FINANCE, COMPETITIVENESS AND INNOVATION FINANCE, COMPETITIVENESS AND INNOVATION EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT Supporting Firms in Restructuring and Recovery March 2021 Supporting Firms in Restructuring and Recovery March 20211 1. This note has been produced under the guidance of Caroline Freund (Global Director, Trade, Investment and Competitiveness) and Jean Pesme (Global Director, Finance). This note has benefited from the contributions and comments of many colleagues within the Equitable Growth, Finance, and Institutions Practice Group, the Finance, Competitiveness, and Innovation Global Practice, and IFC. It was authored by a core team consisting of Denis Medvedev, Mahesh Uttamchandani, Stefanie Ridenour, Pietro Calice, Xavier Cirera, Marcio Cruz, Justin Hill, Leonardo Iacovone, Jose Ernesto Lopez Cordova, Antonia Menezes, Sergio Muro, and Jesica Torres. The authors would also like to thank the following colleagues for their contributions and support: Martha Licetti, Christine Qiang, Randa Akeel, Lucero Burga, Ana Fiorella Carvajal, Loic Chiquier, Ana Paula Cusolito, Fernando Dancausa, Erik Feyen, Tatiana Alonso Gispert, Akvile Gropper, Mary Hallward-Driemeier, Peter Kusek, Andres Martinez, Nina Mocheva, Samia Mouline, Dennis Sanchez Navarro, Will Paterson, John Perrottet, Georgiana Pop, Sylvia Solf, Oleksandra Svyryba, Louise Twining-Ward and Tinting Juni Zhu. © 2021 International Bank for Reconstruction and Development / The World Bank 1818 H Street NW, Washington DC 20433 Telephone: 202-473-1000; Internet: www.worldbank.org Some rights reserved. This work is a product of the staff of The World Bank with external contributions. The findings, interpretations, and conclusions expressed in this work do not necessarily reflect the views of The World Bank, its Board of Executive Directors, or the governments they represent. 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Washington, DC: World Bank. Translations—If you create a translation of this work, please add the following disclaimer along with the attribution: This translation was not created by The World Bank and should not be considered an official World Bank translation. The World Bank shall not be liable for any content or error in this translation. Adaptations—If you create an adaptation of this work, please add the following disclaimer along with the attribution: This is an adaptation of an original work by The World Bank. Views and opinions expressed in the adaptation are the sole responsibility of the author or authors of the adaptation and are not endorsed by The World Bank. Third-party content—The World Bank does not necessarily own each component of the content contained within the work. The World Bank therefore does not warrant that the use of any third- party-owned individual component or part contained in the work will not infringe on the rights of those third parties. The risk of claims resulting from such infringement rests solely with you. If you wish to reuse a component of the work, it is your responsibility to determine whether permission is needed for that reuse and to obtain permission from the copyright owner. Examples of components can include, but are not limited to, tables, figures, or images. All queries on rights and licenses should be addressed to World Bank Publications, The World Bank Group, 1818 H Street NW, Washington, DC 20433, USA; e-mail: pubrights@worldbank.org. Cover design and layout: Maria Lopez / lopez.ten@gmail.com >>> Contents 1. Introduction 9 2. Impact of COVID-19 on Firms 11 3. Pathways of Economic Shock 15 4. Public Policy Responses 17 5. Targeting and Effectiveness of Policy Support 21 6. Where Do Countries Go From Here? 29 7. Looking Forward – How WBG Supports Countries 36 Annex I: Spectrum of Insolvency Processes 39 Annex II: Overview of World Bank Policy Trackers Related to Firm Support 42 Annex III: Sector Specific Considerations (Tourism) 45 Annex IV: The Rise of the State 47 References 57 Figures Figure 1: Businesses in Arrears 16 Figure 2: Access to Public Support by Countries’ Income Groups 19 Figure 3: Access to Public Support and Change in Sales 26 Figure 4: Share of Workers Fired and Access to Policy Support 27 Annex Figure 1: Uncertainty in Developing Countries vs US 50 Annex Figure 2: Size of Fiscal Stimulus 50 Annex Figure 3: Policy Responses by Country Income Groups 51 Annex Figure 4: Preferred Policies by Size and Formality Status 52 Annex Figure 5: Received Policies by Size and Sector 53 Annex Figure 6: Reasons for Not Receiving Policy Support 54 Annex Figure 7: Received Policies by Income Group 55 Annex Figure 8: Access to Public Support by Type of Shock Experienced 55 Tables Table 1: Targeting and Required Interventions According to Different Levels of Financial Distress 23 Table 2: Funding Allocation Mechanisms and Key Considerations 25 Table 3: Pros and Cons of Types of Financial Support to Firms 30 Boxes Box 1: Technology Adoption in Response to COVID-19 11 Box 2: Approaches to Determine Vulnerability 24 Box 3: Emerging Evidence on Targeting 26 Box 4: Rationale for Wage Subsidies 31 Box 5: Debt and Equity 31 >>> Key Messages • Firms and workers continue to be deeply affected by COVID-19, while the reach of policy support has been limited. Only one in four businesses surveyed across 60 countries has received any type of public support, with the share varying from more than 50% in high- income countries to just over 10% for low-income economies. • While several types of instruments – including access to credit, wage subsidies, and tax support –have been effective in easing liquidity constraints and preventing layoffs, policy targeting must be improved. Twenty percent of firms that did not experience any negative shock due to COVID-19 report receiving public support, compared to 26-29 percent of firms that were affected. • Technology is helping firms adjust to the shock, but only about one-third of businesses have been able to increase the use of digital technology in response to COVID-19. Support programs should incentivize the adoption of technology (such as fintech, e-commerce, and B2B digital solutions) and build firm capabilities, including managerial practices, that help firms adopt this technology. Policymakers can further enhance the impact of new technologies through regulatory reform for a contestable digital market, digital access between government and business, and increasing public sector use of digital financial services. • To facilitate a productivity-driven recovery and make the best use of limited fiscal resources, firm support should be targeted to viable firms facing financial distress or insolvency due to COVID-19. Viability is best determined by self-interested stakeholders (i.e., those with a potential claim to the firm and its assets) while policymakers can play the role of a convener. Viability requires considering solvency (the discounted value exceeds obligations to financial institutions, bondholders, and government), vulnerability (whether financial distress is related to COVID-19), firm size and formality status (with support to micro and less formal firms best channeled through social protection mechanisms). All support should be data-driven to the extent possible, while avoiding undue favoritism toward state-owned firms. • Firm support programs should be state-contingent, tied to observable goalposts in recovery, such as control of the virus and feasibility of operating at full capacity, and feature simple and transparent criteria. Since lack of awareness is a key impediment to accessing policy support, information about support programs, insolvency frameworks and options for restructuring must be widely- and well-communicated. • Concentration of market power should not be neglected. Smaller firms have been exposed to bankruptcy to a greater extent than larger players, governments’ policy responses to the crisis may themselves have been raising other risks to competition, and the preference for remote interactions has further boosted the position of the large platform businesses. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 6 Governments should take this opportunity to review the economic rationale of the state- owned enterprises (SOEs) and whether support is not exclusively and unnecessarily granted to dominant firms (SOEs or private). Support should also involve commitments to monitor and strengthen SOE corporate governance. • To address financial distress and maintain productive resources, insolvency and restructuring frameworks may need to be strengthened, including court-sanctioned debt restructuring processes, Out-of-Court Workouts (OCWs) and simplified insolvencies for SMEs. • Based on available recent data, some economies are showing historically high rates of new business creation, along with the unprecedented rates of business bankruptcies and closures. To support effective reallocation of resources and building back better, regulatory reforms should focus on lowering barriers to entry and greater regulatory flexibility while protecting health, safety, and the environment through risk-based solutions. • For stronger and more sustained recovery, the financial sector’s ability to continue lending to the viable corporate sector must be protected. Regulatory and supervisory incentives should be considered, where relevant, to foster early action on non-performing loans (NPLs) and promote effective corporate debt restructuring. If corporate debt is large and growing, focus on measures that reduce dependence on debt finance, such as clearing government arrears, and encouraging equity and quasi-equity stakes. Reform tax laws that incentivize debt over equity. • To calibrate firm support, strengthen insolvency frameworks, and protect the financial system, authorities should collect and analyze data to monitor the impact of the shock on the private sector, and disclose as much information and data as possible to the public. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 7 1. >>> Introduction Firms in developing countries are in financial distress and key indicators suggest a rise in firm insolvencies is coming. Businesses in developing countries were especially hard hit, with revenues down 70% at the peak of the crisis, compared to only 45% in OECD countries. Even several months into the crisis, firm revenues remained 40% lower. Furthermore, there is a growing corporate debt problem in many developing countries. On the eve of the pandemic, corporate debt was already elevated in several emerging market and developing economies (EMDEs). Pandemic-induced negative shocks to earnings have worsened debt service capacity of firms (listed or not), with small businesses being severely impacted (see IMF Global Financial Stability Report and update, Oct 2020, Jan 2021). Recent survey data of more than 100,000 businesses mainly in developing countries shows that 39% of micro and small businesses (those with less than 20 employees) are in arrears or expect to fall into arrears in the next six months (Apedo-Amah et al, 2020). Growth in unemployment has also been a predictor of the growth of insolvency cases in previous crises, and two-thirds of firms have either fired employees, reduced worker hours or wages, or asked workers to take leave. While there are welcome news of vaccines and new treatments for COVID-19, these are unlikely to be available everywhere at once meaning that the economic pain is likely to persist for some time. Policy response has been relatively swift but reach and effectiveness are still limited. In the months following the onset of the pandemic, at least 1,600 policy measures to support SMEs were rolled out in 135 countries. In high-income countries, fiscal stimulus has exceeded 10% of GDP, with more than 40% of the total going to firm support. In low-income countries, less than 2.5% of GDP has been dedicated to fiscal support and less than a quarter of this has likely gone to firm support. Consequently, only about one of ten firms report receiving public support in countries with GDP per capita below US$2,500 compared to 53% in countries with GDP EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 8 per capita above US$10,000. And while there is evidence that The rest of this note is structured as follows. The sectors most affected by the pandemic have been more likely next section presents the main impacts of COVID-19 on to receive policy support, this relationship is much stronger businesses. Section 3 revisits the organizing framework of the in upper-middle and high-income countries than in the poorer first Supporting Firm Resilience note (Freund and Mora 2020), economies. Targeting has also been a challenge: 20% of reaffirming its relevance as the underlying methodology for firms that did not experience any negative COVID-related analysis and guide to policy discussions with client authorities. shock received public support versus 26-29% of those that did Section 4 summarizes the policy responses by authorities experience a negative COVID-related shock. During the early around the world. Section 5 provides some early evidence months of the pandemic, concerns about exclusion errors on the impact of policies as well as recommendations for likely and rightly dominated those about inclusion errors, improving their targeting and effectiveness. Section 6 maps but more precise targeting will be important as fiscal space out the way forward for countries. Section 7 concludes and tightens. outlines how the WBG can support. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 9 2. >>> Impact of COVID-19 on Firms COVID-19 has resulted in a large, sustained drop in firm revenue across the developing world. Data from firm surveys show that 84% of firms in developing countries have reported a reduction in sales relative to the same period in 2019, with an average drop of 49%.2 Micro and small firms have been affected disproportionately, experiencing a decline in sales of 50% or more, while large firms (those with 100 workers or more) saw sales declines of less than 40%. There are also important differences across sectors with tourism-related activities being the most negatively affected due to the high level of face to face interactions. Businesses owned by women or those with an above-average fraction of women employees experienced larger declines in sales, and especially so in hospitality industries. Two-thirds of foreign-owned firms have experienced decreases in investment, revenues, and profits, highlighting that these challenges are not faced only by domestic firms. Financial risks driven by defaults and bankruptcies loom large. The IMF has recently reported that global financial vulnerabilities have continued to rise since the start of the pandemic, partly because firms have borrowed to tackle liquidity shortages during the pandemic (IMF, 2020). The share of SMEs that are already in arrears or expect to fall into arrears during the coming six months has declined somewhat from 48% in April -September 2020 to 39% during October 2020 – January 2021 but remains elevated (Apedo-Amah et al, 2020). Firms in harder hit sectors tend to have bigger financial woes. More than half of firms in tourism-related activities (62% of firms in accommodation and 56% in food preparation services) expect to fall into arrears, as compared to 35% and 43% of firms in financial services and ICT (Apedo- Amah et al, 2020). In Sub-Saharan Africa, 10% of the most affected firms do not have enough cash on hand to survive beyond one day (Apedo-Amah et al, 2020). While there are important differences in financial vulnerabilities across countries, differences within countries have dwarfed those. The bottom 10% of firms in Cote d’Ivoire have enough cash on hand to survive just 14 days whereas the top 10 % can cover as much as 112 days of costs. Likewise, in Kenya, 2. Based on 60 countries covered by the World Bank’s COVID-19 Business Pulse Surveys and COVID-19 Follow-up Enterprise Surveys. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 10 Senegal and Tanzania the bottom 10 % of firms report having shocks. Firms that experienced larger declines in sales zero cash on hand, while the top 10% can cover about a year were more likely to rely on layoffs, but the response has of costs. More firms are likely to face financial distress due to been relatively inelastic: a firm with 100 workers facing an the current spike of COVID-19 cases that many countries in average 53% reduction in sales was likely to shrink by just 4 the northern hemisphere are experiencing, coupled with the employees. Women-owned businesses and those with above- projected 4.3% global GDP contraction for 2020 according to average share of female employees were somewhat more the Global Economic Prospects 2021. likely to shed workers when faced with a shock of the same magnitude. Hardest-hit sectors made the biggest adjustments: The predicted rise in firm insolvencies has not yet fully firms in the accommodation sector had the highest probability materialized, but a closer look at global and country- of granting leave (53%) and cutting wages (34%), while firms level insolvency data reveals cause for concern. Global in the food services sector had the highest probability of laying insolvencies were originally expected to grow by 17% in 2020. off workers (24%). Furthermore, half of foreign-owned firms While accurate data is not available from all markets, many – and among them especially smaller firms – report reducing economies appear to have not seen high levels of growth of total employment by 10 % on average reflecting reduced insolvency cases and, indeed, some have seen a reduction hours and furloughs, in addition to layoffs. in the overall number of cases when comparing 2019 Q2 and Q3 to 2020 Q2 and Q3. It is important to note, however, that Businesses are adjusting by innovating and going digital, even in those countries, reporting a reduction in total cases, but not all firms or countries have benefitted equally. such as the US and Canada, worrying signs persist. In the Firms are responding to the shock by increasing the use US, for example, filings by foreign companies—which can of digital platforms and social media (34% of businesses), use Chapter 15 of the Bankruptcy Code to file in the United making new investments in digital solutions (17%), and States if they meet certain requirements— have risen almost adjusting their product mix (26%, including moving into health- 3 times from Q1 2020 to Q2 2020. Chapter 11 filings – which related products). There is early evidence that digital adoption is more heavily used by larger firms— have risen by almost may be helping firms weather the shock: firms that were more 45% when comparing Q2 and Q3 2019 to the same period likely to adopt digital technology post-COVID experienced an in 2020. Similarly, large value insolvencies in Canada were 8 percentage point lower decline in sales than firms of similar already higher in 2020 than in 2019. size, sector, and the same pre-COVID levels of technology (see Box 1). However, firms in Africa and South Asia have Firms have been holding on to workers, opting instead so far been significantly less likely to adopt digital technology to reduce hours and wages or grant leave. Two-thirds of than firms in other developing countries, and large businesses businesses made some adjustments to their payroll, but most have been much more effective at increasing the use of digital firms did so by reducing hours, wages, or granting (paid or than small firms. These findings have implications for how unpaid) leave to workers. Only 19% of firms fired workers. policymakers approach policies and incentive programs to However, this likelihood has tended to increase somewhat support digital transformation during the recovery phase. over time in cases where countries are facing protracted > > > B O X 1 - Technology Adoption in Response to COVID-19 The pandemic has triggered an unprecedented increase in investments and use of digital technologies, which are positively associated with better firm performance and larger firm size. Faster-growing firms have a higher likelihood of starting use or increasing the use of digital technologies, even after controlling for basic characteristics of the firm, such as country, size, and sector (Figure 1a). However, the use of digital solutions is much lower among smaller firms (Figure 1b). Although the association between digital adoption and performance does not imply a causal relationship, the strong correlation between adoption and the size of firms may raise concerns regarding an increasing digital divide, across firms and across countries.3 For example, the fraction of businesses that increased their use of online platforms ranges from 11% in Ghana to 81% in Indonesia. The quick response from several businesses on going digital represents an important opportunity for technol- ogy upgrading, but additional efforts are needed to facilitate this process for firms with lower levels of capabilities to avoid leaving some firms and workers behind. 3 Cirera, Comin, Cruz, and Lee (2020) shows evidence of a significant gap on technology adoption across small and large firms in developing countries pre-COVID 19. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 11 Figure B1.1 - Digital Adoption in Response to COVID-19 a) Average changes in sales are positively associated with the likelihood of starting or increasing the use of digital technologies for businesses -20 Average change in sales (%) -40 -60 -80 -100 0 .2 .4 .6 .8 Probability of Using Digital Tech b) Average predicted probability of starting or increasing the use of digital technologies Increased Use of Digital Platforms Investment in Digital Solutions .5 .4 Share of firms .3 .2 .1 0 Micro Small Medium Large Micro Small Medium Large Note: (a) Estimates of the relationship between average change in sales and probability of using digital technology for business based on a sub-sample of countries for which the level of information of technology pre-COVID is available. (b) Average predicted probability for size from a Probit analysis that controls for country, size, subsector, and weeks before and after the peak of the mobility shock based on the full BPS sample. Data on “investment in digital solutions” is not available for micro firms. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 12 Mitigating the risks of a growing the technology/digital divide requires removing existing barriers to adoption. Firms in Brazil, Senegal, and Vietnam that were already more prepared with higher level of technologies, particularly digital technologies, pre-COVID, were significantly more likely to accelerate adoption post-COVID. This suggests that the existing barriers may be persistent. Among the factors that likely explain these gaps are issues related with lacking managerial capabilities, lack of access to finance, and limited access to markets or uncertainty – many of which have deteriorated disproportionally for small and female-led businesses, which further exacerbates the barriers to adopt technologies for these SME groups. Governments and business-supporting organizations are intensifying the use of policy instruments to support digital adoption and upgrading. A survey conducted between July and August 2020 with 23 business supporting public programs in Kenya shows that many of these programs have adjusted the services they provide by increasing the support to digital solutions. About 48% of the programs that already existed before COVID-19 reported that they have started or expanded the offer of training and technical support related with digital solutions.4 The most common types of support were related with teleworking and service delivery, marketing, and sales. Similarly, management extension support services in Brazil are experiencing a shift of demand towards digital upgrading programs; and new programs are been created, such as Jornada Digital, to tailor SMEs needs in this area. These programs combine the provision of information with technical assistance, and are taking advantage of greater interest among SMEs for technology upgrading. One concern, however, is the narrow focus of managers and entrepreneurs on upgrading sales and marketing functions while neglecting others. Data for the state of Sao Paulo, Brazil, shows that among all firms adopting and using digital technologies, 76% used digital tools for marketing and 56% used digital tools for sales, but only 12% of firms for digitalizing supply chain management or 10% for production planning. Figure B1.2 - Share of Public Programs That Started or Expanded the Offer of Any of the Following Services to Support Businesses in Response to the COVID-19 Pandemic in Kenya a) 0.48 .5 .4 Share of programs 0.30 .3 0.22 .2 0.17 0.13 .1 0.09 0.09 0 Digital solutions Regulations Finance Managerial training Infrastructure New grants Market access 4. The Kenya Industry and Entrepreneurship (KIEP) project is an example of a US$50 million program supporting technology upgrade implemented by the Ministry of Industry, Trade and Cooperatives (MoITC) of Kenya, with support from the World Bank. The Ministry of ICT, Innovation and Youth Affairs of Kenya also has plans to roll out campaigns to sensitize Small and Medium Enterprises (SMEs) on need to digitize to strengthen their market positions and enable the enterprises conquer new markets. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 13 b) .5 0.40 Share of programs by type of .4 digital solutions 0.30 0.30 .3 0.20 0.20 .2 .1 0 Supply chain management Marketing and sales Online and electronic payments Teleworking or service delivery Other Source: World Bank Entrepreneurship Enabler survey (2020) EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 14 3. >>> Pathways of Economic Shock The Supporting Firm Resilience (Freund and Mora, 2020) note identified four distinct channels of impact of COVID-19 on firms. These channels remain relevant as the adverse effects of the shock continue, and empirical evidence collected since the onset of the pandemic reaffirms their individual importance. While supply and demand shocks were most acute initially, going forward heightened uncertainty is depressing investment and a wave of insolvencies could affect financial stability. Policy dialogue around business adjustments to COVID-19 and public support to aid firms in this process should consider which of these channels presents more risk in each country context and how different types of firms are being affected. Policy responses will need to be tailored accordingly. 1. Supply/lockdown shock. The reintroduction of lockdown and resurgence in the number COVID-19 cases is extending the duration of the supply shock. This generates a temporary decline in output and productivity driven by (a) restrictions to work at full capacity, (b) decline in labor availability, and (c) limited access to inputs (e.g., 60% of firms report difficulties obtaining inputs). While important, this channel is likely to be the more short-lived, and as soon as cases level off and restrictions are lifted, the effects of this channel should dissipate. It should be possible for policy makers to know in real time if this channel is operating or not, which could be important for policies that are state-contingent5. Further, some firms have accelerated the adoption of digital technologies and product innovation in response to COVID-19, which represents a positive supply shock that could also be important in supporting a productivity-driven recovery (although so far, only one-third of firms have been successful in adopting digital technology and one-quarter have innovated into new products in response to COVID-19). 2. Uncertainty shock. In the US, uncertainty has doubled following the onset of COVID-19.6 Yet, developing countries show levels of uncertainty which are three to four times higher than the US peak in June-July 2020 (Annex Figure 1). Uncertainty is correlated to the size of 5. See section 5 for more discussion on this. 6. Uncertainty is measured using subjective sales uncertainty regarding firms’ own future sales growth rates. According to Altig et al (2020), these firm-level growth expectations are highly predictive of realized growth rates, and firm-level subjective uncertainty predicts the magnitudes of future forecast errors and future forecast revisions. See Apedo-Amah et al (2020) for more details on measuring uncertainty in developing countries using World Bank Business Pulse surveys. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 15 the shock, as firms and countries that experienced larger and open at the time of the interview. Their average drop drop in revenues tend to have significantly higher level of in sales is 62%, but values range from -90 to -13, with a uncertainty. Firms that experience higher uncertainty tend standard deviation of 24, indicating wide variability. to lay off more workers and may be more likely to hold off investment or limit innovation. Therefore, uncertainty is 4. Financial shock. In order to support liquidity, many not only worsening the situation today, but may also have countries have so far adopted financial sector measures negative implications for the recovery and medium-to-long that have in effect frozen recourses in cases of non- term growth. Foreign direct investment (FDI) is expected payment. As noted above, risks of financial distress are to have dropped 40% in 2020, and surveys show that 85% quickly building up. In a third of the countries surveyed, of foreign-owned firms in developing countries are either an average firm reports that it has enough cash on hand not changing their investment plans or are investing less. to last just over one month. This is especially concerning Firms are adopting a “wait and see” approach. as insolvency pressures are particularly strong on small firms, for which restructuring may be difficult to achieve 3. Demand shock. Demand for both final and intermediate (Figure 1). Furthermore, experience from previous crises goods continues to be weak, however this is highly suggests that non-performing loans (NPLs), which lead heterogenous across firms and sectors. The demand to firm insolvencies, can take several quarters, after the shock is likely to dissipate more slowly than the supply- onset of economic crisis, to peak. As more debtors default, side shock, but while demand for certain products and an increase in insolvency filings typically follow. Yet, the services may remain sluggish (e.g. travels), for others it process of NPL build-up is often lengthy. For instance, could expand significantly. However, it is important to note taking December 2007 as the date where the Global that while the demand shock is exogenous to the firms, Financial Crisis began, the median lag between the onset firms can attenuate the shock’s impact by adopting digital of the crisis and the peak NPL levels was approximately technology, coming up with new ways to supply goods 13 quarters for the OECD countries and 11 quarters for and services, or introducing completely new products non-OECD countries. In turn, these pressures could put (see point 1 above). This is confirmed by survey results strains on the broader financial system, and limit further showing that firms in same sector and country can access to finance for firms, especially smaller and younger experience widely varying changes in sales. In the sample ones which already have limited access to finance. for Senegal, for example, there are 10 businesses in wholesale and retail with 5 full-time employees each and no part-time employees, interviewed in the same week, > > > F I G U R E 1 - Businesses in Arrears (now or who believe will fall in 6 months) 60 50 Businesses in arrears 40 (%) 30 20 10 0 Micro (0-4) Small (5-19) Medium (20-99) Large (100+) Source: World Bank, COVID-19 Business Pulse and Follow-Up Enterprise Surveys EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 16 4. >>> Public Policy Responses Public response to the pandemic has been swift, especially in advanced countries. In high-income countries, authorities deployed fiscal stimulus packages exceeding 10% of GDP on average (Annex Figure 2), with close to half of this amount directed to support firms. Focusing more specifically on support to SMEs, the World Bank’s SME COVID-19 Policy Response Dashboard catalogues some 1,600 policy measures implemented in 135 countries. More than three quarters of these measures are concentrated in three categories: debt finance (37%), employment cost support (22%), and tax support (20%). The type of policy responses varies systematically across countries. High-income countries rely less heavily on debt finance or tax relief (33% and 15% of all measures, respectively), but use employment support measures (34%) more frequently (Annex Figure 3). More direct forms of income transfers, i.e. wage subsidies and direct monetary transfers, are more common among firms in richer countries. The World Bank’s efforts to track and monitor various types of policy responses by governments around the world since the onset of the crisis can be found in Annex II. The combination of fiscal stimulus and regulatory and legal forbearance has likely helped to mitigate and postpone the impact of the economic crisis. According to IMF calculations, US$9 trillion in fiscal support were injected globally by May of 2020. These interventions included spending and revenue measures of over US$3 trillion, as well as loans, equity injections, and guarantees of over US$4 trillion. These large stimulus packages including direct deposits to individuals, corporate debt purchases, providing public guarantees for bank loans or liquidity or capital injections to financial institutions have likely helped many firms to weather the storm since the initial months of the COVID-19 crisis, primarily, though not exclusively, in higher income economies. As noted in Reinhardt (2020), the features of the economic crisis caused by COVID-19 are different from those of the 2008 global financial crisis (GFC) and other economic or financial crises before. Governments are not only granting significant state aid and bailing out systemic market players as they did after the GFC. They are taking additional measures that reflect much more flexibility to adjust to the unusual circumstances of this crisis, including exemptions to competition policy and law. While unusual measures are warranted, the emergency measures during the containment period should not permanently alter the market functioning in the medium-term. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 17 Credit-support measures have been one of the main of capital and liquidity buffers, the treatment of restructured tools to soften the economic blow of COVID-19. Chief loans, the treatment of non-performing exposures). However, among these were generous loan guarantee schemes compared to advanced economies, low- and middle-income and concessional finance mobilized through public banks. EMDEs appear to have relied more heavily on the relaxation Advanced economies such as France and emerging markets of certain prudential regulations that goes beyond the flexibility such as Peru launched loan guarantee programs worth 12% embedded in the international standards (e.g., lowering and 8% of their respective GDP, while Japan and Saudi Arabia minimum risk-adjusted capital requirements, and particular mobilized approximately 3% and 0.4% of GDP, respectively, changes in the treatment of non-performing loans), perhaps through domestic public banks to support businesses, because they have fewer options at their disposal due to especially SMEs. These measures were complemented limited policy space, bank-centric financial systems, and less by unprecedented monetary policy actions as well as by sophisticated regulatory and supervisory frameworks. The several indirect actions such as tax deferrals and regulatory negative impact of employing regulatory flexibility beyond the forbearance, which provided for additional liquidity room in international standards, even if temporary, should be carefully firms’ balance sheets while incentivizing commercial banks weighed against the short-term benefits to support firms. This to continue to extend credit to firms. However, evidence from is particularly important for some EMDEs which operate in China (Chen et al., 2020) as well as United States’ Paycheck a more constrained environment and have relaxed certain Protection Program (PPP) program (Granja et al. (2020); regulatory requirements that may challenge bank resilience Chetty et al. (2020)) shows that financial support policies in the medium term and may cause a credit crunch which will during COVID-19 have not been effective in alleviating SMEs’ affect firms and the broader real economy (Reinhart (2020)). cash constraints or encouraging the reopening of small One key challenge going forward is the risk of cliff edge effects businesses, potentially due to difficulties in accessing policy- when some of these forbearance measures will be wound oriented loans and misallocation of credit. down. Discussions around the “exit” of financial support measures is only starting and remain challenging given the The World Bank COVID-19 Financial Sector Policy prevailing uncertainties. Response Database shows that many authorities around the world implemented temporary relief measures in While governments’ support and firms’ reactions have support of borrowers and to ensure the flow of credit to certainly played a role in the relative decrease in business the real economy while safeguarding banks’ resiliency insolvency filings, other more direct legal measures may (also see Feyen, Gispert, Kliatskova, and Mare (2020)). have had a larger impact. Several countries have put in A recent study of financial sector policy responses to the place short-term insolvency and insolvency-related measures COVID-19 crisis shows that all 154 of the countries reviewed to help ensure firms and consumers have breathing space have introduced at least one policy intervention, with 80 % during the core of the crisis. In June 2020, the World Bank of the measures being introduced early in the process, by launched the Global Guide on insolvency and insolvency- June 1, 2020. After prudential measures, borrower support related reforms under the COVID-19 pandemic (Guide). Our is the most common action taken by policy makers. Most analysis based on the guide has revealed that over 90% of the measures seek to directly or indirectly avoid a rise of the 62 economies (AE and EMDE) in our sample have of insolvencies of cash-strapped, but otherwise viable enacted insolvency and insolvency-related reforms since the businesses (and households), by providing direct support onset of the pandemic. Specifically, 80% of these economies to borrowers in the form of, inter alia, public guarantees for have relaxed debt repayment requirements for debtors; while bank loans, state subsidies, debt repayment moratoria, or 43% of countries have made it more difficult for creditors to encouraging loan restructuring. Some governments also have force debtor firms into insolvency; and 30% have relaxed the purchased corporate securities outright in capital markets. obligations upon management of the firm to enter insolvency Other measures that also impact firms include those aimed at proceedings when the firm is illiquid or when its assets exceed bringing prudent flexibility to financial integrity requirements to its liabilities. help address COVID-19 related challenges (e.g., supporting digital onboarding, simplified due diligence). Since the start of the pandemic, it appears that the importance of digital payments and fintech have been To support the flow of credit, including to firms, many recognized by governments. Digital payments enable authorities have taken prudential measures seeking Governments to have better control of the integrity of the to support and encourage the use of the flexibility overall payment process and has a bearing on the overall embedded in global prudential standards (e.g. the use efficiency and effectiveness of revenue collection as well EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 18 as expenditures like public procurement and social benefit Albania, Bahrain, India, Malaysia, Saudi Arabia, South Africa, transfers. Increasingly, it is also clear that digital payments are and Vietnam, to temporarily suspend or delay tax and social a core requirement for digital-economy businesses like ride security filings, waive fees for government transactions such hailing and ecommerce. A recent McKinsey study of COVID-19 as licenses, registrations or permits, or automatically extend relief programs concluded that financial infrastructure licenses and permits during the relief stage. Investment (particularly digital payments and digital ID) were critical to promotion agencies (IPAs) are in large part shifting their the successful delivery of the twelve COVID relief programs principal focus from FDI attraction to retention by bolstering across the seven countries examined in the study. In a recent aftercare services that include identifying and directly survey administered jointly by the World Bank and Cambridge contacting at-risk firms according to number of employees, University, of the 114 jurisdictions surveyed, 37% of regulators region, or sector; brokering solutions to their specific confirmed having taken at least one regulatory step to enable issues; encouraging repurposing; and advocating for urgent greater use of fintech since the start of the pandemic, with government actions to solve these issues more systematically digital payments being the area most widely addressed. (to benefit other similar investors). Indeed, 60% of respondents reported an increase in the use of digital payments in their respective jurisdictions (the Despite the expansive roll-out of support measures, Central Bank of Kenya, for example, reported that more than access to policy support has been limited, especially for 1.6million additional customers are using mobile money since small firms and poor countries. Only 33% of firms globally the start of the pandemic). Regulators have taken steps, such has received any type of public support during October 2020 as those taken in Ghana, Kenya, Lesotho, Liberia, Rwanda, – January 2021, although this number has increased from Uganda and Zambia, to facilitate and simplify remote account 26% during May-August 2020. Access to policy has also opening, open the provisions of digital financial services to been uneven: since the onset of the crisis, the probability of new providers and increase transaction limits for the use of receiving support for firms in high-income countries (53%) has mobile money. been nearly four times the likelihood for firms in low-income countries (11%, Figure 2), while almost twice as many large To complement financial support, governments have also firms (30%) as micro firms (18%) report receiving support taken complementary investment climate measures to (Annex Figure 5). The probability of accessing the support is supporting the survival of otherwise viable firms through similar across broadly defined sectors (Annex Figure 5), with regulatory flexibility and targeted services to retain a somewhat higher likelihood in accommodation (31%) and investment. Regulators have taken steps, for example, in food preparation (29%). Finally, as expected, formal firms are > > > F I G U R E 2 - Access to Public Support by Countries’ Income Groups 60 50 50 Businesses with access to public support (%) 40 30 30 20 15 11 10 0 Low Low-Middle Upper-Middle High Source: World Bank, COVID-19 Business Pulse and Follow-Up Enterprise Surveys EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 19 more likely to access public support, albeit the difference is support programs has increased since the peak of the crisis: not large. Still, 24% and 16% of informal firms report receiving approximately 50% of firms report lack of awareness as the monetary transfers and wage subsidies, respectively. This main reason for being unable to access government support 1 is consistent with some views that suggest the use of cash week after the crisis peak, but this remained unchanged even transfers to support informal firms, given the difficulties to 16 weeks after the peak, albeit with some fluctuations. obtain information necessary for targeting of other support types. Another challenge is that policy support provided hasn’t always matched the demands of the private sector. Lack of awareness has been a major challenge, especially Demand for wage subsidies and tax reductions increases in low-income countries. Forty percent of firms across all with income level, driven by higher degree of formalization countries report lack of information as the main reason for and larger average firm size (Annex Figure 4). The opposite is not accessing public support, with remaining reasons evenly observed for monetary transfers, which are more demanded distributed across ineligibility, difficulty in applying or the time by smaller firms. In many instances there is some mismatch gap between application and receipt. Lack of awareness is between policies demanded and offered: for example, access similar across different firm size categories, but there is a to credit is the most preferred policy for firms in lower-middle clear inverse relationship between access to information and income countries, but tax relief is the main mechanism of per capita incomes: 71% of firms in low-income countries but support offered in these economies. For upper-middle income only 11% of businesses in high-income countries report this countries, there is a mismatch for tax deductions and access as the main constraint (Annex Figure 6)7. Strikingly, there to credit, which rank high in firms’ preferences but low in terms is little evidence to suggest that awareness of government of policy utilization or access. 7. In high-income countries, 47% of firms cite ineligibility while 40% cite difficulty in applying as the reason for not receiving government support thus far. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 20 5. >>> Targeting and Effectiveness of Policy Support The main objectives of policy support to firms are to avoid the financial repercussions of mass exit of viable firms facing financial distress, prevent the losses of firm-specific intangible capital, and minimize the friction costs of firms exiting and subsequently re- entering the market.8 While ideally policymakers would ration support to the more productive firms facing financial distress, productivity can at best be observed with a significant lag. Policymakers should therefore look to viability as a key determinant, targeting support to viable firms facing financial distress or insolvency due to COVID-19. However, viability is a complex and nuanced concept that requires taking several factors into account. Blanchard et al (2020) define a viable firm as one whose discounted value exceeds the recovery value of its assets (e.g., a ‘forced-sale’ or liquidation value of the assets). This may be too static a definition of ‘viability’ and may not answer the question of whether the firm, if restructured, could deliver higher returns to its stakeholders than its current break-up value. The break-up value itself may also be adversely impacted by weak demand conditions. Firms’ historical tax returns and EBITDA (earnings before interest, taxes, depreciation, and amortization) can also shed light on viability, but lack of adequate financial information or insufficient analytical capabilities can make determination challenging, especially in a world where there may be persistent changes in demand. The following can serve as useful inputs in determining which firms should be considered ‘viable’, including with respect to possibly benefitting from public support: 8. There may be other, strategic reasons for extending support to specific firms or sectors, such as ensuring uninterrupted delivery of key emergency services (e.g., avoiding disruptions to air cargo services and maintaining the supply flow of essential critical products, including food, medicines, PPE, and other key inputs for sensitive supply chains that were vital during the initial phase of the pandemic) – which policymakers must balance against risks of creating market frictions and distortions. Such considerations, however, are beyond the scope of this note, EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 21 While ideally policymakers would ration support to • Vulnerability. A firm is vulnerable if it is facing financial the more productive firms facing financial distress, distress or insolvency due to the COVID-19 shock. A productivity can at best be observed with a significant number of COVID-19 firm support programs have used a lag. Policymakers should therefore look to viability as a key decline in revenue as a criterion for determining eligibility determinant, targeting support to viable firms facing financial and/or amount of support provided (Box 2).9 It is important distress or insolvency due to COVID-19. However, viability is that the consideration of vulnerability is combined with a complex and nuanced concept that requires taking several some notion of solvency to avoid channeling scarce fiscal factors into account. Blanchard et al (2020) define a viable resources either to firms who do not need support or those firm as one whose discounted value exceeds the recovery who are unlikely to survive anyway (see Table 1). For value of its assets (e.g., a ‘forced-sale’ or liquidation value example, support could be prioritized towards firms which of the assets). This may be too static a definition of ‘viability’ were not cash-flow or balance-sheet insolvent prior to and may not answer the question of whether the firm, if December 2019. Support should also be time-bound and restructured, could deliver higher returns to its stakeholders could be calibrated to firm needs by capping the amount than its current break-up value. The break-up value itself may per beneficiary and varying the limits by sector (Pop and also be adversely impacted by weak demand conditions. Amador, 2020). Firms’ historical tax returns and EBITDA (earnings before interest, taxes, depreciation, and amortization) can also shed • Size/formal status. When fiscal resources are scarce, light on viability, but lack of adequate financial information not all viable but vulnerable firms may be saved. The or insufficient analytical capabilities can make determination rationale for using public funds to support firms weakens challenging, especially in a world where there may be when the recipients are smaller/less formal: for such persistent changes in demand. The following can serve as firms entry/exit costs tend to be low, intangible capital is useful inputs in determining which firms should be considered largely embedded in the entrepreneur herself, and risks ‘viable’, including with respect to possibly benefitting from to creditors’ balance sheets from firm closure is limited.10 public support: In cases such as these, support is better provided directly to workers via social protection channels – although the • Solvency. As noted above, Blanchard et al (2020) provide exact cut-off will be a matter of some discretion and will helpful definitions to analyze the current financial state of a vary by industry and country (it should be noted that even firm. They define a solvent firm as one whose discounted in high-income economies such as Germany and Spain, value exceeds its obligations to financial institutions, a firm with just 11 employees will be in the top 20% of bondholders, and government. Most countries opt to the size distribution [see Li and Rama, 2015]).11 It is also define solvency either through a ‘cash-flow’ or ‘balance- important to consider market dynamics and avoid the anti- sheet’ test. Declining profits together with tightening competitive effects of channeling support to only one firm financial market conditions (e.g., 70% of firms globally or a limited number of firms, notably based on size (e.g., reported difficulties in accessing finance during October large, dominant firms) or ownership (e.g., SOEs). 2020-January 2021 due to rising interest rates and higher repayment risk) will have made some otherwise healthy • Long-term considerations. As discussed in the firms insolvent, making such firms a potential target for Supporting Firm Resilience note (Freund and Mora, public support. In such cases, government arrears to 2020), several types of firms – exporters, young firms firms – where applicable – should be cleared as much as and start-ups, innovative firms – may experience financial possible to provide a more accurate estimate of a firm’s distress during the crisis while being particularly important solvency and should precede or complement other forms for the recovery.12 It is important that these firms are, at of support. a minimum, not left out of the support programs (e.g., by 9. To minimize the risk that moral hazard becomes a problem in the context of a program that compensate firms based on revenues drop this compensation should be lower than a full compensation or it should be anchored to average revenues drop at level of sector or location and not to the self-reported decline in revenue. 10, Mechanisms to support informal firms also tend more limited. They are often outside the tax and banking systems, so tax relief may not be an option and financial support may only be available through non-bank financial institutions and microlenders. 11. Blanchard et al (2020) argue that in instances where support is provided to very large numbers of workers, existing social protection mechanisms such as unemployment offices may struggle with the volume of claims and channeling support to workers via firms’ payrolls may be more efficient. 12. Evidence from firm surveys shows that exporters have generally been less vulnerable to the effects of the crisis (in terms of lower decline in sales and likelihood of falling into arrears) – although the effects are heterogeneous and exporters in East Asia have been somewhat more vulnerable. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 22 virtue of concentrating support in certain instruments which established procedures for asset valuation, valuation can are less applicable to these firms – see the discussion in be more straightforward. There will also be cases where the following paragraphs) and interventions could indeed policymakers may need to weigh into the determination be biased to some extent towards these firms in order to of viability: for example, in cases where a firm’s social support a productivity-driven recovery that creates more value may differ from its private value. In such cases, and better jobs. where the state has a compelling policy need to play a role in viability-determination, such valuation procedures • Who decides? Typically, in the case of individual firms, and the private-sector actors who enable them should be viability will ultimately be determined by self-interested used by the state. In addition, the state can play the role stakeholders (i.e., those with a potential claim to the of a convener, bringing multiple stakeholders together firm and its assets) who believe they stand to gain from and helping establish an appropriate time horizon for continuing to support a particular distressed firm. In determining viability. countries with deep secondary markets for assets and with > > > T A B L E 1 - Targeting and Required Interventions According to Different Levels of Financial Distress Type of Firm Support Needed Instruments Viable and not facing No targeted support needed to Various instruments seeking to enhance the financial distress address financial distress, but general business environment, access to finance firm development policies may support, facilitating access to markets, still be relevant to achieve longer- building firm capabilities. Relaxation of term objectives (e.g., innovation, sector-specific regulatory restrictions. Pre- tech adoption, exports, female-led insolvency proceedings may also be used, participation, green and circular where available, in anticipation of growing economy). financial distress. Viable but facing Targeted support to solve the liquidity Support through grants, loans, subsidies, financial distress problems tax deferrals. Pre-insolvency procedures may also be needed. Viable but insolvent Debt restructuring (possibly followed Debt restructuring procedures that result by targeted support) in win-win for both the firm and lenders, equity participation. These may include out of court, formal and hybrid insolvency proceedings. Not viable and insolvent Liquidation Improved insolvency procedures to reduce the cost of bankruptcy and protect financial sector balance sheets. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 23 > > > B O X 2 - Approaches to Determine Vulnerability A number of COVID-19 firm support programs have used a decline in revenue as a criterion for eligibility or to determine the amount of support provided. For example, a €130 million Danish guarantee scheme for exporter SMEs affected by COVID-19 is accessible to SMEs (and their suppliers) whose exports represent at least 10% of their yearly revenue and who experienced or expect to experience a decline in revenue of at least 30% compared to their revenue before the COVID-19 outbreak in Denmark. In the US, the federal Paycheck-Protection-Program scheme (which offers a loan, 60% to be spent on wages and salaries that turns into a grant if employment is maintained) requires that businesses applying for their second PPP loan show a 25% or greater reduction in revenue, comparing any quarter in 2020 with the same quarter in 2019. At the state level in the US, New Mexico’s Small Business Recovery Loan Fund requires a 30% drop in revenues for eligibility. World Bank operations to support the private sector in response to COVID-19 have also used similar criteria. In Ghana, a US$5 million COVID-19 grants scheme under the Ghana Economic Transformation Project scores potential beneficiaries by the degree of COVID-affectedness (whether a firm is in an area that faced lockdown restrictions as well as a change in sales, employment and exports relative to 2019 – although the score is capped for declines in excess of 50%), pre- COVID performance (whether a firm was an exporter pre-COVID, its output per worker in 2019, and whether it was on a growth trajectory between 2017 and 2019), and use of grant. In Turkey, where the authorities have suspended labor displacements since April 2020 and are supporting employment through wage subsidies, a decline in revenue of 25% or more is an eligibility criteria for performance-based reimbursable support under the US$300 million Rapid Support For Micro And Small Enterprises Project (other eligibility criteria include size, sector, and viability, with special consideration given to young innovative firms). Effective targeting of policy support requires a balance informational rents, that is, to the possibility that firms extract between pragmatism and precision. A critical aspect in private benefits to the detriment of social welfare. Thus, designing effective targeting is that information asymmetries identifying mechanisms to mitigate those asymmetries between firms and policymakers are pervasive. Firms have becomes essential to reduce inclusion errors that provide private information on their productivity, business (i.e., support to firms that do not need them, as well as exclusion profitability) prospects, cost structure, and so on that are errors that keep desirable beneficiaries out of a support typically unobserved by the policy designer, especially in program. Some potential funding allocation mechanisms that developing countries where capabilities are more limited. may also reduce information gaps are outlined in Table 2. The existence of information asymmetries gives rise to EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 24 > > > T A B L E 2 - Funding Allocation Mechanisms and Key Considerations Type Alternative Finance Specialized Processes of Funding Mechanisms (e.g., Grant assessment Banking System Funneling Allocation (Development committees run by the Mechanism Banks, Funds) government or outsourced) Method Traditional credit Using investment Varied, depends on design Tiered, sequenced support assessment assessment but can have elements based on performance, approaches approaches of of quantitative and with better performers venture capital, qualitative assessment, or “graduating” to more private equity, etc. be an ‘entitlement’ based intensive support.13 automated approach Target Bankable SMEs Suitable for non- Varied, may be more Varied with available bankable SMEs, appropriate for smaller financial data option for bankable firms, start-ups, innovators SMEs Scalability Scalable through Using investment Varied, depends on design Tiered, sequenced support banks with SME assessment but can have elements based on performance, focus, including approaches of of quantitative and with better performers through the use venture capital, qualitative assessment, or “graduating” to more of partial credit private equity, etc. be an ‘entitlement’ based intensive support. guarantees automated approach and other credit enhancements Limitations Excludes Limited scalability Subject to arbitrariness Not as effective responding unbanked firms or outright corruption to challenges requiring in contexts with poor immediate attention (i.e. governance need to mitigate liquidity problems that otherwise would lead to outright insolvency); high transaction costs given hands-on approach In practice, targeting has been more successful at the access policy support. Similarly, although firms that declared sector level, and in higher-income economies. Although having experienced no adverse shock due COVID-19 were sectors that experienced larger declines in sales were more less likely to receive public support, 20% of such firms did likely to receive public support, this relationship is driven receive some assistance from the authorities (Annex Figure primarily by high- and upper-middle-income countries (Figure 8). Some mis-targeting is to be expected given that many 3, consistent with Bennedsen et al for Denmark, 2020). As policies (rightly) prioritized speed over precision given limited shown in the previous sections, micro and small firms have information and urgency to help, and concerns about exclusion been impacted most severely by the shock across a range errors dominated those about inclusion errors. However, mis- of performance indicators yet have been the least likely to targeting has been more common in low and lower-middle- 13. For example, information and light touch ‘one-to-many’ training can be provided initially to many recipients, but more intensive and tailored follow-on support (mentoring, strengthening managerial capabilities, and ultimately market linkages and finance) is limited to firms that show an ongoing commitment to improvement, both by a deployment of their own resources but also their actions, as measured against milestones in an improvement plan. See, for example, Grover and Imbruno (2020) and McKenzie (2020). EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 25 income countries, and in countries with lower governance targeting of public programs, both in terms of eligibility criteria scores (Cirera et al, 2021). As fiscal space becomes more as well as program implementation, and minimize inclusion limited going forward, it will be important to improve the errors as well as undue market distortions. > > > F I G U R E 3 - Access to Public Support and Change in Sales 40 Average fraction with access to 35 public support 30 25 20 15 -100 -80 -60 -40 -20 0 Change in sales Source: World Bank, COVID-19 Business Pulse and Follow-Up Enterprise Surveys Note: For each sector in each country we compute the fraction of businesses with access to public support and the average change in sales. The figure is the binned scatterplot of this relationship after removing country fixed effects. > > > B O X 3 - Emerging Evidence on Targeting Emerging evidence on targeting of support policies highlights two main factors associated with mistargeting: i) barriers to access policy support, such as information and application costs, particularly for smaller firms; ii) government capacity and the ability of public agencies to target beneficiaries. In the United States, funds disbursed through the Coronavirus Aid, Relief, and Economic Security (CARES) Act’s PPP did not flow to areas more adversely affected by the economic effects of the pandemic, as measured by declines in hours worked or business shutdowns, but most likely to less hard hit businesses and locations (Granja et. al. 2020). Some of the key challenges to rollout of the PPP funds have been related to the significant heterogeneity across banks in terms of their capacity to disburse the funds (Granja et. al. 2020), the lack of awareness among small firms on the PPP program (Neilson et. al. 2020), as well as bureaucratic hassles and difficulties establishing eligibility (Bartik, 2020). By comparison, the roll-out of a similar program in Italy appears to have been effective in reaching the smaller firms and those in more adversely affected areas, at the most acute phase of the pandemic (Core and De Marco 2020). Their results highlight the importance of the role of information technology and the structure of local banking markets for the allocation of public relief funds during a crisis. In China, although labor informality limited the extent of support to smaller firms, the regressive tax structure of social insurance contributions, and the greater labor intensity of small firms and sectors affected by COVID-19, still allowed tax breaks to deliver substantial benefits to vulnerable firms (Cui et. al., 2020). In a context where labor informality is combined with high-level of informal (unregistered) firms or if those firms are less labor intensive, those firms would be less likely to be reachable and less likely to benefit from a such instrument. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 26 Effectiveness has varied across types of policies. constraints and liquidity problems are correlated with lower Early evidence suggests that some policies have been drop in sales and higher future expected sales growth, as well associated with improved performance across a range as with higher probability of investing in digital solutions.15 of firm performance indicators.14 The likelihood of firing Tax support is associated with smaller reduction in sales workers for a given change in sales (i.e., the elasticity) was and a lower likelihood of falling into arrears, although it has significantly higher for firms which did not receive policy no impact on likelihood of investment in digital solutions.16 support vs those that did, with the relationship driven mainly Finally, payment deferral seems to be the least effective of by access to wage subsidies (Figure 4). Monetary transfers all the policies with only marginal effect on the likelihood of and access to credit which may be relaxing short-term credit- increasing the use of digital platforms. > > > F I G U R E 4 - Share of Workers Fired and Access to Policy Support a) Access to Public Support 50 Share of workers laid off (%) 40 Did not receive public support 20 Received public support 10 0 -100 -50 0 50 Change in sales (%) b) Access to Wage Subsidies 50 Share of workers laid off (%) 40 Did not receive public support 20 Received wage subsidies 10 0 -100 -50 0 50 Change in sales (%) Source: World Bank, COVID-19 Business Pulse and Follow-Up Enterprise Surveys Note: Binned scatterplots. Computations used weights equal to the inverse of the number of observations in each country. 14. Assessing rigorously impact of policies is complex based on cross-section data and the fact that a firm access to policy support cannot be considered exogenous. Given our available information it is not easy to identify an instrument that would work for different types of policies, and therefore the analysis is descriptive and should not be interpreted as association rather than causal impact. 15. Access to credit is also positively correlated with higher likelihood of expanding use of digital platforms. 16. Tax support includes fiscal exemptions or reductions and tax deferrals. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 27 The following four principles could help policy makers • Don’t forget the future. The policy packages introduced maximize the effectiveness of their interventions and get today should keep in mind the interests of the future the biggest bang for the buck. and overcome the strong present-bias that the crisis generates. To the extent that lobbies and coalitions of • Move towards reactivation and recovery. Shortly interests may have shifted during the crisis, there may after the onset of the pandemic the focus of the policy be an opportunity for new social contracts and reforms was to “freeze the economy” in place with a stronger that pave the way to a robust recovery and shift the bias towards maintaining the pre-pandemic equilibrium economy into a higher equilibrium. For example, policies from collapsing. Currently, albeit gradually, it is important and programs that provide incentives to adopt digital to switch the support packages towards measures that technology and innovate are two crucial areas to prioritize start setting the basis for a new equilibrium and facilitate (see, for example, Cirera et al (2020) for a discussion of recovery through reallocation. Two examples may clarify policy instruments to support innovation). Reforms that this principle. First, many countries have introduced promote trade, investment, a level playing field and long- measures to protect jobs and support the payment of run productivity growth should return to be priority areas salaries for furloughed workers. While these policies of focus. In particular, avoiding disproportionate support have helped to contain unemployment, as the lockdown to SOEs, which are likely to crowd out private investment eases and economic activities reactivated, it is advisable ang slow growth. At the same time, the level of legal and to move towards policies that provide incentives to firms regulatory forbearance that has helped avoid widespread restart their operation and grow such as wage subsidies defaults (Muro, 2021) is likely to end and countries must (see Box 2). Second, countries need to gradually phase prepare for the post-forbearance impacts. out regulatory forbearance measures and consider introducing mechanisms for restructuring and bankruptcy • Importance of gradualism. While it is important to that allow firms to restart from a clean slate. complement the lifting of the most restrictive health measures with policies focused on recovery and support • State-contingent policies. In a context where firms are for reallocation of resources towards firms and activities facing unprecedented levels of uncertainty public policy can able to restart and grow, it should be stressed that with play a crucial role in reducing uncertainty and anchoring firms facing low demand and many countries still imposing expectations of firms around specific milestones. Policy significant restrictions to maintain social distance and makers can make policy support conditional to specific slow down the contagion, market reallocation is likely not states of the world, for example at the micro-level make to operate efficiently. In such circumstances, with high support conditional to the level of foregone revenues, unemployment and a slow recovery, reallocation may or at the sector-level support will be continued as long be slower and transition costs higher. Therefore, policy as businesses (e.g. restaurants or hotels) are unable to makers should be ready to either set up adequate social operate at full capacity because of health measures, or welfare and retraining programs for those losing their jobs announce future support conditional to specific states of or accept a gradual approach towards reallocation. the economy. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 28 6. >>> Where Do Countries Go From Here? With the global economy now approaching the recovery phase, bolstered by positive vaccine developments, the challenge for governments will be to combine protection with reallocation. In a context where firms will still have a hard time obtaining credit, many firms are likely insolvent or nonviable, and government interventions face the reality of limited public resources. Financial support to firms can be delivered through a range of channels as outlined in Table 3. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 29 > > > T A B L E 3 - Pros and Cons of Types of Financial Support to Firms Type of Financial Support Pros Cons Grants/Repayable Grants/ Non-dilutive/doesn’t add to Repayable options complex, Convertible Grants debt, repayable offers upside for expensive, needs effective (either non-repayable, or repayable if government, can be bundled with assessment and grant management pre-agreed revenues are achieved) other instruments, can be carefully infrastructure targeted for specific activity (e.g., wage subsidies – see Box 4) Indirect Non-dilutive/doesn’t add to SME Generally requires business to spend (tax incentives for investment or debt load, can be designed as credit then claim back training expenditure) and provide upfront payment, tax system established mechanism for distribution/management/repayment Loans Highly flexible, non-dilutive, allocation Requires collateral and credit through banking system so large history so favors established lower pools of capital can be accessed, risk SMEs, can be short term and distribution scalable, lending criteria expensive, banks may favor ‘who they generally transparent and due know’ diligence/selection done by banks Equity Suitable for riskier and younger firms, Requires specialized delivery can provide longer term finance, structures (e.g. funds) and is ‘smart capital so combines both management personnel, has resource financing and advice/networking, intensive/non-scalable due diligence, funds are responsible for due lack of familiarity/hostility from SMEs diligence and selection, can be mixed in giving up equity, poorly developed/ with quasi-equity/quasi debt to suit no exit markets business Quasi Debt/Quasi Equity More flexible than debt/equity, Needs specialized institution/fund (various models often firm specific tailored to client needs, collateral to manage, heavy due diligence, with repayment tied to revenues) requirements not so stringent as relatively new lending, ‘smart’ capital, generally avoids need for ‘exit’ process EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 30 > > > B O X 4 - Rationale for Wage Subsidies Wage subsidies may not be the appropriate policy in a normal context as they may slow down reallocation, prop up inefficient businesses and distort markets and incentives for firms to become more efficient. However, where governments can afford them, they may be an appropriate response in a world characterized by high-unemployment and weak demand (Blanchard et al, 2020). There are two conceptual reasons that justify the use of wage subsidies under these conditions: • First, in a context of high unemployment the shadow price of labor is lower than the prevailing wages so there is an incentive for private firms to fire workers. However, this would worsen unemployment in the short run, as it is un- likely that the workers would be able to quickly find a job. In this situation the wage subsidies would aim at reducing the cost of the wages paid by the firms and bring them in line with the shadow price of labor. • Second, in the context of high unemployment it can be argued that firing workers does not promote reallocation but instead increases pressure on unemployment. In this context, firing workers generates a negative externality as it increases unemployment and makes the probability of finding a job lower for those already unemployed. Blanchard et al (2020) argue that wage subsidies may be particularly appropriate during economic recovery, in order to tilt firms’ incentives towards restarting (particularly in instances where governments pay the cost of unemployment benefits for furloughed workers while firms pay the cost of wages for active workers). Bruhn (2020) offers empirical support for this suggestion, showing that wage subsidies implemented in Mexico during the global financial crisis did not necessarily result in firms retaining workers but helped employment rebound faster in eligible industries vs ineligible industries by facilitating rehiring of workers during the recovery. The terms of financial support will need to evolve. For Even with all this support, however, a number of firms will likely viable firms with little debt, loan guarantees should remain not be viable and therefore will need to restructure their debts. the instrument of choice, yet with less generous terms and When these loans convert into equity and state participation, conditions (i.e. lower coverage rates that those observed the governments should define a clear exit strategy and should during the outbreak phase, pricing aligned with risk). For refrain from intervening in managerial decisions and prevent firms with large financial liabilities, an appropriate mix of disruption of business decisions. For instance, governments equity/quasi-equity financing and debt restructuring should be can obtain non-voting shares and limit their role as “observer” contemplated (see Box 5). Viable firms could be offered the on the managerial boards, to maintain as much as possible option to convert guaranteed loans into equity or quasi-equity the market-based incentives on the firms. instruments such as preference shares or subordinated debt. > > > B O X 5 - Debt and Equity There are a variety of options for supporting SME funding needs through the COVID recovery stage. Traditional SME lending through the banking sector and microfinance institutions is well established, is generally well understood by SMEs and remains the mainstream platform for bankable SMEs (although still underdeveloped in many countries). Over recent years, alternative equity and variants like quasi-equity/quasi debt/mezzanine have grown in use (albeit from a small base), particularly through hybrid public-private co-investment fund models. These can be designed to support a variety of young and innovative firms. Similarly, hybrid funds that maximize finance for development utilizing institutional investors and other private financing can support investments in firms operating in key industries (Green energy, infrastructure, manufacturing and others) with positive spillover effects on SMEs engaged in these supply chains. There has been a rise in financial institutions and SME funds that can mobilize institutional investor funding and provide long-term financing to mature viable SMEs in a more tailored manner; other types of debt funds (such as receivable funds) EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 31 could also mobilize funding for working capital. These are relatively new solutions in EMDEs; and although they do not have the same scalability as bank loans they could be an interesting complement to bank financing, useful for countries with a robust institutional investor base. These programs will likely require mechanisms to align risk-return appetite of investors such as partial credit risk guarantees; they also require a robust fund management industry; legal and regulatory changes might be needed as well. Finally, leasing or capital goods financing is another form of financing supporting SMEs in manufacturing or commercial agriculture and other industries. Trade financing approaches such as factoring may be lower in risk since they are backed by receivables/invoices and can support cross-border (intra-regional) trade where many SMEs operate. These tools however remain nascent in many developing economies but can play an important role in business continuity and growth if appropriately developed. Policy makers are seeking options for supporting otherwise viable SMEs that cannot raise finance during the crisis, including those that have traditionally relied on debt finance but which may become overly indebted if they rely on traditional instruments. In addition, with many firms beginning to fall into arrears, banks are feeling the pressure of rising NPLs and are restricting new lending, preferring to direct their portfolios towards purchasing government securities. Various specialized financing and de-risking tools that can leverage private resources will be useful to develop both to address these COVID related needs, but also to broaden and deepen the SME finance market. Importantly, these alternatives can relieve pressure on governments from having to extend their borrowing to support channeling liquidity to firms. Some of the tradeoffs and challenges of debt versus equity instruments are summarized below: DEBT: • Banking • Advantages: SMEs generally understand the product, it is non-dilutive, allocation occurs through banking system so large pools of capital can be accessed and distribution scalable, lending criteria generally transparent and due diligence/selection done by banks, • Challenges: requires collateral and credit history so favors established lower risk SMEs, can only be available on short terms and at relatively high cost, banks may favor ‘who they know’, for banks SME lending generally has higher transaction costs than other lending. • Summary: remains main vehicle for scale/mass support for bankable SMEs but is still relatively under-developed in many markets. • Capital markets solutions • Advantages: SME lending funds mobilize institutional investors funding, provide longer term financing in a more tailored manner; other types of debt funds (such as receivable funds) mobilize funding for working capital • Challenges: relatively new solutions in EMDEs; they require mechanisms to align risk-return appetite of investors such as partial credit risk guarantees; they also require a robust fund management industry and specific legal and regulatory regimes; not the same scalability of bank loans • Summary: can be an interesting complement to bank financing, useful for countries with a robust institutional investor base (ongoing work of the WB in Morocco, where FCI is assisting the authorities to set up a sovereign strategic fund, which will have an EME debt fund component; in Colombia, where FCI is assisting the National Guarantee Fund to develop a partial credit risk guarantee that can be used in the context of private credit funds and in South Africa, also assisting the authorities in the development of debt funds; and IFC investment in a receivable fund in Peru) EQUITY/HYBRID: • Venture capital for SMEs • Advantages: suitable for riskier and younger firms, can provide longer term finance, is ‘smart finance’ so combines both financing and advice/networking, funds are responsible for the due diligence and selection, funds can be flexible with their instruments (mixing equity/quasi-equity/quasi debt) to suit firm needs • Challenges: requires specialized delivery structures (e.g. funds or investment companies) and personnel, has EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 32 resource intensive/non-scalable due diligence, due to perceived high risk of investments can be difficult to attract private capital for early stage investing without some risk-sharing from government with mitigation measures to ensure investments and their management are strictly private sector led, lack of familiarity/hostility from SMEs in giving up equity, poorly developed/no exit markets; • Summary: evolving models offer more flexible products for young and innovative SMEs but require different delivery capabilities and higher transaction costs, so scalability is a challenge at the fund level but it can have a catalyst effect by fostering more confidence in the market to support SMEs through demonstration effect. With appropriately designed public-private mechanisms it has been possible to raise private financing and support development of this nascent industry (examples of WB supported projects using this model can be found in Lebanon, Jordan, Morocco, Tunisia, and Egypt). Growing evidence of effectiveness, especially for smaller firms and for firms with lower likelihoods of otherwise being funded, when combined with interventions to enhance investment readiness (see, for example, Cusolito et al, 2019). • Larger companies/firms • Advantages: a similar model of co-investment via funds can potentially be expanded to larger firms (including not listed), but likely will require some focus, large amounts of global capital seeking investment opportunities • Challenges: requires a robust fund management industry, but potentially less resource intensive than VC funds, reluctance of companies to accept external shareholders would still be an issue even under a model where the fund takes a minority stake, but level of indebtedness could incentive a change Independently of the specific form of support, the In addition to financial support, policymakers should also government intervention should be carefully assessed prioritize reforms to the enabling framework with a focus such that risks for distorting market incentives or on addressing insolvencies of corporates and MSMEs. crowding-out market players can be mitigated. Principles As noted above, several countries have undertaken reforms of transparency and accountability are also essential to shape to ‘flatten the curve’ of insolvency cases. These reforms are the government interventions particularly to mitigate the described in Supporting Firm Resilience (Freund and Mora, risks of favoring politically connected firms, providing access 2020) as “Phase 1” reforms designed avoid the insolvency in preferential terms to certain market players or unlevel system from being overloaded with cases. They are not, the playing field (e.g., SOEs or private dominant firms). As however, designed to respond to the longer-term functioning public resources are scarce, governments need to consider of insolvency systems as both liquidations and restructurings, if support to specific private firms and even SOEs is the best resulting from the economic disruption of COVID-19, grow. use of limited resources and monitor program implementation. While some countries may still need to undertake Phase 1 If any form of state ownership is deemed necessary and linked reforms, most will also need additional longer-term reforms. to the support, governments should protect the market-based The scope and severity of these reforms, at individual country incentives of private sector activity. Disclosure of information level, will depend on whether or not firm distress threatens to and accountability principles will also mitigate the risks of reach levels that may trigger a systemic financial sector crisis. potential interference of the government in the day-to-day These reforms may include centralized approaches to deal operation and business strategies of the firms. Governments with systemic insolvencies and critical reforms to implementing should take this opportunity to review the economic rationale institutions such as courts (Menezes and Gropper, 2020). of the SOEs and whether support is not exclusively and unnecessarily granted to dominant firms, be they SOEs Well-developed insolvency and restructuring frameworks or private firms. As with the private firms, support to SOEs typically include a sanctioned (usually by court) debt with structural issues that were incurring in losses prior to restructuring process as one of the tools to address the coronavirus outbreak should be limited to the minimum. financial distress. These processes typically have elements Support should also involve commitments to monitor and of Out-of-Court Workouts (OCWs) and formal insolvency strengthen SOE corporate governance (Pop and Amador, proceedings and are often referred to as “hybrid” or “quasi- 2020). More can be found in Annex IV. judicial” processes. Annex I provides a taxonomy of different types of formal and informal insolvency proceedings. The EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 33 advantages of the hybrid processes to a pure OCWs is that Several countries have taken action to shore up their “standstill” periods can usually be invoked by filing a notice insolvency systems by introducing new fast-track to court to commence a period of negotiation with specific insolvency (restructuring and liquidation) procedures financial creditors who are then subject to stay. In some specifically for MSMEs. Even in normal times, MSMEs tend jurisdictions (e.g. Spain) the commencement of pre-insolvency to be more financially vulnerable than larger firms; as shown proceedings is public, in other (e.g. France) it is confidential and in section 2, their vulnerabilities have been magnified during cannot be disclosed to public. Recently, with the introduction COVID-19 while the majority of insolvency systems, even in of the EU Directive on Preventative Restructuring, a number developed jurisdictions, are not prepared to handle a wave of countries have taken steps to introduce preventative hybrid of MSME bankruptcies. The challenge for medium-sized firms restructuring procedures or to improve the already existing is typically access to more traditional ‘corporate’ insolvency ones. proceedings that are tailored to the needs of these firms. For individual micro-entrepreneurs, the objective is often to The typical features of these processes are the following: address what amounts to an individual insolvency, including through the discharge of debts, without undue moral hazard. • The restructuring plan is negotiated outside of the formal To address this issue, several countries have introduced new bankruptcy proceedings; fast-track insolvency procedures for MSMEs. Such is the case • There is a possibility to impose a court-ordered stay or of the Republic of Korea where a new MSME procedure (the a time-limited moratorium on individual enforcement Summary Rehabilitation Proceeding) was introduced in 2015 actions; and has led to substantial improvements in case duration. The • The process is accessible to a debtor in the situation of simplified restructuring procedures are conducted outside the imminent insolvency; formal insolvency proceedings and are debtor-in-possession • The agreed upon restructuring plan can be made binding processes. Their complexity is further reduced by providing on the dissenting minority creditors, including across easier access (i.e. it is not necessary to meet the insolvency classes of creditors (“cross-class cram down”); threshold and there are lesser requirements for documentation), • There is no court-assessment at the very start of the easier plan approval mechanisms, reduced cost of facilitators/ procedure; insolvency practitioners. Some of the common features of • The process does not affect the directors’ ordinary these procedures include: (1) a temporary stay or standstill management powers, i.e. the debtor remains in control against creditor actions and a suspension of directors’ of the day-to-day operation of the business. Where wrongful trading liability; (2) debtor management remaining in necessary, a neutral third party – a mediator or a supervisor possession; (3) some supervision by a regulated professional - can be appointed by the court; (insolvency or restructuring practitioner); (3) fresh financing; • There are provisions to protect new financing from (4) minimal or no reliance on formal insolvency procedures/ avoidance actions. courts. Unlike simplified restructuring procedures, simplified liquidation procedures involve greater court involvement but Since the onset of the COVID crisis, several advanced with lesser procedural complexity compared to the regular economies have enacted such proceedings, in part as a liquidation process. recognition of the increased volume of cases expected. In October 2020, the Netherlands adopted a new pre-insolvency More broadly, evidence shows that the regulatory restructuring process. This new process enables debtors environment for businesses can influence how well to elect to have their proceeding remain confidential (as an firms and economies overall cope with the crisis. Where inducement to debtors to seek restructuring assistance while business regulations are transparent and efficient and the firm is still savable) and allows for the development of institutions ensure protection of property and contractual restructuring plans outside of the formal bankruptcy process rights, it is easier for firms to adapt to new rules, reorient their which, if approved, can bind all creditors and shareholders economic activity to meet new market demands, and for new while preserving employee rights and claims. On January 1, firms to start up. Countries with lighter regulatory burden and 2021, a new scheme took effect in Germany that will permit lower barriers to entry generally experienced increases in debtors to reject burdensome contracts and access a court newly registered firms, higher productivity growth rates, and appointed mediator to assist in debt restructuring negotiations stronger reallocation of resources towards higher-productivity with creditors. firms (Motta, Oviedo, and Santini 2010; Arnold, Nicoletti, and Scarpetta 2011). EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 34 In assessing the role of a large variety of factors on measures. Single-source procurement, large amounts of state short, medium, and long-term resilience post-crisis in the aid and antitrust exemptions may all be justified in times of European Union, Alessi et al. (2019) find that a favorable unprecedented supply and demand shocks. Yet, this does not business regulatory environment matters particularly imply that response and recovery policies are at odds with for long-term resilience and is associated with stronger competition principles. As with other policies, the remedies to economic bounce-backs. Sound labor and product markets, deal with this pandemic have alternative designs - with some framework conditions that support firm entry and operations, safeguarding competition more than others. Governments can and strong institutions increase resilience towards adverse still consider competition among the criteria for choosing the shocks (Sondermann, 2016). Policy makers should shift right intervention. In practice, to preserve a level-playing field, their focus towards new areas of opportunity in order to build competition authorities can delay enforcement activities, and back better. This entails removing entry barriers, especially prioritize merger review. Authorities can still communicate that in priority sectors, enhancing policy certainty and investor they will prosecute any ongoing anti-competitive practices, protection to enable retention and expansion; and realigning once regular enforcement activity can resume. Competition policy and regulatory environments to facilitate reallocation agencies can give guidance to industries on the activities that of resources toward long-run economic transformation, job are exceptionally permitted. Authorities can actively monitor creation, and inclusion. government interventions and propose gradual adjustments to emergency programs that safeguard contestability and Despite the devastating impact of the crisis, it presents competition. More can be found in Annex IV. an opportunity to build back better in a more a green and sustainable way to accelerate climate change mitigation To help reduce uncertainty and address information and adaptation. While not within the scope of this paper, which asymmetries, authorities should pay particular attention is more focused on the near-term approach, policymakers’ to the transparency of support programs. Forbearance medium to longer term strategy towards resilient recovery measures, targeted support to certain sectors or types of should consider how to accelerate a green recovery. This firms, and other interventions should have clear, measurable, includes green business growth and green job creation, as and well-communicated criteria, ideally supported by data well as policies to green the financial sector. and diagnostics. Spending on support programs should be monitored, and amounts publicly disclosed (e.g., in annual Fostering competition-enhancing policies and reports). Particular attention should be paid to transparency regulations helps increase business dynamism through when support beneficiaries SOEs or large firms, as well as greater entry and exit rates of firms. Emergency-situations ensuring that recipients adhere to principles of good corporate like the one caused by COVID-19 require extraordinary governance. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 35 7. >>> Looking Forward – How WBG Supports Countries The WBG has a range of instruments to support firms that can be adjusted and expanded to address current challenges--mostly through Development Policy Operations (DPOs) and Investment Project Financing (IPFs) guarantees, lines of credit and equity instruments- articulated around the following pillars. Program for Results (PforRs) can also be used where the focus is on implementation. 1. Better targeting of liquidity and support adjustment. Broad-based emergency measures should have been time bound and can be phased out as conditions improve. The Bank and IFC can continue to provide liquidity support to recovering firms through banks, and NBFIs. Targeting programs toward high productivity firms in viable or essential sectors will preserve scarce resources while promoting growth. It will be important to ensure that IFC and WB design joint interventions to facilitate risk sharing solutions, creates additionality and crowd- in private sector financing and capital. Particularly relevant will be to leverage the formal banking sector, NBFIs and microfinance institutions, with the latter two often not having access to traditional central bank liquidity facilities and needing additional support, including potentially through capital markets instruments. This could be articulated through WB IPFs designed to provide lines of credit, equity components, and strengthen partial credit guarantees programs; WB DPOs to support regulatory reforms to facilitate these instruments; and through IFC credit lines to banks and NBFIs, local currency financing, guarantees and other financial solutions provided directly to the private sector in a manner that leverages public sector and eventually donors’ resources. 2. Facilitate the development of digital infrastructure, adoption of new technologies, and the creation of new businesses. Supporting the development of e-commerce and B2B solutions can help firms access new markets, increase matching efficiency and lower transaction costs, especially in a world where face-to-face interactions bring higher risk. GovTech plays a critical role to help governments become more effective and responsive to citizens and firms. FinTech solutions could be leveraged to level the playing field for women-owned or led MSMEs in terms of access to financing, offering an unprecedented opportunity to mitigate EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 36 the impact of COVID-19, especially for those firms without safety nets, and IFC co-investments to recapitalize prior access to the financial sector or to a large extent institutions and help to resolve distressed assets. dependent on remittance flows. Support programs to foster the creation and scale of digital businesses are in 4. Create the enabling framework needed to restructure demand as private investors park their resources in safer debt, providing financial support to firms during the developed markets. MFIs, fintech companies, and SOBs recovery phase: The deterioration of the business cycle can utilize the following to speed MSME loan decisions: will have a large impact on the quality of assets and the (i) simplified loan application processes and remote capacity of firms to continue operating. Many firms will customer due diligence/ Know Your Customer rules to need to restructure their debt profiles and others will facilitate emergency cash transfers (G2P) through digital require to be promptly resolved to avoid an increasing means, (ii) the acceptance of digital payments for essential number of zombie firms. The WBG needs to engage in the entities such as hospitals and pharmacies and (ii) the initial stages with authorities to strengthen the insolvency use of alternative data (leveraging artificial intelligence and resolution frameworks, including legal frameworks for for instance). Additionally, financial institutions could corporate and consumer debt restructuring, and out-of- leverage online platforms and capital market solutions court conciliatory measures. The latter will be particularly for conducting reverse-factoring transactions that could important to prevent a surge in insolvency filings, value- facilitate supply-chain finance to MSMEs and shorten destroying liquidations, and asset fire-sales, helping to the maturity of the payments involved. This could be preserve employment and also reduce pressures on bank done with joint WB-IFC interventions using the range balance sheets which impair their functioning and stability. of instruments needed to accelerate the necessary In many countries the WBG could facilitate, promote and reforms in DPOs and implementation through IPFs/ design systemwide corporate resolution mechanisms PforRs that would facilitate digitalization of financial or “Recovery Funds”. This could be implemented by services, e-commerce development, GovTech a combination of WB DPOs to create the enabling solutions for service delivery and accountability, framework and the design of recovery interventions interoperability of payments systems, merchants’ with different WB instruments (IPFs, PforRs) and IFC acceptance of digital payments. Innovative Fintech financial instruments. Such interventions should solutions can be supported through IFC investments, be designed with an exit strategy in mind to release and helping firms build the necessary management, public resources and let market forces function post organizational, and technology skills to conduct recovery. business online. 5. Undertake reforms to enable firm entry and expansion. 3. Ensure the financial sector has the capacity to provide Countries can focus on improving overall ease of doing the needed liquidity and support without jeopardizing business to lower regulatory costs and risks to businesses its resilience: Unprecedented regulatory forbearance and accelerate digitization of G2B services; risk-based decisions will continue to need to be designed carefully to and safe reopening of the economy; and strengthening avoid increasing financial risk, especially in those systems institutions. Policy makers should shift their focus towards that are already vulnerable. This calls for adequate new areas of economic opportunity. This entails removing reporting and monitoring of forbearance measures to be entry barriers, especially in priority sectors in light of market able to assess asset quality, provisioning, and capital shifts following the pandemic; enhance policy certainty adequacy on a continuous basis, with decisions that are and investor protection to enable retention and expansion; state dependent, transparent and based on rigorous risk and realigning policy and regulatory environments assessments. Monitoring of liquidity would be particularly to facilitate reallocation of resources toward long-run relevant; often, other measures such as restricting the economic transformation, job creation, and inclusion. In distribution of dividends and recapitalization of specific many countries, the WBG is using a combination of banks and NBFIs that are viable may be needed. Recovery DPOs, IPFs, PforRs and supplementary ASAs or IFC and resolution planning for banks and strengthening advisory to design and implement investment climate deposit insurance funds may need to be updated, and reforms for economic reopening and recovery. Since NPL management frameworks put in place together with the outbreak, for example, the WBG has supported comprehensive insolvency and out-of-court processes. at least 70 countries directly through policy lending This could be achieved by a combination of reforms and advisory services around regulatory flexibility, included in WB DPOs, IPFs, PforR to recapitalize improving women’s economic opportunities (e.g. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 37 Women, Business and the Law reforms), increasing online and offline markets during the crisis, consideration investment retention, and tapping new GVC for remedies and insolvency risks on a case-by-case opportunities. basis during merger review and proactive approaches to ex ante regulation to preserve the right market incentives 6. Preserve incentives for recovery and a level playing field. (Pop and Amador, 2020). Targeted WBG support can be During the crisis recovery and for building forward, it will achieved through a combination of DPOs/IPFs/PforRs, be important for all the countries to undertake reforms that ASAs or IFC advisory to design and implement pro- reinvigorate competitive pressures to stimulate productivity competition interventions for economic recovery. growth. A first step is to ensure that recovery measures do not create unintended consequences and permanently 7. Collect data to monitor and analyze COVID-19 impact lock in market structures with lower competitive pressure. on firms and effectiveness of policy support. Continued It will be important to re-establish transparent and monitoring of how businesses are affected by and competitive public procurement processes, limit bailouts responding to the shock, as well as the effectiveness of to companies that already had a good track record, ensure government support programs and policy changes, will that ongoing state support is granted in a transparent and help shape better policy and prioritize the use of scarce non-discriminatory way, and refrain that price controls fiscal resources. The WBG can support data collection to are permanently used to stabilize prices across food monitor COVID-19 impacts on firms and policy responses and non-food markets. Beyond doing no harm, countries (e.g. COVID-19 Business Pulse and Enterprise Surveys will need to enhance competition policy enforcement and Insolvency Reform Tracker – an expanded list of and consumer protection, particularly as regards digital WBG efforts to track and monitor various types of policy platforms, where restrictions on commercial use of data responses by governments around the world since the or open access initiatives may be warranted. Competition onset of the crisis can be found in Annex II). It can also help policy will entail increased vigilance and investigations of clients with data analysis and provide technical assistance potential collusive practices, ending antitrust exemptions to countries to strengthen data collection to ensure policy that allowed for information sharing among competitors in support is targeted as accurately as possible. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 38 >>> Annex I: Spectrum of Insolvency Processes Levels of Key Considerations for Formality Procedure Advantages Disadvantages Distress Enabling Environment* E.g. The • No legislative process required • Coordination problems and • Negotiation culture among London (in some cases non-binding risk of creditor holdout creditors and debtors Out-of-court workouts Approach; guidelines may be adopted • Risk of creditor actions • Availability of financial Imminent insolvency INSOL by a government agency to during the negotiation period information (refer to WB-ICR Financial difficulty Principles) encourage standardized multi- (insolvency filing or individual Principle B1**) creditor behavior) debt enforcement actions) • Existence of contract rules • No court involvement • Risk of avoidance actions in that allow modification of • Confidential, flexible, and fast subsequent insolvency (unless debts and establish good faith • Cost-effective (no court or insolvency law impedes requirements for the parties to insolvency practitioner costs) revocation of good-faith the contract • Option to select creditors to informal workouts) • “Shadow of law” (availability negotiate with • No scrutiny of management’s of recourse to debt behavior pre-restructuring enforcement, liquidation and/ or reorganization proceedings) E.g. Republic • No legislative process required • Fiscal and regulatory • A strong, proactive of Korea (but in some cases corporate incentives can distort coordinating agency (usually Financial restructuring laws may be incentives of market a central bank/financial Institutions’ passed to enhance the participants and prop-up non- supervisor) (refer to WB-ICR Agreement effectiveness of the system) viable businesses Principle B4.1) for Promotion • No court involvement (but • Often involve fiscal costs • Cooperative FIs (inter-creditor Imminent insolvency of Company often another coordinating • Restructurings only cover accords should cover all or Enhanced workouts Financial difficulty Restructuring; institution involved, e.g. certain creditors as part of the almost all FIs) Thailand’s financial supervisor) inter-creditor accord– trade • “Shadow of law” (availability CDRAC; • Cooperation reinforced by creditors, tax claims, labor of recourse to debt Istanbul fiscal and regulatory incentives claims normally excluded enforcement, liquidation and/ Workouts Approach) (e.g. tax exemptions, • Debtor not a party to the inter- or reorganization proceedings) regulatory forbearance, creditor accord and therefore modified labor standards) to does not have a say on the restructure and/or penalties for workout process failure to meet deadlines • Limited effectiveness for • Possible to bind dissenting borrowers with only one creditors that are part of the financial creditor (often micro inter-creditor accord and small enterprises) E.g. US • Combines speed, flexibility, • Due to informality, may lead • Adequate expertise and Chapter 11 and informality of purely to inefficient and/or unfair capacity of courts pre-packaged contractual restructurings with outcomes for minority creditors • Availability of financial bankruptcies; the benefit of access to formal • The court may find that information (refer to WB-ICR UK scheme of processes in court to preserve pre-bankruptcy disclosure Principle B1) arrangement; the going concern business was inadequate and refuse • Enabling legislative framework Singapore’s value approval of the restructuring (refer to WB-ICR Principles B3 Hybrid workouts scheme of • Reduced stigma and publicity plan (see, for e.g. Section and B4) arrangement while negotiations are ongoing 1125(a) of the US Bankruptcy • Availability of recourse to debt (2017); Dutch Code) enforcement, liquidation and/ confirmation or reorganization proceedings of extra- judicial restructuring plan procedure (2021); French conciliation procedure * It should be noted that country approaches to the design of insolvency and restructuring processes vary. It is important that countries, when adopting these processes, consider the unique context of their legal and commercial systems. ** The World Bank Principles for Effective Insolvency and Creditor/Debtor Regimes. Available at: www.worldbank.org/insolvency EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 40 Levels of Key Considerations for Formality Procedure Advantages Disadvantages Distress Enabling Environment* E.g. • Provides for court-imposed • Same as above • Adequate expertise and Germany’s stay • Can be costly as usually an capacity of courts (refer to Preventative hybrid workouts pre-insolvency • Includes statutory protection of insolvency practitioner must WB-ICR Principles D1-D6) Imminent insolvency scheme new finance be appointed • Availability of qualified Financial difficulty (“StaRUG”); • Can bind dissenting creditors • Usually public (which can be insolvency practitioners (refer French (“cram-down” feature) associated with stigma) to WB-ICR Principles D7-D8) safeguard • May provide for court and • Enabling legislative framework procedure insolvency practitioner • Availability of recourse to debt oversight and assistance (e.g. enforcement, liquidation and/ judicial resolution of disputes) or reorganization proceedings while debtor continues to control its assets and business operations (debtor-in- possession) E.g. France’s • Provides access to all formal • Usually costly and lengthy • Adequate expertise and judicial mechanisms to preserve • Can be disruptive to business capacity of courts (refer to reorganization the going concern value of operations WB-ICR Principles D1-D6) Formal insolvency procedures procedure - business (stay, challenge • Sometimes delays inevitable • Availability of qualified redressement of fraudulent or preferential liquidation insolvency practitioners (refer judiciaire; transactions, continuation of • Publicity, stigma to WB-ICR Principles D7-D8) Judiical reorganization Imminent insolvency US Chapter essential contracts, etc.) • The process is driven • Insolvency legislation enabling 11 judicial • Protects new finance by court and insolvency and detailing the formal insolvency reorganization • Plan can bind dissenting practitioners (debtor removed reorganization procedure procedure; UK creditors from management in some (refer to WB-ICR Principles, administration • Allows amendment of systems) Part C) procedure contracts • Provides for substantial court and insolvency practitioner oversight • Some aspects may be simplified for micro and small enterprises E.g. UK • Enables orderly exit of non- • Low creditor recovery (quick • Adequate expertise and liquidation viable business from the diminution in value) capacity of courts (refer to procedure; market and distribution of the • Can be lengthy WB-ICR Principles D1-D6) Republic proceeds to creditors • Auction process can be non- • Availability of qualified Liquidation insolvency of Korea • In some cases, sale of transparent liquidators (refer to WB-ICR bankruptcy business as going concern • Bailiffs/sheriffs might not Principles D7-D8) proceeding can be achieved, thereby have adequate training or • Insolvency legislation enabling preserving its continuity protections for the seizure and and detailing the liquidation • Some aspects may be sale process procedure (refer to WB-ICR simplified for micro and small • Movable property might not be Principles, Part C) enterprises traceable Definitions Out-of-court workout – a privately negotiated restructuring between the debtor and all or some of its creditors Enhanced workout – a workout with the involvement of an administrative authority but with no provision for a court to play a role Hybrid workout – a procedure that involves private negotiation of a restructuring agreement and provides for a court role short of supervision of the full procedure Preventative hybrid workout – hybrid procedure aimed at restructuring, while under court protection, of a debtor’s business that is in financial distress but not yet in a technical state of insolvency Judicial reorganization – a court-supervised restructuring process aimed at restoring the financial well-being and viability of a debtor’s business Liquidation – a court-supervised process by which assets are sold and disposed for distribution to creditors, in accordance with a ranking of claims established by law EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 41 >>> Annex II: Overview of World Bank Policy Trackers Related to Firm Support Scope Unit Sample Size Name of Tracker (type of firms, Measures Tracked (number, $, %) (no. of countries) Main results sectors, etc.) SME COVID-19 Measures to support Measures tracked Number of 1,600 measures The database helps understand Policy Response private sector firms, are classified in eight measures. in 135 countries which support measures have Dashboard especially SMEs, categories: Business Details on been most commonly used, in all sectors of the advice, Business amounts or distinguishing by country economy. climate, Business costs, number of income levels and region. Debt finance, Demand, beneficiary firms Income levels, administrative Employment support, are spotty and capabilities, fiscal space, size of Tax, Other finance only available in the informal sector, among other a few cases factors, may affect the number and type of measures adopted. State Support Approved subsidies State guarantees Number of 611 measures in At least USD 8.4 trillion in state and Aid Tracker; and state aid (for loans or trade measures, 124 countries aid committed as of November including related measures to support credit insurance), tax targeted sector, 20 2020; around 5% of state SOE tracker firms of all sizes, advantages, wage type of measure, SOE tracker: aid measures that specifically types (SME, large subsidies, grants, description, 174 measures in target SOEs; around 32% target companies, SOEs) loans and repayable value in original 75 countries MSMEs/SMEs, 11% target and all industries in advances, subsidized currency and large enterprises and 45% all response to Covid-19; and subordinated loans, USD, recipient enterprises; around 40% of the associated SOE suspension/rebates firms, measure schemes target specific sectors, tracker also includes for input costs, direct objective, of which 30% target air transport measures to support purchase of goods, government (12% of total schemes), 16.5% companies with state equity, packages of participation agriculture (7% of total) and participation or private multiple measures. (%), type of 15% tourism (6% of total); companies where SOE tracker includes measures, and 25 countries across regions support would imply additional data on presence of (EAP, ECA, LAC, MENA, North transformation in the capital injections, equity sovereign wealth America, SSA) implemented ownership structure. transactions (purchase funds (SWF) state aid measures directed at of shares and M&A), SOEs. loans, government guarantees, grants, Capital injections are the PPP, creation of SOEs, most common form of subsidies and tax intervention when targeting deferrals. SOEs (30%) overall. However, the instruments used varies depending on the presence of SWF and the level of state participation. Financial Policy Financial sector firms Support to borrowers Number of Over 3400 Compendium report (link here) Response and their borrowers through financial sector; measures measures in 156 52% of measures in support Compendium and clients central bank support countries of banking sector globally (liquidity), prudential, (mostly prudential and support payments, conduct, for borrowers), 25% liquidity integrity, insolvency measures. Moratoria represent 10% of Banking sector measures; 9% for relaxation on treatment of NPL. Insolvency Economies Insolvency and Number of 62 economies Over 90% of economies Tracker insolvency related measures introduced insolvency or measures insolvency related measures. The most common type of measures were mandatory contract modification measures, addressing either the prospects of repayment or the effects of non-payment. These measures were introduced by 82% of the economies in the tracker. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 43 Scope Unit Sample Size Name of Tracker (type of firms, Measures Tracked (number, $, %) (no. of countries) Main results sectors, etc.) Competition Competition policy Cooperation and Number of 146 measures Around 60% of measures are Policy Tracker actions implemented collaboration among measures, type across 64 implemented in high income by governments, incl. competitors, price of measure, countries (+EU) countries, 42% in ECA and 20% competition authorities controls (fixed or sectoral/ in EAP; 40% of measures allow and other regulatory maximum prices), horizontal cooperation and collaboration bodies across all actions against price approach among competitors, 26% continents gouging, temporary concern price controls and 23% relief of competition involve actions against price laws and/or regulation, gouging; 76% of measures undue regulatory target specific sectors/product barriers, expedited groups, importantly Hygiene and public procurement, medical products (32% of total), simplified merger Food (20% of total), Air transport review procedures and Utilities (6% of total each) and penalties for anticompetitive conduct Industry-Specific Government measures Business climate, No. of measures 238 measures for More than 238 industry- Policy Tracker to support specific business costs, implemented 95 countries specific measures have sectors and industries business upgrading, by country, been implemented across 95 affected due to debt finance, region, income countries mostly in the form of COVID-19 pandemic. employment level, sector and debt support, investment and support, green/ subsector tax allowances, and reduction climate, investment/ of business costs (e.g. fees capital, other finance, rebates). production, regulations, support to demand, tax FDI Entry Investment policy Barriers to investment Number of 64 measures in Provide an accurate and and Screening measures related to entry including: measures 41 countries regularly updated in-depth Tracker the entry of foreign screening mechanisms, database on countries’ investment in all restrictions on hiring responses to the Covid-19 sectors of the economy foreign workers, pandemic as it relates to FDI adopted in the context restrictions on land flows. of Covid-19 across the ownership, restrictions globe. on foreign capital The database appears to ownership support the hypothesis that countries are enhancing Measure facilitating the protectionism to combat the entry of investment: effects of Covid-19; with 71% of Opening a new sector the measures being barriers to to FDI, increasing investment entry. foreign equity ceiling, streamlining foreign Out of those restrictive worker permits, measures 80% are screening streamlining land measures, and OECD countries ownership were the most active countries in restricting FDI (74% of the restrictive measures). Many observations can be made from this dataset that can be found here EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 44 >>> Annex III: Sector Specific Considerations (Tourism) Tourism. As a people-based and travel-reliant sector, tourism demand, tap into larger financial and organizational capital is one of the sectors hit hardest by the COVID-19 pandemic. (which may be difficult to replace), and those with greater There was a 73.9 % decline in international arrivals in 2020 capacity to support smaller and other less resilient firms in compared to 2019 (UNWTO, 2021). Up to 120 million jobs the supply chain. may be at risk, more than half held by women and youth. • Finally, governments will also need to invest in reopening strategies including promotions especially those focused SMEs make up more than 80 % of the travel and tourism on building traveler confidence and on sectors with sector. In the face of complete cessation of demand, SMEs demonstrated pent up demand, product development, need support to address immediate liquidity challenges to limit sustainability and health assurances, and insurance firm closures and prevent widespread layoffs. Tourism SMEs products to help attract back old and new domestic also need regulatory flexibility to ease the pressure on cash travelers. Public investments should be guided towards outflows. Because tourism relies on an ecosystem of SMEs sustaining key assets and supply linkages in destinations including attraction sites, wildlife, parks, restaurants, artisans, and positioning them for greater resilience. During the entertainers, airlines, taxis, marketing, baggage handlers, restructuring phase it will be necessary to support firms in airport concession suppliers and others, helping to prevent changing business models by mobilizing innovation and breaks in the SME supply chain are critical to the whole sector. technology e.g. virtual tourism experiences, ecommerce Measures put in place by governments to save SMEs in etc. tourism are similar to those in other sectors but in general have had to last longer. These include short to medium term direct Good practice examples of tourism sector support include: financial support, wage assistance schemes to reduce layoffs, and cost reductions (tax, tourism authority levies, fees etc.) • COVID Support Hub (Ireland). Fáilte Ireland, the and medium to long term low-interest loans, debt financing, National Tourism Development Authority of the country, product redevelopment, and restructuring. has a COVID Support Hub that highlights learning resources for individuals and businesses to increase their While immediate responses have taken a “one-size-fits-all” competitiveness and navigate the recovery period. The approach, longer term approaches need to be more strategic, hub also includes advisory resources on key topics such allow for the protection of critical assets in the supply chain, as operational cost management. facilitate digital uptake, a transition to greener operations and • Tourism Transitions Program (New Zealand). New enable labor mobility. Zealand’s Ministry of Business, Innovation, and Employment has begun a Tourism Transitions Program • Direct support should be tailored to the type of firms, the to deliver advice and support to businesses interested in amount of resources available and the administrative pivoting to the domestic or regional (Australian) market. capacity of each country. Measures should be transparent, • Support measures (Croatia). Croatia implemented a set and time-bound. of measures to support tourism businesses including • Assistance to firms can include: clearing public arrears postponing payment of fees, tourism taxes, and increasing and expedite payments, with a focus on SME suppliers; their liquidity. Besides tourism specific measures, general mutualizing losses of small businesses by issuing tax economy interventions support the sector by including credits, providing direct transfers, extending guarantees tourism in the scope of the Export Guarantee Fund with for receivables, and/or lending on a concessional basis; the aim of enabling the issuance of guarantees for loans introducing borrower relief measures such as reprofiling to banks for additional liquidity. debt service repayment schedules; and allowing for the time-bound and transparent deferred recognition of NPLs Many policies have been driven by an overwhelming desire to on bank balance sheets. “return to normal” as soon as possible. Yet for many tourism • Special assistance may also be needed for micro firms destinations, the future may look quite different. There may be in the tourism sector such as tour-guiding and operation a shift toward domestic and regional markets. There is also companies which typically lack the ability to access expected to be a shift toward local supply chains, and greener finance due to informality or lack of collateral. These firms and more circular business models that advance sustainability in particular can benefit from support for digitization, digital in the sector. This is an opportunity to accelerate change marketing and sustainability improvements. towards localization, digitalization, and sustainability that will • Support may also need to be channeled to firms that have build sector resilience in time for the next crisis. higher potential to: lead recovery through stimulating EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 46 >>> Annex IV: The Rise of the State COVID-19 has been disruptive for all economies - large firms investment and tax allowances, and reduction of business and SMEs have been facing severe financial distress and costs (e.g. fees rebates). with high levels of uncertainty ahead, some firms are exiting • Finally, the competition policy tracker includes 124 the market or being merged. The unprecedented magnitude competition policy measures across 64 countries put in and length of the COVID shock is changing the business place by governments to provide relief and exemptions landscape and is triggering government measures worldwide. from competition rules. Around 40% of measures allow cooperation and collaboration among competitors, 26% To avoid market disruption, ensure the provision of key goods concern price controls and 23% involve actions against and services, and protect jobs, worldwide governments are price gouging. Most measures (76%) target specific providing policy responses through multiple channels of sectors or product groups. For example, competition support including direct loans, state guarantees, debt relief measures in hygiene and medical products (32% of total), measures, among others. As of early February 2021: food (20% of total), air transport and utilities (6% of total each) are most common. These measures would require • Subsidies and state aid tracker includes more than 650 monitoring to avoid long-lasting market distortions. approved measures directed at private firms and SOEs across 125 countries (EAP, ECA, LAC, MENA, North Many of these emergency policy interventions have as America and SSA). It indicates that state aid has taken objective the provision of undisrupted public services multiple forms, such as grants (25% of measures), or goods. However, these policy interventions can have subsidized loans (14%), state guarantees for loans (13%), unintended consequences in the market dynamics in the tax advantages (9.3%), wage subsidies (4.3%), multiple short and medium-term, especially in scenarios where certain measures (20.4%), among others. Around 5% of state aid market players benefit from the government support on a schemes across 25 countries specifically target SOEs, preferential basis. For instance, a detailed analysis on the many in air transport. measures implemented in the aviation industry highlighted • Further, SOE policy measure tracker shows that more that state-owned airlines received 6.8 dollars vis-à-vis 3.2 than 175 measures implemented across more than 75 dollars allocated to private companies of every 10 dollars economies have been targeted towards companies where provided by governments to support the aviation industry as the government has any level of ownership, surpassing of June 2020 (Martinez et al 2020). This points out the risks USD 889 billion in January 2021. The instruments and of SOEs benefiting from government support that might not conditions provided are not always the same: Capital be available under the same conditions for private firms with injections (30%) and purchase of shares (13%) are the impactful effects on competition (e.g. exit of highly productive most common instruments of intervention for majority firms, higher concentration) and potential delays on the owned SOEs, while loans are provided to minority SOEs. process of recovery (Pop and Coelho 2020). In 11% of the cases identified, SOEs with less than 25% (not even blocking minority) received more than USD 24 • Some government interventions state a clear policy billion in support. One in every 3 SOE-measures identified objective and rationale for the provision of the come with ownership strings attached increasing the support specially when targeted to SOEs, although participation of the state (e.g., Lufthansa loan connected it is not always the case. Some governments have to increased state participation up to 20%). Instruments argued the need of SOE-specific interventions as the also vary depending on the presence of SWF. For instance, instrument to protect jobs, guarantee service continuity capital injections and mergers among SOEs are more of essential services, and ensure the provision of key likely to occur in countries with SWF.17 The tracker also goods under the potential disruption of GVCs. However, reveals that SOE support is targeting mostly companies there is evidence of the expansion of the state as market in commercial and contestable sectors: 47% in aviation, player in commercial sectors (e.g. automotive, steel 11% in manufacturing (automotive, pharmaceutical, and manufacturing, accommodations services). There is also PEP. evidence of business consolidation strategies among • The industry-specific policy tracker reveals that more than SOEs, in addition to those involving private players, that 251 industry-specific measures have been implemented could lead to more concentrated industries after COVID. across 97 countries mostly in the form of debt support, For instance, in Indonesia the government is merging 17. The SOE definition in the tracker includes all companies with any level of government participation and is not limited only to controlled firms (e.g. 50%+ government participation). EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 48 8 SOEs in the accommodation sector with the state- business environments. For instance, governments can run airline to create a large holding company with the impose additional measures to protect contestability of objective of offering lower prices than private competitors the markets and promote other policy objectives. Other and boost tourism. Although related to a policy objective, measures such as environmental standards can also governments should assess the costs and benefits of the be justified in exchange for state support. However, it is measures, identify the appropriate target and instrument recommended that measures are carefully designed to of support, and protect market-based incentives for private respond to a specific objective and do not distort market activity. conditions even further. • As public resources are scarce, governments need • Independently of the specific form of support, to consider if support to specific SOEs is the best the government intervention should be carefully use of limited resources. Governments should take assessed through the competition lens such that this opportunity to review the economic rationale of risks for distorting market incentives or crowding- the SOEs and whether support is not exclusively and out market players can be mitigated. Principles of unnecessarily granted to dominant SOE, especially in transparency and accountability are also essential countries with a large SOE footprint. Support to SOEs with to shape the government interventions particularly to structural issues that were incurring in losses prior to the minimize the potential interference of the government coronavirus outbreak should be limited to the minimum. in the day-to-day operation and business strategies of Support should also involve commitments on measures to the firms, including SOEs (Pop and Amador, 2020). Any monitor and strengthen SOE corporate governance. support provided should be transparently assigned, recorded, and disclosed. Asymmetric conditions for • Criteria for the state to intervene through direct or accessing support for SOEs vis-à-vis private companies indirect measures need to be defined and exit strategies should be avoided and governments should prioritize would require to be in place. The purchase of shares and the assistance on economic and transparent variables increased state participation should be considered as a (e.g. employment), whereas ownership structure should last resort and if deemed needed, it requires the design of not be a decisive variable (e.g. SOE vis-à-vis private a clear exit strategy. Similarly, capital injections or full-scale company). Transparency and accountability mechanisms nationalizations should avoid potential market distortions are determinant to avoid specific support is disguised in associated with state participation in commercial sectors. the form of capital injections, reduced fees to SOEs, or Objective criteria and clear conditions should be included grants to favor specific companies that could create undue to ensure that state support translate into pro-competitive advantages for some companies in the industry. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 49 >>> Figures A N N E X F I G U R E 1 - Uncertainty in Developing Countries vs US 20.00 18.55 Uncertainty about change in sales (%) 15.00 10.00 5.98 5.00 3.00 0.00 Average Developing USA USA Countries (Jan 2020) (June 2020) (May-Aug 2020) Source: World Bank, COVID-19 Business Pulse and Follow-Up Enterprise Survey A N N E X F I G U R E 2 - Size of Fiscal Stimulus Size of Fiscal Stimulus, as % of GDP 1 Low Income 2 Lower Middle Income 3 Upper Middle Income 4 High Income -10 0 10 20 30 40 Sources: CEPR CESI Index. Elgin, et al (2020) and World Bank’s WDI Country income groups are defined according to the World Bank’s World Development Indicators definition. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 50 A N N E X F I G U R E 3 - Policy Responses by Country Income Groups 1 Low Income 2 Lower Middle Income 27% 41% 31% 13% 24% 1O% 3 Upper Middle Income 4 High Income 39% 33% 22% 15% 20% 34% Debt Finance Employment Support Tax Business Costs Other Finance Demand Business Climate Business Advice Source: World Bank Group, Map of SME-Support Measures in Response to COVID-19 Note: Country income groups are defined according to the World Bank’s World Development Indicators definition. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 51 A N N E X F I G U R E 4 - Preferred Policies by Size and Formality Status 60 56 52 49 50 45 42 Percentage of Firms (%) 41 40 40 37 35 35 35 33 32 31 30 27 27 24 22 21 20 18 10 0 Micro (0-4) Small (5-19) Medium (20-99) Large (100+) Monetary transfer Payments deferral Access to credit Tax reductions and deferrals Wage subsidies 60 56 49 50 50 43 42 Percentage of Firms (%) 40 38 40 29 30 23 19 20 10 0 Formal Firms Informal Firms Monetary transfer Payments deferral Access to credit Tax reductions and deferrals Wage subsidies Sources: CEPR CESI Index. Elgin, et al (2020) and World Bank’s WDI Note: Country income groups are defined according to the World Bank’s World Development Indicators definition. Prediction after regression on selecting each policy controlling for firm size, subsector, country, weeks after peak, and formality status fixed effects. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 52 A N N E X F I G U R E 5 - Received Policies by Size and Sector 40 30 Percentage of firms (%) 30 28 24 20 18 10 0 Micro (0-4) Small (5-19) Medium (20-99) Large (100+) 40 Percentage of firms (%) 30 25 24 23 21 20 10 0 Agriculture Manufacturing Retail Other services Source: World Bank, COVID-19 Business Pulse and Follow-Up Enterprise Survey EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 53 A N N E X F I G U R E 6 - Reasons for Not Receiving Policy Support By Country Income Group 100 2 21 15 25 47 80 6 20 3 27 Percentage (%) 71 60 14 51 40 40 18 30 20 11 0 Low Middle Upper Middle High I was not aware Too difficult to apply I am not eligible I have applied but not received it By Firm Size 100 16 18 19 23 80 19 17 18 22 Percentage (%) 60 12 14 13 53 11 50 49 40 45 20 0 Micro (0-4) Small (5-19) Medium (20-99) Large (100+) I was not aware Too difficult to apply I am not eligible I have applied but not received it Source: World Bank, COVID-19 Business Pulse and Follow-Up Enterprise Survey Note: Margins after multinomial logit controlling for firm size, subsector, weeks after peak, and country, fixed effects EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 54 A N N E X F I G U R E 7 - Received Policies by Income Group 68 66 64 60 50 Percentage of Firms (%) 40 30 30 26 28 24 23 22 21 20 19 17 20 17 16 15 13 9 10 10 4 0 Low Low-Middle Upper-Middle High Monetary transfer Payments deferral Access to credit Tax reductions and deferrals Wage subsidies Sources: CEPR CESI Index. Elgin, et al (2020) and World Bank’s WDI Note: Prediction of a probit regression of policy received on firm size, subsector, number of weeks from the peak of the mobility, restriction and income classification fixed effects A N N E X F I G U R E 8 - Access to Public Support by Type of Shock Experienced 40 Percentage of firms (%) 30 28 26 26 19 20 10 0 Demand Production Both No Shocks Shock Shock Suffered EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 55 continuation... 40 Percentage of firms (%) 30 26 20 18 10 0 Sales Decreased Sales remained the same or increased Source: World Bank, COVID-19 Business Pulse and Follow-Up Enterprise Survey Note: Prediction of probit regression on accessing public support, controlling for firm size, subsector, country, weeks after, and type of shocked suffered fixed effects. EQUITABLE GROWTH, FINANCE & INSTITUTIONS INSIGHT <<< 56 >>> References Anderton, R., Di Lupidio, B., & Jarmulska, B. (2019). 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