The coronavirus recession: Living through an apprehensive time

The rapidly spreading corona virus is not only creating a health crisis but also impacting on the health of   the global economy as global growth forecast are revised sharply down. Economists are continually making revised growth projections in light of the changing global economic and financial market effects of the coronavirus pandemic.

Further conditions have been created for more turmoil in financial markets resulting from the oil price plunge amid an outbreak of an oil price war between the two leading oil producers, Russia and Saudi Arabia. This oil price plunge will have very far-reaching effects on debt and credit markets through the financial market transmission mechanism with increased credit rating downgrades and defaults in the coming months. Collapsing oil and commodities futures prices are now feeding into equities and other financial assets. What we are now observing is a financial assets price deflation which is spreading into currency exchange rates causing investors to look for safe havens like gold and treasury bonds. Financial market experts clearly indicate that in many instances credit rating downgrades and debt being lowered to junk status are justified by credit fundamentals.

In fact, stock markets are in turmoil from New York, London, Frankfurt through to Tokyo. Furthermore, disruptions in supply chain have already been causing serious cash-flow problems for companies. Now most of European countries are locked down with Italy being hardest hit by the coronavirus. Such a lockdown will push these countries into recession. The spread of the virus in the US  and other countries around the world has further created uncertainty about the global growth prospect.

In fact, most advanced industrialised economies including Japan, Germany and Italy were already experiencing weakened economic activities and were ill-equipped to face even  small adverse exogenous shocks  before the pandemic. The two largest global economies - the US and China while maintained growth momentum, yet were quite ill-prepared to avert an economic downturn.

The real economy weakness was already there which was masked by excessive risk taking in a period of extremely low to negative interest rates in these countries. Central bank policies of low to negative interest rates artificially repressed financial volatility which added to instability in these economies.

The coronavirus just worked as the trigger to precipitate the current market crash, if it had not been the coronavirus, something else would have contributed to trigger the crisis. The virus simply accelerated and exacerbated the process in a very big way.  The US and most other advanced economies were already weakening in late 2019 with the flow on negative impact on the rest of the global economy. The virus impacted on both supply chain (production) and consumption demand and that led to fall in corporate earnings, causing stock markets go into a downward spiral. Now new bond issuance will almost be impossible, especially companies with significant debt to refinance. Overall stock markets will experience huge volatility around a downward trend.

Despite globalisation, much economic activity remains local and they mostly involve services. Also, services sector now dominates the economy both in terms of output and employment. The impact of virus will result in people postponing or all-together cancelling purchases of services such as dental care, hairdressing, restaurant meals and visiting cafes, holiday travels, besides cancellation of various cultural and sporting events. These  outputs will be lost forever because for example, people who go out to eat once a week, are not going to go out four times a week to eat out when situation becomes normal.

MOST ADVANCED ECONOMIES FOUND THEMSELVES QUITE UNPREPARED: As the coronavirus has come from nowhere suddenly and started to cause sudden destruction all around disrupting and destroying both supply and demand, most advanced economies found themselves quite unprepared (just look at the initial responses of the US and the UK). While saving human lives remains of paramount importance which entails social distancing (human beings are fundamentally social animals), massive shutdown of economic activities, lockdown of human beings in their homes are also the order of the day. Thus completely disrupting the basic fundamental modus operandi of modern economies, interconnectivity and integration.

As the virus continues to spread, the threat grows of a phenomenon economists call a "feedback loop''. This is a situation where even if a country starts to recover domestically from its economic downturn, it suffers from diminished demand from abroad as those countries slip into recession, thus prolonging the economic downturn.

EMERGING CONSENSUS VIEW: With the coronavirus-induced economic shock to the global economy, a consensus view is now emerging that a recession can not be avoided.  How do we draw our conclusion that a country is indeed in a recession.  The conventional definition of a recession is a period when economic output contracts for two consecutive quarters, otherwise known as the technical definition of a recession. However, the US National Bureau of Economic Research (NBER) which makes the official determination of a recession in the US, uses a different approach considering factors such as inflation-adjusted GDP (gross domestic product), employment, Industrial output and income. To put it simply the NBER defines recession as "significant decline in economic activity spread across the economy, lasting more than a few months''.

To determine recession at a global level, the International Monetary Fund (IMF) looks at a number of indicators such as a decline in inflation-adjusted per capita GDP, fall in industrial output, trade, capital flows, oil consumption and unemployment.

FORECASTS: The Organisation for Economic Cooperation and Development (OECD) has already slashed its 2020 global growth rate by half from 2.9 per cent to 1.5 per cent. Oxford Economics also has cut its global growth forecast for the year to 2.0 per cent. Even before the Corona outbreak, S&P Global had predicted 1.9 per cent growth this year. Bloomberg Economics in its March forecast predicts that the chance of a recession within next year now stands at 53 per cent. IMF is now working on revising the growth figure which is likely to involve a very significant revision of the figure.

Furthermore, to complicate the situation, the economic impact of the coronavirus has been very clear from the start. It has affected both sides of the economy: supply and demand. The supply of goods and services are disrupted because factories and offices are closed and output falls as a result. But demand also falls and consumers go for precautionary saving, cut their consumption expenditure and businesses stop investment. Conventional economic policy measures such as pump-priming, tax cuts and interest rate cuts are appropriate tools to deal with demand shocks, but there are very limited policy options available to deal with a combined supply and demand shock. 

The way the global economy is now moving where stocks, oil-commodity futures and forex markets are imploding and feeding back into each other in a downward spiral, the published growth rates rather look optimistic. 

RECOVERY PATHS: There are varied forms of recovery paths from a recession. They include broadly four different patterns of recovery: (i) a V-shaped pattern which indicates a first quarter fall, immediately offset by a second quarter rise; (ii) a U-shaped recovery suggesting a more spread-out time-frame to  recovery from a downturn; (iii) L-shaped indicating a downturn turns into a flat market for quite a while; and (iv) a I-shaped suggesting a free fall for some time.

The already published figures are the first round of revisions and that may be the reason why they rather look optimistic. Now the question remains how long and deep the slump will be. The worst recessions tend to coincide with collapse in the financial system as happened in the Great Depression of 1929-33 and the Great Financial Crisis (GFC) of 2007-08. Another driver of the severity of a recession is how broadly the economy contracts. The 2007-09, recession lasted 18 months, making it the longest since the Great Depression. However, the banking system is not a source of the problem this time. In most major economies banks are better capitalised and managed.

A global pandemic that shutters businesses, sending stock markets to a free fall, cancels travels, sporting and cultural events, has the potential to be that kind of a recession. It appears the available revised growth figures are premised upon a V-shaped recovery but realistically a U-shaped recovery needs to be seriously considered without completely ruling out other two recovery paths.

It is now generally suggested that the global economy will get back  to functioning by the second half of the year, but the overall outcome is expected to be flat suggesting that the coming recession will be U-shaped - a steep decline followed by a period of moving along the bottom. The real recovery will take time but by that time much damage would already be done.

A new normal is likely to emerge in the post-coronavirus period as a new normal emerged in the wake of the GFC. The post-GFC new normal was reflected in persistently low growth, continuous central bank-aided financial stability and worsening income inequality. Many observers are visualising the new normal in the post-coronavirus recession in terms of deglobalisation with multilateral trading system being hollowed out and rising protectionism. Economic policy instruments like US President Trump has already fashioned will be weaponised, especially with regard to trade and investment by more countries to achieve national economic objectives. In an article in Foreign Affairs (March/April issue) KM Campbell and R. Doshi argued that the coronavirus could reshape the global order if the US could not rise to meet the moment - and this could mark the end of US power.

Muhammad Mahmood is an independent economic and political analyst.

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