I was working in London in 2008-2009, when I witnessed how the global financial crisis pummeled the UK, US and the global economy with escalating ferocity and vengeance. At that time policy makers were able to effectively counter this crisis through unprecedented and coordinated fiscal policy intervention, as the massive shock emanated from within the financial system (i.e. it was a financial shock).
This time its different
However this time, in 2020, the shock is different. It’s a supply side (i.e. global supply chain disruption) and a demand side shock (due to the spread of corona virus pandemic and draconian measures taken by governments i.e. country lockdowns etc. to counter the spread of the same) that can transform into a financial shock.
The problem is compounded by the slump in global trade and import demand from China (which accounts for around 19% of global GDP and 11% of global trade), and the gargantuan levels of debt (which touched 322% of global GDP in Q3 2019 – according to IIF) hovering over the global economy- all of which are already exerting substantial downward pressure on global growth. These developments have led to liquidity and capital shocks (which have resulted in a scramble for liquidity and will lead to deferment or massive pull back of capital spending by firms worldwide, particularly in developed economies).
Due to what I have stated above, the situation now is far more challenging and complex for policy makers than during the global financial crisis.
A global recession in 2020 seems imminent now and it will probably be worse than the recession during the global financial crisis of 2008-2009 (despite the array of fiscal and monetary policy stimulus measures undertaken worldwide – particularly by the US and the UK), due to reasons stated above and later in this article.
Two Key Challenges
The two key challenges policy makers face today is to ensure that a liquidity crisis does not transform into a solvency crisis and thereafter into a banking crisis, and that not only banks, but firms and households must have continuous availability of liquidity. Further, if the spread of the corona virus is not effectively countered soon by policy makers worldwide, the aforesaid shocks can transform into a financial shock that will not only ripple across the global economy but also lead to a serious banking crisis in several countries (with deleterious effects on the real economy and labour markets).
Current fiscal stimulus unlikely to be adequate or enough
Given the multiple shocks given to the global economy and due to factors stated above, I don’t think that the fiscal policy stimulus pledge (US$ 5 trillion) announced by G-20, the US (US$ 2 trillion) and many other countries such as the UK, Australia, Hong Kong, China, South Korea, Germany, France, Japan, Italy, Canada, Brazil, Malaysia, Russia and India who are making efforts to stimulate their economies will be adequate enough to resuscitate growth.
The effectiveness of monetary easing, in terms of shoring up growth globally, is highly limited in the current milieu (where global supply chains have been disrupted and consumer and business spending has virtually stalled due to the corona virus pandemic), even if it somewhat stabilizes credit and financial markets in the US and in other developed and emerging economies. More than 20 central banks have eased monetary policy since the inception of 2020.
In view of what has been stated above, more fiscal firepower will probably be a compelling imperative (particularly in the US, eurozone, the UK, Japan and in several major emerging economies). The burden of policy intervention will have to be borne by fiscal policy.
State of the global economy – parlous
Economic activity worldwide has come to a virtual standstill, global supply chains have been disrupted, global and major stock markets such as S&P 500, DJIA, Nasdaq, Europe Stoxx 600, FTSE 100, Japan’s Nikkei and Hang Seng have witnessed a precipitous drop amid a bruising sell-off, business surveys across the US, Europe and Asia (except China where factory activity has witnessed a slight rebound) are amply reflecting the gloomy state of the manufacturing sector, the Chinese economy is expected to contract for the first time in decades in Q1 2020, oil prices have now collapsed to US$20 per barrel from US$65 at the inception of 2020, and discretionary consumer spending globally has plunged (discretionary consumer spending accounts for around 40% of total consumer spending in developed economies).
Yields on US treasury bills have plunged much below 1% (which gives rise to concerns about safety of Chinese investments in US treasuries – China has about US$1.1 trillion worth of US government bonds as part of its foreign exchange reserves), retail, hospitality, travel and tourism sectors have been battered worldwide, in credit markets investors have fled junk bonds, the US has witnessed a surge in unemployment to 6.6 million – historically an unprecedented figure (disconcerting labour marked developments are taking place in Europe too, particularly in Spain and France) and emerging markets have witnessed record capital outflows (that have led to their currencies depreciating vis-a-vis the US dollar) as investors fled to the stability offered by dollar-denominated assets (pushing up the value of US dollar),
Already, it seems evident that the US, the UK, Germany, France, Italy, Japan and Canada are likely to witness a recession in the first half of 2020, which in turn will have cascading downside implications for emerging economies’ growth prospects via trade, confidence, exchange rate and financial market channels.
Singapore’s economy has already suffered its biggest contraction (by 2.2% y/y in Q1 2020 – according to an advance estimate) since the global financial crisis and is expected to witness a deep recession in 2020. Hong Kong is expected to witnesses deepening of recession in Q1 2020 (GDP data is awaited) and large emerging economies such as Brazil, South Africa, Russia and India are already in a slowdown mode.
Turning to GCC economies, plunge in oil prices have now made their economies more vulnerable to global shocks and prolonged economic slowdown, given the small size of their national markets, fall in non-oil exports, high youth unemployment, low regional integration, insufficient economic diversification away from oil and the marked downturn in tourism, travel, retail and hospitality sectors (the UAE among GCC countries seems best placed to weather the current economic storm).
One can expect a marked rise in fiscal deficit in GCC countries this year, as oil prices are likely to remain highly subdued given the dismal global economic scenario (I doubt whether oil prices will cross US$30 per barrel this year). Currently, oil prices have fallen to US$20 per barrel)
Asia, which has been the driver of global growth in recent years, is also likely to face a recession, due to slump in Chinese economic growth, strong possibility of a global recession, supply chain disruptions and fall in domestic demand.
Having stated the above, several factors, such as high debt burdens, capacity constraints, structural factors and institutional weaknesses, are likely to undermine the effectiveness of fiscal policy intervention in most emerging economies. They have already witnessed unprecedented capital outflows (which has put downward pressure on their currencies and led to a sharp fall in asset prices), marked fall domestic demand and plunge in demand for their exports.
Given that I expect a bruising recession in the US (its economy is likely to be pummeled by six factors – collapse of discretionary consumer spending, ocean of corporate debt, particularly huge amount of leveraged loans (US$1.2 trillion), surging unemployment, vulnerability of the US energy sector to plunge in oil prices, possibility of a substantial amount of investment-grade bonds being downgraded to junk levels and scaling back of business investment), Germany, France, Italy, the UK, Japan and Canada this year (2020), a slump in growth in China (between 3-4% in 2020) and lack of adequate fiscal space to counter the downside impact of the spread of corona virus on economic activity in major emerging economies (such as Brazil, India, South Africa and Russia among others), along with constraints (mentioned above) that are likely to undermine the effectiveness of fiscal policy intervention in these economies, the pain for emerging markets seems to have just begun. Emerging Asia and Latin America will probably be most adversely affected.
Global economy is already overladen with debt – a key concern
What particularly worries me is that the global economy is buffeted by an overhang of debt (comprising of non-financial corporate, household, government and financial sector debt as % of GDP) that has touched unprecedented levels, particularly non-financial corporate debt (which touched 92.5% of global GDP in Q3 2019) in the US (74.2% of GDP as of Q3 2019), China (156.7% of GDP as of Q3 2019) and the euro area (107.9% of GDP as of Q3 2019). This data (source: IIF) on debt is indeed rather disconcerting and shows how deeply mired in debt the global economy was even before the advent of this crisis.
With global and US stock markets plunging and economic activity coming to a virtual standstill worldwide, this onerous burden of debt will now exert even more downward pressure on global growth (at a time when policy makers are attempting to stave of a global economic collapse through massive fiscal and monetary policy intervention) – thereby significantly blunting the effectiveness of such (policy) intervention.
To be more specific, the gargantuan size of non-financial corporate debt (as % of GDP) in countries such as the US, China, eurozone, the UK, Japan, Hong Kong, South Korea, Singapore and Chile, high household debt (as % of GDP) in the US, the UK, Hong Kong, South Korea, Malaysia and Thailand, high or rising government debt (as % of GDP) in the US, Eurozone, the UK, Singapore, Japan, Brazil and India, and high financial sector debt (as a % of GDP) in major developed economies mentioned above, Hong Kong, Singapore and South Korea amply demonstrate that if the corona virus and associated country lockdowns are not reversed soon enough, the ramifications of the impending global recession of 2020 in terms of corporate defaults, bankruptcies, layoffs and financial stability could be far more serious than expected or imagined.
Over the coming quarters, government, corporate and households’ indebtedness is likely to increase further world over, due to the massive fiscal stimulus being undertaken (which will place governments increasingly at the mercy of financial markets), corporates making use of credit lines to enable them to pay costs such as wages, interest and taxes and avoid going bust, and substantial rise in unemployment. This in turn is likely to seriously inhibit capital formation and recovery in discretionary consumer spending over the coming quarters. As a result, any meaningful and sustainable global economic recovery from this crisis could take a very long time.
Five other factors that will make global economy recovery an arduous task:
First: the brunt of this crisis will be borne by the large SME (small and medium enterprises) sector, particularly in countries such as the US, the UK, EU, China, India and in many other emerging economies.
Second: with the possibility of continued stress in credit markets, firms will probably find it increasingly difficult to access the corporate bond market over the coming months (particularly in the US and the EU where this market has virtually shutdown), which in turn will seriously deter them from undertaking investment. Further, companies worldwide are likely to find it more difficult to access new financing and may face rising borrowing costs in the months to come – which in turn could result in bankruptcies and massive layoffs. Further, the surge in dollar-denominated debt worldwide will also inhibit firms from undertaking investment over the coming quarters. Moreover, global FDI flows are likely to plunge.
Third: one sector that will probably be badly affected is the global banking sector, particularly the banking sector of Western Europe, Japan, China and India and of several emerging economies, which in turn will weigh on economic recovery over the coming years. Essentially, factors such business activity coming to a virtual standstill, massive plunge in revenues of consumer oriented industries such as aviation, travel, tourism, retailing, automobile among others worldwide, dismal earning prospects of several medium and small scale enterprises in particular and consumers likely to increasingly default on their loans (due to rising unemployment over the coming quarters (resulting in rising NPA’s) – along with marked reduction in interest rates by central banks in both developed and emerging economies – are all likely to take a substantial toll on banks’ balance sheets, net interest margins and earnings prospects worldwide.
This in turn will not only inhibit bank lending at a time when raising funds from the financial markets is likely to become significantly more challenging, it will also result in increasing the cost of capital for firms.
Fourth: large negative wealth effect resulting from the downturn in global financial markets will further restrain consumption spending in several countries, particularly in the US, the UK and also in several other developed and large emerging economies.
Fifth: record levels of consumer and risky corporate debt might exacerbate the economic downturn in the US and turn it into a protracted one. Further, highly indebted firms are likely to retrench sharply from investment spending and hiring, which in turn will make economic recovery more difficult. Moreover, stupendously high levels of corporate debt in China is likely to substantially weigh on its economic growth at least over the next three years, despite policy makers there wanting to bolster growth through more proactive fiscal policy combined with monetary easing.
Together, these economies (US and China) account for around 40% of global output and a protracted downturn or a slowdown in these two economies is likely to have substantial downside implications for European and Asian economies in particular via the trade, supply chain, financial market and confidence channels.
China, of course, can undertake more potent expansionary fiscal policy and has more monetary policy space than the US.
To conclude, given the multiple shocks to the global economy and the plethora of downside factors mentioned above, along with gloomy corporate earrings prospects and global trade outlook over at least the next one year, the infusion of fiscal and monetary stimulus while an imperative to stave off an economic collapse is unlikely to prevent a global recession in 2020.
Further, together with accumulation of too much debt, the shock to capital accumulation in economies worldwide – due to damage to the supply side of economies’ likelihood of increasing hesitancy to invest by firms (which will have downside implications for productivity and hiring) and strong possibility of continuation of stress in credit markets, I am increasingly concerned about the medium-term (3 year) global economic outlook too.
Disclaimer: The views expressed in the article above are those of the authors’ and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.