COVID-19: A Look At How A Pandemic Can Affect An Economy

March 25, 2020


OVERVIEW

The human toll of a global disease outbreak like the novel coronavirus (COVID-19) is obvious. But pandemics have other serious impacts – including those on businesses and economies.

Concerns about the spread of the COVID-19 – declared a pandemic* by the World Health Organization on March 11 – has prompted governments to take drastic actions to help protect their economies. In the U.S., lawmakers approved a $2 trillion stimulus package* to take the pressure off businesses forced to close in order to contain the virus’ spread while the Federal Reserve has promised further measures to keep financial markets operating.

Meanwhile, the U.K. government has pledged “to do whatever it takes”* to cope with the resulting economic catastrophe, offering up to £330 billion ($398 billion) in loan guarantees and a further £20 billion in financial handouts. To avoid mass furloughs and layoffs, the U.K. government has also said it would grant coverage of up to 80 percent of workers’ salaries,* up to £2,500 ($2,900) per worker each month.

“There are two parts to the coronavirus problem,” says Tapan Datta, head of asset allocation at Aon. “One is the virus itself. How do you contain it? You have shutdowns and coordinated global health initiatives around containment. Those containment measures will impose substantial economic costs. And that affects growth, corporate cash flows and profits.”

“The other problem is that the coronavirus outbreak comes at a bad time,” Datta continues. “The global economy was already fragile from the effects of trade conflicts and policy uncertainty.”

The COVID-19 crisis has also prompted a look at previous outbreaks with the goal of better understanding the current experience – and how it might play out.

IN DEPTH

The course of the COVID-19 outbreak in the U.S. – and the response to it – could leave a considerable mark on the global economy. The U.S. 2018 nominal gross domestic product (GDP) of $21.44 trillion represented 23.6 percent of the global economy.*

As we grapple with COVID-19, examining the impacts of other major disease outbreaks can be instructive. Among the immediate economic consequence of the current pandemic are a decline in equity markets value and a dramatic increase in volatility, both of which might continue. At the same time, bond yields have collapsed as the Fed cut interest rates essentially to zero, with the Bank of England trimming the U.K.’s interest rates to as low as 0.1 percent.

Meanwhile, global oil prices have slumped as much as 50 percent, thanks to a supply war between Russia and Saudi Arabia as well as a sharp, dramatic drop-off in demand.

“Initially people thought, ‘This is a sector thing: travel, tourism,’” says Datta. But as governments encourage or mandate distancing, people are avoiding enclosed spaces or large crowds, businesses are closing and the economic effects are becoming more widespread. “The virus scare will have an impact across sectors,” Datta adds. “Yes, travel and tourism will be among the worst affected, but the impact is universal and that suggests significant economic consequences.”

According to Datta, under some economic scenarios, global GDP growth could be near zero for several months, instead of the more typical 2.5 percent to 3 percent.

Impacts On Shipping And Supply Chains

Shipping accounts for 90 percent of global trade,* according to Chris Bhatt, global marine sales director at Aon. Meanwhile, many businesses around the world have moved to just-in-time supply chains.

Many companies, however, haven’t taken prudent steps to trace their supply chains to the very beginning. Often, companies have outsourced the production of parts and components to suppliers elsewhere in the world, unaware that those suppliers outsource too.

Now, with many ports imposing 14-day quarantines for vessels originating in or transitioning through China – and with seven of the world’s busiest container shipping ports in China – those supply chains are being disrupted, Bhatt says.

“Production is being disrupted because parts shipped from China to be assembled in the West are not arriving,” says Bhatt. “Car companies, for example, are slowing down production because they’re not receiving parts.”

“This could be the first time we’ve seen supply chains disrupted by a global pandemic to this extent,” Bhatt says. China’s growing role in the global economy has contributed to that impact. While the SARS (severe acute respiratory syndrome) outbreak of 2002–03 was significant, China represented only about 7 percent of global manufacturing at the time. Today, that share is more than 25 percent. At the same time, the volume of cargo passing through Chinese ports has increased dramatically, according to Bhatt.

Some businesses have learned from past supply-chain disruptions: for example, by increasing their stock of parts and components to 15 to 30 days instead of 10 to 15 days of stock, Bhatt says. Others have looked to create backup supply chains for critical parts and components or moved certain parts of production back on shore.

While COVID-19 has disrupted shipping and supply chains, we believe the shipping industry will recover, says Bhatt. “Shipping is resilient,” he says. “It’s been around since the 1400s and still innovates to keep pace with trade flow.”

Travel And Hospitality Take A Hit

Airlines and cruise lines are already feeling the effects of the latest pandemic, which will likely worsen. In the U.S., airlines have sought more than $50 billion in government assistance* to mitigate the impact of COVID-19.

The International Air Transport Association (IATA) estimated in early March that the global airline industry could lose $113 billion in 2020* as a result of COVID-19. Since that estimate preceded the latest E.U. and U.S. travel bans, the number could rise even higher. The IATA noted that the total value of air travel between the U.S. and the 26 states in Europe’s Schengen Area was $20.6 billion in 2019.

The situation might be even more acute for legacy air carriers with sizable employee benefit programs and other structural costs, according to Bhatt. One European airline said it expects to reduce seat capacity by 80 percent through the end of May and might ground most of its fleet* while another expects to reduce by at least 75 percent in April and May. In the U.S., one airline said it was cutting capacity by at least 20 percent through early June,* and another is cutting by 50 percent in April and May, with those cuts possibly extending into peak summer season.*

Stories of passengers quarantined on offshore cruise ships has left the cruise industry feeling a similar impact. Major cruise operators have announced that they’re halting operations and leaving ships idle* in the worst slowdown since the days following September 11, 2001. Stocks of major cruise companies have fallen 60 to 70 percent since the outbreak began.

When COVID-19 passes, one possible aftereffect is how we take vacations. “The knock-on effect of all this might be that people will holiday in their own country and start to think, ‘It’s actually quite nice here. Maybe we should do this more often,’” says Bhatt.

Other Potential Impacts

There could be further impacts from the COVID-19 outbreak, including positive outcomes. “One of the potential beneficiaries of the shipping slowdown are the cargo airlines,” says Bhatt. “When people suddenly have goods that need to be sent very quickly, they’ll accept the increased cost of air freight,” he says.

The environment has been another beneficiary. Imposing strict shutdowns has reduced travel and manufacturing and, in turn, polluting emissions. One study suggests that the reduction in pollution from factories and vehicles in China might have saved 77,000 lives.* Meanwhile, emissions reductions in Italy could be seen from space.*

For some investors, the market downturn and volatility might provide opportunities. “For investors underweight in equities, this market volatility has made it an attractive time to rebalance their portfolios,” says Datta.

“This volatility gives you opportunities to both buy and sell. If you get your timing right and if you’re nimble, you can buy into weakness and sell into strength,” he says. “You can do that because the market moves have been so large. The volatility provides asset managers an opportunity to take advantage of market moves.”

When The Recovery Comes

Travel and hospitality, among those industries hardest hit at the time of publishing, are likely to bounce back the quickest once the pandemic ends when postponed trips, meetings and conferences are rescheduled.

“As those sectors bounce back, they’ll be bouncing off of a really low point,” says Datta. “So, it might take a while for them to get back to where they were at the start of 2020. But those sectors that have fallen the furthest and the fastest will likely bounce back the quickest once the positive effects of containment start to be seen.”


* This site contains information that has been created, published, maintained or otherwise posted by institutions or organizations independent of AHIC. AHIC does not endorse, approve, certify or control these websites and does not assume responsibility for the accuracy, completeness or timeliness of the information located there.

The post COVID-19: A Look At How A Pandemic Can Affect An Economy appeared first on The One Brief.

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