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A Huge Challenge Looms Over the Global Economy, Says Expert

Globally, banks risk experiencing worse damage when governments start to roll back stimulus packages that are currently keeping business afloat, warns financial expert Piyush Gupta.

Gupta, who is the group CEO of DBS bank in Singapore, said that while these measures are working for now, governments cannot sustain them, and soon there will be “a lot more defaults”. The problems defaulting will cause will then start to “spill over” to the financial sector. After this, banks’ balance sheets will undergo heavy damage.

Banks have become more resilient in dealing with the current global financial crisis than they were ten years ago. However, the Coronavirus pandemic’s effect on the global economy will still worsen after the stimulus measures are over.

Stimulus Measures Will Create Zombie Companies

According to Gupta, governments around the world are using stimulus measures. With this, they can help businesses prevail in the current global recession. But many of the companies will not survive on their own, when governments start to lift those measures.

“If a lot of companies are not able to survive, you’ll have this million-dollar question of how do you deal with these zombie companies.” This is what Gunpta said, speaking to CNBC’s Managing Asia.

He further stated that, when the time comes, governments will have to decide whether they will continue funding dying ventures or let the transition happen through the Creative Destruction concept.

“This is going to be a real challenge particularly in the SME space around the world. I suspect this will be a big, big challenge next year.”

Creative destruction is a concept that was devised by Joseph Schumpeter. He is an Australian economist who argued in his book Capitalism, Socialism And Democracy, that for the new to emerge, the old should be allowed to die.

Governments have to decide which businesses to let disintegrate and which ones to support. They also will experience massive political and civil society pressure, which will influence their decisions. When that happens, a lot more businesses will start defaulting. This will in turn create more problems for the financial sector.

Similar to the grim economic news from all over the globe, Singapore, which is home to DBS headquarters will experience a 4% to 7% economic contraction in 2020, its worst downturn since 1965.

As the biggest banking institution in the country, DBS Group Holdings is estimated to decline by 32% in 2020. This is after earlier predictions estimated that Singapore’s top three banks will decline by as much as 20% this year.

 

Stimulus Measures Cannot Go On Forever

In May, Singapore implemented its fourth stimulus package. This would cushion its economy against Coronavirus-induced lockdown measures. This accounts for 19% of its total GDP, at SGD 92.5 billion.

The stimulus packages allow for promoting domestic economic growth. This is by helping households and businesses, with measures such as allowing loan deferrals, until the end of 2020.

Last week, the Monetary Authority of Singapore (MAS), the country’s central bank and its financial regulator, stated that approximately 34,000 mortgages are currently enjoying either deferred payments on interests and principal or both.

Additionally, the country added another 5,300 small and medium-sized businesses to its stimulus package plan. The relief measures, according to MAS director Ravi Menon, will see the country through the worst of the financial crisis. However, they cannot sustain it in the long run. He added that the resulting debt accumulation will inevitably increase the risk of defaulting in the near future.

 

Macro-Economic Shock in the Horizon

The BDS has resorted to taking some pretty “draconian assumptions”. Specifically, on the number of small businesses that will survive past the stress period. At least as far as Gupta is concerned. He warned that the accumulation of bad loans could be worse than during the 2008 global financial crisis.

“I think you will see more stress on the financial system in the latter part of this year and next year without a doubt. And that’s just because the fallout of the macroeconomics shock has still to filter through the financial system at this point in time, I think it will come.”

Furthermore, banks face additional challenges from the current “low-interest environment” but DBS in particular has tightened its measures in anticipation of the inevitable, upcoming losses.

“The biggest headwind we have obviously is the interest rate. The big cuts by the Fed will eventually trickle through and to our interest rate environment and that’s likely to produce the biggest headwind for us in the course of this year” said Gupta.

The CEO concluded, saying that the bank’s capital base has sufficient funds to not have to contend with losses. That is, if they voluntarily decide to cut dividends. On his final words, he said:

“…I think it’ll be a fair bet to say that we think the outlook is grimmer than we had originally anticipated.”

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