank interest rates will push NFC interest payments on the upside as soon as 2022 as banks show increasing cautiousness. We calculate that an incremental increase of +100bp per year would be equivalent to an increase of close to EUR30bn in the main European countries (see Figure 2) or an impact of -0.5pp on NFC margins (see Figure 3).

Figure 2 – Expected cost in EURbn on operating surplus from the rise in input prices and interest rates
Sources: national sources, Euler Hermes, Allianz Research
Figure 3 - Impact of +100bp increase in interest rates on NFC margins, pp
Sources: ECB, BoE, Eurostat, Euler Hermes, Allianz Research
Figure 4 - Annual change in NFC debt – annual change in NFC margins
Sources: national sources, BIS, Euler Hermes, Allianz Research
Taking into account the expected nominal GDP growth pattern in 2021-22, and therefore turnover growth, we find that corporates’ Covid-19 debt will be fully absorbed in the UK, the Netherlands and Germany by the end of 2022. But only 66-67% in Belgium and Italy, 62% in Spain and 58% in France will be absorbed in the same period. Looking at the correlation between nominal GDP growth and NFC turnover growth, we deduct an average quarterly pace of growth from NFC turnover by country for the coming years. Taking this into account, we are able to calculate how much of the Covid-19 corporate debt can be “naturally” absorbed by the end of 2022 (see Figure 5).

Figure 5 – Simulation of time needed to absorb corporates’ Covid-19 debt in our baseline scenarios
Sources: national sources, Eurostat, Euler Hermes, Allianz Research
What could policymakers do to smooth the debt reimbursement process and avoid a disruptive episode of corporate deleveraging that could weigh on medium-run growth perspectives? This question is particularly important as current excess cash reserves will be much needed for short-term financing and for the increasing working capital requirements as companies seek to rebuild inventories and payment terms are expected to increase. Access to additional liquidity could be particularly challenging in an environment where banks are becoming increasingly cautious in the current context of low profitability, deteriorating asset quality and already tightening lending conditions .

Governments can boost corporate profitability by pursuing fiscal reforms to support NFCs’ self-financing capacities. Using a panel data analysis model (see Appendix) we find that NFC margins need to increase by +1.7pp on average in order to absorb the +8.5pp increase in the corporate debt-GDP ratio in the  largest Eurozone countries as a +1% increase in gross operating surplus decreases the debt-to-GDP ratio by -0.54pp. However, in some countries, the fiscal support from governments needs to be stronger, considering the high levels of debt. The necessary increase in margin is estimated at more than +2pp in France, Italy, Spain and Belgium (see Figure 6).

Figure 6 – Calculations of the necessary increase in operating surplus and margins to absorb corporates’ Covid-19 debt (ceteris paribus)
Sources:  Bank of France, BIS (until Q3 for Belgium and Netherlands), Euler Hermes, Allianz Research
Regarding profit-supportive fiscal reforms, governments have several tools at their disposal: a reduction of employer social contributions, production tax or even corporate taxes. Looking at 2019 NFC payments for France, Belgium, Italy and Spain, a decrease of -3.5pp to -3.9pp in the marginal tax rate for employer social security contributions could help companies in these countries absorb their Covid-19 debt after 2022, as well as provide enough leeway for NFCs to compensate for rising input prices and higher interest rates. In the UK, the Netherlands and in Germany, a decrease of -2.2 to -2.4pp would be needed (Figure 7).

France is the only country where the decrease in production taxes alone could be enough to compensate for corporates’ Covid-19 debt, along with rising input prices and possibly higher interest rates in the years to come. France would need to lower production taxes by EUR28bn (see Table 1), taking into account the absorption of part of corporates’ Covid-19 debt with the expected revenue growth normalization in 2021-2022. Looking at the required increase in gross profit needed to compensate for rising input prices and higher interest rates, the UK could also lower its production tax by EUR19bn.

On the corporate tax front, Biden’s plan of putting a global floor to corporate tax rates at 15% could bring some flexibility to those European countries where the corporate tax is above this level and encourage a convergence process within the EU. While the UK stands at 19%, the other countries in our panel would have more flexibility should they decide to lower corporate tax rates. For instance, in France, bringing the corporate tax rate down to 23.7% could generate EUR28bn of additional cash, enabling the absorption of the Covid-19 debt, rising input prices and higher interest rates. For the other countries, corporate tax rates should be lowered between -2.8pp and -3.6pp in the UK, the Netherlands, Germany and Italy, while Belgium, France and Spain should lower their corporate tax rates between -3.8pp to -5.1pp (Figure 8).

Figure 7 – Simulations of how much social contributions would need to be lowered to compensate for corporates’ Covid-19 debt, higher input costs and +100bp increase in interest rates on new loans taken in 2020
Sources: national sources, Eurostat, Euler Hermes, Allianz Research
Figure 8 - Simulation of how much corporate tax would need to be lowered to cover for Covid-19 corporate debt
Sources: national sources, Eurostat, Euler Hermes, Allianz Research