The coronavirus eradicated decades of fiscal prudence and capital markets orthodoxy in a matter of days. In doing so, it has bound the financial industry to its sovereign governments and supranational entities more closely than ever before.
Perhaps nothing better exemplifies this new reality than the launch of the EU’s extraordinary new borrowing programme, due at the end of this month. More than €30 billion of new bonds will likely be issued before the end of 2020 – more than the EU has ever issued in any single year before. Next year, it will borrow more than twice that amount, possibly much more.
Rebuilding economies
As we discuss in this issue, the EU must now persuade the debt markets to absorb more than €750 billion over the next five years, as it seeks to rebuild economies shattered by Covid-19 lockdowns.
When the virus first took hold in Italy in March, the response was such that many thought it could eventually lead to the breakup of the EU. Just months later, the leaders of France and Germany stood together, calling for joint debt issuance on an unimaginable scale. This could be the turning point in the troubled march towards a more federalized Europe.
The motherland for any such federal union will always be Germany, whose fiscal response to the crisis leaves little doubt as to its view of the role of the state in today’s bewildering post-virus world. Its Economic Stabilization Fund was twice the size of France’s and, having already bailed out national airline Lufthansa, it is now set to roll out further corporate and Mittelstand rescues.
This is exactly the kind of state rescue that the EU has stridently sought to avoid and has historically punished member states for attempting.
Many countries are flirting with QE, something that does not have a happy track record in some geographies
Isn’t this kind of state intervention exactly the kind of thing that sovereign wealth funds were made for? They are designed as a stable, carefully invested buffer to lead countries through the hard times and so should now stand ready to pour reserves into national recoveries worldwide. Indeed, the Institute of International Finance has predicted that sovereign wealth funds in the Gulf will see assets decline by $296 billion over 2020, $80 billion of it in drawdowns.
However, as we explain in our focus on sovereign wealth, only two major funds – and just one oil fund – have so far been subject to state requests for drawdowns. Instead, even governments of countries with big wealth funds have been tapping the international bond markets. This in itself is indicative of the depth of liquidity now available in the capital markets as a direct consequence of state intervention – quantitative easing.
It has also emboldened the funds themselves to pursue ever more diverse investment strategies in areas such as private equity and tech disruption. Strikingly, it also lay behind the Saudi wealth fund’s decision to become one of the largest shareholders in cruise line operator Carnival, in perhaps the most badly disrupted industry of them all.
Quelling nerves
The degree of state involvement in the Covid-19 response worldwide has served not only to alleviate economic hardship but also to quell the nerves of panicked citizens everywhere. But the demands put on fiscal reserves are such that they could push trust in the system to breaking point.
China’s central bank has said that it considers 586 of the country’s 4,379 formal lending institutions, or more than 13% of the total, “high risk”. A third of those were rural cooperatives, widely seen as the bedrock of local communities.
If these institutions fail, it could lead to a widespread breakdown of faith in the credibility of the state as the ultimate backstop. The decision to let Inner Mongolia’s Baoshang Bank fail, which shocked many, shows that this is no longer a fanciful scenario.
Emerging markets will bear the brunt of the economic fallout from Covid-19. The OECD reckons that global foreign direct investment will fall by 30% in 2020, even under its most optimistic assumptions.
That makes the work of the Multilateral Investment Guarantee Agency, whose executive vice president Hiroshi Matano we profile in this issue, even more important.
It also means that many of these countries are now flirting with quantitative easing themselves, something that does not have a happy track record in some geographies.
