Covid-19 measures lead to a deluge of debt

It is not a trivial point that Germany will abandon for the first time the fiscal rigor it has strictly imposed since 2013, after announcing direct, indirect and state guarantee measures equivalent to 23.6 percent of its GDP – the largest package of any country in the world.

As explained in the quarterly update of MAPFRE Economics’ Outlook Report, the package of measures announced thus far by governments and government agencies will lead to an increase in debt of between 15 and 25 basis points of global GDP. “Governments attempting to stimulate their economies will run larger deficits, while there is a prevalence of weak borrowers who may react negatively to their obligations,” say MAPFRE Economics economists.

The packages announced have focused on replacing demand; avoiding a liquidity crisis that could become a solvency crisis; curbing the decline in financial expectations and those of the real sector (producers and consumers); halting the fall in private-sector incomes and their implications for unemployment and personal and corporate bankruptcy; establishing firewalls that prevent a perverse relation between the real and finance sectors; and avoiding a temporary shock such as Covid-19 from becoming permanent.

In the report, MAPFRE Economics experts differentiate between economic policy and fiscal policy measures. Monetary policy, in their view, has been broadly become ultra-accommodative in nature, both in developed and emerging markets (though to a lesser extent in the latter as they try to stem portfolio outflows).

This relaxation has taken the form of:

• Aggressive interest rate cuts. These have led to rates in developed markets moving virtually to the Zero Lower Bound (ZLB), such as in the United States or the United Kingdom, in many cases followed by emerging markets such as Brazil and Mexico, which partially contributed to a depreciation of their currency.

• Balance sheet expansion. The Federal Reserve has agreed to purchases of up to 700 billion dollars (in the Lehman crisis, its purchases totaled 600 billion dollars) and is open to unlimited purchases; the European Central Bank (ECB) is preparing for purchases of 750 billion euros.

• Halting the impairment of asset value. By expanding monetary institutions’ options to purchase mortgage-backed assets (MBS), corporate debt, ETFs, etc.

• Liquidity and solvency measures. Coordinated liquidity auctions in dollars, relaxing of banking system capital requirements (with the ability to release up to 20 billion dollars in liquidity).

With regard to fiscal policy, MAPFRE Economics explains that most countries have embarked on unprecedented deficit-widening pathways that will largely lead to a deluge of debt. In essence, these steps have resulted in direct, indirect and state guarantee measures, and are aimed at softening the slump in demand (through public-sector consumption), income compensation (transfers) and avoiding a liquidity and solvency crisis. In addition, more radical approaches (with thus far uncertain outcomes) such as the drawing up of plans for various bailout funds (Europe), deficit monetization (United States), and even the introduction of universal basic incomes (some countries) are being promoted; experiments that, MAPFRE Economics considers “must be treated with extreme caution.”

With less public policy options available, emerging economies may need to turn to multilateral institutions to roll out measures comparable to those implemented by developed countries. In this regard, as explained in the report, the focus has been on the IMF and non-conditional liquidity mechanisms, such as Special Drawing Rights (SDRs), which are exchangeable securities (at 1.36/USD) between central banks and the IMF. “Liquidity in the system in the form of SDRs is estimated at approximately 200 billion dollars. During the Lehman crisis, 250 billion dollars were required in this type of instrument, so the IMF is discussing creating new issuances that could range from 500 billion to 4 trillion dollars,” MAPFRE Economics indicates. “It should be noted that the IMF is the only institution that can function as a lender of last resort in the emerging world,” it concludes.