Prolonged lockdowns may disproportionately increase risks, S&P says

A drawn-out pandemic-driven crisis might reignite asset price swings and funding pressures

A woman in face mask crosses a street in East London. The British government has extended the lockdown restrictions. Getty Images

A prolonged economic shutdown to contain the coronavirus or a return to lockdown in economies already opening up could result in a disproportionate hit to the economic and credit risks and could affect the survival of a large number of companies, according to S&P Global Ratings.

A drawn-out crisis might also reignite asset price swings and funding pressures, particularly for more vulnerable speculative-grade debt issuers already facing constrained access to finance, S&P said in a report released on Sunday. Changes in consumer habits affecting demand in certain industries, potential acceleration in “secular trends” and disruption to global supply chains could also shape the landscape of industry performance heading into next year.

“In addition to the uncertainty on the timing of recovery, until a vaccine is found, the level and path of economic growth in a post-coronavirus world is subject to lots of uncertainties,” S&P global head of research, Alexandra Dimitrijevic, said. “The potential damage to the fabric of the economy relating to employment, capital, and productivity will be a key determinant.”

The lockdowns have pushed the global economy into the deepest recession since the Great Depression, and is set to shrink 3 per cent in 2020, according to the International Monetary Fund. The bleak forecast from the Washington-based lender is more than a 6 percentage point revision, relative to its October 2019 estimates and updated January 2020 projections of a 3.3 per cent expansion in global gross domestic product.

The outlook, according to the IMF, is worse than the 2008 financial crisis and the lender does not expect recovery to take place before 2021.

S&P has a slightly more optimistic view about the global economy with a 2.3 per cent contraction forecast this year, a sharp downward revision from its 0.4 per cent economic expansion projection in March.

Governments and central banks across the globe have poured more than $8 trillion (Dh29.4tn) into the global economy to ensure financial stability, protect the corporate sector and support smaller businesses. However, the number of job losses is on the rise as the lockdowns remain in effect in large parts of Asia, Europe and North America. Some countries in Europe, the Middle East and Asia have now started easing restrictions, partially opening up their economies.

The pandemic has infected 2.89 million people globally and fatalities have topped 203,000 as of Sunday. More than 822,000 people have recovered, according to Johns Hopkins University, which is tracking the spread of the disease.

“Except for China, which suffered most in the first quarter, many major economies would be hit worst in April-June,” Ms Dimitrijevic said. “We anticipate the recovery through the second half of the year to be slow before gathering strength into 2021. However, the resulting 5.8 per cent global growth rate we see in 2021, driven by a rebound of demand, would be insufficient to recover lost output.”

Unlike the global financial crisis, the corporate sector is getting hit first this time, with certain industries choked by interruption of their activities. The sudden stop has forced corporates to increase debt levels to survive, rather than focus on deleveraging that would be more typical in a normal cyclical downturn.

The services sector, rather than manufacturing, has taken a harder hit by social-distancing measures, as reflected in purchasing managers indexes. The historic collapse in oil prices has also amplified the effect on some corporates. The banking sector, securitisations, and some sovereigns are also not immune to these negative developments.

“As we entered the crisis with a record level of credits rated ‘B’ and below, this will likely push the speculative-grade default rate above 10 per cent,” S&P noted.

Although economic forecasts continue to worsen, financing conditions have been gradually improving, particularly after the US Federal Reserve’s historic liquidity facilities, introduced on March 23, and expanded on April 9. The lifting of some social-distancing measures in China, alongside central bank support, appears to be improving lending trends there, pushing March corporate bond issuance to an all-time monthly high.

“Still, we see more-restrictive lending conditions amid the material contraction in economic activity from global containment measures,” S&P said. “Thus far, borrowers with stronger credit quality have been able to largely resume issuing debt, while funding costs remain prohibitively high for weaker borrowers in an environment of collapsing revenues.”

After a decade of tighter regulations around the world, banks have entered this crisis with much stronger balance sheets than they had at the onset of the global financial crisis. Capital and liquidity levels will provide material buffers for large banks in advanced economies to cushion the blow from this downturn.

However, once the dust settles and economies bounce back, the earnings recovery for banks is unlikely to be as sharp as the GDP rebound, according to S&P.