The impact of the health crisis by COVID-19 on the Spanish financial and economic system
Introduction
Federico Steinberg, Professor of the Department of Economic Analysis of the Autonomous University of Madrid and principal researcher of the Royal Institute Elcano, reference in one of his latest articles for this prestigious Spanish tank the explanation of Nicholas Taleb of what are the black swans:
Very difficult events to anticipate and that has such a high impact that, when they happen, they force us to question any previous prediction exercise. Thus, the fall of the Berlin wall and the Soviet block in 1989, the 11-S attacks in 2001, the financial crisis of 2008 and the impact of the COVID-19 we face, would fall into this category .
For this last example of Black Swan, the worldwide pandemic generated by the Sras-COV-2 virus (commonly known as Coronavirus), will need extraordinary containment measures, not only in the health field, but also that they must extend globallyto the scope of security, social or labor, not forgetting those that try to alleviate the economic impact, which will come to impact as a tsunami, irremediably after the first months of the measures of social isolation.
The effectiveness of these containment measures, the management of social fear and the effects of the fiscal and monetary measures that are adopted, will determine the final economic effect in each country. In order for the impact on markets and the economy to be transitory, it will be necessary to “avoid the risks that make this expectation of temporality to fail and the effects become permanent” . If the measures are successful, the recovery scenario will be in the form of a V, with a return to the rapid and moderately traumatic normality. Otherwise, the progress of the recovery will be in the form of a U, slow and with sequels that will generate very painful effects.
Although the COVID-19 crisis has often categorized together with the 2008 financial crisis, reality is being very different. The effects that this global health crisis is leaving is not only having an effect on the aggregate demand of the financial system, but it is also impacting on the aggregate offer, with the closure of factories, the production chain is significantly affected, notThere are trips, no tourism, schools close, etc .. . Instability and uncertainty, catalyzed by the informative crisis in which we are, has caused financial marketsaffect added demand ”3.
This work will try to transfer the knowledge acquired in the subject Financial System, within the “Spanish and World Economy and Financial System” of the second course of the Finance and Accounting degree of the University of Granada, applied to the practical case of the current crisiscaused by the global pandemic of the Coronavirus, with the aim of identifying the unconventional measures of the Spanish economic system that allow to alleviate the consequences of the financial crisis caused by this pandemic.
Study
As mentioned in the introduction, the impact of this crisis on the financial system differs from the previous economic crisis of 2008, by causing a shock of both supply and demand, in the face of which we must fight with different policies.
On the one hand, supply and supply problems are being produced following the closures of the factories, starting with China, where the epidemic originated, but little by little the same shortage effect has been extended by the rest of the world. Both cases, the health crisis and the financial economic, are effects of globalization, where the origin of the problem is sure to lie, but also part of the solution. The Asian giant is the origin of 12% of world exports and the braking that it has suffered in its production has had a huge drag effect on the rest of the countries.
On the other hand, there has been a great drop in demand, caused by uncertainty. The demand shock depends greatly on the information campaigns made, "because they influence the degree of concern of citizens and, through it, in the abruptness of the fall in demand" . To avoid irrational fear, it is important to avoid giving alarm signs. "A global knowledge, which covers the entire data spectrum associated with the pandemic, from the virus biology itself to the socio -health structure," including health statistics and scientific research information, will be decisive as a strategic tool for public powers for the public powers. The use of data to control sovereignty is being debated . In addition, panic has also been reflected in financial markets, re -influence consumers, and, in the medium term, income decreases, affecting demand again3. If measures are not taken that increase confidence, consumers will continue to generate “waterfall sales, flight to safe assets such as gold or US debt, appreciation of the dollar and fall in the price of oil and other raw materials”
Alicia García Herrero, in her latest publication for the Roy.
The first, mitigation, focuses on braking – but not necessarily stopping – the propagation of the epidemic with the aim of reducing the maximum demand for medical care and, at the same time, protecting the most exposed people. The second, the suppression, aims to reverse the growth of the epidemic, but with the risk of a rebound in the number of cases every time the suppression measures are raised.
In Spain, government decisions are deriving towards the second scenario. This strategy aims to control the epidemic faster, through rigorous isolation measures. In this way, it is intended to lower the infection curve that had caused the saturation of the health system, and thus allow, also in a short time, a return to the normality conditions that allow the economy to recover before.
However, under these planning conditions, the situation is more prone to present a collapse both in supply and demand, since social confinement measures are much greater and most of the population will not be able to work.
Looking at China as an example of pandemic suppression, supply shock can be even greater than demand. In this case, we would face a stagflation, where unemployment and inflation increase simultaneously.
It can be deduced that before a global impact of this caliber and being completely interconnected countries, international cooperation is necessary to increase the effectiveyour neighbor », like competitive devaluations”. It seems that it is easy to conclude that a government or a central bank will not be able to control this crisis with global characteristics alone.
The EU should take care of the unlimited financing of banks and sovereign, centralize health spending to take advantageECB support) to avoid a potential GDP drop and, if there is consensus, establish an unemployment reinsure at European level to relieve national public accounts
The national measures will have to synchronize with the European ones, seeking to relieve unemployment as much as possible and keep workers and companies afloat (especially the most vulnerable: autonomous and small and medium enterprises).
What is, then, the first objective in this situation? Different sources point out that the main thing is to maintain financial stability while the impact of virus2 takes place. This will allow the system to function sufficient fluency until we can recover.
Financial stability is threatened due to applied containment measures (quarantines, mobility restrictions and closure or cancellation of public agglomerations and events) 1, which are preventing the development of economic activity and causing a destruction of employment. Looking more specifically towards financial entities, "the disruption of activity is intensifying credit, market and operational risks" . This means an impact on balances. And, in situations like this, the increase in defaults and delinquency are the order of the day. This creates pressure on the results accounts of Spanish banks. In its latest Spring Financial Stability Report 2020, the Bank of Spain points out that:
The emergence of the Covid-19 Pandemia and the necessary containment measures implemented have adversely affected the expectations of the banking sector, since they can expect them to have a negative impact on delinquency, additionally pressing the profitability to the decline. In this sense, it should be considered that the results accounts are less comfortable than at the beginning of the century, and that delinquency is higher than that existed before the global financial crisis.
Similarly, the Bank of Spain also adds in relation to defaults by families, which:
In families with loans from credit entities, the results indicate that indebted homes, given financial difficulties, are first delayed in the payment of credit for consumption, about a year later they stop paying supplies and, if that situation persists aMore year, they stop satisfying their mortgage obligations.
There will also be an added pressure on the profitability of the banks due to the drop in income8. Later we will see that for financial stability to remain, the ECB will seek to solve the risk of liquidity and “an equally relevant risk about the value of the assets that also derives in solvency problems”
Measures
After a staging of the main impacts that the COVID-19 crisis has had in our financial system, we proceed to explain the measures that have been implemented seeking to solve them.
Referring to topic 2 of this subject, I will use as a reference and explanatory guide the slides of unconventional measures for financial crisis.
Reduction of interest rates
The reason why interest rate is reduced during a financial crisis is to induce citizens to consume more. Although a drop in interest rates could be a way to try to convey confidence to investors, it would not be enough to eclipse the uncertainty of how this pandemic will evolve. In addition, interest rates were already in case at very low levels. The drop in interest rates, so that it meets its objective of rejuvenating the economy, must be accompanied by other factors that allow production and sale conditions to be optimal and, in this way, that consumers acquire products and services.
Observing the decreases of the exchange rate by the Bank of England and the US Federal Reserve in March we see that this is confirmed. As Gonzalo de Cadenas Santiago explains in his article for El Confidencial, published in March 2020, the decline of these types:
They could open a currency war if they are perceived by others as measures to depreciate the exchange rate. Surely, a coordinated response would have been better by the main central banks of the world (ECB, Fed, Chinese Central Bank, Bank of Japan and Bank of England). The joint action would have sent a much more powerful signal on the disposition of the political authorities to act in a resolution, avoiding competitive depreciation and contributing to avoid a global deflation situation generated by the collapse of the demand, which would be very dangerous given the highDebt levels.
Expansion of assets in guarantee and purchase of private and public debt
In its March 12 statement, the president of the European Central Bank, Christine Lagarde, announced a package of monetary policy measures, seeking to support the liquidity and conditions of financing households, companies and credit entities.
On March 28, the ECB launched a “Assets Purchase Program (the Emergency Purchases Program for Pandemics; or PEPP)”, committing to buy an equivalent to 750.000 million euros in euro zone assets.
The purchase of assets is an unconventional measure taken by the European Central Bank to face too extensive deflation periods:
When the ECB buys private sector assets, such as asset titration bonds or guaranteed bonds, which are linked to loans that banks grant to companies and households in the real economy, the increase in demand for those assetsmakes their prices up. This encourages banks to grant more loans, which can be used to create or sell more assets or guaranteed bonds. The increase in loan supply tends to reduce the interest rates that entities apply to companies and households, which improves general financial conditions
Subsequently, on April 7, the Governing Council of the ECB made a series of decisions for “the relaxation of the requirements applicable to the guarantee assets, to help the counterparty entities of the Eurosystem to maintain and mobilize sufficient guarantee assets to participate to participateIn the supply operations of the Eurosystem " . The same council recognizes the danger that this availability of guarantee assets can assume, and asks the Eurosystem to increase their risk tolerance temporarily, “to help counterpart entities to obtain liquidity and thus also support credit to the economy of the economy of the economy of theeuro zone, even by reducing valuation cuts applicable to certain guarantee assets ”.
On May 15, the Governing Council approved modifications to additional temporary loans of six National Central Banks (BCN), at the request of the respective BCN. The proposed extensions refer mainly to the acceptance of a new additional loan frame
Offer liquidity
In a situation of uncertainty, the demand for money triggers because the initial reaction of economic agents is to monopolize effect: citizens do it to buy supplies and protect themselves to the possibility that they must receive income and companies to cover doubtful chargesthat they will emerge. In addition, the braking of economic growth causes banks to restrict credit granting. These circumstances make an increase in demand for money and a fall in its supply, so the monetary circulation is reduced and there is a disappearance of liquidity in the system.
This is why, without "extraordinary liquidity lines by the central banks," it would be impossible to soften the impact of the double shock of the demand and supply we were talking about previously and achieve financial stability.
The practice of Carry Trade (receiving ECB liquidity and buying public debt) will be intensified during the following exercises. To put into practice it is necessary that two things happen: that the states issue more debt to finance public deficits and that the income of financial entities has fallen.
Likewise, there is also a growing shortage of dollars outside the US. UU., Therefore, the swaps between the Fed and the main central banks in a more expanded and extensive way than we have seen so far will have to be implemented so far.
Financial aid to EMA countries, Mede
In recent months, an agreement has been reached by the Eurogroup on the characteristics of the European Rescue Fund (Mede). The established conditions are almost null and the very beneficial advantages, since each country can request 2% of its GDP for direct and indirect expenses related to the COVID-19 crisis, being able to return a type of type of 10 years to a type of type of 10 yearssymbolic interest of 0.115%. Another remarkable fact is that, unlike other situations in the past, there will be no structural conditions or austerity plans added to the granting of credit by Mede .
The European Union has implemented this measure with others in a package that has called a triple security network, which will mobilize around 540.000 million euros. Of these, supplies to governments through Mede will be 240.000 million. Other measures in this package are the credits made to companies through the European Investment Bank (BEI), which will be of another 200.000, and the remaining 100.000 million will pay subsidies to ERTE (and the like in other countries) by the European Commission.
Ltros and tltros
Another way in which the ECB has focused to provide liquidity is through the financing programs in favorable conditions for banking, the LTROS. . “At the current auctions of long -term refinancing (Ltro) a new one is going to be added to a type of less than -1%. That is, a bank can go to the auction and take 500 million to grant financing to companies and families, and to buy a 10 -year Spanish bonus with a 0.7%profitability ”18. In addition, there will be temporary changes (which will last a year) in all TLTRO III operations in force since June 2020, seeking to support above all the bank credit of SMEs13. The rate applied to loans will be “25 times lower than the main refinancing rate, and 25 times lower than the deposit rate (previously equal to the deposit rate) if the banks meet their reference point for loans”
conclusion
The great obstacle that the health crisis of COVID-19 has been to be seen as a scenario of renewal and learning opportunities. In the few months we have been pandemic, the need for multilateral and coordinated action has highlighted, where the effectiveness of the different financial, national and international institutions has come to light.
It remains to be seen what the outcome of the decisions already made will be and what will be the next steps to follow to continue the search for financial stability that does not leave our country to permanent sequelae.
With this essay I wanted to capture part of the theory studied in the subject of financial system to a specific and current case, so that the concepts studied are materialized in a more precise way.
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