April 9, 2020

Fathom’s Recession Watch 09.04.2020

by Fathom Consulting.

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Headlines

  • Warnings about potential economic and social costs of COVID-19 on African countries — coordinated financial assistance and/or debt moratorium needed
  • Larger emerging markets have initiated bond-buying programmes, which has brought down the yield on their government debt
  • Geopolitical tensions rising: US president criticises the WHO and China; international row about procurement of medical equipment; EU’s top scientist resigns
  • US economic sentiment falls sharply, but by a lot less than GDP expected to decline

Weak healthcare systems, infrastructure bottlenecks and poor or non-existent social safety nets make Africa particularly vulnerable to the social and economic fallout from the coronavirus pandemic. As outlined in yesterday’s Recession Watch, vast sums of government money will be needed to reduce the healthcare and economic fallout from the virus in advanced economies. Emerging markets may require even larger amounts (as a share of their economies) to deal with the pandemic – these resources, particularly in the case of many African countries, are lacking.

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EMs could turn on the fiscal and monetary taps like the advanced economies are doing. And indeed, some of the larger, more industrialised EMs, with relatively sophisticated financial markets, such as Brazil and South Africa, have done so. These actions have stabilised bond markets in these countries so far, highlighted by the chart below, which show that their government bond yields declined after the moves. On Tuesday, Thailand announced a third stimulus package (fiscal and monetary), which was tentatively welcomed by bond investors as the yield on its ten-year government note edged lower. But EMs are walking a fine line — if they go too far, they risk losing fiscal and monetary credibility, and currency depreciation and higher inflation will follow.

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Indeed, these concerns appear to explain South Africa’s reluctance to loosen its fiscal purse strings too aggressively; instead, it has relied on private contributions for the bulk of the funds used to tackle the virus fallout. Despite the fiscal restraint, the country’s debt was downgraded to junk status by the credit rating agency Moody’s on 27 March. Smaller, less industrialised African countries have even less fiscal and monetary room to manoeuvre. Aggressive fiscal loosening — of the sort which is required to deal with this pandemic — could lead to a disastrous currency sell-off and increase in inflation.

Some African economies are also losing badly needed foreign exchange income due to the fall in commodity prices. Zambia and Angola, for example, are among the countries most likely to default on their debt, according to our Financial Vulnerability Indicator. Analysis by Moody’s suggests that $115 billion of African sovereign debt is set to be repaid over the next two years. There have been growing calls for a moratorium on these debt repayments, as well as calls for financial assistance packages from the international community: a rescue package of $100 billion was proposed by a group of African finance ministers.

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The size of international support packages, what they look like, who pays for them, the conditions attached, as well as how they are branded, will be vital and is something we intend to address in a note to clients in due course. International cooperation will be key to ensuring that any such action is effective, although that has been in short supply, at least over the last few days.

Disagreements about responsibility for the initial outbreak and its subsequent handling have boiled over, and the US president publicly criticised both China and the WHO for their roles in the pandemic. There has also been an international row about the procurement of important medical supplies, with some countries complaining that supplies destined for them were diverted to the US at the last minute. Bidding wars have pushed up prices for this equipment.

Meanwhile, Europe’s top scientist, Mauro Ferrari, has resigned from his post as president of the European Research Council and strongly criticised the EU and its handling of the COVID-19 crisis. There is also a dispute among euro area finance ministers, who, at the time of writing, had been unable to agree on the terms and conditions of the so-called coronabonds (mutual debt instruments issued with the proceeds used to tackle the economic and social fallout from the crisis). On Wednesday France signalled that it would be prepared to issue such bonds, along with some other Eurozone members, even if there was no unanimous agreement. Such disputes, if not managed carefully, could increase financial market volatility and cause peripheral bond yields to spike, at a time when they can least afford it.

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Finally, we have updated our US Economic Sentiment Indicator, one of our suite of proprietary sentiment indicators, with a reading for March. The index is a single measure which incorporates readings from a range of business and consumer confidence surveys. The index dropped very fast in March, but it still remains in positive territory; much higher than it was at any point in 2008 or 2009, even though there is a widespread expectation that the short-term economic contraction due to the crisis is going to be a lot bigger than the contraction in late 2008/early 2009.

There are a few possible interpretations for this. First, that consumers and businesses are looking through the current shock and expect activity to rebound soon (supporting the case for a V-shaped recovery and giving the government a thumbs up for its support measures taken thus far). Second, that technical quirks with the business and consumer surveys mean that they do not fully reflect the magnitude of sharp swings in real economic activity. Third, that some of the surveys were conducted during the month of March and did not fully incorporate the effect of the lockdown. We will explore these issues in more detail in due course.

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Interesting reading

 Fathom forecast scenarios

Economic forecasting is difficult even at the best of times. It is particularly difficult today. At Fathom, we think in terms of scenarios and seek, wherever possible, to downplay point forecasts. A severe contraction in global economic activity through the first half of this year is inevitable – we are facing what French economist Pierre-Olivier Gourinchas has referred to as a ‘sudden stop’, something the global economy has never experienced before. But how long will it last? In our Global Economic and Markets Outlook for 2020 Q1, we set out three scenarios. The first was a V-shaped recovery, in which the number of cases peaks within months and begins to decline, allowing activity by the end of this year to return to normal levels. The second was a U-shaped recovery, where the virus continues to spread, depressing activity until a vaccine is found, but the economic and financial market infrastructure remains in place to deliver a strong rebound when that occurs. The third was an L-shaped recovery. Since we finalised our forecast on 17 March, a number of major economies have placed more severe restrictions on movement, and imposed a temporary shutdown on more industries than we had thought likely. This more aggressive action has caused us not only to anticipate an even sharper contraction in economic activity in the first few months of this year, but to increase the weight we attach to a V-shaped recovery. At the same time, we have also increased the weight we attach to our more severe risk scenario, making the outlook somewhat bimodal. In the event that COVID-19 returns with equal or greater vigour once restrictions that are holding back economic activity are lifted, then a severe financial crisis will be very hard to avoid.

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