COVID-19's Escalating Macro Impact

The COVID-19 pandemic looks set to far surpass the infection rate of any other epidemic in living memory, and well over a 100 countries are now infected. World Health Organization officials have declared that Europe is now the epicenter of the pandemic, reflecting its rapid spread globally. The ramifications for economies worldwide are now material, with a considerable likelihood of a global recession.

In our latest global credit conditions report (see "COVID-19 Macroeconomic Update: The Global Recession Is Here and Now," published March 17, 2020) we further revised downward our macroeconomic assumptions for the global economy as a direct result of the expected impact of COVID-19, and we now believe global GDP will be between 1.6-2.1 percentage points lower compared to our December 2019 estimate. The initial data from China suggest a significantly deeper economic impact of the social-distancing measures than previously feared. These measures are now being aggressively enacted in a growing number of European countries.

Our macroeconomic assumptions nevertheless cloud important sector-specific risks. We believe that travel will be particularly affected. Few sectors have benefited as much from globalization over the past two decades as travel. But quarantine measures such as those recently announced by various European authorities (including outright border closures) have led to wholesale cancellations of flights into and out of these countries, and further such measures could yet be enacted elsewhere globally. Year-to-date travel numbers are significantly down, airline and travel stocks have been routing in global equity markets, and we have already seen the first airline bankruptcy, Flybe, as an indirect result of the outbreak. An extended aversion to travel while the risk of COVID-19 infection lingers is likely to present the global tourism sector with considerable headwinds in 2020. The U.S. announcement last week of a 30-day ban on arriving European flights, as well as the U.S. travel advisories, add to the concerns that even larger diversified exporters of tourism services, such as Portugal and Spain, are far from invulnerable.

For many sovereigns that we rate, tourism is key source of foreign exchange, GDP growth, and fiscal revenues. The magnitude of the sector's slowdown is currently subject to appreciable uncertainty. However, a protracted slowdown in international tourist arrivals would, regardless, likely place negative pressure on tourism reliant-sovereigns' credit metrics.

In addition to this scenario analysis, we will be assessing over the coming months the impact of COVID-19 on each of the sovereigns we rate. Our sovereign ratings criteria take into account structural features, such as a volatile or concentrated economy, and hence the current vulnerabilities are reflected in current ratings. We will nonetheless be assessing whether the recent deterioration is sufficiently captured within current ratings.

Our Scenario Assumptions

To understand which sovereigns are most exposed, we have modelled three shock scenarios calibrated to be in line with IATA's recent impact assessment (see "Related Research" below). These scenarios are not intended to be interpreted as forecasts, and instead are simply intended to portray one set of many conceivable outcomes for sovereigns' tourist receipts.

These three scenarios include "limited", "extensive" and "extreme" shocks, with respective falls in global tourist footfall of 11%, 19%, and 27%. In each scenario, we assume these declines are uniform across all sovereigns. The "extreme" shock deviates from IATA's scenarios, and may therefore be less likely to play out at the global level. We present this "extreme" scenario to stress-test at the individual sovereign level, where we consider that such an extreme decline is in fact more plausible. The "extensive" and "extreme" shocks imply a pronounced reduction in tourist footfall, equivalent to or greater than that experienced in the aftermath of the global financial crisis.

Our stress scenarios make the following additional assumptions:

• There is no policy response from governments (and here we note that individual EU members have already rolled out an array of fiscal and liquidity measures to support small and midsize enterprises (SMEs)--in the tourism sector via guaranteed credit lines and tax deferrals).
• Tourism's share of current account receipts would otherwise have been constant in our forecast.
• Following the shock in 2020, tourist receipts fully recover by 2021.
• Governments fully fund the worsened current account balance by a drain on international reserves.
• We have taken assumptions for the domestic value-added share in international tourist expenditure from OECD estimates (see Related Research). For all non-OECD countries, this is set at 84% (the average of OECD countries), meaning that for each $100 loss in tourist receipts there is a partially offsetting $16 fall in imports.
• We assume revenue-to-export elasticities at 1, meaning a 1% decrease in exports corroborates with a 1% decrease in central government revenues. On the other hand, we assume there is no impact on revenue from the fall in imports.
• We have not modelled indirect or second-round effects (for example on domestic consumption or investment).
• We have not taken into to account seasonality of individual sovereigns' tourism sectors.

Results

The starting point for our analysis is the proportional share of tourism receipts relative to total current account receipts, which we source from the World Tourism Organization and combine with our own estimates. From this perspective, small island economies appear most exposed to a slowdown in tourism. At nearly 75% of current account receipts, the reliance on such flows in both Aruba and the Bahamas is very significant. In total, at least 16 sovereigns source at least one-quarter of current account receipts from international tourists.

Our analysis of the fiscal impact starts with an estimation of the direct growth impact, and therefore ignores potential indirect effects along with policy responses (which may, in fact, include higher stimulus expenditure). Our estimate of the growth impact includes an estimation of the offsetting fall in imports. In our "extreme" scenario, seven sovereigns could see a drag on growth by at least five percentage points of GDP, while 49 out 122 will experience a drop in growth by more than one percentage point. This implies the direct growth impact purely from the drop in tourism will be very widespread.

Table 1

In all our scenarios, the contraction in growth is followed by a subsequent rebound in growth the following year--meaning the GDP level in 2021 is unchanged. We have not modelled any second- or third-round effects in our estimates of how much tourism declines subtract from growth this year. Under our estimates, a single-year hit to GDP growth would likely lead to a one-off deterioration in fiscal metrics in 2020, which permanently worsen public indebtedness.

In the "limited" scenario, only three sovereigns would experience a worsening of their fiscal deficit by 1% of GDP or higher, namely Aruba, Montenegro, and Cape Verde. Our "extensive" scenario sees an additional nine sovereigns join this group where the fiscal impact is material. Finally, the "extreme" scenario has a total of 17 sovereigns where fiscal metrics deteriorate by at least 1% of GDP. This grouping of economies includes many of the previously mentioned sovereigns, but also some new names where the external impact is relatively more limited. This includes Curacao, Jamaica, Georgia, Croatia, Malta, Jordan, and Iceland. To be clear, this figure represents only the deterioration in budgetary performance from a tourism shock, not from the rest of the economic fallout from COVID-19--in particular to domestic demand.

Table 2

When assessing external risk, we consider a sovereign's external liquidity pressure as measured by the gross external financing needs to current account receipts plus usable reserves. This captures a country's near-term debt and import needs. When assessing a sovereign's overall indebtedness, we look at narrow net external debt to current account receipts (or current account payments if the sovereign is in an asset position). This represents a country's gross external debt position after netting out only the most liquid of assets (for more information see glossary of "Sovereign Rating Methodology," Dec. 18, 2017).

Our simulated scenarios have somewhat differing impacts on these two ratios. Gross external financing needs worsen most dramatically for the Bahamas, while the impact is expectedly large for other small tourist-driven economies such as Barbados, Aruba, Belize, Cape Verde, Montenegro, and Albania. Owing to already large external financing needs, several notably larger eurozone sovereigns would also experience material worsening in their external liquidity, including Greece, Cyprus, and Portugal. In the "extreme" scenario, a total of nine sovereigns would experience a worsening in gross external financing by at least 10% of current account receipts plus usable reserves, and for an additional 18 sovereigns this is greater than 5%.

Table 3

External indebtedness deteriorates most dramatically in the Bahamas, Montenegro, and Greece, which each experience a worsening of around 30% of current account receipts in the "extreme" scenario. Indeed, our analysis suggests 22 sovereigns would face a worsening of this ratio by at least 10 percentage points. However, in most cases, this is expected to be short-lived because current account receipts rebound to trend levels, meaning that, by 2021, only three sovereigns have external debt ratios 10 percentage points worse than the baseline. In the case of Greece, specifically given Greece's membership in the European Monetary Union, Greek financial institutions retain access to the ECB's long-term refinancing lines, while those Greek SMEs most exposed to COVID-19, particularly in tourism, have access to dedicated targeted longer-term refinancing operations (TLTRO) III lines on highly accommodative terms. This should shield the Greek economy from intense external liquidity pressures.

Table 4

Regional Breakdowns

Our analysis suggests that small "Sun, Sea, and Sand" island destinations would be the worst affected from a slowdown in global tourism flows. In relative terms, Aruba, the Bahamas, Barbados, Cape Verde, and Fiji would likely experience the most significant deteriorations in credit metrics. Other Caribbean sovereigns would also be moderately affected, but to a lesser degree.

Nonetheless, our simulations rest on several important assumptions. Our estimates for the domestic share of value-added in the tourism sector come from OECD averages. This could be understating the reliance on imports of island economies' tourism sectors, and therefore the structural external vulnerabilities. We note that small island economies are unlikely to produce the same proportion of, for example, foodstuffs domestically compared to larger more developed countries (although we note that the tourism-reliant OECD member Iceland is estimated to have a similar domestic value-added share of tourism as the OECD average). Another important consideration is the impact of lower energy prices (see "Unrestrained Supply Swamps Oil Outlook: S&P Global Ratings Revises Oil & Gas Assumptions," published March 9, 2020) given that most island nations have significant energy bills.

Table 5

The next most exposed region is central and eastern Europe (especially the Balkans), which contains several sovereigns with meaningful tourism sectors. Montenegro appears most vulnerable within this grouping, mostly because it relies on tourism for two-fifths of total current account receipts--by far the largest in all of Europe. Albania and Georgia additionally appear somewhat vulnerable, but, given both countries' relatively healthier starting position on their external balance sheets, they appear somewhat more capable of handling the shock. Larger and more diverse sovereigns Hungary and Turkey would likely experience some deterioration in their fiscal and external balance sheets respectively under our stress scenario, but in our view their economies are more vulnerable to other COVID-19 effects, both the damage the virus is doing to domestic demand, and, in Turkey's case, its vulnerability to currency depreciation through the confidence channel.

Table 6

In the eurozone, Greece, Cyprus, and Portugal would all face considerable challenges from a sudden stop in tourist flows. While these economies are generally more diversified than other tourist destinations, the very significant pre-existing external financing needs would amplify the effect of a tourist shock. Of all eurozone sovereigns, Malta would face the largest shock to its fiscal balances, which we believe could worsen by as much as 1.3 ppts of GDP in the "extreme" scenario. Spain and Italy, despite having sizable tourism sectors, have more diversified economies. Even so, on top of the depressive effects of mandatory national quarantines in effect in both jurisdictions, the loss of tourism receipts in 2020 under the extreme shock would, under our estimates, subtract 1.4 ppts and 0.6 ppts from headline GDP growth, respectively. With this said, these sovereigns continue to enjoy unique access to the very deep euro area capital markets, allaying some of our concerns. Last week, the ECB announced dedicated TLTRO III lending facilities to provide support to eurozone SMEs most exposed to the fallout from COVID-19 on working capital. Eurozone governments are already rolling out tax deferrals for most employers, as well as additional credit lines that target tourist providers in particular. These also include subsidies to employers to retain staff.

Despite these mitigating factors, it is important not to underplay the drag that COVID-19 will exert on major exporters of tourism in the EU, including Hungary, Greece, Cyprus, Italy, Portugal, and Spain. Even in cases where tourism represents less than one-tenth of gross value added (such as in Portugal), once related services such as car rental, restaurants, air travel are included, the contribution to gross value added is far above 10% of total national output. There is no getting around the observation that in Southern Europe in particular an important component of the economic recovery since the global financial crisis has been to pivot towards services exports. Every major southern eurozone economy runs an external services surplus exceeding 3% of GDP. Hence, the COVID-19 outbreak is a serious and negative development that could, under some scenarios, permanently put at risk the globalization of services sectors, not least tourism. Since tourism is also a labor-intensive sector, there would potentially be a big hit to employment levels in countries such as Spain and Greece, which are still posting high structural unemployment.

Table 7

Finally, several sovereigns in the Middle East could see additional pressure on credit metrics resulting from the tourist slowdown. Jordan appears the most exposed, owing to the country's large reliance on the sector for just under 30% of current account receipts. Bahrain would likely face the next largest set of challenges, in spite of only relying on tourism for about 10% of current account receipts. This is mostly due to our very low estimate of usable reserves in the sovereign, which magnifies the effect of any drop in current account receipts (particularly if this leads to a further drop in reserves, as this exercise assumes). More broadly, the drop in oil prices is likely to lead to additional rating pressure for Middle Eastern sovereigns. Even for oil importers in the region such as Jordan, Egypt, and Lebanon, a lower oil price is likely to be correlated with lower worker remittances, and fewer aid and financing flows from neighboring GCC governments.

Table 8

Conclusion

Our scenario analysis gives a general estimate of how a slowdown in tourism--in isolation from other coronavirus effects-- might affect the sovereigns we rate. The analysis relies on several assumptions, which are unlikely to play out exactly as envisaged due to the uncertainty of how the coronavirus pandemic might unfold. Our estimate of the shock to GDP performance is highly simplified, meaning that it excludes the effects of lower tourism receipts on other sectors, and excludes the second- and third-round effects of the decline on the rest of the economy. Moreover, these estimates exclude the effect of policy responses from most governments, which may involve a fiscal and/or monetary stimulus package, as well as the possibility of fiscal austerity measures to contain budget deficits. Indeed, across Europe we are already seeing large fiscal stimulus packages ranging from 1.4%-3.0% of GDP. Finally, our analysis does not address the collateral costs of a tourism shock to airlines or to state-owned entities, which means that the final fiscal costs could be considerably above what we estimate. Nonetheless, we believe this ranking communicates which sovereigns' credit metrics could be most vulnerable to a tourism shock of several different magnitudes.

Related Research

On RatingsDirect

• COVID-19 Macro Update: The Global Recession Is Here and Now, March 17, 2020
• Coronavirus Impact: Key Takeaways From Our Articles, March 13, 2020
• Credit FAQ: Coronavirus And Its Possible Impact On Global Sovereign Ratings, Feb. 13, 2020
• Eurozone Sovereign Creditworthiness Unaffected For Now From Coronavirus-Related Effects On Growth, March 10, 2020
• Sovereign Rating Methodology, Dec. 18, 2017
• Unrestrained Supply Swamps Oil Outlook: S&P Global Ratings Revises Oil & Gas Assumptions, March 9, 2020
• The Commonwealth of The Bahamas Outlook Revised To Negative From Stable On Increased Debt Burden; 'BB+' Rating Affirmed, March 12, 2020

External research

• IATA Updates COVID-19 Financial Impacts -Relief Measures Needed, March 5, 2020 https://www.iata.org/en/pressroom/pr/2020-03-05-01/
• OECD Tourism Trends and Policies 2020, March 4, 2020 https://www.oecd-ilibrary.org/urban-rural-and-regional-development/oecd-tourism-trends-and-policies-2020_6b47b985-en