These are, without doubt, the worst of economic times. Not since the Great Depression of 1929-31 have we seen such peacetime disruption to the global economy and financial markets.
Perhaps most unsettling is that the scale of the impact is still very unclear. Standard Chartered’s predictions for 2020 global GDP growth were set at -0.6 per cent at the beginning of Q2. This, however, assumes that the disruptions to economic activity mostly fall in Q2.
“Our estimates are based on one-month lockdowns, which we are currently seeing across much of the world,” David Mann, the Bank’s Global Chief Economist, commented during a recent live webcast with clients. If these lockdowns persist – a significant possibility – then the outlook is likely to be far worse.
Many questions remain. How disruptive will these lockdowns be? How long will they last? Will the virus come back in fuller force? We all grapple with these questions daily. What we can say is that the strength of governments’ reaction – and specifically their capacity to implement rescue policies – will likely determine the fate of the global economy.
Policy response: Whatever it takes
With normal economic activity grinding to a halt in most economies by end-Q1, the policy response was understandably aggressive. Rapid ramping up of quantitative easing (QE), credit easing, and repo arrangements were quickly announced – both to support the flailing economy and to stop the rapid liquidation of financial assets.
The latter was a critical first step. “Without efforts to slow the sell-off, economic policy thereafter would have been far less effective,” Eric Robertsen, Global Head of FX, Rates and Credit Research at Standard Chartered, said during the webcast.
Moving into Q2, the “dovish wave” cited in the Bank’s 2019 economic outlook had swelled into a “policy tidal wave”, according to Mann. For the G3 central banks, the QE programmes now being implemented make those of the recent decade appear tame.
Such aggressive monetary policy is entirely justified, Mann and Robertsen argued. Yet beyond this initial economic support, governments need to act quickly on the fiscal front too, taking a leading role in job protection. SMEs – which account for most private sector jobs globally – are at real risk of sudden bankruptcy. Immediate government action will be critical.
“Even in developed markets, small businesses are extremely fragile under such conditions,” added Mann. In the UK, for example, one-fifth of small businesses could go bankrupt after just one month of economic shutdown, according to one survey1.
Emerging markets are beginning to see the economic impact now, but are expected to face an even bleaker story. With typically weaker health systems and with large proportions of workers in the shadow economy, some governments will struggle to give their people and the economy the support needed. Unsurprisingly, 80 developing countries have already sought financial support from the IMF.
China: A model for recovery?
Standing apart from its emerging-market counterparts is China. As the key driver of global GDP growth in normal economic times, following its recovery precedent largely makes sense – especially given that it was the first to be hit by the COVID-19 outbreak, argued Mann.
Taking China as a guide, the good news is that the current figures look promising. Standard Chartered’s monthly survey of 500 China-based SMEs showed a bounce-back in March. PMI figures showed a similar rebound in sentiment.
China’s market performance is also cause for optimism, with both the bond market and the currency demonstrating relative stability since late February, according to Robertsen.
Yet the sustainability of the country’s current economic and financial steadiness is far from assured. First, we can’t assume China won’t see a resurgence of COVID-19 cases. And even if China recovers well in Q2 (as the Bank currently expects), its medium-term economic growth is likely to be impacted by the now-looming global economic depression – bringing the question of its global trade connectivity back into the limelight.
Trade war: A backwards step?
Prior to the outbreak, trade-war tensions between the United States and China appeared to be waning. Now, this progress looks set to be another casualty of COVID-19.
“The positive impact of the phase one trade deal has diminished, not least because the US is now in a deep recession,” said Mann. Political tensions are now likely to resurface, spilling over into a health debate and a probable ‘blame game’.
This relationship setback is hard to quantify, and the knock-on impact on global supply chains compounds this concern. According to Mann, the scale of the health, social and economic shock from COVID-19 has brought entire global supply chains into question.
“We are now all wondering – are they too complex? Too exposed? Will this trigger a wave of anti-globalisation around the world?”
This is something businesses will need to assess looking ahead, according to views shared on a recent Standard Chartered webcast on COVID-19’s impact on global supply chains. Businesses must evaluate their supply concentration risks and consider opportunities and ways of working previously set-aside, to strengthen their resilience to such huge shocks.
Darkest before the dawn
With so much unknown, this is not the time to chase risky assets, according to Robertsen. Yet there are some pockets of good value at present. The fundamental case for holding gold remains intact, in the Bank’s view. In currencies, some emerging markets may offer opportunities against the backdrop of declining oil prices. And as mentioned, China’s fixed-income markets are looking relatively stable in such times.
Yet it’s important to remember that the full extent of the downturn is yet to be measured. The Bank’s projection is that Q2-2020 will be worse than any single quarter during the global financial crisis (GFC).
For Robertsen, the biggest concern will be the ability of both corporates and consumers to service their debts. “As economies and labour markets slow, people and businesses will find their debts increasingly unmanageable,” he said.
Banks can come to (and be directed to) the rescue in the medium term – but cash flow will soon become a major concern, especially given that stretched leverage was already a worry for many developed economies prior to the outbreak. “We’ll be watching the narrative on potential defaults extremely closely,” Robertsen added.
Central banks will need to focus all their efforts on limiting a mass default outcome. But the most critical element will be implementation. “Speed will be everything,” urged Mann.
And while governments grapple with their immediate responsibilities, longer-term challenges also need to be faced. Even if government efforts are strong enough to support jobs and control defaults, they have limited control over consumer sentiment. In China, despite the end-Q1-recovery in PMIs and SME sentiment, the service sector – which now makes up the largest part of the economy – is still struggling to recover.
The ‘are we out of the woods yet?’ psychology will weigh on everyone’s minds for some time to come.