COVID-19: Nothing else matters

Are we headed for a global recession?

The impact of COVID-19 now extends much beyond China and its trading partners to the rest of the world, hitting major economies like the European Union and the US. We face the risk that the virus shock may persist – with outbreaks resuming in places that had brought the situation under control – or that we see major credit shocks, despite government interventions to limit economic upset and mass layoffs.

In this context, we predict global growth at 1.6 per cent for 2020, falling to levels not seen in 37 years (excluding the Global Financial Crisis). The second quarter is likely to be the worst for global growth as US and Europe disruptions hit a slowly recovering China. We foresee a global recession in the first half and a gradual recovery in the second.

We had originally expected growth to stabilise in 2020, supported by China’s fiscal stimulus, the lagged effect of last year’s rate cuts from central banks, inventory rebuilding and a global trade recovery. All of these support factors have now been delayed, and the loss to this year’s growth caused by COVID-19 will push the global economy into recession, in our view.

‘Whatever it takes’

The depth and duration of the recession will be determined by the speed and effectiveness of the policy response. The good news is that governments, particularly in Europe and the US are working on ultra-strong responses to cushion the blow. The ‘whatever it takes’ messaging from policy makers in the US and Europe shows how aggressive the fiscal policy response has become. Relative to monetary policy, it can more directly tackle the real-world challenges of businesses shutting down and laying off workers. As in all crisis situations, the three key areas to focus on are fundamentals, policy and confidence.

Substantial fiscal stimulus packages are being put together to respond to the shock, given past experience showing that early and aggressive action is most effective. Central banks around the world have embarked on aggressive easing, led by the US Federal Reserve’s 100 basis points emergency cut on 15 March. China already has a robust fiscal stimulus plan in place.

So, the policy response is unfolding; how effectively it is implemented will determine how quickly confidence can return to markets.

What’s ahead for the West?

We expect the second quarter to be the worst for US and euro-area growth, followed by a gradual recovery, with forecasts for the US and euro area now -0.3 per cent and -3.0 per cent, respectively.

This assumes that the stringent measures to slow the virus will cause months of weaker consumer spending and delayed durable-goods orders. A strong rebound in private-sector investment is also unlikely in the immediate aftermath of this shock.

What areas are most vulnerable? 

Despite policy stimulus, the real economy will continue to face challenges; the SME sector is particularly vulnerable to cashflow shocks as normal economic activity ceases. In most economies, SMEs account for 80 per cent or more of employment. Targeted measures from policy makers are vital to contain further spillover effects on their economies. The majority of workers in economies globally work for SMEs rather than large companies, so this crisis is a major social issue as well as an economic one.

Overall, corporate credit risks need government intervention, stepping away from the ‘moral hazard’ argument of liberal economies during normal times. This is particularly true for the US, where for the first time since the early 1990s, US corporate-sector debt is higher than household debt. In Singapore, Spain and Taiwan, the most highly leveraged companies have debt levels that exceed their Earnings before interest, tax, depreciation and amortization (EBITDA) by 12 times. For Hong Kong, corporate leverage is high but cash ratios remain healthy. Among the emerging economies, Turkey has the highest levels of corporate leverage.

What are we watching?

We are keeping abreast of government policy responses as they evolve, with a particular focus on services and manufacturing. With robust policy responses, we will be able to reduce the shock to both the global economy and individual markets, setting up to achieve recovery in due course.