Macroeconomic Policies in time of COVID-19

First post

By: Juan M. Gutierrez

The COVID-19 pandemic has generated an unprecedented economic crisis. The leading global economies are in a sharp recession, and this will inevitably impact Latin America. In fact, since the financial crisis of 2008, we did not see a combination of factors that are so harmful to the region, ranging from trade contractions caused by the closure of factories in Asia to the collapse of the price of raw materials - especially energy - and the drought of external financing.

An example of the seriousness of the situation is that since the beginning of January, the block of emerging countries has accumulated capital outflows of approximately USD 85,000 million, much higher than those observed during the 2008 crisis and other episodes of financial volatility in the last decade.

It is essential to understand that the necessary measures of social distancing or quarantines that are adopted have a high economic cost. The paralysis of activity, particularly in the sectors that generate the most jobs - services, construction, commerce and tourism - significantly reduces the income of households and companies and drastically limits consumption and investment.

Faced with this, the governments of the region are considering immediate attention measures to the emergency in the monetary, exchange, financial and fiscal fields. On the one hand, central banks implement monetary policies to prevent companies from running out of liquidity and to enable them to pay their employees, avoid mass layoffs and maintain payments to suppliers. At a technical level, these measures focus on reducing interest rates and increasing liquidity in national currency through extraordinary facilities.

Exchange rate measures include direct interventions in the currency markets to reduce volatility and accelerated depreciation of the exchange rate (for example, in Brazil), or the use of financial instruments to reduce uncertainty about the price of the currency. For example, the Bank of the Republic of Colombia announced an auction of foreign exchange forwards for USD 1 billion to give stability to the market.

On the financial side, interest and principal payments on companies' debts also restructured. Public and development banks are also contributing their resources to support companies. For example, measures have been announced such as the refinancing of the credit lines offered by BIESS in Ecuador, the increase in funds to Siga for loans to SMEs in Uruguay, or the liquidity credit line for companies in the tourism and aviation sector of Bancoldex in Colombia.

These measures complemented with fiscal contributions, the scope of which may be higher and more expeditious. In the case of a health emergency, it is imperative, first of all, to strengthen the capacities of the health sector to protect the population.

It is also seeking to support the productive sectors and segments of the population most affected by the crisis, safeguarding its operability and consumption capacity. On the business side, for example, payments of corporate taxes, payroll and VAT are being deferred and, in parallel, transfer systems have expanded for the vulnerable population, such as unemployment insurance and pensions.

Taking into account the high levels of labour and business informality in Latin America, it is necessary to extend support and reach the lowest income segments of the population and the most vulnerable productive sectors, such as micro-SMEs, through mechanisms such as direct transfers. It will also be necessary to include independent workers and class professionals who provide personal services, without unemployment insurance, with little ability to save and who do not receive social transfers from the most vulnerable groups.

The authorities face enormous challenges to achieve the expected objectives. In the first place, there are few countries in the region with space to advance fiscal stimuli that respond to the magnitude of this crisis. Many of the countries go through budget consolidation processes to restore or guarantee the sustainability of their debt, a fact that reduces their room for manoeuvre. In this sense, many of the measures represent advances of expenses or reallocations of budget items, rather than additional stimuli.

Second, the cessation of domestic activity will imply a substantial deterioration in tax revenues, something that will further reduce the space to apply necessary measures such as reducing taxes or expanding spending. Third, the financial panic in international markets will limit the possibilities of indebtedness, and this will restrict the margin of action, especially in countries with poorly developed domestic financial markets and that resort mainly to financing and external.

In this scenario, in the short term, the action of multilateral organizations will be meaningful. IMF, World Bank and at the regional level, the IDB and CAF have offered new loans to face the coronavirus as well as readjust existing credits to face the emergency. In the case of CAF, an emergency credit line of USD 2.5 billion has launched for the countries of the region.

In summary, high uncertainty prevails regarding the effect that this crisis will have on the economies of the region and their resilience. However, decisive and timely action must take to prevent these disruptions from causing much more permanent damage to the economy.

Monetary measures.

The US Federal Reserve (Fed) is leading the monetary policy reaction to the threat of the coronavirus. The Fed, following in the wake of Australia. After the reduction, not less - half a point -, the reference rate is in a range of between 1% and 1.25%. The $2 trillion stimulus package agreed by Congress represents around 10$ 6 trillion in liquidity for consumers and businesses over the next nine months. The stimulus package approved by Congress made up of the following key elements: permanent tax transfers to homes and businesses of nearly $5 trillion. People will receive a cash payment of$ 1,200 ($300 billion in total). Small business loans, which turn into grants if jobs are kept ($ 367 billion). Increased unemployment insurance payments that now cover 100% of wages lost over four months ($200 billion).$ 100 billion for the health system, as well as $150 billion for state and local governments. The rest of the package comes from temporary liquidity support to households and businesses, including tax delays and exemptions. Finally, draw on of the Treasury Exchange Stabilization Fund for loans of$ 500 billion for non-financial companies. With a global crisis on the horizon, global demand for bonds from emerging countries in local currency is likely to collapse, well below their financial needs. Dependence on the US dollar will increase. Why? When hundreds of countries try to copy the printing and reduction rates of the Federal Reserve without having the legal, investment and financial security of the United States, ignoring the real demand for their national currency. A country cannot expect to have a global reserve currency and maintain capital controls and investment security gaps at the same time. ECB is likely to understand this shortly when the considerable trade surplus supporting the euro collapses in the face of a crisis. The FED when analyzing the global demand for US dollars and knowing that its money supply must increase much less than its total money demand is essential. In reality, the Fed's QE is not unlimited. Limited by the real demand for US currency, something that other central banks ignore or prefer to forget. Should be a lesson for all countries. If they fall into the trap of playing with the reserve currency and endless printing without understanding demand, the dependence on the US dollar will intensify. Furthermore, there is a legitimate concern that easy monetary policies applied by the developed world could channel much of the money to the financial sector rather than to the real economy, and a significant portion of that money could eventually end up in higher-yielding emerging markets.

The importance of fiscal spending Massive fiscal spending is needed to combat the economic downturn caused by the virus outbreak. Enact sizeable fiscal stimulus measures to recover the real economy. They could undertake a wide range of tax measures. These may include direct income support through cash brochures, food aid and unemployment assistance; wage subsidies; guarantees to cover the health costs related to the virus; expansion of social safety nets; increased spending on social assistance; cheaper loans and loan guarantees to small and medium businesses; public procurement of goods and services; and short-term tax relief. Several countries affected by the endemic have announced or carried out some of these fiscal measures mentioned above. Hong Kong, for example, offered a cash payment of HK $ 10,000 to its permanent residents over the age of 18. It is equally vital that fiscal measures should direct at those individuals, households, and businesses that are experiencing economic hardship due to the coronavirus outbreak. Since poor and low-income households can suffer disproportionately from the virus outbreak, special measures must take to provide them with economic security.