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Week in Review

What We're Reading:

May 4, 2020

Global trade suffers steepest decline since financial crisis. Global trade volumes have suffered their greatest drop since the 2008 financial crisis according to new data provided to the European Commission, with the COVID-19 pandemic causing a slowdown in all regions of the globe. (GTR)

May brings reopenings around the globe as virus toll climbs. May is bringing cautious reopenings from coronavirus lockdowns, from Beijing’s Forbidden City to shopping malls in Texas, as the grim toll from the pandemic ticks higher.  (AP)

Oil climbs amid output cuts and rising demand. Oil advanced for a second day on signs fuel consumption is starting to recover in the world’s biggest economies, while global production cuts also begin to offset the demand destruction caused by the coronavirus. (Business Mirror)

Singapore prepares to resume cross-border travel with South Korea, Australia, Canada and New Zealand. Singapore is working on guidelines with four other countries to prepare for the resumption of essential cross-border travel in an effort to maintain global supply chains during the coronavirus pandemic. (South China Morning Post)

China’s manufacturing weaker in April as virus hurts exports. China’s manufacturing activity weakened in April as the coronavirus pandemic clobbered global consumer demand, hampering Beijing’s efforts to revive the world’s second-largest economy, two surveys showed on April 30. (Business Mirror)

China exports outlook dims as U.S. and EU economies tank in first quarter of 2020. Britain is failing to move in talks on its future relationship with the European Union despite setting a tight timetable, the EU’s chief Brexit negotiator said on April 24. (South China Morning Post)

Shipping is just waiting for the inevitable. With the global economy expected to be in recession mode from the second quarter onwards, expectations for a shipping industry rebound in 2020 are practically non-existent, with the sole silver lining being the low oil price environment, which has tempered operating expenses for ships. (HSN)

UN envoy brings new allegations of war crimes against Myanmar. The United Nations' outgoing chief human rights monitor for Myanmar is calling for an investigation into allegations of ongoing war crimes and crimes against humanity in the southeast Asian country's Rakhine and Chin States. (NPR)

China and the West competing over infrastructure in Southeast Asia. The U.S. and China are promoting competing economic programs in Southeast Asia. (The Brookings Institute)

Kim Yo-jong: North Korea's most powerful woman and heir apparent? Over the past few years, Kim Yo-jong has emerged as a key figure in Pyongyang's opaque architecture of power. She is the younger sister of Supreme Leader Kim Jong-un and the only one of his siblings considered a close and powerful ally. (BBC)

Trump isn’t ready for Kim Jong-un’s death. Language more normally suited to wartime is commonly invoked around the COVID-19 pandemic, but can we learn anything from past conflicts in our battle against coronavirus? (Politico)

COVID-19: What we can learn from wartime efforts. The COVID-19 pandemic could not have come at a worse time for the Middle East. Since the U.S.-led international coalition secured the territorial defeat of ISIS three years ago, the region is still struggling to achieve lasting peace. (BBC)

ECB says virus may hobble euro area growth until 2022. The eurozone economy is likely to rebound in the second half of this year, but it may fail to grow back to last year’s level until as late as 2022 due to the coronavirus pandemic, the European Central Bank said on May 1. (Reuters)

The U.S. has started down the path to opening up the economy; there are only a few states that have started the process as yet. All eyes will be on Georgia because its governor decided to call off the lockdown sooner than anybody anticipated.

The model developed by the University of Washington had predicted that Georgia would be one of the last to open based on the spread of the virus in Atlanta and in many of the rural communities. It was on its list for a June reopening. Now it has become the nation’s guinea pig. Beyond the experience in Georgia, there will be an opportunity for the U.S. to look at what has been happening in other nations.

China was at the epicenter of the viral outbreak and is now at the epicenter of the recovery phase. There has not been a new case of a COVID-19 death in more than a week, and there are no more COVID-19 patients in the Wuhan hospitals. The Hubei region had reached a peak in mid-March; there has been a steady decline in numbers of infections since then.

One of the more pressing questions has been the reliability of data coming from China. It was abundantly clear that China was obfuscating and hiding data through the first few months of this year. As a matter of fact, it was obvious that China knew about this outbreak late last year and did nothing but try to hide it. In the last two months, the Chinese have not been able to hide the data as the country is overrun with members of the international health community. The CDC is there, WHO is there and so are representatives from every national health ministry in the world. They are now the ones collecting the data. The economy of the Wuhan region is getting back to normal. The same can be said for the whole of China. The limitation on its recovery is the rest of the world. The Chinese need their consumers back. The majority of them are in the U.S., Europe, Japan and other industrialized states.

British Prime Minister Boris Johnson was hospitalized by his bout with COVID-19. He was forced to turn his powers over to other cabinet officials, but he is now back to work. That has encouraged many in the U.K. because it demonstrates that recovery is possible. Plans are under way to open the U.K. economy by the middle of May. The Italians have been among the hardest hit (along with Spain). The U.S. has been looking at a death rate of 164 per million, while Italy is at 436 per million and Spain at 490 per million. Both of these nations have elected to loosen their restrictions. These had been some of the toughest in the world.

There is an expectation that looser restrictions will mean a possible renewed outbreak—as a matter of fact that is a near certainty. The question of control has shifted for many nations. The issue now is fatalities as opposed to infection. The polls taken indicate that people will accept getting sick as long as the possibility of death is remote. The changes in the last two months have been slight. There is still no reliable cure and a vaccine is still distant, but the treatment has improved as hospitals have started to catch up to the crisis. There have been improvements in testing as well. This may be enough for the moment as it starts to get society to the point that survival is common even as getting sick is also common.

Another nation that has gotten a lot of attention has been Sweden as they did not pursue the tight distancing policies the other states in Europe pursued. They have had 18,640 cases and 2,194 deaths. That is a rate of 217 per million and that puts them much higher than Germany as well as the U.S. The Swedes have been criticized by the other EU states for this policy.

Although the main focus has been on China, Europe and the United States, the consequences of the COVID-19 pandemic is likely to be more severe in emerging economies, said trade credit insurer, Coface, in a new report.

Even though their degree of vulnerability to this shock depends on many factors, the initial situation of their public finances is a key issue, as it determines their response capacity to the multitude of economic consequences of this crisis, the firm noted. However, their public debt was already at an all-time high in 2019.

The massive capital outflows generated by this health crisis also remind us that many emerging economies continue to suffer from the “original sin”, i.e. the inability to issue bonds in local currency.

In addition to this initial risk on public finances and the depreciation of currencies, Coface emphasized that the COVID-19 pandemic could expose emerging countries to three other risks:

• The implementation of strict containment measures,
• The reliance on tourism revenues and
• The dependence on non-agricultural commodities.

Nine countries are affected by three out of these four sources of vulnerability, 31 by two of them, and 71 by one of the four. The nine countries include South Africa, Algeria, Angola, Ecuador, Lebanon, Mauritania, Oman, Tunisia and Venezuela.

The additional financing provided by international organizations (notably the IMF) and the debt arrangements announced by creditor countries will help many low-income countries, but should be of little use to the larger emerging economies, Coface said.

Asia was hit hard by the first wave of the coronavirus, as the sudden stop in activity struck households and firms simultaneously—first in China, then elsewhere in Asia, and now globally. Policymakers responded swiftly with aggressive spending to support the medical response and vulnerable households and firms. And central banks took swift actions to expand liquidity.

While this helped support financial markets and sentiment, we may be on the cusp of a new, more dangerous phase of “economic deleveraging” as firms struggle to repay loans and pay workers in the face of a sudden collapse in cashflow and tighter credit.

Full Stop

In Asia and elsewhere, small and mid-sized enterprises are at greater risk in this new deleveraging phase. They are also concentrated in services where the containment and social distancing measures have hit the hardest. Compared to large corporates, small firms have thin cash buffers, are more leveraged, and rely mainly on short-term loans and retained earnings. Against this “crisis like no other,” small businesses face severe cashflow shortfalls with few financing alternatives.

Banks need to step forward in a major way to provide the working capital, but banks too are facing their own pressures, as large firms access credit lines to boost cash reserves. With banks looking to service first their largest customers, smaller firms will be left behind to fend for themselves.

The approach in Asia so far—to encourage loan rollovers through regulatory forbearance and guarantees and provide cheap lending to banks—will help but may not be enough to save small and mid-sized firms, given banks’ capacity and reluctance to take on this risk. Neither step addresses the massive need for new working capital to keep workers employed as cashflows dry up. Some private surveys suggest that small businesses, as the major employers in these economies, may have less than 3 months of cash left, raising the specter of a wave of defaults and a surge in unemployment.

To prevent this, smaller firms need a temporary lifeline—an economy-wide “working capital bridge loan”—that goes well beyond current policies. Such financial support is essential for maintaining jobs and incomes and preventing the downturn from turning into a prolonged depression that permanently damages the economy. Only the public sector has the means to extend this lifeline in the face of a such an unprecedented shock.

Bridging the divide

The question then is how best to do this while maintaining the proper incentives. One idea would be for the government to create a special purpose vehicle—a temporary public entity tasked for a specific purpose, namely to facilitate new working capital loans to small and mid-sized firms.

To address those most in need, only the firms that can show they were sound borrowers last year but are now experiencing significant revenue declines from the virus, would be eligible. They would apply to banks for a new 3-year loan covering working capital needs and payments (interest and principal) falling due over the next 12 months. In return, the firms would commit to maintain employment while avoiding dividends or share buybacks.

On the public side, the central bank would provide funding to the special purpose vehicle to purchase these new “working capital loans” from the banks, thus freeing up space for banks to lend more now. The central bank would be secured by the assets of the special purpose vehicle and receive some loss protection from the government’s initial equity investment.

Banks would retain the remaining portion of the loan to keep “skin in the game.” To manage losses, the special purpose vehicle would look to maximize recovery value and have banks collect on defaulted loans through foreclosure and bankruptcy. While this idea can apply easily to bank-centered economies, it could be extended to those with more-developed capital markets in Asia, such as Japan or Korea, by securitizing these loans and selling the tranches to institutional investors for broader risk sharing with the private sector.

Whatever it takes

The alternative is for governments to use their budgets, but the difference between the current crisis and past ones is the enormous scale of financing needed to roll over working capital loans for an extended period. Many emerging markets in Asia have limited fiscal space to fill in this gap using credit guarantees or lending but are under immense pressure to do whatever it takes to prevent large layoffs and defaults. Some are considering commercial banks or even the central bank directly financing the extra fiscal spending (i.e. direct monetization).

For these economies, a risk-sharing mechanism as described above that uses the flexibility of central bank funding can achieve this objective while preserving hard-earned central bank independence and banking soundness. Fiscal policy, by providing some loss protection, can complement monetary policy and enhance the potential economic benefits through greater lending. Governments and central banks in advanced economies, such as the U.S. Treasury and the Federal Reserve with its Main Street Lending Program, have introduced similar special purpose vehicles with some public risk sharing to support distressed companies.

Given the exceptional measures needed in this crisis, emerging markets in Asia could borrow a page from this playbook to do whatever it takes to rescue their economies.

 Week in Review Editorial Team:

Diana Mota, Associate Editor and David Anderson, Member Relations