It is no exaggeration to say that the challenges facing the new government are both unprecedented and among the largest in the history of state. As the economy has now more or less re-opened, the immediate challenge is to get businesses back up and running and, in so doing, get people back to work. As a recent TASC brief lays out, there are several issues at stake.
Excluding TWSS and PUP, which support either households or indirectly support firms, the raft of measures introduced so far to support has been worth up to €6.5 billion. Among the most important for SMEs have been the Credit Guarantee Scheme (CGS) worth up to €2 billion and the Restart Grant worth €250 million. A range of other supports have also been made available from sector specific measures, to other forms of subsidised lending, to tax deferrals.
Under the CGS, the government provides a guarantee for 80% of a loan granted to SMEs. However, banks can only claim 80% losses from the government on 50% of its loan portfolio, which could shrink the guarantee to 40%. The term of the bank loan ranges from three months to six years, with lending facilities between €10,000 and €1 million. The interest rate charged on the loan is to be the banks’ SME lending rate, plus a premium of 0.5% (which could increase). Because a major portion of the losses are guaranteed, lending rates are below market rates.
Despite being smaller in terms of funds allocated, the Restart Grant is important because it is a grant, distinct from a loan or guarantee. It has been created to assist re-opening for businesses with no more than 50 employees, turnover of no more than €5million, and which have suffered a fall in turnover of at least 25%. Under the scheme companies receive a rebate on commercial rates paid in 2019, up to a maximum of €10,000.
The Verdict on Business Supports
It is now widely accepted that the range of business supports has been ineffective. Among the complaints are that the government has 'over-engineered' its response - the supports available have been too numerous and complicated for an SME owner to take stock of and evaluate. A simpler, more streamlined system is needed.
Moreover, in terms of scale, the size of the credit guarantee, for instance, is much smaller in Ireland compared to other EU countries. Here it amounts to 0.97% of GNI* at most, compared to guarantees of 8-15% in the major EU countries. Most importantly, a paltry €95 million of the total liquidity supports available to SMEs has been released. This appears to be in part because the legislation required for CGS has not yet been enacted. For comparison, The Central Bank has estimated that excluding payroll costs, the three-month liquidity needs of SMEs is between €2.4 and €5.7 billion. According to IBEC fewer than 51% of companies with under 50 employees have reserves that last less than three months.
The July Stimulus as referred in the Programme for Government is sure to expand the supports available to SMEs. IBEC has proposed to expand the guarantee under the CGS to 100% as some countries have done. This would significantly increase the uptake and banks’ willingness to lend, and help kickstart the economy. It could, however, end up being extremely costly. The FT reports that default rates could be between 40 and 50% under the UK bounce back plan, which provides a 100% guarantee to SMEs. Clearly the current CGS is inadequate and the level of guarantee is surely to be increased in the coming weeks. But the benefit of not providing a full guarantee is that it incentivises banks to properly screen borrowers. This reduces the cost to the state as fewer losses are likely, and the state is on the hook for less when a portion of loans inevitably goes south. A guarantee which is somewhat less than 100% is reasonable.
The scale of grants is also likely to be increased, either under the Restart Grant or some other scheme. The benefit of grants is that funds can be channeled to firms quickly and the take-up will be universal. Another argument is that loans and guarantees may not suit all businesses. Similarly, firms which are highly indebted have been found to be less likely to hire and invest, even after controlling for profitability and the business outlook.
Alternative Ways Forward
While there is a case for expanding grants, especially while other schemes get up and running, they should be used sparingly. They are the least cost effective from a public finance perspective as in principal the state does not get the money back. Companies have diverse needs and for those companies where the money is not needed, the grant is likely to have adverse incentive effects. For instance, some firms will be less willing to negotiate with landlords reductions in rent - an effective net transfer to commercial landlords. Another form of subsidy or grant is a VAT holiday, which has again been advocated by business groups. In evidence given to the Oireacteas, Barra Roantree of the ESRI notes that VAT holidays tend to increase profit margins when in place, and lead to spikes in prices when removed. Indeed, this is what happened with the VAT reduction for hospitality.
An alternative policy could have the option of converting loans into equity as suggested by the Peterson Institute. For instance, instead of the loan being repayable to the bank, an SME which borrowed to manage the crisis could exercise an option so that the government now becomes the SME creditor. Repayment would be a percentage of profits, which could be a 5% surcharge annually. In effect the state would take on the obligations of the loan and be remunerated by firms paying higher future taxes once they return to profitability. The advantage here is that the firm is not laden with debt.
A similar policy outlined by SAFE, and also Michael Taft, would be to use equity-type investments from the outset. For instance, a tax-based grant system is one in which the government provides grants but repayments are based on profits. Similar to the debt-to-equity/tax conversion above, funds would be repaid only after firms return to profitability. Like other forms of finance, firms would have to demonstrate they were commercially viable prior to the crisis. Funds could be channeled through existing networks such as through the Revenue or through the SBCI.
A range of policy options are available to the government to support SMEs. It is not plausible that a company would favour going out of business over taking on debt. Those who insist that we rely on grants should be treated with a pinch of salt. Funds can be disbursed without inflicting undue damage to the public coffers. Outside of grants, loans, and guarantees, other supports will be needed. Some sectors will need continued wage supports, and larger companies will require different forms of finance. For now, SMEs need liquidity.
Robert Sweeney @sweeneyr82
Robert Sweeney is a policy analyst at TASC and focuses on issues surrounding Irish political economy and distribution. He has a PhD in economics from University of Leeds, which concentrated on financial markets and investors, banking, international macroeconomics, and housing. He is also interested in debates on alternative schools and methodology in economics, and ownership.
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