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Institutions worry about how to maintain aid to the economy and about the turmoil that would be unleashed if they were withdrawn at some point

In the Road Runner cartoon, the Coyote trudges off a cliff while running out of ground until he looks down and realizes there is no further travel. This crisis causes vertigo in the governments. How long will they be able to continue spending like this? Especially if the second wave of the virus causes a relapse of the economy.

It is the main concern of international institutions and authorities. Once the first blow has been stopped with the measures implemented by States and central banks, experts warn of the so-called cliff effect (cliff effect, in English): the risk that a stimulus is suppressed without having sufficiently recovered the activity, causing an abrupt fall that damages the productive structure.

In Spain, the magnifying glass is placed on five points: ERTE, the deficiencies of the ICO, the moratorium on the obligation to declare bankruptcy and, to a lesser extent, the deferrals of mortgages and consumer loans. Perhaps the greatest risk of all is a reduction in the ECB’s debt purchase program due to the pandemic, which is now acquiring around 90% of the new debt of the Spanish Treasury and whose decrease could leave Spain without its greatest support, especially if the economy is lagging behind and without redirecting the hole in public accounts. Last week the president of the Bundesbank already criticized these purchases for indiscipline to the countries.

There is also a cliff effect of global scope: as Emilio Ontiveros, president of Afi, points out, the international business landscape is dominated by companies whose turnover is not enough to cover their debt. A few sales of rating that they put some significant firms on junk bonds to unleash a stampede and leave many companies without access to financing, fueling mistrust and market turmoil.

At the end of World War I, the United Kingdom cut spending overnight to finance the war effort. And it suffered a recession greater than that of the years of the conflict, recalls Ignacio de la Torre, an economist at Arcano. It is a historical example of a cliff effect. In the United States, the term fiscal abyss was used in 2012. Also in Greece. And now it comes back. It was the central theme of a Eurogroup. The governor of the Bank of Spain has mentioned this risk. And the IMF warned last week that “all aid should be reviewed whenever possible to avoid cliff effects and that when withdrawing them there are bankruptcies, loss of income or defaults.”

Unlike the previous crisis, in which there was a bubble to adjust in construction, this time it was diagnosed that the fall caused by the covid was temporary, and that therefore the economy had to be supported, avoiding further damage. It was simply a matter of holding on until the pandemic passed. However, these policies are limited by a very strong increase in debt that is being sustained by purchases by central banks and whose risk is that at some point it will be perceived as unsustainable. Hence the need to return to discipline, especially in countries with high debts and aging problems. As Saint Augustine said, give me chastity but not now …

However, this return to fiscal normality is not without its concerns. In the economic literature there is talk of the cliff effect when there is a sudden and unexpected decrease in public aid with only a slight increase in income. The danger is that with insufficient recovery there will be a suppression of aid that has greater consequences. The Bank of Spain and the IMF have asked that they be maintained but gradually graduated, focusing them where it is most necessary and in viable companies. But how do you do that?

In the case of ERTEs, the problem lies in the day they end, when the company faces the dilemma of assuming the salary bill or paying for layoffs at a time of lower income. To make matters worse, it is unknown how long the extensions will last, and while companies are accumulating debt by having to bear the rest of fixed costs. If the ERTEs end without the activity having been revived, they will have been of little use, and the effect will be huge on employment, demand and confidence.

In Germany they have given more certainty by guaranteeing their ERTE until the end of 2021. But Spain does not have the same fiscal muscle. And the fear is that at some point a decoupling will be visualized and the punishment of the markets will begin while the debate with the hawks at the ECB prevents further measures. Reports from analysis houses such as Goldman Sachs or Allianz are already beginning to draw a Spain characterized by health stigmatization, political fragmentation and the inability to take action.

As a government source says: is it possible to maintain the stimulus until the European funds arrive and soften the withdrawal of ERTE and other aid? That’s the focus as the virus rides like a rollercoaster undermining confidence and activity. JP Morgan has been the first to predict that in the fourth quarter the Spanish GDP will stagnate.

As for ICO guarantees, they have a deficiency around the year. In a similar program developed by the United States during the previous crisis, the end of the deficit caused a sharp increase in non-performing loans, something that if it happened now would affect the bank’s already battered accounts. Furthermore, if companies have to use their liquidity to pay for the reinstatement of workers or layoffs, then they will not have it to pay back the loans.

Another tricky point is in the bankruptcy proceedings. As in other countries, the Ministry of Justice decreed that with the pandemic, compulsory competition would not be declared until January 1. As of that date, many companies are expected to do so, with the consequent risk of collapse in processes that bog down many resources. Which will also force banks to provision. That is why the Bank of Spain and the IMF have demanded that debt restructuring be facilitated and that more agile out-of-court solutions be formulated.


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