1. Comments on “Corporate Debt Overhang in Croatia” Evan Kraft American University 22nd DEC Conference

2. The paper’s contributions Provides firm-level estimates of the sustainability of firm indebtedness in Croatia through 2017 Connects these estimates with an investment equation to show aggregate impacts of excessive leverage

3. The paper and the literature Aligns with tradition of macro papers that trace the importance of firm cash flows for investment (Fazzari, Hubbard and Peterson 1988), agency costs (Bernanke and Gertler 1989), and leverage cycles (Kiyotaki and Moore 1997) Also, builds on more recent empirical papers on the impact of excessive leverage on growth in Europe post-crisis (Goretti and Souto 2013, Battini et al 2015) Finally, adds to a smaller literature attempting to assess the extent of excessive leverage (Damijan 2014 for example)

4. The overindebtedness model Uses firm-level data to estimate Net Free Cash Flow = Operating income – interest paid – capex – dividend Operating income is projected to 2017 using the elasticity of cash flows to GDP Capex and dividends are frozen at 2014 levels

5. Strengths and weaknesses of the model STRENGTHS Produces firm-specific estimates Does not use arbitrary cut-offs as in some other papers WEAKNESSES Hard to believe that elasticity of cash flows to GDP for all firms will be equal Treatment of investment assumes a steady decline with a trough in 2014

6. Is it possible to assess sustainability from an airplane flying at 30,000 feet?

7. Maybe not, but the view is pretty! Debt sustainability reflects many firm characteristics that are not available even in this extensive micro data set Investment life cycle Industry capital intensity Cash flow timing, term structure of debt Structural change, shocks Exercise is still worth doing as a guide to policymaking, but has to be taken as an order of magnitude indicator to gauge priorities

8. Suggested improvements Add dummies for sector (4-digit? 5-digit) to Cash flow-GDP regression to get closer to specific growth potentials of firms Experiment with other values for investment Average of 2010-14 Lowest in 2010-14 Note that lower investment values will lower the amount of overindebtednesss Try to get a range of estimated excessive debt rather than a point estimate

9. The investment implications Authors present a model to tease out the implications of high leverage on investment in line with similar papers for Portugal (Barbosa 2007) Denmark (Kuchler 2015) and others Suggestion: take another step to estimate the percent increase in investment available from eliminating all excessive debt. Useful as a ceiling for policy impact.

10. Policy issues: how big is the problem? If these estimates are even close to correct, the problem is major This is true even though the larger problem may still be one of weak overall demand (Banerjee et al 2015) The paper must be a great deal clearer about The magnitude of the problem Diagnosis of causes Range of possible policy measures

11. Debt concentration and the public sector: step one The “overindebtedness” problem is highly concentrated, with 10 firms accounting for about one-third of the problem. Some of the largest debtors are Government-owned First policy recommendation: restructure the highly-indebted Government enterprises

12. What about the banks? Often, after a major banking crisis, a highly leveraged corporate sector is a problem because banks cannot absorb further losses Is this true in Croatia?

18. Step 2: Policy effort to force provisioning up In 2013, the Croatian National Bank required banks to increase provisions by 5% if they did not make efforts to collect obligations in full or did not mark-to-market collateral Result has been increased provisioning This has set the stage for writing off and/or selling some of the loans (next slide)

19. Market solution: loan sales and write- downs In the last year, banks have been able to sell some loans to private investors Loans sold at a discount Banks remove NPL’s from balance sheets, borrowers have loans restructured Promising solution, but so far not extensive enough to resolve whole problem

20. Creditor reluctance still a problem Croatia continues to see limited activation of bankruptcy procedures. Creditors seem to prefer to keep debtors in business, paying interest but stagnating Key question is how to stimulate further debt restructuring Law on Pre-Bankruptcy Restructuring has not succeeded in speeding up this process Bankruptcy proceedings may be avoided because courts are seen as slow and outcomes unreliable, although there have been fairly successful cases (a big retail firm is an example)

21. Step 3: Possible further steps Government or central bank as convenor of debt renegotiations? Problem: lack of legal authority, would be only moral suasion Problem: if no public money available, would anyone comply? Public money to share burden of write-downs? Mobilization of equity investment With Government sponsorship or participation? With international assistance?

22. Important and well-done work, but more needs to be done! Thank you for your attention.