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What will be the economic impact of COVID19

Economic good news is emerging, but beware inflation and consider strategic plans for corporate responsibility, says Jackie Bowie

Corporate Financier article imageWriting an economic piece at the outset of 2021 was full of ‘ifs’ and ‘buts’. While optimism abounded about the possibility of a strong recovery across the economy, the timing was questionable. The result of the race between the virus (and its mutating new variants) and the vaccine was impossible to predict.

But we can now confidently say that the vaccine is winning. Also, economic good news is emerging from all sides – on employment, consumer confidence, retail sales, manufacturing activity and house prices. For example, the most recent Bank of England revisions to GDP growth for the UK are quite astounding, with the UK economy set to grow at 7.25% in 2021, and a further 5.75% in 2022. This level of economic activity would all but wipe out the ‘headline’ economic impact of the virus in two years.

One repercussion of economic strength, which is more worrisome, is inflation. Surging commodity prices are feeding through to the real economy – food prices are up by 40% since the start of the year according to the United Nations Food and Agriculture Organisation, and Brent Crude oil prices almost 50%. Pandemic-related government spending and ongoing stimulus are adding further pressure.

Central banks in both the US and the UK are keen to dismiss the impact as transitory – there’s bound to be an increase in prices as economies re-open and businesses that have some pricing power will take advantage. Also, little real transaction data was available for leisure activities, holidays or plane tickets, so there are questions about the accuracy of inflation figures.

However, inflation seeps into the real economy through anticipation. The Federal Reserve’s comment that “expectations about future inflation are well anchored” is not comforting the markets. The Bank of England has stated it will not tolerate a persistent overshoot of its 2% inflation target – so interest rates could rise.

Significant shifts are also happening in the structural economy – driven, or accelerated, by the pandemic. These sectors will in turn drive deal activity – where and how businesses physically operate, how consumers purchase and consume goods and services, the new technologies to support this, and heightened interest in biotech and healthcare. Some are predicting that 2021 will spark the Fourth Industrial Revolution, driven by artificial intelligence and machine learning.

Corporate finance takes off

Globally, the second quarter of this year looks set to be the second biggest quarter ever for M&A activity, driven by low borrowing costs and dealmakers trying to get ahead of new booms, as they reposition portfolios for a post-pandemic world.

Equity capital markets are very strong and that tends to drive deal flow. Estimates put private equity dry powder globally at $1.6trn (according to Preqin), due to a decline in deals concluded last year and successful fundraising.

The emergence of special purpose acquisition companies (SPACs) has altered the rules of engagement for acquisitions. While creating a very different type of deal structure to private equity, it does indicate that there are many alternative sources of capital competing for new investments. Regulators are wary of SPACs’ ‘blank cheque’ nature and overly optimistic revenue projections, with celebrity endorsements targeting retail investors, but less knowledge of how these companies actually work.

Environmental, social and governance (ESG) has gained more coverage and commentary. It existed pre-pandemic, but has moved from a nice-to-have to a must-have. Policymakers want the recovery to be ‘green tinged’, and the broader ESG ‘wrapper’ is now omnipresent. Investors must demonstrate their strategic plans – corporate responsibility is more than a buzzword now.

A disciplined focus on ESG can be monetised by lowering the cost of capital. For example, a very large European multi-asset investor launched two ESG-linked subscription credit facilities with interest rates that are reduced if the firm performs against the pre-agreed set of indicators. Another US fund also launched a similar initiative with its $4bn ESG-related credit facility for its PE funds. The facility links the price of debt to a goal of having 30% diverse directors on portfolio company boards, within two years of the firm’s ownership.

These are great examples of active management, with investors using not just their capital, but also their influence to make an impact on the different industries and sectors in which they are active. But what counts as ESG impact is not uniform or easy to define: 2021 witnessed the rush to label funds and investments as being ESG-screened, and 2022 will hopefully sift out the real results from the box-ticking exercises.

About the author

Jackie Bowie, co-head of Europe, and head of global real estate, Chatham Financial – a member organisation of the Corporate Finance Faculty