- KPB & Co Research
The global economy was already wobbling before COVID-19, but now the virus threatens to literally bring the world to a standstill unless all levels of government effectively implement a coordinated response. So far this appear to be happening, as both central governments and monetary authorities of most countries have announced new measures. In a previous article, we shed light on the monetary policy initiatives, but in this piece we highlight some of the fiscal policy initiatives as well as some of the enhanced monetary policy initiatives announced this week. The size of the stimulus packages that have been announced are extraordinary by any measure, and in a perfect world, would lead to an immediate boost to confidence and morale. In reality, the freeing up of capital is more often than not a slow grinding process that takes time to work its way through the system. On the positive side, some policy makers recognize this and have made adjustments.
Over US$3.4Tn in Government Pledges
Monetary and fiscal authorities across G7 countries have committed to providing an unprecedented amount of money to boost liquidity across financial and non-financial sectors. The biggest commitment thus far, appears to be that of Italy's government, which committed about 50.0% (US$971Bn) of GDP to a broad range of initiatives including government backed loans. Following Italy is Canada with commitments that total 24.5% of GDP (US$405Bn). Spain has committed to funding totalling 16.3% of GDP, followed by the United Kingdom 14.6%, France 14.2%, Sweden 5.75%, and the USA 5.16%. While these numbers are remarkable, they can't be interpreted at face value. These funding items are split amongst various initiatives that may not see a significant portion of these funds deployed until a year.
Distribution of stimulus
Majority of each of the stimulus packages are allocated towards providing additional capital to banks in order to keep liquidity strong and lending to businesses stable. It seems central bankers have learnt lessons from the credit crunch of 2008, and are now aggressively trying to get money to banks. In the United Kingdom, roughly 30% of the amount allotted for financial aid will go directly to consumers and businesses in the form of direct cash deposits, and tax deferral - delay in paying cash over to the government and other statutory benefits. The rest will go to shoring up the financial system through asset purchases, assets such as mortgages, corporate debt, and treasury securities. In some instances such as in Spain, Italy, UK and France a significant amount of capital has been set aside for the provision of government backed loans for on-lending to businesses through banks. In Italy about 8% of the stimulus can be considered direct-to-businesses and direct-to-individuals transfers, while in Canada it stand at about 14%, Spain approximately 40%, France 24.4%, and the USA approximately 25%.
In administrating such a large amount of funds, the government naturally faces a number of challenges. First, cash is needed in the system yesterday, and so speed is important else they run the risks of the vulnerable going bankrupt. Small businesses and individuals with little or no cushion are the most vulnerable in these times. With the slowdown in consumer demand, business revenues are certain to drop by a large percentage (20% -50% or more), at the same time small businesses may have fixed costs such as interest payments, long term leases, and insurance. Individuals may have mortgages and groceries to cover all while they face uncertainty about jobs. In some industries such air transport, up to 90% of staff have been laid off. Second, there has to be accountability. If the money is not used in areas that will secure jobs and consumer demand, then it would have defeated the purpose. In this context, government has to balance the need for speed, with accountability, which leads to the result that money will flow into the economy through trusted channels that have infrastructure that have been tried and tested. The commercial banks have credit scores and legions of loan officers to ensure a comfortable degree of accountability. The usual infrastructure that handles pensions, social safety nets, and unemployment benefits etc. will be a trusted source in the eyes of the government.
The way government have designed the packages, with majority of the money going through the banking system, suggests that they believe that they have some amount of time on their hands. It will take weeks, at a minimum, for individuals and businesses to secure funds through banks. In circumstances where these businesses or customers already have a strong well established relationships with the bank, the turn around time may be a bit shorter. In the interim, the businesses and individuals have to rely on their savings. If you have very little wiggle room you are in a tough spot.
As time goes by we expect further liquidity support to be provided especially if the stock market continues to drop. With the drop on the stock market, banks may not meet their capital adequacy requirements, and so there might be adjustments to the requirements as in the case of Canada or more bond buying as in the case of the European Commission. Where there is room there may be further cuts to interest rates. In fact the Bank of England did an emergency cut yesterday, and the Bank of Canada is expected to cut again soon.
These are challenging times. For the most part, the response of the government has been good given the circumstances that they face. On the other hand, given that a significant part of the western world will likely go into lock-down mode soon, we fear that we are at the early stages of serve economic repression that could last six months or more. It is incumbent on the government to act faster and take risks in situations where there is no super safe way to implement policy. Customers and businesses will be in need of cash to stave off bankruptcy and keep people employed. At the same time, strong preemptive measures need to be taken to restrict the movement people so that the COVID-19 can be kept in check.