Key Details
The IMF working paper Rethinking Zombie Firms: From Volatility to Viability asks whether prolonged weak earnings reliably identify businesses with no viable future.
Evidence base: The paper analyses about 15 million firm-year observations from Canada and 25 million from seven European countries, covering periods up to 2019.
Recovery: Among firms classified as zombies, 30.94% in Canada and 25.75% in Europe move back to healthy status in the following period.
Firm size: About 65% of Canadian and 45% of European zombie firms have one to five employees.
Model result: A model based on changing firm productivity generates zombie-firm shares of 3.98% for Canadaand 3.54% for Europe, close to the observed shares when firms are classified by sustained non-positive earnings.
Stricter measure: About 0.25% of firms meet the authors’ model-informed test for potential unviability: five years of non-positive earnings alongside declining revenue and productivity. This is not a direct measurement of every firm’s future prospects.
A Weak Firm Is Not Necessarily a Firm That Should Exit
“Zombie firm” is commonly used for a mature business that keeps operating despite prolonged financial weakness. The label often implies that lending, public support or obstacles to closure are sustaining a business that would otherwise disappear. Yet past losses do not reveal what a firm expects to earn in the future.
The paper finds that zombie-classified firms are generally less productive than healthy firms, but their condition is often temporary. Many are also micro-sized businesses, rather than the large, indebted companies most readily associated with concerns about banks keeping weak borrowers afloat.
Productivity Shocks Can Produce Viable “Zombies”
The authors model firms facing changes in productivity. A firm can remain open after several loss-making years if its expected future value is still positive; firms without that value exit the model. Even without subsidised credit, government support or barriers to exit, the model reproduces much of the observed zombie-firm pattern.
In a simulated downturn, the zombie-firm share more than doubles before gradually recovering. In another exercise, greater volatility increases that share but can also raise overall productivity and household welfare. The result is not that weak firms never cause harm. It is that a high zombie count alone cannot establish economic damage or its cause.
A Stricter Test Finds Far Fewer Potentially Unviable Firms
To look beyond losses, the authors combine five consecutive years of non-positive earnings with falling revenue and productivity. Around 0.25% of firms in the analysed data meet this stricter definition. That figure depends on the authors’ model and test; it should not be read as a universal rate of unviable firms. Greece is excluded from this final calculation because the necessary productivity observations are missing.
Policy Relevance
The paper is a warning about diagnosis, not an assessment of Indian firms. RBI, IBBI and corporate-policy researchers may use measures of prolonged distress, but those measures should not automatically be treated as evidence that a firm lacks recovery prospects or is being kept alive by distorted lending.
The distinction matters when evaluating credit allocation, restructuring and insolvency. Firm-level evidence on revenue, productivity, financing and subsequent recovery would help determine whether a weak business is experiencing temporary distress or sustained deterioration. The paper does not show that zombie lending is absent in India—or in the countries it studies.
Follow the Full Working Paper Here: Rethinking Zombie Firms: From Volatility to Viability