Last week’s contribution was about the impact of coronavirus on the economy. I had written that the impact could be quite significant even if public pronouncements were that the effect would be temporary. This week the story continued to unfold as cases were reported in countries where it had not hit yet and it spread more deeply in those countries where it existed already.
The surprise move of this week was the interest rate cut made by the Federal Reserve of the US. It cut its interest rate by half a percentage point, which is quite significant when one talks of interest rates. It was described as an “emergency rate cut”. The decision was prompted by its intention to protect the US economy from the impact of the coronavirus outbreak and by pressure for President Donald Trump to act.
In addition, the G7, the group of the world’s leading economies, have promised action to protect jobs and economic growth. In their statement they promised that they would use “all appropriate tools to tackle the economic fallout”. A number of companies have announced profit warnings and last week stock markets had their worst week since the 2008 crisis in the financial markets.
Action is also expected by the Bank of England. The outgoing governor, Mark Carney, said the impact on the United Kingdom could include an economic shock that could be large even if temporary. Then he reiterated that: “The bank will take all necessary steps to support the UK economy and the financial system”. Analysts are expecting the Bank of England to announce a cut in its interest rate sooner rather than later.
Countries need to cooperate on two levels
Mentioning the financial system, commercial banks are caught between the two proverbial stools. They are facing a demand by businesses for emergency funding as their operations come under stress and are being disrupted by non-payment by their customers and unreliable supply chains. Some have also resorted to sending their employees to work from home, adding further to the disruption.
On the other hand they have to operate within regulatory requirements related to risks posed by lending in these circumstances. A widespread worldwide slowdown in economic activity could cause insolvencies and defaults on bank loans, putting the viability of banks in question, and spreading financial disruption even further.
The announcement, earlier on this week, by the Organisation for Economic Cooperation and Development that the coronavirus represents the gravest threat to the world economy since the financial crisis of 2008, appears to establish in no uncertain terms, the significance of the impact of the disease.
At best, global economic growth could be falling to 2.4 per cent for the whole of 2020 compared to 2.9 per cent in 2019. If the contagion spreads further, global economic growth would barely reach 1.5 per cent, half the original estimate for 2020.
At this stage the European Commission also needs to intervene to mitigate the economic impact of the virus. It is as yet unclear whether governments will be allowed to follow an expansionary fiscal policy and run up a public sector deficit that could be greater than the three per cent threshold, to support their economy.
In the current scenario there is very little the European Central Bank can do, given the current negative interest rate. As such governments have to resort to fiscal policy rather than monetary policy.
As the story about coronavirus continues to unfold, it is becoming increasingly evident that countries need to cooperate on two levels. First, they need to take concerted action to combat the spread of the disease and ensure that their health services can cope with its containment. Second, they need to cooperate such that the negative economic impact is significantly mitigated.
What the coronavirus experience has shown is just how fragile the global economy is.