Worrying resurgence of covid-19 infections

Almost nine months after the first reported outbreak of the covid-19 virus, the virus is continuing to wreak havoc in the world. The USA, many countries in Latin America and other countries (such as India) are not getting the virus under control despite containment measures. In many Sub-Saharan African countries, the covid-19 virus seems to have just started its destructive path. On the upside, the number of infections has decreased significantly in Europe, China and Australia (and other countries) thanks to strict restrictive measures. However, the recent and quicker-than-expected resurgence of covid-19 infections in some of these countries is worrying as it highlights that there might be no respite as long as no effective vaccine or medical treatment is found. Although some progress has been made in the development of a new vaccine, there is still a lot of uncertainty on the timing, the effectiveness of such vaccine, the scale of production, etc. Hence, it is becoming increasingly likely that episodes of relaxation of restrictions will be followed by a tightening of (local) restrictions depending on the evolution of the number of infections. The past few months have shown that such restrictions (e.g. social distancing, travel restrictions, curfew, lockdown) – while effective in (temporarily) stemming the spread of the disease – weigh heavily on economic activity despite the large monetary and fiscal policy support measures.

Implications of the resurgence of covid-19 infections

Whereas some indicators were pointing to an improvement of economic activities in countries where covid-19 was under control, the resurgence of the virus could threaten this fragile recovery and prolong the negative impact that the covid-19 and containment measures have on the economy. Therefore, economic growth projections – already regularly revised downward in the past months – could change more in the coming months (including projections for 2021). Furthermore, the support measures put in place by the authorities – while crucial to avoid a bigger economic crisis – led to a sharp increase in public debt. This in turn might lead to some financial difficulties if countries are not able to pay back their public debt. In this regard, it should be highlighted that if the pandemic lasts beyond 2020, the G20 debt-service suspension initiative – aimed at suspending MLT debt service due between May and December 2020 of the poorest countries – might not be sufficient to help them.

The sharp contraction of the economic activity worldwide affects many firms’ revenues even if the magnitude largely depends on the sector of activities. Some sectors, such as food retail, have even benefited from the crisis. On top of that, the covid-19-related restrictions have impeded firms’ productivity due to constraints on activities imposed by containment measures, and underutilisation of production capacity. In this context and taking into account the existing financial vulnerability, a sharp increase in bankruptcies is to be expected worldwide despite all support measures put in place. Widespread bankruptcies would further delay the recovery. Indeed, it would lead to a further rise in unemployment, further disruption in supply chains of surviving firms, and a deterioration of the asset quality of the banking sector.

Longer duration of domestic and external shocks

The covid-19 pandemic represents large domestic and external shocks that affect almost all countries in the world. On the domestic side, restrictive measures and (renewed) uncertainty dampen consumer demand, while there is a loss of revenues (e.g. (partial) unemployment), less opportunity to spend, and lower consumer confidence (risk of losing one’s job and uncertainty about the evolution of the pandemic). Moreover, the pandemic changes consumer preference and behaviour (e.g. people avoid travelling abroad, large public gatherings, shopping malls and public transportation). Such behavioural shift – even if some changes are temporary and imposed by containment measures – might hit certain sectors hard, such as the non-essential retail sector (particularly physical shops), tourism, hotels, restaurants and cafés, textile and aviation to name a few.

On the external side (in most cases), lockdown measures and travel restrictions hit the tourism sector hard and thereby countries that heavily rely on tourism in general. Despite a recent rebound in tourism in some countries, the latest resurgence of covid-19 infections does not bode well for the sector. Indeed, new covid-19-related restrictions might impede the recovery, if any. In addition, the longer the crisis lasts, the bigger its impact on travellers’ disposable income and hence on the tourism sector.

Most commodity prices have rebounded to a certain extent (cf. graph 1). Oil prices, however, remain very low, which is affecting oil exporters and companies active in this sector. The magnitude of the shock on oil exporters’ economic activity, current account balance and public finances depends on the diversification of the countries as well as their policy responses. Revenues of companies active in the oil sector have dropped drastically, leading to financial difficulties (and even bankruptcies). Even if commodity importers have benefited from low commodity prices, many are affected by a sharp drop in remittances. In the past, remittances proved to be a very resilient flow even in periods of stress. However, this time is different for many countries. The lockdown measures and sharp contraction in economic activities strongly affected remittances. Hence, most of the countries relying on remittances are heavily impacted by this drop as it reduces not only their current account receipts but also their domestic demand which is often supported by income sent by migrant workers.

In a context of rising tension between the US and China and a sharp drop in external demand, the world trade volume contracted sharply (cf. graph 2). The supply disruptions recently witnessed also highlight the complexity of the global supply chains. Whereas before the pandemic the focus was on efficiency (economy of scale, labour cost, etc.), now it is likely to be more on resilience. That being said, no major reshuffling of supply chains is to be expected in the short term, as such decisions are usually long term.

Whereas capital flows to emerging markets plummeted in Q1 2020, putting heavy pressure on the exchange rate of some currencies, they largely recovered afterwards, easing pressure on exchange rates (along with the weakness of the US dollar). Looking forward, new episodes of capital outflows might not be ruled out given the large uncertainty related to the covid-19 pandemic as well as the large geopolitical tensions (especially between the US and China).  Moreover, whereas capital flows have recovered somewhat, foreign direct investments (FDI) have fallen despite global easing in the monetary policy. In its World Investment report 2020, the UNCTAD forecasted FDI flows to decrease by up to 40% in 2020, 5% in 2021 and to achieve an initiate recovery in 2022. Such unprecedented and significant drop in FDI leads to challenges for many countries, as it deprives them from an important source of external financing and of long-term investments and their related positive spillover effects. On the positive side, it is also likely to lower imports of capital goods – often related to such investments – which in turn can improve the current account balance.

Conclusion

The covid-19 pandemic and related containment measures have pushed the world economy in a very deep and synchronised recession. It is the first time that both advanced economies and emerging-market economies are in recession since the Great Depression of 1930. There is still a lot of uncertainty related to the duration of the pandemic. The recent and relatively quick resurgence of covid-19 infections in countries where the virus was under control is worrying as it highlights that containment and (voluntary) restraining measures are likely to remain in place (or at least to be periodically reinstalled) for a longer period that initially thought. The covid-19-related uncertainty and measures have a large impact on firms’ productivity, consumer demand, supply chains, global trade, remittances, tourism, commodity prices, investments and global financial conditions. In this context, the IMF’s global growth projections of -4.9 in 2020 (June World Economic Update) is likely to be still too optimistic. Moreover, growth is likely to remain lacklustre as long as the virus is out there.

Analyst: Pascaline della Faille - P.dellaFaille@credendo.com