Can the global economy, which began the year on the path to recovery, get past the coronavirus outbreak and back on the road to growth? A look at three potential outcomes for 2020.
With economic activity disrupted and capital markets dislocated, investors have been debating if Covid-19, known colloquially as the coronavirus, could derail the global cycle. Given the sharp drops in global asset markets recently, pessimistic prognoses are easy to make. However, during times like these, some clear perspective is warranted.
Below I will walk through what my colleagues and I on the firm’s economics team see as the three most likely outcomes for the impact of the coronavirus outbreak on global growth. In our most likely scenario, new cases and disruption may continue near-term, but global policymakers will likely use easing measures and rate cuts to help mitigate the impact. Assuming new cases peak by mid-May, global growth could pick up in the third quarter.
To set the backdrop: Coming into the year, my colleagues and I saw a growing evidence of a global economy on the mend after a tough 18 months. Headline Purchasing Manager Indices (PMIs) had bottomed out, and new-order survey data showed improvement as of October. Global trade was growing again in December, after contracting for six months. Despite lingering skepticism, we thought these data points supported our thesis of a global recovery taking hold in the first quarter of 2020.
The outbreak of Covid-19 has certainly changed that near-term narrative. Considering the weak starting point for global growth and still nascent recovery, this untimely disruption to economic activity will likely slow global growth this quarter.
The key question now: Could this exogenous, transitory shock fundamentally challenge the growth cycle? For now, we don’t think so. Indeed, throughout this expansion cycle, the global economy has weathered a series of shocks, each in turn giving way to a minicycle in global growth that has helped to extend the greater expansion by interrupting a stage of overexuberance that may have led to overheated growth and an end to the expansion.
Scenario #1 – Containment by March: The virus outbreak is contained by end-March and production disruption is limited to the first quarter. Policymakers in China and Asia move to provide meaningful fiscal and monetary support, with China expanding its fiscal deficit by 1.2 percentage points, keeping it high for the second year running. Global growth dips to an annualised rate of 2.5% in the first quarter, down from 2.9% in the fourth quarter, 2019, but recovers meaningfully from the second quarter onward.
Scenario #2 – Escalation in new geographies, disruption extends into the second quarter: In this scenario, new cases continue to rise in other parts of the world, before peaking by the end of May. The disruption extends into the second quarter, affecting corporate profitability in select sectors, risking the emergence of corporate credit risks. If the dislocations in asset markets also persist into the second quarter, a sharp tightening in financial conditions may mark a tipping point, exacerbating the impact on growth via weaker corporate confidence, falling capital expenditures and cutbacks in hiring.
In response, policymakers around the world would step up easing measures, with fiscal policy in Asia and Europe and monetary policy in the U.S. doing the heavy lifting. Today, the Fed announced an unexpected half-point rate cut and our Chief U.S. Economist, Ellen Zentner, expects the Fed to cut rates again by a quarter-point at its April meeting, with the risk of an earlier action given the “fluidity” of the situation. In this scenario, global growth averages just 2.4% in the first half of 2020, but starts to pick up in the third quarter.
Scenario #3 – Persisting into third quarter, escalating recession risks: The outbreak’s global disruption continues to spread into the third quarter, encompassing all the large economies. China faces a renewed rise in new cases as it restarts production. The extended disruption to economic activity damages corporate profitability and brings about a rise in corporate credit risks and significant tightening in financial conditions, which exacerbate the slowdown in global growth.
Central banks will embark on a renewed easing cycle, with the potential for a coordinated response. In this scenario, we expect the global weighted average monetary policy rate to dip to its lowest level since 2012. The Fed would extend its cuts from March-June and could become more aggressive and take rates to close to the lower bound by the third quarter.
The fiscal response across key developed and emerging economies also becomes more aggressive, with China taking up two percentage points of fiscal expansion. The cyclically adjusted primary fiscal deficit for China and the G4 nations (Brazil, Germany, India and Japan) widens to 5.1% of GDP in 2020, from 4.1% in 2019. Global growth stays weak (i.e., below 2.5%) between the first and third quarters.
Global Growth Is Disrupted Near-Term; Recovery Is Likely Delayed
(Global Annual Real GDP Growth)
Developments related to the outbreak remain key, and we are monitoring the following signposts:
- The ability to bring control outbreaks in affected areas and the scope of the spread across Europe and into the U.S.;
- Whether China faces a rise in new cases, as it continues to restart production; and
- Updated data from the therapeutics in development.
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