COVID-19: Global and Local Economic Outlook
For more than a month, we have been facing an unprecedented time as a global community due to the threat of COVID-19 or coronavirus. A deadly virus that started more than three months ago from Wuhan, a city in South China, has now spread throughout the globe threatening our health, way of life, and future. To combat the spread of the virus, governments around the world have imposed extremely restrictive measures which have led to a complete collapse of the global economy. So inevitably the health crisis will lead to an economic crisis. The magnitude of the economic crisis will depend to a large extent on whether we can contain the spread of the virus within a reasonable amount of time, but also on the type and magnitude of the economic response by the authorities.
So what is the current situation? This is a once-in-a-century pandemic with massive implications to the global economy. We are experiencing a huge shock to supply (as people become sick but more importantly due to the lockdown measures) but also a huge shock to demand (people are getting very cautious to spend as they fear about the future). This has led to sharp falls in commodity prices (e.g. oil), real estate prices, and massive losses in financial markets (e.g. stocks but also bonds). The initial indications of what to expect are extremely discouraging (e.g. the U.S. jobless claims in the three weeks since the shut-down of the U.S. economy has reached the staggering number of close to 17 million!). In response to this situation, nearly all the authorities around the world have taken extraordinary measures to combat the impact of the crisis in an effort to “freeze” the situation until the economy can start functioning again. These measures are to a large extent similar in all countries affected – fiscal measures that aim to subsidize and relieve distressed households and corporations, but also monetary measures through central banks that aim to provide emergency liquidity to the market (central banks can achieve this through lowering of interest rates, relaxing capital and liquidity requirements of commercial banks, or QE programmes). These are needed to avoid spikes in bankruptcies and layoffs. The extent or magnitude of the support measures depends upon the financial situation of each individual country. As an example, the U.S. government has announced recently the biggest economic stimulus in the country’s history, a relief package of $2 trillion which constitutes around 10% of U.S. GDP. Certainly, more will come if lockdown measures persist for too long. As mentioned though earlier, despite the unprecedented measures the outlook for this year is bleak for almost all countries affected – sharp and deep recession of magnitude that we have not experienced since the Great Depression, spike in unemployment level and number of bankruptcies, in the level of government debt, and substantial fiscal deficits. Recovery is forecasted for 2021 as the expectation is for a vaccine to be available and the global economy to get back to normal. This recovery can take the form of either a V-shape or a U-shape. The V-shape points to a rapid recovery while the U-shape points to long lasting effects of the shutdown before we see the recovery. Hopefully, we will experience a V-shape recovery.
Cyprus cannot be an exception to the massive negative shock that the global economy is facing. We are a small, open economy that depends to a large extent on foreign demand and investments. So even if we are able to contain the spread of the virus relatively quickly, the economy will not return to normality until the virus is contained on a global scale. The current situation is as follows – the restrictive measures imposed by the government have basically put the economy on a “freeze” mode. Shops have closed, schools have shut down, the public sector is only operating on a minimal scale, and most businesses are working from home or either not operating at all. The authorities, in an effort to support the economy, have announced a number of measures – fiscal and monetary. Similar to other countries, the fiscal measures (through programmes announced by the Ministry of Labour) aim to subsidize and relieve distressed households and companies. These measures have been extended until June, with another extension of four months if the situation does not stabilize. At the same time, the government has decided to tap the international financial markets and borrow €1.75bn through a debt issuance of a 7-year note and a 30-year bond. The plan is to borrow another €1.25bn from local banks. The total of €3nb (around 15% of the country’s GDP) will provide a “buffer”, along with the budget surpluses of recent years, for future needs. The reasoning behind these actions is to act proactively and borrow now that interest rates are still relatively low and there is available demand for Cypriot government bonds. Given the growing capital needs of every country, coupled with the fact that the interest rates for the periphery countries of the EU have been going up due to increased risk, I believe the timing was probably right. However, with the sharp increase of government debt along with the expected drop in our GDP, we run the risk of losing our investment-grade status. It is a price to pay given such difficult times. At least, for the time being we don’t have to worry about possible penalties imposed by the EU for deviation from our fiscal targets. These have been relaxed as every country in Europe will need to increase their public debt (with substantial budget deficits) to address this crisis. In any case, it’s imperative that prudent and responsible use must be made with the recent borrowed money (taxpayers’ money) as the rating agencies and investors will be certainly closely monitoring us. We should also take advantage of the financing sources available from the EU (€160mn available to Cyprus through the SURE fund to support employment protection programmes, and another €400mn available through EIB to fund SMEs). At this point, funding is also available through ESM for the Eurozone countries (€240bn in total) but only for health-related expenses. There is also discussion for the joint issuance of Eurobonds (coronabonds) or the creation of a recovery fund (financed with joint debt) to address the recovery needs, but unfortunately we are still a long way in reaching to an agreement.
A number of steps have also been taken related to liquidity measures. For a start, the ECB has temporarily relaxed the capital and liquidity buffers to allow banks to provide liquidity to the market and absorb losses (total capital freed up for Cyprus amounts to €1.4bn). ECB has also announced a €750bn pandemic emergency asset purchase programme (QE) running until the end of 2020 to support the Eurozone economies. Furthermore, the Cypriot Parliament has recently passed a law to freeze loan installments until the end of the year, a move that will allow necessary liquidity to remain within the economy to relieve distressed households and companies. There is another necessary measure that is being discussed at the Parliament with no agreement yet – the state guarantees of €2bn to encourage banks to provide cheap funding to viable businesses and self-employed people during the crisis period. In case of future losses, the risk is disseminated between the state (70%) and the banking institution (30%). The caveat is that the borrowers are not allowed to proceed with layoffs until the end of the year. The majority of the loans will go towards SMEs, the ones that need this the most. Opponents of this measure argue that the funding should come directly from the state and not the banks. The counterargument to this is that the state guarantee is a contingent liability, and might never realize. So it does not increase the level of debt, at least not at the moment. Even if some losses do realize in the future, the extra burden on the public debt will probably be a small part of the €2bn. Furthermore, the government does not have the mechanism of deciding which companies to fund or not. And even if it did, it could have easily created a moral hazard issue. This is the role of the banks that have ample liquidity and are ready to fund the market. What the government can do is to monitor this scheme.
Even with the above measures, the forecast for the Cypriot economy for this year is discouraging and is along the lines I described above for the global economy. We should expect a sharp and deep recession, rising unemployment, substantial fiscal deficit, and a sharp increase in the level of public debt. The measures though are important so that when the economy starts functioning again, the recovery will come faster and stronger. Main sectors that drive our economy – tourism, construction, shipping - will be badly hit whereas the impact on the services industry will be probably less severe.
But as always, crises bring also and some opportunities. For example, this might be the right time to start planning and developing further other promising industries such as education or research and innovation. It is also a wake-up call to become more digitally driven as a country to be able to compete in the global economy. The crisis exposed our weaknesses in this area as few organizations were able to immediately switch online and continue offering their services. Many organizations as well as the public sector are still struggling to operate in this difficult environment.
In closing, I would say that we need to stay calm, we should always remember that eventually we will defeat this virus, the economy will bounce back, and we should draw some valuable lessons at every level (government, company, household) from this crisis so that we are much more prepared for future events.
The writer is an Associate Professor of Finance at the Cyprus International Institute of Management (CIIM) and Director at Goal Portfolios Insurance Advisors (www.goalportfolios.com)