The shape of recovery

The Sunday Times of Malta

12 April 2020

After every economic downturn there comes a recovery.   In economic jargon such recoveries are defined by their shape.

A (V) shaped recovery happens when the downturn is overcome and the economy is restored to its pre-recession level quickly. In such case the economic damage is light and quickly forgotten as the economy resumes its long term growth trend. This is a typical cyclical shallow recession that happens in the normal course of events.

A (U) shaped recovery happens when the economy spends quite some time at the bottom of the downturn and the road to recovery is long and painful. In such case the economic damage is quite substantial and the economy may take very long both to reach its pre-recession level and especially to recover its long term growth rate.  This is quite what happened with the recession caused by the financial crisis shock of 2008 and the euro crisis of 2012.

An (L) shaped recovery is the worst type of recession where there is such a sharp and deep drop of economic activity, often caused by unexpected shocks causing physical destruction,  such as wars and natural disasters, that recovery is very long, painful and at best uncertain.

What shape will be the recession of 2020 caused by the sudden shock of the COVID-19 pandemic?

You have to be a great optimist to believe that the recovery can be (V) shaped.  The shock is so deep and wide, sparing no major economy, that in a world that is economically interdependent, the whole world will struggle to regain confidence to restart the economic engine.

It is more likely that the recovery will be somewhere between the (U) and the (L) shapes. Much depends on how long our health priorities will constrain us to keep our economic units on life support if not totally frozen. The longer this takes the more difficult will be the recovery.  This must not be interpreted as any appeal to subordinate health priorities to economic objectives. It is presented as factual; the longer it takes to put this epidemic behind us, the harder will be the road to recovery. If anything it is an appeal to heed all advices given by health authorities, which is the only way we can put this health crisis behind us as quickly as possible.

Even though our economy has entered this shock from a position of strength (low unemployment, strong growth, low and reducing public debt to GDP ratio, and several years of fiscal surplus) resources are not infinite.  And given the prospect of a long hard slog to recovery, our resources need to be applied judiciously with the long term in perspective. 

Even though our economy has entered this shock from a position of strength resources are not infinite

When health authorities signal their consent to start relaxing restrictions it is obvious this will not be a big bang, Trump notwithstanding. It will be a gradual and stepped up approach. Initially small shops may be allowed to open up without relaxation of crowd limitations.  Then larger shops will be brought back to life and if all goes well than small catering and entertainment outfits will be switched on. 

The last to join the fray will be outfits which by their nature attract crowds such as churches, sport and cultural events, cinemas, large entertainment outlets and so on. And up to this point it would still be largely a domestic affair. Before opening up to international travel the authorities would need to be confident that inflows from other countries would be safe enough to restart hotels and other tourist accommodation outlets. Clearly it would be a slow gradual process involving months not weeks.

Government assistance has been timely and effective. Highly-impacted sectors were given payroll subsidies on condition they keep their workers in employment. The cash flow of business units has been alleviated by deferrals of tax payments due in the months of March and April.

The government has offered banks guarantees to release bank finance to the tune of €770 million at very low interest rates, to give working capital support to businesses, both small and large, so that they can spread the burden of this crisis over four years and possibly longer.

Obviously the businesses that were not classified as highly-impacted feel short changed.  They claim discrimination especially as they start being impacted by the ripple effects if the crisis, less direct but still painful.

Their claims for direct subsidies have merits. But equally valid is the government strategy not to fire all bullets when it is clear that the recovery will be long drawn out and painful. If the government can be confident that the recovery can be more (U) shaped than (L) shaped it can fire more bullet subsidies to cushion the secondary ripple effects.

However, with what is going on in the EU and particularly the euro area, can one really have confidence that we can avoid an (L) shaped recession?

The euro area entered this recession in pretty bad shape. The ECB was keeping it artificially together by promoting a negative interest policy to give time to political leaders to work out a more stable structure for the euro monetary system before it would be wiped away by the next deep recession.

The time was largely wasted and the next deep recession arrived unheralded much earlier than wished for.  While it is true that it takes a crisis to forge solutions in the EU, the divide between those insisting on coronabonds and those insisting that each country should remain responsible to keep their fiscal accounts in order, is too wide to bridge over in a sustainable way.

If on the top of the COVID-19 recession we risk great instability caused by the threat to the very existence of the euro, then the base of the (L) shaped recession could be quite long, and we must take that into consideration in our recovery plans.

How much is enough?

Times of Malta

Opinion

30th March 2020

This question is often put to me by concerned and interested observers wondering whether the three aid programmes so far announced by the government would be enough in their cumulative impact to restore the country’s economy to its normal state of sanity and growth, as experienced until the COVID-19 pandemic turned everything  upside down.

The simple answer is that we don’t know. Nobody knows.  There are three basic unknowns which render a proper assessment of the size of the problem impossible.

So equally impossible is any certainty regarding the type and dosage of the required medicine. 

What’s for sure is that we need to have a very deep war chest and have to be ready and flexible to dose the solution commensurately, as the size of the problem continues to emerge.

The three basic unknowns are:

1. How much resources do we need to channel to the health sector to ensure it stays ahead of the curve as the pandemic reaches its peak and then hopefully starts to recede gradually?

2. For how long do we need to keep the productive economy largely frozen as many workers, consumers and clients are forced by circumstances to live within their household walls?

3. Once we get over this scare and we start the process to normality, what would be the gradient of the recovery process?

The first unknown will have a substantial impact on government finances but contribute to economic growth as government has to deliver more services. 

The other two unknowns have a huge negative impact on both government finances as well as the general economy as economic activity freezes and economic units lose huge chunks of their operational revenues.

It is difficult to escape the conclusion that 2020 will register both a contraction in the economy, i.e. register negative growth, as well as substantial shift from surplus to deficit in government finances. 

Government programmes so far have given first aid support

What we cannot be sure of at this stage is the intensity of such shifts. Some models I have seen show that if the crisis stretches over four months i.e. March until June, the eurozone economy could shrink by 10 per cent in 2020.

I think this is quite plausible for our circumstances given our exposure to highly impacted sectors like tourism, entertainment, financial services, and construction, and assuming that it could take six months to restore consumer confidence to its normal level.

Should we worry? Of course we should; there are too many uncertainties not to worry. Should we panic? Absolutely not.

We must do whatever it takes to keep our workforce healthy and to help our economic operators to stay alive until we put this crisis behind us. The size of the budget deficit needed to achieve these objectives is quite of secondary importance and we have ample debt capacity to borrow whatever needs to be borrowed to see us through.

It is evident that government is the only entity that can do what needs to be done to get us out of this crisis with the least damage possible and in a situation where our economic operators stay healthy enough to return to full activity and efficiency.

Government programmes so far have given first aid support. The first package provided liquidity through deferred tax payments. The second and third versions extend payroll support to the most impacted sectors.  They also provided for highly needed contingent obligations by the state to enable banks to extend liquidity support to borrowers without risking their own (banks) state of health.

Nobody knows if this is enough. My feeling is that the first package was absolutely needed and easy to implement.  It is also indiscriminate among business sectors. The second and third packages have a hint of instant cooking and discriminate among sectors. It was put together with urgency with understandable focus on protecting employment in the most impacted sectors.

At some stage one has to consider whether payroll support is sufficient or indeed the most effective way to go about it.

If difficulties prolong, the call for more will become irresistible. At some stage one has to consider whether payroll support is sufficient or indeed the most effective way to go about it. While most economic outfits should be able to absorb a bad month, few are in a position to withstand a series of bad months where most or all of their operating revenues simply evaporate.

For those outfits that do not qualify for the payroll support schemes announced, or wish to opt of them and are manifestly being impacted by the crisis through lower or no operating revenues, the government may have to consider the introduction of revenue support schemes.

Basically this would involve the outfit demanding support by explaining how their revenues are being hit and government considering grants up to 50 per cent of the revenues declared in their VAT returns for the comparative period of previous year 2019.

The remaining 50 per cent would reflect the direct expenses that would be saved and the profit margins that economic operators have to forego.  This would always be subject to qualifying enterprises committing to keep on their entire workforce.

This scheme would protect the job safety of those not enjoying payroll subsidies of current schemes and enable economic operators to stay broadly current with their other operating expenditure like rents, insurance, energy bills and other overheads.

Failure on these payments would otherwise deepen and prolong the recession.

We need to be ready for the worst and believe that whatever the financial impact experienced, we can recover all setbacks over the medium term as we bounce back into activity to reclaim and extend our full economic potential.

Going through this together

Times of Malta

Opinion 21 03 2020

 These are extraordinarily abnormal times. An invisible virus has come out of nowhere to shake the major economies of the world. No one was really prepared for this. If the crisis prolongs, the world will be dragged into a recession. The type of recession will depend on developments which are mere guesstimates at this stage.

If the spread is controlled within the next few weeks and confidence to resume normal times emerges in the the second half of spring, then we can expect a good recovery in the second half of the year so that the year will finish with lower growth but still some growth. This will be a V-shaped recession.

If on the other hand the recovery in consumer confidence takes longer to re-emerge, this recession will be as bad a recession as that of the early 1908s.

It will be a U-shaped if not L-shaped recession.

In Malta, thankfully, we are facing this challenge from a position of economic strength. The performance these last seven years has been impressive and the macro economic position is endowed with fiscal buffers which can be released to cushion the negative impact of the current crisis. Debt to GDP is now just over 40 per cent, down from 68 per cent in 2012.

The government budget has been in surplus for four successive years. Reserves have been stashed away in the National Development and Social Fund (NDSF) to be used to finance investments outside the main budgetary stream.

The government has already announced measures to aid businesses to manage their cash flows as their revenue streams dry up. This applies particularly to economic operators in tourism, hospitality, personal services and distributors/retailers of non-essential goods.

It may apply also to other sectors like construction and manufacturing if workers cannot get to work or if orders get cancelled in the face of emerging uncertainty.

Postponement of tax payments due in March and April offer a boost to business cash flows which help them to stay alive until we put this crisis behind us.

However it does little or nothing to cushion the blow to the operating performance of businesses in the eye of the storm.

The government could consider sending a payment to every household to maintain consumer confidence

Hotels, restaurants, retailers of non-essential goods, and small businesses offering personal services could be severely hit. On the other hand, wholesalers and retailers of food, medicine and other essential goods and services are having a Christmas in spring.

The government needs to extend support to those being hit in a socially just manner. It cannot condone the principle that profits are to be privatised but losses are to be socialised. 

Whatever it does must be focused on those who need assistance to stay alive so they can be around to facilitate the recovery when the crisis abates. The level of government support should be timed to facilitate coming challenges not to address past stress. A bad month after several years of growth should not be fatal to serious businesses.

Assistance needs to be targeted to help businesses and protect workers. Those enterprises that need to adopt short work weeks should benefit from a government subsidy to keep intact the basic take home pay of affected workers.

Employees who are forced into mandatory quarantine should have a good part of their salary financed by the state.

The government can offer indemnity to banks against a good part of losses they may incur through offering borrowers a one year capital repayment moratorium. This applies to business loans as much as to house loans, though interest has to continue being repaid as due.

The government could also consider sending a payment to every household to maintain consumer confidence in the face of rising prices caused by panic buying. No cheques... simple direct credits to avoid sending people to queue outside our banks who are already stressed by staff shortages. Ideally this measure should be timed to impact as soon as quarantine restrictions are lifted to give a boost to consumption which is currently being constrained.

These measures and the huge expense government is incurring to try to keep us healthy, will probably turn a projected one per cent budget surplus to a few percentage points of deficit.

So be it! The priority now is not the budgetary end result.

The priority is saving the economy and protecting our operators to ensure that they stay energised to regain traction when this crisis is behind us in the second half of 2020.