Coronavirus: Containing the financial contagion

Coronavirus: Containing the financial contagion

By Amit Marwah

The coronavirus is clearly threatening to trigger a financial contagion in the world economy and this time the impact could be very different from the scenarios experienced in the financial crisis of 2008. We are witnessing the phase one of this epidemic, where the focus of every country is to take care of the health of its people. However, the financial impact of this medical crisis in the days to come could outweigh the medical mayhem it is causing now. Irrespective of their position in size hierarchy of the companies, whether it be a SME or a blue-chip player, business entities are taking big blows from the widespread pandemic, putting immediate pressure on companies’ profits along with a downside impact on their ability to borrow money and keep their operations intact. The sectors which are expected to take the hardest hits will include aviation, hospitality, transportation, retail & entertainment. This a sort of double whammy where we are facing both demand and supply-side shocks. Customers are staying at home, leading to a demand-side shock and at the same time, there is an equally lethal supply-side shock as the factories and offices are shut as well. There is going to be a significant meltdown in the cash flows of operating businesses in the impacted markets like the US & major parts of Europe, creating survival problems, especially for the highly leveraged lot.

This is pretty evident from the panic we are witnessing among the central banks around the world, leading them to slash interest rates to virtually zero and follow all the monetary and fiscal tools at their disposal. Though these sledgehammer actions have not done much to quell the financial markets, these disruptions in the economy could result in a contraction of global growth, at least for the first half of this year. However, on a positive side, as history has shown us before, we hope the recovery will not be as procrastinated as many experts are predicting. There is light at the end of the tunnel with positive noises coming from the Chinese markets. Both the demand and supply side seem to be making a comeback in China, giving the other affected markets a hope that this situation can be contained. Emerging markets like India and even the Middle East (with the exception of Iran) have done well to not let the situation go out of hand. A lot of faith is pinned to the fact that even if the world enters a recession, it will be sharp but we shall bounce back as soon as the virus subsides.

Once the dust settles down and the new cases start to plateau, the central banks, finance ministries, and commercial banks will have to sit down to chart out a mitigation plan to minimize the economic aftermaths caused by this interruption and lockdown. It will take a coordinated effort to allow a smooth transition for the industry, out of this crisis. It is better for the governments and the banking sector to provide a window of comfort to corporate borrowers in these impacted sectors, where they are able to match their debt repayments with their cash flows at least for the next quarter. Other measures could also include direct short-term working capital loans to impacted sectors, tax breaks, etc. to name a few. These measures could go a long way in averting a corporate debt crisis, especially in the developed markets, with corporates sitting on a large pile of debt and a lot of these companies do not generate enough cash flows to cover their interest payments. Policymakers need to swing into action now to avoid strains on corporate balance sheets and avoid any solvency crisis.

On the financial markets side, another interesting move could be removing the taxation on buyback of shares, which shall allow cash-rich companies to buy back their own shares and thus providing a floor to the exasperated fall witnesses in the stock markets.

Though it’s good to hope that this nightmare will end soon. However, hope is not always a sound financial plan. Corporates should be doing all kinds of financial stress testing and scenario analysis, to create alternate financing and business continuity plans. It is time to think ahead of the curve and prepare for the next two quarters on all fronts including workforce management, supplier frameworks, customer engagement, financial planning & restructuring, etc. It’s important to plan and not just react for corporates at this stage of the corona pandemic cycle.

Mr Amit Marwah, CFA, is Chief Investment Officer – Dayim Holdings, Kingdom of Saudi Arabia.