Spreading across the globe, coronavirus poses significant macroeconomic and microeconomic risks. Publicly discussed scenarios that were at first “cautiously benign or pessimistic” are now “pessimistic and extremely pessimistic”. In early March Moody’s analytics doubled its recession probability for 2020, from 20% to 40%. In late March, however, it estimated a sharp fall in economic activity across all advanced economies in the first half of this year that will not be reversed in the second half, indicating recession with near certainty. In this article, we discuss what are the current and possible impacts on the global economy. The most important message the readers should acknowledge is to assess the potential risks, source the tools and take actions that will help mitigate risks that lie ahead through building partnerships.
While financial markets tend to be a recession indicator, Harvard Business Review (HBR) provides historical data which shows that recession and bear markets need not be directly conflated. In the U.S. market, for example, one out of three bear markets do not result in a recession. Nevertheless, we must assess the disruptive potential that markets have correlated with the spread of the coronavirus, as it could have a huge impact and pose a substantial risk to the real economy. HBR speculates that the most possible outcome is a real recession which usually affects capital expenditure, derailing the expansions of firms. Observing the historical outcome of the events such as wars, disasters and other disruptions – similar to the coronavirus, one can mostly observe severe contractions in the real economy. Financial markets have recently attributed enormous economically disruptive potential to coronavirus. The real economy could face a crisis that would cause financial imbalances that seriously affect cash flows and operations of all-, but especially small and medium-sized companies.
J.P. Morgan predicts a global contraction of 7.5% GDP or more as no country is spared the introduction of strict disease-spreading precautionary measures first implemented in China and Italy. Similarly, their colleague analysts produce estimates of comparable magnitude, based on various high-frequency and forward-looking alternative data indicators (energy consumption, consumer spending, pollution, sports activities, etc.) and assumptions regarding the lockdown duration. Banque de France is estimating that every two weeks of economic shutdown wipes off 1.5 percentage points of the GDP. The current situation can knock down many years of growth in only a few months. With this new reality, central banks and governments have made some swift immediate monetary and fiscal stimulus that should provide businesses and consumers afloat with sufficient liquidity at hand. Nevertheless, this crisis is different to the one we have experienced a decade ago. Low interest rates and non-conventional liquidity measures invented by central bankers during the last recession are not sufficient panacea to cure the shocks to supply-chains and demand. Significant fiscal measures are needed to address issue of temporarily protecting companies to lay off workers. Sure, we will see more fine-tuned measures to follow in the coming days and weeks.
The complete lockdowns throughout the world are leaving broad services sector directly impacted. Restaurants, bars, tourist venues, traveling hubs, transportation facilities and alike are closed for weeks. Worse, they will be impacted by adjusted consumer patterns for months. Services sector is very important in developed economies today constitutes from 2/3 and 4/5 of the GDP. Coronavirus is also disrupting global value chains, which are essential for economic growth.
Today’s global economy is built around cost competitive sourcing with minimum intermediate stocks. The produced side effect by this trend is risk of disruption in supply-chains that appears obvious in this pandemic situation. Consequently, the automotive industry which is well-known for its just-in-time and outsourced supply chain is heavily impacted. According to World Economic Forum, China’s entire automotive industry is 50% below its pre-coronavirus production rates. In Europe, automotive sector could not resist and has shut down production entirely despite the fact they were not directly impacted by lockdown measures. Other production sectors are faced with tough options.
Companies affected by disruptions in the supply-chain should focus on their production capacity and try to protect their revenue generation ability. In this challenging time, it is not margins and cost savings that should remain priority, but capacity aiming at a rapid economic restart. Companies should think about and utilize alternative sourcing options, try to shorten supply chains (doing this will also help resolve some long-term sustainability issues and ESG footprint) and also to partner with suppliers taking joint actions in order to develop the best possible and sustainable solutions that reflect altered economic reality. This should include both profitability and risk aspects. The more companies are agile finding solutions of the current challenges, the lower the chance that obvious recession patterns repeat. Namely, recession triggers a large drop in the number of suppliers. A Case Western Reserve study reports 20% drop in number of suppliers in the US auto industry during the last financial crisis. It is time to think how to avoid such a scenario.
This article was written by the team at ALPHA CREDO