If these figures are the start of a trend, it could be good news. It would mean one of the obstacles to recovery – firms' desire to rebuild their balance sheets – is now out of the way.
Or is it? By historic standards, firms are still quite highly geared. At £424.2bn, non-financial firms' bank debt is equivalent to 2.51 years of their disposable income. That compares to a post-1987 average ratio of 2.28. If we add in other debts, such as bonds and commercial paper, firms’ debt-income ratio is 4.55, well above the post-1987 average of 3.85.
What’s more, deleveraging has been smaller this time than it was in the 1990s recession. Since its peak at the end of 2008, firms' bank debt-income ratio has dropped from 3.63 to 2.51. But between September 1991 and December 1994, it fell from 3.6 to 1.5. If that’s a relevant precedent, deleveraging has further to go.
But is it relevant? In a recent speech MPC member Ben Broadbent suggested three reasons why it might not be, and why deleveraging isn’t a threat to the recovery:
- Low interest rates mean that a given debt level is more bearable now than in the past – and especially compared to the early 90s.
- International evidence tells us that corporate debt only constrains GDP growth when it is very high indeed. Research at the Bank for International Settlements finds that it is only when corporate debt exceeds 90 per cent of GDP that growth suffers. UK non-financial corporate debt (bank debt plus bonds and commercial paper) is only half this level.
- High corporate debt is only half the story. Non-financial firms have also built up substantial liquid assets. They now have £296.8bn sitting in the bank – equivalent to 21 months of disposable income.
Does all this mean we should stop fearing deleveraging and start looking forward to a healthy expansion?
Not necessarily. Mr Broadbent points out that although domestic debt isn't a threat to the recovery, overseas debt might be; he believes UK banks' problem is the potential for further overseas losses, rather than domestic ones. This could limit their ability to lend domestically.
I'd add another worry. The composition of debt and assets matter. If it is the same firms holding cash as have debt - which is reasonable if firms' fear the withdrawal of credit - then there is little problem. But if some firms are highly geared and so unable to invest, whilst others are sitting on cash because they just cannot see where to invest, then we have a bigger problem.
If this is the case then our problem is not just or even mainly high debt, but rather the dearth of good investment opportunities - in which case even healthy balance sheets might not be sufficient to generate a healthy economic upswing.