Liquidity to solvency – the changing dynamics
August 11 2020 12:30 AM
Dr R Seetharaman
Dr R Seetharaman

By Dr R Seetharaman

In its July 2020 meeting, the US Federal Reserve kept interest rates at 0% and extended its emergency lending programmes till the end of 2020, a three-month addition that, while not surprising, signalled how lasting the economic damage from the coronavirus is proving.
In a liquidity crisis, otherwise healthy firms collapse because they can’t access credit. The Fed can resolve such a crisis because it can print and lend unlimited amounts of money. In a solvency crisis, companies can’t survive no matter how much they can borrow — they need more revenue. The Fed can’t solve that.
In its July 2020 European Central Bank meeting, the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility were left unchanged at 0.00%, 0.25% and -0.50% respectively. The ECB will continue its purchases under the pandemic emergency purchase programme (PEPP) with a total envelope of €1,350bn. It is too early to tell whether the ECB’s actions will stabilise the economy.
In Europe’s bank-centric system, market interest rates play only a limited role. Banks appear hesitant to increase lending, despite all the cheap funding the ECB is providing, because demand for credit is weak and they see few viable projects as the economic outlook remains so uncertain. In weak economic conditions liquidity crisis can become solvency crisis if demand does not pick up. 
In August 2020, the Bank of England (BoE) kept the main lending rate at 0.1%, after it cut rates twice from 0.75% since the beginning of the coronavirus pandemic. The Monetary Policy Committee opted against extending its bond buying programme, having announced a £100bn ($131.4bn) expansion in June which took the total Asset Purchase Facility to £745bn.
The BoE said the UK’s economic recovery will “depend critically on the evolution of the pandemic, measures taken to protect public health, and how governments, households and businesses respond to these factors. “The risk of insolvency increases as Covid-19 persists. To assist businesses dealing with the economic impact of the pandemic, the UK government followed in the footsteps of countries including Spain, Germany and Australia and announced certain changes to UK insolvency law.
In August 2020, the BoJ decided to maintain its ultra-easy monetary policy to bolster the country’s economy, keeping short-term interest rates at minus 0.1% while guiding long-term rates at around zero%. The BoJ decided to keep its corporate support measures totaling ¥110tn ($1tn), including interest-free loan programs for companies and corporate bond and commercial paper purchases. While bankruptcies rose 6.3% in June from a year earlier and unemployment increased to 2.9% in May 2020, the figures suggest that central bank and government efforts are helping to limit the damage from the crisis. The uptick in the jobless rate is far smaller than the spikes seen in other developed economies.
In August 2020, the monetary policy committee of Reserve Bank of India kept repo rate unchanged at 4% while maintaining an accommodative stance. The reverse repo rate was kept unchanged at 3.35%. The RBI has already reduced the repo rate by a total of 115 basis points since February 2020, on top of the 135 basis points in an easing cycle last year. Despite the easing of lockdown partly, the Covid-19 has not subsided which could lead to solvency concerns in many firms.
In July 2020, the People’s Bank of China left the loan prime rates unchanged. The PBoC, China’s central bank, has kept the policy interest rates on hold since April. The 1Y loan prime rate and 5Y loan prime rate remain unchanged at 3.85% and 4.65%, respectively. The Covid-19 wave, the first wave dies down, however economic waves: Unemployment, bankruptcy and default, which will build through the end of the year.
In Qatar, the central bank (QCB) has cut rates twice in March 2020 in line with the US Fed action. In the last action, the QCB announced that it reduced its deposit rate (QCBDR) by 50 bps to 1.00%, lending rate (QCBLR) by 100bps to 2.50%, and the QCB repurchase rate (repo) by 50 bps to 1.00%.
Qatar unveiled stimulus packages worth 75bn riyals ($20.5bn) for the private sector to help mitigate the economic impact of the coronavirus outbreak.
Liquidity and solvency are two critical challenges faced by Corps in the region. Fiscal and monetary alignment based on cross border and counterparty risk will strengthen the financial stability. Solvency is based on improvement in economic outlook. Companies need to their understand their available capital and liquidity resources amidst Covid-19. They should develop scenario modelling and contingency planning expertise, incorporating the impact of Covid-19 and the drop in oil prices. The crisis management should include identifying key sectors/ customers who are impacted by Covid-19 and accordingly plan the next course of action. Working capital management needs to be more robust.
The legal implications from non-recovery of dues should also be explored wherever necessary. The potential risks from bankruptcy and restructuring options should also be evaluated. 

* The author is Group CEO of Doha Bank.

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