Macro Economic Commentary – April 2020

Author: Morotola Pholohane

Unprecedented uncertainty: A look at the details

Exponential change is a difficult concept for the human mind to grasp. What seems painfully slow at first can quickly become unfathomably fast. The coronavirus disease 2019 (C0VID-19) pandemic is disrupting the world’s economy in a significant way, and it is hard to keep track. Economic slowdowns caused by the virus-suppression efforts in many countries may lead to the most significant quarterly decline in economic activity in almost a century. Indeed, it has been estimated that declines will be higher than the Great Depression of the 1930s. Yet there is valuable detail to be explored at both the global and country-level which hints at the shape of things to come.


Around the globe, central banks’ responses to the COVID-19 pandemic have generally been accommodative, with the magnitude of policy reforms depending on the extent of policy ‘space’ available. The United States Federal Reserve System (the Fed) has taken a step to expand its balance sheet, while the European Central Bank (ECB) has made similar commitments. Emerging markets and developing economies, on the other hand, have less policy space. In South Africa, the South African Reserve Bank (SARB) is using a variety of instruments to try to facilitate the smooth functioning of financial markets, including buying government bonds and instituting temporary regulatory relief for banks. Economies around the world face huge uncertainty as the impact of the COVID-19 crisis deepens, and the rate of deterioration in some contexts has been alarmingly quick.

Economists are taking note, and a huge effort is underway to gauge the situation, in order to forecast the future outlook. The International Monetary Fund (IMF) recently downgraded its global growth forecast. Global economy is now expected to shrink by 2.9 percent in 2020, as a direct result of the virus-related economic contractions taking place at country level, in both advanced and emerging markets alike. It forecasts that the United States (US) and Euro-area economies will contract by 5.9 and 7.5 percent respectively, while China is estimated to grow only by 1.2 percent in 2020. The IMF predicts that the growth shortfall to come will be so massive that the global output gap will remain deeply negative until at least 2022, even with a sharp economic rebound of 5.8 percent expected in 2021. The large cumulative output gap implies that inflation will remain benign in the near future and, as a result, markets should remain flush with liquidity for an extended period. Consequently, risky assets such as global equities are likely to recover over the medium term.

It is, however, far too early to call a recovery, and indeed the productivity numbers, in particular, are dire. The latest Purchasing Managers’ Indices (PMIs) reported are in contraction across most economies. In the US, the manufacturing index component fell to 36.9 points in March from the February value of 48.5 points while that of services fell to 27 points from 39.8 points. Likewise, in the Eurozone, the manufacturing and services PMIs reported fell significantly to 33.6 points and 11.7 points in March, from 44.5 points and 26.7 points in February respectively. While February PMI numbers were low, the published March figures were nothing short of dismal. Severe restrictions in the travel, tourism and hospitality-related sectors due to COVID-19 contributed substantially to the slumps in services PMIs. Euro-area manufacturing PMIs are sitting close to levels last seen during the global financial crisis (GFC) in February 2009 – namely, 33.5 points. Within the European Union (EU), notable declines have reflected in countries like Germany, France, Spain, and Italy. Looking forward, expectations of near-future output are even weaker, suggesting that companies are not assuming that the current crisis will end anytime soon. All in all, the PMIs suggest that the Eurozone will record a substantial decline in economic growth.

In the United Kingdom (UK), PMIs have also hit record lows, both in manufacturing (32.9 from 47.8 points) and services (12.3 from 34.5 points) for the same period. According to Markit, COVID-19 disruptions have led to a fall in activity of around 81 percent among service providers and 75 percent among manufacturing companies.

What we are seeing almost everywhere now is fiscal stimulus. Government stimulus packages in most countries around the world in response to COVID-19 are very high by historical comparison, in some cases more than double those of the GFC. During 2009, the stimulus schemes were predominantly taken up by the manufacturing sector. Yet the picture is slightly different today, as it is the services sector that is most affected by the lockdown responses to the pandemic. Services sector employs a much larger proportion of people than does manufacturing: about 70 percent in Europe, and 80 percent in the UK. And at least 67 percent of gross domestic product (GDP) in most economies is concentrated in the services sector, with the US leading at 77 percent (in 2017). These stimulus plans are thus not the ‘traditional’ stimulus approaches one would expect to see in textbook. Packages are structured to include job retention schemes, direct cash payments, healthcare, and loans/grants for businesses. Interestingly, there is a strong degree of similarity in the stimulus approaches taken by developed and emerging markets, though of course with country-specific features.

changes in government expenditure are more effective than tax cuts, due to the economic multiplier effect.

It is well documented in the economics literature (for example, see Caldara & Kamps 2017, Brinca, et al. 2016) that changes in government expenditure are more effective than tax cuts, due to the economic multiplier effect. The economic benefits of the multiplier effect vary depending on factors such as exchange rate regimes, standing debt levels, monetary policies, wealth inequality, global trade, and the output gap. While fiscal multipliers attempt to quantify the output gap, given changes in government spending, the classification of budgetary stimulus (into either taxes or expenditure) can be tricky. Some of the schemes that have been announced feature a combination of spending and tax relief. For example, US unemployment benefits are classified as ‘expenditure’, while stimulus under the Coronavirus Aid, Relief and Economic Security (CARES) legislation is set-up as ‘accelerated tax rebates’, which is technically a tax cut.

If the present fiscal stimulus were to respond to the structural imbalances of the housing bubble or debt reliance such as witnessed in the last global financial crisis, it would have been deemed to have less multiplier effect on the economy. However, the current COVID-19 approach to fiscal stimulus aims to maintain the existing structure of the economy – hence the expectation that the fiscal multiplier effect will provide the broadest economic support. Some incentives such as loan guarantees for businesses struggling to stay afloat, especially small and medium-sized enterprises (SMEs) are worth noting. The cash flow liquidity cycle for the SMEs is estimated to be limited to only two weeks, so guarantees are helpful to avoid immediate insolvency or liquidation for businesses that can be saved. Since the fiscal stimulus enacted thus far is intended to boost global GDP, further ‘waves’ of stimulus will likely be rolled-out if economies fail to withstand or recover from current shocks.

Never in history has the WTI been negative, not even in the booms and busts due to wars and financial crisis, until now.

One of the most startling moments in the pandemic thus far has been the shocks experienced in the oil market. In April, the US’s West Texas Intermediate (WTI) crude oil price crashed as the demand dried up by at least a third worldwide. The May WTI futures contract settled at a negative US$ 37.63 per barrel in New York at expiry; thus, as storage tanks reached capacity, oil traders or producers were effectively paying buyers to take oil off their hands. Never in history has the WTI been negative, not even in the booms and busts due to wars and financial crisis, until now. Both Brent crude oil (international benchmark) and WTI (US benchmark) are likely to remain under pressure, as most of the world is on lockdown. With airlines grounded and cars parked, there is an unprecedented lack of demand. The economic damage of COVID-19 may end up dwarfing the initial health crisis.


In China, the economy recorded negative growth of 6.8 percent year-on-year in the first quarter, after a 6 percent growth rate in the previous quarter. This represents the first, and worst, contraction since the start of official releases of quarterly data in 1992. The primary sector recorded -3.2 percent, the industrial sector -9.6 percent, services -5.2 percent, and car production declined by 44.6 percent. Shutdowns in large parts of the country due to COVID-19 brought about the negative growth. However, the Chinese authorities are viewing the slack in growth as a short-term fallout due to the pandemic. This is something temporary because the economic fundamentals of the growth trajectory remain unchanged. Indeed, China’s latest official manufacturing PMI for March 2020 rose to 52.0 from a low of 35.7 in February, the highest reading since September 2017. This resurgence is the result of companies starting to operate again, following the relaxation of strict lockdown measures in some areas. Yet, while the pace of expansion in the manufacturing sector (PMI of above 50) is robust, this may not be a strong enough signal of overall stabilisation in economic activity.

The Chinese economy has made progress in getting back on its feet, with COVID-19 infections and deaths in decline and mostly contained. The WeBank China Economy Recovery Index points to the gradual resumption to normality, increasing to 91 percent in mid-April. The difficulty is no longer to do with supply disruptions and is now more the result of persistent weakness in domestic demand and exports – reflecting the global downturn. Declines in export activities point to weak external demand, which is also evident in lower forex market turnover. Production activities are, however, picking up in certain areas; for example, the run rate of oil refineries’ levels in coastal powerhouse Shandong province is higher than earlier in January and is comparable to levels in 2018 and 2019.

Despite disappointing quarterly figures in most economic data, some economic activities in China have indicated a rebound. There was an improvement in the year-on-year industrial production (-1.1 percent) and fixed asset investment (-9.4 percent) numbers, after double-digit declines in January and February were suffered. Retail sales slid (-15.8 percent) year-on-year after slumping (-20.5 percent) in the first two months of 2020. Car sales increased in March, compared to February, but were still below the averages seen earlier in January. Some local governments have offered subsidies and relaxed regulation on automobile licences as a way to spur demand. A host of uncertainties remain, and it is too early to interpret the March rebound in some activities as proof of a Chinese recovery. Even as lockdowns are lifted elsewhere in the world, quarantine measures and social distancing will likely remain in place, and households may remain cautious, fearing a second wave of the pandemic. While we can undoubtedly say that China’s nascent recovery is a good omen for the world’s economies, it is evident that the worst is not yet over.

China’s economy has mostly been driven by a trio of capital investment, consumption and exports. Of these, investments might be first to recover following the pandemic, and indeed this is already becoming evident in the rebound in fixed-asset investment. For consumption and exports, things will likely get worse before getting better, as can be seen in retail sales and export activities. Consumption activities will remain stagnant as local consumers continue to exercise caution. Meanwhile, the contraction in global growth implies that Chinese exports are likely to stay low. Some rough estimates suggest that exports may fall by between 20 and 45 percent, which would cause the contribution of the next quarter to the country’s annual GDP to decline by between 4 and 8 percent. Clearly, with all major economies projected to be in deep contraction in the second quarter, China will not be spared from the global recession. Even if China outperforms its peers, the road to recovery is long and uncertain. The IMF expects China to grow by 1.2 percent in 2020 and by 9.2 percent in 2021.

Chinese authorities have already rolled out supportive measures, such as increasing fiscal spending, cutting lending rates and reserve requirements, and issuing local government special bonds. To date, the state’s response to COVID-19 has been less than 3 percent of the country’s GDP, which is low compared to a massive 10 percent in the US and 20 percent in Japan. In a meeting of the politburo in March 27 2020, China’s top decision-making body suggested the scaling up of the stimulus package, in an effort to raise the fiscal deficit ratio, and also to respond to pressure in employment and weak sentiment pointing to more hardship. This is, therefore, an indication that targeted stimulus packages will see more resources devoted to supporting consumer spending and the private sector. China’s policymakers are faced with difficult choices: go for a massive stimulus and risk a financial time-bomb, or tolerate further economic slowdown. Regardless, more policy support is needed on both fiscal and monetary fronts to stimulate weak growth.


In the South African (SA) context, Fitch Ratings has joined Moody’s in pegging the country’s credit rating deep into junk status. The SA rating is now at two levels below investment grade (at BB from BB+), and on a negative outlook. As with Moody’s, Fitch is concerned with weaker growth and the slow pace of structural reforms. Both rating agencies have expressed their diminished confidence in the government’s ability to make meaningful spending cuts. The downgrades reflect an unclear path of debt stabilisation and magnify the impact of COVID-19 on public finances. Fitch expects SA’s growth to contract by 3.8 percent in 2020, with a rebound of 1.7 percent in 2021. Moreover, the debt-to-GDP ratio is expected to balloon to 80.2 percent in 2021/2022. All in all, SA’s risk profile has increased substantially. It is therefore not surprising that now all three international rating agencies are aligned: Standard & Poor’s unexpectedly downgraded the country just before its official credit review scheduled in May.

Moody’s recent forecast (April 14 2020) includes an economic contraction of 6.5 percent, budget deficit of 13.5 as a percentage of GDP, and debt-to-GDP rising to 84 percent in 2020.  The government aims to finance most of the virus-related relief package through re-allocations within the existing budget, as well as through other cheaper sources of funding from multilateral institutions (such as the IMF, World Bank, New Development Bank and African Development Bank, amongst others) in response to rising borrowing costs.

Even before the COVID-19 lockdown, SA was faced with stagnant growth, rising government debt and a weakening currency, factors that made the country’s bonds less attractive to investors. SA was already facing a high probability of recession on domestic constraints alone, with electricity disruption being the major obstacle to economic growth. With the South African economy already floundering due to weak demand, the added shock to the global economy due to the COVID-19 pandemic makes a 2020 contraction virtually guaranteed. The SARB forecasts GDP to shrink by 6.1 percent in 2020, which is worse than the IMF’s forecast of a contraction of 5.8 percent. Further, it expects headline and core inflation to be contained and lower than the midpoint of the target  (4.5 percent) until 2022. The Monetary Policy Committee enacted a further 100 basis points rate cut in April, bringing total rate cuts to 225 basis points since the beginning of 2020.


The picture outlined above reflects high liquidity driven by the stimulus, as well as accommodative monetary policy, which tends to be supportive of the equity market. Also, a not-so-expensive stock market, due to recent corrections, may be expected. However, the downside remains high in the short term. Cheaper market or stock prices does not mean they cannot fall further. When it comes to the exact location of ‘the bottom’, it is anyone’s guess. As so many public commentators are continually pointing out, these are unprecedented times. One can predict the rationality of value, but not the irrationality of human sentiment, which sometimes drives prices.