COVID-19: let’s get fiscal

07 August 2020

8 minute read

By Henk Potts, London UK, Senior Investment Strategist

Governments around the world have responded to the pandemic by turning on the spending taps and assuming record debt levels. Some have endorsed green commitments in doing so. But can such largesse prove successful or is it a risky last throw of the dice?

The pandemic is a medical crisis that has hit the global economy and financial markets. The locking down of populations has resulted in an unprecedented drop in activity, surging unemployment, permanent loses in output and temporarily slower potential growth.

The scale of economic risk has encouraged governments to embark upon an exceptional fiscal response, including allowing companies to furlough staff and pledging vast sums in loans, grants and credit guarantees.

In March, the leaders of leading economies, the G20, said they were committed to do whatever it takes and will use all available policy tools to minimise the impact from the pandemic. They promised to inject $5 trillion, 7% of 2019 gross domestic product (GDP), into the global economy to counteract the social, economic and financial impacts of the pandemic. As the true impact of the crisis has developed, so has governments’ willingness to ramp up the measures to deal with the damage; economists now estimate the total has surged closer to the $7 trillion mark.

US enters unchartered waters

With the US economy facing the biggest economic downturn since the Great Depression, a considerable increase in stimulus has been unavoidable. The bulk of this comes from the Coronavirus Aid, Relief and Economic Security (CARES) Act. The largest rescue package in the country’s history, amounting to more than $2 trillion, the legislation is aimed at protecting citizens from the public health and economic impact.

The major elements include payments to American households of $1,200 per adult and $500 per child on families with an income up to $75,000. The stimulus plan allocates $500bn for loans, grants and guarantees, including $25bn for the airline sector. It provides assistance for small businesses through the Paycheck Protection Programme, allowing them to maintain their payroll and hire back employees who may have been laid off.

The Coronavirus Relief Fund provides for payments to state, local and tribal governments. Hospitals, healthcare systems and providers will also receive a substantial increase in funding with a further $27bn for spending on tests, vaccine development and medical treatment devices.

Household and business support

The CARES Act has provided immediate support for households and businesses. US policymakers are also debating further stimulus in the form of infrastructure projects to provide longer term support for the broader economic recovery.

It will come as little surprise that these measures resulted in soaring US debt and deficit levels. The Congressional Budget Office estimates that the federal budget deficit was $863bn in June 2020, compared with $8bn in the same month last year. As a result of the measures, US public debt is likely to rocket to 128% of GDP this year from 108% in 2019.

Europe launches green response

The economic dislocation caused by the pandemic has resulted in Europe suffering its deepest recession since world war two. While a number of individual countries quickly established stimulus programmes, most notably Germany, the step change was establishing of the European recovery fund by the European Commission (EC).

The fund comprises of €390bn of grants and €360bn of low interest loans. The plan proposes establishing a green recovery roadmap for each industrial sector and meeting the EU’s 2050 target for greenhouse gas emissions reductions. The proposal also takes a significant step in outlining the future of the EU in the long run with money made available for digitalising the economy and investing in research and innovation.

The plan proposes establishing a green recovery roadmap for each industrial sector

Embracing shared debt liability

The EC plan to borrow the money, using guarantees from the EU’s long-term budget as security, embraces shared debt liability. The fund is seen as an important development for the future of the European bloc.

The proposal not only supports battered economies (particularly the most vulnerable southern European ones) but also demonstrates a commitment to much greater levels of fiscal integration; a decision that reduces concerns about the fragmentation risk of the EU. The extraordinary measures instigated by European officials will also have an impact on its debt levels. The euro area debt to GDP ratio is likely to hit 108% this year, from 86% in 2019.

UK suffers more than most

The UK has recorded the highest number of coronavirus deaths in Europe and the economy was quarantined for a prolonged lockdown. Output shrank by a fifth in April and prompted the chancellor to open the spending taps and turn his back on a decade of austerity.

The government injected hundreds of billions of pounds of stimulus into the economy, primarily aimed at tackling the fallout from the outbreak. The funds have been channelled through accelerated infrastructure projects through the recovery phase, loan guarantees to businesses and furlough schemes to help prevent a huge surge in unemployment claims. According to official statistics at the start of July, 9.4m workers had been furloughed, at a cost of nearly £30bn.

Chancellor spends, spends and spends

In the summer statement, the chancellor, Rishi Sunak, confirmed the furlough scheme will end in October. New support measures included a job retention bonus for retaining furloughed workers and a VAT cut, for hospitality, accommodation and attractions, to 5% from 20% for the next six months.

The government is also putting in place funding to cover the national minimum wage for six months and for new jobs for 16-24 year olds. There are also provisions to boost skills and apprenticeships. The chancellor has also made the transition to the green agenda an integral part of the recovery, with funding to make public buildings and housing more environmentally friendly.

The expansive actions taken by the UK government have resulted in an unmatched rise in peacetime borrowing. UK debt may surge from 83% of GDP last year to 101% in 2020.

Innovative, but risky, response

Governments have proved to be both proactive and innovative in devising solutions to deal with the economic ramifications of the pandemic. Without such action the long-term scarring to the global economy would have been much worse and humanitarian damage far greater.

However, the policy initiatives are by no means a risk-free bet. Fiscal deficits and public debt are skyrocketing and government borrowing in many countries is soaring to levels not seen since the 1940s. Servicing that debt has been made possible by historically low interest rates (a function of central banks’ bond-purchasing programmes).

However, if public finances are to be put back onto a sustainable path, there will need to be some longer term constraints on fiscal policy, including higher taxes and substantial cuts to government spending.

Nevertheless, in the short term, policymakers are gambling that doubling down on the fiscal response today will boost the trajectory of the recovery, thus making it easier to repay the outstanding markers.


Market Perspectives August 2020

Financial markets remain fixated on pandemic risks, and hopes of a COVID-19 vaccine, as spikes in infections occur in regions of leading economies.


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