Credit after coronavirus

Dr Nirmala Lee, Associate Professor in Banking and Finance, comments on the likely impacts of COVID-19 on credit lending and availability.

Will the COVID-19 pandemic lead to another credit squeeze?

Business cycles are described as comprising an expansionary period that peaks and a recessionary period that troughs before a recovery phase sets in paving the way for businesses to expand again.  Expansionary periods are usually accompanied by increased credit availability, while recessionary periods are associated with credit crunches where credit supply is squeezed. The UK and much of the world are currently facing a recessionary period due to drastic policy measures such as lockdowns that have been instituted by governments in order to contain Covid-19. Predicted contraction during the second quarter of 2020 ranges between 8% and a high 15%. Compare these estimates with the 2.2% contraction in the fourth quarter of 2008 during the recent financial crisis, and we begin to see the scale of the contraction being forecast. The contraction and the ensuing credit squeeze, are likely to affect some sectors more than others as battered lenders hit by bad debts and loan losses contract the supply of credit available: the larger businesses are likely to be favoured by lenders in their attempt to ration credit in their flight to quality, and smaller businesses many of whom may have all but succumbed during the lockdown can never hope to enter the recovery phase.

What happens when ultimately all of this money being paid out and/or loaned to business needs to be repaid?

COVID-19 is reported to have evolved and mutated into at least eight different strains, and the challenges and disruption caused by the impact of the virus on businesses are also evolving. Outcomes depend on the massively complex decisions that confront the government as it attempts to steer the country towards the goal of achieving more sustainable public finances.  Fiscal sustainability, in the long run, is not necessarily inconsistent with the unsustainable levels of public debt in the short run. The economist Keynes, for example, argued that deficit spending and debts incurred to sustain that spending can help countries climb out of economic recession. Eventual fiscal adjustments can bring debt dynamics back to sustainable levels.

Businesses may require bailouts during recessions with the expectation that bailouts will be repaid at least partially when the economy recovers. Bailouts represent trade-offs for businesses between receipts of resources in times of need and financial constraints and defaults over the longer term. There will be winners and losers: digital and online businesses may thrive at the expense of bricks-and-mortar-based businesses; erstwhile low-status groups such as hospital porters, shopkeepers and cleaners may be deemed as essential to the war effort and be subject to more permanent policy shifts in their favour; continued low interest rates may favour borrowers and businesses at the expense of savers.

The government may attempt to balance its books by resorting to increased levels of borrowing in the form of long-term debt. There was patriotic fervour for the purchase of war bonds that were issued to the public to help the government raise finance to fund the cost of the world war. There is similar appetite among the public to support the government’s corona war efforts, and ‘corona bonds’ could be issued on the lines of ‘war bonds’ to help the government raise long term debt to meet all the money being paid out.

What do payment holidays really mean?

Payment holidays refer to pauses or temporary changes to the payment schedule to avoid

default, but the original contractual obligations continue to apply, and the original payment schedule will eventually resume. Thus, payment holidays do not involve debt forgiveness.  The lender benefits by avoiding the costs of default while foregoing current cash inflows.  The borrower buys a temporary reprieve by delaying repayments, but the interest continues to accrue on the debt, leading to increased payments over the long term and increased financial vulnerability.

How benevolent do is HMRC likely to be?

The HMRC has currently acquired a benevolent hue, being perceived as dropping the attempt to pursue people for non-payment of taxes in their efforts to prioritise support for individuals and businesses to cope with the Covid-19 crisis. HMRC has teamed up with the Treasury to design a scheme to pay the wages of furloughed staff at rates of 80 per cent of normal pay up to a cap of £2,500 a month and the online system expects to be able to deal with 450,000 claims an hour when it goes live on 20 April 2020.  However, it should be remembered that while HMRC is offering support to people including the opportunity to defer tax bills in the form of a temporary pause for those who require it, they are not cancelling tax enquiries or writing off any tax due.

What will reduce tax receipts mean in the long run? 

Massive tax reliefs have been put in place in most countries around the world, leading to reduced tax receipts in the short run. However, as health status improves in the population, we can expect to see increased productive output and tax revenues to arise from these improvements. It is difficult to predict what the future holds, but experience from previous wars suggest that human resilience will ultimately prevail in the face of adversity even when the war is waged against an invisible non-living virus.


Dr Nirmala Lee