COVID-19 economic update – July 17, 2020

Euro area banks report higher demand for credit from enterprises and lower demand for housing loans, according to the European Central Bank`s July 2020 euro area Bank Lending survey (BLS). The steep rise in enterprise credit demand in the second quarter follows an already strong increase registered in the first quarter. Liquidity needs related to inventories and working capital drove the credit demand (Figure 2). In the third quarter, banks expect a further increase in demand for loans, but at a slower pace than in the second quarter. Demand for housing loans shows the opposite trend, with a sharp fall in the second quarter. These trends are reflected across countries. Net demand for loans to enterprises, driven by working capital needs, increased considerably in Germany, France, Italy and Spain, whereas demand for housing loans declined.

Banks report tighter credit standards for loans to enterprises in the second quarter and expect a further substantial tightening in the third quarter. Euro area banks tightened somewhat their standards for loans to enterprises in the second quarter, contrary to the expectations registered in April BLS, when banks said they expected a loosening of credit standards for loans to enterprises. Nevertheless, the tighter credit conditions reported by euro area banks are not as harsh as during the global financial crisis or the sovereign debt crisis. Going forward, banks expect credit standards to tighten considerably for firms in the third quarter, as guarantee schemes in some large EU countries come to an end and asset quality deteriorates. This aggregate picture, however, masks important differences across countries. Credit standards on loans to enterprises tightened in Germany and loosened in France, Italy and Spain. For housing loans, credit standards tightened in Germany, France and Spain and remained unchanged in Italy.

The International Monetary Fund (IMF) emphasized that the longer the slump, the greater the need to carefully target fiscal support to highly indebted countries in the European Union. The IMF also called for a greener EU recovery. The IMF published projections for the European Union in June. It expects gross domestic product (GDP) to contract 9.3% in 2020, before growing 5.7% in 2021, and to return to its 2019 real GDP level only in 2022 , according to the IMF’s forecast, which confirms a longer, U-shaped recovery.

The IMF warned of potential social unrest due to the crisis in Middle East and Central Asia region. In its Regional Outlook, the IMF expects the region’s GDP to contract 4.7% this year, falling two percentage points from the level in April, with a number of downside risks, including social unrest and political instability, as well as potential renewed volatility in global oil markets. In particular, MENA (Middle East and North Africa) economies are expected to shrink 5.7% on average in 2020, before recovering 3.4% next year.

In Asia, the latest economic projections and data remain mainly bleak, while in China the situation is gradually improving. Singapore’s economy shrank by 41.2% in the second quarter compared to the first quarter, following a 3.3% contraction in the first quarter. The economy shrank 12.6% year-on-year in the second quarter. The Bank of Japan has kept monetary policy on hold, but revised down growth projections. It now expects the economy to contract 4.7% in 2020, with consumer prices falling 0.5% in the same period. The economy should recover in 2021, growing 1.5%. On the plus side, China’s GDP exceeded forecasts to grow 3.2% in the second quarter, compared with the same period last year. Strong industrial production, which increased by 4.4% in the second quarter, and robust exports (+0.5% year-on-year in June), buoyed the economy. Unemployment declined to 5.7% in June, while retail sales remained weak and fell 3.9% in the second quarter compared to a year earlier.

Political uncertainty intensified in Ivory Coast after the death in early July of Prime Minister Amadou Gon Coulibaly, the presidential candidate of the incumbent RHDP party in upcoming presidential elections scheduled for October 2020. Coulibaly’s death could prompt in the country’s aged president, Alassane Ouattara, to run for a third term, or for the acting prime minister, Hamed Bakayoko, to run for president. Another presidential candidate could also emerge or elections could be postponed due to the coronavirus pandemic.

Moody’s Investors Service said the pandemic made a debt restructuring in Zambia more likely. Moody’s sees Zambia’s debt burden rising to 110% of GDP as the budget deficit remains persistently large and the currency continues to depreciate. According to the Zambian Ministry of Finance, the government is seeking a two-year debt moratorium from Group of 20 nations. In the meantime, Fitch Rating affirmed its long-term issuer default rating of CCC for Mozambique.

POLICIES

The ECB decided to keep monetary policy unchanged following a meeting of its Governing Council 16 July. The ECB reiterated that incoming data was signalling a gradual recovery of economic activity in the euro area, although the level of activity remained well below levels before the pandemic hit and the outlook was highly uncertain. The ECB also said that ample monetary stimulus remained necessary to support the economic recovery and to safeguard medium-term price stability.

EU leaders are convening for a special European Council meeting in Brussels on 17 and 18 July with the aim of agreeing to the European Union’s long-term budget and the recovery fund. The size of the recovery fund and its structure (grants/loan mix) remain the main points of contention.  The European Council president, Charles Michel, presented the proposal for the multiannual financial framework (MFF) and the recovery package ahead of the council meeting July 10. The proposal puts forth a slightly smaller budget (the proposed size of the MFF is €1.074 trillion) but maintains a plan for €500 billion in economic recovery grants for EU members as a part of a total planned recovery fund of €750 billion. The Council proposal envisages the repayment of joint debt to start in 2026, two years earlier than the European Commission proposed, and includes plans for new budget revenues (a plastic tax) as well as potentially exploring other “own resources.”

Croatia and Bulgaria received the green light to be part of the Exchange Rate Mechanism (ERM-II) and the Banking Union. Both countries are expected to adopt the euro in two years. The ECB has also set base rates for their currencies: 1.95583 Bulgarian Lev per euro (the rate in place since 1997) and 7.5345 Croatian Kuna per euro. The agreement on participation in ERM II is accompanied by a firm commitment from national authorities to pursue sound economic policies, maintain economic and financial stability, and achieve a high degree of sustainable economic convergence with other EU members, in line with the Maastricht convergence criteria. From 1 October, the Single Supervisory Mechanism will directly supervise the two countries’ largest banks and the Single Resolution Board (SRB) will become the resolution authority for big national banks and all cross-border groups. The SRB will also oversee resolution planning for smaller banks.

Shareholders of the European Bank for Reconstruction and Development (EBRD) have approved Algeria’s application to become a member. The EBRD is already active in the  southern and eastern Mediterranean region, with a presence in Egypt, Jordan, Lebanon, Morocco, Tunisia, and in the West Bank and Gaza. To date, the EBRD has invested over €12 billion in 260 projects across the region.

FINANCIAL MARKETS

As of mid-July, stock prices of non-financial corporations in Europe stand 5% to 10% below December 2019 levels, with very large sectoral differences (Figure 3). The sectors most affected by the confinement measures, such as travel and leisure and real estate, are lagging behind the recovery. Conversely, the stock prices of companies boosted by the crisis have gained. Health care, pharmaceutical and retail stock prices have surpassed December 2019 levels. Automakers and their suppliers, whose share prices declined during the peak of the crisis, have almost entirely recovered, possibly the result of supportive government measures.  

Corporate bond yields have remained stable since the beginning of June (Figure 4). After rising rapidly during the first half of March, non-financial corporate bonds yields declined steadily and plateaued since the beginning of June. From the beginning of June through the middle of July, the yield on five-year bonds remained in a range of 80 to 90 basis points for BBB-rated corporates (down from a peak of 170 basis points) and in the range of 30 to 40 basis points for A-rated corporates (down from a peak of around 120 basis points). While declining bond yields bode well for corporate credit, many firms faced downgrades as indebtedness increased.

A spike in COVID-19 cases and a warning by the Chinese authorities on the dangers of a potential equity bubble triggered a retreat in emerging market equities, after share prices reached a nearly four-month high the second week of July. Yields of investment grade, emerging market, dollar-denominated debt increased to 428 basis points over United States Treasuries, up from 418 basis points the previous week. The virus is flaring again in parts of Asia, with Hong Kong and Tokyo reporting record spikes in new infections just days after Melbourne locked down again. Brent oil is currently hovering around $43 a barrel, unchanged relative to the previous week. OPEC+, which includes OPEC members plus ten other producers, is leaning towards a gradual relaxation of its August cut in output as demand recovers.

For more insight into labour market developments, we use Google search data to assess the pandemic’s impact. The indicator measures individuals’ search queries on Google related to the topic of “unemployment” and offers a real-time assessment of “perceived unemployment risk” (with a 36-hour delay, for more information see https://trends.google.com). The statistics are available at the regional level, allowing for fine-grained analyses of local labour market developments. The analysis uses information based on representative samples of search queries focusing on searches for unemployment². The web-based unemployment indicator in its original form is measured as search interest over time in a specific region. The values are standardized to a scale of 0 to 100. A value of 100 is the peak popularity for the term in a given period. A value of 50 means that the term is half as popular as during the peak³.

The COVID-19 crisis quickly reflected short-term declines in economic activity and increasing unemployment concerns. The pace and magnitude of the shock were unprecedented, as illustrated in the business and consumer confidence indicators that plummeted across the globe, with some subcomponents falling to all-time lows (Gurria, 2020). In turn, slowing economic activity fueled concerns about potential job losses, reflected in elevated interest in unemployment and traffic to job websites and employment platforms. At the EU level, the Google searches of unemployment spiked in late March 2020, alongside a rising number of newly identified COVID-19 cases and increasingly severe containment measures (Figure 2).

Google unemployment search data can provide a leading indicator for unemployment. Examining the relative changes in the unemployment rates and in search behaviour in the early months of 2020, we find that, on average, in countries where search activity for unemployment increased in March compared to January, unemployment rates also increased in the subsequent months. The relationship is  particularly strong in countries where unemployment searches surged the most (for example Romania, Ireland and Belgium). However, the subsequent move in the unemployment rates varies across EU members. The variation depends on the exposure to the crisis, as well as labour market institutions and policy measures taken during the first months of the crisis. The variation also highlights the importance of controlling for such factors in the empirical assessment, which we address in the analysis. 

The impact of the COVID-19 shock varies across sectors and regions in the European Union. Some economic activities and sectors have been particularly hard-hit, notably non-essential services requiring a high degree of face-to-face interaction or production relying heavily on inputs from global supply chains. Other sectors experienced little, if any, downturn in production. Those sectors include  telecommunications, food and healthcare, with companies showing little inclination to cut hours or jobs (Fitch Ratings, 2020; Ifo Institute, 2020). Moreover, some jobs can easily be performed remotely provided that sufficient digital capacities are in place, reducing the unemployment risk. Looking at sectoral exposure and company sizes and structures, Doerr & Gambacorta (2020) find that regions in Southern Europe and in France have the highest shares of jobs under threat from the pandemic, while risks are relatively low in Northern European regions. Similarly, a recent analysis by the OECD suggests that some regions in Greece, Spain, Portugal and France are more exposed to unemployment risks, as tourism activities tend to be concentrated in those regions (OECD, 2020).

Companies’ financial strength before the crisis can reduce the shock. Companies’ financial strength before the coronavirus pandemic played an important role in how they resisted the crisis and in subsequent job losses. Companies’ cash reserves suffered as revenue dried during confinement. Large financial buffers buy companies time. Moreover, it allows firms to respond more flexibly to the crisis. Jobs that were easily done remotely could be moved to home offices, assuming the digital infrastructure was in place. Regions with higher shares of liquid companies should be more resilient, lessening workers’ concerns.

We examine how the COVID-19 shock affected job market sentiment based on corporate characteristics per region. We analysed a panel of 354 EU27 and United Kingdom regions⁴ from 1 January to 29 June 2020. As a leading unemployment indicator, we use unemployment searches as reported by Google Trends. The countrywide evolution of COVID-19 pandemic comes from the European Centre for Disease Prevention and Control (ECDC). Our main identification strategy measures how the (constant) regional characteristics affected the propagation of the (time-varying) COVID-19 shock to the regional search interest in unemployment topic. As regional metrics, we consider the share of employment in sectors exposed to the crisis (Doerr & Gambacorta, 2020). We use available cash at the individual firm level to indicate corporate health⁵. Our analysis controls for the regional health capacity (number of hospital beds per inhabitant), income (households’ net disposable income) and population⁶.Figure 2 presents the cushioning effects of stronger liquidity on unemployment concerns.

While the leading unemployment indicator was elevated in regions highly exposed to the coronavirus, a strong corporate ecosystem mitigated the impact. Controlling for a number of observable factors, as well as unobservable regional-level, country-weekday and country-month fixed effects, we find that regions with a high risk of unemployment due to the pandemic had more online searches for unemployment. However, this effect was mitigated if companies in the regions had more cash on hand. More specifically, in an average region in which 50% of all jobs were exposed to the COVID-19 shock, and in which the magnitude of the crisis had reached 1 000 newly identified cases, the unemployment search intensity hit 56 if the corporate liquidity buffers covered only one month of operations. However, two extra months of liquidity cut the search intensity by more than a half, to 26 (Figure 3). This suggests that regions with healthier companies with strong cash buffers saw less severe unemployment effects and therefore less concern from individuals about losing their jobs.

These results have interesting implications for policymakers’ crisis response in the near future and beyond. The impact of firm’s liquidity on job-market sentiment underscores the need to support companies’ access to finance as an immediate crisis response, which should help reduce uncertainty and avoid repercussions on demand. The strong use of short-term work schemes across Europe, a distinctive feature of this crisis, has a dual role in this respect, mitigating job losses and supporting corporate liquidity. Providing access to credit might also provide a shelter, preventing the transmission of the crisis to the labour market.

The findings also reemphasize the need for more structural policy measures to strengthen companies’ financial health and to boost resilience. These policy measures include reducing operational obstacles for firms and incentivising investment in areas that boost profitability, which enables firms to build up cash. At the corporate level, technology adoption is key as digital firms in the European Union tend to be more profitable (EIB, 2019). At the same time, the crisis has speeded up digitalization overall. Policy measures that support companies’ transformation during the recovery combined with investments in high quality digital infrastructure could help strengthen competitiveness and resilience. However, these efforts should be complemented with support for labor markets, such as investments in skills and (re)training to adapt to changing demands.

Bibliography

• Doerr, S., & Gambacorta, L. (2020, May 15). Covid-19 and regional employment in Europe. BIS Bulletin.
• EIB. (2019). EIB Investment Report 2019/2020: accelerating Europe's transformation. Luxembourg: European Investment Bank.
• EIB. (2020, June 10). COVID-19 economic update. Retrieved from EIB Economics Department: https://www.eib.org/en/readonline-publications/covid-econ-briefing-10-june
• Fitch Ratings. (2020, March 27). Fitch Ratings Updates 2020 Sector Outlooks To Reflect Coronavirus Impact. Retrieved from Fitch Ratings: https://www.fitchratings.com/research/fund-asset-managers/fitch-ratings-updates-2020-sector-outlooks-to-reflect-coronavirus-impact-27-03-2020
• Gurria, A. (2020, March 26). Statement for the G20 Videoconference Summit on COVID-19. Retrieved from OECD Library: https://read.oecd-ilibrary.org/view/?ref=126_126445-5ofyod1xpv
• Ifo Institute. (2020, May 5). Short-time work reaches almost all sectors in Germany. Retrieved from Ifo Institute: https://www.ifo.de/en/node/55086
• OECD. (2020). Employment Outlook 2020: Worker Security and the Covid-19 crisis. Paris: OECD.

1. For better tractability and comparison of the results, Google aggregates similar keywords and search phrases into topics. Topic indices offer two advantages over the standard keyword-based web indicators. Firstly, they categorize keywords, queries and page contents in a consistent and comparable way across the jurisdictions. Secondly, they standardize the language differences.
2. A score of 0 means there was not enough data for this term, and we exclude such data points.
3. While our baseline regional unit is the NUTS2 region, as defined by the Eurostat, some of the Google Trends results are available at different aggregation levels or for different regional units, like the UN ISO classification. We match these regions on the best effort basis, using a non-overlapping combination of different regional classifications in the analysis.
4. Doerr & Gambacorta (2020) estimate the share of employment in industries that are likely to be the most affected by the COVID-19 shock at the NUTS2 level (industry classifications G, H, I, R, S, T and U). Corporate health measures for how many months a company can sustain its outstanding obligations under the full lockdown scenario, as calibrated by EIB (2020). We calculate it at the firm level from ORBIS, for the same sectors as COVID-19 exposure index, and then aggregate it at the region level.
5. Source: Eurostat, most recent years available.