Global financial markets reacted strongly in the past three weeks with the virus spreading to Europe, U.S. and the Middle-East. Covid-19 risks are now priced aggressively in various asset classes. Why? A perception that global recession is on the way. Projecting impact is hardly a science. Only astute economists or investors could get that right.
Recessions typically fall into one of 3 categories:
(i) Real recession – severe exogenous demand and supply shocks can push an economy into a contraction. Covid-19 has the greatest chance to inject the host;
(ii) Policy recession – policy rates too high that chokes off expansion;
(iii) Financial crisis – a credit bubble leading to financial imbalances before unwinding and impacting the real economy.
What is Likely Recovery Path?
Three broad scenarios, described as V-U-L come to mind:
(i) V-shaped – growth rebounds after a displacement of output.
(ii) U-shaped – the shock persists and if initial growth is resumed, there is some loss of output.
(iii) L-shaped – this scenario is ugly and there is significant structural damage – labour market, capital formation or productivity.
V-shapes have been predominant in prior shocks – SARS, H3N2 (1968), Asian flu (1958) or the Spanish flu (1918).
Will There Be A Lasting Impact?
There are three plausible transmission channels:
(i) indirect hit to confidence (wealth effect) – consumption falls, savings rate moves up.
(ii) direct hit to consumer confidence – keeps consumers at home, lowers discretionary spending and a pessimistic long-term view.
(iii) supply-side shock – supply disruptions, which are happening now that will impact delivery and sales.
What Should Businesses Do?
It is being agile and nimble that really matters. Impact will not be uniform across industries. Some sectors may require drastic cut in staff or a significant reduction in salaries. Others may need faster adoption of new technologies and processes to prepare for the post-crisis world. In the meantime, lobby strongly for Government support on wages, fixed cost and tax-related benefits to minimize the impact.
1. Philipp Carlsson-Szlezak, Martin Reeves and Paul Swartz, What Coronavirus Could Mean for the Global Economy, 3 March 2020, https://hbr.org/
2. Yen Nee Lee, Rate cuts can’t save the global economy from the coronavirus, say analysts, 6 March 2020, https://www.cnbc.com/