Kiwibank’s chief economist Jarrod Kerr looks back to SARS, and into the future, to help make sense of this once-in-a-generation economic storm.
Covid-19 has drawn comparisons to the 2003 SARS outbreak, but those who lived through that should know that this is a very different era. Hits to our short-term confidence, business’s supply chains and tourism in 2003 landed like jabs back then, but will feel more like blows to the solar plexus this time around.
The threats are simply greater. China’s economy today is much larger, more integrated and more urbanised. Its much larger middle class are a key tourist contingent, and consumer market in their own right. China is the world’s largest trading partner – 124 countries (including NZ and Australia) consider China their largest trading partner. As a result, any disruption in China has ramifications for the world economy.
Covid 19 has contributed to a worldwide wave of fear, much of it well-founded, because this is a double-edged sword. We’re seeing a huge demand shock for our exporters, with buyers for their fish and timber disappearing. At the same time, there’s a supply shock for our importers, who don’t have Chinese-made goods to sell people. China is the factory to the world, and the disruption to global supply chains is far greater than first feared.
Factories in China are slowly coming back online, but the disruption will be felt around the world for some time. Despite the virus getting under control in China, it’s surging in other parts of the world. Italy, France, South Korea, and large parts of the developed and emerging world have been impacted.
Italy has gone into complete lockdown, with people unable to travel without “urgent, verifiable work situations and emergencies or health reasons”. France won’t allow the congregation of more than 1,000 people – no rugby, soccer, concerts or conferences. Event organisers around the world are on notice, and on edge – oiver the last week, Coachella and SXSW, two of the US’s biggest and most lucrative festivals either cancelled or postponed. Locally, international travel has been banned by numerous organisations. Beyond the official cancellations come the voluntary ones, which prove it’s more than just a traded goods problem. The service sector, encompassing tourism, hospitality and events, has been one of the bright spots of the last ten years. It’s acutely exposed to the downstream effects of the virus, thanks to a phenomenon known as social distancing (“let’s hang out”… “no, you might have the bug”).
The extent of the economic impact from the coronavirus requires a coordinated response from both governments and central banks. The G7 group of major wealthy nations have assembled, and their finance ministers and central bankers have pledged to use “all appropriate policy tools” to support economic health. Last week, the US Federal Reserve, its central bank, delivered a large emergency 0.5% rate cut which, worryingly, had almost no impact on the markets. Australia’s central bank made a similar move, while also leaving the door wide open for more.
Our policy makers are moving a little more slowly, but we at Kiwibank expect a 0.5% move from the RBNZ on March 25th, by way of a coordinated catchup. The government is in the process of devising a plan, including wage subsidies, to be announced next week. The coordinated response by governments and central banks around the world means much lower interest rates in the short term, with the intended message to businesses and consumers being to get spending.
The full impact of the Covid-19 virus on businesses and households is impossible to quantify at this stage. All we know is that it’s severe, and could get a whole lot worse. At Kiwibank, we’ve re-run our numbers, and expect the first half of 2020 to test many small-to-medium sized businesses. Economic activity will contract by 0.2% in the first quarter, because of the hit to tourism, education, and agricultural exports. Our current forecast is a mediocre gain of just +0.2% in Q2 – avoiding a recession, for now.
This is the exact moment we should see the power of central government, which must backstop NZ business. Any policy response used should aim to cushion falls in confidence, which has already taken a hit from a virus whose impact we don’t really understand.
The government, and the Reserve Bank, have an incredibly difficult task ahead. Most policy tools are used to boost demand: interest rate cuts, tax breaks, or cash in hand are designed to get us spending. But what happens when we’ve locked the door on our panic room, admiring our twelve-month supply of toilet paper and baked beans? We’ve outlaid a bit of extra cash at the grocery store, but that’s where our spending spree ends. We’re not going to the cinema, we’re not dining out, we’re not going to concerts. Our extra allowance is deep in our pockets, which ultimately makes all of us a bit worse off.
The best policy for a pandemic is fiscal, not monetary. Monetary policy, which is the state changing interest rates, is a blunt tool. Cutting the cash rate is like a surgeon taking a broadsword, when in this case a scalpel is required. Fiscal policy – the combination of taxation and spending – is the most effective, targeted response. So far, the government is targeting the industries most at risk, and will be judged on the size and effectiveness of the response. It’s essential to backstop business when faced with recession, and no government will be criticised for supporting industries devastated by seizures in trade.
The government is in the process of providing assistance to businesses directly impacted by the Covid-19 disruption. There is little chance they could be seen as doing too much – but they could easily be seen as doing too little. The goal is simply to support struggling businesses before they are forced to lay off staff, and close up shop. The communication and flow of information out of the government has been impressive, but they should stand ready to do more should the situation continue to spiral. Tax breaks, wage subsidies, even direct cash payments can all help. And banks need to continue to do their part by offering repayment holidays, interest-only periods, and temporary credit extensions.
The cumulative effect of all this fear and uncertainty is that financial markets are reacting in ways we haven’t seen since the GFC in 2008. The spread of the virus outside China sent some markets into freefall. Equity markets have fallen 10-20% in just two weeks. The price of oil had been on the glide path lower as Covid-19 caused demand to drop, but tumbled further as Saudi Arabia took on Russia in a battle to gain supply routes.
Safe haven assets, like bonds and gold, have found much love. Interest rates, the most beautiful of financial market instruments, have plummeted. The interest rate on 10 year Kiwi government bonds has dropped from nearly 1.5% a few weeks back, to just 0.9% today. That means the government can borrow money at a rate any serious investor, business, or developer would laugh at.
For all this panic and all the unknowns, our forecasts into 2021 remain unchanged. We expect the need for governmental responses to the Covid-19 outbreak to be temporary.We see global growth recovering into next year. That will inevitably feed quickly through to New Zealand. And the government’s earmarked infrastructure investments could not be better timed, and will provide a much needed boost. The lesson is to be concerned in the short-term, but to recognise that this is temporary, and that most people, businesses and other entities have enough resilience to weather this viral storm, and bounce back soon enough.