The COVID-19 outbreak and ensuing disruptions will likely lead to a recession. Uncertainty will remain until there is clarity over when containment can be relaxed.
The combination of the global COVID-19 pandemic and a severe oil shock has driven the Canadian economy into a recession. Forecasters are still struggling to assess the degree of economic decline, because it is not clear when containment efforts can be relaxed and when a vaccine will be available.
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Much of the plunge in activity reflects policymakers putting the economy on hold in order to stomp out the virus. Many businesses are shut down temporarily, and some won’t reopen. The near-term economic forecasts are based on what is still in operation, and then adding on the impact of the severe drop in oil prices. At the time of writing, the consensus is that the Canadian economy contracted about 3.8 percent annualized in the first quarter of 2020.1 Our forecast is that the decline will likely be closer to 5 percent. In the second quarter, we expect a significant economic downturn. Our projection of a 23 percent annualized decline in the second quarter is close to the consensus of forecasters. That is more than twice the worst quarter in 2008–09. The estimates will change as new information comes in, but the absolute number doesn’t matter at this point—the contraction will be substantial.
What happens after the initial drop? Our base case is that containment efforts will prove successful in bending the curve on the number of net new cases (as it did in China), which will eventually set the stage for a rebound in economic growth when containment is relaxed. We expect this to happen sometime in the middle of the third quarter and anticipate a double-digit growth rate in the fourth quarter. If this happens—putting aside all of the quarterly volatility—the Canadian economy will post an economic contraction of between 4 and 5 percent for the year 2020 as a whole. In 2021, we anticipate a recovery, but the pace will be muted by the legacies of the recession this year.
Canadian economic growth slowed in late 2019, with the economy posting a very modest 0.3 percent annualized gain in the final three months of last year.2 However, things were looking up. The United States and China had reached a trade agreement that would halt the escalation of the tariff war that was jeopardizing global economic activity.3 The United Kingdom negotiated and successfully legislated the terms of an exit from the European Union, avoiding the hard Brexit that would have been very damaging to the European economy. Indeed, the Deloitte forecast was that global and Canadian economic growth would improve in 2020.
That all changed in January with news of the COVID-19 outbreak in China. The dramatic efforts at containment were bound to have significant global economic and financial effects. A weaker Chinese economy lowered demand and depressed prices of commodities. Trade flows with China were disrupted, and this had knock-on effects through global supply chains. In mid-February, the number of net new cases in China were falling. As a result, we had expected the bulk of the blow to global economic growth to be felt in the first quarter of 2020, but a rebound was anticipated in the second quarter. In Canada, rail blockages were also expected to take an economic toll in early 2020.
Then, matters deteriorated greatly. Although containment was working in China, the number of cases outside China jumped higher—particularly in countries like Italy, South Korea, and Iran. With the economic disruption likely to last longer, financial markets increasingly priced in the possibility of a global recession. Equity prices fell and money fled to bonds, lowering bond yields to record lows. As the financial distress persisted, there was a move to the safety of cash, the US dollar, and, to a lesser extent, gold.
The pandemic continued to escalate with a rising number of cases in a growing number of countries, including in Canada and the United States. As the virus spread, containment became the priority. In Canada, the federal government urged people to maintain social distance, but this soon became a call to stay home and practice self-quarantining. Nonessential businesses were closed, as provinces from coast to coast imposed a lockdown on activity.
The pandemic shook financial markets, triggering a fall in equity prices and commodity prices. The decline in oil prices was further aggravated by a failed OPEC meeting in early March.4 Saudi Arabia had wanted an agreement to reduce supply to support oil prices, which had fallen from US$60 a barrel on the West Texas Intermediate (WTI) benchmark at the start of the year to around US$45 prior to the meeting. Over the past three years, Russia—which is not an OPEC member—had attended the meetings and committed to coordinate supply with the oil cartel. At this meeting, however, Russia refused to agree to a reduction in oil production. Many viewed this as an effort to protect its share of the global oil market, which has been reduced in recent years by the rise of US shale oil. Due to the disagreement, Saudi Arabia announced that it would increase oil supply, causing a plunge in oil prices. Crude oil prices tumbled, with the price of WTI crude oil falling to around US$20 a barrel at the end of March. Worse still for Canadian energy producers, the price of the domestic Western Canadian Select (or WCS, as it’s commonly called) fell to nearly US$5 a barrel.
The economic lockdown, global recession, and oil shock threw the Canadian economy into recession. This has led to a strong and coordinated policy response. Central banks around the world have provided monetary stimulus and governments have deployed massive fiscal stimulus. Canada is no different.
One cannot provide a complete list of the actions taken, as they are too numerous for an economic outlook note.5 The Bank of Canada slashed its benchmark overnight rate to near zero. It boosted liquidity to relieve stress in the financial system. It also launched an asset-buying program. The federal regulator of the major chartered banks, OSFI, adjusted its capital requirement to allow banks to lend more to businesses and households. However, given the nature of the current health crisis, the most important policy tool is fiscal policy.
The federal and provincial governments correctly identified that the two issues most critical to address are the negative shock to personal income and the cash flow and balance sheet strains for businesses. Addressing these are key to tempering the economic decline and will help households and businesses survive until containment efforts can be relaxed.
The federal government expanded access to the Employment Insurance (EI) program and created a program for non-EI-eligible unemployed workers. It announced that a 75 percent wage subsidy would be implemented in April to encourage businesses (of all sizes) not to lay off workers and to address the cash management pressures on businesses. Large-scale tax deferrals were also announced. Additional funding to health care was provided as well. The federal government increased funding of Business Development Bank of Canada and Export Development Canada, crown corporations that lend directly to businesses and partner in lending with major banks. In doing so, they reduced the risk on loans the private sector is making. In total, direct spending support by the federal government was estimated to be US$105 billion. Then there are the additional funding programs. The provincial governments also launched stimulus measures. The total federal and provincial fiscal stimulus is estimated to be about 13 percent of GDP. This number will increase, as measures to help hard-hit sectors, like oil and gas, are still coming at the time of writing.
The policy response cannot stop the economic pain. Our base case forecast is for a recession, with a 4–5 percent contraction in 2020. Were it not for the policy stimulus, the decline would be dramatically larger. There is, regrettably, still enormous uncertainty. When will containment efforts prove successful? When containment is lifted, work is unlikely to return to normal, but what will the new normal be? There are worries that we could have waves of infection. In other words, containment could be lifted and then reimposed for a time. Given the magnitude of the initial contraction in the economy, it is highly likely that any relaxation of containment will cause a rebound in growth. But after that initial jump, the pace of growth is likely to be slow as economies deal with the legacies from the deep recession. It also seems highly likely that the future will be characterized by considerable volatility in both economic and financial conditions.