Central Banks Against Coronavirus
Ignacio de la Torre on central banks reactions to the corona outreak.
CNN reported yesterday that, according to a recent poll, 38% of Americans wouldn’t buy “Corona” beer under any circumstances due to coronavirus. Although the television network itself has made it clear that there is absolutely no relationship between beer and the virus, this anecdote can help us understand the decorrelation that still exists between rationality and emotionality.
The danger is when this temporary illiquidity situation becomes insolvent due to the inability to refinance maturities.
Panic, based on a varied reasoning and emotions, marks our behavior and can lead to deferring consumption or investment decisions, which fully affects economic growth. If this is reduced, the company’s turnover suffers, and the most sensitive (usually SMEs and companies with low coverage between operating profits and financial expenses) can suffer intensely. Such suffering via cash flow, decisions can be derived such as reduction in workforce, which would affect consumption as a second derivative, which would in turn generate a vicious circle. The danger is when this temporary illiquidity situation becomes insolvent due to the inability to refinance maturities. Covid19 can generate these effects with greater or lesser intensity in the economies concerned, hence it’s important to understand the results.
To avoid this ‘supply shock’, central banks reacts with more or less pronounced measures. Let’s look at the first reactions:
The Chinese central bank is aware that the crisis caused by the coronavirus will have a significant impact on its economy and that in this situation, banking tendency will be to scoring loans to the largest companies in the hands of the state, at the expense of reduce flows to SMEs. As a result, it has announced a number of available liquidity stimulus measures to banking only if this liquidity is channeled to SMEs, in order to deal with the liquidity crisis. In turn, the tax authorities announced a temporary delay in complying with indirect and tax-related payments. The latter measure aims to deal with the tsunami that may affect Chinese developers, who have witnessed a fall in household sales by more than four-fifths. On the other hand, Chinese central bank has made a timid rate hike (10 basis points), and it may announce reductions in lace coefficients (reserve ratios), so as to free up liquidity in the banking system in an attempt to cope with the liquidity crisis faced by companies.
As I explained two weeks ago, the effects of the crisis are asymmetrical. Countries closer to China suffer more because greater proximity explains more trade relations (via exports and tourism). In the case of Japan, the Governor of its central bank, Kuroda, announced the agency’s willingness to increase market asset purchases (quantitative easing), which seems to take shape in line with Japanese asset movements. Other central banks in the region such as Australia and Malaysia, have already announced a rate hike, a process that will be emulated by other countries including those sensitive to commodities. However, weakness in emerging currencies could generate inflation and eventually limit the possibility of lower rates in these countries and certainly that some emerging countries will be forced to raise them in the medium term.
The Federal Reserve advanced the rate hike expected by the market with an announcement of a 50 basis point drop, placing rates in the range of 1-1.25%. In my opinion, it is likely that it will announce an extension of the liquidity operations it has been conducting since September in the money markets (he is injecting about $60,000 million per month, a process that would end in April and this circumstances may be prolonged).
In the case of the euro area, given that the decline margin in negative rates is limited and sometimes counterproductive, an extraordinary liquidity programme is announced to the bank subject to the use of flows made available lending to SMEs, which as I said, are more vulnerable to liquidity shocks.
Finally, countries can respond to the situation with some fiscal stimulus, such as the timid impulse announced by Italy, or the strongest in South Korea or China.
The consequences of these measures are still uncertain. They work more when there is a demand for credit, which can be low when there are so many medical and economic clouds. In any event, they will somehow mitigate the temporary risks of illiquidity in employment critical segments. On the other hand, the reaction of the central banks can help to mitigate market volatility which is another precondition for its proper functioning. Finally, the reaction of monetary policy can help to minimize the gap between the emotional and rational referred to at the beginning of this article.
In the short term, it will be necessary to discern whether stock market falls have caused a lesser wealth effect which results in lower consumption, and also whether weaker economic growth can cause localized market problems, corporate bonds, particularly in the United States. However, the most pertinent question is whether the resumption which will take place will take a “V” shape as observed when SARS was sent in 2003 or a “U.”
I bet we’ll see a two-speed recovery, V or U depending on the geography.
Ignacio de la Torre is chief economist at Arcane and the Academic Director of Finance at IE Business School. This article was originally published in El Confidencial newspaper in Spanish.