Covid-19 Pandemic Creates High Risks, Triggers Deep Global Recession

2020’s global recession will be deeper than even that seen in the global financial crisis trough of 2009 when world output contracted by 0.1%, says Scope Ratings. For more detail, see Scope’s Q2 2020 Sovereign Update: Covid-19 pandemic’s economic impact: significant risk as the world economy falls into recession.

None of the world’s largest economies will escape the pandemic’s macro-economic and financial-sector impact. We forecast an economic contraction of around 6.5% for the euro area in 2020, with the steepest declines in Spain (around 8%) and Italy (around 7.5%) with Germany’s economy shrinking 5.2% and France’s by 6.3%. China grows only 4%, while the United States contracts around 3.5% and Japan’s GDP recedes 4%.

Double impact on sovereign ratings

“The pandemic-linked recession will have a double impact on sovereign credit ratings,” says Giacomo Barisone, head of public finance at Scope.

“The cyclical implications of this crisis relate to the severity and duration of the downturn in the near-term with risks linked to rising non-performing loans, unemployment and corporate defaults,” Barisone says.

“Structural implications correspond to the extraordinary mobilisation of monetary and fiscal policies to respond to the economic impact of the health crisis, which will raise debt ratios longer-term and structurally weaken private sector as well as government balance sheets,” he says.

Higher borrowing rates and currency depreciation are further rating-relevant risks.

Countries most exposed include: China (rated A+/Negative), Japan (A+/Stable), Italy (BBB+/Stable), Spain (A-/Stable), and Turkey (BB-/Negative).

Assumptions in baseline forecasts

“We have made several assumptions, including the prospect that, in China, the outbreak stays fairly contained after end-March, while in Europe and the US, there is momentary but marked slowing of infections by end-Q2,” Barisone says. Scope assumes an associated gradual lifting of containment measures during Q2 and entering Q3.

“Our baseline forecasts reflect, moreover, the assumption that economic output among most developed economies declines sharply over Q1 and Q2 and gradually recovers starting in Q3, with the strength and durability of this recovery subject to risk in the second half of the year and depending on the country,” Barisone says.

Thirdly, the recovery in China, where the coronavirus outbreak started, and the country that plays such a crucial role in global supply chains, will precede those in the US and Europe, with the latter economies beginning to recover after a delay.

“The recovery, when it does take place, will reflect the pandemic’s longer-lasting impact on supply chains and sentiment and the impact of potential further waves of coronavirus infection, which is why we see neither a dramatic V-shaped turnaround nor a prolonged L-shaped slump,” says Barisone.

Risks to baseline outlook

“That said, we cannot ignore downside risks to our economic baseline,” Barisone says.

In one stress case scenario, assuming lockdowns and quarantine policies are extended significantly in western economies to the end of Q3 2020, global growth would contract an unprecedented 3.5%, with a 11.5% decline in the euro area and 8.0% drop in the US economy. China would experience its slowest growth since 1976 of about 2%.

Giacomo Barisone is Managing Director in Public Finance at Scope Ratings GmbH.

Markets are Trying to Buy the Dips of Quarantine

On top of this, governments are increasing measures to support small businesses and large companies. These decisions lead to an increase in demand for the purchase of shares of strong companies, which, according to market participants, were undeservedly sold out during the market crash earlier this month.

The announcement of new liquidity support measures by the Fed and the impressive (almost 20% of GDP) stimulus package in Germany have renewed the interest of markets for purchases. Futures on US and European stock indices have been rising more than 4% today.

At the same time, the markets are moving in contrast to the economic news, which is showing a decline in business activity on PMI indices. These indices have become a kind of universal measure in recent months, as the same methodology is used for different countries, with most of them publishing in the course of today.

Already released data from Japan and France showed a sharper than expected decline in activity in the service sector. In France, the PMI for the services sector collapsed by 29, the lowest level in the history of this study with a large margin. Business activity in the country collapsed at its highest rate in 22 years of research, indirectly indicating a more than 3% decline in the coming quarters.

Germany’s composite index was also weaker than expected. In essence, the service sector index declined to 34.5 vs 43 expected, the composite index fell to 37.2 from 50.7 a month earlier, vs 41.5 expected.

Indicators for Italy have not been published, but they would have come out even worse than these.

A month earlier in China, we also witnessed higher economists’ expectations against real statistics. Such dispersion once again shows a substantial undervaluation of quarantine impact on the economy.

The markets are reacting as if the data is the matter of the past. And the best strategy, for now, is to try to buy at the peak of fears. But this can be a dangerous mistake.

Quarantine measures have increased dramatically in recent weeks, but they were not enough to contain the increasing number of new cases in Germany, Spain, France. Even more so in the United States. Over the past 24 hours, the number of new cases there grew by more than 10K, accounting for more than a quarter of all new cases. In other words, neither the pandemic situation, nor economy has reached a turning point.

With such background, the final business activity data in March and statistics in April may turn out to be even worse, risking turning the health care crisis into an economic one. The proactive steps of the Fed, ECB and many other central banks has so far helped to offset the risks of a full-fledged financial crisis. But this means that markets have passed the peak of volatility, but not the lowest point. After a short bounce, stocks and commodity assets may turn back to decline, without a real recovery in demand.

 by Alex Kuptsikevich, the FxPro senior market analyst.