The estimation of below-market borrowings compares the actual interest rates charged to firms against hypothetical benchmark interest rates that could have been charged in a private market, based on the characteristics of the borrower, as laid out in (OECD, 2021[28]).
Since information is not available on every single interest rate charged to all firms covered in the MAGIC database, firms’ annual average interest rates are computed by dividing their interest payments in any given year (t) by the average debt outstanding in the same year (t) and the previous year (t-1). Information necessary for performing this calculation is retrieved from the financial statements of each firm, wherever available.
Calculating rates in this way ensures consistency across the sample of firms. The benchmark interest rates are constructed following established finance principles by combining a risk-free base rate and additional spreads that reflect the credit risk of a borrower. Depending on their availability and on each country’s practice, risk-free base rates include and are chosen from: common banking reference rates (e.g. the US Secured Overnight Financing Rate, Euro Interbank Offered Rate, Tokyo Interbank Offered Rate, etc.); one-year government bond yields; or other commonly used base rates (one year), such as the base rates published by the People’s Bank of China (e.g. the Loan Prime Rate).. As the currency of benchmark rates should ideally match that of the corporate debt being analysed, the computation takes into account a company’s funding currency. For instance, if a company is holding debt for which half is denominated in EUR and the other half in USD, the average of USLIBOR and EURIBOR is used as a benchmark base rate. Risk-adjusted spreads are, for their part, constructed by combining the following items:
Credit risk spreads: These spreads are established based on the average spreads observed between corporate bonds and government bonds. Spreads are averaged for each credit rating (e.g. AA or BBB), where lower-rated bonds have a higher spread. The terms of these benchmark spreads should ideally match the weighted-average life of each debt transaction in question. Because this paper looks by necessity at corporate-level annual average interest rates, a term of benchmark spreads of one year is applied as a proxy and, in a few cases, is extended to five years where one year rates are not available.
Government guarantee: These spreads correspond to the additional spreads that would have otherwise been charged absent government guarantees (explicit or implicit). Accredited credit-rating agencies usually base their standalone credit ratings for firms on corporate performance alone, following which they adjust the ratings to account for additional external factors, including expected government support in case of financial distress. Considering such information, these additional spreads represent the increase in interest rates that would occur absent such government support.
