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COVID-19 economic update – March 30, 2020


Summary

Our Economics department keeps track of all the important developments in the financial markets in both advanced economies and emerging markets. We are publishing periodic briefings with analytical assessments of the current macroeconomic and financial market situation. Find out more about the EIB Group's response to the crisis


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Business and consumer confidence indicators plummeted across the globe in March, with some subcomponents reaching all-time lows. Flash global Composite PMIs (Purchasing Managers' Index) in March declined sustainably (Figure 2). In France, the business climate indicator has experienced its most significant drop since the start of the series (1980). A similar dynamic was also observed in Italy where both consumer sentiment and economic climate indicators have plummeted sustainably. In Germany, the IFO Export Expectations in manufacturing decreased from -1.1 points to -19.8 points, its lowest level since May 2009, marking the sharpest drop since German reunification.

The Economic Sentiment survey for the EU published today also shows a sharp decline. Economic Sentiment indicators fell dramatically in both the euro area (-8.9 points down to 94.5) and the EU (-8.2 down to 94.8 points). Similarly, the Employment Expectations Indicator (EEI) plummeted by 10.9 points to 94.1 in the euro area and by 9.7 points to 94.8 in the EU. This is the single worst monthly fall since the series started in 1985 and is at the lowest level since 2013. Italy experienced the biggest decline in sentiment, with a drop of 17.6 points, followed by Cyprus, Slovenia and Germany (Figure 3). By sectors (Figure 4), services experienced the steepest decline (from 10.6 to -1.6) followed by retail trade (from 1.3 to -6.1). At a more disaggregated level, accommodation, food and beverage are the most hit among the services and clothing, leather and furniture among the manufacturing.

Incoming macroeconomic data clearly point to a severe recession. In the US, weekly jobless claims increased to 3.2 million in the week to 26th March, from 282,000 the week before. Economic growth in Singapore tumbled by an annualised 10.6% in Q1 2020, the sharpest drop in a decade, showing that even the countries that have been most effective at fighting the disease can expect to contract substantially.


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Despite the encompassing nature of the shock, some sectors will experience relatively sharper contractions. The tourism sector, one of the most strongly hit, will face an output decrease as high as 70% in some countries as reported by the OECD. The airline industry also faces rather grim prospects. The International Air Transport Association (IATA) reports that 1.1 million flights have been cancelled as of March 27th and year-on-year bookings are down about 50% in March and April and by 40% for May. Up to now, around one-third of the total global passenger fleet has been parked. IATA also estimates that passenger revenues will be USD 252 billion lower this year compared to 2019 and that revenue passenger kilometre, one of the key measures for the passenger traffic profitability, will decline by 38% in year-on-year terms, assuming about a three-month deadlock. Another badly hit sector is the automotive industry. According to preliminary simulations by IHS Markit, the German automotive sector could shrink anywhere between 9.6% and 30.6%, while the wholesale trade could contract between 6.5% and 7.5%. In Italy, the sharpest contraction is expected in the accommodation and tourism sector, ranging between -4.4% to -22.4%, while machinery and equipment sector could contract by above 10%. In France, the accommodation and tourism sector could shrink between 0.7% and 12.7% this year. In Spain, the automotive sector could decline between 4.7% and 35.7%, while accommodation and tourism could drop between 1.8% and 9.8%.1  


1) Simulations were run on latest PMI sectoral data and latest available IHS forecast.


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In line with the sobering data releases, 2020 real GDP forecasts are being constantly revised downwards. A severe global recession, with a contraction of economic activity stronger than during the 2008-2009 financial crisis, is now the most likely baseline scenario according to most recently published projections. Indeed, the Economist expects the US and the euro area GDP to contract between 5 and 10% this year and potentially more in a more adverse scenario. The OECD has also estimated that for each month of containment, a loss of 2 p.p. points in annual gross domestic product can be expected. Therefore, if the shutdown continues for three months, as currently envisaged by most observers, with no offsetting factors, annual GDP growth could be 4 to 6 p.p. lower than originally forecast. Having said this, extreme uncertainty continues to surround these figures as few hard data are available so far in the year, and it remains difficult to predict for how long drastic containment measures will remain in place.


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Corporate bond yields have plateaued in Europe. The continuous, substantial rise that has been observed since the beginning of March, from 0-40 to 120-160 bps for corporates rated A to BB and bonds of 5-years maturity, has been suspended (Figure 6). Currently, corporate bonds spreads stand well less than half-way from the peak reached during the Lehman crisis, at the beginning of 2009. The rise in corporate bond yields has been symmetric across the rating spectrum. Indeed, at the current juncture, the sectoral dimension may dominate considerations usually brought forward to estimate risk: passenger airlines, tourism, automobile, hotels and restaurants and non-food retail sector are the most exposed, while pharmaceuticals, utilities, energy and digital are cushioned. This is reflected in the wave of downgrades implemented by rating agencies in the previous week.

Sovereign bond yields were much less volatile last week, and, when moving, tended to fall. Cyprus, Greece, Italy, Portugal and Spain experienced a large decline on Thursday (Figure 7), when the ECB declared that it would scrap its self-imposed bond-buying limit of a third of a member state’s debt. The compression of bond yields stretched beyond the euro area, with the Czech Republic, Hungary, Poland and Romania also experiencing a drop in yields. Outside the EU, the UK was downgraded by Fitch to AA- with a negative outlook.


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Funding markets for banks are showing some signs of distress, but the current situation is different from the global financial crisis. In 2008/2009, banks faced real liquidity constraints that are now almost residual, given the central banks' long-term liquidity provision. Money market spreads, usually a measure of liquidity risks, show some stress in the US. The Libor-OIS spread increased by almost 100bps in March, the steepest increase since the global financial crisis. This likely reflects the increasing demand for USD, the global funding currency. Indeed, heightened uncertainty pushes up demand for USD funding worldwide. Some global banks have opted for issuing long-term debt despite the recent increase in funding costs. That said, the current Libor-OIS spread is quite far from the peak levels registered during the global financial crisis. Additionally, in the euro area, the euribor-eonia spread barely increased since the start of the COVID-19 crisis.

While the funding provided by the central banks virtually eliminates the risk of a severe liquidity crisis, this does not mean that all banking sectors and banks face the same challenges. Funding needs from maturing bonds for the main European banks will reach close to EUR 800bn until 2025 (Figure 8). The bulk of these needs are concentrated in 2021 and 2022, when maturing debt will reach EUR 320bn for the group of selected banks. Some banks show a relatively smooth maturities profile while others have most of their funding needs concentrated until 2022.

After a sharp increase in the beginning of the month, European Financial institutions credit risk came down somewhat during the week. CDS spreads, increased substantially since late February but registered a relative decline in the past week. The picture is relatively common across some of the main European Banks. Still, banks show a different credit risk depending on the country where they concentrate their operations and their idiosyncratic profiles (Figure 9).


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  • Heightened risk aversion and flight to quality, resulting in plummeting capital inflows. Since early March, flight to quality has led to a sharp reversal in portfolio flows, thus contributing to a surge in government bond spreads, collapsing equity prices and significant domestic currency depreciations. As of March 24th, total capital outflows from emerging markets reached USD 78 billion (this compares with a total outflow of about USD 90 billion in the entire course of 2008 - Figure 10). Spreads on emerging market bonds have already increased sharply, indicating significant liquidity tensions, which if protracted may lead to sustainability problems. These developments are particularly worrisome for small frontier and emerging market economies, but also for large countries heavily reliant on foreign funding like Turkey, South Africa, Nigeria, India, Ukraine, and Indonesia (Figure 11). South Africa was downgraded by Moody's to Ba1 from Baa3 and outlook remains negative. Bond yields increased rapidly for SSA countries from mid-March. Yields on Zambia’s bonds have risen to around 50%. In the last month, Argentina’s USD denominated bonds increased by 2100 basis points, whereas Brazil, Mexico and Chile experienced a 200 basis points increase. Steep depreciation trends in EM currencies, resulting from massive capital outflows, also threaten macroeconomic (e.g. through increasing inflationary pressures) and financial stability (e.g. increased dollarisation, rollover and repayment capacity) in these countries. The Mexican peso and the Brazilian real depreciated heavily, by 31% and 15% respectively in the last month (Figure 12). Several SSA oil exporters have seen major depreciation. Nigeria was forced, by rapid loss of reserves, to unify its multiple exchange rates – equivalent to a devaluation of around 17%. In addition, retrenchment in remittances will harm many Eastern Neighbouring countries heavily dependent on them to sustain the national income and using them as a source of foreign currency financing. For less developed emerging markets, typically heavily reliant on bilateral and multilateral loans to cover for external financing needs, lender counterparties’ ability and willingness to roll over maturing debt will be critical. Among those, countries that are more reliant on IFIs’ funding are likely to experience less stress.

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  • Deterioration of fiscal balances and increased costs of external financing, pushing up risks of sovereign downgrades and defaults. Countries with large external debt burdens, such as South Africa, Zambia, Angola, Montenegro and Albania are particularly vulnerable. Economies that are highly dependent on oil for foreign exchange, such as Nigeria and Ecuador, or closely linked to virus-hit countries (for instance Mexico), economies in extreme economic difficulties, such as Lebanon, Argentina and Zimbabwe and those recovering from extended slumps, for example Mozambique, are also poorly placed to deal with the severe tightening of global financial conditions. The World Bank and the IMF have expressed support for debt relief for the poorest countries.

Room for policy response is limited and support from the international community will be needed as much as ever. In many emerging and developing countries the room for manoeuvre to counteract the economic downturn is going to be hindered by already weak macro-financial conditions, limited fiscal space and constrained access to international finance (market or otherwise). Some countries, such as Nigeria, have or will be forced to adjust their 2020 budgets downwards to account for loss of revenues from commodities. A number of countries have cut monetary policy rates, and a number of central banks are providing payment holidays on facilities to commercial banks, introducing new liquidity facilities, or extending eligibility for existing facilities to critical centres such as healthcare. Some are mandating or “requesting” commercial banks to provide payment holidays to their creditors, particularly the poor and micro, small and medium enterprises (MSMEs). A number of central banks are temporarily reducing reserve requirements or exercising varying types of forbearance on commercial banks, in an attempt to keep money flowing in the real economy. Despite these interventions, for many of these countries the trade-off between containment measures to stop the virus from spreading and the economic contraction that they will bring poses an even more daunting challenge than in the advanced economies and it will require as much support as possible from the international community.


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Country

Source

2020 forecast

prior to COVID-19

from source

2020 forecast

post COVID-19 baseline

2021 forecast

prior to COVID-19

from source

2021 forecast

post COVID-19 baseline

Italy

 

IMF

0.5

 

 

 

Goldman Sachs

0.2

-3.4

 

 

IHS

-0.1

-3.5

 

 

S&P

0.2

-11.6

0.6

1.0

Deutsche

0.5

-2.7

0.6

2.6

Continuum Economics

-

-1.7

 

0.8

Moody’s

 

-2.7

 

2.1

Prometeia

0.1

-6.5

 

 

Germany

IMF

1.1

-

 

 

Goldman Sachs

0.9

-8.9

1.4

8.5

IHS

0.4

-1.2

 

 

S&P

0.5

0.0

1.0

1.5

Deutsche

1.0

-4.5

1.1

3.4

Continuum Economics

-

-0.3

 

1.1

Moody’s

 

-3.0

 

2.5

German Council

 

-2.8

 

3.7

France

IMF

1.3

-

 

 

Goldman Sachs

1.1

-7.4

1.4

6.4

IHS

0.8

-0.6

 

 

S&P

1.3

0.7

1.3

1.7

Continuum Economics

-

0.0

-

0.9

Moody’s

 

-1.4

 

1.8

Spain

IMF

1.6

-

 

 

Goldman Sachs

1.8

-9.7

1.7

8.5

IHS

1.7

-1.8

 

 

S&P

1.7

1.3

1.6

1.9

Continuum Economics

-

-0.2

 

0.8

Portugal

BdP

1.7

-3.7

1.6

0.7

Czeck Republic

IIF

2.6

-5.4

 

 

BNP

2.7

-1.0

3.0

7.0

Hungary

IIF

3.0

-6.0

 

 

BNP

3.1

-1.5

3.6

6.0

Poland

IIF

3.9

-6.4

 

 

BNP

3.3

0.5

3.4

6.0

Romania

IIF

3.4

-6.1

 

 

BNP

3.0

-2.0

3.5

7.0

Slovenia

MIoS

1.5

-6.0

2.2

 

UK

Moody’s

 

-2.6

 

2.4

Goldman Sachs

1.0

-7.5

2.1

7.3

IHS

 

-4.3

 

0.8

China

IMF

6

-

 

 

Goldman Sachs

5.5

3.0

 

 

Moody’s

6.2

3.3

 

6.0

IHS

5.8

2.0

 

6.4

S&P

-

2.7 to 3.2

 

 

Deutsche

6.1

1.0

6.0

10.0

IIF

5.8

2.8

 

 

BNP

5.7

2.6

5.8

7.6

Continuum Economics

-

5.3

 

6.0

US

IIF

1.5

-4.9

 

 

Goldman Sachs

2.3

-3.8

2.4

5.3

Continuum Economics

 

-0.7

 

2.9

BNP

1.5

-0.7

2

2.4

Moody’s

1.8

-2.0

 

2.3

Deutsche

1.9

-0.8

2.1

2.4

S&P

1.9

1.6

 

 

The Economist

 

-5.0 to -10.0

 

3.4

IHS

 

-5.4

 

 

Notes: 1) From these institutions/banks/agencies, no forecasts are available for the EU yet.

Sources and dates of revised forecasts: IMF WEO (January), GS (March 17th (World) and 27th), OECD (March 27nd), ECB (March 12th), Moody’s (March 20th and March 26th), IHS (March 27h), S&P (March 3rd and March 17th), Deutsche Bank (March 18th), IIF (March 23 and 25th), BNP (March 20th), Continuum Economics (March 21st) , The Economist (March 28th).