Analysts were worried about a global recession because of poor cash flow, stretched valuations of firms, and rising leverage since 2019. No one, however, guessed that a micro-organism could trigger a financial shock across the globe.
The coronavirus is going to have a significant impact on the economy. The rapid spread of this virus threatens to cause global recession even though central banks and governments are doing their part to limit this shock. Both the supply and demand have a significant effect on the economy, but their impact is different from past crises. Every country has to develop substantial targeted policies to support their economies through this epidemic. They must also work toward maintaining the balance in various economic relationships such as lenders and borrowers, suppliers and end-users, workers, and businesses. This is the only way to ensure that the economy can recover once the effects of this outbreak fade. The objective is to prevent this crisis from harming firms and people permanently through bankruptcies and job losses. The costs incurred by humans have drastically increased. The disease is relentless and is spreading across countries at an alarming rate.
The primary objective of every country should be to keep the people safe and healthy. Countries must work toward improving and investing in their health care systems through diagnostic tests, additional hospital beds, screening, and personal protective equipment. Since there is no vaccine to stop this virus, countries have done their best to limit the spread. They have set restrictions on travel, closed schools and offices temporarily and locked countries down. These measures help to buy the country some time to prevent overwhelming health care systems.
One cannot determine the financial impact of the virus using a single economic indicator. The only thing people are certain of is that the financial impact is global. For instance, the financial distress caused to the Chinese market is the biggest blow to the world. China is the manufacturing hub of the world, and several parts of China were placed under strict rules and restrictions immediately after the outbreak was identified. They were, however, unable to control the community spread, and within a month, the number of infected people and deaths rose significantly. In response, the Chinese government locked down prominent stores, factories, and manufacturers. This led to huge economic losses around the world. You can view the losses in the stock market across the globe as evidence of the impact. Experts also predicted that the global GDP would take a massive hit since the lockdown would lead to disruptions in demand and supply.
The Economic Fallout
Having said that, governments and firms can prevent the spread of the disease if they work on defining mitigating steps. They must impose a partial or full lockdown and prevent large gatherings to help reduce the spread. Unfortunately, these steps will drastically hit the demand. Firms that have a weak revenue will struggle with repayments and cash flow. A daily wage earner may also struggle to put food on the table. Governments and firms must find a way to provide for these individuals.
The impact on the economy of the countries most affected by this virus is visible. For example, the service and manufacturing sector activity in China has declined rapidly since January 2020. The effect on the manufacturing sector could be due to the start of the global financial crisis. That said, the decline in the services industry is greater this time because of social distancing. The global demand and supply for dry bulk shipping products such as commodities and building materials has dropped due to the acute global financial crisis. This decline reflects the curtailed economic activity associated with the effort countries are making to contain the virus. This drop in the service industry didn’t exist after the 9/11 attacks in the US or during recent epidemics.
Supply and Demand Shocks
The coronavirus epidemic involves both demand and supply shocks. Disruptions made to business have reduced production, leading to a decline to supply. Since businesses and consumers have reduced their spending, it has led to a decrease in demand.
There is a supply of labor from caregivers who must take care of their children because schools are closed, from labor because they are unwell and, sadly, from the increase in mortality. There is a larger effect on the economy because of the efforts that countries are taking to contain the spread of the virus. They are doing this through quarantines and lockdowns. These methods led to a drop in the utilization of capacity. Additionally, firms are unable to obtain parts for their products and services, especially if they rely on the supply chain. They cannot obtain the products either internationally or domestically. For example, China supplies most intermediate products, including automobiles, machinery, equipment, pharmaceuticals, and electronics, to the rest of the world. The disruption in China has led to a terrible effect on the downstream firms. These disruptions lead to a rise in business costs that can reduce productivity, thereby reducing economic activity.
The fear of contagion, the heightened uncertainty, and the loss of income will always make people spend less. Firms may lay off employees since they are unable to pay their salaries. This has a severe effect on some industries or sectors like hospitality and tourism. One of the best examples is Italy. The US equity market began to sell equity on February 20, 2020. Since then, the prices of airline stocks have decreased disproportionately. This is in line with the effect that 9/11 left on the economy. The prices of airline stocks, however, are lower than they were during the global financial crisis. In addition to this, changes in the business and consumer sentiment can always lead firms into believing the demand will be lower. They will soon reduce their investment and spending, which will exacerbate job losses and business closures.
Financial Effects and Spillovers
As recently seen, financial conditions will tighten, and borrowing costs will rise. Banks suspect that firms and customers may find it difficult to repay their loan installments in a timely manner. When banks increase their borrowing costs, they will expose the different financial vulnerabilities that financial institutions face because of the low interests they charged over the years. This will lead to the heightened risk that financial institutions cannot roll over on their debt. The reduction in credit will exemplify the effects of demand and supply shocks on the economy.
Financial experts fear that these shocks, when synchronized across different countries, can reduce international trade. This will dampen global activity and reduce the price of the commodities. The price of oil has reduced drastically over the last few months. The current price of oil is 30 percent less than the price of oil at the start of the year. Some countries that rely only on external financing will find themselves at risk because of the changing market conditions. This will require the intervention of foreign exchange. Financial institutions can also change the flow of capital.
The current economy and market situation are close to what they were when the market crashed in 2008. The market crashed in 2008 when the Lehman Brothers filed for bankruptcy. What is happening now is exactly what happened then. The prices had crashed across various asset classes, and many investors rushed to exit the market. In that instance, every country worked together to stabilize the economy. Unfortunately, governments are not working together to respond to economic change. That said, central banks and governments are working together to roll out rescue packages. From Malaysia to the UK, governments across the world have announced stimulus packages, and central banks have eased both capital requirements and liquidity.
Adapt to Overcome
Many financial experts have talked about the effect of the virus on the economy. They believe the world has suffered tremendously, especially due to the shocks in demand and supply mentioned above. These experts believe that countries should develop substantial targeted policies to back the economy during these troubled times. We will look at these policies in detail in the next section. Further, these experts believe that firms and businesses across the globe will not escape unharmed. They must, however, work harder to recover once countries contain the virus. The objective was to prevent the crisis from causing permanent harm to people.
Targeted Economic Policies
Since the economic fallout reflects acute shocks in demand and supply in various sectors, policymakers must find a way to implement targeted financial, monetary, and fiscal market measures that are significant. These measures must help all affected businesses and households.
Any households and businesses hit by disruptions in supply and drops in demand can always be targeted to receive wage subsidies, tax reliefs, and cash transfers. This will help businesses and people stay afloat during these times. For instance, Italy has extended the tax deadline for all companies and firms in affected countries. The government has also chosen to increase the wage supplementation fund to support workers who have been laid-off. Following the Italian government, the Korean government also introduced wage subsidies for laborers and small merchants. The government also increased the allowance for job and homecare seekers. China has also waived any contributions that businesses make toward social security.
For the people who were laid off due to the crisis, countries should work on enhancing the unemployment insurance by increasing benefits, relaxing eligibility, and extending the duration. Some businesses, institutions, and governments do not offer their employees paid family and sick leave. Such firms must fund the hospital bills for unwell workers without the fear of them losing their jobs.
Central banks and other financial institutions must find a way to provide liquidity to nonbank finance companies and banks. They must do this, especially for small, medium, and large enterprises if they cannot withstand any disruptions. Governments should also offer targeted and temporary credit guarantees to meet the liquidity needs of businesses in the short-term. For instance, Korea has instructed financial institutions to provide loan guarantees to small, medium, and large enterprises. The government has also found a way to expand lending for various business operations. The financial market supervisors and regulators can also encourage extension on loan maturities by offering a moratorium. For example, Citi Bank in Malaysia has offered lenders a moratorium period of six months since the country is locked down for six months. The Reserve Bank of India (RBI) also has requested banks and other financial institutions to give the lenders a moratorium period where they could avoid paying the installment for two or three months.
Governments can support and lift the confidence of financial markets using broader monetary stimuli such as asset purchases or policy rate cuts. They must do this, especially when there is a marked risk of a tightening in the financial conditions. This can only happen if large central banks develop a strategy to generate favorable spillovers for any countries that are vulnerable. Businesses and financial institutions can lift the aggregate demand by developing broad-based fiscal stimuli. These stimuli must be consistent with the fiscal space that is currently available for countries. They will, however, be more effective when business operations normalize.
Countries must work together to respond to the changes in the economy caused due to the virus. The virus has spread across various nations, and the extensive linkage between the economies affects the financial and commodity markets, thereby affecting the global economy. The international community must find a way to help countries find a way to avert or reduce the risk of a humanitarian disaster by improving their health capacity. The International Monetary Fund works on supporting numerous countries with various lending facilities. They are willing to disburse emergency funds that can amount to $50 billion to those countries with low-income and emerging markets. If countries work on developing a global-economic response, we can bounce back.