The year 2020 is going to be the worst for the global economy since at least the Second World War.
In its June economic outlook report the World Bank forecasts global GDP to fall by 5.2% this year with declines of around 6% in the US and Japan, 9% In the euro-zone and positive growth of just 1% in China. For Emerging Markets (EMs) a contraction of 2.5% is expected, the worst since at least 1960 when comparable statistics began. Meanwhile the OECD in its June Economic Outlook is more pessimistic, forecasting a 7.7% fall in world GDP this year, including declines of 8.5% in the US and 11.5% in both the euro area and the UK.
Whole year forecasts for 2020 mask a truly awful first half featuring precipitous falls in GDP, followed by some degree of recovery in the second half. The April to June quarter will show the biggest quarterly falls in GDP across most economies for many decades. For example, the US Congressional Budget Office projects a 12.25% fall in US GDP over the first half of this year with the vast majority (11.6 percentage points) coming in the second quarter. Official monthly GDP data in the UK showed a 20.4% collapse in activity in April; the economy is now fully one-quarter smaller than at the end of 2019. Over the second half of the year recovery in advanced economies is likely as lockdowns are gradually lifted. (The US CBO has pencilled in a rebound of 7.5%.) Extreme intra-year volatility is unprecedented in economic history.
As we move into the second half of the year, are there signs of a return to growth? Official and survey data for May tend to show continued contraction in activity but at a more moderate pace than in April. For example, the purchasing managers indices (PMIs) in the US, UK and euro-zone all remained at levels consistent with falling output in both manufacturing and services in May. But in all cases latest monthly readings were above the record lows reported for April. A similar pattern has emerged for retail sales in the US, UK and Germany. High frequency data, such as Google mobility data, visits to shopping centres and road traffic flows have shown continued upward trend through May and into June. The easing of lockdowns, which began in May and has gathered momentum through June, points to recovery in economic activity in the second half of the year. Pent up demand in certain areas, for example for consumer durables, will give growth an initial burst - third quarter growth may see quite a strong rebound in activity in many economies.
However, beyond the third quarter the picture is less clear. Generous fiscal support measures designed to support incomes through lockdowns will be increasingly withdrawn as those lockdowns are eased. It is at this point that the sustainability or otherwise of economic recoveries will become apparent. It is highly likely that policy stimulus – mainly fiscal – to sustain recovery will be necessary. The economic shock of the COVID-19 crisis is shifting unemployment rates from close to record lows late last year to extreme highs in the space of a few months. In the US the unemployment rate has risen to 13.3% in May from below 4% at the start of this year. Elsewhere, the more widespread use of furlough schemes in Europe has so far prevented similar steep rises in unemployment. But as these schemes are withdrawn in coming months big rises in unemployment look inevitable. In its latest Economic Outlook in June the OECD forecasts that the euro are unemployment rate will rise to 11% by the end of this year, from around 7% a year earlier.
High unemployment rates, along with continued social distancing restrictions, is likely to contribute to consumer caution and subdued spending. True, household savings rates have shot up during the crisis as spending has fallen more than disposable incomes. But beyond a reduction to meet up pent up spending it is not clear how far savings rates will fall – and therefore consumer spending will rise – back towards pre-crisis rates. Businesses are unlikely to boost their spending in this highly uncertain climate: cost cutting and reducing debt are likely to take priority over increased investment. Hence the need for policy stimulus. Despite the huge cost of fiscal support measures during lockdowns, advanced economies do have the policy bandwidth to provide a fiscal boost, especially with government bond yields at such low levels. (Germany has already announced a stimulus, including a temporary reduction in the rates of VAT and incentives to buy electric cars.) Stimulus packages are likely in the US, UK and EU in the second half of the year. Central bank policy will continue to be exceptionally easy: interest rates close to zero with aggressive quantitative easing (QE) programmes.
China is in a slightly different economic situation as the first country to lockdown in January and then start to relax measures from March onwards. Reflecting this, China’s GDP fell by 6.8% in the first quarter of 2020. But second quarter data is likely to show some recovery. The manufacturing PMI for China is signalling expansion in May, unlike in all advanced economies with similar surveys, Retail sales data show a 7.5% fall over the 12 months to April, but this is well above the 20% annual declines recorded over January and February. Indeed, some categories, such as personal care and telecoms, are showing positive annual growth rates in spending. Nevertheless, GDP growth this year will be the weakest in 40 years at around 1% according to the World Bank: some restrictions remain in place, disrupting labour supply and exports will remain weak given the parlous state of the rest of the global economy.
Emerging markets (EMs) are being hit especially hard by the COVID-19 crisis. EMDEs are suffering the domestic demand impact of efforts to contain the spread of the virus, similar to advanced economies. But most EMDEs lack the fiscal capacity to provide significant support to their households and businesses, especially compared to advanced economies. The IMF estimate that non-health fiscal measures among emerging markets have averaged 2.5% of GDP compared with 7.7% of GDP in advanced economies.
Moreover, there are several additional channels through which economic harm is being transmitted to EMs. These additional sources are likely to persist into next year as they will require sustained recovery in advanced economies before their effects lose potency. First, many EMs are heavily reliant on exports to advanced economies or of commodities, where demand and prices have fallen significantly as the global economy entered recession. In addition, overseas tourism accounts for a significant proportion of GDP in many EMDEs, so the virtual ending of overseas visits is having a material effect on these countries. Other economies rely on remittances from migrant workers overseas to support domestic activity but the value of remittances has fallen significantly as those workers have lost their jobs or been furloughed in their host country.
Financial market developments were also unfavourable to EMs, reflecting a sharp increase in risk aversion as the crisis developed. EMs have suffered significant portfolio outflows in recent months. Of greater concern is that their already stretched debt positions have been exacerbated with many facing the prospect of sovereign default, Unlike in advanced economies where government bond yields have fallen EMs are facing higher borrowing costs, reflecting greater default risk. Data from the World Bank show that EMs on average now have to pay over 6 percentage points more interest on new sovereign debt than advanced economies, compared with three percentage points more in December 2019.
With the exception of the East Asia and the Pacific region that includes China, the World Bank expects every EM region to experience economic contraction this year, underlining the truly global nature of the COVID-19 economic shock.
The Global Outlook in 2021
On the assumption of no second wave of the virus that requires renewed lockdown measures the global economy will recover in the second half of this year and through 2021. But the pace of expansion in 2021 is highly uncertain and will depend on developments in the health crisis, such as treatments or a vaccine as well as on economic factors such as policy, and consumer and business confidence. More generally the degree of so-called scarring will become apparent; how much permanent damage has been done to economies and certain sectors such as hospitality, travel and tourism – and crucially how far and fast is unemployment falling across economies.
it is unlikely that growth will be sufficient to lift the level of economic activity to its pre-crisis level by the end of next year. Indeed, most advanced economies are not likely to reach end-2019 levels of output until at least the second half of 2022.