COVID-19 - impact on the global economy and increase in debt defaults

Global coronavirus lockdowns and ever-deteriorating situations

At the date of publishing, more than 750,000 confirmed coronavirus cases and over 36,000 deaths around the world, 12,000 of which are in Italy alone, are reported. For time being, there is no sign of the rate of infection slowing down.

Most nations have been or are in the process of implementing border controls, travel restrictions and/or lockdown measures to help reduce the mass spread of the contagion.

• In Asia, Hubei province in China (where Wuhan is situated) has close to 68,000 cases of infection and Mainland China as a whole, approximately 81,000 cases. Hubei province was in a state of lock down since January, only lifting restrictions on outgoing travelers on March 25, provided they had a health clearance code.

  Recently, due to the increasing number of imported cases in China, major Chinese cities and provinces such as Beijing, Shanghai and Guangdong provinces tightened their quarantine rules, and individuals arriving from overseas are subject to centralised quarantine and health checks. The Hong Kong government has recently implemented strict restrictions on public gatherings.

• Other Asian countries such as Japan, South Korea and Thailand with high infection rates are also implementing travel restrictions or quarantines.

• In Europe, Italy, Spain, Germany, and the U.K have been all severely affected by COVID-19. Individual countries such as Belgium, Italy, France, Greece and Spain have imposed national lockdowns.

• In the United States, the number of cases on the date of publishing is in excess of 140,000, surpassing those in China, and foreign nationals who have traveled to European Schengen areas, UK, Ireland, China and Iran in the past 14 days are barred from entering the United States.

Impact on economies by the global spread of COVID-19

Global recession?

No doubt the global economy and major economies such as those of U.S., China, Japan, Germany and other large economies are severely impacted by COVID-19. As of now, it’s difficult to anticipate how long it will take for them to bounce back. Economists are warning that a global recession is no longer a looming threat.

S&P said that the coronavirus outbreak has plunged the world's economy into a global recession. Goldman Sachs downgraded its outlook for GDP in the U.S., citing a cutback in spending, supply chain disruptions and the impact of local quarantines. Goldman Sachs has estimated that the U.S. economy would shrink 5% between April and June, and the chance of a global economic recovery in the second half of the year was slim. S&P is less optimistic and has anticipated GDP in the U.S. to fall by 6% in the second quarter.

National Governments are responding with measures to prevent a repeat of the 2008/09 financial crisis. The U.S. Federal Reserve announced on 15 March it will lower the target range for federal funds rate to 0 to 1/4 per cent. Other countries such as Korea and Hong Kong also announced similar interest rate lowering policies. On 27 March the U.S. enacted a US$2 trillion stimulus package to provide economic relief to workers and businesses squeezed by restrictions meant to stop the outbreak.

China’s economy

China’s manufacturing, supply chain, airline, tourism retail and other consumer industries inevitably suffered in the first quarter of this year. According to the National Bureau of Statistics of China, retail sales plunged by 20.5% during January and February compared to 2019, industrial outputs were down by 13.5%, and fixed asset investments fell by nearly 25%.

Larry Hu, chief China economist for Macquarie Group, estimated that China's economy would shrink by 6% in the first quarter. The unemployment rate has shot higher, up to 6.3% in February from 5.2% in December last year. S&P revised China’s economic growth to 2.9% this year, well below its previous projection of 4.8% growth.

The Chinese government has also acted quickly to stabilise the economy. The People's Bank of China injected 100 billion Renminbi into its banking system by offering low-cost loans to banks to encourage additional lending to businesses and individuals. It was also announced that they would further reduce cash reserve requirements. These moves are estimated to inject 550 billion Renminbi into its banking system.

Expected increase in debt defaults

In the last weeks stock markets have plunged amid panic selling by innumerable investors, and as investors anticipate volatile stock markets they are willing to take a more risk-averse approach. Many analysts have predicted that corporates will face difficulties in refinancing.

Mohamed El-Erian, chief economic adviser at Allianz SE, shared that companies with vulnerable balance sheets - meaning little cash and high maturing debt - are going to have difficulty refunding themselves and there is going to be an increase in credit defaults. Lotfi Karoui, chief credit strategist at Goldman Sachs told clients that default and downgrade risks have increased to their highest levels since the start of the current business cycle.

There seems to be increasing concern as to the ability of companies that rely on tourism or similar businesses such as airlines, hotels and cruise lines to generate income, as growing restrictions on movements and lockdowns are witnessed and more people are staying or forced to stay home.

Furthermore according to Matthew Mish, a UBS credit strategist, a slowdown in consumer and business spending could be particularly damaging for broadly syndicated loans and private credit, and if ratings agencies downgrade BBB-rated bonds to junk, many investors would seek to sell or be forced to sell them, putting even more pressure on markets.

It’s anticipated that almost US$840 billion of bonds rated triple B or below in the U.S. are set to come due this year and roughly US$270 of U.S. bonds now trade below 90 cents on the dollar. Many companies have already been known to be locked out of refinancing or selling new debt.

Debt defaults in China

China’s debt market is in the size of more than approximately US$14.3 trillion. Bloomberg sees a maturity wall with RMB1.3 trillion onshore bonds coming due in 2020. As a result of COVID-19, China’s onshore bond defaults are expected to further accelerate, although it was expected by many that default rates would rise in 2020 even before the outbreak occurred.

China’s weakest property developers risk defaulting on their US dollar bonds, as home sales suffer and access to cash dries up. Also, S&P anticipated that the local government financing vehicles would face severe repayment pressure on their RMB2 trillion debts that are in effective maturities in 2020.

In addition, bond failures may spread geographically. In recent months, Shandong province, having high concentration of private-sector borrowers who guaranteed each other’s debts, may see a chain of defaults when one goes into trouble. Liaoning province is showing a raft of defaults due to concentration of aging smokestack industries.

For the loan markets in China, S&P estimated earlier that its non-performing loan ratio could jump above 6 per cent if the public health crisis was drawn out.

To fight against the default problems, the Chinese government urged banks not to terminate or call back loans given to virus-hit companies and encouraged instead lending to small companies.

Despite the government’s efforts to curb and control the rising debt defaults, the existing and continuing impact of COVID-19 on China’s economy may potentially cause a historic-record of debt defaults in China. We anticipate the climate will further deteriorate as other major economies which are heavily reliant on exports from China face similar issues and increased debt defaults themselves.

See our Coronavirus (COVID-19) feature for more information generally on the possible legal implications of COVID-19.