The coronavirus crisis is having a very negative impact on people's daily lives as well as on markets, the economy and politics. A recent report by Arcano Economic Research explains the consequences of the disease in these areas, and the scenarios that may arise afterwards. According to the organisation, the biggest challenge for governments is to strike a balance between containing the pandemic and avoiding damage to economic activity.
Search for balance
The seriousness of this epidemic lies in the fact that there is still no vaccine. This means that contagion is increasing rapidly, causing hospital systems to collapse. To measure the level of infectiousness, experts use two ratios: the infection rate or Rowhich indicates how many people would be infected if no one, neither people nor governments, did anything. And the effective infection rate, or Rewhich measures this level after containment measures have been implemented. It serves to measure the extent to which they are effective.
Governments have set themselves the target of moving from 2.3 per cent of GDP to 2.3 per cent of GDP. Ro to a level below 1 in the Re. Because reaching this figure means defeating the disease with containment measures, which opens the door to a resumption of economic activity. China, Korea and Japan are reaching this stage.
Impact on the global economy
The panic caused by the pandemic delays consumption and investment decisions sine die. This hurts the supply side, because companies slow down production, and the demand side, because consumers stop consuming. Between them, they generate 80% of GDP, hence the importance of the disease. As a result, Arcano Economic Research estimates that global growth will fall from 3.4% on average over the last 10 years to less than 2.5%, the worst since 2009.
By regions, the worst affected will be China, which will suffer a very sharp fall in GDP in the first quarter, and the emerging countries. The OECD area will be hit in the second quarter. The recovery will come in the second half of the year, but at different speeds; in China and emerging countries in the form of a "square root" (downturn followed by zero or low growth for several quarters), and in the rest in the form of a "U" (downturn followed by flat growth in one quarter and a sharp rise in the next).
The reason: China will have to take structural damage to its economy. The liquidity crisis in small companies and the bursting of the real estate bubble will affect the banking system and cause GDP to fall in the first quarter between 2-31Q2013.
The Chinese growth model, based on outsourcing for the supply chain, will have to change to insourcing, i.e. the use of own, not external, resources, which will threaten China's industrial sector, which accounts for 43% of GDP. Added to this is the demographic decline, which has been going on for six years. In this tough environment, China will have to manage a high level of public debt, which is likely to slow down its growth recovery.
With regard to Europe and the United StatesThe impact on the first quarter will be zero, because the February data do not indicate that activity is falling. The ISM indicators (surveys of purchasing managers) do show sharp declines in the second quarter, and we will have to see how this translates into employment. Another factor to watch will be the banks' capacity to inject liquidity into the system, especially for SMEs, which generate most jobs.
In the emerging zone, the worst capital flight in many years is taking place, due to the fall in the price of raw materials. This is a dangerous situation that could lead to bankruptcies in countries that have abused their debt, as in the case of Lebanon.
Market impact: volatility
As in 2008, markets are experiencing a liquidity shock. However, back then investment banks provided liquidity on the trading desks, which current regulation does not allow. The result is highly illiquid markets, a factor driving volatility.
Thus, the US stock market has reached volatilities of 50%, when its historical average is 19%. Only during the Lehman Brothers crisis did volatility reach the record level of 89%, compared to 40% during the Second World War, when Hitler invaded France.
Another factor driving volatility in the markets is algorithmic trading or quantitative selling managed by robots. These are tools that replicate the behaviour of the stock market, both in sales and purchases, amplifying volatility. It is estimated that in just one week, the US stock market lost 50 billion dollars for this reason, although when the epidemic is contained, the market rebound will be greater thanks to quantitative management.
Impact on asset classes
- Sovereign bondsInvestors are seeking refuge in sovereign bonds, but they are discriminating and choosing the strongest countries, so those emerging economies that are more fragile - for example, Turkey - may suffer.
- Currencies: The yen, Swiss franc and euro are rising at the expense of the dollar. The reason for this is that investors tend to go long (buyers) in currencies that pay yields, and fund themselves in currencies with zero or negative yields. To profit from the spread.
In the current environment, the currencies in which the market has been long are being sold, and those in which it has been funded are being bought back: the yen, the franc, and the euro. As a result, the dollar is at historic lows, and weakness in emerging currencies is growing. So if an emerging country is borrowing in dollars but raising money in local currency, it has serious liquidity problems.
- Money markets: Money markets are experiencing a flood of liquidity. In the United States, the Fed announced that it was raising its daily intervention to 150 billion dollars in the repo market, to provide liquidity in the interbank market for banks that want to lend to other Asian or European financial institutions. This scenario is not comparable to that of 2008, when the banking system had solvency problems, which was dangerous for the economy. Today's banking systems are more solvent, and have access to liquidity more easily. This is therefore a temporary situation.
- Credit marketThe focus of the market is on the investment grade segment. In the US, the lack of liquidity could create a problem if recession hits and BBB- bonds are reclassified to BB+ bonds; in that case, there would be no money to buy bonds with this rating. In contrast, the situation in the high yield markets is devastating: no liquidity, huge price falls, primary market closure, and rising default rate.
- EquitiesWe find ourselves in a bear marketwith corrections of 30% or higher. The market is anticipating recession, but out of the last seven bear marketIn only two have recessions been confirmed. So, when this scenario is ruled out, money will quickly flow back into equity.
- Raw materials: Those most sensitive to the cycle are going through a phase of weakness, as in the case of zinc and copper. Oil prices are expected to see lower demand, due to geopolitical issues. In the past, the OPEC production cartel tried to reach an agreement with Russia to continue production. However, Russia refused in order to raise the price and hurt the US.
In this situation, Saudi Arabia has decided to increase production to keep prices low and avoid bankruptcies in corporate bonds (high yield) of crude oil distributors, and to get Russia out of the market. An environment of nervousness accentuated by the coronavirus. In the short term, this is bad news for countries like Mexico, a quarter of whose income depends on the price of oil.
Impact on the Spanish economy
The engine of the Spanish economy is tourism, because 12% of Spanish GDP is generated by this sector. Half is international and half domestic, although international tourism is the most relevant for our economy.
It seems reasonable to estimate a drop in revenues from the Easter season of 50%. Easter accounts for 15% of the total revenue generated by international tourism. If the coronavirus is contained before the summer, the summer season will not be affected.
Where there may be a more serious impact is in the fall in investment in the second quarter: less business spending, less consumption, frequent ERES and ERTES in small and medium-sized enterprises, which account for 60% of GDP and 80% of employment and a decline in exports of goods. The case of China is worth highlighting, because we export 0.5% of GDP to this country, and 500,000 Chinese tourists visit us every year. Finally, the housing market will suffer delays in the purchase of houses due to the fall in demand.
But not all of the impact will be negative. Falling oil prices can benefit our economy, because we spend 2% of our GDP on oil and oil products. And as China recovers its production capacity and inventories - it is at a much more advanced stage of containing the epidemic than Spain - the beneficial effect on the Spanish economy will be greater.
In conclusion, the experts at Arcano Economía Research predict a fall in Spanish GDP due to the coronavirus of 0.6%. And a rise of 0.2% due to the effect of the fall in the price of crude oil. At the end of 2020, the growth estimate stands at 1.3%, a level that is insufficient to create employment.
Nevertheless, given that the recovery of our economy will be U-shaped, we will return to normal in the fourth quarter, laying the foundations for stronger and more stable growth in 2021.
Globally, analysts expect a return to normality in May-June and a second half of the year of growth. In the markets, the reaction may be very positive at some point in the second half of the year, given the precedents. In 2008, global GDP fell -0.11GDP3Q3. Thanks to the signs of economic recovery that started in March, 2009 was the best year ever for the stock market.
Javier Ferrer
Head of the Financial Communication Department of Proa Comunicación