Covid-19: Lessons for US from China on financial stability

ABOUT 80,000 infected cases and 3,000 deaths later, the one lesson China has learned from the novel coronavirus outbreak is that it is very contagious and highly disruptive. Now Beijing can teach the Federal Reserve a thing or two about how to contain its financial destruction.

Fed chairman Jerome Powell may have thought he was ahead of the curve by cutting rates by 50 basis points before the central bank's scheduled March meeting, but traders were unimpressed by his reluctance to go further. This sent the S&P 500 Index 2.8 per cent lower on Tuesday; the Chinese yuan strengthened 0.68 per cent against the US dollar in Asian trading, the most this year.

They have a point. The headlines may sound nice, but questions remain about whether this transmission mechanism works, especially for smaller businesses.

In China, this is the sector most affected by the outbreak. For one, these companies do not have much sway over the supply chain, even for items as simple as face masks and hand sanitiser. Large corporations such as Apple Inc supplier Foxconn Technology Co have started their own mask assembly lines just to meet its workers' needs. That option is simply not available if you are sub-scale. And while bigger companies are largely back in operation, two-thirds of smaller ones still could not get their employees to work as of last week, according to Beijing's own government briefing.

The situation could be even more dire in the United States, where small and medium-sized enterprises (SMEs) are less profitable and more indebted.

In its latest global financial-stability assessment, the International Monetary Fund found that while Chinese SMEs remain highly profitable and large, state-owned enterprises are economic drags, the situation is just the opposite in the US. American SMEs are in the worst financial shape among countries in the survey, which looked at more than 1.3 million companies across major global economies.

GET BT IN YOUR INBOX DAILY

Start and end each day with the latest news stories and analyses delivered straight to your inbox.

Sign UpVIEW ALL

Over 60 per cent of SME corporate debt is issued by borrowers that do not make enough profit to cover their annual interest payments. In times of distress, it is unclear that banks and the private-loan market will allow smaller businesses to refinance.

Welcome to China, where bureaucrats are now forcing their banks to extend loans to SMEs. In addition to cutting the new benchmark rate, the People's Bank of China has set up a re-lending facility aimed at smaller businesses, dictating that banks must not issue loans above 4.55 per cent, a very generous level considering the loan prime rate - that is, the rate banks offer to their best corporate clients - is 4.05 per cent.

THE FED SHOULD CHANGE

Meanwhile, to get the financial plumbing going, Beijing is tweaking all sorts of rules, making it easier for companies to issue bonds and raise funds via equity follow-on offerings. To prop up its credit markets, banks' wealth-management units no longer require first-time retail investors to go into local branches for in-person risk assessments. You can just open accounts online and start buying. In February, mutual funds and exchange-traded funds (ETFs) raised over 100 billion yuan (S$19.9 billion), the most since June 2018, which has helped China's stock market stage a V-shaped rebound.

I am not saying that China is doing everything right, and many of its emergency policies could become additional risks to financial stability. But you have got to give Beijing credit for being creative and throwing the kitchen sink at the virus.

The Fed, meanwhile, comes across as ambiguous and hesitant. At the press conference following the announcement, Mr Powell described the current policy stance as "appropriate", and that future changes depend on "the flow of events" and "a range of things".

Last September, when the Fed somehow botched a critical market rescue operation - its first overnight repurchase agreement operation in a decade - traders in China were perplexed. Open-market operations have become commonplace in the mainland, and the central bank is designing sophisticated, new tools to help its banks shore up capital and guide them to targeted lending.

Blanket interest cuts will not kill the virus and are only likely to benefit the rich and powerful. That is probably why Bernie Sanders' populist message is resonating with small business owners in the aftermath of the global financial crisis. The Fed needs to get creative and more targeted in its market rescue. BLOOMBERG OPINION