Many workers will be displaced and many businesses will close as a result of the slowdown caused by COVID-19. Providing support to those affected gives them a fighting chance.
Travel restrictions, store closures and social distancing, prompted by COVID-19, is causing an economic slowdown that may last to the end of 2020 and possibly beyond. Businesses are experiencing a precipitous fall in demand, which is reducing revenue and making it difficult to pay bills, including wages. Layoffs have started. Workers without wages means households without income and that, in turn, leads to difficulty buying food and other essentials.
Keeping businesses operating – which helps to keep workers employed – is thus essential in cushioning the impact of the slowdown on households. In this way, policies that support small and medium-sized businesses, and other affected enterprises, are an indirect but critical means of providing social protection. They are not a substitute but a complement to more direct social protection measures.
How can governments support businesses, particularly small and medium-sized enterprises (SMEs) that collectively employ an average of 60% of the workforce in Asia countries and are particularly vulnerable to a demand shock? We suggest three measures.
1. Provide credit: With reduced revenue, enterprises are running short of working capital. At the same time, banks and other financial institutions will be reluctant to lend, in part because they predict some businesses will not survive and the loans may never be repaid. Nonetheless, lending can be encouraged in several ways. One is to use state-owned banks, of which there remain many in Asia.
For private banks, more funds can be provided by the central bank for on-lending to businesses. This can be further encouraged by the expanded use of credit guarantee schemes which exist in an increasing number of countries. The coverage ratio on loans (i.e. share of the loan that is guaranteed), which is usually set at 50% to 80%, can be increased to 100%, as is being done in Hong Kong, China, and was done for emergency loans in Japan to cushion the negative impacts of the Great East Japan Earthquake in 2011
Governments can also encourage the delay of payments on existing credit, as Italy has recently announced. Such a mid-tenure grace period means that interest and principal can be deferred for 3 to 6 months, taking some pressure off businesses. This measure will no doubt impinge on the liquidity of banks. They can be encouraged through extra liquidity provided to them, moral suasion, and the idea that a delayed payment is better than no payment should the business collapse. Tax breaks or deferments for banks will also ease liquidity constraints.
2. Reduce business transfers to government: Payments remitted by businesses can be deferred by governments. This includes taxes on income, property taxes, excise duties, employers’ contributions to social security programs, and others. This will help to conserve needed operating capital in the short run. Several countries have already announced such measures. For example, Viet Nam will allow a delay in tax payments for 5 months. It will also delay land use fees until October 2020. Thailand will extend the deadline for corporate income tax payments by three months. Excise payments required by entertainment and service businesses will also be extended for 3 months.
3. Maintain employment: Government, along with chambers of commerce, should encourage enterprises to maintain employment, where possible. Certainly, quarantine restrictions and government mandated lockdowns will leave businesses shuttered and people unable to get to work. Where businesses can remain in operation, firms might reduce work hours but still allow workers to earn some income.
For example, if the enterprise reduces operations by 50%, it would be better to reduce the work hours of all workers rather than laying off half of them and keeping the others all full hours. In countries with unemployment benefit schemes, the lost income from reduced hours can be made up from unemployment insurance benefits.
Reduced hours and partial use of unemployment insurance were methods used during the global financial crisis to cushion the employment impact. Governments in some countries, including the United Kingdom and Denmark, are providing businesses with 75% to 80% of the wages for workers who would otherwise be laid off during the pandemic.
These measures will be costly for the government and for lenders. The number of nonperforming loans, even with a grace period, will rise. Banks will become more highly leveraged. Payouts on credit guarantees will increase and the credit guarantee fund likely need replenishment. Government revenues, from income and other transfers, will tighten. This is to be expected as government has a role to play in the intertemporal reallocation of resources to cushion the effects of an economic crisis. The idea is to reduce the severity of the slowdown on households and businesses during the pandemic by shifting some of the support costs to the post-pandemic period. Businesses, banks and governments will be better able to bear those costs as the economy revives. For its part, the central bank can allow some regulatory forbearance in terms of loan classification.
It is important for an economy that businesses survive during a temporary crisis. When businesses collapse, assets are sold off, and workers are let go. An entity that generates output and employment is lost. The loss of value has a scarring effect on the economy as there is an element of irreversibility in the loss of business investments, and liquidations are costly to the broader economy. It is also costly to reconstitute businesses after the crisis, not only for firms themselves but also their employees. Workers face costs in finding jobs and may need to be retrained. Avoiding bankruptcy will help recovery and give it a better chance to be v-shaped instead of u- or bathtub- shaped.
Evidence from the global financial crisis showed that business support can be a valuable investment. While costly during the crisis, it allows many firms to continue operating and then fully reboot once the crisis is over. Equally important is the fact that business support measures are valid instruments of social protection. They can protect workers from the loss of employment and the coincident loss of income to support their families.
There is little doubt that many workers will be displaced as a result of the slowdown and many businesses will collapse. But support to businesses gives some of them a fighting chance to weather the storm.