Summary
- The COVID-19 outbreak has quickly morphed into an unprecedented global economic shock. What started out largely focused on China’s highly-integrated supply chains, has turned into a globally transmitted supply and demand shock. As more countries try to clamp down on the virus’ spread with social distancing tactics, an initial sharp drop in travel and tourism is being followed by a reduction in other activities and spending. This is now a question of whether governments and central banks can shore up business and household confidence, in the face of extreme equity and bond market volatility.
- Past virus outbreaks offer only limited insight into current developments. A key distinction with COVID-19 is not the number of impacted countries, but rather the strong behavioral response to limit contagion via large-scale quarantines and interruptions to business operations. We have not seen anything similar in scale in recent history. The result creates far more forecast uncertainty over the next several months.
- Wild swings in global equity markets have echoed and amplified these concerns, further punctuated by an unanticipated sharp drop in oil prices. Weakening global demand was already weighing on oil prices. However, a failed OPEC+ meeting to tighten supplies led to a complete 180-degree tactical move by Saudi Arabia, which has decided to instead flood the market with record levels of supply. This appears to be an attempt to squeeze out marginal producers and strong-arm other OPEC+ members to fall in line.
- Regardless of the rationale, the negative ramifications are borne out in oil-exporting regions, with Canada among those absorbing a significant income shock. The U.S. oil and gas sector will also not be spared, with the potential for amplified financial risks imparted to heavily indebted firms.
- As we’ve noted several times in the past, markets always fear what they cannot measure. Today’s environment is riddled with uncertainty, complicated by a large economic shock from business and household behavioral adjustments.
- When sitting within the nexus of uncertainty, it’s important to not have a knee-jerk reaction on the forecast. We must permit time to evaluate the responses of central banks and governments to mitigate the downside. In doing so, we start with some basic assumptions based on observations. The first of these is that preliminary data indicate China’s aggressive quarantine measures have limited the number of new cases of the virus and contained the economic shock to a relatively short period of roughly three months. However, for that period of containment, the impact to retail sales and industrial production was far greater than ever seen in its historical data.
- This speaks to depth, but not duration. We assume similar outcomes occur among other countries, with Italy, Spain, and France being the latest to implement stringent containment measures. Together, this assumption reduces global growth by 1.3 percentage points and leads to the slowest pace since the global financial crisis, at just 1.7%. However, the recovery phase creates a tailwind to growth in the second half of this year, which lifts our 2021 annual growth by 0.7 percentage points (to 4.0%) relative to our prior forecast in December.
- For the United States and Canada, the impact on activity is expected to follow a similar pattern, with the second quarter bearing the brunt of the economic adjustment. Canada’s greater dependence on global trade and commodity exports implies a more severe economic impact than stateside, made worse by the added negative income shock from the sudden drop in energy prices. However, in advance of the real impacts to either economy, both central banks have responded proactively by lowering rates and shoring up liquidity. In addition, governments have been able to mobilize to ensure appropriate income support measures will be in place to the most heavily impacted businesses and households. Combining the influences still results in a significant downgrade to our 2020 forecast, by 1.4 percentage points for Canada and one percentage point for the U.S. with annual growth of 0.2% and 1.0%, respectively.
Containment is priority number one
- As the virus has spread, attention has rightly turned to the policy response. The first task is to contain the virus. Large scale quarantines in China led to a steep drop in economic activity in February. This was evidenced by double-digit declines in auto sales, exports and plummeting manufacturing activity. China’s manufacturing sentiment indicator plummeted to 35.7, a level that is lower than the global financial crisis experience (38.8). The good news is that the rapid decline in reported new virus cases is prompting Chinese authorities to begin to normalize operations. Absent another large breakout elsewhere in the country, growth is expected to re-emerge in the second quarter of this year.
- Unfortunately, the rest of the world is now in the thick of containment measures and efforts appear to be following a similar playbook. In Italy, France, South Korea and Iran, lockdowns have been mandated across the entire country in varying degrees. Irrespective of the number of confirmed virus infections, surrounding regions are also responding proactively by limiting entry into their countries and pursuing widescale cancelations of group events. Perhaps nothing is more symbolic of this than Ireland’s cancellation of the annual St. Patrick’s Day parade with 21 known coronavirus cases at the time. These responses will impart a large near-term economic shock, but hopefully show success in reducing cases and limiting the duration of the shock.
| Table 1: Forecast Revisions | ||||||
| Dec QEF | Mar QEF | Change | ||||
| 2020 | 2021 | 2020 | 2021 | 2020 | 2021 | |
| World | 3.0 | 3.3 | 1.7 | 4.0 | -1.3 | 0.6 |
| Advanced | 1.5 | 1.7 | -0.1 | 2.3 | -1.6 | 0.6 |
| U.S. | 2.0 | 1.9 | 1.0 | 2.1 | -1.0 | 0.2 |
| Canada | 1.6 | 1.8 | 0.2 | 2.1 | -1.4 | 0.3 |
| UK | 0.9 | 1.5 | -0.7 | 2.4 | -1.6 | 0.9 |
| Japan | 0.6 | 0.8 | -1.4 | 1.1 | -2.0 | 0.3 |
| Euro Area | 1.2 | 1.5 | -1.6 | 2.5 | -2.9 | 1.0 |
| Germany | 0.5 | 1.4 | -0.5 | 2.1 | -1.0 | 0.7 |
| Emerging Markets | 4.1 | 4.4 | 2.9 | 5.1 | -1.2 | 0.7 |
| China | 5.9 | 5.7 | 4.1 | 7.3 | -1.7 | 1.6 |
| Source: TD Economics | ||||||
Policy coordination is priority number two
- Governments and central banks are following a coordinated, risk management framework to setting policy in an attempt to smooth out the economic risk. However, coordination will mean different things to different countries and institutions.
- Central banks are speaking with one voice on the intent to shore up liquidity, credit and confidence, but their actions will differ depending on the starting point. Central banks in Europe, Japan and the UK have far less scope than those in North America to cut interest rates. Instead, they are leaning more heavily on other tools, such as longer-term refinancing options for the most vulnerable sectors of the economy, corporate bond purchases in the event of liquidity strains, and relaxing counter-cyclical capital buffers among banks in order to free up capital for lending. The central banks in Canada and the U.S. are pursuing similar measures, but have the added advantage of lowering interest rates aggressively. The Federal Reserve has swiftly returned rates to the zero lower bound, while Canada conducted an unprecedented combined cut of 100 basis points in 10 short days.
- However, given the nature of this economic shock, the success of central banks being proactive would be met with limited success if government policies don’t address the supply side shock to prevent it from morphing into a widescale demand side one.
- Fiscal policy is a critical component to economic success. Governments within virus-impacted countries are moving quickly to announce financial support to the most vulnerable areas of the economy: small businesses, households and the services sector (tourism and transportation in particular). In many cases, programs set up in the past to deal with natural disasters, such as loan guarantees for businesses and income supports to workers and businesses are being re-activated.
- Among the countries that have announced fiscal stimulus to-date, the amounts vary but some are substantial and greater than 1% of GDP (Table 2). All told, targeted fiscal packages should help to shore up confidence and mitigate the negative income impacts. This should help return activity to normal and allow for make-up growth in the second half of the year.
Greater economic disruption if containment fails
- It’s hard enough being an economist without also having to be an epidemiologist. The main downside risk to the forecast is that the efforts to mitigate the spread of the virus take a greater toll on financial market confidence and carry a longer duration across a broad set of countries. Our baseline forecast is pinned to economic disruptions persisting through April, with the recovery taking hold thereafter. If we’re wrong on the period of disruption, then the economic pain will be more severe and likely accompanied with broad job losses. With uncertainty elevated, the recovery in financial and commodity markets could also be stalled, contributing to greater pullbacks in investment and spending. In this situation, a formal recession would come into scope globally and domestically. Canada would be at a clear disadvantage in this scenario. The shock to income from a declining price of oil hits energy-producing countries harder. In addition, across the country, high levels of household debt make spending more vulnerable to income shocks, requiring a more skilled hand at policy responses. Both the history and the recent experience of China suggest that a long or deep global recession is not the most likely scenario, but it will require the actions of policy to deal deftly with the rapidly changing situation.
- And just like any forecast, there could also be some unexpected surprises to the upside in the months ahead. The outlook now incorporates significant monetary and fiscal stimulus. As these measures feed through the economy with lags and linger, it’s quite possible that the recovery stage of the economy later this year proves stronger than expected once the weight of containment measures lifts. Only time will be the ultimate judge of success, for now we remain cautious on the outlook and hope for the best.
| Table 2: Countries' Fiscal Response to COVID-19 | ||
| Country | Fiscal Response | |
| Australia | • Support business investment and provide cash flows assistance for businesses | • Support households with cash handouts and help affected regions and communities |
| A$17.6B | 0.9% of GDP | ||
| Canada | • Credit facility program worth C$10B for SMEs | • Funds for medical research, including funding for vaccine research and clinical trials |
| C$11B | 0.5% of GDP | • Funding for medical gear, public education, surveillance, monitoring, and access to testing | • Increased federal lending to help struggling businesses access credit |
| China | • Allocation for outbreak relief and cutting unnecessary government expenses | • Tax waiver for overtime income earned by medical workers and offering cash and free transport to workers |
| ¥99.5B | 0.1% of GDP | • Reduction in corporate taxes | |
| Euro Area | • €37B directed towards healthcare systems, SMEs and labor markets | • Investments worth €20B by EIB in SMEs |
| €113B | 0.9% of GDP | • European Investment Bank (EIB) and European Commission to do €28B in working capital lending | |
| Germany | • In the form of loans through the German development bank | • Loan terms changed so that the government assumes more risk, while loan applications procedures simplified and speeded up |
| €553B | 15.5% of GDP | • Companies allowed to defer taxpayments | |
| • Announcement of "no upper limit on the amount of loans" | ||
| Hong Kong | • A HK$10,000 one-time cash handout to all permanent residents | • Reduction in corporate and salary taxes and subsidies for utility bills |
| HK$120B | 4.2% of GDP | • Low-interest loans with government guarantees for small businesses | |
| Italy | • Tax credits for companies that reported a 25% drop in revenues | • Suspension of loan payments (including mortgages) from virus-hit companies, resources for health and emergency services |
| €25B | 1.4% of GDP | • Tax cuts and extra cash for the health system | |
| U.K. | • £7 Funding for the self-employed, businesses and vulnerable people | • Government to backstop sick pay for small businesses for two weeks |
| £30B | 1.4% of GDP | • £5 emergency response fund for the public healthcare system | |
| • Additional spending of £18B to support the economy | • Cash grants for small businesses | |
| U.S. | • R&D for vaccines, treatments and diagnostics | • Funding for centers for disease control and prevention |
| $8.3B | 0.04% of GDP | • Medical supplies to boost preparedness and community health care | |
| Source: TD Economics | ||
Global Outlook: Coronavirus Pandemic Brings the Global Economy to a Standstill
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- The rapid expansion of COVID-19, first in China and now the rest of the world has prompted a major downward revision to global growth. Due to the economic fallout from the virus, we have revised down our 2020 global growth forecast by 1.3 percentage points (ppt) to just 1.7%, the slowest since the global financial crisis. Global growth at this rate implies several economies in recession in 2020.
- The economic shocks generated by COVID-19 are the side-effects of mandated quarantines and travel bans, as well as voluntary social distancing – people staying home and bunkering down until fear subsides. These are necessary actions to prevent the further spread of the virus but generate negative demand and supply shocks to the economy:
- Supply shock: factory closures, supply chain disruptions, labor supply constraints
- Demand shock: drop in tourism, transportation and other services, decrease in consumer and business sentiment
- These shocks are reverberating through the global economy through several channels, including cross-border flows of goods, services, people, skills, financial capital, foreign direct investment, banking and exchange rates.
- As disease-related disruptions end, the return to more normal levels of activity will imply a fillip to economic growth. Assuming the virus can be contained to the first half of this year, economic growth is expected to bounce back in 2021 to 4.0%, 0.7 ppts above our prior forecast.
Rolling disruptions having a domino effect as virus spreads across time and space
- China’s drastic containment measures to tackle COVID-19 have been reflected in recent economic data. For the months of January and February, the manufacturing PMI plummeted 17% and retail sales dropped by a 20.5% compared to the same period last year, while the unemployment rate jumped to a record 6.2%
- The upside is that the number of new reported cases have drastically fallen, factories are re-opening, and people are going back to work, albeit gradually. This too is reflected in the data and can be seen in China’s PMI expectations.
- China’s quarantine spread the pain to neighbouring Asian economies via supply chains. Many of them heavily rely on China for intermediate goods, tourism, and transport (Chart 2). Economies in emerging Asia most highly linked to China, such as Vietnam, Malaysia, Thailand, and the Philippines, see significant downward revisions to growth in 2020.
- Like China, some Asian economies such as Hong Kong and Singapore have proven successful in dramatically reducing the number of new cases, but at the cost of considerable declines in economic activity. Tallying the impacts, these disruptions are expected to bring Asia’s growth in 2020 to 3.3%, 1.4 ppts below our previous forecast.
- The virus is now fast spreading in Europe. France, Italy, and Spain have imposed a country wide quarantine but are still seeing growth in cases. France, Germany and the United Kingdom have closed schools, encouraged people to work from home, and have taken other social distancing measures aimed at limiting the disease’s spread. At the European level, the 26-state Schengen zone has banned all non-essential visits from third countries.
- If China’s January and February economic data are any indication, these measures will have severe economic consequences for Europe. Therefore, we have expect growth to contract by -1.6% for the Euro Area. The country most severely hit in 2020 is Italy which is expected shrink by 2.9% in 2020. Other countries such as France and Spain are not far behind, as they are expected to contract by 1.5% and 2.2%, respectively.
- Elsewhere, oil exporting countries will be particularly hit by the price wars that started as Russia and Saudi Arabia failed to come to an agreement during the OPEC+ meetings. Oil prices were declining due to weakening demand caused by COVID-19, but the price war exacerbates that decline.
- Countries most severely hit by this double whammy include several oil-exporting emerging market economies (EMEs) in the Middle East and Latin America. For example, Brazil’s growth has been revised by 1.2 ppts to 0.8% for 2020. On the other hand, oil importing countries would benefit from the decline in oil prices. However, their ability to benefit from this decline would depend on how severely COVID-19 affects their domestic demand.
- The COVID-19 shock adds to prevailing idiosyncratic weaknesses in several EMEs:
- Mexico’s economy has been facing severe structural challenges resulting in negative growth in five of the last eight quarters. Low oil prices will further put downward pressure on the Mexican economy. We expect Mexico’s economy to contract by 0.1% this year.
- India’s economy also continues to disappoint, decelerating into the start of 2020. India depends heavily on China for both demand and supply of inputs and will be impacted similar to other Asian countries from China’s slowdown. Meanwhile, accelerating inflation has limited the Reserve Bank of India’s ability to help support growth, but lower oil prices may provide some respite and allow policy to become more accommodative.
- Finally, recent fears in financial markets have worsened the downside risks to near-term economic growth. EMEs are going through a sudden-stop, as they experience sharp net capital outflows in recent weeks, weakening currencies, tightening financial conditions, and subduing asset prices (Chart 3). However, it is important to keep in mind that flows to EMEs are volatile, and therefore, may flow back at the earliest signs of virus containment. This becomes even more likely given the lose monetary stance of central banks in Europe and North America.
Timely and targeted policy measures are necessary to mitigate economic damage
- The spread of COVID-19 has prompted widespread policy actions. Central banks were first to spring to action. The People’s Bank of China (PBOC) acted swiftly, followed by other Asian central banks, and now by European and North American central banks. The uncertainty and headwinds caused by COVID-19 makes it necessary for monetary policy to remain supportive. Declining inflation expectations and a deeply inverted yield curve, alongside widening credit spreads imply a sharp tightening in financial conditions that lower policy rates can only partially mitigate.
- In addition to lower rates, the PBOC, the European Central Bank (ECB), and the Bank of England have taken several targeted monetary policy actions along with macroprudential steps (See Table 3). Major advanced economy (AE) central banks have also enhanced the provision of liquidity via liquidity swap arrangements. However, EMEs – who are facing a severe dollar shortage – were conspicuous by their absence in the AE swap arrangements.
- The outlook for China is contingent on authorities being able to manage ongoing financial stability concerns. Corporate defaults have been on the rise, and banking authorities have been diligent in bailing out troubled banks. Managing these risks while addressing U.S. trade-related issues will be key to successfully steering the economy to a soft landing.
- In terms of fiscal policy, early responses have been directed towards containing the virus, protecting the health care system, containing negative supply shocks, and improving sentiment and demand. However, more and more countries have now announced broader fiscal stimulus packages aimed at supporting growth (see table on page 3 for more details). Countries’ fiscal responses have been broadly of three types; measures targeting aggregate demand (Hong Kong, UK), insurance policies (Canada, Germany), and incentive policies (Australia, China). The European Union (EU) has also relaxed fiscal rules and redirected budget funds, allowing member countries to free up fiscal space.
- The best fiscal measures will be timely, targeted and well communicated. Measures should include income support for households and businesses unable to work or facing a significant drop in sales. The fiscal multiplier of any spending is likely to be low in the current environment. Still, transfers can help mitigate a fall in spending from households without other sources of income or ready access to credit and prevent a rise in defaults that would only deepen and prolong the recession.
Table 3: Monetary and Regulatory Responses Country Actions Australia • Benchmark interest rate cut by 25 basis points (bps) to 0.5% • Injection of $5.4B into the repo market Canada • Policy interest rate first cut by 50 bps to 1.25% and again cut by an additional 50bps to 0.75% • Market liquidity injections through expansion of the bond buyback program and term repo operations • Cut in domestic stability buffer by 1.25 ppts to 1.00% with no increase in the next 18 months • Funding support for SMEs through Bankers' Acceptance Purchase Facility • CMHC to purchase up to C$50B in mortgage pools via Insured Mortgage Purchase Program China • 10 bps drop in interest rates on reverse repurchase agreements and medium-term lending facility loans • 1-year and 5-year loan prime rates cut by 10bps and 5bps, respectively • Net repo injections • Increase in re-lending and re-discounting quotas targeted towards SMEs • Dictating banks to issue loans to SMEs at favorable rates and an extension on loan repayments for certain SMEs • Cut in targeted reserve requirement ratio, releasing $79B into the economy Euro Area • Additional longer-term refinancing operations (TLTROs) • More favorable terms applied to the existing TLTRO III and targeted towards SMEs
• Additional quantitative easing worth US$134B with an emphasis on private sector debt • Bank temporarily allowed to operate below their mandated capital levels
Japan • $4.7B in short-term liquidity to banks and increase the purchase of exchange traded funds • Purchase of government bonds worth $1.9B United Kingdom • Benchmark interest rates cut by 50bps to 0.25% • Counter Cyclical Capital Buffer moved to 0% • Term funding scheme for SMEs for one year amounting to more than $129B • A freeze on banks' dividends and bonuses United States • Target range for the federal fund rate lowered by 50 bps to 1.00% – 1.25% and by another 100 bps to 0.0% – 0.25% • Increase in quantitative easing by $700B ($500 Treasuries and $200 MBSs) • Eliminating reserve requirements for depository institutions • Interest on excess reserves cut by 50 bps to 1.1% • Injection of up to $5.5T to the repo market until April Coordinated Response by: Canada, England, Euro Area, Japan, Switzerland & United States • Central banks to enhance the provision of liquidity via the standing U.S. dollar liquidity swap arrangements by lowering the pricing on swap the arrangement by 25 bps and by increasing the maturity of the US dollars offered. Source: TD Economics
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