Two lessons from the COVID-19 pandemic: Be debt-free and have a financial buffer

However, many economists are quite sure the economic impact of Covid-19 will likely be worse than the Great Depression of the 1930s. Statistics coming out from America, the most important player in the global economy, paint a very grim picture. Over a period of just three weeks up to eary April, a staggering 16.8 million Americans lost their jobs, which is worse than even at the peak of the global financial crisis of 2009. One report predicted that 47 million jobs could be lost in America resulting in a 32% unemployment rate.

Germany, the most important economy in Europe, is also sliding into its deepest recession on record. Its economy is predicted to shrink by almost 10 per cent in the three months to June. More than 230,000 people are expected to lose their jobs. The drop in output during this period is more than double the figure in early 2009 during the global financial crisis.

The situation is the same in almost all other countries leading Oxfam to say that half a billion people may end up in poverty unless urgent action is taken to bail out developing countries. Only China is an exception because the number of new infections have almost disappeared. As a result economic output in the country has seen some modest improvement. However, whether this can be sustained is still uncertain because the demand for China’s output externally is very weak and a second wave of Covid infections there cannot be ruled out.

The process of global economic recovery is expected to take time once this pandemic ends. The principal factor is the extent of global indebtedness which is the highest in human history. This is reflected by the size of global debt which now stands at more than USD253 trillion. If translated into ringgit, that is more than RM1 quadrillion, a term which not many have ever come across.

All three sectors of the global economy – public, corporate and household are struggling with high debt levels. In October 2019, the IMF noted that companies have debts that risked becoming a USD19 trillion timebomb in the event of another global recession. It further stated that almost 40% of the corporate debt in eight leading countries – the US, China, Japan, Germany, Britain, France, Italy and Spain – would be impossible to service if there was a downturn half as serious as that of a decade ago.

That recession has now obviously arrived and it is certainly more serious. Many segments in society are facing the prospect of financial ruin and have already demanded financial assistance from their governments. But the fact is most governments are also in financial difficulties. For example, the Malaysian government has a debt burden of over RM1 trillion while the US federal government debt is more than USD25 trillion or 111% of its GDP. Government revenues around the world will also be reduced as tax collections will also decline during a recession.

The only groups of businesses or individuals who are not in urgent need of any government assistance are those that have minimal debt obligations and enough financial buffer to pay for expenditures for the coming months. Unfortunately, they are the exception rather than the norm. A recent survey by the Department of Statistics showed 71.4% of self-employed Malaysians have savings that can last less than 4 weeks. In fact 43% have savings that can last less than 2 weeks, while only 28 per cent said they had enough to last two months.

When it comes to indebtedness, the situation is no better. Total household debts in Malaysia now is more than RM1 trillion. World Bank’s Malaysia Economic Monitor report shows that about 27 per cent of households in Kuala Lumpur who earn less than Bank Negara’s estimated monthly living wage (RM2,700 a month for a single adult or RM4,500 ringgit for a childless couple or 6,500 ringgit for a couple with two children) tend to take on personal financing loans and credit cards to keep up with lifestyle choices and to raise living standards leading to high rates of bankruptcy because of borrowing for consumption.

The study found bankruptcy cases involving personal financing and credit card debts had grown by 104 per cent and 43 per cent in 2018 and 2012 respectively. What is also worrying is bankruptcies among those aged 25 to 34 which constitutes 60 per cent of total bankruptcy cases.

This sad situation is an outcome of a combination of several factors. One of them is the rise of consumerist values. The World Bank report stated that Gen Y – the generation born between 1981 to 1996 – spend well beyond their means due to “impulse-buying behaviour, easy access to personal loans and credit card financing, the want for instant gratification and seamless online purchasing”.

The second factor is the willingness of the banking industry to provide loans which enable people to to consume more than what they can afford. In good times, this will lead to impressive economic growth figures. But this paints a false and temporary picture of prosperity and is now being truly exposed by the Covid-19 pandemic. Bankruptcy figures will increase drastically now as the economy falters.

In reality the way out of this situation is pretty straight forward: banks must give time to borrowers to pay back their loans. If possible, their debts should also be forgiven. If banks are able undertake these recommendations, businesses will be able to recover, workers will get back their jobs and the world economy will get back to normal again once the Covid-19 epidemic ends.

Unfortunately, that is wishful thinking because `debt forgiveness’ is not in the vocabulary of banks. Other than the 6-month moratarium on loan payments as directed by Bank Negara Malaysia, the only help which commercial banks are willing to offer is new additional loans on top of their existing loans.

As a result, governments are forced to implement `economic stimulus packages’. Part of that involves the government providing direct financial assistance to groups that are badly affected by the MCO. In Malaysia that amounts to almost RM35 billion. However a huge chunk of that money involves additional government borrowings. In other words, the exercise is merely a strategy of postponing the problem to a later time, the proverbial `kicking the can down the road’. In the future, ordinary taxpayers will have to contribute more in terms of additional tax payments so that the government can pay back its loans.

We clearly need to develop a long term solution to the problem so that future generations will not have to endure the pain we are all suffering now. In short we need to revamp the financial system to create one that does not encourage the growth of debt nor seek to make money out of people’s indebtedness. But for that to happen, we also need to revamp our value system such that the yardstick of success is not merely material possessions or luxury experiences, but the ability to make real positive contributions to society. Of course we also need to revive and nurture the savings habit i.e. the habit of putting aside some money so as to prepare for rainy days.