What Can Government Financial Institutions Do During a Pandemic?

What Can Government Financial Institutions Do During a Pandemic?

Historically, endemics and pandemics lead to a “V”-shaped economic pathway. In this insight, we show how the direct lending capability of National Development Banks (NDBs) can be leveraged to take on additional responsibilities in exceptional times.

The coronavirus COVID-19 and the public health response (e.g., quarantining specific populations for 2 weeks or more) has quickly become a global threat. What can national development banks (NDBs) do during exceptional times, faced with a pandemic that continues to spread and multiply?

COVID-19 has quickly become a dominant short-term economic risk factor, starting in China and spreading to many other countries. It is causing a sharp and immediate disruption to economic activity, with an impact on both supply capacity and demand. The impact of COVID-19 is being felt in affected countries but there is also a negative ripple effect across the global economy.

The risk of contracting COVID-19 is still very low (there currently appear to be only a few cases per million population), but the rate of infection is much higher in specific regions and localities. The mortality rate can be very high, from 1 per cent to as much as 4 per cent of those affected, making it up to 40 times more lethal than influenza.

Economic impacts

COVID-19 has created significant uncertainty for all economic actors. This uncertainty has quickly turned into a reluctance to take economic decisions and action today, let alone plan for the future. Uncertainty amplifies the economic slowdown and makes it harder to see a positive turning point.

Overall economic activity is now slowing, due to a combination of supply disruptions and consumer demand being curtailed. The economic outlook for 2020 has become more negative and the slowdown is likely to affect the entire economy, including both domestic activity and international trade.

Based on the pattern of past epidemics, we should anticipate an economic pathway over the next quarter or two that will likely resemble a downward “V”. We should anticipate a pronounced drop in GDP for a quarter or two, which could mean a recession in many cases. If the epidemic then winds down as hoped, a quick bounce-back to trend growth is possible. There would be a loss of GDP during the “V” period but a quick return to a normal growth trend by mid-year. However, a more difficult economic pathway, with deeper recession and slower recovery, is also a realistic scenario.

Media reports indicate the pandemic is having a significant negative impact on specific sectors. Prominent affected sectors include hospitality and tourism; airlines and cruise ships; hotels; the meetings industry; and large public sporting and entertainment events. Sports matches and other public events are now being postponed or canceled, or proceeding in empty stadiums. An added factor is the concurrent steep drop in oil prices, which benefits consumers but puts regions and firms in the oil sector under added pressure, with a negative impact on investors and financiers.

Financial markets are feeling the combined effects of epidemic risk, heightened uncertainty and lower oil prices via a sharp drop in equity prices and lower interest rates across the yield curve.

Policy intervention is now taking place via cuts to interest rates and fiscal action. Ideally the policy intervention would be able to address both uncertainty and affected sectors and firms, but traditional stimulus policies may not be effective in those areas.    

What could NDBs do?

NDBs have a public policy mandate to meet the credit needs of businesses in their respective markets, and specifically to help fill market gaps. During the 2008-09 global financial crisis, many NDBs took on new business activity and developed new products and services, as well as serving their existing clients. The direct lending capacity of NDBs was used actively to provide credit to clients when financial systems became constrained and where commercial lenders and insurers pulled back from the market. The same could be done as required during this current period of heightened turmoil and uncertainty.

A rapid economic slowdown caused by COVID-19 would quickly translate into disruption in business cash flow, exposing business balance sheets for highly leveraged and small businesses, particularly in exposed sectors. NDBs can take a number of steps to ease the cash flow pressures on these businesses. They could help to maintain access to liquidity in order to keep operations active, by extending and expanding credit lines for existing clients, and by developing new facilities and serving new clients. In some cases, there may be a need to address a client’s debt service payment capacity, including restructuring payment terms if necessary.

Priority could be given to sectors that are the most affected so far, like hospitality and tourism. NDBs could also take steps to ensure their clients are receiving solid advice on the management and sustainability of their business model.

More broadly, NDBs may be asked to play a larger role in the national financial system, as they were in some countries (like Canada) during the 2008-09 global financial crisis. They could examine structural gaps that have been exposed in financial markets, stepping in to help fill those market gaps as required. This might require further financial backing from their governments, to ensure the NDBs have the required financial strength to take on larger volumes and added risks. They might also be asked to play a role, along with central banks, in addressing weaknesses in the balance sheets of specific commercial financial institutions, to help the commercial financial sector through this epidemic period.

Since the 2008-09 global financial crisis, many Export Credit Agencies (ECAs) have developed direct lending facilities to provide continued liquidity when there is private sector capital available to ensure access to export and trade finance can be maintained. Otherwise, the more traditional credit and political risk insurance products to cover the cross-border risks associated with trade and investment transactions remain important in these volatile times.

National development banks and export credit agencies can help to fill market gaps in the best of times, and they can take on added responsibilities in exceptional times, such as today. Ensuring that clients are able to maintain access to liquidity is an important first step, but NDBs can do much more to help the economy stabilize and return to growth while efforts are undertaken to tame COVID-19. 

*Originally published on March 3, 2020*

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