Tackling weak investment with an adjustment to the COVID-19 credit programme

Recovery of consumption

The COVID-19 pandemic has seen the economy collapse, in Switzerland and around the world, to a much greater extent than, for example, during the global financial crisis. The federal government reacted quickly and effectively. Around 20 percent of all small- and medium-sized enterprises (SMEs) have made use of the new COVID-19 credit programme so far. The total volume of loans granted currently lies at 15.3 billion Swiss francs. So far, the program has helped to prevent a wave of bankruptcies. Additionally, the extended short-time work regime and the compensation for lost earnings have prevented a sharp rise in unemployment for the time being. The purchasing power of households has thus been largely preserved. This is one of the reasons why consumer spending is now recovering rapidly.

Persistently weak investment

However, business investment remains weak. It collapsed to an extent comparable to private consumption, but no quick recovery is to be expected for the second half of 2020. According to the latest KOF Investment Survey, companies have considerably reduced their investment plans for equipment and for research & development, and to a much greater extent in the case of SMEs than in the case of large companies. In its just-published economic forecast, the KOF expects overall investment in machinery and equipment to fall by around 13 percent this year, while private consumption should decline by about 2½ percent.

There are four reasons for the weakness in investment: First, export-oriented firms are investing less due to the expected decrease in foreign demand. Second, uncertainty about both immediate and long-term economic development is high at the moment. No one knows whether a second wave of the pandemic will occur – and if so, how severe it will be. And even without any second wave, it is difficult to predict how the economy will develop. In times like these, companies postpone investments or abandon their investment plans altogether. Third, profits have tumbled in the wake of the coronavirus. Since Swiss companies finance their investments to a large extent through retained earnings, they are now reducing their investment activity. Fourth, companies that already had to bridge liquidity bottlenecks with loans can no longer invest to the same extent as before, as they try to further debt.

The weakness in investment not only puts a short-term drag to overall economic growth; it also has negative long-term consequences by limiting the build-up of the capital stock and the production potential. In addition, weak investment has negative repercussions on the labour market: when firms accumulate less physical capital, they generally hirer fewer workers.[1]

Adjustment of the COVID-19 credit programme

In its current form, the COVID-19 credit programme cannot counteract the weakness of investment, because the loans can only be used to cover operational costs. It is prohibited to use them for new investments in fixed assets. We therefore recommend supporting the recovery of investment activity by adjusting the COVID-19 credit program.[2] Specifically, we propose the following:

1. The COVID-19 credit programme is to be extended for one year, i.e. until 31 July 2021. The total maximum amount of CHF 40 billion approved so far for the programme remains as a ceiling.
2. All newly approved loans can also be used for investments, such as machinery, equipment and research & development.[3]
3. All newly approved loans are only partly guaranteed by the federal government. The rest of the credit risk should fall to the credit-issuing bank. In addition, the portion of the guarantee borne by the state should decrease over time. For example, the state might bear 70 percent of the risk for the program “COVID-19 Credit” until the end of 2020, and then 50 percent in 2021.[4]
4. The credit-issuing bank must maintain its already existing, unsecured exposure to the borrowing company in full until a given date.

The existing rules of the COVID 19 credit program should be examined to see whether they need to be adapted. For example, it should be examined whether the conditions for the solidarity guarantee need to be adapted, whether the refinancing by the SNB is still necessary and whether the circle of eligible companies should be expanded. The established financial budget should remain in place and, for the sake of simplicity, as many conditions as possible should be retained.

Rationale for the adjustment

There are four reasons why the COVID-19 programme should be adapted:

First, banks cannot fully diversify macroeconomic risks, such as those caused by uncertain pandemic and economic developments. They therefore demand higher risk premiums for loans or do not offer them at all. Companies anticipate this and therefore often do not even apply for loans in the first place. A partial guarantee from the state can boost lending.

Second, the value of collateral that banks typically require for issuing loans is currently subject to great uncertainty, which also jeopardizes bank lending. A partial guarantee by the state can mitigate this collateral problem.

Third, in case of severe underutilization of economic capacities, it is more worthwhile for a company to invest if many other companies also invest. This triggers demand and supply impulses. Such externalities are typically not taken into account by private actors. As a result, at the aggregate, not enough bank-financed investment is taking place.[5] A partial government guarantee for loans can correct this underinvestment.

Fourth, the pandemic is changing consumer behaviour, and in some cases, exporters have to explore new markets. This may require additional spending on research & development and investment in new business models, whose returns are typically subject to great uncertainty. The reallocation of capital to new business models will happen too slowly when firms reduce outlays for research & development because of reduced profits or high debt levels. Partial government guarantees can accelerate the reallocation of capital to new business models.

To summarize, there are good reasons why temporary partial guarantees from the state can accelerate the economic recovery. Moreover, the proposed reduction in government guarantees over time, once uncertainty has been reduced, should ensure that worthwhile investments are made sooner rather than later.

Concerns

We propose a simple, targeted and temporary federal measure to promote investment activity. Nevertheless, regulatory concerns must be taken seriously.

Economic freedom is not restricted by our proposal. After all, the choice of investment projects is left solely to private actors. Moreover, because banks also bear part of the credit risk, incentives remain to finance only investment projects for viable business models. Companies that do not have sustainable business models will therefore not benefit from the program. The program will not hinder the desired structural change, but rather promote it.

The federal budget is only affected in the event of loan defaults. The risks for the federal budget are reduced by the fact that, until a date to be determined, the credit-issuing bank has to maintain its already existing credit exposure to the borrowing company, which is not secured by the federal government. This prevents the transfer of earlier default-endangered risks to the state. A more rapid recovery in innovation activity may even ensure that the adjustment of the program is self-financing.

Of course, the government might provide guarantees for loans that would have been granted anyway. But this deadweight effect is not necessarily problematic: if the bank had granted the loan without state guarantee, the risk of default is small. The partial guarantee by the government will then simply reduce the cost of the loan and not burden the federal budget.

Efficacy

If, despite the proposed adjustments, an ongoing investment crisis occurs, further temporary measures would have to be considered. Conceivable are tax relief, such as an extension of the possibility of offsetting current losses against profits from previous years, faster depreciation options for investments and financial support for research & development expenditure. However, since these measures would generate direct revenue losses, they would be much more expensive for the government than the adjustment of the existing credit programme we are proposing.

[1] The positive correlation between physical capital accumulation and labor force expansion applies, provided that rationalisation investments do not dominate.

[2] In a similar way, the guarantee scheme for start-ups could also be adjusted.

[3] We also suggest that already-approved but not yet fully-utilized loans can now be used for investments. There is anecdotal evidence that some of the loans issued have not been fully used.

[4] For the revised programme COVID-19 Credit Plus, a lower state guarantee share should be chosen; we suggest 60 percent in 2020 and 40 percent in 2021.

[5] See Gersbach und Rochet, Journal of Monetary Economics 2017.