Greece Special Focus Report: Financial Frictions & Covid-19 (September 2020)
Timely and appropriately targeted credit allocation to enterprises is limiting the impact of the Covid-19 crisis
The already large impact of the Covid-19 shock could be further amplified by a tightening in financial conditions arising from disruptions in liquidity and credit flows to enterprises in the presence of high uncertainty and balance sheet constraints (so-called "financial frictions").
The analysis uses an innovative approach to link GDP growth developments with a detailed analysis of the adjustment process by private sector businesses to their operations. This framework permits the endogenous determination of financing needs due to the Covid-19 shock and the subsequent feedback loop back to the economy, if firms remain liquidity constrained. A comprehensive dataset of 30,000 enterprises (corresponding to about ⅔ of economy-wide sales and more than ½ of GDP covering 11 sectors of economic activity) is utilized to construct a consolidated "Business Sector Balance Sheet" that lies at the core of the analysis.
Under the assumption that the Covid-19 pandemic in Greece will remain broadly under control for the rest of 2020, GDP is envisaged to contract by 7½% y-o-y in FY:2020 and we expect a drop in enterprises' sales of 19% (corresponding to €50 bn). According to our "Business Sector Balance Sheet" model, business sector adjustments to operations will reduce the initial funding gap to €33 bn, following the implementation of cost control actions by individual firms.
Prompt government measures, along with the banks' moratoria, will cover a large part of this gap (i.e. €12 bn), while the use of ½ of the companies' available cash buffer (i.e. €6 bn) will further reduce the funding gap to €15.5 bn. The residual funding gap can be closed through bank lending associated with the government sponsored programmes (TEPIX and the guarantee scheme) of c. €9 bn, along with the use of already approved bank credit lines and new lending, including to cover expiring credits. Of course, the measures and the restricted capacity for lending must be applied in a timely fashion and to the appropriate firms. Inefficient use would lead to a credit gap, with subsequent declines in activity and employment. Pre-Covid loss-making firms are unlikely to access credit, but account for only 5% of activity, albeit 8% of employment (and approximately €3 bn of the above mentioned funding gap).
With the availability of the above-described funding, business labor compensation will decline by 20.3% (with 60% offset by government support programmes, and employment declining by 4.0% y-o-y by year-end) and business profitability by 14.5% y-o-y, with the non-business sector more resilient to Covid-19 (e.g. public sector, agriculture).