Keywords

corporate debt, investment, debt overhang, deleveraging, crisis, Croatia

High corporate sector leverage has often been highlighted as one of the major impediments to economic recovery. We conduct a debt sustainability analysis for Croatian corporates based on firm-level data. The analysis shows that around one third of the corporate debt in Croatia is unsustainable, thus pointing to sizeable deleveraging needs. By relating the estimated firm-level debt overhang indicator with investment activity, we find that over-indebted firms have reduced their investment to a greater extent than those without debt overhang. This especially holds among exporters and domestically owned private companies, whose higher sensitivity to unsustainable debt probably explains why they are less debt burdened. Our paper contributes to the existing literature by showing that, in the case of Croatia, the estimated firm-level debt sustainability thresholds, unlike the aggregate thresholds, capture the asymmetrically negative effect of debt overhang on investment. The estimated size and impact of the debt overhang in Croatia warrant policy engagement that would include more efficient bankruptcy procedures, swifter balance sheet clean-up supported by specific tax treatments, enhanced restructuring of unsustainably indebted state-owned companies as well as a comprehensive policy strategy for improving business climate and competitiveness.