By Vazil Hudák, Vice-Chair, GLOBSEC and former EIB Vice President & Miroslav Kollár, Board Member, 4 Gimel Investments & former IMF Board Member
The new coronavirus COVID-19 and the associated lockdowns are creating an enormous hit to the global economy and an almost unprecedented policy response. We are not experts on pandemics, only history will tell in retrospect whether the government response in terms of strict lockdowns was appropriate or not. There are, however, a few things that we can already pencil down on the economic front.
The level of GDP in Europe and in the US is projected to be at least 10 to 20 per cent lower this year. This comes from the hit to corporate revenues, which in turn leads to massive layoffs and reduction in corporate and household spending. Furthermore, the unemployment rate in advanced economies might surpass that of the 2009 crisis. The stock markets in the US and Europe have initially fallen by more than 30% in March this year, more than during the euro area crisis although still less than the 56% decline during the 2008-2009 crisis or the 86% decline in 1928.
Governments and central banks are trying to fill this hole in national incomes with extraordinary stimulus measures. For example, the US is expected to record a fiscal deficit of about 20% of GDP this year, taking into account the 2 trillion dollars a fiscal package, commensurable only to the 1940s era. The euro area finance ministers just announced half-a-trillion euros worth of support package. The expansion of the Fed’s balance sheet is surpassing the levels seen during the Lehman crisis, and the ECB has stepped up its quantitative easing program. Thus, we are clearly seeing a war-like policy response.
The question remains whether this massive fiscal and monetary stimulus is going to be enough to counter the negative consequences of this crisis. This depends on how successfully the pandemic is contained and how long the current lockdown will last. At least in the US, the announced fiscal package coupled with further Fed’s easing and additional measures should cover most of the initial dent to the economy. The euro area’s response has been a bit smaller and more diverse, given the pending lack of area-wide fiscal policy and north-south differences. This adds more weight on the shoulders of individual member states and on the ECB. We believe that more stimulus might still be needed globally once the second-round effects of the COVID-19 income shock flow through the economic system as companies start reducing investment further. Some sectors will have a stronger recovery, once the lockdowns are over, but a lot of sectors will have a more long-lasting downturn.
A few policy lessons from previous crises could be considered when the forceful stimulus packages are crafted for the COVID-19 aftermath.
The first wave of crisis response by central banks and governments has been rightly targeted at alleviating the liquidity constraints of governments, companies and households. The next wave of the response will need to target national governments and capital support for companies in need.
The EU leaders should decide to focus the 2021 EU budget on the post-COVID-19 recovery of Europe. That’s why the agreement on the 7-year EU budget should be postponed and instead, 2021 should be structured as the contingency budget with major allocations for those areas that require EU support for economic recovery.
On the government level, the return to the stricter fiscal limits of the Stability and Growth Pack in the European Union should be sequenced and coordinated. The Recovery Fund as proposed by France and the other Member States should be partly supported from re-allocations within the 2021 EU Budget. Unused capacity of the European Stability Mechanism should be focused on post-COVID-19 recovery. These ESM credit lines to the Members States in need should be based on country-specific recovery plans approved by the European Commission, and they should be provided under clearly formulated conditions. Besides fiscal and structural policy conditions, there should be benchmarks to achieve a “smart and green recovery”. By doing this, Europe could actually come out of the crisis in a stronger and more competitive position vis-à-vis the rest of the world, while making important milestones in achieving its green objectives. In addition, EU funds should be allocated to support large public infrastructure investment projects on the national level to boost demand in the short term and increase the economies’ potential in the longer term.
Earlier this year, even before the global pandemic broke out, the ECB’s President Christine Lagarde said that “it would be very welcome to have other policies join the monetary policy in order to support the reduction of slack and to arrive at that growth potential”. The COVID-19 crisis has brought a new regime forward, as monetary and fiscal policies are being forced to work more in sync in order to foster the economic recovery while keeping the public debt sustainable.
The euro area crisis taught us that when companies are going through a balance sheet recession, easing of lending standards would not automatically induce them to invest more. Addressing the weak balance sheets with direct support is necessary. More debt is not an answer for already indebted companies. Therefore, the lifelines that the governments are providing to the hard-hit companies should find the right balance between debt and equity. For example, and on top of the already announced measures, EU leaders should consider creating a Recapitalization Fund that could help to strengthen the balance sheets of companies. The European Investment Bank and its European Investment Fund, as the largest equity capital providers in Europe, could be tasked to administer this fund. Such fund would complement various national initiatives to support the capital base of companies in Europe. This should go hand in hand with relaxing the state aid rules in the EU. Europe cannot risk jeopardizing the stability of its systemically important companies that could then become an easy target of foreign investors.
European policymakers would also need to brush up their playbook on how to deal with widespread corporate defaults. The debt of viable enterprises would be restructured, while the nonviable companies would be liquidated. Experience from the US Savings & Loans crisis of the 1980s or the post-1989 debt restructuring in the post-communist economies in Europe could serve as illustrative examples.
Finally, the COVID-19 crisis provides a wake-up call for Europe to strengthen its strategic sovereignty and resilience. This includes better planning for crisis situations particularly when it comes to health and food supplies, strengthening the position of Europe in global supply chains, improving civil defence coordination among member states and reviving the solidarity within the European Union. Not to mention that this crisis risks to deepen the gap between poor and rich even more and strengthen political populism.
Only coordinated actions at the level of governments and corporations can transform the challenge of COVID-19 into an opportunity for Europe to become more competitive and more united.