The Global Economic Impacts Of Covid-19
Confirmed cases of the novel coronavirus (Covid-19), which first appeared in China at the end of last year, have continued to climb significantly higher. The vast majority of new cases reported since late 1Q 2020 have occurred outside the country and spread all over the world.
Hence, what was initially seen as a largely China-centric shock is now understood to be a global crisis. The virus’s spread has regrettably borne out analysts’ downside scenarios, with investors digesting the implications of disrupted supply chains, official containment measures, and spillovers from the real economy to financial markets.
These plus volatility in the financial and jobs markets have unnerved investors while questions about governments’ abilities to mount an effective and coordinated response linger
In this review, PEG Global Head of Strategy Steven Liew sits down with our Head Of Corporate Finance, Albert Ting to look at the broader macro outlook from the Covid-19 impact. Thorough reviewing a number of experts forecasts and reports, we look at some of the impact on the virus on the global economic growth and the likely recovery parth for the global economies.
Q1: What will be the impact of Covid-19 on the global economy?
A1: According to the Center for Strategic and International Studies (CSIS), the extent of the damage will depend on how quickly the virus is contained, the steps authorities take to contain it, and how much economic support governments are willing to deploy during the epidemic’s immediate impact and aftermath.
Although the outbreak appears to have slowed in China, COVID-19 and its impacts have gone global. Infections are mounting in Europe, South Korea, Iran, the United States, and elsewhere, with authorities implementing increasingly restrictive measures to contain the virus.
CSIS believes that Europe and Japan are likely already in recession territory given their weak fourth quarter performance and high reliance on trade. While the United States entered the crisis with a tailwind, some analysts are forecasting a contraction in U.S. GDP in the second quarter. Estimates of the global impact vary.
Indicatively, the Organisation for Economic Co-operation and Development (OECD) predicted that COVID-19 will lower global GDP growth by one-half a percentage point for 2020 (from 2.9 to 2.4 percent) while Bloomberg Economics warns that full-year GDP growth could fall to zero in a worst-case pandemic scenario.
Q2: What sectors and economies are most vulnerable to the effect of the virus?
A2: The COVID-19 outbreak has generated both demand and supply shocks reverberating across the global economy. Among major economies outside of China, the OECD forecasts the largest downward growth revisions in countries deeply interconnected to China, especially South Korea, Australia, and Japan.
Major European economies will also experience dislocations as the virus spreads and countries adopt restrictive responses that curb manufacturing activity at regional hubs, including in Northern Italy. As a result of depressed activity, the United Nations projects that foreign direct investment flows could fall between 5 and 15 percent to their lowest levels since the 2008-2009 global financial crisis.
CSIS says that at sectoral level, tourism and travel-related industries will be among the hardest hit as authorities encourage “social distancing” and consumers stay indoors. The International Air Transport Association warns that COVID-19 could cost global air carriers between $63 billion and $113 billion in revenue in 2020, and the international film market could lose over $5 billion in lower box office sales.
Similarly, shares of major hotel companies have plummeted in the last few weeks, and entertainment giants like Disney expect a significant blow to revenues.
Restaurants, sporting events, and other services will also face significant disruption. Industries less reliant on high social interaction, such as agriculture, will be comparatively less vulnerable but will still face challenges as demand wavers.
Q3: Is the weak energy sector hurting the global economy?
A3: According to CSIS, economic slowdowns generally lead to lower energy demand, and the fallout from COVID-19 has proved no different. Often, producers respond to demand slumps by cutting supply to buoy prices.
Oil prices have fallen to new lows as a resuly and analysts are still predicting further declines ahead. The damage from the Saudi-Russian price war sends an unsettling signal to markets hungry for a coordinated policy response to the epidemic, especially considering Saudi Arabia’s current role as G20 president.
In response to the price shock, CSIS says that large oil producers, including U.S. firms, could pare back investment and production, with heavily indebted firms in particular at risk of layoffs, consolidations, and even bankruptcy.
In theory, lower oil prices should help oil-importing countries, but depressed activity due to COVID-19 could limit that benefit. In addition, the boom in domestic U.S. energy production in recent years means the United States is exposed to price declines in a way not seen in previous economic downturns.
Q4: How does the economic slowdown impact financial markets?
A4: Fears of a broader outbreak and its economic impact have spread to the financial markets and most international indices are nearing or already in bear market territory (declining at least 20 percent from the 52-week high) as investors process the lower corporate earnings that will result from the virus.
Amid the equity rout, CSIS says that investors have fled to safe haven assets such as U.S. Treasury bonds, leading to record low yields. Low yields translate into low borrowing costs for the U.S. government, but low interest rates may not benefit private companies or individuals (or even all sovereigns) who may find financial markets too risk adverse to extend credit in light of such uncertainty.
The longer the virus spreads, the more economic and company performance will be impacted, raising concerns about debt sustainability, especially for highly indebted countries and companies, absent official support.
Q5: How have or can governments around the world responded to cushion the economic fallout from this epidemic?
A5: Thus far, national governments have announced largely uncoordinated, country-specific responses to the virus. In China, the epicenter of the outbreak, officials announced billions in special-purpose loans to companies facing liquidity constraints as well as financial support to specific sectors such as aviation.
In the United States, the Federal Reserve cut the policy rate in an emergency action on March 3, and on March 9, in coordination with other U.S. bank regulators, it encouraged financial institutions to “meet the financial needs of customers and members affected by the coronavirus,” a move aimed at supporting financial conditions to prevent the growth shock from turning into a broader financial crisis. On March 9, the Federal Reserve Bank of New York also announced expanded overnight repurchase operations by $50 billion to avoid a deeper credit crunch.
The European Central Bank and Bank of England are expected to take action when their monetary policy committees meet later in the month. According to CSIS, countries announcing fiscal measures include Japan ($9.6 billion, or 0.19 percent of GDP), South Korea ($9.2 billion, 0.56 percent of GDP), and Italy ($4.1 billion, 0.20 percent of GDP).
The adequacy of such spending will depend on the virus’s path as well as the effectiveness of other measures to contain negative spillovers from the growth shock.
In terms of coordinated action, G7 finance ministers have reaffirmed their “commitment to use all policy tools” but did not outline specific steps. For their part, the International Monetary Fund and World Bank has announced the availability of $50 billion and $12 billion in financing, respectively, to support low income and emerging market economies’ responses to the virus.
Scientists do not yet have a clear understanding of the virus’s behavior, transmission rate, and the full extent of contagion; and as such analysts say that uncertainty will be part of the backdrop for the foreseeable future.
Q6. What would a Covid-19-Induced recession look like?
A6. According to the Harvard Business Review, the recessionary risk is real. It says that the vulnerability of major economies, including the U.S. economy, has risen as growth has slowed and the expansions of various countries are now less able to absorb shocks. In fact, an exogenous shock hitting the U.S. economy at a time of vulnerability has been the most plausible recessionary scenario for some time.
According to Harvard Review, recessions typically fall into one of three categories:
Real recession. Classically, this is a CapEx boom cycle that turns to bust and derails the expansion. But severe exogenous demand and supply shocks — such as wars, disasters, or other disruptions — can also push the real economy into a contraction. It’s here that Covid-19 has the greatest chance to infect its host.
Policy recession. When central banks leave policy rates too high relative to the economy’s “neutral” rate, they tighten financial conditions and credit intermediation, and, with a lag, choke off the expansion. This risk remains modest — outside of the U.S. rates are already rock bottom or even negative, while the Federal Reserve has delivered a surprise cut of 50 basis points. Outside of the monetary policy response, the G7 finance ministers have also pledged fiscal support.
Financial crisis. Financial imbalances tend to build up slowly and over long periods of time, before rapidly unwinding, disrupting financial intermediation and then the real economy. It’s difficult to see Covid-19 contributing to financial imbalances, but stress could arise from cash flow strains, particular in small and medium enterprises (SMEs).
Looking at this taxonomy, and again at history, Harvard Review believes that there is some good news in the “real economy” classification. It says that though idiosyncratic, real recessions tend to be more benign than either policy recessions or those induced by financial crisis, as they represent potentially severe but essentially transient demand (or supply) shocks.
Policy recessions, by contrast, can be, depending on the size of the error, severe. In fact, the Great Depression was induced by perhaps the largest policy error ever. And financial crises are the most pernicious kind, since they introduce structural problems into the economy that can take a long time to be corrected.
Q7. What is the likely recovery path for this crisis?
A7. According to projections by the Harvard Business Review, whether economies can avoid the recession or not, the path back to growth under Covid-19 will depend on a range of drivers, such as the degree to which demand will be delayed or foregone, whether the shock is truly a spike or lasts, or whether there is structural damage, among other factors.
It’s reasonable to sketch three broad scenarios, which it described as V-U-L.
V-shaped: This scenario describes the “classic” real economy shock, a displacement of output, but growth eventually rebounds. In this scenario, annual growth rates could fully absorb the shock. Though it may seem optimistic amid today’s gloom, we think it is plausible.
U-shaped: This scenario is the ugly sibling of V — the shock persists, and while the initial growth path is resumed, there is some permanent loss of output. Is this plausible for Covid-19? Absolutely, but Harvard Review says that this requires more evidence of the virus’ actual damage to make this the base case.
L-shaped: This scenario is the very ugly and poor relation of V and U. For this to materialize, one would have to believe in Covid-19’s ability to do significant structural damage, i.e. breaking something on the economy’s supply side — the labor market, capital formation, or the productivity function. This is difficult to imagine even with pessimistic assumptions. At some point most analysts believe that the world will be on the other side of this epidemic.
Harvard Review says that it’s worth looking back at history to place the potential impact path of Covid-19 empirically. In fact, it finds that V-shapes monopolize the empirical landscape of prior shocks, including epidemics such as SARS, the 1968 H3N2 (“Hong Kong”) flu, 1958 H2N2 (“Asian”) flu, and 1918 Spanish flu.