Economic Recovery with a Double Face
The Covid-19 virus has caused great economic damage. For the western economies, the biggest declines will be visible in the growth figures for the second quarter, which will become available from July on. Nevertheless, the global economy is already recovering, thanks to the phasing out of lockdown measures and the gradual, but faster-than-expected, restart of the economy. Economists are remarkably unanimous in their pessimistic economic outlook. Nevertheless, we see that financial markets are drawing a more optimistic map. Is there a contradiction here? That depends on the time perspective. In the short term, we do indeed see a lot of positive elements, such as the restart of the economy and the policy stimulus. But the risks surrounding the Covid-19 virus remain high, and the ongoing uncertainty makes a slow and prolonged recovery the most realistic starting point.
Positive sounds in a rock-bottom 2020
International institutions have further downgraded their economic outlook over the past two weeks. The IMF now expects global economic growth to fall by 4.9% in 2020. Not only will the impact of the corona crisis be stronger than previously expected, but the global economic recovery will also be slower. Earlier, the OECD also lowered its outlook. The Paris-based think tank now works with two economic scenarios, including a scenario assuming two consecutive economic shocks, with the second shock being caused by a new Covid-19 virus outbreak. KBC Economics has been working with such scenarios since March 2020, always emphasising that a new virus outbreak could significantly increase the economic damage of the corona crisis and make the recovery even slower. Since then, we have nevertheless been able to observe a number of positive developments. The faster-than-expected economic recovery mitigates the negative growth impact in the second quarter. Moreover, most governments now seem willing to implement significant fiscal stimulus, helped by the European Commission's 'Next Generation EU' plan.
Optimistic noises, but we must remain cautious.
As the economy restarts, the supply side of the economy is getting back on track, but it is still not running at cruising speed. Social distancing and other precautions continue to disrupt the production process of goods and services. A functioning of 90% seems to be the most feasible option in many sectors, while a limited number of sectors still have to apply the brakes or have yet to even start up (e.g. major events). The demand side of the economy also remains under pressure. There is a clear recovery in consumer and business demand, but no full recovery at all. Prudence remains a trump card, as we see, for example, in increasing savings behaviour. Sentiment indicators are gradually recovering but still remain in negative territory, confirming the cautious attitude of businesses and consumers.
Bad news on the way
Fiscal stimulus will undoubtedly support both supply and demand. However, one may wonder whether measures to stimulate demand are always equally useful. In uncertain times, demand usually remains under pressure. Moreover, not only domestic demand is under pressure, but also export demand has fallen drastically. And in the future world of increasing protectionism and economic nationalism, the question is whether exports will soon recover fully. The clouds have to disappear before the economic engine can run at full speed again. That incomplete recovery in the short term has a high toll. We expect unemployment to rise considerably. Once again you can interpret recent international trends both positively and negatively. On the positive side, US unemployment seems to be stabilizing, but around 14%, which is unprecedented in the post-war period. On the positive side, European unemployment remains low, but we must immediately nuance that it is because all European countries have introduced some kind of system of temporary unemployment. This leads to an exceptional picture today with much higher unemployment in the US than in Europe (see Figure 1). Of course, this is only the silence before the storm in Europe. European effective unemployment will rise in the coming months due to lower economic output and uncertainty. More job losses will be felt in household consumption and investment.
In addition to rising unemployment, there will be more negative economic news. Many companies have been badly affected by the temporary economic slowdown. The weaker among them, especially companies with limited liquidity and low solvency, will not survive the corona crisis in the longer term. For the time being, they are on a drip of government guarantees, debt moratoria and concessions. But those systems will fade out and eventually disappear. Looking at it through rose-coloured glasses, one can say that the structural economic damage is not that bad at the moment. From a more realistic perspective, we know that the real shock is yet to come. One can rightly fear that the collapse of a few companies will cause a chain reaction. A cascade of problems will lead to a wave of bankruptcies, which will also affect relatively healthy companies. Collateral damage, as it were. Credit losses at financial institutions will increase. And the question is whether companies still dare and want to invest in such an environment. Surveys already show that business investments will take a steep dive. And that will put pressure on growth in profitability and productivity.
The optimism in the financial markets therefore seems strongly based on hope for recovery and the relatively rosy short-term outlook. Fundamentally, that view is correct, since after the huge downturn in the economy, there will in any case be a clear recovery that is already underway today. But the risks seem too high today to justify unbridled optimism. Rather, a cautious optimistic stance seems most in line with economic indicators and expectations. Hope brings life, but hope is a poor basis for strategic decisions.