Recovery to wane as economies diverge

Global Overview – The initial rapid pick-up in economic activity has offered encouragement after an almost unprecedented recession. But households and firms will remain in cautious mode, preventing a full V-shaped recovery.

While policy is set to remain supportive, the recent huge impetus must ultimately be wound down with adverse effects. China, Korea and Taiwan are among the furthest along the road to recovery and we expect them to stay in the lead, while economies in southern Europe, Latin America and Africa lag behind. In all, it will probably be a few years before the global economy returns to its pre-virus path.

  • Hard data for May and June were generally stronger than we had anticipated, and we have revised up many of our 2020 GDP forecasts accordingly. From here, the recovery will be uneven, with EMs outside East Asia generally faring worse than advanced economies.
  • The strength of the recovery in different parts of the world will depend on at least four factors. The first is how the virus plays out, and health policy responses to it. Restrictions are generally more damaging for the economy than cautious behaviour by firms and individuals. They are more likely to be tightened where health systems risk being overwhelmed, and death rates are high and rise further. New cases are high and rising in the US and South Africa. But whereas the death rate has been broadly stable in the US, it is surging in South Africa, which has less capacity to meet health needs. So, tighter restrictions are likely to drag on recoveries in the likes of South Africa and parts of Latin America but are less likely to do so in the US and more developed countries.
  • The second factor is sectoral composition. It already appears that economies with bigger retail and hospitality sectors have fared worse so far. While retail spending has bounced back in many countries in May and June, the sector remains vulnerable to renewed outbreaks. Social distancing will hit countries with large retail and hospitality sectors more in the recovery. And with less international travel, it will take years for tourism sectors to get back on their feet, which will hurt Thailand, Mexico, and Mediterranean countries.
  • The third element is the scale of fiscal support. Limited fiscal headroom and tight external financing conditions have constrained how much several EMs have been able to do on the fiscal front. In some cases, like in India and Brazil, governments were simply slow to act. Advanced economies have generally been a lot more generous with direct giveaways, such as tax breaks and income support.  This is part of the reason why we expect their recoveries to be firmer than in most EMs.
  • The fourth factor explaining relative prospects in the next couple of years is the strength of balance sheets coming into the crisis. With few exceptions, households have manageable debt burdens. Bigger differences emerge in other sectors of the economy. The super-strong finances of Japan’s corporate sector, for example, mean that firms there are under little pressure to deleverage, whilst Turkey’s bloated corporates sit at the other end of the spectrum.
  • Banks were generally in a strong position heading into 2020, but there are exceptions where already-large portfolios of NPLs – such as in India – will hold back lending and the recovery. Meanwhile, we think most countries can manage their higher public debt burdens without the need for austerity. But tighter fiscal policy will hurt recoveries in some emerging economies where debt is on an unsustainable footing and spending cuts are politically viable.
  • Overall, after shrinking by 4½% this year, we forecast the world economy to be over 3% smaller than it would have been without the virus by the end of 2022, with DMs generally getting closer to pre-virus trends than EMs.  Our 2020-21 forecasts are above consensus in most advanced economies outside the euro-zone, and we are well below consensus on most of Latin America, as well as parts of SE Asia and Africa.
  • Just as output is on the recovery path, inflation is too. We expect higher oil prices to fuel a 2%-pts rise in inflation from trough to peak, on average.  Supply constraints in some sectors like hospitality and travel, and massive policy stimulus, will put a floor under how far core inflation will fall, rather than drive it up. By 2022, global inflation should settle slightly below pre-virus rates.

GLOBAL ECONOMIC OUTLOOK

US – While the economy initially experienced a particularly sharp rebound, the recent resurgence in coronavirus cases has warranted caution about the economic outlook. The recovery looks set to be slow regardless of who wins this year’s election.

Euro-zone – The concerted fiscal and monetary policy response to the crisis and tenuous steps towards a fiscal union have come as a relief. But the region will still take longer to recover than other advanced economies as the tourist-dependent south suffers long-term effects.

Japan – Low reliance on tourism, strong banks, healthy corporate balance sheets and huge fiscal support should allow for a fairly rapid recovery to by international standards.

UK – The economy has suffered a prolonged lockdown and will take some time to recover as Brexit adds additional uncertainty to an already cloudy outlook.

Canada – Despite success in containing the virus, high reliance on commodities will hold back the recovery.

Australia & New Zealand – Australia’s resilience is at risk from rising virus cases and high household debt.

The Nordics & Switzerland – Should continue to benefit from good virus control and supportive policy.

China – China will outperform other major economies. Its shutdowns, while severe, were shorter than seems likely elsewhere and its recovery will be aided by the state control of its industrial and financial sectors.

India – The recovery will be particularly slow as authorities struggle to control the virus.

Other Emerging Asia – While South Korea and Taiwan appear to be among the most resilient economies in the world, the likes of Cambodia, Thailand and Malaysia are vulnerable to sustained weakness in tourism.

Emerging Europe – Central Europe looks set to recover relatively quickly, but Russia will lag behind.

Latin America – Failure to contain the virus and muted fiscal support will keep LatAm at the back of the pack.

Middle East & North Africa – Exposure to tourism will take a toll, compounded by a return to austerity.

Sub-Saharan Africa – The fiscal costs of the crisis will push many countries towards debt defaults.

Commodities – High stocks will cap gains in oil prices while industrial metals benefit from recovery in China.

This article reflects the research and opinions of Capital Economics and Irongate and is not intended to be a forecast or recommendation.