It's clear that the hit to global economic activity from the measures to slow the spread of the coronavirus pandemic will be massive. In turn, the sudden economic stop caused by outbreak-containment measures will bring intense credit pressure to bear on borrowers worldwide as slumping cash flows and tight financing conditions weigh on creditworthiness.

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak between June and August, and we are using this assumption in assessing the economic and credit implications. We believe measures to contain COVID-19 have pushed the global economy into recession and could cause a surge of defaults among nonfinancial corporate borrowers (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

To date, S&P Global Ratings has taken almost 300 rating actions on nonfinancial corporate borrowers that were at least partially related to the outbreak's effects. We now expect the U.S. speculative-grade corporate default rate to rise to 10% in the next 12 months from 3.1% in December 2019. Outside of corporates, we've placed the ratings on 77 classes from 32 aircraft and aircraft engine asset-backed securities (ABS) transactions on CreditWatch with negative implications.

Questions And Answers

What are S&P Global Ratings' latest thoughts on how the economic stop associated with coronavirus-containment measures will affect global GDP growth in the short and longer terms?

As more data on the effects of such things as social distancing and shelter-in-place orders come in, we see a growing downside risk to our March 20 macroeconomic forecasts. For the U.S., the decline in GDP in the second quarter now looks to be at least double the 6% contraction we estimated then, and we now expect a contraction in the first quarter as well. The first-half hit to Europe's GDP looks to be of similar scope but with a somewhat larger decline in the first quarter than the second, given that the shock started earlier there.

In contrast, the outbreak seems to be largely contained in China, and its economy seems to be stabilizing. Traffic patterns, shipping data, and other anecdotal evidence--along with some official data--show that economic activity is beginning to recover, albeit more slowly than originally expected. Our estimate of the drag on first-quarter GDP was a 13% contraction (annualized).

We have less data to work with regarding emerging markets--the last group globally to be hit by the pandemic--but now see a similar shock, with possible double-digit percent declines in GDP in the second quarter.

The risks are still quite clearly on the downside. And it's worth remembering that this is a health event, not a purely macroeconomic event. So we're deferring to epidemiological experts for the medical prognostications and then mapping that onto the macroeconomic environment. We normally have confidence gaps around our macroeconomic view, but in the current environment, those confidence intervals are much wider.

What is the timeline for the expected effects across regions? What's driving that view?

As we've said, our expectations for timing factor in what medical experts--such as those at Johns Hopkins--are saying about the progression of the pandemic. It seems to have leveled off in China, which means that the biggest damage to that country's economy will probably have been in the first quarter, with stabilization in the second quarter and a substantial recovery in the latter half of the year. In Europe and the U.S., where reported cases are still growing rapidly, the drag on the economy will show up later. In Europe there will likely be some damage to economic numbers in the first quarter, spreading into the April-June period. We believe most of the U.S. damage will be in the second quarter.

What could help foster a quick rebound once the pandemic is contained?

Given the growing size of the demand shock and the corresponding potential dislocation to production and labor markets, governments' policy response could cushion the effects of the sharp decline in growth and lay the groundwork for recovery. The less economic dislocation now, the faster a rebound can gain traction, and the less economic activity will be permanently lost.

Monetary policy can work to keep markets orderly, and we continue to expect a plethora of new initiatives in this regard--such as the U.S. Federal Reserve's plan to buy as much government-backed debt as needed to keep financial markets functioning. However, the fiscal response of the U.S. government is now front and center in the policy debate, with figures approaching $2 trillion (equivalent to 10% of GDP of the world's biggest economy) being discussed.

Labor-market policy seems key because workers in the most-affected sectors are already being laid off at rapid rates. About 15% of U.S. workers (mainly in the services sectors) are at risk, and headline unemployment could reach the mid-teens percentages.

When we put together our economic assessments, we ultimately look at three things: the labor market force, the capital stock, and productivity. If those make it through the crisis intact, longer-term growth won't likely be affected too severely. Still, the shape of the recovery is a big question. We don't believe this will be a V-shaped rebound. We won't necessarily recover all of the output that's lost. But we do think that by next year, we could be back on the growth path we were on earlier, with perhaps a bit of lost GDP. So the slope of the path for 2021 and beyond should be similar, if a bit lower, reflecting lost output.

What are the sectors hurt most by the crisis, and what will be the effect on credit?

The current situation is exceptional on three fronts: the sudden stop in the global economy, the collapse in oil prices, and the record volatility in the capital markets. Together, this is putting significant pressure on borrowers' creditworthiness globally and will undoubtedly lead to increased defaults. However, the magnitude of the effects will vary tremendously by industry, geography, and rating.

The industries most exposed to the collapse in global demand--such as airlines, transportation, and retail--or those heavily dependent on cross-border supply chains are likely to suffer most, both from slumping cash flows and much tighter financing conditions. In terms of ratings, we expect that companies rated 'B' and below will come under the most pressure. These low ratings reflect higher vulnerability to adverse business financial and economic conditions.

There has been a significant increase in the number of these lower-rated companies in the past few years, particularly in the U.S. and Europe. In fact, the percentage of U.S. issuers rated 'B-' and below is at an all-time high of more than 30%. These companies are the most vulnerable to pressures on liquidity, from working capital needs or refinancing needs. They are also the most exposed to the risk of distressed exchanges or debt restructuring, which would qualify as a default under our criteria.

By contrast, we expect entities with investment-grade ratings to exhibit stronger resilience and have more flexibility to absorb the effects of a global recession. That is not to say we don't expect a certain number of rating actions on these companies, particularly for those in sectors most exposed to the economic disruption. As central banks and governments around the world implement policies that will soften the blow to liquidity, we don't believe this will prevent all deterioration of credit fundamentals, particularly in the most exposed industries.

When assessing credit quality, how does S&P Global Ratings account for the post-pandemic environment? In other words, is there a through-the-cycle approach at play?

"Rating through the cycle" can be a misleading term that means different things to different people. What we always strive for is to be timely, transparent, and--most important in the current environment--forward-looking. Again, how we look at the credit deterioration on a borrower depends not only on the severity of the sector stress but on where the particular borrower is on the credit spectrum. We consider speculative-grade companies (those rated 'BB+' and lower) to be more vulnerable to adverse severe cycles. The lower the rating, the higher degree of vulnerability. That's because at 'CCC' or--depending on the sector and the impact--even 'B' or 'B-', a crisis as severe as this one could be existential. Some can't make it through, even with adequate liquidity entering into the downturn.

Conversely, we view companies with investment-grade ratings as having greater ability to weather adverse credit conditions. To be clear, there will be rating actions on investment-grade companies, but we generally expect them to be less frequent and less stark because of these borrowers' stronger business positions and financial flexibility. So we have the ability to look forward to our expectations for 2021 and 2022 financial metrics--however uncertain these might be--for companies that have much stronger business profiles and more flexibility. This, of course, is assuming the borrower's fundamental long-term business prospects haven't changed.

How might fiscal stimulus measures affect sovereign ratings?

We look at fiscal and monetary stimulus in the contexts in which they're implemented. In this particular case, it's an economic crisis that started a few months ago, mainly as a supply-chain disruption, then quickly evolved into a demand shock that has resulted in large amounts of monetary stimulus and now fiscal measures. The latter are designed and implemented, especially in this moment, as a bridge for the private sector between the short-term impact and a recovery toward the end of the year.

With regard to ratings, we want to be timely, but we also don't want to overreact. Sovereigns generally have ample space to cope with situations such as this. Within this context, the first aspect we look at is how long this is going to last. We're expecting a U-shaped recovery, but the question is how long the bottom of the U lasts. That's going to be important to understand how deep the damage is going to be. The second aspect is the timeliness and adequacy of policy response, which is not the same across the world. Of course, some economies will have much more latitude. Some of these stimulus packages are in the form of executive orders or other moves that are quick to come to the market. Others aren't as fast and require a different process, such as congressional approval, which also matters.

The last point--and definitely a very important one--in how we look at different markets is the underlying economic and political resilience of these economies heading into the crisis. It's safe to say that whenever this crisis is over, most countries will have weaker balance sheets than before. The capacity of economies to recover after that is a very important point in understanding how profound the effects of fiscal stimulus are.

Here, we can make a broad distinction between developed and emerging economies. The former generally have capacity to exercise larger and more effective amounts of stimulus, given that most are wealthy and with ample access to funding. Most countries in this category carry a relatively high sovereign rating, which could be affected by the crisis, as there may still be balance-sheet damage--but we would expect it could be fairly contained.

For emerging markets, many are more exposed to the tightening of the credit markets and commodities prices. And some of these--especially in Latin America and in Africa--had structural weaknesses before the coronavirus outbreak. These governments don't have much room for countercyclical policies to cushion the hit to their economies; and in some extreme cases, their access to funding is limited, relying mostly on accessing international capital markets. In situations such as this, when market liquidity is very tight, negative ratings actions become more likely.

Writer: Joe Maguire