By Matthias Busuttil
As the damaging effects of the coronacrisis is realised in incoming economic data releases and survey-based indices, the full extent of the economic fallout and path to recovery remain largely uncertain. Many economists and official bodies have shared their own assessments of the forecasted contraction in economic activity and the expected hit to the labour markets. While most agree on the direction of travel, the degree of severity in macroeconomic forecasts can range quite widely in any economic area.
The disagreement around the extent of the economic impact and rate of recovery is driven by multiple factors which can be broadly categorised as follows:
- assumptions around the path of the virus contagion and the conditions for the scale-back of restrictive measures;
- assumptions around the success of the emergency fiscal and monetary policies put in place to sustain economic players and avoid structural issues;
- assumptions around the recoverability from disruptions in supply chains and economic productivity;
- assumptions around the reengagement of economic players and restoration of economic confidence.
Sizing up the crisis and studying the potential extent of the economic downturn is an important assessment to understand the potential implications on financial markets and asset valuations going forward.
Some silver linings to the otherwise very obscure outlook are key features that characterise the crisis and which are distinguishing factors compared to previous crises.
The crisis is characterised as event-driven as opposed to a structural crisis. In other words, this crisis has been brought about by what is defined as an external shock to the economy as opposed to the implosion of systemic risks which were built up over time, such as the 2008 sub-prime mortgage crisis.
Moreover, financial institutions have been significantly recapitalised over the last decade with the introduction of more onerous capital and liquidity requirements. This has resulted in a more robust financial system which can serve as a stronger platform for the provision of credit under stress conditions.
Trends in personal income, consumer consumption as well as household debt also suggests stronger household balance sheets built up over the years since the last crisis. This is expected to result in a higher ability to absorb financial losses at a domestic level and improve the rate of normalisation in consumer spending during the recovery.
Lastly, the sizeable fiscal and monetary policy response, aimed at limiting the damage to companies, sustain workforce retention and household income and to ensure easy monetary conditions throughout, was actioned relatively early on with the onset of the crisis.
These characteristics are shaping the expectations that the damage to the economy will be less long lasting, thus allowing for a higher possibility to restore economic productivity and output at a relatively faster rate. However, the downturn is also expected to be deeper than previous crises, given the shock dealt to both the supply and the demand side which effectively brought the economy to a sudden stop.
Financial markets have already metabolised most of the potential economic fallout with major equity indices dropping by 30% to 35% from the end of February to mid-March. This market reaction came in anticipation of the challenging economic, operational and financial conditions. However, risky assets, namely equities and corporate bonds, have recovered significant ground since then, given the strong policy response, the slowdown in cases and the communication from authorities around the reopening of economies.
At this stage, the balance between scaling back restrictive measures for the sake of the economy while avoiding an acceleration or a spike in new cases could not be more delicate. The notable rebound in financial markets suggests expectations around the rate of the recovery which are probably too optimistic.
The scope for another phase of market weakness can increase as the downside risk factors remain very much prevalent while events of defaults and bankruptcies in the highly impacted industries is yet expected to gain momentum.
The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi and Partners Ltd. is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.