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STANLIB: Investing through a market crisis

By: Chief Economist Kevin Lings

An updated assessment of the economic impact of COVID-19

The number of COVID 19 infections outside of mainland China continues to rise at a very significant pace. In fact, out of the 182 406 infections reported worldwide to date (17 March 2020), approximately 101 356 are outside of China. Most of these new infections have been within Europe and the United States, although an estimated 155 countries are reporting infections.

Most of the countries that have experienced a substantial increase in infections during the past two weeks have initiated some form of “lock-down,” which typically includes travel restrictions (especially international travel), the banning of large gatherings, as well as the closing of education and entertainment facilities.

At this stage, it is very likely that China will incur a decline in GDP during Q1 2020. However, there are tentative indicators that business activity levels are slowly improving as the rate of new infections subsides. In contrast, Europe is likely to go into recession on a broad scale with negative GDP performance expected in all major European economies. Likewise, the current spread of the virus in the United States makes it likely that their economy will also slow substantially over the coming months. A recession in the United States would almost certainly signal a global recession.

A couple of weeks ago, the South African economy was expected to grow by around 0.5% during 2020. However, the “lock-down” measures announced by President Ramaphosa this week, while highly appropriate under the circumstances, will most likely have the effect of extending South Africa’s current economic recession well into 2020.

There is also a significant concern about the lack of liquidity in international credit markets. This is reflected in a sharp widening of credit spreads as banks and investors adjust their risk assessment to take account of the deteriorating economic environment. A lack of access to affordable credit could severely damage key parts of the world economy as businesses conditions are heavily impacted by COVID-19. This was a key factor in the US Federal Reserve cutting interest rates by 50bps at an unscheduled FOMC meeting on 3 March.

Most recently, the international oil price (Brent crude) plunged from around $53/bl at the start of March to $36/bl on 9 March, a drop of just over 30%. The sharp decline in the oil price can be ascribed to the breakdown of talks between OPEC and Russia regarding the need to cut oil production in order to support the oil prices, as well as Saudi Arabia’s response to this breakdown in discussions by indicating that they would increase output. However, the economic disruptions caused by COVID-19 has led to a sharp fall-off in oil demand, undermining the oil price in recent weeks.

The sharp fall-off in the oil price, combined with the continued spread of the virus internationally and the systematic downward revisions to global growth estimates, has started to more significantly undermine emerging markets, including foreign capital flows. Consequently, during the past couple of days the rand has weakened to over R16/$, which is a decline of almost 13% since the beginning of the year.

The number of new infections continue to rise at a very rapid pace

Globally, the rate of new COVID-19 infections per day has risen sharply from an average of around 2 600 per day in the first eight days of March to an average of 8 100 per day in the past eight days.

Fortunately, the fatality rate remains below 4.0% globally (currently sitting at 3.8%) with 7 154 deaths reported. Furthermore, an estimated 79 433 people have recovered from the virus, with only 6.0% of all infections reported as serious or critical.

The rate of new infections in mainland China, where the virus originated, continues to moderate, decreasing to well below 30 cases a day in the last six days. On 13 March for example, there were only 11 new cases confirmed in China. Furthermore, even though China still has the highest number of reported cases (81 050 people as at 17 March). The data shows that more people have recovered from the virus than those who remained infected. In fact, on 16 March, there were only 9 848 people still being treated for the virus in China.

With the number of new infections in China (and South Korea to a certain extent) slowing sharply, concerns about the spread of the virus around the world, particularly in Europe, are rising. So far, the virus has affected 155 countries including South Africa. Outside of mainland China, the number of confirmed cases has increased substantially from 29 306 to 101 356 in just a week. The rapid rise in global infections has been driven mainly by Italy (27 980 infections), where the number of new cases has risen by around 3 000 people per day during the past few days – which is similar to the peak rate of new infections experienced in China during February. In addition, Italy also continues to face the highest number of deaths outside of mainland China, with a fatality ratio of 7.3% (as of 16 March, 2 158 people have died in Italy), substantially higher than the worldwide case fatality ratio. It is speculated that the higher mortality rate in Italy could be because the average age of people living in Italy is much higher than China and South Korea

Rapid increases have also been observed in other European countries, namely, France (6 650), Spain (9 942), and Germany (7 272). In fact, six of the top 10 countries impacted by the virus are in Europe. This is not surprising given the high level of connectivity in the region as well as the ease of travel.

The United States has also seen a rapid increase in the number of confirmed cases, increasing to 4 661 (16 March) from a low of 583 on 9 March. Thankfully, many European countries as well as the United States have implemented a range of measures to contain the virus including significant travel restrictions and the restriction of large gatherings. In Italy, the extent of the “lock-down” measures have become very extensive including the closing of all shops, apart from supermarkets and pharmacists.

As at 16 March, South Africa has reported a total of 62 infections, mostly from Gauteng (31), the Western Cape (16) and KZN (12). While the number of confirmed cases in South Africa is small compared to global figures, it is expected that the number will increase in the coming days as local transmissions start to increase. So far, most of the cases are from people who have recently returned from travel to high risk countries, however, local transmissions are under investigation and are expected to escalate. Regionally, 300 people have been diagnosed with the virus, with Liberia becoming the 27th African country to confirm the illness.

Measures introduced by South Africa to control the virus appear entirely appropriate

In response to the COVID-19 outbreak, on 15 March 2020, the South African government declared a national state of disaster in terms of the Disaster Management Act. Given the rapid progression of the virus in South Africa, government announced a range of isolation measures which are intended to contain the spread of the virus, including the partial closing of borders to foreign travel, prohibiting gatherings for groups larger than 100 people, domestic travel only if necessary, and the closing of schools from 18 March.

In addition, government announced that they will be introducing a range of fiscal and other support measures to mitigate the impact of COVID-19 on the economy. (These measures will be evaluated once they are announced). Furthermore, the Reserve Bank is expected to cut their repo rate this week by as much as 50bps to help ease the pressure on economy.

While the budget for the disaster management has not been revealed, the Finance Minister stated that the required funds for the fiscal stimulus and other measures will come from money set aside through the reduction of allocated amounts from other government programmes and the national disaster fund. In addition, to provide direct support to affected industries, it is expected that government will provide some safety net to households in need as well as small and medium enterprises. It is unlikely, however, that government will be able to rollout an extensive fiscal stimulus package given its weakened fiscal position.

Given how rapidly COVID-19 has spread in several countries, the measures announced by the President are entirely appropriate and indicate that the South African government is taking this threat extremely seriously. While these measures themselves will have a negative effect on domestic economic activity, especially tourism and related travel and service industries, waiting to implement these restrictions would have probably worsened the situation, resulting in a faster spread of the virus and an even deeper, longer-lasting recession.

Global economic impact of COVID-19

The economic impact of the virus has intensified substantially in the past few days and now represents a set of circumstances the world has never experienced before.

Essentially, as we highlighted in our previous update on COVID-19, the economic impact of the virus can be broken down into three areas of concern.

  1. A global supply-side shock. This is most evident in China, with the closing of many factories and distribution hubs as workers were told to stay at home in order to reduce the risk of further infections. The fall-off in manufacturing activity within China severely disturbed global supply chains leading to a shortage of many goods around the world. The situation has been aggravated by the international spread of the virus as well as the ‘just-in-time’ inventory system many companies operate.
  2. A demand-side shock. This is now evident in many countries, especially Europe, as tourism plummets and people avoid large gatherings. The result is far less retail activity, empty hotels, vacant tourist attractions as well as the cancelling of sporting events. While the spread of the virus has increased on-line demand for goods and services, this had not been nearly enough to compensate for the decline in in-store activity.
  3. The shock to global financial markets, including credit markets. As COVID-19 spreads to countries outside of mainland China, many investors switched from holding risky assets (equities) into perceived safe-haven assets, for example US government bonds. This switch has resulted in the US equity market losing almost 30% of its value since 19 February – and remains under enormous pressure despite extensive monetary stimulus from the US Federal Reserve. During the same period the South African equity market declined by a shocking 30%.

In contrast, the US 10-year bond yield fell from 1.56% on 19 February to 0.54% on 9 March, its lowest yield ever recorded. Since then the yield has risen somewhat to 0.73%, although this appears to relate to liquidity issues, which the Federal Reserve has subsequently tried to mitigate.

Unfortunately, the South African 10-year bond market has weakened noticeably in the past few days, with the 10-year bond yield rising by around 100bps. This largely reflects foreign investor concerns about the economic impact of COVID-19 on most emerging economies, and is not specific to South Africa, although the deterioration in South Africa’s fiscal position and weak economic environment is clearly unhelpful. At the same time the Rand exchange rate has weakened substantially, depreciating by almost 16% since the beginning of 2020 and by around 9% since 19 February. This decline in the value of the Rand is also not specific to South Africa. Since the beginning of the year the Colombian Peso, Russian Ruble, Chilean Peso, Brazilian Real, and Mexican Peso have all lost well over 10% of their value against the US Dollar.

There is also a significant concern about the lack of liquidity in international credit markets. This is reflected is a sharp widening of credit spreads as banks and investors adjust their risk assessment to take account of the deteriorating economic environment. A lack of access to affordable credit could severely damage key parts of the world economy as business conditions are heavily impacted by COVID-19. This was a key factor in the US Federal Reserve cutting interest rates by 50bps at an unscheduled FOMC meeting on 3 March and then by a further 100bps at an unscheduled meeting on 15 March. The Federal Reserve also announced that they are re-initiating conventional QE and will look to purchase a further $500 billion government bonds and $200 billion mortgages backed securities. While these are bold measures from the Federal Reserve, they are likely to have only a limited impact on the world economy since the damaging economic effect of the virus is primarily caused by the isolation measures needed to contain the spread of the virus.

The international oil price (Brent crude) plunged from around $53/bl at the start of March to $36/bl on 9 March and $29/bl on 16 March, a drop of 45%. The sharp decline in the oil price can be ascribed to the breakdown of talks between OPEC and Russia regarding the need to cut oil production in order to support the oil prices, as well as Saudi Arabia’s response to this breakdown in discussions by indicating that they would increase output. However, the economic disruptions caused by COVID-19 has also led to a sharp fall-off in oil demand, further undermining the oil price in recent days.

It is worth highlighting that the sharp fall-off in the oil price, combined with the continued spread of the virus internationally and the systematic downward revisions to global growth estimates, has started to more significantly undermine emerging markets, including foreign investor appetite for emerging market assets.

The combination of a supply-side, demand-side and financial shock is rapidly undermining business, household and investor confidence around the world. Unsurprisingly, most economists, including ourselves, are in the process of revising their GDP growth estimates lower, while at the same time trying to gauge the spread of the virus. It is not the virus itself that is undermining the world economy, but rather the measures that are needed to contain and control the spread of the virus.

At this stage we are expecting that China’s GDP will have declined quarter-on-quarter in Q1 2020, but that there should be some pick-up in activity in Q2 2020 as more businesses resume production and travel restrictions within the country start to be slowly lifted. In contrast, there is now extreme concern about how rapidly the virus continues to spread within Europe. Given that the economy of Europe is similar in GDP size to China and is also very open to international trade, the impact on the world economy of a recession in European, which is now our base case expectation, is likely to be very meaningful over the coming weeks and months.

The United States, which remains the world’s largest economy, has seen their number of infections rise from 66 at the end of February to 554 on 9 March to 4 661 on 16 March. A sharp and uncontrolled increase in the number of COVID-19 cases in the United States that leads to widespread travel restrictions and the closure of many businesses would clearly push the world economy in recession. Consequently, the spread of the virus in Europe and the United States is being watched very carefully, but we need to warn that a global recession is fast becoming our base case assumption.

Lastly, data on the spread of the virus, the assessment of its economic impact and its effect on global financial markets is evolving daily. The measures introduced by the major central banks have, so far, had only a very limited effect on stabilising the financial markets. We have revised our global growth estimates meaningfully lower, including a revision of South Africa’s GDP growth for 2020 to reflect an extension of the recession that started in H2 2019. Hopefully, the fiscal and monetary authorities in South Africa are soon able to announce a range of support measures to assist the economy over the coming weeks. We will continue to monitor the situation daily, and provide regular updates as circumstances change.




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