ECONOMIC RECESSION: SHORT AND SURMOUNTABLE

The COVID19 pandemic and the measures put in place to contain it have delivered an enormous shock to the world economy. Indeed, the IMF has said that this crisis is like no other due to the shock being so large and sudden, with a continued high degree of uncertainty about how long it will last. As a result, economic forecasting in the current unprecedented COVID19 recessionary environment is very difficult, with a wide range of outcomes possible for GDP.

What is clear, though, is that GDP will contract sharply in 2020. Incoming macro data are reflecting a sudden and very severe contraction in activity. For example, the Composite PMIs for April from the US, Eurozone and UK plummeted to record lows, with the weakness most evident in the services sector and consistent with a large contraction in business activity. Other data, including US monthly payrolls and jobless claims, highlight the unprecedented collapse in employment and surge in unemployment. Big falls in GDP for the first quarter of the year are being seen in many economies.

The most comprehensive set of economic forecasts published since the onset of the COVID19 pandemic have come from the IMF in its semiannual World Economic Outlook, April 2020.

The IMF baseline scenario is a deep recession in the first half of 2020, with output declines concentrated in the second quarter. This is followed by a gradual recovery in activity during the second half of the year that gathers momentum in 2021.

The IMF assumes in its forecasts that the virus outbreak will peak in most countries during quarter two and fade in the second half of the year, with business closures and other containment measures gradually unwound. The strong growth projected for 2021 is based on the view that the aggressive policy actions taken by governments and central banks across the world will be effective in restoring consumer and business confidence, as well as preventing widespread bankruptcies, extended job losses and systemwide
financial strains.

Overall, the IMF see world GDP falling by 3% in 2020, but rebounding by 5.8% in 2021. This would be the biggest fall in GDP since the Great Recession in the early 1930s. While growth is projected to be well above trend in 2021, the IMF calls it a partial recovery as the level of output next year is almost 4% below what it had projected before the virus hit.

Western economies are being hardest hit by the pandemic, with the IMF forecasting that their output will fall by 6.1% in 2020. Despite expanding by a predicted 4.5% next year, their level of GDP will still be 5% below that projected before the virus struck. Ireland’s main trading partners have been hard hit by the coronavirus outbreak and thus have had to impose strict lockdowns. Thus, not surprisingly, the IMF is forecasting that GDP in the Eurozone, UK and US will fall by 7.5%, 6.5% and 5.9%, respectively in 2020.

In terms of the Irish economy, the IMF is expecting GDP to contract by 6.8% this year. Meanwhile, the ESRI and Central Bank of Ireland are forecasting that Irish GDP could decline by 7.1% and 8.3%, respectively, in 2020, while the Dept. of Finance is projecting a fall of 10.5%.
The Irish unemployment rate, which was below 5% at the start of the year, spiked higher to 16.5% in March. It is seen by the IMF as averaging 12.1% in 2020. The ESRI has quite a similar unemployment forecast for 2020, with the jobless rate put at 12.6%. The Dept. of Finance sees unemployment averaging 13.9% this year. The Dept. is forecasting that the unemployment rate will fall to an average of 9.7% in 2021.

Like other countries, Ireland is heading for a blowout in the public finances this year. Governments are providing income and financial supports for households and businesses to help them get through the recession. Meanwhile, tax receipts are plummeting with economies in lockdown. The Dept. of Finance is forecasting a budget deficit of €23 billion or 7.4% of GDP in 2020, compared to a budget surplus last year.

However, the ECB’s rampedup Quantitative Easing bond buying programme is underpinning Eurozone sovereign debt markets, allowing Governments to fund at low interest rates, unlike during the Global Financial Crisis a decade ago. This was evident in April, when the National Treasury Management Agency raised €6bn in a new 7 year bond, issued at a yield of just 0.25% amid very strong investor demand.

It is important to bear in mind that the Irish economy is facing into this crisis from a strong starting point. The unemployment rate had fallen to below 5%. Meanwhile, the economy had undergone a period of major deleveraging in the private sector, including households. The household debt to disposable income ratio had fallen from a peak of around 210% a decade ago to below 120%. From a government finances perspective, the budget deficit had been eliminated at a quicker than expected pace, returning to a surplus in 2018/19. The balance of payments had also returned to significant surplus. The property market was characterized by stable prices and limited supply.

Overall then, the economy should be in a good position to bounce back from the recession. There are two risks, though, that could delay a recovery. First, the virus proves very persistent requiring most of the restrictions on economic activity to remain in place for a prolonged period of time. Second, that there is a second wave to the virus later this year or in 2021, which sees the lockdowns reimposed.

Indeed, for some sectors of economies, such as hospitality, tourism, travel, entertainment, education and the leisure and sports industry, it may take a complete disappearance of the virus or the arrival of a vaccine for activity to return to normal.

Oliver Mangan, Chief Economist, AIB