Quantifying the Toll of Covid-19
The latest economic research from Atradius suggests global GDP may recover rapidly in 2021—but only if some key assumptions are met.
As Covid-19 spread around the world this spring and governments locked down their economies to slow the virus, both advanced and emerging-market economies suffered greatly. These lockdowns prevented nonessential businesses—such as restaurants, barbershops, and sports and arts venues—from opening their doors for an indeterminate period of time. They also prohibited many employees from traveling to work, even if working from home was not an option. As a result, a large swath of businesses, including many factories, were not able to operate.
This created a supply-side shock, as products and services could not be produced. On top of that, demand fell as workers lost their income and economic uncertainty climbed. Precautionary savings rose. Consumption fell. Businesses, facing lower demand and higher uncertainty, reduced capital expenditures. Falling equity prices exacerbated the situation, restricting financing opportunities. Indeed, even demand for many products and services that could still be produced in lockdown fell precipitously.
The ultimate result was a supply shock, in combination with a demand shock. The impact on countries’ gross domestic product (GDP) has been profound. In Q2/2020, the U.S. economy shrank at a quarterly rate of 9.5 percent, which translates into an annualized rate of 32.9 percent—the sharpest downturn since the U.S. Commerce Department began tracking quarterly GDP in the 1940s.
Nosedive in Global Trade
When Covid-19 struck, global trade was already ailing. The 2008–2009 financial crisis marked a turning point from a long-term average growth in trade of 5 percent annually. China started to produce more locally, transportation costs were no longer declining, and trade finance started to become scarce. On top of that, the United States launched a trade war with China in 2018.
As the global economy slid to its lowest growth since the Great Recession, trade growth turned negative in 2019, albeit marginally negative. By the end of last year, some hope had returned for better times ahead, as China agreed to buy a large volume of U.S. exports under “phase one” of a trade deal. Then Covid-19 hit.
First readings for 2020, available through the end of March, showed an even bleaker picture, with global trade contracting 1.2 percent for the first quarter. This was only the start. Analysis by the Atradius Economic Research team suggests global trade will shrink about 15 percent for the year. Still, our baseline scenario predicts a strong recovery in 2021.
This predicted drop in global trade is significantly larger than our current expectations for a 5 percent decline in global GDP over the course of the year. This tracks with Oxford Economics research, which shows that, in downturns, the fall in trade growth could be two to four times higher than the fall in GDP.
Plummeting Oil Prices Don’t Help
It would be an understatement to say that the widespread lockdowns have not gone unnoticed in the oil market. Whereas early in the year, the price of Brent crude hit US$70 per barrel, it plummeted to just $9 a barrel on April 21. The industry partially recovered by cutting production by 9.7 million barrels per day—abruptly ending the price war that Saudi Arabia and Russia started in early March. The agreement to limit production is expected to last well into 2022.
The pressure on oil prices was caused by a sharp drop in demand—by about 30 percent in April—as stay-at-home policies around the world reduced road and air traffic to unprecedented lows. Oil production, which is rather inelastic by nature, was unable to adjust quickly to the falling demand. Under normal circumstances, such low prices would lead to a rapid recovery in demand, but a bump in demand is not feasible during lockdown, so low oil prices continue.
Our baseline scenario does predict a partial recovery in demand for oil. Overall, oil demand for all of 2020 is expected to be about 8 percent lower than in 2019. As production and inventories shrink, though, we expect the price of oil to average around $50 a barrel in 2021. As lockdowns are slowly lifted around the world, oil producers will reap the benefits of higher consumption—but very gradually. It’s reasonable to expect prices to remain suppressed for the next year. (Take this forecast with a grain of salt. Oil-price forecasts are always surrounded by a high level of uncertainty, and the current circumstance calls for even more prudence than usual.)
In the immediate term, we expect any growth in demand for oil to disappear into what economists call “precautionary savings.” That is partly voluntary, due to uncertainty, and partly mandatory as the supply of certain services is simply limited under continued social distancing rules. Therefore, the low oil price is a negative for the global economy, for the time being.
Massive Government Interventions
To combat plunging consumer and business demand, governments and central banks in every region of the world moved quickly and aggressively to address Covid-19 fallout. Before the pandemic hit the West, central banks had already come back from their tightening stance, with the U.S. Federal Reserve softly increasing quantitative easing and the European Central Bank (ECB) implementing a Long Term Refinancing Operations (LTRO) III program. From there, Covid-19 forced central banks to ramp up monetary support significantly.
Global governments have also committed to drastically increasing spending. Their goals with these interventions are to limit short-term damage to GDP and, perhaps more important, to suppress what economists call “hysteresis”—the prospective long-term damage to economic networks and skill sets of workers and entrepreneurs that could result from a prolonged economic shutdown. Their massive financial commitment equates to a combined total of around US$7.8 trillion, or nearly 9 percent of global GDP.
The obvious first step for governments is to help businesses and workers by providing liquidity support. This can be done for workers in the form of government-paid sick and family leave, transfers, unemployment benefits, wage subsidies, and deferral of tax payments. For companies, especially small to midsize businesses, it can take the form of the government providing liquidity to reduce the risk of bankruptcy.
As lockdowns are lifted, governments need to instill confidence through initiatives that reinvigorate the economy. The role of government is then to get private investments on track in areas such as healthcare and education—with direct financial support, if needed. Governments coming out of lockdown should also accelerate planned spending on infrastructure projects. Finally, they can use the tax system and unemployment benefits to help stabilize firms’ and households’ spending.
China, careful to avoid running up too much more debt, provided tax relief for citizens. It is also encouraging borrowing among small to midsize enterprises through state-backed credit guarantees and delayed loan and interest payments. Meanwhile, India has committed to spend 10 percent of its GDP on healthcare, and to provide cash to low-income households and small businesses.
All this government support directed at alleviating the pain of the lockdowns is necessary, but it is not sufficient. The next step is designing policies that reinvigorate local, national, and regional economies—and such policies are currently in short supply. The exception is the US$2 trillion EU Pandemic Fund, initiated by France and Germany and approved late last month. It will distribute grants and loans to the countries and sectors most impacted by the coronavirus pandemic, which will help economies in hard-hit southern countries recover at a rate similar to that of other EU member states.
Such fiscal policy intervention has clear consequences for the national balance sheet. Indeed, the additional spending in 2020, in combination with the sharp drop in GDP, has already pushed government balances toward levels that were difficult to imagine at the time Atradius released our “November 2019 Economic Outlook.” In our new baseline scenario, the U.S. federal budget deficit, as a proportion of GDP, will increase by more than 10 percentage points this year. We expect the deficit growth rate in the U.K. to be even higher, at 13 percentage points.
Is this the time to be worried about growing government debt? Looking at the increase in debt-to-GDP ratios, one may be inclined to answer in the affirmative. A number of countries already have high to very high levels of debt, and the pandemic response is pushing these levels even higher. Germany will soon be unable to meet the (formal) EU norm of debt equaling 60 percent or less of GDP, a target that has already been out of reach for many European countries for quite some time. Only China and India are likely to keep government debt ratios at modest levels through the Covid-19 crisis.
Still, before panicking, we should consider two mitigating factors. First, interest rates are exceptionally low and are bound to stay at these levels through the end of 2021 (our forecast period). And second, central banks are acting as “buyers of last resort” for government debt. This implies that Italy—which already had a debt-to-GDP ratio of close to 150 percent in 2019—can safely continue issuing bonds, knowing the ECB will buy them if necessary. Absent the ECB, matters would look much worse for Italy and the entire Eurozone.
How Things Could Get Worse
Our baseline scenario for the short term includes a deep recession from which we begin to recover in late 2020, and a relatively strong recovery starting early next year. It’s important to keep in mind that we’ve built this scenario on a series of assumptions. If our underlying assumptions are not met, things could get worse. For example, we assume that medical researchers will find a vaccine, or else global leaders will find a way to overcome the effects of social distancing on their economies, by early 2021 at the latest. We also assume that lockdowns peaked in the second quarter of 2020 and will continue to gradually ease from here forward—but a strong second wave of infections could quickly undercut this trend. Finally, we assume that low oil prices will continue and that the U.S.-China trade war will not resume while both countries struggle to contain the economic impacts of the pandemic.
Based on all these assumptions, we predict that the global economy will contract by 5 percent overall in 2020, and that U.S. GDP will fall by 6.1 percent this year. The primary reason is that the United States has trailed much of the world in getting the virus under control. The U.S. tops the list when it comes to the absolute number of Covid-19 cases, accounting for 5.7 million of the world’s 22.5 million confirmed cases, as of this writing. Per inhabitant, the U.S. is worse off than the EU as a whole, but the U.K., Spain, Italy, and Sweden have all experienced a higher rate of deaths per million inhabitants.
Like the rest of the world, the United States has found that lockdowns designed to counter the spread of the virus have wreaked havoc on the economy. Job losses are running over 40 million, pushing the unemployment rate to 13.3 percent—from a low of 3.5 percent—in just four months. In addition, disposable income in the U.S. fell by 2 percent in March alone, due to reduced number of hours worked and salary reductions.
These employment trends mean that consumption—which is usually the pillar of U.S. GDP growth—is unlikely to contribute to growth this year. Q1 data shows a 7.6 percent quarter-over-quarter decline in consumer spending, particularly on cars, clothing and recreation, accommodation, and specific healthcare spending. The drop in spending was partially caused by lack of supply, but also due to a state of mind that can best be described as “economics of fear.”
Despite this grim picture, our baseline scenario projects a 6.5 percent rebound in global GDP, and 6.3 percent growth in U.S. GDP, next year. Such a recovery would be good news for governments, businesses, and consumers around the world. But achieving it will require our key assumptions to be pan out. If widespread lockdowns remain in place well into the third quarter, the global economic contraction will be deeper and longer than we’ve forecast. The economic contraction would extend later in the year, which would mean larger declines in global and domestic GDP than our baseline scenario predicts. Moreover, recovery in consumer and business spending would be slower, as the virus would have done more damage to the confidence of businesses and households.
Another concern is that government support has clear limits. The surge in government debt, in countries around the world, will push up spreads and stoke fears of financial-market distress. That, in turn, will give rise to more pronounced tightening of finance costs, compounding the spending restraint.
Under this scenario, we would expect to see a much deeper recession in 2020, with contraction rates more than doubling compared with the baseline. For the global economy, this downside scenario predicts a 12.2 percent contraction in all of 2020, vs. the baseline scenario’s 5 percent decline. No regions would escape the pain, but the impact of the downside scenario would be muted on the United States, moving from our baseline 6.1 percent drop in GDP to a 7.9 percent decline.
This would represent a massive hit to the global economy. However, we would expect 2021 GDP growth rates in this downside scenario to remain similar to those in our baseline scenario.
Any way we slice it, the next year will be very challenging, at the level of national governments, corporate management teams, and even personal household finances. Advanced and emerging markets alike face a sharp economic contraction through the end of this year, and the possibility of a V-shaped recovery in 2021 is surrounded by a high level of uncertainty.
The entire world is truly in this together—which may or may not provide any solace for treasury and finance teams trying to ensure their businesses have liquidity to weather the storm.