Demographics Squeeze Advanced Economies’ Long-Term Growth Potential; Big Test for Italy & Japan

Scope Ratings has examined the impact of demographic trends on long-term economic growth in major economies, assuming productivity growth and employment rates remain constant.

“We show that GDP growth rates are likely to decrease in all countries in the coming decades, but large differences exist between advanced economies. Comparing the best and worst performers – the US on the one side and Italy and Japan on the other – over time highlights the magnitude of the problem: by 2050, US GDP could be significantly higher compared to its 2020 level in real terms, while, in the absence of significant productivity and employment gains, Japan and Italy would likely have lower real GDP levels than potential GDP today,” says Giulia Branz, analyst at Scope Ratings.

At the same time, countries can enhance productivity to maintain positive long-term growth and implement policies to address adverse demographic trends and employment trends – two key variables that are captured in the ESG-risk pillar in Scope’s forthcoming update to its sovereign rating methodology.

Demographics explain a large part of structural downward trends in growth

Demographic factors explain a large part of the downward trend in advanced economies’ recent economic growth rates and are likely to remain important over the coming decades according to Scope’s study of the 1960-2050 period, focusing on working-age populations, productivity, and employment rates.

“Our model holds productivity and employment rates constant at 2014-19 levels – which we recognize is a bold assumption as these can change significantly as a result of government policies – but this allows us to estimate a country’s growth prospects based only on its demographic trends that are less likely to fluctuate as significantly,” says Branz.

Significant differences in growth prospects between countries

Growth prospects are structurally declining in all advanced economies, but significant differences exist across selected countries:

  • The US, UK, and France are likely to continue to grow over the long term thanks to relatively favorable demographic trends.
  • Germany and Spain are likely to see GDP stagnate over the coming decades. Adverse demographic trends are likely to offset some of the expected gains in productivity and employment (assuming the latter are sustained over the coming period).
  • Japan and especially Italy would likely experience a marked decline in GDP levels over the next decades based only on adverse demographic trends were such trends not offset with productivity and employment gains that have been distinctly lacking over recent years.

“Our findings have important implications for public debt dynamics and, as a result, sovereign ratings,” says Branz. “Policies that improve countries’ productivity levels, demographic trends, and employment rates are critical to ensuring the long-term sustainability of public debt.”

Download the full report from Scope Ratings.

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Giulia Branz is Associate Analyst in Sovereign and Public Sector ratings at Scope Ratings GmbH.

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.