'Zombie' companies are headed for a year of pain as rates move higher and access to credit gets cut off, think tank expert says

• "Zombie" companies are facing a year of pain ahead, according to think tank expert Sonya Gibbs.
• Gibbs pointed to higher interest rates, which could strain finances at overborrowed firms.
• But higher rates are necessary to correct major problems in the market, she added.

Indebted "zombie" companies are headed for a year of pain as financial conditions continue to tighten, according to one think tank expert. 

In a recent interview with Bloomberg TV, Sonja Gibbs, the head of sustainable finance at the Institute of International Finance, pointed to upcoming challenges stemming from higher interest rates in the market.

Over the past year, the Fed has hiked interest rates over 1,700% to control inflation – a move that's significantly raised the cost of borrowing for firms. Rates are now targeted at 4.75-5%, the highest since 2007, and markets are pricing in another quarter-point increase in May.

"Over the longer term, it's going to correct the problem of too-easy access to capital, too much debt and so on. In the short term though, higher rates are going to cause a lot of pain," Gibbs warned.

That's especially the case for what she calls "zombie" companies, or firms that overborrowed when interest rates were ultra-low but don't earn enough to cover their debt-service costs or operating expenses.

"It's why we call them zombies. They're on borrowed time," she said.

That pain will be amplified with the ongoing credit crunch, Gibbs added, as banks weathering huge holes in their balance sheets are now less willing to lend, or will only do so at higher rates.

Banks have tightened lending by the most they ever have, according to data from Morgan Stanley. And credit availability just saw its largest drop in 20 years according to the most recent small business lending survey.

"The next six months to a year are going to be very challenging in terms of making sure that companies can service their debt," Gibbs said.

Other market observers have raised similar concerns as the Fed continues to raise interest rates. On the more bearish end of forecasts, "Dr. Doom" economist Nouriel Roubini warned markets of an incoming financial crisis as central bankers try to battle inflation and debt-laden entities at the same time.