I recently updated some macro scenarios around the impact of the novel coronavirus (covid19) which update my initial thoughts and my early 2020 risk scenarios. This companion post looks at some of trends which will shape not only the near-term scenarios but may shape any eventual recovery. Many economists are expecting a V-shaped recovery when the outbreak is eventually contained (an outcome that seems far off at this point. There are several themes (some sectors) where activity, output and supply chains are likely to adapt over the longer-term. Similarly there are elements of balance sheet stress that may be exacerbated by these and other shocks, especially for commodity producers.
Global tourism flows, especially from China. China has become a major source of tourism flows at home, in Asia and globally, to the extent that tourism imports by China have become a major driver of the services account (despite some data issues and overinvoicing). It might take many months after the all-clear to restart official tourism especially when the Chinese authorities will be focused on restarting domestic growth. Given the political nature of such outbound flows and willingness to use such internal and external official travel to meet economic and political goals, the ramp up might be more modest. Moreover when global airlines reassess their flight itineraries, some might choose to scale up only slowly, not restarting all flights and possibly bearing greater costs of carrying airlines etc. Cruises in particular look vulnerable. While these trends might not be long-term and effect all jurisdictions, they are likely to be among the consumer services that suffer – and some of those trends may last well in 2021 exacerbating other challenge. Business travel too is likely to take a hit.
One upside might be around remote work/e-learning: one major response to quarantines has been to step up e-learning capabilities, most effectively in higher education in countries like Singapore and to mixed results. Many key events and business travel have been curtailed, whether big tech meetings, oil conferences or policy gatherings. It will remain to be seen if this will lead to more remote events and cuts to travel budgets.
Reinforcing the role of government investment in key emerging economies: Efforts to restart activity in China will likely include targeted government investment and pump-priming that could focus on adding further overcapacity on infrastructure. These government led investments tend to be quick to scale up and are less demand-sensitive. It risks reversing some of the rebalancing trends, something that already began in 2019 as the role of the government increased. There is a key role for governments to play in providing bridge lending, providing clarity and building resilience – see the recent fiscal packages from HK and Singapore for example. The challenge will be to target spending to focus on near and long-term needs. Expect oil producers also to double down on government-led pump-priming and activity, which may increase their debt burdens, lead to crowding out of private credit and put more emphasis on off balance sheet spending (see oil producers section below).
Trade tensions/decoupling and thicker borders: Its broad consensus that the virus has made it even more unlikely that China can meet its phase 1 trade deal requirements especially on commodity purchases and less likely that phase 2 talks will kick off any time soon. The timing of the phase 1 deal already allowed the Trump administration flexibility until after the election, which buys time if they want to take it- but the Trump administration may not. 2020 is likely to be characterized by more trade threats to Europe than Asia, given the irritants with Germany, the negotiations with the UK and more.
Border restrictions are likely to increase along with quarantines, which may last beyond the immediate response. This could be a logical public health decision, but may have significant ramifications on bilateral trade as well as political dynamics in affected countries. Formal quarantines and school and work shuttering are likely to be the major determinant of the economic impact. In some cases, especially with Iran and its neighbors borders may remain thick and supply chains shift even after the virus is eventually brought under control.
Amplify pressure on fuel producers: Oil producing companies and countries have been having a tough few years due to ample supply of oil and gas and slower/stalling demand growth due to structural growth challenges in Europe, Asia among others. Now lower Chinese demand, and cuts to passenger and air freight traffic might amplify the trend and could persist for some time, while there is pressure from institutional investors to weaken funding to fossil fuel projects especially costly ones.
Countries with higher fiscal break-evens and higher debt burdens and debt service look most vulnerable. These include Iraq, , Nigeria as well as sanctioned Iran and Venezuela. Saudi Arabia has more runway than neighbors like Oman but the combo of lower production (as they bear the brunt of more OPEC+ cuts) and lower prices suggest they will need to issue significant debt (tens of billions of dollars) and put more pressure on the PIF to stimulate growth. Smaller open economies like the UAE will also face exposure to lower tourism flows, exacerbating the existing pressure on the construction and other sensitive sectors. By contrast, Russia looks more resilient due to its flexible exchange rate, its fiscal and external balances and lower debt burdens. While the likely pickup in sanctions, direct and indirect remains a valid concern for financing, Russia will remain less reliant on foreign portfolio finance than its peers to manage its sovereign debt. This trend will hold regardless of the planned increase in spending this year.
Decoupling/Distrust and deepening of local supply chains in major economies. Expect greater pressure for businesses to build redundancy and alternate sources in their supply chains. This will likely include select deepening of supply chains in the U.S, on key health care goods, and a lot of bluster on relocating manufacturing, though actual investment is likely to lag. There will also likely be a greater push to deepen supply chains outside of China in countries like Vietnam, which has begun, but which is facing capacity constraints, as well as Mexico. Being tough on China is a popular bipartisan issue in the U.S. with not only some Trump administration officials but also key Democratic presidential candidates like Elizabeth Warren responding to the crisis by lauding plans for deepening U.S. supply chains to reduce supply chain vulnerabilities and add jobs.
While there are legitimate security concerns, the distrust could undermine investment, scientific cooperation and other associated work and lead to unrealistic expectations on economic investment and job creation. As colleagues have noted cogently, focus on building up alternative infrastructure, messages and alternative solutions around financing and 5G is key.
Exacerbating debt burdens: Weaker growth is likely to hit revenues across many economies, while corporations forced to shut down may face financial pressure. In China, there is a good chance that authorities will opt for forbearance to avoid a spike in defaults, adding to the pace of growth in debt and reducing quality of growth. While interest rates are likely to stay low globally, helping with financing, the efficiency of spending may have significant concerns. Governments might find it useful to provide some targeted funding for businesses most exposed and help them build out alternatives in their supply chains.
In the U.S. household balances might suffer if there is a wider spread outbreak. Should the number of cases increase, out-of-pocket costs for testing and treating the illness might put a significant pressure on individuals with limited insurance coverage and might even discourage testing and seeking treatment. There is likely a role for coordinated government programs to encourage quick testing and come up with cost-sharing rather than spread the illness. The U.S. and others might well also take the lesson of stepping up monitoring at key airports as Asian and European counterparts have.
Ziemba Insights 