Article by Governor Carlos da Silva Costa in the "Jornal Económico": A joint response to a common challenge is needed
The pandemic crisis we are now facing will have a profound impact on the world economy. Its duration and size are still surrounded by great uncertainty.
The effects on economic activity and employment depend on the extent and duration of the containment measures that are eventually considered necessary to avoid the collapse of health systems and minimise the loss of human lives associated with the pandemic outbreak. They also depend critically on the measures adopted by the authorities to safeguard the economic system over the course of the containment period, and the rationality of economic agents’ behaviour, based on the degree of confidence in a fast recovery over the subsequent period. In the absence of appropriate measures, the impact of this pandemic on GDP could be larger than that of the Great Financial Crisis.
Contrary to the circumstances leading up to the 2008 crisis, which started in the financial system, the situation we are now facing reflects the propagation of a health crisis into the real economy, with its effects amplified by the international financial system. The cause is not idiosyncratic, it is common to all economies, and it does not lie in economic policy imbalances.
This being an exogenous shock, and surely temporary, affecting all European economies, a joint response to this common challenge is called for. It is essential and urgent that the different players – central banks, regulators and supervisors, and especially European institutions and national governments – take decisive and joint action at national, European and global levels.
Firstly, the pandemic must be fought resolutely with an appropriate healthcare response. Secondly, and at the same time, action is required on demand and supply, so as to safeguard income and the productive potential for as long as the pandemic lasts, ensuring that jobs are still available when workers return from preventive isolation and recovery from this shock begins.
Given that it is a common challenge, at budgetary level, funding the necessary effort for the healthcare response and policies to support the economy in every Member State should therefore benefit from innovative and exceptional measures, such as the issuance of so-called Eurobonds. This situation is clearly cut out for EU funding, insofar as there is a common interest and no moral risk.
As is evident, monetary policy is already proactively in the field, and a set of unprecedented measures has been adopted to ensure financial sector liquidity. An example is the decision of the Governing Council of the ECB to create a bold Pandemic Emergency Purchase Programme in terms of size, flexibility, duration and commitment to supporting families, firms, banks and governments in the euro area. However, despite being a necessary condition, it is not sufficient.
The financial system now plays a critical role, preventing temporary cash flow difficulties for firms and families from becoming insolvencies. Making use of available liquidity, the financial system is responsible for ensuring that funding to the real economy continues, at a time when – as a result of an abrupt and very sharp drop in revenue – firms across the board will face serious cash flow constraints. Firms will struggle to pay wages, taxes, contributions and suppliers, and service their debt. These cash flow difficulties can seriously compromise recovery unless addressed by medium-term funding that guarantees repayments can be extended over time and safeguards the working capital needed for business continuity.
Under these circumstances, it is absolutely essential that the financial system, in particular banks, maintain active credit lines, continue to approve new loans and are willing to accept interest payment and principal repayment moratoria and extend the maturities of credit granted. For this to be possible, it is important to minimise capital consumption and mitigate credit risk. This requires public credit guarantee mechanisms, namely through recourse to national promotional banks or public budget guarantees, by using the flexibility that the European Commission promptly introduced into State aid rules and fiscal rules.
In fact, to continue to grant credit in a context of an exponential increase in risk and uncertainty, banks need not only to be assured (by central banks) that they will not be short on liquidity, but also that they will not be penalised in their capital and that the risk taken is within their capabilities. In other words, in the absence of public guarantees, ongoing funding of the economy can be jeopardised both by the increase in risk and the increase in capital consumption resulting from default.
We are now facing a transition period, where we must be strong enough to cross this torrential river and resume our normal course, that is recover our pre-crisis production potential.
Banco de Portugal is monitoring developments in cooperation with the competent authorities. This public health situation, which may turn into an economic and financial crisis, requires unity and joint action from all those responsible at national and international level. It is thus essential that each player assumes their role in a decisive and coordinated manner, with the common goal of reducing uncertainty, conveying confidence and moderating the impacts of the pandemic on firms and the workforce.