COVID-19 – Of Lockdowns, Downgrades and Cost of Stimulus
THE STATE OF AFFAIRS
COVID -19 has wiped out a significant portion of the income of the Caribbean region putting it at risk and the world grapples with a novel financial crisis. Novel in the sense that it is attached to an underlining cause the nature of which demands treatment that will continuously further damage economies. This is a moment of economic lockdowns, downgrade by rating agencies and worry of the ability of emerging economies to finance their recovery.
There were two headlines carried in separate publications on April 10, 2020 which we think signals the inevitable. “Moody’s Bahamas rating under review for downgrade” and “Fitch Ratings revises Jamaica’s outlook to stable, affirms B+”. Economies around the world and certainly within the Caribbean are under pressure from the effect of COVID-19 virus. The need for social distancing and necessary lock downs of businesses has resulted in significant slowing of commerce. The economic impact from the COVID-19 event is substantial and devastating. The two mentioned sovereign reviews of The Bahamas and Jamaica, from is, in our opinion, the start of the unfolding of how deep this devastation will become, with no certainty of how long it will last. For policy makers, it would be wise to take a long view of the time to recovery and plan accordingly. With best case of obtaining a vaccine, according to the experts, as much as a year away, any planning based on a very short time horizon will be, in our opinion, imprudent. However, in all efforts to save economies, time is of the essence.
With all we now know, it is not beyond the imagination to project that the lingering effects of the virus could be with us for as much as eighteen months. Failure to understand that the future health of the economy is intrinsically attached to the resolution of the virus will lead to serious consequences. Failure to appreciate that lockdowns, which will further devastate economies, will be longer than desired, will lead to fatal decisions and ultimately the economy and the people will suffer! There is a price to be paid for the resolution of this event and every country must pay this price. There is no choice. What may be optional is whether the payment is on the front or back end. In the case of the former, that price is somewhat controllable. In the case of the latter, the cost will likely be more significant and evidence of a battle lost. Caribbean nations cannot afford to lose the battle but winning will not be easy. Those willing to make bold moves will improve their chances thereof. Sitting back and waiting could lead to long-term damage to countries.
What then are some of the critical issues that may be occupying the minds of policy makers at this time? Foremost, we think the biggest question on the minds of policy makers surround when the lockdowns will be lifted. They are likely thinking of the extent to which the economy of their respective country will be affected. In addition, very likely they must be considering where their respective sovereign ratings may end up in the short to midterm. Policy makers will be occupied with the thought of the impact continued lockdown will have on the ability of government to afford the stimulus which will be required during and at the end of this event, whenever that may be. They must be necessarily concerned about the fact that there is an abnormal global demand for capital by emerging economies, many of them likely to see their sovereign debt rating downgraded shortly. They must be considering the systemic risk of default increasing and consequently sovereign debt attracting risk premiums across the board. Amongst others things, with an eye on the post crisis era, they have to be concerned about the significant level of capital flight taking place to developed countries, seeking safe harbors. The issues are many, connected and complicated. The extent to which they are factored into national planning will be critical to the way forward.
For context consider the recent meeting where the IMF announced the cancelling of the debt payments, for six months, for twenty-five countries around the world. The total value of the package pegged at $215 million. For the region Haiti was the only country to be included in that package for a paltry amount of $4.8 million. This action is an immediate signal of what the uphill battle will be for countries the region. The financial burden will be huge; the challenges with funding will be significant, the economic future of the region is uncertain, resting on the ability to restart commerce and secure funding or relief. With the significant loss of tourism revenue, discussed further below, the ability to survive is at risk. This is a moment when CARICOM must come together, as a bloc, and fight for its survival. The process will be grueling and potentially very complex. However, these are the moments when leadership earn credibility and concretize value. More now than ever every country will be looking for effective leadership. The fate of nations will depend on it.
THE VIRUS IS THE ECONOMY
All policy makers, we think, understand that opening the economy too soon could come at a significant cost. The pressures to do so are significant, understandably so as business are at risk of failing the longer they remain close. The longer the lockdown lasts, the more devastation is being wreaked on the economy. The possibilities of businesses closing increases, the cost to government increases, reducing its ability to afford the inevitable post crisis response, as we watch time sensitive opportunities wane. In the case of The Bahamas with its significant reliance on tourism, which is almost 100% gone, the implications are brutal for the business sector. However, let us consider the very recent experience of Singapore as they grapple with the dilemma of balancing the challenges faced with this economic and health crisis.
On March 5, 2020, the World Economic Forum boldly stated the following on its website “Singapore contained Coronavirus. Could other countries learn from its approach?” The endorsement continued, pointing to the emergence of a potential best practice since the start of the event. The article stated “As the novel coronavirus starts to gather speed in Europe, the Middle East and the U.S., there’s one place it is seemingly being contained: Singapore.” An unequivocal vote of confidence of a country that consistently outpace, topping most major performance indices especially in the economic and competitive arenas. The endorsement ended with the following, “With no reported virus-related deaths despite 96 cases, and a slowing rate of infection that’s been outpaced by recoveries, the Asian city-state is emerging as a litmus test of whether the deadly pathogen can be, if not contained, then neutralized.”
Let us fast forward to March 22, 2020 and Aljazeera’s headline states “Singapore closes borders to keep virus at bay, but no shutdown”. The move it said followed Singapore’s first two coronavirus-related deaths together with a surge in cases from overseas. By March 9, 2020, the story changes dramatically with reports that Singapore has instituted a partial lockdown to the fourth of May in order to contain the spread of the coronavirus. This move, it was reported, “could cost the economy about S$10 billion ($7 billion) in lost output”, approximately 2% of its GDP.
This example underlines the seriousness of managing this event. We fully appreciate that the longer the lockdown lasts the more difficult it will be to restart the economy. The Singapore development, however, demonstrates the danger and the risks involved. Opening borders will mean that new cases are being imported leading to a flare up of cases. Singapore has, by global standards, a topnotch health care system. It was not however willing to take the risks of leaving its borders and businesses open, having made a brief misstep in this area. Imagine therefore the countries of the Caribbean with weak healthcare systems, which could be quickly overrun and overwhelmed, leading to wider spread and deaths. The decisions to be made are therefore very difficult ones. Open too soon and exacerbate the health effect. Leave it too long and decimate the economy! Caribbean leaders will likely be forced to take risks in this area. A delicate matter required careful and deliberate planning. A country like The Bahamas has a slight advantage due to its archipelagic nature. Unfortunately, most of its economy is concentrated on one island. This is instructive of how wide policy makers will need to look. As they work to recover and fix economies consideration matter such as reducing concentration or look at another way, expanding and better devolving commercial activities and economic centers.
The sad reality, which should not be ignored, is that without a vaccine, the emerging best practice is mass testing (as in the case of Korea) and social distancing. The effectiveness of social distancing is enhanced by a lockdown of normal economic, social and community activities. In our view, the lock down for Caribbean countries is likely to be a bit longer than what may emerge as a norm, largely because of the limitation of health assets and health care machinery. Looked at another way, a longer period of lockdown is the cost of not having well developed facilities with the capacity to take significant numbers of virus victims. Policy makers, the business sector and citizens should quickly come to grips with this fact. The length of lockdowns and the confidence to reopen will, amongst other things, be a function of bed stock, intensive care capacity and medical facilities available to fight the virus. COVID -19 will exert adverse pressures on all countries where these are lacking. A quick glance at the Bahamas, Jamaica and across the region will confirm weak systems and therefore points to a lagging recovery, compared to countries with a more developed and robust systems.
The natural outturn of the preceding is that economically weaker countries with underdeveloped healthcare may pay a greater proportional price because of the need to shutter its economy for a longer period. The vicious cycle should be evident. Damage to the economy, increased cost to the government, further potential downgrade, and a lack of fiscal space to respond leads to the need for borrowing, which become more difficult to access at reasonable rates. From an economic perspective, a classic case of “damned if you do and damned if you don’t”.
RATINGS AND FISCAL RESPONSE
Policy makers are dealing with an evolving crisis, a major treatment of which creates greater economic damage. The focus on time is multifaceted and important for the region as countries start to make plans to restart their economies. As time drags, we can anticipate that the crisis will impose a higher cost on funding the recovery. Moody’s indication that its rating for the Bahamas is under review for a downgrade, due to the fallout from COVID-19, is significant for the region. Moody’s statement that the decision “reflects significant risks to its economic and fiscal metrics as a result of the coronavirus outbreak” should cause many other countries to become very concerned.
Most countries within the region’s sovereign debt are rated as risky. With the exception of Cayman, which has an excellent investment grade rating, The Bahamas and Trinidad share the next highest ratings in the region, BB+ and Baa3 ratings from S&P and Moody’s respectively. Both of which are considered “lower investment grade”. A downgrade for The Bahamas therefore holds very worrying implications for the rest of the region. With weaker economies, most could be firmly relegated to effectively junk status. Many are already in the realm of being “highly speculative”, as is the case with Jamaica, or the lower level rating of
“substantial risk”. A downgrade for The Bahamas itself will push its sovereign rating into the non-investment grade category rendering it a higher risk and potentially pushing up the cost of borrowing significantly.
The average debt to GDP of CARICOM countries stands at approximately 65% ranging from a low of 33% (Haiti) to a high of 125% (Barbados). Adjusting for the two lowest countries, Trinidad and Haiti this ratio increases to 78%. This number is significant. Using 60% Debt-to-GDP as a benchmark which most countries wish to remain below. It indicates that most countries do not have the fiscal space they would desire. For example, during the global crisis of 2008 The Bahamas had a Debt to GDP of 39% compared to its current position of 64%. Certainly a less strong position from which to respond.
The combination of potential downgrades and limited fiscal space will spell trouble for many countries and borrowing therefore becomes an imperative. It does not require expert assessment to determine that with the significant loss of tourist dollars, across the board, countries will need to borrow. In the case of the Bahamas, in its most recent quarterly publication, the Central Bank outlined this very clearly. Speaking to projected fiscal activities for 2020 the publication stated, “In terms of the fiscal sector, expenditures related to the restoration of key infrastructure and social welfare spending, combined with revenue intake disruptions related to COVID-19, are anticipated to weigh profoundly on the Government’s fiscal outturn. Re-insurance receipts and donations from domestic and international sources should mitigate some of the shortfall in revenue. However, the remaining budgetary gap will require a rise in domestic and external borrowings.” The circumstances for Barbados, Belize and Jamaica, with much high debt to GDP, is more disconcerting. This will no doubt be very concerning for the leaders of those countries. If our argument of a need for significant borrowing holds true, as we think it will, policy makers must be ready to make hard decisions and be ready to bring some level of creativity to reinvigorating the economy, should inflows from borrowings prove insufficient.
Will further rating agency reviews place greater pressures on the region to secure funding for economic recovery? Could we become the victims of concern for increased risk of default on sovereigns? Will the region be able to afford any attendant premium that may arise because of the current set of unfavorable factors? Factors such as unusually high demand for debt, weakened economy and negative outlook, potential shortages of bi-lateral loan arrangements and limited resources of multilateral agencies. These are important questions to contemplate for policy makers and citizens alike. The answers to this hold potent influence for what our recovery may look like.
THE RISK FACTORS FOR THE REGION
As it relates to sovereign debt, the continued COVID-19 event may be delivering to the world a ticking time bomb. Is there a storm brewing as it relates to emerging economies securing loans? There are a number of factors to be considered as we analyze the potential challenges which emerging economies face at this time. These provide important signals. This economic and financial crisis is different from past events in that every single country is experiencing the ravages and outside of a few will need to borrow. The demand, as mentioned before, increases the potential cost of securing debt. The market for borrowing is reduced given the fact that facilities which Caribbean countries would normally look to secure, borrowing on a bilateral basis, or through some predetermined agreements, have likely evaporated, as the countries that usually facilitate these are themselves grappling with the immense cost of securing funds for stimulus. Soft loans that may be available prior to now are likely all gone. The demand is high in a contracting market.
Countries within the region will most likely resort to multilateral agencies such as the IMF. According to Kristalina Georgieva, Managing Director of the IMF, speaking on a recent call, there is an estimated demand for $2.5 Trillion dollars, an estimate that is considered to be on the lower side. Our research shows that traditionally IMF available resources are likely to significantly lag this amount. Where then will some of the most vulnerable states turn, some of which are within the region? Policy makers should take seriously the statement she made on the same call noting that over eighty countries had already placed requests for IMF financing. One question is whether this will be granted on a “first come first served” basis or will there be an underwriting standard, which takes into account the fundamentals of the country? Will sovereign ratings, the risk of some disorderly sovereigns and unusual demand place certain countries at risk of having to navigate the post COVID-19 event with very limited resources?
Certainly, the impact will vary. However, taken as a whole, the region is highly dependent on tourism for its foreign exchange inflows. There are commentators who have espoused the idea that countries should start looking within for resources to fund the recovery. While this may be a supplemental approach, it is not likely to be optimal. Such an approach will fail to address the need for new capital injection while, especially for net importing countries, and those with pegged exchange rates such as The Bahamas, put net reserves under significant pressures. It is worthwhile to repeat that there is no definitive projection as to when this event ends. It is also worth underlining that the end of the virus is not the natural end of the financial and economic pressure. There will be a likely lag as behaviours renormalize, reversing social distancing as a necessary precursor for the return to vibrancy of tourism, the lifeblood for the Caribbean.
According to Oxford Tourism (Oxford Economics), 15.2% of the Caribbean’s GDP and 13.8% of employment is generated from tourism. On an individual country basis, this contribution ranges significantly from a low of 7.7% of GDP, in the case of Trinidad and Tobago, to a high of 98.5% of GDP for the British Virgin Islands. In 11 of the 21 countries analyzed, tourism accounts for over 25% of GDP, which is more than double the world average of 10.4%. In the case of The Bahamas, the contribution amounts to 48%, Jamaica approximately 20% of GDP. This dependency highlights the vulnerability of the region, which gets worse for many individual countries.
Given that a large portion of our spend is to developed countries, and having regard for the potential difficulties, based on the risk highlighted above, can an argument be made thatG7/G10 countries start looking at how they can support the region and other emerging economies? After all, these are their markets. These markets certainly will have pent up demand but with significantly retarded ability to purchase. This therefore may be a practical way of addressing the demand side shock of this event. Following the global supply chains it will be easily appreciated that weakened importing countries will result in weak sales for exporters. As policy makers interact with their global counterparts, initiating strategic conversations such as these could bring value to a country.
While all the above are fundamental, maybe the most significant risk facing the region is the main source of its tourism market, the USA. To date the challenges seen in battling the virus in the US suggest that the tourism market is in serious peril and will be so for a long time. Therefore, despite efforts to restart economies, we are grappling with a demand side shock, which has to be solve first before any semblance of vibrancy is lily to return to the market. Until this state of affairs changes, there will be little progress. Understanding that tourism contributes heavily to the majority of foreign exchange inflows for the region and the USA provides the bulk of the region’s tourist, in instances up to 80%, we must guided by the evolving developments in that country. With jobless claims standing at 22 million and unemployment increasing daily, with the stock market and nest egg investment portfolio taking huge losses, with reduction in earning disposable income will decrease. We must therefore anticipate a curtailment of discretionary spend and hence a hit to the travel and
tourism market. As we argued in our previous articles, the industry itself is likely to display a long tail recovery and this spells trouble for earnings and government revenue.
This article has so far provides perspectives on the current state of affairs of the COVID-19 crisis with a leaning towards sovereign debt financing and considered concerns facing policymakers. We looked at the potential for sovereign downgrades and defaults and finally delineated some of the risk factors at play.
If all that we have explored in this paper holds true then the ability to apply a range of classic fiscal responses may be very limited. Essentially, it will be a matter of affordability. Will The Bahamas, Jamaica, the rest of the Caribbean be able to afford the stimulus needed to move economies forward? For context, let us consider highlights from our previous papers. We pointed to the analyses done by the International Development Bank and Caribbean Development Bank (CDB). According to the IDB, using a highly tourism centric modelling, a worst-case scenario could see countries in the region losing up to 30% of GDP. The same was confirmed by the CBD using a more diverse modelling. For the Bahamas, this translates to almost $4 Billion. The impact on unemployment, government revenue, poverty, and standard of living should be immediately clear to keen observers. Proactive steps are therefore an imperative. Moving quickly carries one important benefit. It will provide important information to policy makers as to what potential shortfalls they might face and the level of creativity and ingenuity (non-traditional responses) that may need to be brought to bear to help solve their country’s challenges.
Firstly as a pro-business stance, and while accepting that there are important the limitations, policy makers must move strategically to explore how best to reopen economies. The objective is to limit the fall out in terms of potential bankruptcies, increased unemployment, and a narrowing of fiscal revenues. The latter is important in the face of increase need for state facilitated safety nets. To benefit the business sector and the wider economy it must be structured; well informed guided by public health experts; built on the foundation of clearly articulated protocols; always erring on the side of public safety first.
Countries should move as quickly as possible to secure the maximum amount of loans possible based on careful needs analysis. In some instances, while the realities will not escape lenders, initiating actions before the next scheduled credit review, could be advantageous. We understand clearly that this financial crisis will automatically create triggers, which allow sovereign reviews to be initiated. Most certainly, any foray into the market, seeking loans, will generate reaction from rating agencies. Still we believe that there is value in getting ahead of the line and securing what is needed or what is available. Importantly those who do will be able to bring greater certainty to their economies, better able to communicate economic strategies to the business sectors and citizens and signal the countries readiness to start moving the economy forward. With an expected contraction in FDI dollars seeking a home, the early bird countries in the region are likely to get the first bite that most important economic worm.
It is likely that we will see defaults across the globe. Caribbean leaders loathe defaults and history suggests that they will pay away the country’s last dollar rather than default on a loan. Regional leaders may therefore wish to, as a block, call for moratorium on loans by their lenders. Looked at from a global perspective this achieves the benefit of freeing up cash that can be spent locally and settles the market for sovereigns by not triggering a potential rash of defaults. This is a sound argument on which such a call can be made. A period of two to three years could prove beneficial for most countries especially those that find themselves in a high debt-to-GDP category. It does suffer one important weakness and that is without inflows the “cash saved” in the near term may be in fact nonexistent and there will still be a need for actual capital (debt) injection.
What could a substantial program of relief look like? An examination of what Jamaica was able to achieve through two IMF programs provides important clues. While they were not the same as a moratorium, the message is in what can be achieved when funds are available to invest back into the local economy. This same stimulating impact is possible albeit likely to be on a more constrained basis. What is the likelihood of a moratorium emerging? We cannot say but would quickly point to the potential need to avoid a situation that led to the Brady Plan for Latin America. Policy makers should look to history in formulating sound arguments for the benefit of individual countries and the region as a whole.
Countries should start taking advantage of IMF and other multilateral agencies’ concessionary loan facilities. This requires quick decision and nimble action as the demand is significant. The IMF itself has made the call for bi-lateral debt relief for low-income countries. Being on the inside and with an understanding of the country's need and support of one of the multi-laterals, negotiating bilateral relief could become easier. Ultimately, lenders want assurance of repayment. The longer loans are rescheduled, especially in an environment with the early challenges of a global financial crisis, the more likely for there to be default. However, with secured support lenders may be willing to agree to payment holidays, on the basis that the economy will have a chance to rebound.
Ratings will continue in this environment to hold great sway of how the market will see a sovereign. Downgrades may be inevitable but the strategies for recovery could be the x-factor. Policy makers should not assume that the normal fiscal responses would be either effective or sufficient. This is a time where clear, cogent and practical national strategies can bring great value in blunting outlook. Understandably, most emerging economies are likely to be at best, stable. Our assessment of sovereign ratings shows that this is definitely so concerning the Caribbean. However, in those instances where the fundamentals are weak and the outlook is negative, effetely laid out plans can serve to blunt its effect and therefore place the country in a more favourable position for attracting borrowings at reasonable rates. The unfavorable economic circumstances are systemic, therefore any action, which reduces risk premium, is a win for a country.
Policy makers should consider engaging with borrowers to secure all undrawn loans facilities. Where these were granted with specific or narrow purposes, as most loans are, then an agreement to repurpose for broader fiscal application should be secured. This will provide an important jump on the stimulus efforts. Where funds were initially earmarked for enabling or facilitative projects that have long-term economic impact it may be wise to not change route but to make strategic adjustments to take into account changes in the environment and the need to stimulate commerce. For example a project which can be executed by a local professional who may not have had the capacity prior, could be directed to boost employment or revisiting clauses where by agreement there were restrictions on where expertise can be sourced. Out of necessity, bold and creative moves will go a far way in taking on the arduous task of stimulating commerce.
We are of the view that the COVID-19 crisis will present challenges well beyond whatever capacity for borrowing exists in any one country. Every country will need to get creative and strategic. This is a great time to rally the resources and geniuses of a nation. It is a strategic time to call on the country’s entrepreneurial class. It is a necessary and appropriate time to reevaluate the extent to which government systems adequately facilitate the economic opportunities for citizens and residents, revamp policies, search for values in dormant or underused legislation, and make decisions, which hitherto now would be unpopular but have economic, social and financial value. Where this is not the case, it should be fixed. Where this is so, enhance it. We argue for this on the basis that a stronger and more robust economy may be the best antidotes for correcting the economic fallout, for creating insulation for the next crisis, but also to respond to important geo-economic and geo-political changes that we will see. Changes we should anticipate due of the harsh lessons that are emerging from this current event.
COVID -19 has created a global economic crisis that will continue to challenge many emerging economies, including the island state economies of the Caribbean. Without question, there will be limitations of resources. Economic pressures leading to downgrades will also exert negative influence on the ability to secure capital inflows at reasonable rates. However, rational and practical economic plans could blunt the effects of downgrades painting a country’s future in a better light despite current negative circumstances.
Policy makers in The Bahamas, Jamaica and the rest of Caribbean should act quickly. There is an opportunity to move as a region in seeking relief. Whatever approach is taken, one thing is clear, which must inform all future approaches and developments of industries, is that the region has significant vulnerabilities and lacks sufficient economic diversity. How policymakers decide to respond, the extent to which they move quickly, eschewing the business as usual approach, will be fundamental to post event recovery and long-term success.