Financing the cost of the pandemic

Governments and economists across the world are trying to predict the approximate cost of the virus-related lockdowns on their own economies. Will GDP shrink by 10%, 15% or 20% in the coming months? Will the abrupt halt of many economic sectors and the resultant weak economic activity last for three months, six months or more? How will an economy respond thereafter? Will there be a quick return to economic activity in a similar pattern as that of before the outbreak of the COVID-19 or will there be a prolonged recession thereafter?

We are living in the greatest period of uncertainty in modern times as it is yet unknown when the pandemic will subside and therefore when economic activity can start to return to normality. In Malta’s case, the timing becomes even more critical due to the importance of the tourism industry and its multiplier effect across other economic sectors especially now that we are approaching the summer months.

What is clear is that many economies will enter into a deep recession in the coming months and unemployment rates will spike. In an article published in the Financial Times by the former President of the European Central Bank Mario Draghi, it was argued that in order to avoid a lengthy recession or a depression, a significant increase in public debt is required for Governments to support their respective economies. He also compared the impact of the virus to that of World War I.

In fact, Mr Draghi stated “it is the proper role of the state to deploy its balance sheet to protect citizens and the economy against shocks that the private sector is not responsible for and cannot absorb”. He also argued that it is inevitable for public debt levels to increase. The former president of the ECB claimed that “the alternative — a permanent destruction of productive capacity and therefore of the fiscal base — would be much more damaging to the economy and eventually to government credit”.

The Government of Malta launched a number of initiatives in recent weeks to assist targeted sectors of the economy. The Prime Minister explained that the recent pattern of government finances where a surplus was being registered is no longer tenable in the present circumstances. In view of the ensuing deficit as a result of the pandemic as well as the finances required to fund the various initiatives launched to date and possibly others in the coming weeks as the impact of the economic lockdown deepens, the Government will need to issue significant additional amounts of government bonds.

In recent years, Malta’s public finances strengthened materially and its debt to gross domestic product (GDP) ratio dropped to 43% (far below the average across the eurozone economies). This enables the Government to take on a significant amount of debt to finance a series of initiatives in order to ensure that the economy can rebound quickly when the pandemic subsides.

Last Friday, the Government announced the issuance of up to €300 million in new government bonds. These are once again aimed at financial institutions given that the offering will be done via an auction taking place tomorrow with a minimum tender size of €500,000.

At the start of the year, the Government had originally intended to raise up to a maximum of €450 million during the course of 2020 to finance the redemptions of Malta Government Stocks taking place this year totalling €461 million as the economy was expected to continue along its growth path and another budget surplus was projected for 2020.

The first issue of €100 million at the end of February was well received by institutional investors as total tenders amounted to over €230 million with the average yield for the 6-year bond in negative territory and the yield on the 25-year bond at less than 1%. The coupon of the 25-year bond at 1.5% will result in the annual servicing cost for the Government being not that high given the very low interest rate environment.

The data provided by the Treasury of Malta indicates that the buyers of the MGS offerings in February were in the main local credit institutions and insurance companies although international credit institutions also participated. Most credit institutions in Malta have very high levels of liquidity and therefore the €300 million on auction tomorrow should again be in strong demand given the cost of holding excess liquidity is the negative interest rate imposed by the European Central Bank.

Following the imminent MGS offering on auction tomorrow, the Government would have utilised most of its borrowing requirement for 2020 and as a result, last Monday evening the Minister of Finance presented a Bill in Parliament to amend the previous Budget Measures Implementation Act, 2020 to increase the borrowing requirement to a maximum of €2 billion. Should the Government continue to target institutional investors to raise the required funding or should it consider the issuance of bonds directed to retail investors? Also, should the Government seek funding from alternative sources?

At the EU level, currently there are ongoing debates about the possible launch of ‘corona bonds’ representing joint debt issued to member states via the European Investment Bank. So far this has not been agreed to since some countries (Germany and The Netherlands in particular) are opposing this initiative. Instead, the EU could decide to use the Eurozone bailout fund, namely the European Stability Mechanism (ESM), which currently has €410 billion at its disposal to provide financial assistance, in the form of loans, to Eurozone countries or as new capital to banks in difficulty.

However, as explained by Minister of Finance Edward Scicluna in a media interview earlier this week, Malta has strong debt metrics and therefore one would not need to resort to the European Stability Mechanism. Moreover, as was evident for some countries a few years ago, any bailout funds dispersed from the ESM would place stringent conditions which would be best avoided.

As such, it would be best for the Government to source as much of its borrowing requirements as possible from within the local sphere. If the amount required to be raised would be too much for the institutional investors to absorb, then the Government should consider devising offers for the retail investors. In recent years, the Government only issued the 62+ Government Savings Bonds to eligible senior citizens. The Minister of Finance once again indicated in Parliament on Monday that further tranches of these bonds would be issued in order to raise the large amounts required during the course of the year. However, due to the significant amount of debt required by the Government in view of the extraordinary conditions of the current pandemic, it may be opportune to structure new offerings to target a wider audience and not remain restricted to the eligible investors in the Government Savings Bonds. Possibly, zero-coupon bonds issued at a steep discount to par value, thereby offering an attractive yield upon maturity, should be considered as such bonds will not place added pressure on the annual debt service requirements of the government. All Maltese citizens should be encouraged to participate since the future of Malta’s economy is truly dependent on the support that can be injected over the coming weeks and months.

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