This week saw the coordinated international policy response to the coronavirus (Covid-19) that markets had recently been demanding. A surprise out-of-meeting 50bps rate cut by the US Fed led the way on Tuesday, following an otherwise underwhelming G7 statement. Australia, Canada and Malaysia have all cut rates this week. The IMF and World Bank also pitched in with offers of financial support to affected countries. Still nothing from the ECB though (although it has asked banks for emergency plans to deal with the outbreak). Besides the global monetary response, some countries have also instituted their own fiscal packages. Whether this global response is enough remains to be seen. It may just be the first wave.
The coordinated response followed the almost panicked market reaction last week. Global equities fell sharply, with S&P500 -13%, EUROSTOXX -14%, and the Nikkei -10%; the EMBIGD spread rose 65bps, while safe haven US government bonds saw 10yr yields fall 32bps to 1.15% (they have since fallen to all-time lows, below 1%). Investors’ initial concerns over the virus earlier this year centred on what the hit would be to China’s Q1 GDP and what this would mean mechanically for global growth (given China’s global economic influence is so much bigger today than it was 20 years ago, even 10 years ago). But with the spread of the virus outside China and its near neighbours, beyond the evolving human tragedy, concern over the global economic impact has been magnified. The OECD warned of a global recession on Monday. The IIF today said global growth could approach 1.0%, below the 2.6% last year and the weakest since the global financial crisis. There will surely be casualties from a more prolonged period of weaker economic growth, increased risk aversion and tighter financial conditions, which may cause some countries and corporates to fall into distress, although the most vulnerable in the near-term look to be those with pre-existing vulnerabilities (whether that’s Ecuador or the UK’s regional airline Flybe).
For EM sovereigns specifically, the macroeconomic impact will depend, inter alia, on i) the impact of weaker Chinese and global growth, and impact on trade, ii) lower commodity prices – which can be positive or negative depending on their economic structure, iii) financing conditions (higher yields and/or weaker currencies), and iv) policy space – fiscal or monetary – in order to respond to the shock, and the quality of infrastructure and public services, especially health services, to deal with it.
The IMF announced yesterday that it will make available US$50bn through its existing rapid-disbursing emergency facilities, with US$40bn available to emerging markets through the Rapid Financing Instrument (RFI) and US$10bn at zero interest for the poorest members through the Rapid Credit Facility (RCF). Neither of these facilities require policy conditionality. They have been used before recently, usually in the context of natural disasters, for example, Ecuador’s RFI in July 2016 after its earthquake, Mozambique’s RCF in March 2019 in the wake of Cyclone Idai, and Iraq’s RFI in July 2015 following the ISIS insurgency and fall in oil prices. Financial support under the Catastrophe Containment and Relief Trust (CCRT) is also available for eligible countries providing up-front grants for relief on IMF debt service falling due. The CCRT was used during the 2014 Ebola outbreak.
The World Bank meanwhile announced US$12bn in aid for developing countries, with half coming from the IFC. Of the US$12bn, US$4bn is being shifted from previously available funds. For comparison, the IMF increased its lending capacity by some US$460bn during the global financial crisis through bilateral borrowing agreements with its members and expanded new arrangements to borrow (excluding the SDR allocation in 2009 and quota increase in 2010).
But we think there is only so much traditional economic policy levers can do, while public policy will shift from containment to mitigation. Token monetary easing may help soften the blow and alleviate financing pressures for some, although targeted fiscal measures – for the vulnerable, unemployed, working poor and credit constrained – may be more useful. But none of these can ensure a V-shaped recovery rather than a U-shaped one, while the fear-factor (simple psychology) dominates and uncertainty over its duration persists. Moreover, we think simple comparisons of how quickly markets recovered after previous episodes of pandemic/epidemic (SARS, MERS, Swine flu) are flawed given they were not associated with anything like the same risk to the global economy (or have attached the same fear) that we’re seeing now with Covid-19, and don’t often control for other events that were happening at the same time. Notably, for instance, swine flu in 2009 occurred at the tail-end of the global financial crisis. Instead, perhaps investors may hope that when the rate of infection goes down, they will be able to pick up bargains, as has happened after previous sell-offs (eg 2009, 2016, 2018). What also remains to be seen is whether the impact of Covid-19 leads to more permanent changes in economic behaviour (hysteresis effects), positive or negative, and judging the winners and losers, and whether, and in what way, it might change the rise of China to superpower status.
Yet, what this week also shows is that global policy coordination is not dead, at least not when it is really needed. That the G7 actually met may be reassuring, in an era when post-GFC and during the Trump presidency, multilateralism has been replaced by bilateralism, and the G7 – and other international fora – have been increasingly seen as irrelevant, if not redundant.