Covid-19 is on the verge of becoming the first pandemic viral outbreak of the 21st
century, with cases now showing up across the world. The outbreak comes at a time of slow economic growth and geopolitical tensions, such as the US-China trade conflict. Nevertheless, we expect the negative economic impact of the epidemic to recede in the coming months. In China, draconian quarantine measures have helped contain the spread of the virus. Warmer seasonal weather could also help in the coming months. Co-ordinated monetary and fiscal intervention, combined with exceptional micro-economic management, will also be needed to stave off disaster.
What economic impacts do we expect?
Supply problems in China were already visible in some sectors before the outbreak in Italy. Now the arrival of the virus on European soil threatens to inflict direct damage on the continent’s economy. The first victim will be tourism, a major revenue source for many southern European countries still struggling with the legacy of the European debt crisis (Greece, Italy, and to a lesser extent Spain and Portugal). The European Union’s more industrialised countries could be hit by supply chain problems and falling demand, as consumers retrench and business investment plans are shelved.
In Japan, the outbreak comes on the heels of last October’s ill-timed value-added tax increase and slowing economic growth. China was already slowing before the outbreak as the trade conflict and efforts to improve company balance sheets took their toll on growth. The draconian quarantine measures had a large impact on industrial production. The China Caixin manufacturing Purchasing Manager Index published by IHS Markit on 2nd
March showed a sharp fall in in activity during February. Chinese businesses are now struggling to get production back up to speed. U.S. economic growth is holding up for the time being, but this is largely dependent on consumers continuing to spend.
Economic growth is expected to fall in the first half of 2020, although estimates about how much vary widely. The big question is how long it will take before things get back to normal again. Part of the lost output should be recovered quickly if the current production standstill ends quickly. However, the longer the situation persists, the harder this will be, as cash flow problems could push heavily leveraged businesses into insolvency. For example, the French shipping company CMA is experiencing financial difficulties and could be indicative of a much wider problem.
The Chinese playbook holds an important positive lesson: the quarantine measures that created such constraints on production appear to have been successful in containing the spread of the virus. China’s rate of recorded new infections has decreased sharply from the crisis high of more than 3,000 per day in the first week of February to just 125 on March 2. Recent economic data indicate that China is gradually getting back to work, albeit more slowly than originally hoped. And if we are lucky, warmer seasonal weather might limit Covid-19’s spread, as many virologists expect – although nobody knows for certain. As for a vaccine, that could take at least a year to arrive, despite hopeful speculation in the media.
A recovery is likely, but governments need to help
Our base scenario envisages a recovery over the course of the second quarter, when we expect the spread of the virus and fatalities to slow. However, this scenario depends on two important assumptions. First, it would need a gradual drop in infection numbers toward the end of March. Secondly, it would require a co-ordinated effort by the authorities to contain the economic impact. This time, the effort cannot be left only to central banks, although they will have a role in the containment effort. The US Federal Reserve reduced interest rates by 0.5% on the 3rd
March. Other central banks may follow their lead. More support from governments is also critical. For example, will Germany may finally drop the ‘black zero’ brake on debt designed to ensure a balanced budget?
Much in the same way that governments stepped in to save the banking system from collapse in 2008, they may now need to support hard-hit business sectors to avoid lasting damage to the economy. Again, the Chinese playbook may hold some useful examples, such as cuts in value-added tax for small firms, exemption from penalties on late payments, and easier roll-over of existing loans. For that, the authorities need to get their act together, and we can only hope that history repeats itself and the prospect of impending economic disaster focuses the minds of bickering European and US politicians. Another longer-term impact of the crisis might be a rethink by business of its dependence on cheap but complicated and thinly-stretched supply chains. The coronavirus may have driven another nail into the coffin of globalisation, structurally changing the way businesses operate over the coming decade.
Our annualised GDP growth forecasts vs. Bloomberg consensus forecasts
Source: Quintet Private Bank and Bloomberg, 3 March 2020
Appendix: Covid-19 case fatality rate
We are learning more about the clinical impact of the virus. On 24th
February, China’s Centre for Disease Control and Prevention published the first large-scale study of 72,314 Covid-19 cases diagnosed in China. This included data up to 11th
February and showed 19% of those infected become seriously ill, with 14% developing serious pneumonia and 5% becoming critical cases suffering from respiratory or organ failure. About half of those becoming critically ill die; the total case fatality rate in this study was 2.3%. The study also showed that the risk of death increases sharply with age, probably as the infection compounds complications for people with pre-existing conditions such as cardiovascular problems, diabetes or cancer. The mortality rate amongst young children was zero and the fatality rate for people aged below 40 was 0.2%.