As the spread of COVID-19 goes global, the economic effects of social-distancing measures to contain the virus, along with plummeting consumer and business confidence, have delivered a sharp blow to near-term growth prospects and roiled financial markets. In addition to the fast-rising human toll of the virus (i),we are entering a period of unprecedented rates of decline in economic activity and financial-asset prices, and equally fast and unprecedented policy responses to both combat and offset these declines.

The recent extraordinary movements in key economic and financial variables include:

• U.S. jobless claims surging to 3.3 million for the week ended March 21, more than four times the 1982 record;
• China's January-February fixed-asset investment falling 45% year on year, industrial production slipping by 14%, and retail sales dropping 21%--declines not seen since the reform era began in the late 1970s;
• Capital outflows from emerging markets far outpacing any previous global crisis episode; and
• The benchmark S&P 500 index tumbling 30% in a record 22 trading days, while the VIX measure of volatility spiked to levels not seen since the Global Financial Crisis (GFC).

Chart 1

These quickly unfolding events have led us to lower our GDP growth forecasts beyond our report of just two weeks ago (ii). We now forecast global growth to be just 0.4% this year. This compares with the 3.3% we had expected during our previous quarterly Credit Conditions Committee in December (iii), and 1.0%-1.5% in our March 14 update (iv). In terms of regions, the main driver of this change was sharply lower forecasts for Europe and the U.S., of about 1 percentage point each (v). The lower global growth forecast also reflects markdowns for most emerging markets, with India making the biggest dent. In contrast, we have maintained our forecast for China's growth at just under 3% (see table 1).

Our Assumptions

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. We believe the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Table 1

U.S.

The longest economic expansion in U.S. history has ended abruptly. We now forecast a record downturn in the second quarter with a recovery taking hold in the second half of the year and into 2021. Our revised GDP growth forecast for all of 2020 is a contraction of 1.3%, including a 12% decline in the second quarter, from the first. Growth will likely rebound to 3.2% in 2021, implying a loss of GDP of $360 billion relative to our December 2019 baseline. Labor market outcomes are deteriorating sharply and the unemployment rate will likely top 10% in the second quarter (with a monthly peak above 13% in May) with more unemployed workers than during the GFC. The federal government's $2 trillion fiscal package should cushion the downside by injecting money directly into households (vi), extending unemployment benefits to 13 weeks, making money available to small and medium enterprises (SMEs), funding hospitals and local governments, and providing guarantees and subsidized business loans.

See "It's Game Over For The Record U.S. Run; The Timing Of A Restart Remains Uncertain," published March 27, 2020

Europe

Eurozone GDP will likely fall by 2.0% this year as the constraints to consumption and the sharp downward revision to U.S. growth (the EU's biggest export market) weigh on activity. We expect a solid rebound in 2021, with 3% growth. The decline in growth represents a loss in output this year of €420 billion for the eurozone and U.K. together relative to our previous quarterly forecast. We estimate that lockdowns across the continent will reduce household spending by 40%. As to individual countries, Italy and Spain will be hit hardest, with growth declining 2.6% and 2.1%, respectively. U.K. output will fall 1.9% this year. The biggest hit to growth will span the first and second quarter (earlier than in the U.S.), before a modest recovery begins later this year. European countries and central banks have been quick to activate safety nets and inject liquidity into their economies. This should support the recovery once containment measures are lifted. Importantly, these actions seek to ensure that especially SMEs continue to have access to credit and minimize the shedding of jobs. The European Central Bank's (ECB) move to lift the issuer limits on the bonds it buys will help ease financial conditions in the peripheral economies. More fiscal solidarity is expected at the EU level.

See "COVID-19: The Steepening Cost To The Eurozone And U.K. Economies," published March 26, 2020.

China

The Chinese economy took an enormous and much larger-than-expected hit in the first quarter as fixed-asset investment, industrial profits, and retail sales fell by unprecedented amounts (as noted above) (vii). We forecast that GDP fell almost 10% in the first quarter from a year earlier. For 2020 as a whole, we now forecast 2.9% growth, down from 4.8% in our previous Credit Conditions Committee. Our forecast assumes that year-on-year growth rates turn positive in the third quarter, at about 8%, and peak well into double-digits in the first quarter of next year. In turn, we forecast growth in 2021 at 8.4%. Encouragingly, a recovery is now taking hold as indicated by high-frequency traffic, shipping, and capacity data, although the pace is slower than we previously thought. That said, the deepening downturns in the U.S. and Europe will impede the rebound in manufacturing and trade, with lower oil prices providing a boost. While we expect the authorities to continue to support growth and employment during the COVID-19 downturn, we don't expect anything near the record 2009 fiscal stimulus given their continued focus on debt sustainability and financial stability.

See "Asia-Pacific Recession Guaranteed," published March 16, 2020.

Emerging markets

Emerging markets (EMs) are facing three simultaneous shocks relating to COVID-19: supply chain disruption and restricted people flows, falling demand for commodities, and capital outflows.

Chart 2

These will lead to tighter financial conditions, including in U.S. dollar funding markets. Poland and Mexico have the most exposure to goods trade, while Thailand has the largest exposure to tourism. Falling commodity prices are negative for a wide swath of EMs (most notably Saudi Arabia and Russia), although many economies in Asia-Pacific will benefit.

Capital outflow pressures have hit Mexico, Russia, Brazil, and South Africa the hardest. While EMs are relatively late in facing the challenges of the pandemic, only a few key economies in this group will escape GDP contraction this year (mainly in Asia-Pacific), but even those will see a sharp decline in activity. Given the pattern in other global regions, we expect the economic data to worsen in short order. One risk specific to this group is that less developed healthcare and government support systems in some key EMs are likely to result in larger human and therefore economic effects than in advanced markets.

See "Emerging Markets: Empty Streets And Rising Risks," published March 27, 2020.

The Macro Shock Will Also Pressure Creditworthiness

The sharp decline in economic activity and "risk-off" activity in the financial markets is putting significant pressure on creditworthiness globally and will undoubtedly lead to increased defaults. However, given the uneven effects of social distancing policy on economic outcomes, the magnitude of these effects on creditworthiness will vary tremendously by industry, geography, and rating.

The industries most vulnerable to social distancing and the collapse in global demand--such as airlines, transportation, and retail--or those heavily dependent on cross-border supply chains are likely to suffer most, both from slumping cash flows and much tighter financing conditions. In terms of ratings, we expect that companies rated 'B' and below will come under the most pressure. These low ratings reflect higher vulnerability to adverse business financial and economic conditions.

See "Assessing The Coronavirus-Related Damage To The Global Economy And Credit Quality," published March 25, 2020.

Policymakers Face An Enormous Challenge

The economic policy challenges relating to COVID-19 are enormous (viii). Given the nature of the size and nature of shock, effective policy will cushion the blow, ensure markets continue to function as smoothly as possible, and--critically--create a bridge to the eventual recovery.

As the impact of the pandemic has escalated, many central banks moved decisively to ease financial conditions, help ensure adequate liquidity, and support price discovery. The application of the lessons learned during the GFC and European Debt Crisis are clear. An easing of macroprudential requirements will support these monetary policy changes. Fiscal policy has been almost as bold, albeit not as timely, perhaps reflecting the starting point of elevated debt-to-GDP ratios following a decade of heavy borrowing in the post-GFC period.

As of late March, all major central banks are now (back) at the zero lower bound for their policy rates (ix). All have (re-) started bond-buying programs, with some important amplification. The U.S. Federal Reserve has widened its asset purchases to include investment-grade corporate debt in both the primary and second markets (x). The ECB has launched a €750 billion Pandemic Emergency Purchase Programme (PEPP), under which it will purchase assets eligible under the existing program (plus nonfinancial short-term corporate debt) and, importantly, waive the 33% purchase limit of any specific debt issue (xi).

Waiving the purchase limit will provide direct support to the sovereign bonds of the peripheral euro area countries. Major central banks have also committed to purchases of commercial paper and money market securities in order to keep those markets functioning. Also, the Fed has reached agreement with a half dozen central banks on enhancing swap lines to ensure the smooth functioning of dollar funding.

Macroprudential policies have been made flexible as well in an effort to ease financial conditions. Measures vary across jurisdictions but include temporary relief regarding banks' capital requirements, flexibility around the handling of deferred loan and mortgage repayments, nonperforming loan classification, and suspension of foreclosures. Some of this relief is conditional on continued lending to the most credit deprived sectors.

The bold moves by central banks and other macroprudential authorities may not be sufficient to weather the crisis and support the recovery. A strong fiscal policy response is needed to create public demand to offset the sharp drop in private demand. Most advanced economies have passed packages that ensure some combination of corporate loan guarantees and direct support to SMEs and workers. The former generally run from one-half to two-thirds of the total. On the latter, European and Asian measures aim to keep workers on the payroll and SMEs afloat while the U.S. approach aims more toward compensating those suffering losses. We assess these two approaches below.

A danger is that once the dust settles there will be a ratcheting-up of public-sector involvement in the economy. It will therefore be important to make measures time-bound or conditional on need, and roll them back as the recovery takes hold and conditions normalize.

Mapping The Recovery

Despite the current angst and market gloom, the recovery will eventually come. We expect the recovery to be strong, but two issues could affect the speed and magnitude of the upturn.

Once the health situation stabilizes, meaning normal production and consumption can resume, how quickly can economies recover? This will depend in part on the structure of the labor market and the SME sectors. Here we think the differing approaches of Europe-Asia and the U.S. may be important. Once social distancing ends and normal economic activity can resume, companies with an existing workforce (likely furloughed and receiving at least partial compensation) will be able to resume production almost immediately. Workers simply go back to work. However, if those employment relations have been severed (workers were laid off), then the hiring and matching process must take place to onboard new workers. This could in principle simply mean re-hiring previous employees, but that outcome is by no means guaranteed.

A similar argument can be made for SMEs and supply chains. If firms still exist when the health crisis ends (perhaps they received some combination of direct payments and loan deferrals if they kept their workforce) then production can resume quickly once demand returns. This will be particularly important for firms in supply chains, where there may be network dependencies on these firms. In contrast, if firms closed because of the COVID-19 shock, then restarting production will take more time.

Note that this isn't necessarily an issue of the amount of fiscal support. The transfers to workers and firms in the two models may be identical so that no one is worse off in the downturn. However, the recovery will be different, suggesting that the strategy of "letting the market work" and offsetting unemployment and firm closures with direct payments may be dynamically inefficient in that it leads to a slower recovery and lost wages and output.

The second issue regarding the recovery is: how much output is lost? (We provided some estimates for advanced countries above.) Here, it's important to separate the potential rate of growth from the level of activity. On the former, we see little change from pre-COVID-19. Accounting identities state that rate of potential growth depends on the labor force, the capital stock, and productivity. To the extent that none of these meaningfully change as a result of the ongoing pandemic, potential growth won't meaningfully change. However, the level of activity may be lower. This would result from the combination of supply loss and demand destruction (xii). The cancellation of sporting and entertainment events, the closure of restaurants, and other social activities is unlikely to be fully recovered once the health crisis passes. The net result of these factors would be path of output that is parallel to, but lower, than the pre-COVID-19 path.

Risks Still On The Downside

The risks to our baseline forecast remain firmly on the downside. These are at least threefold. First, the mapping from the spread of COVID-19 to economic outcomes remains unclear and could be worse than assumed. Witness the steady deterioration of economic forecasts, including our own, in the past few months. Even if the spread is contained, the economic fallout could be worse. Second, and more pernicious, the containment could take longer than expected. We believe the economic damage with respect to COVID-19 is non-linear. That means, for example, that if the containment takes twice as long as projected, then the economic damage will be more than twice as bad.

Finally, for any downturn, the recovery could take longer and be shallower (with more lost output) than projected. China's recovery is already a bit slower than previously thought and will be watched closely. As noted above, we would flag the U.S. fiscal response of unemployment damage control versus the Europe-Asia model of keeping existing employment linkages intact as another potential downside risk to the pace of recovery.

We will continue to monitor macroeconomic, financial, and credit developments closely and update our scenarios as needed.

End Notes

(i) The Johns Hopkins University dashboard has become the authoritative source on COVID-19 developments: https://gisanddata.maps.arcgis.com/apps/opsdashboard/index.html#/bda7594740fd40299423467b48e9ecf6.

(ii) See "The Global Recession Is Here And Now, March 17, 2020

(iii) See "2020 Vision: Global Macroeconomic Outlook Steady For Now," Dec. 4, 2019.

(iv) The 1.0% to 1.5% global growth forecast in our March 17 report was an "off model" exercise. The forecasts in this report are model-based, being part of our regular quarterly Credit Conditions Committee exercise.

(v) Together the U.S. and Europe comprise over 35% of global GDP using purchasing power parity exchange rates.

(vi) The terms "helicopter money" or "printing money" are now back in fashion, and we would urge caution in their use. The key question is around funding and its permanence. If the government issues a bond to the capital markets and uses the proceeds for direct payments to households, then that represents a temporary shift in purchasing power from the new bondholders to households. It is not helicopter money, which aims for a permanent increase in the money supply and spending. This example is not permanent because at some future date households are taxed to repay the bondholders, which offsets the effects of the initial cash transfer--this is the well-known Ricardian Equivalence Theorem. However, if the government obtains direct and permanent financing from the central bank (by issuing a perpetual, zero-coupon bond to the monetary authority), then permanent money and purchasing power are created. The government deposits the proceeds of that bond directly into household accounts at financial institutions, and households spend it. This is permanent because this bond is perpetual (it has no maturity date), carries no interest, and is never repaid. Note that the net discounted value of this perpetual bond is zero, meaning the central bank now has a permanent "hole" in its balance sheet and households have permanent "more money." For more background, see https://www.hks.harvard.edu/sites/default/files/centers/mrcbg/files/PSheardQEQAAugust2014.pdf.

(vii) The surprising magnitude of these declines suggests that the authorities are unlikely to be smoothing the data, an accusation that has been leveled in the past.

(viii) The IMF has compiled a country-by-country list of policies enacted to date: https://www.imf.org/en/Topics/imf-and-covid19/Policy-Responses-to-COVID-19.

(ix) The Reserve Bank of Australia and the Reserve Bank of New Zealand are the newest joiners of the ZLB as well as the QE club.

(x) See "Federal Reserve announces extensive new measures to support the economy," March 23, 2020, https://www.federalreserve.gov/newsevents/pressreleases/monetary20200323b.htm.

(xi) See "ECB announces €750 billion Pandemic Emergency Purchase Programme (PEPP)," March 18, 2020, https://www.ecb.europa.eu/press/pr/date/2020/html/ecb.pr200318_1~3949d6f266.en.html.

(xii) Analysis of the effects of Brexit on the U.K. economy was similar to the arguments made here.

Related Research

• It's Game Over For The Record U.S. Run; The Timing Of A Restart Remains Uncertain, March 27, 2020
• Emerging Markets: Empty Streets And Rising Risks, March 27, 2020
• COVID-19: The Steepening Cost To The Eurozone And U.K. Economies, March 26, 2020
• Asia-Pacific Recession Guaranteed, March 16, 2020
• Assessing The Coronavirus-Related Damage To The Global Economy And Credit Quality, March 25, 2020