COVID-19 economic update – April 3, 2020

• Economic sentiment indicators released in the course of the week ending April 3, 2020 added further gloom to the economic outlook for the European Union and the rest of the world. Jobless claims have skyrocketed in the United States and came well above expectations. In some EU countries, initial labour market data is also worrisome (e.g. Spain, France, Italy, Germany). In 2020, economic activity is expected to contract between 5% and 10% in the Euro area, while some EU countries could experience an even sharper contraction. All sectors, especially services, retail trade and manufacturing, will be extremely hit in the following months (Section 1).
• At the national level, additional economic measures to counter the crisis have been taken. Support schemes are now moving into the implementation phase in a number of countries. The size of the policy intervention differs sustainably across EU countries, ranging between 1% of GDP and over 20% of GDP. At the EU level, The European Commission presented a proposal for temporary support to mitigate unemployment risk in an emergency, designed to help protect jobs and workers affected by the coronavirus pandemic. Furthermore, the Eurogroup continues preparatory work on proposals to develop pan-European financial responses, to be discussed on April 7. The importance of a pan-European scheme is evident in the context of a highly integrated European economy, where spillovers, related to intra-EU trade, European confidence and financial loops are sizable for each and every member state (Section 2).
• Financial conditions remain tight and stock markets volatile in both advanced and emerging economies (EM) (Section 3). Although relatively high, European sovereign and corporate spreads remained mostly stable this week. Further, bond issuance was strong among investment-grade corporates. On the other hand, capital outflows from emerging economies have reached a record USD 83.3 billion on a cumulative basis since the beginning of the year, and several developing and emerging countries have seen their sovereign ratings downgraded. Going forward, heightened financial market volatility is to be expected.
• Zooming in on European banks (Section 4), the banking sector is in a better shape than during the 2008-2009 financial crisis, but clearly the current economic shock poses risks. In comparison to the 2008-2009 financial crisis, the initial shock will most likely be shorter if the policy response remains strong, timely and well-targeted; the the crisis is not originating in the financial and banking sector; and banks have sounder capital and liquidity positions than in 2008 on the back of the policy and regulatory measures undertaken following the financial crisis. On the other hand, the contraction in GDP is likely to be more substantial and more concentrated in time than during the global financial crisis. It is also likely to trigger a more immediate impact on non-performing loans, as entire economies are being shut down. All in all, we expect European banks to remain resilient. Yet, uncertainty remains huge and a prolonged or sharper recession will not leave banks unscathed.

As of 3 April, more than 1,000,000 infections have now been confirmed and more than 50,000 people have died due to the virus or by the complications it caused. More than 200,000 patients have recovered. The epicentre of the virus has moved to the United States, where new infections are increasing exponentially. While at the moment the heaviest death toll remains in the European Union (Figure 1), infections seem to have plateaued in Italy and Spain (the most affected countries in Europe so far).

EU member states have been actively intervening with economic measures to counter the crisis. New measures adopted by EU countries include:

• a voluntary postponement of the repayment of loans for six months, financial support for self-employed and temporary deferral of rents for companies in Czech Republic. In addition, the Czech Central Bank eased existing restrictions to conduct open market transactions.
• In Spain, the government announced to halt evictions, financial aid for temporary workers and interest-free micro-credit for tenants. The Spanish Central bank announced that the activation of counter-cyclical buffers for domestic lenders would not come into force for the next quarter.
• The Cypriot Central Bank communicated a series of measures to support those affected by the COVID-19 pandemic, including a pledge to provide liquidity and reductions in the costs of banking services.
• The German government said that it would provide a total of EUR 2bn in short-term financial assistance for startups struggling with the impact of COVID-19 but may not be eligible for other programs.

Beyond policy measures by individual member states, there is a strong need for a common, mutually reinforcing EU response to the crisis. European economies are strongly interconnected and a shock in any MS propagates to the rest of EU through labour movements, value chains, terms of trade and external demand. These spillovers can be quite large: besides the direct impact, a 1% decline in the GDP of Germany, France, Italy and Spain results in a further decline in the euro area’s GDP of 0.25%, 0.2%, 0.1% and 0.1 % respectively, merely on account of intra-euro area trade spillovers (European Central Bank (ECB), Monthly Bulletin 2013). Similarly, a positive shock in any EU country triggers positive impacts throughout the European Union. Macroeconomic modelling by the Economics Department of the EIB Group together with the Joint Research Centre of the European Commission shows that in the long run cross-country spillovers in the European Union explain, on average, 40% of the impact of the EIB investment on jobs and GDP inmember states. While smaller and more integrated countries gain relatively more, large EU countries also greatly benefit from positive spillovers (in Germany, for instance, they account for more than 30% of the total impact of EIB investment on jobs). On top of trade links, EU countries are also deeply interconnected via financial markets and confidence feedback loops. Taking these spillovers into account when designing the EU response to the unprecedented crisis we are facing is crucial: leveraging on additional and mutually reinforcing effects, a joint EU response can reach far and above what any individual MS can achieve alone.

Steps to strengthen the joint European response to COVID-19 have intensified this week. Following the invitation by the European Council, the Eurogroup has continued preparatory work on proposals to develop pan-European financial responses, to be discussed on April 7. In the public discussion, several ideas continue to be debated, including the enhanced use of the ESM credit lines, common bond issuance, an enhanced role of the EIB via a guarantee fund to support corporates, as well as possible avenues to deploy the next MFF in support of recovery. Given that different measures also address different problems stemming from the crisis, including short-term liquidity constraints and mid-term needs to finance the recovery, combinations of instruments could provide for a forceful response to increase the block’s economic resilience and prospects for recovery.

The EC approved several national schemes to support firms and mitigate the economic impact of the pandemic, proposed additional support to the healthcare systems mobilising EUR 3bn from the EU budget for emergency support and medical equipment, and presented a proposal for temporary support to mitigate unemployment risk in an emergency (SURE). SURE will assist with loans of up to EUR 100 bn, supporting member states in addressing higher public expenditure to preserve employment. The scheme aims to help cover the costs of setting up or extending short-term work schemes and similar measures. Supported by a system of voluntary guarantees, the Commission will on-lend to member states requesting support on favourable conditions. While still pending approval and envisaged as a temporary measure, SURE can help to mitigate protracted divergences across European labour markets as experienced in the years following the financial crisis providing support for employment across the European Union.

In the United States, the Fed eased a capital rule for large banks, intending to stimulate banks to lending more and play a more prominent role in the US Treasury market. The “supplementary leverage ratio” was a rule adopted in 2013 and required large banks with international portfolios to hold capital (equal to 3% of total assets) to absorb losses. The Fed stated that now banks can exclude Treasuries and cash reserves held at the Fed from these calculations for a year. This way, the Fed pushes more cash reserves into the banking system: the banks will be able to take those reserves on to their balance sheets without having to increase capital at the same time.

The IMF has received requests for aid to deal with the coronavirus from more than 80 countries (50 emerging countries and 31 middle-income countries), totalling more than USD 20bn. This is less than half of the USD 50 billion in support that the fund made available in rapid emergency financing for low-income and emerging markets. However, the Fund sees developing nations needing USD 2.5tr in financial support to fight the coronavirus. Among the countries, Argentina is pursuing a restructuring, Ecuador is discussing a re-profiling, and Zambia is seeking to restructure its foreign bonds. Pressure on developing economies’ financial assets is expected to continue as several economies need to repay dollar-denominated government debt coming due in the second quarter of 2020.

The first World Bank emergency funds have been approved to help developing countries fight the pandemic. The envelope with USD 1.9bn lending capacity to support projects in 25 countries and project in another 40 countries is close to approval. Of the 76 low-income countries qualifying for assistance under IBA, 40 had also applied for assistance.

The corporate sector showed some signs of (temporary) sstabilisation this week, though at high levels, while sectoral differences remain visible. Non-financial corporate stock prices have hovered around the level reached last week, 25% below December 2019, but 10% above the trough of two weeks ago according to the data until April 1. Between-day volatility, though, persisted. Importantly, corporate stock prices have decoupled from banks’ stock prices as of last week. After resuming their decline, banks´ stock prices have been hovering around a level similar to their previous low reached around the 20th March. The overall decline in corporate stock prices is uneven across sectors. Passenger airlines, tourism, automobile, hotels and restaurants and non-food retail sector are the most exposed sectors, while pharmaceuticals, health care, utilities, energy and digital are more cushioned (Figure 5).

Credit risk spreads have also stabilised over the last two weeks, after having gone substantially up during the first half of March – from 0-40 to 120-160 bps for corporates rated A to BB, and bonds of 5-years maturity (Figure 4). Currently, corporate bonds spreads – vis-à-vis monetary policy rate – stand less than half-way from their peak reached during the Lehman crisis, in the beginning of 2009.

Corporates have actively tapped the bond market not only in the United States but also in Europe. Issuance by investment-grade companies reached USD 259bn in the US (a new monthly record) and EUR 135bn in Europe (the most since 2016). Moreover, this trend in Europe intensified last week with 17 deals issuances last Wednesday, totalling EUR 26.8bn.

This section zooms in on the European banking sector, trying to understand how well-placed banks are to cope with the ongoing crisis. We do so by comparing the current situation with past crisis episode.

(1) Banks are better placed to withstand the shock than in 2008.

European banks’ capital position is now substantially more robust than in the previous crisis. Core tier 1 capital stands now at 18% of risk weighted assets for the EU average, 8 p.p. higher than in 2008 (Figure 8). Moreover, while this aggregate figure masks some notable differences across countries, the countries that currently have a weaker capital position are still in a much stronger position than before the onset of the global financial crisis. The Single Supervisory Mechanism makes explicit reference to the fact that banks have enough buffers (for capital and liquidity) and therefore should use them (more details on point (3) below).