The Key Role of Liquidity and Possible Policy Interventions to Ensure It Amid COVID-19 Crisis
I cannot imagine any event in recent times that has impacted the corporate sector so intensely on a worldwide scale as has the corona virus (COVID-19) crisis in terms of macroeconomic supply and demand side shock. So what has been the blow on Indian small and medium enterprises (SMEs) and other firms?
Worldwide, many SMEs and larger corporations are now confronting unparalleled and phenomenal falls in revenues as country-wide lockdowns (that are indeed necessary) have been instituted to prevent or contain the spread of COVID-19 and safeguard the health of the general population. Many countries are yet to fully open up (as is India).
The key question here is whether these companies, including the SMEs, have the ability to wade through and overcome these truly extraordinary circumstances and survive the long-drawn and uncertain impact of COVID-19. If not, then what policy measures could possibly salvage them out of the COVID-19 crisis?
In the short-term, the COVID-19 crisis impacts corporate liquidity by denting corporate cash-flows significantly. Cash-flows have already become profoundly negative for many companies, and especially for those that have not been able to reduce costs commensurately, especially in the context of the huge fall in revenues. It is set to worsen, if there is no strong and immediate policy intervention.
A number of issues further compound this aspect. As a result of restrictions against commercial activity, many companies have not even been able to borrow against the existing inventories, let alone sell them. Trade credit has also stalled as companies have started deferring the making of due payments—this has further exacerbated the woes of the corporate sector and deprived it of an important lubricant, which is very necessary for smoothing functioning.
Third, while it is normal to expect existing (institutional) credit lines to provide companies with the much required additional resources—often to meet short-run liquidity aspects—increasingly, banks and financial institutions (FIs) are reluctant to lend further to these companies as they do not find it worthwhile to put good money out in the current very uncertain and stressed environments.
It is here that policy interventions could make a substantial difference.
First and foremost, it would be very appropriate for the respective central banks to intervene and ensure that 'bridge loans' are provided to all companies so that there is no further breakage in corporate cash-flows. This will help ensure that companies do not default on operating expenses, wages, salaries and short-term obligations. This is very, very critical to keep the engine of the economy running in good and lubricated condition.
That said, let us not forget that such (exceptional) credit will unduly enhance corporate leverage, which, in turn, could possibly create solvency problems later on. But, let us leave that aside for the moment as companies have to survive to fight another day.
Bridge loans, with sunset clauses can be guaranteed in part or full by the central banks (say from 60% – 90% as appropriate) through special purpose vehicles (SPVs) that can be capitalised in eclectic ways. These bridge loans can be made available through banks, non-banking finance companies (NBFCs) and alternative finance institutions including FINTECH companies, which are new kids on the block.
Second, governments must provide subsidies for firms in the hardest hit sectors like aviation, hospitality, tourism, travel and the like. This must be conditional on these companies maintaining or reinstating employment, which, in turn, will ensure stable income for wage earners and prevent sudden lay-offs. It should also help prevent corporate bankruptcies.
Of course, much of this will depend on how long the lockdowns last. Indeed, recovery of these subsidies is very much possible as in the case of the global financial crisis of 2008, when many large banks that owed their existence to bailouts by governments using tax payers’ money, eventually turned the corner and paid back the subsidies in good measure.
Alternatively, the subsidies could also be treated as quasi-equity and sold off at a later date, when these companies have turned the corner and become profitable. Remember, there is huge cost to recreating institutions with the right set of people and that is why governments must do all that they can to help companies) survive.
The existing corporate infrastructure is far too valuable to discard as the trickle-down effects will be huge. And make no mistake, it cannot be rebuilt that easily again. This is a key lesson from the Great Depression of the 1930s as well as the 2008 global financial crisis.
Third, we also would need ways to prevent the stalling of trade credit. For example, special schemes that can help corporates and SMEs dispose of their receivables or at least receive specialised credit against them, would be helpful and required here. Here again, there is ample scope for central banks to intervene.
This would entail central banks, offering through an SPV, a specialized facility where certain short-run claims collateralised with certain types of assets can be rediscounted. This again could come with a specific sunset clause on when this scheme would come to an end as also other conditions to prevent free riding in common economic parlance.
Without a doubt, corporate liquidity is more important than ever before as COVID-19 has caused brutal corporate distress for many companies and SMEs the world over. Before the spillover impact becomes huge and percolates to the entire global economy, it is imperative for central banks and governments to be bold, unconventional and take a key lesson from the 2008 global financial crisis—where many firms were brought back from the brink of disaster to succeed—and the same lesson is very relevant today.
If institutions and people don’t survive, nothing will, and we will have to rebuild from scratch after the holocaust caused by COVID-19 is over.
(Ramesh S Arunachalam is author of 12 critically acclaimed books. His latest release in January 2020 is titled, “Powering India to Double Digit Growth: Five Key Steps To A Robust Economy”. Apart from being an author, Ramesh provides strategic advice on a wide variety of financial sector/economic development issues. He has worked on over 311 assignments with multi-laterals, governments, private sector, banks, NBFCs, regulators, supervisors, MFIs and other stakeholders in 31 countries globally in five continents and 640 districts of India during the last 31 years.