The State of the Nation: Covid-19 and the spectre of recession

This article first appeared in The Edge Malaysia Weekly, on March 9, 2020 - March 15, 2020.
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AT the time of writing, the 2019 novel coronavirus (Covid-19) had affected 100,257 people across the globe and claimed 3,408 lives. In Malaysia alone, the number of cases had risen from 22 to 83 last week.

China, the world’s second-largest economy and the origin of the outbreak, has the bulk of the coronavirus cases — at over 80,000.

Governments across the globe are stepping up efforts to contain the spread of the virus, including carrying out lockdowns and shutdowns of offices and manufacturing plants.

On the economic front, both fiscal and monetary bullets are being used by governments and central banks around the world, including Malaysia, which has a RM20 billion stimulus package to help ease affected sectors such as tourism and airlines, and has cut the key lending rate by 25 basis points to spur consumption.

All this has been done to avert a painful slowdown in economic growth or — in a worst-case scenario — a recession, which is defined as two consecutive quarters of contraction.

The risk of a global recession will be higher if Covid-19 becomes a global pandemic, says Dr Khor Hoe Ee, chief economist for the Asean+3 Macroeconomic Research Office (AMRO), based in Singapore.

For clarity, a pandemic is the worldwide spread of a new disease and, at the time of writing, the World Health Organization had not labelled the Covid-19 outbreak as one, though it has spread to more than 45 countries. On Jan 30, the WHO declared the outbreak as a “public health emergency of international concern”.

Given this scenario, global tourism is expected to be the first casualty, but Khor does not see this as reason enough to trigger a recession.

“For the tourism industry, we can expect a sharp decline in [the number of] Chinese tourists in the next several months because of the measures taken by both the Chinese government and governments around the world to contain the spread of the coronavirus outbreak.

“This will have a significant impact on the global economy, as tourism contributes to around 10% of global GDP and Chinese tourists account for about 9% of the total tourist arrivals. However, this alone is unlikely to trigger a global recession, although it will have a severe impact on the hospitality services and airline industry,” says Khor.

China’s role as a crucial source of supply and demand in the world’s integrated supply chain has also sparked fears of a China-led recession across the globe.

Adding fuel to the fire is the less-than-encouraging economic data from China, with the Caixin/Markit services sector Purchasing Managers’ Index (PMI) falling to 26.5 in February — its lowest level since the global financial crisis. Meanwhile, manufacturing PMI fell to 40.3 in February — a record low since the survey was launched in 2004.

Khor says, at the moment, the likelihood that a global recession will occur due to supply chain disruptions worldwide is low.

“Despite the widespread adoption of just-in-time method of production, the practice of holding zero inventory is rare, and firms and factories in the global supply chain tend to maintain a certain level of inventory to cope with supply suspension due to the Chinese New Year holiday and other unforeseen disruptions.

“This will continue to support their operations in the short term,” he tells The Edge.

“In addition, the Chinese authorities are paying close attention to firms that are critical to the global supply chains. Data released by the authorities shows that the large companies are resuming operations and the level has reached 80% in some industries. In the case of small and medium enterprises, the resumption of operations is also happening, albeit at a slower rate.”

Salvatore Babones, an associate professor at the University of Sydney and an adjunct scholar of Australian think tank The Centre for Independent Studies, believes China will see a recession in the first half of this year.

According to its official government statistics, China’s gross domestic product (GDP) growth rate for 2019 was 6.1% year on year.

Babones says: “With unsold steel stockpiles at record levels, auto sales down 8% in 2019, mobile phone sales down 7% and exports up only 0.5%, it’s a miracle that China’s economy grew at all last year.

“Proprietary analyses based on satellite observations and other direct measures suggest a growth rate of between 3% and 3.5% [in 2019]. Models based on indirect modelling of growth rates yield figures in the same range.

“If China went into 2020 growing at just over 3%, don’t expect it to keep in the black this year. Hubei province alone, the locked-down province at the centre of the coronavirus epidemic, accounts for more than 4% of China’s GDP. And Hubei isn’t the only province affected.”

Babones says, however, that it is an exaggeration to talk about a Chinese recession as a global recession.

“Many countries, especially in Southeast Asia, will benefit from orders that have been redirected away from China. The biggest worry for the global economy isn’t actually China. China will take extreme actions to keep its economy running. The real worry is Europe, where the underlying economy is weak and policy responses to the coronavirus epidemic are poorly coordinated,” he explains.

Nomura Global Markets Research, in its Anchor Report on Covid-19’s impact on the world economy, expects China’s economy to grow at 0% y-o-y in the first quarter of the year.

“With the slower-than-expected rate of business resumption, we now cut our 1Q y-o-y GDP growth forecast to 0% from 3%. We also cut our annual GDP growth forecast in 2020 to 5% from 5.5% (versus 6.1% in 2019). These forecasts are also estimates from our new baseline scenario under which we assume lockdown measures end in late March,” the firm says.

AMRO’s Khor says while China’s 1Q GDP will be very low, a full-year recession is unlikely at this point in time.

“Since the Covid-19 outbreak, the Chinese authorities have taken fast and unprecedented measures to contain its transmission and, at the same time, employed fiscal and monetary policies to mitigate the impact on the economy.

“These efforts are expected to boost growth, especially in the second half of the year when the coronavirus outbreak has receded,” he says.

 

Monetary easing may not be enough

Last Tuesday, US Federal Reserve chairman Jerome Powell took the world by surprise when he announced a 50bps emergency rate cut to the federal funds rate to a range of 1% to 1.25%.

The Fed said that though the fundamentals of the US economy remain strong, the coronavirus poses evolving risks to economic activity. It was the Fed’s first emergency rate cut since the 2008 global financial crisis.

Federal funds futures indicate over 40% chance of the federal funds rate’s being cut to between 0% and 0.25% by year-end.

Before the Fed’s move, central banks across the globe had already started the ball rolling with rounds of monetary easing to minimise the economic impact of the virus. The Reserve Bank of Australia slashed interest rates to a record low of 0.5%, the Bank of Thailand eased its rates by 25bps to 1%, and the Philippine central bank cut its key rate by 25bps to 3.75%.

On Tuesday, Bank Negara Malaysia decided to reduce the overnight policy rate by 25bps to 2.5% — a nine-year low, which the central bank said was due to the Covid-19 outbreak, which has disrupted production and travel activity within the region. This was the second consecutive rate cut by the central bank this year after it reduced the OPR by 25bps to 2.75% in January.

OCBC Bank economist Wellian Wiranto wrote in a note on March 3 that Bank Negara’s monetary policy statement, with its repeated focus on near-term downside risk, should signal to the market that it remains open to further rate cuts.

“We think at least one more rate cut is in the pipeline, potentially coming as soon as the next meeting in May, especially if either or both of the virus and political concerns [in Malaysia] continue to weigh on growth,” he says.

However, the solution for alleviating the economic woes brought on by the virus may not just be one that involves rate cuts or cash handouts.

Nomura says, given that this is an “abnormal global economic slump”, the most effective immediate policy response is not monetary or fiscal policies, but health security controls.

“If health security controls fail to contain the spread of Covid-19, financial markets may soon have to accept that a global recession is a forgone conclusion,” it adds.

 

 

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