By Rashna Mahzabin
Quarantined World Economy
Pandemics are large-scale outbreaks of infectious disease that can greatly increase morbidity and mortality over a wide geographic area and cause significant economic, social, and political disruption. The World Health Organization (WHO) has officially declared the outbreak of COVID-19 a pandemic, after the disease caused by the new coronavirus, spread to more than 100 countries and led to tens of thousands of cases within a few months. At the time of writing this article, there are 218,815 confirmed cases of coronavirus worldwide and the death toll is 8,810. The virus can be deadly for people who already have a compromised immune system and battling with other physical problems.
The last pandemic the world has seen is the influenza outbreak in 1918. Since then the world has become globally connected and the economies have become intertwined; which means if a country falls, all the countries related to it also face the heat, even if indirectly or partially. In the case of coronavirus, not one but the majority of the world is faced with the challenge.
WORLD ECONOMY VS CORONAVIRUS
Economics is secondary to the health consequences for any pandemic that has a significant fatality rate (as coronavirus so far appears to have). The economics are important in their own right and as a warning to avoid drastic measures that do not influence the number of deaths, but beyond that, there is no meaningful trade-off between preventing deaths and losing some percentage of gross domestic product for less than half the year.
As the world grapples with the coronavirus, the economic impact is mounting – with the OECD warning the virus presents the biggest danger to the global economy since the 2008 financial crisis. UNCTAD, the UN trade agency, warned of a slowdown of global growth to under 2% this year, effectively wiping $1 trillion off the value of the world economy. A poll of economists by the London School of Economics found 51% believed the world faces a major recession, even if COVID-19 kills no more people than seasonal flu. Only 5% said they did not think it would. Businesses are dealing with lost revenue and disrupted supply chains due to China’s factory shutdowns. Weeks after China imposed travel restrictions on millions of its people, Italy placed quarantine measures on its entire population, with France and Spain imposing similar measures and many other European countries restricting movement and business activity. On 11 March, some key industries in Wuhan were told they can resume, a day after Chinese President Xi Jinping visited the city for the first time since the outbreak began.
Here are few ways the virus outbreak is creating ripples around the world:
Falling Stock Oil Prices:
To combat the economic fallout, the US Federal Reserve on 15 March cut its key interest rate to near zero.
But the move, coordinated with central banks in Japan, Australia and New Zealand in a joint-effort not seen since the 2008 financial crisis, failed to shore up global investor sentiment, with oil prices dipping below $30 a barrel on 16 March, and a 9% slump in share values when Wall Street opened.
China is the world’s biggest oil importer. With coronavirus hitting manufacturing and travel, the International Energy Agency (IEA) predicted the first drop in global oil demand in a decade.
“Covid-19 (coronavirus) has spread beyond China and our 2020 base case global oil demand forecast is cut by 1.1 mb/d. For the first time since 2009, demand is expected to fall year-on-year, by 90 kb/d,” the IEA said in its monthly report for March 2020.
On 9 March, oil prices lost as much as a third of their value – the biggest daily route since the 1991 Gulf War, as Saudi Arabia and Russia signaled they would hike output in a market already awash with crude, after their three-year supply pact collapsed.
“A WHO declaration of global emergency and U.S.-EU traffic ban is dampening the global energy demand outlook, in conjunction with an intensified price war between Saudi and Russia,” Margaret Yang, market analyst at CMC Markets in Singapore, told Reuters. “Bears are dominating the oil market and there might be more downside before a bottom can be reached.”
Anyone hoping cryptocurrencies might prove a safe haven was disappointed. Bitcoin lost more than 30% of its value in the five days to 12 March, Reuters reported, outpacing losses for stocks and oil. “We’ve seen de-risking across all asset markets,” said Jamie Farquhar, portfolio manager at London-based crypto firm NKB. “Bitcoin is certainly not immune to that.”
Impact on Air Travel:
On 5 March – before the US travel ban was announced – the International Air Transport Association (IATA) predicted the COVID-19 outbreak could cost airlines $113 billion in lost revenue as fewer people take flights.
“The industry remains very fragile,” Brian Pearce, the IATA’s chief economist, told the Associated Press. “There are lots of airlines that have got relatively narrow profit margins and lots of debt and this could send some into a very difficult situation.”
On March 16, British Airways said it would cut flying capacity by at least 75% in April and May. Other UK airlines, including Virgin Atlantic and easyJet also announced drastic cuts.
In most of the African countries flights from Europe, Asia and the USA are banned. Countries that give visas on arrival have stopped till further notice is published.
Production Fall:
Production in China, USA, Italy, Spain has stopped because of quarantine. The countries are in lockdown hence all the production is halted all over. China, being the number one manufacturer country, is facing the back lash. The manufacturing sector in China has been hit hard by the virus outbreak. The Caixin/Markit Manufacturing Purchasing Managers’ Index — a survey of private companies — showed that China’s factory activity contracted in February, coming in at a record-low reading of 40.3. A reading below 50 indicates contraction.
Such a slowdown in Chinese manufacturing has hurt countries with close economic links to China, many of which are Asia Pacific economies such as Vietnam, Singapore and South Korea.
Factories in China are taking longer than expected to resume operations, several analysts said. That, along with a rapid spread of COVID-19 outside China, means that global manufacturing activity could remain subdued for longer, economists said.
Downgrades in economic forecasts:
The outbreak has led major institutions and banks to cut their forecasts for the global economy. One of the latest to do so is the Organisation for Economic Co-operation and Development.
In a March report, the OECD said it downgraded its 2020 growth forecasts for almost all economies. China’s gross domestic product growth saw the largest downgrade in terms of magnitude, according to the report. The Asian economic giant is expected to grow by 4.9% this year, slower than the earlier forecast of 5.7%, said OECD.
Meanwhile, the global economy is expected to grow by 2.4% in 2020 — down from the 2.9% projected earlier, said the report.
2020-2021 WORLD ECONOMY
Growth prospects are very uncertain this year. The projections are based on the assumption that the epidemic peaks in China in the first quarter of 2020, with a gradual recovery through the second quarter aided by significant domestic policy easing. Together with the recent marked deterioration in global financial conditions and heightened uncertainty, this will depress global GDP growth in the early part of the year, possibly even pushing it below zero in the first quarter of 2020. Even if the COVID-19 effects fade gradually through 2020, as assumed, illustrative simulations suggest that global growth could be lowered by up to ½ percentage point this year. New cases of the virus in other countries are also assumed to prove sporadic and contained, but if this is not the case, global growth will be substantially weaker.
On this basis, global GDP growth is projected to slow from 2.9% in 2019 to 2.4% this year, before picking up to around 3¼ per cent in 2021 as the effects of the coronavirus fade and output gradually recovers. Announced and implemented policy actions incorporated in the projections will help to support incomes in the near term, particularly those well-targeted on affected firms and households.
Macroeconomic policy stimulus in the most exposed economies will help to restore confidence as the effects of the virus outbreak and supply-side disruptions fade. Low interest rates should help cushion demand, although the impact of recent and projected changes in policy interest rates on activity is likely to be modest in the advanced economies. Fiscal policy easing will also help in Asian economies, but it appears likely to be more restrictive than desirable in many others, particularly in Europe, given soft growth prospects and low borrowing rates.
Household spending continues to be underpinned by improving labour market conditions, but slowing job creation is likely to weigh on income growth, and persistent weak productivity growth and investment will check the strength of real wage gains. Uncertainty is likely to remain elevated, with trade and investment remaining very weak. The downturn in financial market risk sentiment, and reductions in business travel and tourism are also likely to constrain demand growth for some time.
Prospects for the major economies are mixed:
Prospects for China have been revised down markedly in 2020, with calendar year GDP growth projected to be just under 5%. Calendar year growth in 2021 is correspondingly pushed up to between 6¼-6½ per cent, with the level of output through 2021 broadly in line with what would have been projected in the absence of the coronavirus outbreak. A similar, albeit less pronounced, pattern is projected in many economies strongly interconnected with China, including Japan, Korea, Australia and Indonesia.
The effects of the coronavirus outbreak on other economies less heavily integrated with China are projected to be relatively mild, particularly in the United States and Canada, although the decline in confidence, disruption to supply chains and weaker external demand will moderate growth prospects.
Growth in the euro area is projected to remain sub-par, at around 1% per annum on average in 2020-21, although the impact of the virus outbreak will weaken outcomes in the first half of 2020. The projections for the United Kingdom and the euro area are based on an assumption that a basic free trade agreement for goods comes into force from the start of 2021. Even if this is implemented smoothly, the higher costs for service exports and non-tariff administrative barriers are likely to weigh on exports and output growth through 2021.
A gradual, albeit modest, recovery in many emerging-market economies is projected for 2020-21, but the extent of this recovery is uncertain. An upturn will require a positive impact from reforms and monetary policy support in India and Brazil, well-focused policy measures in Mexico and Turkey to boost sustainable growth, and a gradual recovery in commodity exporters exposed to the slowdown in China this year.
DOWNSIDE RISKS
Growth could be weaker still if downside risks materialise. In the near-term, the major downside risk is that the impact of the coronavirus proves longer lasting and more intensive than assumed in the projections. In the event that outbreaks spread more widely in the Asia-Pacific region or the major advanced economies in the northern hemisphere, the adverse effects on global growth and trade will be much worse and more widespread. Illustrative simulations of this downside risk scenario suggest that global GDP could possibly be reduced by 1½ per cent in 2020, rather than by ½ per cent as in the base-case scenario. A larger decline in growth prospects of this magnitude would lower global GDP growth to around 1½ per cent in 2020 and could push several economies into recession, including Japan and the euro area. The overall impact on China would also intensify, reflecting the decline in key export markets and supplying economies.
Other important downside risks include:
Trade and investment tensions remain high and could spread further. The prospects for a further trade deal between the United States and China that would remove all the remaining tariffs put in place over the last two years are uncertain. In addition, other bilateral trade tensions could also still spread, notably between the United States and Europe. Failure to achieve a prompt resolution to the current disruption to WTO dispute settlement procedures would also add to global trade policy uncertainty. A particular concern is that trade and investment restraints may be used as levers in negotiations about taxation of global corporations and other non-trade-related issues.
Uncertainty remains about the future UK-EU trading relationship and whether negotiations on this can be completed before the end of the transition period set out in the withdrawal agreement (currently end-2020). The possibility that a formal trade deal will not be agreed remains a downside risk and a source of uncertainty. If trade between the United Kingdom and the European Union were to revert to WTO terms after 2020, instead of a basic free trade agreement for goods as assumed in the projections, near-term growth prospects would be significantly weaker and more volatile. Such effects could be stronger still if preparations to border arrangements failed to prevent significant delays, or if financial market conditions and consumer confidence were to deteriorate considerably.
The recent sharp reaction in financial markets to the spread of the coronavirus in late February adds to the persisting financial vulnerabilities from the tensions between slower growth, high corporate debt and deteriorating credit quality, including in China. Globally, just over half of all new investment grade corporate bonds issued in 2019 were rated BBB (the lowest investment-grade rating) and a quarter of all non-financial corporate bonds issued in 2019 were non-investment grade. These developments raise the risk of significant corporate stress if risk aversion intensifies from already high levels, especially in event of a sharp economic downturn. In such circumstances, current BBB-rated bonds could be downgraded to non-investment grade, with the associated enforced sales amplifying the financial market effects of the initial downturn triggered by the coronavirus spread.
COULD COVID-19 CREATE ITS OWN STRUCTURAL LEGACY?
History suggests that the global economy after a major crisis like Covid-19 will likely be different in a number of significant ways.
Microeconomic legacy: Crises, including epidemics, can spur the adoption of new technologies and business models. The SARS outbreak of 2003 is often credited with the adoption of online shopping among Chinese consumers, accelerating Alibaba’s rise. As schools have closed in Japan and could plausibly close in the U.S. and other markets, could e-learning and e-delivery of education see a breakthrough? Further, have digital efforts in Wuhan to contain the crisis via smart-phone trackers effectively demonstrated a powerful new public health tool?
Macroeconomic legacy: Already it looks like the virus will hasten the progress to more decentralized global value chains — essentially the virus adds a biological dimension to the political and institutional forces that have pushed the pre-2016 value chain model into a more fragmented direction.
Political legacy: Political ramifications are not to be ruled out, globally, as the virus puts to the test various political systems’ ability to effectively protect their populations. Brittle institutions could be exposed, and political shifts triggered. Depending on its duration and severity, Covid-19 could even shape the U.S. presidential election. At the multilateral level, the crisis could be read as a call to more cooperation or conversely push the bipolar centers of geopolitical power further apart.
WAY FORWARD
Against the background of an already weak global economy and downside risks, the near-term challenges from the coronavirus outbreak reinforce the need for policy actions to contain the spread of the virus, strengthen health care systems, boost confidence and demand, and limit adverse supply effects. Multilateral policy dialogue is essential to agree on appropriate containment and policy measures to restrict the spread of the coronavirus and limit its economic costs. If growth were significantly weaker than projected, co-ordinated policy action within and across all the major economies would provide the most effective and timely counterweight.
An immediate need in all economies, but especially those most affected by the COVID-19 epidemic, is for effective public health measures that prevent infection from spreading. Well-targeted economic policies are required to help support health care provision, and protect solvent companies and workers from experiencing significant temporary income disruptions because of the coronavirus outbreak.
First and foremost, additional fiscal support for health services is required, including sufficient resources to ensure adequate staffing and testing facilities, and all necessary prevention, containment and mitigation measures.
Measures can also be taken to cushion adverse effects of the outbreak on vulnerable social groups. Short-time working schemes, where available, can be utilised to enhance the flexibility of working hours whilst preserving jobs and take-home pay, although such schemes do not protect temporary or migrant workers from lay-offs. Governments can also help households by providing temporary assistance, such as cash transfers or unemployment insurance, for workers placed on unpaid leave, and by guaranteeing to cover virus-related health costs for all, retrospectively if needed.
In the very short term, the provision of adequate liquidity in the financial system is also a key policy, allowing banks to provide help to companies with cash-flow problems, particularly small and medium-sized enterprises, and ensuring that otherwise solvent firms do not go bankrupt whilst containment measures are in force. Measures that reduce or delay tax or debt payments, or lower the costs of inputs such as energy, for firms in the most affected regions and sectors should be considered. Temporary reductions in the level of reserves banks are required to hold at the central bank could also be implemented if required. Swap lines between major central banks may also need to be utilised, particularly if widespread disruption to trade or a flight to safety by portfolio investors enhances the demand for US dollars.
In addition to allowing the automatic fiscal stabilisers to work fully, and expanding spending on health services, targeted and temporary fiscal measures could also be implemented to support businesses in sectors particularly exposed to a sharp downturn in travel and tourism. Funds established to reintegrate workers who have lost their jobs due to globalisation could also be utilised. In the European Union, other potential options are to adapt temporarily the state aid framework, as was done at the height of the financial crisis in 2008-09, or to allow more leeway within the EU fiscal rules to affected economies, in recognition of the exceptional circumstances.
More broadly, lower policy interest rates and stronger government spending can help boost confidence and assist with the recovery of demand once the outbreak eases and travel restrictions are removed. However, such measures are less effective in dealing with the immediate supply-side disruptions that result from enforced shutdowns and travel restrictions.
In China, a wide range of fiscal (including quasi-fiscal) and monetary policy actions have been announced over the past month, as appropriate given the adverse shock to the economy, and should help demand to recover as restrictions on labour mobility are lifted. Scope remains for additional measures if growth weakens further or if policy instruments are less effective than in the past, but careful choices are needed to avoid adding to structural problems such as high corporate debt and ongoing deleveraging challenges.
Additional precautionary reductions in policy interest rates may also be merited in a number of economies particularly exposed to the coronavirus outbreak, including Korea and Australia. Such measures can help to restore confidence and reduce debt-servicing costs.
Stronger government investment spending, particularly bringing forward planned repairs and maintenance of the public sector capital stock, could be utilised to help provide a short-term stimulus.
