The global coronavirus pandemic and the necessary public health response have quickly become a threat to the global economy. Many national economies are under acute pressure; output is already contracting as demand shrinks in many affected sectors and social distancing is increasingly enforced. The OECD is now projecting a global recession of at least 0.5 per cent in 2020, spread across many nations. A deeper recession is also possible if governments do not act sufficiently to stem the pandemic, flatten the curve, reduce the pressure on the health care system, and allow the economy to recover.
In our previous article, we highlighted how the direct lending capacity of national development banks (NDBs) can be used actively to provide credit to clients when financial systems become constrained and where commercial lenders have pulled back from the market during this current period of heightened turmoil and uncertainty. NDBs are already playing an enhanced role in some countries to maintain access to liquidity for businesses, especially SMEs.
We are now hearing early anecdotal evidence that the credit insurance market, both for export and for domestic sales, is beginning to contract as private insurers reduce or pull credit limits for specific buyers or across the board. We probably shouldn’t be that surprised if this becomes a trend, for two reasons.
First, the pandemic has led to a sharp decline in demand in many affected sectors, as well as creating significant uncertainty for all economic actors. Much slower demand growth quickly translates into less business revenue, a need to reduce business operating costs, and impairments to the creditworthiness of firms across the supply chain. Heightened uncertainty quickly turns into a reluctance to take economic decisions and action today, let alone plan for the future, which amplifies the economic slowdown.
And second, the private credit insurance industry has been quick on previous occasions to protect its own financial position, often unfortunately at the expenses of its clients. During the 2008-09 financial crisis, private credit insurance coverage was quickly reduced or even completely pulled, both for exports and domestic sales. This action left many credit insurance clients much more exposed to credit risk from their buyers and, worse yet, facing a concomitant reduction in their bank’s credit line — at precisely the time when the economy was in a sharp downturn and buyer risks were rising.
As we argued for enhancing the direct lending capacity of NDBs, there is a strong case for an expanded role for export credit agencies (ECAs) at this time. ECAs exist to meet the credit insurance and financing needs of those businesses exporting or investing abroad, and specifically to help fill market gaps. During the 2008-09 global financial crisis, many ECAs had to step into the space left by the withdrawal of private credit insurers from the market. For European ECAs, this meant arguing to ease the EU’s directives on short-term business as risks that were formerly “marketable” quickly became temporarily “non-marketable”. Much the same response can be anticipated this time around (if early indications prove to be correct), with ECAs able to step into provide credit insurance cover to clients that have been dropped by their private insurer.
Providing cover for export sales is, of course, the raison d’être for ECAs, and a logical place to start; but we anticipate there will be market gaps for domestic cover as well. The inability to obtain cover for domestic repayment risk, and a failure to be paid by a domestic buyer, can impair a seller’s ability to export just as much as not getting paid by a foreign buyer. If an ECA does not currently have the authority to cover domestic business, this may be an opportunity to develop that capacity.
Finally, the current exceptional period raises some fundamental questions about the importance of an ECA’s ability to quickly respond to market gaps during the full business cycle. Insurance is of little benefit to clients, and to the economy, if cover gets pulled repeatedly during recessions and other exceptional times, like today. There may be a structural gap in the credit insurance market through the entire business cycle that the private sector simply cannot reliably be expected to fill, such as for SMEs or high-volume buyers with scarce credit limits. ECAs have the potential to step into that role and ensure that national firms can secure credit insurance cover through the full business cycle and in exceptional times. Moreover, there is no inherent reason why ECAs cannot provide this service while operating profitably, if they are properly structured and managed over the long term.
Glen Hodgson is Chief Economist of International Financial Consulting Ltd. Glen is an economist and author with decades of experience in economic policy and sustainable growth. Glen’s career has spanned The Conference Board of Canada, Export Development Canada (EDC), the International Monetary Fund (IMF) and the Canadian federal Department of Finance. Glen has published two books and written over 400 reports, briefings and articles, and writes regular commentary for the CD Howe Institute, where he is a Senior Fellow, and in The Globe and Mail. Previously, Glen was the first Senior Fellow at the Conference Board of Canada after twelve years as the Board’s SVP and Chief Economist. He is a member of Canada’s Ecofiscal Commission, a Fellow of the Public Policy Forum, represented by Speakers Spotlight, and an advisor to a new research institute that is soon being launched.