Pandemic makes credit dirt cheap

With Covid-19 excuse in place, countries boost record spending

Photo: EPA Mario Draghi

Do you remember anything about credit ratings? We mean the funny looking numbers and letters that used to make credit cheaper or expensive. Well, we should all forget about that era of financial discipline. With the coronavirus death toll surging to record highs, countries around the globe spurred spending, boosting debt numbers to record levels. No one really cares about ratings anymore.

The spending door is wide open and everybody is invited to join in. The world is too busy reporting the number of body bags and governments are not enthusiastic to pick up the check for the drastic measures and the monstrous aid packages.

Unprecedented support from central banks has unlocked a surge of borrowing by governments around the world as they look to fund expensive coronavirus relief efforts. According to the International Monetary Fund, the ratio of sovereign debt to GDP in advanced economies will rise by 20% to about 125% of GDP by the end of 2021.

The latest example of a notorious economic bailout comes from Italy. The most indebted European economy after Greece issued a three-year bond that pays zero interest.

Why it matters: It says something about the current environment that a country with as much baggage as Italy can borrow money for free.

China also raised $6bn in an international bond sale. The issuance directly targeted American buyers for the first time in more than a decade, and generated significant interest from investors hunting for yield in emerging markets. And despite concerns about debt sustainability, borrowing has continued apace in so-called frontier markets, a category that includes countries like Oman, Bahrain and Zambia, according to a recent report from the Institute of International Finance.

The flood of debt hitting markets is thanks in large part to the huge stimulus programmes enacted to date. Central banks quickly slashed interest rates when the pandemic shut down economies earlier this year and have snapped up trillions of dollars in bonds, reducing borrowing risks.

Bond investors in Europe are now betting that the European Central Bank will turn on the stimulus taps again, possibly as early as December, by adding billions more to its $1.35tn asset purchase programme.

With little risk that central bankers will take their foot off the pedal, voices that would normally be more conservative on borrowing are encouraging countries to take advantage of the situation.

Federal Reserve Chairman Jerome Powell said earlier this month that there is little risk of the government overdoing stimulus, whereas too little support would lead to a “weak recovery”.

Even the IMF, known for taking a tough line with governments that rack up unsustainable debts, has cautioned against withdrawing aid too soon.

“Preventing further setbacks will require that policy support is not prematurely withdrawn,” chief economist Gita Gopinath said in a report published last month.

But the IMF warned that especially in emerging markets - where debt servicing costs are high and tax revenue is down due to brutal contractions in economic activity - there will be significant aftershocks to manage.

With large sums of money needed to pay off growing debts, there will be less left over to fund social spending in the future. That could exacerbate the rising poverty and worsening inequality stemming from the pandemic.

Italy also sold longer-dated bonds at record low yields, despite a downgrade by Fitch Ratings in April that puts the country's credit rating one notch above junk. The IMF expects Italy's economy to contract 10.6% this year and forecasts government debt to exceed 160% of GDP by the end of 2020, up from 135% last year.

Italy's ability to raise debt so cheaply highlights how unprecedented intervention by central banks has created a disconnect between financial markets and the real economy.

“We are still in the midst of a global pandemic, yet Italy can fund itself for free,” said head of rates strategy at Rabobank Richard McGuire. Investors are expecting even more support from the European Central Bank, he told CNN Business.

Italy is also benefiting from plans by the European Union to transfer huge sums of money to the hardest hit states as part of a €750bn post-pandemic recovery fund.

The country is set to receive some €86.6bn from the fund, according to Berenberg chief economist Holger Schmieding.

“Thanks to the prospect that money will flow eventually, even fiscally challenged EU Member States can now borrow at extremely favourable terms on markets,” he said in a note to clients.

With interest rates anchored at zero percent, most of the banks are desperately looking for alternative sources of income.

Europe's biggest bank, HSBC, has said it could start charging for “basic banking services” in some countries after it reported a 35% fall in quarterly profits.

It said it was considering charging for products such as current accounts, which are free to UK customers. The bank said it was losing money on a “large number” of such accounts.

A spokesman later told the BBC it was committed to continuing to provide free “basic bank accounts” in the UK.

But they added: “We always keep under review the pricing for our standard current accounts and associated services.”

Very few banks still charge for standard bank accounts, but experts say this could change if the UK falls into negative interest rates due to the pandemic.

That would see the Bank of England take interest rates below zero to help boost consumer spending and revive the economy.

HSBC reported a 35% fall in pre-tax profit during the third quarter of the year to £2.3bn, while revenues fell 11%.

Along with other banks, it has seen earnings hit amid an environment of rock bottom interest rates, and so is now considering other ways of boosting revenues.

The lender also said it would accelerate its restructuring plan, cutting costs further than previously suggested.

Despite the tough environment, HSBC chief executive Noel Quinn said there were some bright spots. “These were promising results against a backdrop of the continuing impacts of Covid-19 on the global economy,” he said.

HSBC had set aside between $8bn and $13bn for bad loans as it expects more people and businesses to default on their repayments because of the Covid-19 pandemic. However, it now says its expenses are likely to be at the lower end of that range.

In September, HSBC's share price fell to its lowest level since 1995 amid allegations that the bank had allowed fraudsters to transfer millions of dollars around the world, even after learning of the scam.

Even before the Covid-19 pandemic hit, HSBC was restructuring with a plan to cut £3.6bn of costs by 2022. The European Central Bank had cut its rate as recently as September 2019, charging banks 0.5% to hold their cash. But over the six years since ECB rates went negative, the policy has provoked increasing outcry that it has crippled banks and robbed savers. In Germany - a nation with a strong culture of socking money away - tabloid newspaper Bild railed against the central bank, casting former ECB President Mario Draghi as a savings-sucking vampire it dubbed “Count Draghila”.

The idea behind negative rates is simple: They drive borrowing costs lower and punish lenders that play it safe by hoarding cash. But economists argue about whether they also have perverse effects that outweigh the textbook economic benefits. Chief among them is the impact on bank profits. Since many banks are reluctant to start charging for deposits, the spread between the rate they pay for funds and what they can earn lending money can be squeezed.

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