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Economic Research: Asia-Pacific Losses Near $3 Trillion As Balance Sheet Recession Looms

Economic Research: Asia-Pacific Losses Near $3 Trillion As Balance Sheet Recession Looms

S&P Global Ratings now expects a steeper decline of economic growth in Asia-Pacific in 2020. We forecast a 1.3% contraction this year before growth of 6.9% in 2021, compared with our previous projection of 0.9% and 6.7%. This means our GDP forecast for the region for 2020 and 2021 is about $2.7 trillion lower than before the pandemic began. Asia-Pacific has shown some success in containing COVID-19 and, by and large, responded with effective macroeconomic policies. This can help cushion the blow and provide a bridge to the recovery. Still, by the end of 2023, we expect permanent damage to the level of output of between 2% and 3%. Risks are more balanced as pandemic curves flatten but remain prominent.

One risk now looming larger is yet another "balance sheet recession." Richard Koo coined this phrase in 2003 although the roots of this idea stretch back to Irving Fisher in the 1930s. [1, 2] The basic story is that at least one important sector of the economy--the government, firms, or households--tries to bolster its weak financial position by saving more, paying down debt, and spending less. The economy can then only avoid a prolonged recession if at least one other sector is using up its savings, re-leveraging, and supporting demand. Previous balance sheet recessions resulted in permanent losses in Asia-Pacific's GDP, of about 12% from the Asian financial crisis of 1997 and 3% from the global financial crisis of 2008.

The downturn caused by COVID-19 did not start as a balance-sheet recession but will end up as one. The pandemic caused a sudden stop in activity and will depress demand for a sustained period. To prevent a collapse, policymakers, helped by banks, have provided extraordinary financial support to firms and households. Some money was given away but much of it was lent. There was no good alternative to "save everyone and worry about the implications later" and this will come at a cost.

As economies normalize, demand will improve but will remain lower than if COVID-19 had never happened. Banks may lend less than they normally would in a recovery to focus on the overhang from the pandemic. Private firms may prefer to stabilize debt rather than ramp up spending on new investments, even though demand is improving. S&P Global Ratings expects credit measures for some corporate sectors will not recover until beyond 2021. While revenue for these sectors may recover as soon as next year, a full recovery of credit metrics will take longer as companies dig out of the higher debt load they now carry. (see COVID-19 Heat Map: Post-Crisis Credit Recovery Could Take To 2022 And Beyond For Some Sectors, published June 24, 2020).

In turn, economies will invest less in productive capital and fail to return to the pre-pandemic trend level of output. Ordinarily, we would expect state-owned enterprises and governments to offset weak demand in other sectors, but we wonder whether there will be appetite for another surge in public borrowing. For some emerging markets, normalizing risk premiums may further discourage more borrowing.

Less private investment will mean a slower jobs recovery but it need not leave eventual unemployment any higher than if investment had recovered quickly. The bad news, though, is that with less capital at their disposal, workers will be less productive and so firms will pay lower wages, crimping consumption growth. We still expect unemployment rates to peak across the region around the middle of this year before drifting gradually lower, getting back to pre-COVID levels in 2023 in most cases.

While we incorporate accelerating deglobalization into our medium-term forecasts, there is little doubt that this could worsen. COVID-19 has hardened economic nationalism and may spur new attempts by large economies to disrupt supply chains, use trade as a diplomatic tool, and impede foreign direct investment. The U.S.-China Phase 1 deal will stay alive a while longer but the longer-term dynamics of the relationship are not improving. Absent a sudden escalation, we would characterize this as "boiling the frog": As the protectionist heat is gradually turned up, the economy (the frog) does not notice the danger he is in until it is too late.

The Current Situation Versus A Balance-Sheet Recession

Dating recessions is more art than science. We identified three recessions over the 30 years before COVID-19 when growth across Asia-Pacific, excluding China and India (see chart 1), was at its lowest (a lack of data precludes us from including these two giants). These episodes surely pass the recession sniff test: the Asian financial crisis of 1997; the technology bust of 2001; and the global financial crisis of 2008.

Chart 1


We calculate the costs of these recessions by comparing real GDP to its pre-recession trend, which we estimate as a straight line. (For COVID-19, we compare real GDP to our late 2019 forecasts, which in most cases were close to trend.) The trend shows how the economy might have grown if it had behaved in a similar way as before the recession began. We calculate lost activity during the first year of the recession, which is a rough estimate of its short-term costs. We also calculate how far GDP is from its pre-recession trend three years after the recession started. This is a rough estimate of the long-term cost and this is where balance sheet recessions become important.

COVID-19 Will Leave Asia-Pacific Economies 2%-3% Smaller

Compared with our forecast from late 2019, the short-term cost of the pandemic-led recession is high, with first year costs of about $630 billion (see chart 2) or $1.6 trillion including China and India. Many activities hit by COVID-19 mitigation in 2020--from restaurant meals to vacations--are lost forever. By the first quarter of 2023, three years from now, we assume that actual output will be about 2%-3% lower than our 2019 forecasts due to weaker investment and a lower capital stock.

Chart 2


How does this compare with previous recessions? A glance at our forecasts for 2021 suggests optimism. However, we should look at levels more than growth rates, and not be fooled by the low base of 2020. As Asia-Pacific flirts with a balance sheet recession, the COVID-19 episode appears to be at least as damaging as the global financial crisis in some respects.

The Asian Financial Crisis: From Currencies To Balance Sheets

The Asian financial crisis was traumatic and the story is well known. Capital flight triggered large devaluations of pegged exchange rates starting in 1997 across the region's emerging markets, exposing huge currency mismatches on bank and corporate balance sheets. In some cases, policies were tightened rather than eased (a lesson not lost on the policymakers of today). As banks and firms downsized their balance sheets, domestic demand collapsed, and in the first 12 months lost activity reached $470 billion in 2015 prices. Three years after the crisis began, real GDP for the region was 12% below the pre-recession trend. Of course, with hindsight, the pre-crisis trend was unsustainable and this remains a useful comparison. The good news is that Asia-Pacific was eventually able to start expanding again at roughly the same pace, albeit from a much lower entry point.

Chart 3


The Tech Bust Was A Mild Recession And Left Few Scars

The tech bust of 2001 was mild and this may be largely explained by the absence of pernicious balance sheet effects. While the collapse in global equity prices hit wealth and lowered investment, with the effects compounded first by the terrorist attacks in the U.S. in 2001 and then SARS in Asia in 2002, widespread balance sheet contraction was avoided. Asia-Pacific suffered a much smaller loss of activity during the early stage of the recession of about $137 billion in 2015 prices. The region's economy also made up lost ground and output was back at the pre-recession trend three years later, even though SARS was hitting activity in 2003.

Chart 4


The Global Financial Crisis Was A Balance Sheet Recession For Some

The global financial crisis of 2008 (GFC) was a mild balance sheet recession. In some cases, these were indirect as U.S. and European banks that had been lending in Asia-Pacific, including for trade finance, began deleveraging, triggering a negative credit impulse. Some of the region's financially integrated economies also suffered from deleveraging and this was only partly offset by China's massive stimulus in 2009. Losses in the first year reached $472 billion in 2015 prices and three years later, output was about 3.2% below the pre-GFC trend.

Chart 5


What Goes Down Must Come Up

Putting all four recessions on a chart can be misleading because trend growth rates change over time. Still, it is helpful to compare the shapes of different recession directly. Our forecasts imply a post COVID-19 rebound similar to the one after the GFC albeit from a lower base. The Asian financial crisis and the tech bust are the extremes of shallow and deep recessions, respectively.

Chart 6


Recession Costs Will Be Uneven Across Economies

The permanent cost across economies, which we measure as the gap between actual (or forecast) GDP and the pre-recession trend after three years, will be much higher for some countries (see table 1). There are striking differences. Losses vary across economies, even when the shock is global, due to initial vulnerabilities (such as high debt or a weak banking system), the specifics of the shock (trade versus financial, for example), and the policy response (robust or anemic). We expect the permanent costs of COVID-19 to be highest in India and the Philippines, due mainly to the severity of lockdowns, and in Thailand given its high exposure to international travel.

Economies that flattened COVID-19 curves quickly (China, Korea, and Taiwan) and launched substantial and well-targeted stimulus (Australia, Japan, New Zealand, and Singapore) are expected to escape with less permanent damage, ranging from 0.5% to 3%.

Table 1

Long-Term Costs Of Recessions--Real GDP Compared With Pre-Recession Trend After Three Years
Asian financial crisis Tech bust Global financial crisis COVID-19
1997 2001 2008 2020
Asia-Pacific ex. China and India (12.1) (0.2) (3.2) (2.2)
Australia (1.0) (3.8) (3.2) (2.7)
China (3.3)
Hong Kong (13) 3.4 (18.5) (1.8)
Indonesia (33.1) 8.7 0.4 (2.1)
India (10.9)
Japan (3.2) 0.1 (6.0) (2.7)
Korea (9.9) (5.2) (0.8) (0.4)
Malaysia (22.1) 0.1 (3.6) (2.1)
New Zealand (1.3) 2.5 (9.8) (2.7)
Philippines 0.6 4.2 (4.7) (4.5)
Singapore (13.2) 1.8 8.9 (1.3)
Thailand (39.8) 34.6 (10.7) (3.8)
Taiwan (1.3) (11.4) (9.0) (0.4)
Note: China and India are excluded from the comparison for the years 1997, 2001, and 2008, due to data availability. Figure for 2020 is the latest forecast compared with pre-COVID-19 forecast.
Source: National Statistical Authorities, International Monetary Fund, CEIC, and S&P Global.

Why Balance Sheet Drag Leads To Permanent Costs

Credit ratings look through the cycle and so should economists. In the medium term, say three to five years, GDP is determined by the supply potential of the economy and this, in turn, is determined by the factors of production. These include the number of people available to work, their skills, capital including machines but also intangibles like software, and know-how or technology. We can draw a direct link between weak balance sheets, capital, and permanent costs.

We expect governments, banks, and firms, especially private firms, to focus more on fixing their balance sheets when demand is improving, rather than spend or lend more once the pandemic starts subsiding. Who tightens their belts the most will vary by country. Many banks will face customers that are deleveraging, a cost of risk that will likely be well above pre-pandemic levels, and lower rates for even longer (see "How COVID-19 Is Affecting Bank Ratings," published June 11, 2020). Private firms may want to edge back toward their pre-COVID-19 leverage ratios, which would mean less desire to borrow and invest. Governments and state-owned enterprises may have little appetite to keep borrowing after supporting demand for so long and market pressures could prove an insurmountable constraint for some emerging economies.

The first casualty of belt tightening will be investment because it is often seen as discretionary spending, something that can be cut without jeopardizing current operations. This is where much of the permanent loss in output will come from, because investment does not just add to demand today but it also determines how much the economy can produce in the future. We now expect both public and private investment to increase at a slower pace during the recovery than our previous forecasts. Three years from now, Asia-Pacific economies will have to make do with less capital, lower labor productivity, and lower output.

Why Lower Rates For Longer Do Not Preclude A Balance Sheet Recession

Persistently low real interest rates are an outcome of high savings and low investment. If savings fall and investment rises by more than we expect, interest rates will rise. Led first by bond yields, central banks will be able to start lifting their policy rates. While this may be challenging for some borrowers, at the macroeconomic level this would be healthy and consistent with a robust recovery and higher, not lower, investment. This seems unlikely, however. The structural forces keeping savings high and investment low--including aging societies, rising inequality, and stalling globalization--will not improve as a result of COVID-19. Low rates may keep indebted firms alive and prevent a disorderly deleveraging but are unlikely to ignite an investment boom.

China Needs Private Demand To Step Up For Sustained Recovery

We maintain our growth forecasts for China at 1.2% and 7.4% for 2020 and 2021, respectively. The economy is healing, helped by building stimulus and a buoyant property market. However, policy-led infrastructure investment will need to hand over to private demand, especially consumption, if the rebound is to take hold next year. Private-sector confidence remains fragile. Still-tight COVID-19 mitigation measures, a large hit to household incomes during the first quarter, weak labor demand, and the lingering effects of trade tensions on manufacturing investment (which is dominated by private firms) are dampening spending. If private-sector spending does not improve quickly, more stimulus may be unleashed.

Japan's Downbeat Consumer Activity Will Lead To A 5% Drop For 2020

We cut our forecast for Japan's economy to -4.9% for 2020 and expect a 3.4% rebound next year. Notwithstanding the country's apparent success in containing COVID-19, and an enormous fiscal package with direct transfers to households, consumers have not recovered from the blow of last year's consumption tax. The underlying weakness of the labor market due to the rising share of part-time and casual workers has been laid bare by COVID-19, with nominal wages plunging by 4% in April versus the same time a year ago, driven by lower hours worked across all sectors but especially hospitality. We assume that greater uncertainty about future income will encourage higher household savings and a more moderate rebound in spending now that the state of emergency has been lifted. Prospects for external demand from G7 economies have deteriorated since our last forecasts, evident in recent orders data, and this will dampen investment.

India's Rebound Will Be Off A Very Low Base

India's economy is in deep trouble. Difficulties in containing the virus, an anemic policy response, and underlying vulnerabilities, especially across the financial sector, are leading us to expect growth to fall by 5% this fiscal year before rebounding in 2021. The pandemic remains the key driver of the country's prospects. Even though lockdowns have eased in less populated areas, urban growth engines are still held back by rising infections, severe mitigation policies, and consumer risk aversion. A normal monsoon, low oil prices, and supportive external financial conditions will only partly offset these effects.

Australia Is Reopening, With A Big Question Mark Now Over Jobs

Australia has flattened the COVID-19 curve and the subsequent re-opening has led to a sharp bounce in consumer activity in May off depressed levels the previous month. As in other economies, however, the labor market is still deteriorating and much will depend on how many jobs quickly return. The unemployment rate has risen by 2 percentage points since late last year to just over 7% in May, but that is being held down by reporting quirks that are forcing down the participation rate. The shutdown and below-normal activity levels are likely to keep labor demand subdued and we still expect unemployment to average 7.5% for the year as a whole, which is consistent with our unchanged forecast of -4% GDP growth. China's stimulus is rippling through commodity markets, as we expected, helping lift the terms of trade and net exports.

Korea Is A Global Outperformer With Our Forecast At -1.5% For 2020

Korea is set to perform better than other countries this year with a modest contraction of 1.5% (unchanged from our last forecast). COVID-19 containment, a swift reopening of the economy, targeted fiscal easing, and high exposure to the resilient technology sector mostly explain Korea's resilience. While the government has periodically retightened mitigation policies, the overall level of stringency remains low. Employment has started to pick up again after falling by over 3% but this will bring people back into the labor force and keep the unemployment rate stubbornly high at above 4.5%, holding back consumption.

Different Emerging Markets, Different Outlooks For Growth

The COVID-19 curve has not yet flattened in Indonesia as policymakers are easing lockdowns to moderate levels. The country enforced tight lockdowns only briefly, but economic activity has still slowed sharply as businesses shut down and households cut back spending. A sizable fiscal stimulus, combined with aggressive monetary policy easing is helping to limit the contraction in activity. We expect growth of 0.7% in 2020 followed by 6.7% expansion in 2021. There are still risks, however, particularly if the outbreak continues unabated, which could lengthen the duration of the shock, weaken balance sheets further, and hinder economic recovery.

We expect Malaysia's economy to contract 2% this year before recovering to growth of 7.5% next year. The COVID-19 outbreak is largely under control, paving the way for a gradual economic recovery. Policymakers have undertaken sizeable fiscal stimulus, amounting to about 5% of GDP, and have relied on the financial sector to cushion the blow.

In Thailand, the outbreak and mitigation measures have caused severe disruption in the large tourism sector. We expected this to lead to permanent economic losses of about 4% of GDP, significantly higher than the regional average. The Bank of Thailand has lowered policy rates by 75 basis points this year to 0.50%, but more easing is needed as the economy is experiencing deflation with prices falling 3.4% in May. We forecast growth of -5.1% this year followed by 6.0% next year.

The Philippines imposed among the world's longest tight lockdowns but new COVID-19 cases remain stubbornly high. Economic activity has stalled and we expect the economy to shrink 3% this year, compared with growth of 6.0% in 2019. We forecast growth will rebound to 9.4% next year as activity resumes. Risks to the recovery path include the persistent spread of the coronavirus and weakened balance sheets in the private sector due to the length and magnitude of the downturn.

Singapore's lockdown is gradually easing and new virus infections are now gradually falling. Policymakers have introduced one of the largest fiscal responses measured as a percent of output at about 20% of GDP. The government is financing much of this spending from assets, which will limit deterioration in public and private sector balance sheets and limit permanent losses to output. We expect the economy to contract 5% this year before growing 6.7% next year.

The Recovery Path Largely Hinges On How The Pandemic Evolves

We assume, but do not predict, that the complicated transition from lockdowns to a "new normal," before a vaccine is found, will persist for the next 12 months. We have assumed different paths for three groups of economies: early, mid, and later exiters. This determines not only how quickly we expect COVID-19 mitigation measures to be relaxed but also the risks of large, renewed outbreaks in the months ahead. Among the early group is China and Korea. The late group includes India and Indonesia, with most of the rest of Asia-Pacific in the middle. While we assume periodic outbreaks and moderate, temporary re-tightening of COVID-19 mitigation policies, we do not factor in additional waves of infection and widespread lockdowns. By late 2021, we assume that COVID-19 mitigation policies will gradually be phased out and consumer and firm behavior will start normalizing. Uncertainty remains high, of course, and there remain difficult-to-quantify risks and opportunities.

External Assumptions: The Environment Will Be Tough

The U.S. and eurozone are forecast to contract by 5.0% and 7.8% in 2020, respectively. The recovery is already underway but after the initial pickup will likely become a slow grind, with output not returning to late 2019 levels for at least 18 months. We believe central banks in these economies will maintain extremely loose monetary policies. Emerging markets outside Asia will fall sharply this year and we expect large permanent losses in output in some cases, in excess of the losses we expect in Asia-Pacific.

We Expect Policies, Especially Monetary, To Remain Supportive

The U.S. Federal Reserve's accommodative policy stance and forward guidance have provided room for central banks in the region to maintain highly supportive monetary policy. We expect that the low-interest-rate environment is here to stay, with most central banks in the region hiking policy rates only in 2022, when some emerging market central banks will tighten policy ahead of G7 central banks as the market focus shifts to exit strategies from global monetary policy easing. We expect policymakers to unwind accommodative fiscal policies gradually. A risk to growth is if some economies prematurely tighten policies, especially fiscal ones, for example by allowing temporary measures such as wage subsidies or tax cuts to expire.

Table 2

Real GDP Forecast
Forecasts Change from April 2020 forecast (ppt)
(% year over year) 2019 2020 2021 2022 2023 2020 2021
Australia 1.8 (4) 5.3 3.1 2.6 0.0 (0.4)
China 6.1 1.2 7.4 4.7 5.3 0.0 0.0
Hong Kong (1.2) (4.7) 4.9 2.4 2.1 (0.8) 0.1
India 4.2 (5.0) 8.5 6.5 6.6 (6.8) 1.0
Indonesia 5.0 0.7 6.7 5.5 5.4 (1.1) 0.4
Japan 0.7 (4.9) 3.4 1.0 0.9 (1.3) 0.4
Malaysia 4.3 (2) 7.5 6.1 4.7 (0.9) (0.1)
New Zealand 2.2 (5) 6.0 3.4 3.0 0.0 0.0
Philippines 6.0 (3) 9.4 7.6 7.5 (2.8) 0.5
Singapore 0.7 (5) 6.7 2.5 2.5 (1.2) 0.5
South Korea 2.0 (1.5) 4.0 3.8 2.6 0.0 (1)
Taiwan 2.7 0.6 3.2 2.5 2.4 1.8 (0.8)
Thailand 2.4 (5.1) 6.0 4.6 3.8 (0.9) (0.2)
Vietnam 7.0 1.2 9.5 7.1 6.8 0.0 0.0
Asia-Pacific 4.6 (1.3) 6.9 4.7 4.8 (1.6) 0.2
Note: For India, the year runs April to March, e.g. 2019-- fiscal 2019 /2020, ending March 31, 2020. ppt--percentage point.

Table 3

Inflation (year average)
(%) 2019 2020 2021 2022 2023
Australia 1.6 1.0 1.5 1.8 2.0
China 2.9 3.2 1.8 2.1 2.1
Hong Kong 2.9 0.8 1.9 2.2 2.2
India 4.8 4.0 4.4 4.4 4.2
Indonesia 2.8 2.4 3.2 3.4 3.2
Japan 0.5 (0.3) 0.2 0.7 1.0
Malaysia 0.7 (2.4) 2.4 2.3 2.0
New Zealand 1.6 1.7 1.8 2.0 2.1
Philippines 2.5 1.2 1.9 2.3 2.6
Singapore 0.6 (0.9) 0.5 1.8 1.8
South Korea 0.4 (0.1) 0.2 0.5 1.0
Taiwan 0.6 (0.5) 1.3 1.4 1.2
Thailand 0.7 (1.9) 0.5 1.4 1.2
Vietnam 2.8 1.8 3.0 4.0 4.5
Note: For India, the year runs April to March, e.g. 2019-- fiscal 2019 /2020, ending March 31, 2020.

Table 4

Policy Rate (year end)
(%) 2019 2020 2021 2022 2023
Australia 0.75 0.25 0.25 0.25 0.75
India 4.40 3.00 4.50 5.00 5.50
Indonesia 5.00 4.25 4.25 4.50 4.75
Japan (0.07) (0.05) (0.05) (0.05) (0.05)
Malaysia 3.00 1.75 1.75 2.00 2.25
New Zealand 1.00 0.25 0.25 0.50 1.00
Philippines 4.00 2.00 2.00 3.00 3.00
South Korea 1.25 0.25 0.25 0.25 0.75
Taiwan 1.38 1.13 1.13 1.13 1.13
Thailand 1.25 0.25 0.25 0.25 0.75
Note: For India, fiscal years end in March, e.g. 2019-- fiscal 2019 /2020, ending March 31, 2020.

Table 5

Exchange Rate (year end)
2019 2020 2021 2022 2023
Australia 0.70 0.69 0.70 0.71 0.72
China 6.99 7.11 7.15 7.19 7.23
Hong Kong 7.79 7.77 7.80 7.80 7.80
India 74.40 74.00 74.50 76.50 78.50
Indonesia 13,883 14,200 14,300 14,400 14,500
Japan 109.12 106.0 105.0 103.0 101.0
Malaysia 4.09 4.15 4.15 4.19 4.23
New Zealand 0.67 0.65 0.66 0.67 0.68
Philippines 50.74 53.00 52.33 51.67 51.00
Singapore 1.35 1.39 1.40 1.39 1.38
South Korea 1,158 1,200 1,150 1,100 1,100
Taiwan 30.11 29.80 29.50 29.30 29.00
Thailand 30.15 30.80 30.40 30.00 29.70

Table 6

Unemployment (year average)
(%) 2019 2020 2021 2022 2023
Australia 5.2 7.5 6.9 6.1 5.4
China 5.2 6.0 5.7 5.4 5.0
Hong Kong 3.0 4.8 4.3 4.0 3.7
Indonesia 5.1 5.8 5.5 5.4 5.3
Japan 2.4 3.1 2.9 2.6 2.4
Malaysia 3.3 4.9 4.7 4.3 3.9
New Zealand 4.1 5.8 5.6 5.2 4.9
Philippines 5.1 11.0 7.0 5.6 4.8
Singapore 2.3 3.2 2.9 2.7 2.6
South Korea 3.8 4.6 4.3 4.0 3.9
Taiwan 3.7 4.1 3.9 3.8 3.7
Thailand 1.0 1.7 1.6 1.5 1.4

A Note On Our Coronavirus Assumption

S&P Global Ratings acknowledges a high degree of uncertainty about the evolution of the coronavirus pandemic. The consensus among health experts is that the pandemic may now be at, or near, its peak in some regions but will remain a threat until a vaccine or effective treatment is widely available, which may not occur until the second half of 2021. We are using this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: As the situation evolves, we will update our assumptions and estimates accordingly.

[1] See Koo, Richard C., 2003, Balance Sheet Recession: Japan's Struggle with Uncharted Economics and Its Global Implications, Wiley, New York.

[2] Fisher, Irving, 1933, "The Debt-Deflation Theory of Great Depressions," Econometrica, pp.337-357.

Related Research

How COVID-19 Is Affecting Bank Ratings: June 2020 Update, June 11, 2020

This report does not constitute a rating action.

Asia-Pacific Chief Economist:Shaun Roache, Singapore (65) 6597-6137;
Asia-Pacific Economist:Vishrut Rana, Singapore (65) 6216-1008;

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