Economic Affairs

Economic carnage from Covid-19 laid bare

It's worse than predicted in April, and will test policymakers

During the past week, three institutions well respected for their economic research - the International Monetary Fund (IMF), the Bank for International Settlements (BIS) and the United States Federal Reserve - have released reports about how the economic impact of the Covid-19 pandemic will play out. Overall, it's a grim prognosis and full of uncertainties, which pose daunting challenges for policymakers.

The big picture looks worse than it did even just two months ago. The IMF has downgraded the growth forecasts it had made as recently as April, which it doesn't normally do. It now says the global economy will contract by 4.9 per cent this year, not by 3 per cent as projected in April.

Advanced economies will crash by 8 per cent, not by 6.1 per cent. There will be double-digit contractions in France, Italy, Spain and Britain. The US economy will tank 8 per cent, not 5.9 per cent. The best performer among advanced economies will be Japan, whose economy will shrink by 5.8 per cent.

Emerging markets and developing countries will contract by 3 per cent, not by 1 per cent as predicted in April. For the first time, every region in the world will record negative growth. World trade will collapse by 11.2 per cent.

And this is not even the IMF's worst-case scenario. The forecasts are subject to a "higher-than-usual degree of uncertainty", it points out. The unknowns include the depth of the contraction in the second quarter; how long the pandemic will last, which will determine the duration of lockdowns; the extent of "voluntary social distancing" if lockdowns are lifted, which will affect consumer spending; how soon laid-off workers will find new jobs and how supply chains will reconfigure.

Almost everywhere, the impact on the job market has been catastrophic. According to the International Labour Organisation, the global decline in working hours between January and March (compared with the pre-Covid period of October to December) was equivalent to the loss of 130 million full-time jobs. The decline in the April to June quarter is likely to equal the loss of more than 300 million jobs. Low-skilled workers who are unable to work from home have been the hardest hit.


Drilling down to a more granular level is the Bank for International Settlements, which is the forum for the world's central bankers and keeps a close eye on banking and financial flows. In its annual report released last week, the BIS does a deep dive into how the pandemic will impact corporate borrowing and the banking sector, as well as the likely shape of the economic recovery.

Based on simulations of firm-level balance sheets and financial statements for 33,150 firms from 19 major advanced and emerging market economies, the BIS projects there will be widespread operating losses this year. In all countries, the median firm would swing from comfortable profits (estimated at above 5 per cent of revenues) last year to losses "well in excess of 20 per cent of its 2019 revenues".

In a scenario where firms can't borrow and have to repay their maturing debt, the median firm in many countries would need public support equivalent to about six months of revenues to stay alive - which suggests (although the report does not state this) that millions of firms would probably go bankrupt.

The Covid-19 crisis will be particularly challenging for small and medium-sized enterprises (SMEs), which tend to be more active in sectors worst hit by lockdowns, such as hotels, restaurants and construction. SMEs also rely more on internal financing and have fewer borrowing options than larger firms.

Corporate debt will soar. Since the global financial crisis (GFC) of 2008, companies around the world have gone on a borrowing binge. Total credit to the non-financial private sector climbed from just over 120 per cent of gross domestic product just before the GFC to 144 per cent at the end of last year. A lot of this was US dollar denominated debt, which hit US$12.2 trillion (S$17 trillion), of which US$3.8 trillion was held by emerging market entities. It is not known how much of this debt is hedged, which means borrowers, especially in emerging markets, could be vulnerable to exchange-rate depreciations. Fortunately, emerging-market currencies - at least in Asia - have not depreciated as sharply as, for example, during the Asian financial crisis of 1997.


Mr Siddharth Tiwari, the Hong Kong-based representative of the BIS in Asia, pointed out in an interview with The Straits Times that this is an tribute to the policy frameworks adopted in Asia since then and the fact that Asian central banks responded early to the crisis.

Nevertheless, the Covid-19 crisis has put commercial banks everywhere under pressure, according to the BIS report - even though they are in a stronger position than during the GFC. Many of them have been forced to increase their loan-loss provisions. For example, US banks increased their provisions more than fourfold in the January to March quarter.

In its June report on stress test results on the US banking sector which was released last week, the US Federal Reserve projected that 33 large financial institutions would experience losses of US$552 billion over nine quarters in a "severely adverse scenario" defined as "a severe global recession accompanied by a period of heightened stress in commercial real estate and corporate debt markets".

But under a more extreme scenario, where output declines are deeper and unemployment higher, the losses would balloon to US$700 billion - far worse than during the GFC - and would push the weakest 25 per cent of banks close to their minimum capital standards.

More than half of the banks' losses would come from three areas: credit cards, commercial and industrial loans and domestic commercial real estate. As a precaution, the Fed last week announced that it will cap dividend payments by big banks and bar them from buying back their shares until at least the fourth quarter.

The BIS report draws attention to falling property prices as a point of vulnerability. It points out that market indicators suggest "sizeable declines in many countries, especially in the prices of commercial properties for the sectors most affected by the lockdowns". But banks' direct exposures to large firms in heavily affected sectors such as airlines and oil firms "appear limited", it says.


The BIS notes that most observers now agree that a V-shaped recovery is "out of the question". But even a more gradual U-shaped recovery may prove elusive, if there are renewed outbreaks of infections (as has happened in many countries) and containment measures are re-imposed. In that case, instead of being U-shaped, the recovery would be "W-or wave-shaped, and of uncertain length". This would put further pressure on both monetary and fiscal policy.

So how can policies help?

In the area of monetary policy, central banks have already gone beyond their normal toolkit to create the conditions for revival, according to the BIS' Mr Tiwari. "They have not only relied on traditional monetary measures like reducing interest rates, but also activated and expanded their 'lender of last resort' functions, for example by providing massive liquidity to financial institutions, corporates and mutual funds and even buying securities of private companies to ensure that markets don't seize up."

However, while central banks can ease liquidity pressures, their lending "cannot avert corporate insolvencies indefinitely", he said.

"Their approach has been not to initially discriminate among businesses, because central banks don't have the ability to discriminate. So they have provided liquidity on a broad basis."

As much of the assistance amounts to loans, "in due course it will become clear who is able to repay the loans and who is not. At that point, as the focus of the crisis turns to solvency, fiscal policy has to do the heavy lifting".

Fiscal policies have been aggressive, especially in advanced economies where the transfers up to early last month amounted to around 10 per cent of GDP (20 per cent in the case of Singapore).

But the way the money has been spent has been different from during normal recessions. The BIS points out that during a pandemic, boosting demand is not a priority because, with many economic activities restricted, spending does not respond to such stimulus. Instead, the objective is to ease the cash-flow problems of firms and households resulting from the economic standstill, which is "akin to providing a lifeline to a patient in an induced coma, to keep vital organs functioning".

This lays the foundation for the recovery once lockdown measures are relaxed.

Once this happens, the IMF proposes that the emphasis of policies should gradually shift from supporting firms to supporting households in a targeted way, including through measures to encourage people to return to jobs safely and to match laid-off workers to new jobs that are more relevant to the post-Covid-19 era.

Once the pandemic is under control, more traditional fiscal stimulus can return. The IMF suggests that this be focused on public investment in physical and digital infrastructure, healthcare systems and the transition to a low-carbon economy.

Commenting on Singapore's response, Mr Tiwari pointed out that besides its strong fiscal package, what was most striking was the Government's emphasis on retraining. "Very few countries right now are focused on retooling their workforce for tomorrow," he said. "I think it's forward-looking to look beyond the immediate crisis to the important work ahead."


Looking ahead, policymakers everywhere face acute uncertainties, which make it hard to put together a foolproof strategy. Dilemmas abound. For example, the BIS cautions that spending too little could cause widespread bankruptcies and layoffs. But spending too much too soon could leave the authorities exposed should infections re-emerge or spike, thereby prolonging the crisis. Allowing bankruptcies to happen too early could kill the drivers of future growth, but delaying them too long could keep unviable firms alive and slow the economy's recovery.

The legacy of the Covid-19 crisis "will linger for a long time to come", says the BIS, and new, unforeseen problems may arise. "It is difficult to look ahead in the midst of a storm", it concludes, "but once the winds subside the task will be to navigate in waters that are familiar in some respects, but potentially more treacherous in others".

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A version of this article appeared in the print edition of The Straits Times on July 01, 2020, with the headline Economic carnage from Covid-19 laid bare. Subscribe