Mark Carney, the outgoing Governor of the Bank of England has described the implications of the coronavirus as ‘disruption, not destruction’ but the unfortunate demise of the beleaguered Flybe budget airline last night highlights the very real risk to business of disruption in demand.
In this piece, Independent Economic Consultant to FPC, Peter Stanyer comments on the economic implications for business and investors as the virus takes hold.
Peter comments …
In the last few days, governments, including the UK’s, have started to talk publicly of the need to prepare for the coronavirus spreading widely throughout their populations. This new virus, which is sometimes compared to seasonal flu, seems more dangerous and although most who fall sick recover quite quickly, the mortality risk is reckoned by most experts to be significantly higher than for seasonal flu. The elderly are particularly vulnerable.
Despite this, the detailed pattern remains uncertain and the incidence of the virus outside hospitals is unclear. The new virus has been traced to Wuhan in China late last year and after some mis-steps elicited a robust response from the Chinese authorities in their attempts to contain the virus. It now seems to be spreading to almost all corners of the globe. The medical authorities (in the UK and elsewhere) tell us that if the virus cannot be contained, measures should at least aim to slow its spread.
The economic cost of containment measures
The economic impact of those robust measures has been amplified as China is now in effect the ‘factory to the world’. The locking down of large cities and the compulsory extension of holidays after Chinese new year have disrupted manufacturing supply chains with significant impact around the world.
In the first instance, the reaction to the virus has represented a temporary, albeit substantial supply shock to the global economy, which will severely undermine this year’s global growth forecasts. This shock has led to an immediate widespread loss of income, as well as output which extends to spread across almost all sectors of the global economy. This includes tech companies unable to assemble their products, international airlines scaling back flight schedules as their customers cut travel, and tourism suffering from heavy last minute cancellations.
But less obvious corners of the global economy are also feeling the impact, from Australian universities suffering a large drop in fee income as travel restrictions have prevented Chinese students returning at the start of term; to UK wool producers hit by a collapse in demand from the Chinese clothing industry. There have even been reports of the supply of generic drugs from China being disrupted by production difficulties in China.
More generally, international trade has been having a dreadful start to 2020, which is reflected in the benchmark cost of shipping goods around the world halving in value in January, its worst month for eight years, before stabilising in February.
Each of these impacts by themselves might prove temporary. As China and other countries normalise after the virus; their economies should rebound and a more usual pattern of trade and travel should resume. In this scenario, most of the impact on the global economy would be transitory.
However, the loss of income caused by the disruption of demand and disruption to their employees could prove challenging for many indebted companies.
What can the banks do?
Many firms, already carrying heavy burdens of debt, do not have ‘rainy day’ facilities to draw upon to bridge a temporary drop in income or increase in costs. The final demise of Flybe in the UK provides a stark illustration of how the reaction to the new virus could prove the tipping point for some over-indebted firms. If the virus takes root in the UK and elsewhere, efforts by the health authorities to slow the spread of the virus will be important in limiting the disruption to the economy too.
To help them cope, the Bank of England and other central banks may have a role to play in relaxing guidelines for bank lending. Cuts in interest rates may help, but more important could be measures to directly encourage lending to firms suffering a temporary loss of income.
Longer term, it matters that many of these companies will already be heavily in debt. Some central banks, and especially the European Central Bank, may yet regret that they did not take advantage of better economic conditions to raise interest rates, to give them more flexibility to respond now to any adverse shock to their economies.
Meanwhile, in the words of Mark Carney, the outgoing Governor of the Bank of England, the most likely economic impact of the coronavirus and measures to contain it, is ‘disruption rather than destruction’.
In financial markets, share prices have given back some of their recent gains, and stock market volatility and credit spreads have increased. It is for times like this that a margin of liquidity provides an essential element of insurance and reassurance to investors.
FPC clients should be well placed to weather this storm if they have followed the firm’s policy on segregating cash reserves. At a portfolio level, broad diversification and the avoidance of higher risk, high yield bond funds will also now be judged prudent rather than cautious.
Peter Stanyer, Independent economic consultant to Financial Planning Corporation LLP