E-insight snapshot

February 27, 2020

The outbreak and spread of the coronavirus is a key risk to the global economic outlook. This snapshot outlines our current thinking about the potential economic fallout based on what we know so far.

The current strain of coronavirus (COVID 19) is more contagious than the SARS strain 17 years ago, but the medical data suggests it has a lower fatality rate. While both epidemics started in China, the global importance of the Chinese economy was far smaller in 2003—just 4.3 percent of world GDP, compared to 16.3 percent in 2019.

SARS lowered global growth by 0.15 percent. COVID-19 will have a significantly larger negative impact. How much depends on how far it spreads and for how long. Until late February, it looked like containment was working, with the number of new cases each week declining. This provided hope that the economic weakness would be concentrated in the first quarter of the year and economic activity would rebound sometime in April. Under this assumption, global economic growth would be reduced by 0.3 percentage points, reducing it from around 3 percent to 2.7 percent.

In recent days, however, the number of cases outside of China have risen and this raises the prospects of a bigger negative economic shock. However, it should be stressed that it is still early days and the number of cases outside of China are still limited. The future extent of contagion is still a matter of speculation. The COVID-19 outbreak has occurred when the world economy is weak. Global manufacturing suffered a contraction last year, reflecting the negative impact of the US-China trade war and uncertainty related to BREXIT. The good news was that the weakness in manufacturing was abating and the global slowdown looked to be stabilizing. Our team was expecting a slight acceleration in growth in 2020, but then the flu outbreak occurred. In our opinion, the economic fallout of COVID-19 will lead to a renewed downturn in global manufacturing. The real question is whether consumer confidence will decline in the wake of the flu pandemic news and the headlines from financial market volatility. So long as consumers continue to spend and the services industries grow, a recession should be avoided. At this point, it still looks like we are headed for a global economic slowdown, but the recession risks have certainly increased and certain sectors are particularly vulnerable.

The economic weakness so far has been concentrated in China. The biggest impact will fall on Chinese consumer spending, but it will also materially reduce investment and industrial production. China’s year-over-year growth rate may drop to 4 percent or even lower in the first three months of this year, and it may lead to a growth rate of around 5 percent in 2020—very weak for this country. The deceleration will be tempered by Chinese efforts to fight the outbreak, which can be additive to economic growth (e.g., through increased health-care activity), and by fiscal and financial stimulus to combat the slowdown.

As the flu spreads to other countries, their economic activity will be dampened by efforts to contain the virus. The extent of the economic disruption will be proportional to the extent of the outbreak, which we do not know at this point.

For Canada, the coronavirus outbreak and its fallout will affect economic activity this year in many ways:

1. Reduced global economic growth will soften demand for raw materials and result in lower commodity prices. The weakness in commodity sectors will dampen economic activity in provinces that are heavily reliant on commodities and it will have a knock-on effect on industries tied to activity in commodity sectors.
   
2. Regions forced to make concerted efforts to contain the flu will experience weaker consumer spending and investment. This will negatively impact trade between these regions and Canada. It will lower exports from Canada, while curtailing imports to Canada from the affected regions. The latter effect could create inventory challenges in the domestic market.
3. Lower industrial output in affected regions will be felt through global supply chains. This will directly affect Canadian exporters. In addition, the indirect effects could be significant—for example, Canadian firms can sell to companies outside China, but if those firms are adversely affected by weaker Chinese demand, the repercussions will be felt by the Canadian exporters. In other words, Canadian firms can feel indirect effects through global supply chains.
4. There are significant sectoral implications. The lower trade in goods will hit the transportation sector—land, sea, and air. Some sectors are more exposed. For example, in the case of China, some industries are more affected by the lockdown of certain Chinese cities; in particular, the operations of some major global players in the auto, health, and technology sectors will be affected. If the flu spreads and other cities have to do containment, similar sector vulnerabilities will occur on a city-by-city basis depending on the industrial mix in the affected urban centre. Tourism activity will also decrease.
   
5. The outbreak has added to financial volatility, and has implications in the financial market. The US dollar, for example, is stronger against the Canadian currency because the greenback is a safe-haven currency during times of greater risk. Due to America’s large domestic market, the US economy is less vulnerable to the negative economic implications of the outbreak overseas. Interest rates have also fallen in the wake of the negative news regarding the spread of COVID-19. A weaker Canadian dollar and lower interest rates help to reduce the negative impact on the respective economy. However, equity markets have also experienced a pullback. One could argue that the gains in global stock markets last year were excessive and a correction was overdue, but the negative news in the stock market is not helpful for business and consumer confidence.
6. The weaker economic growth will result in less tax revenues for governments that could lead to a weaker fiscal position.
   

For the Canadian economic outlook, successful containment of the epidemic and limited international contagion looked like it would lower economic growth by around 0.2 percentage points this year. This is bad news, as the economy delivered a weak performance in the fourth quarter of 2019 giving a weak handoff heading into this year. Then there is the negative impact of the rail blockages that hurt economic activity. This has lowered our tracking of economic growth in 2020 to 1.4 percent, which is a weak performance. News of the spread of the flu outside of China creates a downside risk to the outlook. At this point, the base case forecast is for slow growth—not a recession.

It’s worth highlighting that the previous assumption of limited economic impact is why neither the US Federal Reserve nor the Bank of Canada is signalling a plan to ease monetary policy in response to the economic fallout from the coronavirus outbreak. As the risk to the global economy increases, however, the central banks stand ready to deliver stimulus if required, and that looks increasingly likely.

We want to be clear: this is only our preliminary assessment, based on publicly available information and on historical economic relationships. The clinical economic impact estimates should also not detract from the human tragedy that’s unfolding.

Businesses need to think about their direct and indirect vulnerabilities. They should consider running scenarios or stress tests under different assumptions, paying particular attention to supply chains and second-round effects. However, they should not adopt a recession bias. It is important to understand the risks, but not let fear drive investment and hiring decisions.

We will continue to monitor developments and will update the Canadian forecast in our quarterly economic outlook in April.