Recently published economic data suggests that we may be heading towards the deepest economic downturn since the Great Depression, given the toll that COVID-19 is having on countries around the world. To address this concern, on June 9, 2020 the European Risk Management Council hosted a RiskVirtual meeting for senior executives in Europe, APAC, and the U.S. looking at The Global Economy in Intensive Care: Are We Facing the Worst Recession in Recent History? The session addressed a number of important questions, including:
- What is the true scale of the COVID-19 impact on the global economy?
- How will the financial and credit markets be further dislocated by the ongoing crisis?
- What is the most likely scenario for the global economic recovery?
Below is a summary of the key themes and issues that were covered in the main presentations.
COVID-19 is Reshaping Public Policy Priorities
The speakers at the session agreed that what we have seen over the past few months is truly astonishing. The coronavirus spread like wildfire across the globe, creating 8,525,042 confirmed cases and 456,973 deaths as of June 20. The economic impact has been devastating and could result in dire social consequences, affecting the lives and livelihood of most of the global population and threatening to have millions fall into poverty.
Given this situation, speakers felt that governments must continue to coordinate policy on a global level to help maintain financial stability and, within countries, create guidelines that are clear and consistent across regulatory agencies. In addition, there will be new priorities for public policy. Governments will likely need to expand the size and scope of support programs to help “flatten the curve” of firm bankruptcies, which are expected to increase substantially. More assistance may also be needed to help emerging markets and developing economies.
A Look at the U.S Economy
The downturn in the U.S. was rapid and sharp, with damage in the labor market without historical precedent. Every component of private spending contracted – consumer spending, investment spending, exports, and housing. Real GDP fell at a 4.8% annual rate in the first quarter, and it is likely that output in the second quarter will register a significant decline, as well. With many states opening up, however, there could be a rebound in the latter half of the year if there isn’t a second wave of the virus.
The U.S. labor report in May was a surprise, showing a slight drop in unemployment that suggested continued improvement, although this was mainly due to people returning to work in restaurants and similar sectors as lockdowns ended. Overall, the labor market remains in a very bad state but, looking forward, things should improve through the rest of the year. Many people have been furloughed and remain attached to their jobs as they collect unemployment insurance. They have the opportunity to return to their work once the economy opens up further, making it easier for firms to restart production. Still, the recovery will be a long process. Social distancing will likely remain for months to come and there will be permanent job losses due to structural change, which the pandemic has caused or accelerated. In addition, state and local governments are faced with enormous revenue shortfalls, and are poised to slash employment levels unless Congress provides substantial aide. It is hard to imagine unemployment falling anywhere near pre-crisis levels for many years to come.
Looking at inflation, the pandemic has led to a reduction in the supply of certain goods and services, which normally puts pressure on prices. But the drop in demand has swamped the impact on supply, placing downward pressure on inflation.
With respect to fiscal policy, the U.S. economy has received enormous support, with Congress legislating large packages in excess of what was done after the 2008 financial crisis. Importantly, unemployment checks are replacing almost all income lost by workers who are receiving them, and eligibility requirements have been loosened. Many households also received one-time payments, and small businesses received loans that will turn into grants. Much of the support to workers is scheduled to end in the summer, however, more needs to be done to stop the negative impact on demand that will intensify the downturn.
With respect to monetary policy, the Federal Reserve intervened quickly realizing that the pandemic would cause a severe economic downturn and push inflation below its 2% target. It, therefore, cut the fed funds rate and issued guidance that the rate would remain low for a long time. It also started asset purchases, without setting any limits on the size or duration. As a result, the 10-year treasury rate plummeted. The global rush to safety as a result of the pandemic resulted in enormous market dislocations, with liquidity drying up even in the treasury market, given massive sales by hedge funds facing margin calls and sales by foreign holders. Without extensive emergency lending operations beyond the banking system, there likely would have been another financial crisis.
In contrast to 2008, banks have performed well, most likely due to stronger supervision after the financial crisis. If the downturn were to continue, however, banks will probably come under pressure.
A Look at Europe
It is important to consider how long it will take before sectors, such as hospitality and leisure, get back to normal and what scars will be left. There have been tremendous efforts by governments in Europe to try and prevent negative impacts on the labor market. The longer the virus goes on, however, we will likely see a more permanent shifts in employment.
One thing that is well recognized is that there will be much higher levels of debt in both the public and corporate sectors after the pandemic. The impact of COVID-19 was a shock that was absorbed on the public sector’s balance sheet, which most agree was the right thing to do. Central banks also made sure that governments had access to finance in a very short space of time, and the joint action of monetary and fiscal policies was prudent. A concern is that this debt may create a new wave of austerity, however, and restrain the expansion.
Different parts of the world are at different stages of containment. Some countries that were hit earlier are showing signs of coming out without a second wave, but emerging countries that were hit later have an escalating number of reported cases. What can we learn from countries that seem to have been successful at containing the virus? First, you should wait to reopen until you are confident that the infection rate is very low in your population. Second, you need to have strong track and trace systems in place using technology to monitor people, so you can quickly isolate cases. Also, in Asia, the SARS experience equipped them well with lessons about hygiene practices. It is unclear whether some countries in Europe, as well as the U.S., had these adequate measures in place before they started to open up, which introduces concerns about a second wave. There is also a political narrative that has evolved that we have a choice between our economy and health, and areas are opening up to protect the economy. This creates uncertainties about where we are in terms of overcoming the virus.
Sectors that are heavily impacted include travel and tourism, a very large segment of GDP for most of the major European economies. This will drive a wedge between northern and southern Europe, as southern countries, like Spain and Italy that depend on tourism, will suffer for a longer time; recovery funds will be needed. As we look at the recovery, we will likely see a deep contraction in 2020 with some offset in 2021. The recovery will be slow and prolonged, with starts and stops as the virus reemerges and social distancing is put back in place.
Using Statistical Models to Assess the Credit Outlook with COVID-19
Databases with details on public and private companies around the world can be very helpful to support statistical models that can be used to evaluate different economic scenarios, especially given the many uncertainties that currently exist. These statistical models are well suited for assessments of small- and medium-sized enterprises (SMEs) that represent a large percentage of global business and employment, but often lack good financial data to support analyses. It is important to recognize that, unlike the 2008 crisis, corporates and SMEs were the first to be affected by the virus through disruptions to international supply chains and a drop in demand. While government support programs are in place to assist with liquidity, much of this is going to larger corporations.
Scenarios show that companies and consumers are expected to delay investments and large purchases in the current environment. This affects producers of durables and consumer goods. Similarly, a lack of spending will continue to weaken the risk profile of companies in the hospitality, automotive, and retail industries. Other sectors, like pharmaceuticals and health care, will not be substantially affected.
These formal presentations were followed by a series of questions and answers.
 “I.M.F. Predicts Worst Downturn Since the Great Depression”, NY Times, April 2020, www.nytimes.com/2020/04/14/us/politics/coronavirus-economy-recession-depression.html.
 “WHO Coronavirus Disease Dashboard”, World Health Organization, June 20, 2020, https://covid19.who.int/?gclid=EAIaIQobChMIkbKWnfuQ6gIVRtyGCh1_RwXjEAAYASAAEgJSjfD_BwE.
 “Gross Domestic Product, 1st Quarter 2020 (Advance Estimate)”, BEA, April 2020, www.bea.gov/news/2020/gross-domestic-product-1st-quarter-2020-advance-estimate.
 “America's unemployment rate falls to 13.3% as economy posts surprise job gains”, June 2020, CNN Business, www.cnn.com/2020/06/05/economy/may-jobs-report-2020-coronavirus/index.html.
 “SMEs Finance”, The World Bank, 2017, www.worldbank.org/en/topic/smefinance.