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Economy

Australia risks 'insolvency tsunami' when coronavirus aid ends

'October cliff' looms for weak businesses that were likely doomed before pandemic

A moratorium on insolvent trading appears to have allowed many Australian businesses to forge ahead, when they normally would have had to wind up their operations.   © Reuters

SYDNEY -- Australia faces an "insolvency tsunami" when government handouts to help businesses cope with coronavirus restrictions expire on Sept. 29.

The payments are a major plank of the government's stimulus package, which now runs into the hundreds of billions of dollars. They were designed to help businesses keep paying staff and creditors, including those in the "hibernation" period the government ordered for "nonessential" establishments such as bars, nail salons and fashion boutiques.

John Winter, CEO of the Australian Restructuring Insolvency and Turnaround Association, or ARITA, said many of the insolvencies expected after Sept. 29 would occur because those businesses were not financially viable at the start of the COVID-19 crisis, or would no longer be viable in the constrained post-coronavirus environment. These operators are hurtling toward what has been termed the "October cliff."

"What's happened is that the government's stimulus packages, and particularly the moratorium on insolvent trading, have ensured that some businesses decided, 'We'll try to keep going for a bit longer,'" Winter told the Nikkei Asian Review. "There will need to be a catch-up on those business that would have failed in the natural course of business anyhow. So that is going to be part of the aggregation of failures that will come in October when the stimulus packages come to an end."

The moratorium on insolvent trading means that businesses that cannot pay their bills -- and are therefore technically insolvent -- have been allowed to continue operating without penalty. Under normal conditions, trading while insolvent is a serious offense.

Professor Renee Fry-McKibbin and Dr. Adam Triggs, leading academic economists at the Australian National University, argue against the withdrawal of support on Sept. 29, saying it would be an extreme shock to the economy. Their prediction stands in contrast to the widely debunked notion of a robust "snapback" in the economy the government initially expected -- or at least hoped for -- once the coronavirus curbs were lifted.

Fry-McKibbin and Triggs argue instead for continued wage support and a large-scale fiscal stimulus via a "greening" of the economy and major public works projects, including a program to tackle a housing shortage of about 650,000 homes. They argue this could help stave off some of the expected bankruptcies.

ARITA's Winter disputes this view, however, noting that Assistant Treasurer Michael Sukkar and opposition Labor Party Shadow Treasurer Jim Chalmers both favor post-COVID policies that would provide targeted assistance to the hardest-hit industries, rather than continued economywide stimulus. Moreover, Winter said, Australia's reliance on now-disrupted global supply chains means that many vital inputs for such major projects would not be available.

The political consensus may be tested by the fact that the government miscalculated demand for wage support from employers, setting aside 130 billion Australian dollars ($84.9 billion) when businesses had only asked for AU$70 billion. The government has declined to reallocate the funds to stimulus projects, saying the money may be needed if the expected recovery is delayed -- a severe disappointment to advocates for major public investment.

The challenges posed by the impending wave of bankruptcies are complicated by the state of the insolvency industry itself. Insolvency appointments were down by 40% and 53% in the weeks of April 26 and May 3 from the same period last year, figures from the Australian Securities and Investments Commission show. Insolvency practitioners have also been making use of the government's Jobkeeper subsidy, while an ARITA survey of its membership found more than half of them were worried about their viability this year.

Winter further cautions that there may be not be enough registered liquidators to manage the wave of insolvencies expected when government supports end. This lack of capacity is compounded by strict timetables set by the government for insolvent businesses to wind up. Winter suggests that businesses with no hope of recovery should be given extensions to complete the process, freeing up liquidators to concentrate on more viable cases.

Yet another risk arising from the lack of registered liquidators to take on insolvencies is that creditors are even less likely to receive timely payments from the insolvency process, if at all, endangering their viability.

"Insolvency is all about recycling capital to more efficient and effective use. So that process of creative destruction, if you like, is vital to longer-term economic growth," Winter said.

Indeed, creative destruction -- coined by economist Joseph Schumpeter in 1942 -- may well be the hallmark of the COVID-19 pandemic, and it can take a harrowing toll.

The pandemic hit Australia just months after the country's Small Business and Family Enterprise Ombudsman launched an inquiry into the insolvency and turnaround profession's track record of handling the 8,000 insolvencies normally seen each year.

"So far, more than 300 small businesses have come forward to share their experiences of going through the insolvency process," the Ombudsman said in an update. "Many have spoken of being left with nothing -- no business, a ruined reputation, and often no home and broken families. It's absolutely gut-wrenching."

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