A V-shaped recovery is possible, at least for the time being

Dr Piotr Boguszewski (©NBP)

Obserwator Finansowy: Why wasn’t the NPB Quick Monitoring Survey published in April 2020?

Piotr Boguszewski: We decided not to publish the survey in April due to concerns that the data may no longer be up-to-date and accurate. We should keep in mind that the main source of the so-called “hard data” contained in the report are the data of the Statistics Poland. And in the Q1’20, the crisis has not been particularly visible yet, because the lockdown had affected only the two second half of March, one-sixth of the entire period. Moreover, our so-called “soft data” from the surveys had been collected – in accordance with the schedule of this study – up to mid-March, that is, also before the lockdown. If we had published a report based on these sources, then it would have been outdated and irrelevant and could be misleading the public opinion. So, we quickly decided to update and verify the data and we launched a special survey of about 500 companies by the end of March. The results were primarily used by the central bank’s decision-making bodies, but now they have been made public in the July edition of the NPB Quick Monitoring Survey, which was the first one published since the outbreak of the pandemic.

In your opinion, have you managed to capture the essence of the impact that the first phase of COVID-19 had on the economy?

It seems to me that we have managed to capture at least one of the main mechanisms that impacted companies in early stage. I’m talking about the sharp decline in revenues amid a simultaneous high level of fixed costs. The problem was visible in certain services, where the administrative decisions associated with the lockdown may have completely wiped out demand, as in the case of hairdressers. However, all the fixed expenses remained – the salaries, the cost of renting premises, etc. This was a practical test of the financial cushion accumulated by companies during the pre-pandemic period. The businesses where this cushion was too thin could have faced liquidity problems very quickly. Because of that, already in March, we were asking companies about the thickness of this cushion. It turned out that over a dozen per cent of the enterprises were signaling problems at the beginning of the crisis. This shows the importance of the swift actions to support liquidity which were taken by the government and the central bank at that time.

But this is only the first issue, isn’t it?

Yes, although the most important one. The second issue, which became visible, is the impact that the lockdown had on expectations. It should be clearly stated that apart from the impact on the real economy, this shock has also caused a lot of different and very strong psychological reactions, which have translated, or will translate, into economic decisions. Sometimes these reactions also hindered the proper interpretation of the survey results. In particular, such a large, negative shock was undoubtedly a source of excessive pessimism in assessments. Right now, it may sometimes be difficult to determine to what extent the decline in the given indicator stemmed from the actual deterioration of the companies’ situation, and to what extent it was the result of the aforementioned pessimism. Of course, this problem is always present in opinion surveys, but in “normal” times some of the respondents have overly optimistic assessments, while others are overly critical, but a majority remain reasonable. With such a large crisis, however, there are almost no “optimists”. Our subsequent surveys conducted in March, May and June confirmed it. This is also associated with a reverse phenomenon – a possible improvement in the situation, after such an adverse event, may be assessed by the companies in an overly positive manner. This can happen when the rebound from a sharp decline is significant in the first phase (and the so-called low-base effect may also appear) and to many people it may seem that everything will easily and quickly return to the pre-crisis situation.

In March, 43 per cent of the surveyed companies assessed the impact of the pandemic on their situation as catastrophic or highly negative. Meanwhile, in May this share fell to 38 per cent, and in June it only reached 23.4 per cent.

It’s worth finding out why. Of course, the psychological mechanisms certainly played a role, especially since we didn’t see a dramatic collapse which some companies had feared. But there is another, more important factor, which additionally strengthened the impact of the first one – various support programs were launched, and businesses were able to take advantage of many assistance instruments. Both of these elements contributed to the reduction of the reported concerns by about 20 percentage points within two months, although it is difficult to estimate their respective impact, and whether they were the only factors here.

The report indicates that the situation was at its worst between the second and third quarter of 2020, and that we should get back to the pre-pandemic levels a year after that. Could this happen sooner if the optimism persists?

Economists are frequently arguing about this issue, and it is as if they had returned to school and were learning the alphabet – they are debating whether the recovery path will resemble the letter V, U, W, L, or maybe the shape of the square root symbol. The entrepreneurs interviewed in our survey indicate that – at least in the initial stage of the reconstruction after the shock – there is a high chance of a V-shaped recovery, especially since we haven’t seen serious damage to the supply side of the economy so far. There aren’t too many signals concerning broken supply chains, mass bankruptcies of firms, or a wave of unemployment as large as we had feared at the beginning of the pandemic. Moreover, this supply-side potential could be matched by the robustly recovering consumer demand. The latter is highly sensitive to the situation on the labor market, which isn’t too bad. In any case, for the time being, companies are quite optimistic – 80 per cent of them claim that it shouldn’t take them longer than a year to get back to the pre-pandemic levels of economic activity.

However, the more distant future is harder to predict. The remaining mysteries include the investments – forecasts  and the situation abroad are not overly favorable, as many countries have been affected by the pandemic much more severe than Poland. Then there is also the issue of consumer sentiment in the longer run. In the long term, the growth could be less dynamic than indicated by the right side of the letter “V”.

Industrial production and retail sales have already produced V-shaped charts. Was this recession entirely different from the slowdowns recorded in 2001, 2008 or 2011?

Yes, this shock is completely different. In the NPB Quick Monitoring Survey we refer to it as an administrative shock with deep economic consequences, because it has been caused by discretionary decisions relating to anti-pandemic measures, which additionally prevent a number of “normal” economic adjustments from happening. In the case of an economic shock, for example, when unemployment increases, consumers may be less willing to eat out. But in such a situation the restaurants can respond by reducing their prices, introducing special lunch offers, and so on. However, if all the customers simply disappear overnight as a result of an administrative decision because their company has been shut down, then the restaurants initially have no room for maneuver. In this sense, the administrative shock blocks multiple channels of natural economic adjustments, and because of that it is often difficult for economists to analyze such an event.

From the point of view of the pace of economic recovery, what happens later is particularly important. If the shock stops short of causing serious supply-side effects, such as mass bankruptcies, production and supply cutbacks, or disruption of economic life in other areas, then the recovery could even be easier than in a typical economic slowdown, because frequently it is enough to lift to initiate the recovery phase.

Provided that the administrative shock has affected an economy that was in a good condition and that did not have built-up imbalances. Has this been Poland’s case?

There are no economies without problems in the world, but that’s a good point. The pre-crisis condition of the enterprise sector was relatively sound, although we were in the phase of a cyclical slowdown, and about a dozen per cent of companies experienced some liquidity problems very quickly after the introduction of the lockdown.

I also want to draw attention to one detail, which in practice means that the tools aimed to support the economy in light of its problems caused by the pandemic may also – to some extent – have an anti-cyclical effect. It is often difficult to distinguish a cyclical or seasonal deterioration of a given company’s condition from disturbances solely caused by the pandemic. Often these two situations overlap in a given enterprise, which means that if the given company wasn’t already in a worse cyclical position, then the effects of COVID-19 alone wouldn’t have reduced that company’s revenues below the thresholds entitling it to take advantage of the aid instruments. Therefore, in such cases the assistance provided as part of the “anti-crisis shield” may also have a counter-cyclical dimension.

The surveys show that in the worst months – March and April – industry and construction did the best, while hospitality industry did the worst, and some exporters who were cut off from some of their customers in the EU.

This was true in March and April. Exports annual growth was strongly negative during these months, although it’s too early to draw any long-term conclusions here. However, I think that in the long run Polish exporters could benefit from deglobalization and the reduced length of supply chains. Experience shows that they are flexible and cost-competitive.

As for the individual domestic industries, it’s a bit more complicated. With a shock of this nature and scale thinking in categories of individual industries could involve certain traps. For example – a hotel located close to an airport, which previously mainly organized international conferences, may be empty now and in the foreseeable future, but a hotel located in a tourist town and catering domestic visitors could be flooded with guests. Both operate in the same industry, but their situation is completely different. Strictly economic shocks ripple across industries in a more “democratic” way, eliminating the less effective entities first. In this case, the airport hotel may have been much more profitable than the guest house by the sea prior to the crisis, but their chances of survival are now reversed.

How many companies will no longer be able to continue their business activity after they run out of state assistance? The indicator of bankruptcy risk exposure is 7.5 per cent, which is the highest in the history of the survey.

Although the conditions for the provision of aid contain certain mechanisms which are supposed to incentivize companies’ restructuring while discouraging attempts to “game the system through bankruptcy,” some distortions are likely to occur anyway. The real moment of truth will come after the companies have used up the available support, which is in fact already running out. However, I hope that most of the companies benefiting from the state aid will be able to cope in the new reality on their own, especially if the recovery process is V-shaped, at least in the near future. If the economy is able to avoid deep supply-side effects, especially ones that are structural in nature, then for many entities the strategy of “buying time” will actually be enough to get back on track. The situation could be much more difficult for companies operating in economies that are, for example, highly dependent on international tourism, which could experience problems for a long time to come.

The most difficult issues faced by companies included the pressure of labor costs amid a sharp fall in revenues, followed by payment backlogs, and negative consumer sentiment. The declines in commodity prices and the lack of foreign workers were seen as the least important issues. Did something surprise you?

It confirms the diagnosis that in the Polish economy the demand-side effects prevailed over supply-side effects during the lockdown. This wasn’t obvious, because in the US there have been studies suggesting the opposite hierarchy. If the supply-side effects dominated in Poland, then the list would be different – the most important problems would include supply shortages, disruption of production processes, etc. In such case the assistance programs would have to be designed differently in many places.

Market reactions after the publication of the report were focused on the collapse in investment. The real growth in investment amounted to a mere 0.9 per cent y/y compared with an average of 8.7 per cent y/y in the years 2018/2019. It seems that it might be difficult to go back to the previous values.

I would ask the following question – could the situation be any different with this kind of economic shock? When we have declining revenues and fixed costs, it is necessary to seek liquidity. The first source is the postponement of expenditures that can wait, and this includes investments. I’m deliberately talking about postponement and not cancellation, because a number of investment projects could be brought back in better times. Additionally, entrepreneurs have to ultimately “do something” about each source of uncertainty, unless these disappear on their own. And if it turns out that, for example, the pandemic will gain strength in the autumn and winter, and there is no vaccine or effective medication, then these are facts indicating that the companies will have to function in such conditions, with the virus, maybe even for a number of years. This uncertainty then turns into certainty. Let’s suppose that I’m the owner of a hotel – in such a case I would remodel the kitchen, and eliminate the common dining area. For now, I have no information that would allow me to determine whether this is necessary, but once I have such information appears – as pessimistic as it is, pointing to the chronic nature of the pandemic – I will simply have to implement these changes (which are investments). Well, I will either have to implement them or move to a completely new business, which also requires investment.

And could public investment effectively substitute for private investments if this doesn’t work?

Of course, in times of crisis, when the activity of the private sector is subdued, it is a rational action on the part of the state to stimulate effective public spending. This is also associated with the belief that public investment may also stimulate some private investment, and concerns about the so-called crowding out effect are not as important. Let’s also keep in mind that in Poland investment expenditures are highly concentrated and a few large investors – either private or public – could generate huge results. This doesn’t necessarily have to be the sum of many smaller investments.

Can you promise that the worst is already behind us, and that we will not get back to the situation observed in March?

I would like to emphasize one thing which is often overlooked in the press coverage. Two thirds of surveyed companies declare that their condition is good or very good. So, what does “the worst” mean? It means that the number of companies that are suffering is much higher than in better times. Therefore, in order to determine that the worst is behind us, the situation of the weakest companies has to improve, and the situation of the strong companies shouldn’t deteriorate. Of course, in the current situation there are plenty of risks. This includes the risks related to the condition of the global economy and the economic situation of Poland’s main trading partners. So, we have to be more cautious than usually, we have to bear some costs, and we have to accept that the recovery will take time.

Dr Piotr Boguszewski (©NBP)

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