Silvia Pavoni assesses the consequences of the Covid-19 pandemic on global economies, and how governments and populations will likely respond once the coronavirus eventually recedes.
When her architectural studio opened in Brooklyn, New York in 2008, Deborah Mariotti had her work cut out for her: as she was starting to woo clients, the financial crisis was making it increasingly impossible for them to spare any cash on new projects. Like many others, she is being tested again – and by a much more insidious threat.
As of mid-April 2020, the Sars-CoV-2 coronavirus that is believed to have first infected humans in a wet market in Wuhan, China at the end of 2019, is fast spreading across the US, having badly hit Europe. All across the world, people’s health, health systems and economies are being challenged by by the pathogen. For the first time in four decades, China’s output shrunk, with gross domestic product falling 6.8% in the first quarter of 2020.
A world in lockdown
In its April World Economic Outlook, the International Monetary Fund (IMF) predicts a 3% global contraction by the end of 2020; in its worst-case scenario, in which lockdown measures designed to reduce contagion are protracted to the second half of this year and there is a second wave of contagion next year, the global economy will remain in recession through to 2021.
The lack of a pharmaceutical treatment has made severe social distancing measures the only response to the crisis in a desperate attempt to avoid overwhelming hospitals and buy whatever time is possible until a vaccine is found. By the beginning of April 2020, half the world’s population was on some form of movement restriction.
The longer that lockdowns remain in place and economic activity is slowed, the direr the hardship for those who, though they might have escaped contagion, now face unemployment. Vaccines typically take many months (if not years) to develop. Natural immunity after contagion lasts for an as yet unknown period of time. Harvard TH Chan School of Public Health expects regular wintertime occurrence of the virus and the disease it causes, Covid-19, which would require prolonged or intermittent social distancing beyond 2022.
Even after apparent elimination, the virus could re-emerge in 2024. It is hard to imagine what that would mean for the global economy when forecasting business activity beyond only a few weeks ahead may seem injudicious, as it does at present.
Cost to business
New York, the new epicentre of the pandemic at time of writing, had suffered 12,192 deaths from Covid-19 as of April 16, nearly half of total deaths in the US, where the virus has spread to all 50 states. At that time, New York governor Andrew Cuomo announced he would extend the lockdown until at least May 15.
In Brooklyn, Ms Mariotti believes her clients can hang on for another two or three months at most. Even if social distancing measures were relaxed or lifted thereafter, she imagines the possibility of needing to apply for permits to restart work on building sites, all of which, for now, are at a standstill. “We were working on a high-end menswear store in Soho and a gelateria in Lincoln Centre, in New York, and a nightclub in Philadelphia. All are on hold,” she says.
Not even the unprecedented government interventions quickly introduced around the world may be sufficient to avoid an economic catastrophe. The US’s rescue package totals $2284bn, its largest ever; yet the fund reserved for small businesses has already run out of cash after the whole $350bn was allocated by mid-April.
Corporates’ main focus has been on liquidity, says Philip Drury, Citi’s Europe, the Middle East and Africa head of banking, capital markets and advisory. For the largest, lower risk companies, bank finance can now be supplemented by funds raised on the capital markets, after markets’ nerves cooled since the onset of the pandemic.
But not all good businesses may be able to keep funds flowing and survive. “Even businesses that [in normal circumstances would be] completely solvent can suffer because of artificial lockdowns,” says Evgueni Ivantsov, chairman of the European Risk Management Council and a member of World Economic Forum’s advisory group on global risks. Furthermore, both governments and companies run the risk of taking on too much debt.
Public deficits
According to recent calculations, the IMF predicts a worrying rise in public debt as budget deficits swell to support struggling individuals and businesses. Net public debt will rise from a projected 69.4% of national income in 2019 to 85.3% in 2020.
While government measures are essential in this time of crisis, Natixis chief economist Patrick Artus notes the burden on economic recovery imposed by a potential need to finance this additional government debt through restrictive fiscal policies. As private sector investors may be unable or unwilling to buy such debt particularly during a recession, higher taxation is a real possibility.
Larger debt levels are also a concern for companies’ balance sheets. In addition to government grants, banks are offering emergency loans and waiving covenant requirements but those loans must still be repaid. Without a brisk recovery, the chances are that not all businesses – or, indeed, governments – will be able to meet those obligations. Naturally, this is a concern also for the banks that have lent to those corporates and that hold large amounts of government debt.
“Overall, most banks should be able to cope with a V-shaped economic scenario – a strong rebound following a brief general paralysis of the economy – without too much stress,” says Mr Artus. “In Europe, banks are solid, but the length of the crisis will be key.” The shape of the post-Covid-19 recovery remains unclear: whether the economy will rebound quickly and growth rates will chart a V, as many hope; or if it will be W-shaped with a second dip; stay longer at the bottom, looking like a U; or whether, after falling, it will lay flat for quite some time, resembling an L.
Changing behaviours
The coronavirus pandemic is set to change other aspects of economic and financial life. In a research note, Mr Artus also points to a potential rise in risk aversion that may further influence corporates’ access to credit and investment – as well as their business models, with a distinct preference for e-commerce. As many have experienced during lockdown, being able to sell goods and services online has given a chance of survival to many businesses.
In some cases, such as food home delivery, it has proven an essential service that has helped keep the most vulnerable people safe. In others, such as the provision of exercise tutorials, it has proven ingenious while exposing the flaws of an existing business model. As Mr Ivantsov points out, gyms have traditionally relied on physical memberships, many of which are largely unused by members. Being locked at home, many have cancelled their memberships. Those who always exercise might consider paying for online personal training sessions, while the others might think twice before returning to the gym, he adds. Such specific models may struggle to return as the public becomes more familiar with online equivalents.
“As a risk manager, on the one hand, I hate something like this because my job is to predict and somehow mitigate the impact of [crises]; but on the other hand, I know that each crisis opens gateways to new businesses,” says Mr Ivantsov, who previously served as Lloyds Bank’s head of portfolio management and strategy. “This crisis means that the traditional bricks-and-mortar[-only] business is dead.”
Logically, this also implies an even greater acceleration towards the digital provision of banking services. Financial innovation can in turn help deal with the crisis. Lesly Goh, senior technology adviser and former chief technology officer at the World Bank, points to the example of Ant Financial and the government in the Zhejiang province in China, for which the fintech giant created a blockchain-based online information platform for a more transparent allocation of epidemic prevention materials. It did something similar for Gansu province: a blockchain-based online bid opening system to help small businesses participate in contactless bidding remotely during the Covid-19 outbreak.
Thinking bigger
But this crisis is not only speeding up existing trends, it is also reversing others. The benefits of ‘big government’, out of favour as a preferred economic policy set-up in some parts of the Western world, are being reconsidered. This is relevant not only in terms of greater funding of healthcare systems, particularly in countries left exposed to avoidable loss of human lives because of lower numbers of doctors or intensive care hospital beds in relation to the overall population, it also relates to a closer relationship between state and enterprise, as well as finance.
Michiel Haasbroek, visiting research fellow at Xi’an Jiaotong-Liverpool University in China, thinks that there will be greater acceptance for a stronger involvement of governments in the economy, similarly to what was implemented by the booming ‘tiger’ economies of south-east Asia in the past decades. In Europe, “the Netherlands and Germany are countries with [sufficient] fiscal flexibility [thanks to their sustainable public debt profile] to determine a more nationalistic agenda, where closer co-operation is sought and formed between banks and industry through clear state guidance on what to do to get out of this [crisis],” adds Mr Haasbroek, who was previously ABN Amro’s chief risk officer for greater China.
There is also the question of a ‘big’ EU. As the hardest hit European countries seek greater support from Brussels, a rejection of the proposed 'coronabonds' that would be issued by the bloc to jointly raise cheaper funds has reinvigorated nationalistic talk across the region. France’s president Emmanuel Macron recently warned the EU could unravel unless it embraces financial solidarity.
Debt mutualisation has been attempted before, in response to the eurozone crisis and then the refugee crisis, with no result. In the coronabonds case, it is not just Italy and Spain, where loss of life is already devastatingly high, that support it. France, Belgium, Ireland, Portugal, Greece, Slovenia and Luxembourg back it too. The bonds are opposed, however, by Germany, Austria, the Netherlands and Finland.
If debt mutualisation is unlikely to be agreed upon, the bloc can count on interventions from the European Central Bank (ECB). The ECB has offered support through a €750bn pandemic emergency purchasing programme to buy both eurozone corporate and government debt. This will prevent losses on banks’ bond portfolios by avoiding a rise in long-term interest rates and, therefore, a reduction in value.
Natixis’s Mr Artus points to the fact that eurozone banks also have access to funding at an interest rate of -0.75% via the ECB’s targeted longer-term refinancing operations, which props up liquidity and profitability – meaning that they can lend at a positive margin. He adds that the easing of solvency requirements has led to a doubling of the excess capital available. The measures temporarily allow banks to fully use capital and liquidity buffers to help them support economic activity.
Leveraged up
Similarly, in the US, the Federal Reserve has relaxed leverage ratios to help banks buy Treasuries and therefore indirectly lend to the economy, according to Jean-Edouard Colliard, associate professor of finance at HEC Paris. He wonders what the long-term consequences of such protracted measures will be, however. “Imagine that banks keep on accumulating these types of securities and actually have a huge leverage after a couple of years. It is going to be very difficult to immediately return to normality and say ‘okay, now you have to respect [all] regulatory constraints’. This will have to be phased in,” he says.
In addition to government and central bank measures, lenders have released their own emergency policies too, which include cutting senior management remuneration, putting repayments on ‘holiday’, removing covenant requirements and releasing emergency loans.
The Institute of International Finance’s president and CEO, Timothy Adams, hopes that whereas banks were at the epicentre of the previous crisis that led to financial meltdown and economic hardship, their actions now may help regain public trust.
Globalisation debate
The coronavirus crisis has also fuelled the debate over the benefits and dangers of globalisation. The development of global supply chains now means some industries rely on certain components to be delivered from abroad, having lost the capacity to make them domestically. The manufacturing and transport challenges of the past months have exposed the risks of this system.
“As a consequence of the pandemic, governments will undoubtedly want to onshore strategic industries such as medicine, telecoms, internet services or equipment for renewable energies,” says Mr Artus. “Similarly, there will also be a desire among companies to return to regional value chains, so that they are no longer dependent on a single supplier of components and parts.” Such changes, he adds, could be positive for countries that had lost that part of the industry, yet negative for producer countries, including emerging markets, that are part of global supply chains and have much of their economic growth dependent on this model.
On a human level, the pandemic is affecting the way in which people live and work. Office jobs are now performed at home, rather than in the office. In countries under lockdown, business and financial districts have emptied; homes and their smooth functioning (from Wi-Fi connections to efficient division of space for all occupants, including children) are now crucially important.
“If you'd have asked me a year ago how we would operate if all of our employees were working from home, I would have foreseen much bigger challenges than the ones we’ve actually come across,” says Citi’s Mr Drury. “We now realise that you can also be effective and productive while working remotely. So I think that moving forward, once we get through this, we'll have a greater appreciation of [work/home] balance.”
Psychological effects
It remains unclear, however, how the world will get through this crisis. “In China, they’ve been working from home for 10 weeks. Some people haven’t left their house for 10 weeks,” says one Hong Kong-based finance professional about his colleagues on the mainland. “And we still have a bit to go.”
But even as social distancing measures are broadly relaxed, there may be permanent consequences. Mr Artus anticipates a potential lasting distrust of long-distance travel, for example. Habits consolidate in a month, says Guendalina Graffigna, professor of consumer and health psychology at Milan’s Catholic University of the Sacred Heart, so it may well be that the internalisation of working practices and the consumption of services alters during this crisis.
“If we all went back to our regular life tomorrow, there may be no lasting effects; but if lockdowns continue, on and off, for many months, from a psychological point of view, it will bring change,” she says. She believes this situation may even affect people’s personalities as well as the traditional customs of certain societies, such as shaking hands.
There will be an effect on the physical environment too. If the domestic space gains in importance, with people carrying out their lives entirely at home, business districts as they exist now will lose some meaning. Space-starved city residents could benefit from a more careful design of houses and objects (kitchen tables that turn into ergonomic desks, for example). And trends to reduce excessive urban zoning are likely to accelerate, so that the use of a part of the city will not be almost entirely dedicated to one destination (with separate financial centres, residential areas or shopping districts).
There may be more automation in public spaces – for example, motion systems to call lifts, where the machine activates by hand movements rather than by touch, avoiding possible contagion. And pavements could be widened to help keep people at a safer distance from each other.
Disease, after all, has always influenced urban development, according to Ms Mariotti. From the cramped, older downtown, “the development of upper New York City’s [wide and orderly] grid also responded to public health considerations”, she notes.
Most of the concerns over Covid-19 remain unanswered, including the financial health of Ms Mariotti’s architectural clients. The new coronavirus’s most immediate, tragic impact is on health and human lives. Its effect on livelihoods is sadly also evident. But the pandemic could also have broad, long-lasting consequences on society, on the way individuals wish their communities to be organised, on their priorities when it comes to voting for politicians, on what they expect from governments, and from businesses and banks. It is worth reflecting on what that might look like.
