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Frank Newman

Financial Contagion

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There is no understating the financial implications of Covid-19 – or more precisely the isolationist response of central governments to it.

As at Monday the 16th of March, the NZX index of the top (largest) 50 companies was down 20% from its high just three weeks earlier. Those operating in the tourism sector have been the hardest hit. Air New Zealand was down a whopping 44% in the last three weeks (the government is a 52% shareholder) before halting trading in their shares, Tourism Holdings is down 50% and Auckland International Airport is down 34%.

The obvious question is whether these declines are rational? Equities can be sold in an instant and at low transaction cost, so getting out and taking a wait and see approach is rational capital protection, especially by those investors with a short-term investment horizon. Significant selling is likely to be coming from fund managers (like KiwiSaver funds) as investors switch from balance and growth funds with a high equity component to conservative funds invested largely in interest bearing securities.

The reality is that most businesses run on lean margins and too many have highly geared balance sheets that do not contain reserves large enough to absorb a seismic shift in revenue for any sustained length of time. It is likely that the more marginal operators and those with weak balance sheets will go out of business.

The sharemarket is a very good bellwether of what lies ahead. Investors are dumping companies that rely on tourism or communal activities and taking a wait and see approach with most other companies.  A global recession is now inevitable, and it will be particularly pronounced in New Zealand given our reliance on tourism. For the year ended March 2019:

  • About 230,000 people were directly employed in tourism or 8.4% of the total number of people employed in New Zealand.
  • International tourists generate around $1.8 billion in GST revenue a year and total tourism $3.8 billion.
  • Tourism contributes about $16 billion to gross domestic product (GDP) or 5.8% directly, and a further $11 billion or 4% indirectly.
  • It is our biggest export industry, contributing 21% of foreign exchange earnings.

New Zealand is self-isolating and the policy measures announced last week (Saturday the 14th of March) are some of the world’s tightest border controls yet. In effect it places a wall around New Zealand that closes off international travel and shuts down our international tourism industry.

  • All travellers arriving in New Zealand after 1am Monday the 16th of March, including New Zealand citizens will need to self-isolate for 14 days.
  • All travellers into New Zealand are being registered, and Healthline will step up how it monitors the self-isolation process.
  • All cruise ships are being told to stay away until 30 June.
  • The government is urging people to reconsider any non-urgent overseas travel.
  • The measures will be reviewed in 15 days.
  • Advice on large gatherings will be released shortly.

These measures are intended to slow or halt the spread of the virus, but the economic consequences are significant. Major sporting and social events are being cancelled or postponed for an indefinite time and people are staying at home rather than go out to cafes and restaurants.

To his credit, the Finance Minister has been upfront about the prospect of a recession, and will within the next few days be announcing a range of support packages intended to mitigate the effects.

The issue most are now pondering is how long the financial contagion will last. That depends on how long the virus remains socially active, how long the government restrictions remain in place, and how effective government measures are in mitigating the economic effects of their controls.

According to the NZ Herald (9 March), the package will include, “a wage subsidy scheme for workers in the most affected sectors, training and redeployment opportunities for affected employees, and working with banks on potential support that can be offered to firms”.

It also reported, “Treasury and the Inland Revenue Department have also been tasked with developing tax policy options to ease the impact on affected businesses to help them meet their obligations and maintain employment, while Treasury and the Ministry of Social Development were told to come up with options to support households.”

Whether those packages can repair the damage remains to be seen, but whatever benefits they bring they are unlikely to prevent a recession or comfort those caught in the flow-on effects.

In my view, the duration of the “event” is more likely to be determined by the time it takes to develop a vaccine and bring it to market, and considerable attention and money is being given to that. But even after a vaccine is available, it remains to be seen how quickly tourists fully regain the confidence to travel as they are currently.

Investing is an act of optimism. The greater threat for our economy is the damage that has been done to business confidence. Pessimists don’t invest. Anecdotally I am aware of investors who have within the last week withdrawn from purchase agreements because of the new risks. Others will be doing likewise. Would-be investors will put off buying a businesses or an investment property. They will simply wait and watch, and that’s the rational thing for risk averse individuals to do.

Those who have lived through previous financial crises know the billions of dollars wiped of investment values in the last few weeks and in the weeks that lie ahead will be recovered when the markets reach new highs. That has been the pattern after every market crash, and will be again. The uncertainty is when. Realistically no one knows what lies ahead. We don’t know if the national self-isolation will extend into months rather than days, or whether the recession will go on for years.  And we don’t know whether the 0.75% reduction in the OCR by the Reserve Bank will create a spending stimulus, or whether the yet-to-be announced government package will save us from the worst of the recession. We now sit and wait – and make sure we wash our hands properly!