Downturn now set to be deeper than the financial crisis - Capital Economics
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Downturn now set to be deeper than the financial crisis

Global Economics Update
Written by Vicky Redwood
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What were downside risks to the global economy just a few days ago are fast morphing into our central scenario. We now expect global GDP to fall by about 1% this year, which would be twice the decline seen in 2009. And while the rebound will hopefully be quicker, downside risks are rising.

  • What were downside risks to the global economy just a few days ago are fast morphing into our central scenario. We now expect global GDP to fall by about 1% this year, which would be twice the decline seen in 2009. And while the rebound will hopefully be quicker, downside risks are rising.
  • Developments have been worse than we had assumed a week or two ago. The virus is becoming more widespread than we had anticipated. We had been working on the assumption that we would see thousands of cases in all of the major economies, but that is now heading into tens of thousands. And the disruption related to the virus has been bigger too. Containment measures by many governments have been far more draconian than we had first anticipated and data from China suggest that we should not be surprised to see near-term falls in retail sales and industrial production in the order of 20% y/y.
  • As a result, we have slashed our GDP forecasts for most economies, but particularly the developed world. (See Table 1.) Although this has some downward impact in the first quarter, the main effect (given that it is mid-March already) is to reduce GDP in Q2, especially in Europe. At least there seem to be early signs of some recovery in activity in China so, barring a renewed “imported” outbreak of the coronavirus, GDP there should start to rise again in Q2 and the slump elsewhere might also be short-lived.
  • We have therefore pencilled in global GDP dropping by 5% q/q in Q1. This would be the sharpest quarterly fall since our records began in 1980 and much worse than the 1.6% drop seen at the depth of the global financial crisis in Q4 2008. A recovery in China could help world output to stabilise in Q2, despite a slump in activity in advanced economies. Even so, world GDP in 2020 as a whole now looks likely to fall by about 1%, compared to our pre-virus forecast of +2.9%. Other economists still have much stronger projections, with the OECD at +2.4% for example, but they will surely come down before long.
  • The one consolation is that, assuming the virus is brought under control, we should see a rebound in activity next year. For now, we are assuming a 7.3% increase in GDP in 2021, which would be better than the 5.4% gain after the financial crisis in 2010. But there are two reasons to fear a longer downturn. The first is that the direct virus-related disruption itself lasts longer than our revised assumptions. After all, we can only guess at how long schools, shops, restaurants or factories will be closed. Each extra month of school closures, for example, could easily knock another 2.5% off quarterly GDP. (See here.)
  • The second, more worrying risk, is that this downturn gathers a momentum of its own. With activity shutting down, there is a growing risk that otherwise solvent companies start to hit the wall, with knock-on effects on unemployment and consumer spending. This could result in anything from a lengthy recession to another financial crisis. Policymakers are pulling out all the stops to try to stop this from happening. But central banks now have very little ammunition left, meaning that the onus falls firmly on fiscal policy to prop up demand. (See here.) We will discuss the long-term effects more fully in a forthcoming Update.

Table 1: Change in CE 2020 GDP Growth Forecasts

Pre-virus

Latest

Difference

Pre-virus

Latest

Difference

Advanced

1.2

-3.5

-4.7

Emerging*

3.9

0.4

-3.5

US

2.0

0.0

-2.0

China*

5.0

-3.0

-8.0

Euro-zone

0.7

6.0

-6.7

India

5.7

4.8

-0.9

Japan

-0.2

-4.0

-3.8

S. Korea

2.5

-1.0

-3.5

UK

1.0

-7.0

-8.0

Brazil

1.5

0.5

-1.0

Global*

2.9

-1.0

-3.9

Russia

1.8

0.8

-1.0

Sources: Refinitiv, Capital Economics, *numbers based on our own estimate of Chinese activity, the CAP


Vicky Redwood, Senior Economic Adviser, victoria.redwood@capitaleconomics.com
Jennifer McKeown, Head of Global Economics Service, jennifer.mckeown@capitaleconomics.com