The first quarter of 2020 is fast drawing to a close, and what a tumultuous period it has been. We entered the year full of hope, bolstered by, among other things, a seeming cessation in the US-China trade war, a recovery in the semiconductor industry and returning investor confidence.
Alas, it was not to be. Two major black swans have destroyed all optimism, and the world economy is now precariously close to the brink of a recession. And there is a growing view among economists and world leaders that the looming economic and financial crisis may be worse than the 1997 Asian financial crisis and the 2008 global financial crisis.
They may well be right. And here is why.
The Covid-19 pandemic is unprecedented in nature. First detected in December 2019 and announced in January, it very quickly spread across the world, affecting more than 100 countries, with thousands of fatalities reported. Even as we speak, no one can rightly say how long this pandemic will last and what the final devastation to the economy and human lives will be.
The wheels of commerce are grinding to a halt across the world — an occurrence that has never been seen before. More and more countries have announced lockdowns of their major cities and borders — from London to New York and Kuala Lumpur to Manila — to battle the contagion. As each day passes, the news gets worse, with many countries reporting an exponential rise in the number of Covid-19 cases.
Equity markets are free falling, with benchmark indices sinking to levels not seen in the last decade. Currencies are coming under intense downward pressure, with some, like the Australian dollar, at a 10-year low. The exception is the US dollar, on the premise of its safe haven status.
Gold, no surprise here, has been on the up, as jittery investors take flight to safe assets.
Never in the crises of 1997 and 2008 did we see empty malls, empty food and beverage outlets, factory shutdowns and almost empty airports in some parts of the world that have restricted outbound and inbound travel. Productivity is at an all-time low as a result. Meanwhile, hospitals are bursting at the seams.
Many economists have opined that the Covid-19-induced economic crisis is testing the strength of the global recovery since the 2008 financial crisis. Thus far, they believe that fundamentally, there has not been significant real strengthening and doubt if such fragility can withstand the lash from the impending economic crisis. In the weeks ahead, employment data will likely show more job losses across the globe as the crisis takes its toll on economic activity, and this will translate into falling consumption spending.
A vicious cycle is underway.
Major sectors have been adversely affected by the pandemic — energy, travel, airline, banking, transport, hotel and retail. Rating agencies like Fitch have revised the outlook for US banks to negative, citing the impact of the pandemic on the global economy, rising possibility of loan defaults and margin squeeze as interest rates fall to near zero. Some of the world’s biggest corporations in these sectors may soon be in need of a government bailout. Indeed, some governments have already announced bailout plans.
In the midst of the pandemic, a price war between the Organization of the Petroleum Exporting Countries and its former allies has sent crude oil prices tumbling. The international benchmark Brent crude is currently trading below US$30 a barrel, at US$24.52 a barrel on March 18. West Texas Intermediate crude oil sank to US$20.06 – an 18-year low. The energy sector, already highly leveraged, market participants warn, are in for a rough ride ahead.
We are looking at how a health crisis has turned into an economic crisis, which may now snowball into a global financial crisis of proportions still unknown. A red flag that has been raised in recent days is that financial markets are now seeing nascent signs of a credit crunch as investors rush for cash or liquid assets — the yields on three-month US Treasury bills have fallen into negative territory while longer term 10-year US T-bills saw yields plunging to 0.3% a week ago but managed to claw back some ground to more than 1% last Wednesday after the US government announced a US$1.2 trillion fiscal stimulus package. (US T-bills are regarded as liquid safe haven assets.)
In fact, last Thursday, Malaysia’s bond market saw a major selloff by foreign investors in a flight to safety, and this is expected to continue in the days ahead. Bond dealers say the central bank intervention was detected, taking up the ringgit from the sellers and providing them with US dollars. To mitigate a credit crunch, Bank Negara Malaysia cut the statutory reserve requirement for banks to 2% from 3%, releasing some RM30 billion into the market. Principal dealers are also allowed to use MGS in lieu of cash.
Another indicator of rising funding cost and tighter liquidity is cross-currency basis swaps. Cross-currency swaps are among the most sensitive gauges of bank liquidity. For example, the premium on euro-US dollar swaps has widened to levels last seen in 2008. From the Australian dollar to the ringgit, it is more expensive to buy the greenback.
Market watchers say that going forward, if central banks run out of monetary policy bullets to flood the markets with cash, the liquidity crunch will be the trigger for the next financial crisis.
Compounding the concern is the fact that this is happening at a time when global corporate debt is at a record high, thanks to the availability of cheap money since the 2008 global financial crisis. According to the Institute of International Finance, corporate debts among non-banks ballooned to US$75 trillion as at the end of 2019 from US$48 trillion in 2009.
With the global economy heading for a recession, companies, especially those in the sectors most impacted by the pandemic and oil shock, may not be able to meet payments that are due. This raises the risk of defaults and, hence, rating downgrades. Market observers note that some 50% of corporate bonds are rated triple B, the low end of investment grade. Rating downgrades will trigger a sell-off in the bond markets as many institutional and pension funds invest in bonds that are investment grade. Such a selldown, if widespread, will deal another shock to global financial markets and pummel already deteriorating investor confidence.
Unlike the two crises in 1997 and 2008, this global pandemic has left no country unspared so far. In the 1997 crisis, the West was not as severely affected as Asia, the epicentre of the financial storm. Hence, affected countries were able to make a V-shape recovery. The Malaysian economy, for example, contracted 7.4% in 1998 but staged a strong recovery in 1999, posting a 6.1% GDP growth.
In 2008, the global economy bounced back up quickly, in part thanks largely to China and the hinge fiscal and monetary stimulus programme that boosted its economy and demand for imports.
We have seen how central banks and governments across the world have brought out their monetary and fiscal bazookas to mitigate the impact of the Covid-19 pandemic. In the weeks ahead, more measures are likely to be announced in the form of tax cuts and further increases in government spending.
But there are concerns that on the monetary policy front, major central banks may have run out of bullets with interest rates already close to zero. Quantitative easing and bond purchases are likely to step up pace to prevent a liquidity squeeze, but for how long?
On the home front, the Malaysian economy was already slowing as it entered 2020, posting a 3.6% growth in GDP — its slowest quarterly growth since 2009. Stock prices have fallen and are still slip sliding, with financial markets experiencing a huge outflow of funds as investors take flight to safety.
Bank Negara Malaysia has announced two rate cuts since January, slicing 50 basis points off the overnight policy rate to 2.5%. Expectations are for another rate cut sooner rather than later.
On the fiscal front, a RM20 billion stimulus, looking at how the situation has worsened, is not enough. It will be interesting to see what further measures will be undertaken by the new government, which faces a oil revenue setback in light of the sharp plunge in oil prices.
A recession looks inevitable in the first half of the year — it is a matter of how deep and for how long. For many of us, the best step forward is to plan for the worst, and hope for the best.
Anna Taing is managing editor at The Edge