Coronavirus outbreak feeds uncertainty about the economic outlook

The abrupt rise in uncertainty that surrounds the global spread of the coronavirus can put both economic growth and financial stability at risk, according to IMF.

However, targeted economic policies and fiscal measures coupled with the right monetary and financial stability policies could help the global economy.

Now, stock markets in major economies, such as the US, the Euro area, and Japan, fell sharply and witnessed a surge in implied volatility. This resulted in credit spreads across markets, as investors are reallocating from relatively risky to safer assets. High-yield and emerging-market bonds are hit particularly hard by these reallocations. Furthermore, a tightening in financial conditions caused companies to experience higher funding costs when they tap equity and bond markets.

The sharp decline in interest rates, combined with growing anxiety about the economic outlook, have also raised investor concerns about the health of banks. Banks’ share prices have fallen sharply, and bond prices of banks have also come under some pressure.

Still, banks are generally more resilient than before the 2008 financial crisis, because they have greater capital and liquidity cushions. This means the risks to financial stability stemming from the banking sector are much lower, despite declining share prices.

Nevertheless, supervisory authorities need to monitor developments at banks very closely. Given the temporary nature of the virus outbreak, banks could consider a temporary restructuring of loan terms for the most-affected borrowers. Supervisors should work closely with banks to ensure that such actions are both transparent and temporary.

In case economic and financial conditions continue to deteriorate, policymakers might use the broader toolkit that was developed during the financial crisis. For example, the Bank of England and UK Treasury introduced the Funding for Lending Scheme after the 2008 crises, where a funding subsidy was provided to incentivise the expansion of lending to households, small and mid-sized enterprises and non-financial corporates. Also, the Federal Reserve launched the Term Asset-Backed Securities Loan Facility in 2009, which provided targeted funding. Other authorities, too, have deployed variants of such lending schemes that aim at lowering the costs of borrowing in certain sectors.

The sharp tightening in financial conditions, along with expectations of low inflation, means that monetary policy has a role to play at the current juncture. Central banks can act quickly to help ease the tightening of financial conditions by injecting liquidity and cutting interest rates, thus preventing a possible credit crunch.

Synchronised actions across countries increase the power of monetary policy. Therefore, global cooperation to synchronise monetary policy must be high on the agenda. Ample liquidity within countries, and across borders, is the prerequisite to the successful reversal of the rapid tightening in financial conditions, IMF adds.