Thursday Dec 12, 2024
Thursday Dec 12, 2024
Friday, 10 April 2020 00:00 - - {{hitsCtrl.values.hits}}
By Usama Jiffry
COVID-19, the novel corona virus (“the virus”), has dictated an unprecedented change in the global environment causing countries, industries, companies, etc. to completely change its trajectories for the future. The virus will set in motion economic implications which will be of a monumental magnitude.
S&P global in its recent press release illustrated that the virus has “plunged the world’s economy into a global recession” (source: CNN Business). The IMF’s Managing Director Kristalina Georgieva described the pandemics as “humanities darkest hour” during her lifetime. Geogieva illustrated the impacts to the emerging markets and developing markets were the hardest hit with nearly $ 90 billion in investments flowing out of market and more than 90 countries have asked for emergency assistance from the IMF.
The economies will be facing risks from a range of directions including the supply side shocks; which will arise as a result of plant shutdowns, logistic constraints and changes in the demographics, shortages in supplies, etc., demand side shocks: where consumer preferences will change during and over a period of time as a result of the requirement for non-discretionary products, effects of consumer confidence and spending, etc., and financial shocks; business and consumer lending being affected, liquidity constraints, foreign exchange related impacts, etc.
The economic impacts of the virus will particularly be devastating to the smaller economies, such as Sri Lanka, which rely on the small and medium sized enterprises, foreign currency earning capacity and simultaneously having to address a vast national debt position.
Larger risks for smaller, developing economies
The impending global recession and the impacts of the virus on the domestic economy will have lasting effects. The dimensions, length of time and the intensity of the virus will only become clearer over a period of time, the uncertainty of which will also affect the economy.
The extent of integrations between economies in the modern business context is guaranteed to create a domino effect on the economies. Sri Lanka will be no exception, the reliance on the US, European and Chinese markets will be felt as these are key business partners for Sri Lanka. The slump in the respective markets will cause the demand for domestic exports to decline which in turn will affect the availability/continuity of jobs and the possibility of pay cuts affecting the disposable income of consumers.
Overall as the demand for exports curtail, consumer spending power declines and economic growth is suppressed the local economy will be at risk over a reasonable period of time. The tenure to normalise will be dictated by the country’s time taken to resolve, bounce back and return to normal levels. Further the new “normal” is will most likely to change given the dramatic changes in the global, regional and domestic markets.
Financial markets will experience change as individual/institutional portfolios are rebalanced to incorporate risk and altered circumstances
As a result of the demand side, supply side and financial shocks the economies will face the capital markets will also be a recipient of the impacts. The investment portfolios will be rebalanced to factor in the changes in global and domestic macroeconomic shifts, change in personal circumstances and the change in the objectives of the individuals and entities. Considering the potential recessionary circumstances consumer spending, consumer savings and investment, government spending, private sector credit growth, etc. will all be among the derivative areas affected.
The capital market will experience the effects of the pandemic in the form of participation being at extremely low levels. This will be due to the consumer patterns being more towards provisioning for the foreseeable future and to maintain their funds in more liquid sources. The change in personal circumstances could see funds being in relatively less risky more liquid investments which can see its effects on the capital market interest being curtailed to some extent.
Industry exposures: Mostly negative
Apparel
China being a key raw material destination, shutdowns and quarantines will have supply side shocks
US and Europe are key customer destinations for apparel, with a significantly curtailed consumer spending, which will cause demand side shocks
Tourism and leisure
One of the most affected industries due to envisaged recession resulting from the pandemic.
Restrictions on travelling, closure of airports, etc. have had substantial impacts to the travel and leisure industry.
Considering the nature of the virus the effects on the industry can be expected to be seen in the medium term as consumers take on a more conservative approach substituting leisure and travel with other forms of spending.
Financial sector
The banking segment is generally a low performer when economies are faced with a crisis.
The banking segment has particularly become an essential service to the communities at this critical juncture. Customers are demanding for liquidity to support their essential day to day supplies.
Costs have escalated for banks with having to establish secure remote working facilities for employees as well facilitate efficient online payments and transfers in addition to having mobile banking/ATM facilities, etc.
As a result of the liquidity requirements, safety and changing consumer patterns the bank will also be compelled to carry high levels of liquidity which will have a bearing on its performance.
Lower interest rates to stimulate/support the economy will affect the net interest margins of the banks.
Job cuts, pay cuts, corporate and business sector growth and losses, etc. will affect the credit quality and the non-performing loans aspect of the bank’s portfolios.
Lower spending through credit cards to will affect the fee income of the banks.
Requirement for higher liquidity, increased credit losses, higher provisioning, will have an impact on the capital adequacy and risk of the banks.
The scope of the impact will therefore extend to the interest, fee and commission income, higher expenses and losses, exposing the sector to a high risk.
Consumer durables
Consumer spending patterns have already shifted to almost entirely provisioning for the near term and the patterns in the medium term can be expected to be more of a cautious approach which can be expected to reduce the confidence and quantum of spending.
Global trade, freight forwarding and shipping
Recessionary threats, changing demographics in the consumer spending patterns, curtailed demand conditions, etc. will have an impact to global trade.
Therefore, will have a significant impact to the respective industries performance.
Construction
Government spending on infrastructure is a key driver for the Sri Lankan construction sector.
The Government spending will most definitely be directed at stimulating the economy and relief efforts.
This will affect the construction sector growth and profitability.
In the more recent past the condominium and apartments sector was a key focus for the construction industry. As a result of the change in the consumer spending demographics the demand conditions affecting the respective segment will also affect the construction sector performance.
Telecommunication
The silver lined industry in the gloomy situation!
Stay at home, work from home situations, home based entertainment, communication and social media interactions will create demand conditions which will be unparalleled to past requirements.
Provides substantial opportunity for growth, positive operational gearing and profitability potential.
Commodity market impacts
Oil prices: Oil prices have fallen by more than half during the month of March due to production cutbacks in the manufacturing sectors and the aggressive suspension of the aviation industry following post lockdowns of major economies. Brent crude fell to its lowest level since November 2002 and meanwhile the price of US West Texas Intermediate (WTI) fell below $20 a barrel and close to an 18-year low. Further, the price war between Saudi Arabia and Russia in early March led to an additional drop in demand where Saudi Arabia jacked up oil production in response to Russian refusals to agree on oil supply cuts. The current pandemic situation and its growing global momentum with growing lockdown measures could drive global demand reduce by 20% to 30% and prices may remain depressed for a longer period due to less demand for transport mainly caused by suspension of airlines and lack of vehicle movement amidst the lockdowns in addition to slow down in global manufacturing.
Commodity market outlook: The rapid transmission of the coronavirus pandemic has caused cutbacks and shut down of businesses and manufacturing plants due to rapid lockdown across US and Europe in addition to China. However China has indicated they have managed the pandemic and ready to open up the economy yet the uncertainty remains where other major economies are still under the crisis and may not open up their economies soon hence cannot expect smooth operation of outbound logistics. Reported events such as Chinese bulk rice buyers cancelling recent orders from Pakistan due to logistic issues and Malaysia deciding to replenish rice stocks to ensure sufficient supply during the outbreak has caused price volatilities in the bulk rice prices.
Global cotton price: Global cotton prices are also suffering from the temporary closure of factories due to aggressive social distancing and lockdowns. Further, due to US dollar appreciation amidst the crisis to seek safe haven by investors and further appreciation hinders export opportunities for cotton in US. Further, it is highly likely to result in a global economic slowdown in the long term due to the pandemic which may result in decrease in cotton demand in future. However, the current pressure on global oil prices may increase the competition of synthetic fiber as an alternative.
Global metal prices: Global metal prices are also under pressure due to slow down in global manufacturing and further an economic downturn or recession will hinder construction, consumer and manufacturing sectors, and impact the demand of metal prices in the longer term.
A long journey ahead
The way forward is not going to be an easy one, nor is it looking like a short journey either. The efforts of the Government: in its rapid response time, mobilising resources to contain the virus; healthcare sector: Medical personnel in committing themselves at a high risk to their own health; Forces: In taking prompt and continued action to control the movements of individuals, must be applauded as it is their collective efforts is what has kept the virus at controllable levels currently.
It must be reiterated that the coming period according to many analysts will be a critical one for Sri Lanka to contain and emerge out of this status. Therefore, following the directions of the authorities in relation to protecting one’s self and the communities/locality will be paramount in the coming weeks.
(The writer, CFA, is attached to Candor Research.)
