South Korea has been seeing an increase in zombie firms -- especially those who have been incapable of covering annual borrowing costs for more than two years –- and they have been dragging down the manufacturing sector’s labor productivity, a report by the nation’s central bank said Monday.

The Bank of Korea defined zombie firms as at least 10 years old and unable to cover debt servicing costs from current profits due to struggling with an interest coverage ratio below 1 for over three years. They are largely abandoned by investors and usually remain in business only by tapping banks or bond investors for extra credit.

Zombie companies accounted for 9.5 percent of the entire manufacturing sector in 2018, which had increased by 2.1 percentage points in eight years. The corresponding figure stood at 7.4 percent in 2010 based on data from 76,753 local manufacturers, according to the BOK.

In the same period, those who remained in the “zombie state” for more than two years had increased by 1.6 percentage points to 5.8 percent, compared with 0.5 percentage point increase that new zombie firms – around one year old – saw. This indicates that the country’s manufacturing sector is being saturated with such half-dead businesses, which are highly-indebted and on the verge of bankruptcy.

Such firms have less than half the productivity of financially healthy or normal businesses, contributing to lackluster economic growth. Korea’s labor productivity would have increased by 4.3 percent in the 2010-2018 period, without risks stemming from zombie firms dragging down the related numbers, the BOK said.

The zombie firms have also blocking healthy capital flows into normal firms with high manufacturing capabilities, dealing a blow to the economy.

“Through active restructuring of marginal or zombie firms with weak labor productivity, the nation’s manufacturing sector will be able to see an improved productivity,” said Song Sang-yoon, a researcher at the BOK’s Economic Research Institute.

By Jung Min-kyung (mkjung@heraldcorp.com)