COVID19 and its policy response has been damaging to global growth and a sharp global recession is now the base case. Most major economies are likely to experience sharp recessions as economic activity is shut down to avoid over-taxing the health care system. Globally this suggests rolling recessions, albeit very close on their heels beginning in China, Europe and moving to the US and many emerging economies in March.
The crisis and quarantines represent a major global demand shock – for services, for energy, for non-essential equipment – which is likely to be exacerbated by supply challenges (first due to China shutdown) and now because of export controls of select basic goods) – and liquidity issues. These trends have been amplified by the financial market repricing and USD liquidity shortages that are an issue for many businesses and many EM.
The economic contraction is sharper, quicker and may be more painful than the global financial crisis. Why? Unlike in the global financial crisis, which began as a financial shock that hit the real economy as businesses and households could not access credit, this emerged as a real economy shock – a health shock and quarantine policies. It then bled to the financial system rather than other way around due to reassessment of earnings, revenues and ability to pay.
Several sectors are most affected – energy and basic materials, all in person services (including travel, tourism, cultural and sporting events). However all other sectors are affected – productivity is weaker across the broader economy as people work from home and face additional childcare requirements,, health care is under strain due toloss of money-making surgeries and even strong companies have challenge accessing credit. This may reinforce the pre-existing weakness of capital investment which reflected trade and tariff uncertainty.
Even within services the impact is divergent. The composition shift – to basic consumer goods, especially good and delivery services. While manufacturing struggles, it’s the service supply chains, a big area of economic growth, activity, taxes and employment that look worse off. Those were sectors that were more resilient in 2019 when recession went into near recession. The full economic hit will depend on how quickly the virus can be contained, and when and what sort of economic activity restarts. The most resilient countries are those with the capacity to encourage employers to keep people on payroll even if not working or provide a financial safety net. Still, the patterns of consumption are unlikely to
Shutdowns in India, South Africa and other emerging market economies follow shutdowns across most of the advanced economies. Even countries which were more targeted in their closures and quarantines like South Korea and Japan, have faced sharp drops in local consumption and retail demand as well as facing supply chain issues and the weakness in their exports. Weaker growth has increased pressure on government financing in emerging economies. While revenues are down across the board, its only in EM where major currency declines and interest rates increase financing costs. In DM low rates have kept interest rates from spiraling, facilitating major financial lifelines.
China provides an important test case. Economic data out of China from February and March suggests a very sharp contraction, much worse than in the global financial crisis, while more recent data suggests that the restart of the economy has been more modest. With many Chinese trading partners on life support, China will struggle to restart to the same extent as if the global economy was stronger. China’s crisis response and revival has reinforced the role of state-owned enterprises and government within the economy – a trend that’s likely to be true across some other jurisdictions such as the GCC. China’s also been able effectively to do loan delays for business and to a much lesser extent households.
These policy moves and the lack of global coordination will likely deepen US and Chinese distrust, increasing deglobalization risks. Chinese policy response at home has been somewhat measured – no big stimulus like 2009, in part because of fears of exacerbating debt burdens and increasing liquidity too early. Arguably this policy mix also helped facilitate a more stable Chinese currency. Overall the policy stance – modestly supportive, contrasts with bigger lifelines in developed economies. What’s also notable is that China has been limited in its
Oil producers face a particular vulnerability and security challenge to US global and security. The most vulnerable economies include – Iraq, Algeria, Nigeria, Angola, Libya Ecuador– and sanctioned Venezuela and Iran. Oman and Bahrain -. All of these economies lack meaningful financial savings and were already running a major fiscal deficit even with oil at 70. They will struggle to maintain spending, distribute wealth and deliver basic services – amplifying political challenges. Countries like UAE, Qatar, Kuwait and even Russia are somewhat better off. In this crisis unlike past oil shocks – local domestic demand or non-oil economy helps less – as these countries are facing their own shutdowns and declines in tourism. Russia – because sanctions proofing its economy has reduced capital needs. While Russia has only been surviving, its balance sheet is stronger than in 2014 and 2008, though this shock is of a different nature. . Saudi Arabia stands somewhere in the middle – plenty of liquid assets for now, but likely to draw to draw them down sharply.
This doesn’t bode well for a quick resolution of the oil war as both KSA and Russia look to force higher cost producers – US, Canada, Brazil among them – to adjust. Should they follow with production gains, they will outrun storage capacity very quickly. A face-saving resolution may not be possible until late in Q2. This suggests oil prices have more downside risks, as does associated credit.
Typically weak oil prices help importers – this is less likely this time around given the demand collapse and financing challenges.
The big emerging economies are now on some form of lockdown– South Africa, Argentine, Malaysia and one of the most populous economies India – have less scope for stimulus than their DM counterparts. These countries had already used up policy space and have been currency pressures. Others like Mexico and Brazil are headed that way too, While many import bills have shrunk in recent years due to lack of growth, these countries will struggle to access capital and some dollar funding pressures persist. there’s an important role for IMF and Multilateral development bank funding to help avoid fiscal cuts, support health systems and maintain long-term investment. Recent plans call on bilateral creditors to excuse debt payments – this would help but would be insufficient. There’s also a role to avoid excessive trade protectionism that drives up cost of medical equipment globally. 50 countries and counting have engaged in some restrictions.
So far there has been talk of global policy coordination – including at this week’s G20 – pledges to unroll fiscal measures, global central banks have cut rates or provided liquidity at unprecedented rates – even more than in the GFC. However, details about the coordination are still lacking – and whatever it takes is still put to the test. Fighting the virus, maintaining political stability and addressing costs will be painful. Expect a weaker new normal and the lack of global and in some cases regional coordination will leave scars.
Ziemba Insights 