How will COVID-19 affect the global economy?

Global economy: Whatever it takes

The shock from Covid-19 represents an unprecedented hit to both supply and demand: the former as the containment measures adopted in many countries disrupt global value chains and reduce the supply of labour; and the latter as, for example, households retrench their travel and recreational spending.

We have already concluded that this shock will push the global economy into a recession. This update to our global forecasts provides more precise figures, though in the current circumstances any forecast is inevitably subject to unusually high levels of uncertainty, implying an unusually low degree of confidence in any point forecast or even forecast ranges. Nevertheless, we think the exercise provides a helpful benchmark against which to evaluate upcoming news flow.

Assumptions about control measures and policy responses:

Our starting point is to assume that measures to limit contagion, such as social distancing, where not already applied, will be implemented in all countries hit by contagion, albeit in different forms and to different extents. Even in the absence of explicit containment measures, we assume a significant shift in consumer behaviour, with a sharp fallout in demand for tourism, recreational activity and other non-essential services.

Specifically, we assume that the measures will remain in place for about four to six weeks before being relaxed over time as the peak of the virus is reached and the situation improves. Key risks here include a longer implementation period and/or further waves of contagion as restrictions are lifted. The three waves of the so-called Spanish flu, for example, lasted from March 1918 to the summer of 1919.

The second assumption is that policymakers across the globe will adopt a “whatever it takes” attitude in a coordinated fashion, putting in place a number of forceful monetary and fiscal policy interventions – including liquidity injections and asset purchases, loan guarantees, delays to tax payments and other forms of short-term support in order to support the financial system and ensure that firms do not go out of business and workers remain employed.

In this respect, the response to date has been encouraging but it is still not sufficient, and we expect more to come in the coming days and weeks. In some economies, such as the eurozone, this might challenge the rule book. We think such rules will be flexed and adapted over time to cope with this unprecedented shock, which will probably change the framework even after the virus is under control.

The third and last assumption is that these measures will be effective in allowing financial markets to function effectively and limiting second-round effects from the shock. To be sure, policy interventions will not be able to limit the first effect of the shock, as consumers retrench and corporates deal with a double shock from supply and demand. But by preventing closures and dismissals, effective policies can prevent severe damage to an economy’s supply-side capacity, creating the conditions for a post-shock economic recovery.

Only gradual recovery in H2 2020: Based on our assumptions, as the shock fades, growth will eventually bounce back. We doubt, however, that this recovery will be as immediate and steep as we and many others initially assumed.

The shock has been staggered. As some countries relax restrictions and economic activity begins to recover, others might be reaching their peak of contagion, spreading the global economic impact over time. Taking China as an example, while improving contagion rates look to be easing its supply shock, demand- side implications from the rest of the world are at their most vulnerable.

More generally, it will very likely take time for a given economy to go back to pre-crisis activity rates, as containment measures will be lifted gradually and frictions and other logistical difficulties emerge, while uncertainty and concern over another wave of contagion might persist.

As the first country where containment measures were implemented, China provides a glimpse of what might be in store for other economies globally over the next few weeks. In the first two months of the year, China’s fixed asset investment fell by 24.5% y/y and industrial output by 13.5%, according to the national statistical office. We estimate that GDP contracted by 8.4% y/y in Q1. In addition, firms have resumed production more slowly than we initially anticipated, suggesting the recovery will be gradual. Activity will not be able to make up for the lost output until next year, in our view.

Under our assumptions, we expect a significant drop in GDP in most economies in Q2, with a gradual recovery in H2. We have revised down average growth for 2020 considerably in all the economies we cover; in many instances, we expect it will be negative.

Conversely, we have revised up most of our forecasts for 2021, as activity returns close to (but not to) its pre-crisis levels and base effects push growth significantly higher than its trend. Under this scenario, higher demand will be limited by bottlenecks and some lost supply, leading to temporarily higher inflation.”