The Global Economy Is in Recession and Recovery May Not Occur until the End of the Year
April 22, 2020
About the author: Mr. Zhang Jiarui, Fellow of the Taihe Institute, Assistant Professor in Economics, Nottingham University Business School, and Researcher of CEIBS.
(Credit: QUARTZ)
Hit by the outbreak of the COVID-19, the global economy has fallen into recession, factories have been shut down, and demand has shrunk. In the first quarter of 2020, China’s GDP growth rate declined by 6.8% in Comparable Prices. The annual growth rate of added value in the three major industries dropped sharply, of which the industrial growth rate fell by the widest, reaching -9.6%, exceeding those of the service and agriculture sectors. Many industrial enterprises generally do not shut down fully during the Chinese Lunar New Year. However, these enterprises had to shut down completely this year due to the pandemic, leading to sharply contracted industrial production on a year-on-year basis, which is an important reason for the decline in China’s GDP growth. In addition, China’s consumption also slumped dramatically in the first quarter, with a year-on-year growth rate of -20.5% from January to February and of -15.8% in March. The pandemic has dealt a huge blow to China’s economy both in production and consumption.
Looking at the data for the three months of the first quarter, it appears that after the shock of the previous two months, the Chinese economy has shown some positive momentum in March. However, as the global economy has fallen into contraction and recession as a result of the global spread of the virus, the truly serious test for China’s economy has only just begun.
Affected by the pandemic, Europe and the U.S. have shut down factories and stopped production in succession since March. The U.S. financial markets have been in turmoil, as economic activity has shrunk sharply, the retail sector has been hit heavily, the unemployment rate has skyrocketed, overall prices have fallen, and the market has predicted deflation or even depression in the U.S. Indeed, the U.S. economy has fallen into recession due to the impact of the outbreak, but there is little chance of a prolonged depression. On the one hand, the external reasons behind the heavily-hit U.S. financial market are the impact of the pandemic and plummeting crude oil prices, but the internal cause is due in large part to the bubbles stimulated by the Federal Reserve’s long-term low-interest-rate policy stimulus. Overall, the balance sheets of U.S. companies remain healthy, with an average asset-liability ratio of about 65% for S&P 500 listed companies and a steady ratio of cash reserves to operating income of about 15%, which suggests that the U.S. companies have sufficient cash reserves. On the other hand, while the leverage ratio of the U.S. corporate and government sectors has increased gradually over the past decade, the U.S. household sector has been deleveraging, which could prevent the recession from being amplified due to financial imbalances in the household sector to some extent. Third, the Federal Reserve has learned from the financial crisis in 2008, cutting interest rates in an emergency and releasing an unlimited amount of quantitative easing (QE), thus alleviating liquidity problems in the financial sector. It is therefore unlikely that there will be a large number of bankruptcies among financial institutions in the U.S. Because of these three factors, although the U.S. economy has fallen into recession due to the impact of the pandemic, a long-term depression seems unlikely to happen. With the outbreak under control and production activity recovering, the U.S. economy will rebound slowly, but this is projected to happen in the fourth quarter of this year at the earliest.
(Credit: The New York Times)
The magnitude of Europe’s recession may be slightly greater and will last longer than that in the U.S. On the one hand, before the impact of the pandemic, the speed of economic recovery in Europe was slow, essentially because of the slow pace of deleveraging in Europe since the 2008 financial crisis, and the lack of rapid and effective reallocation of resources to more efficient economic sectors. On the other hand, the European Central Bank, which had already been in quantitative easing, has little room for flexibility in monetary policy, and its effect of monetary stimulus has been very limited. Imbalances in the structure of the eurozone’s economies are also difficult to compensate for with monetary policy. Although the European Central Bank has launched its asset-buying program, it is difficult to secure liquidity and cash flows for companies mostly in need in the eurozone’s economies.
As for China, in the first quarter China’s economy suffered mainly from factory shutdown, production stoppage and shrinking demand caused by the pandemic. Starting in late March, the real blow to China’s economy will be a sharp contraction in overseas market demand. While the Chinese government has launched a policy portfolio aimed at stimulating domestic demand through investment in “old infrastructure” and “new infrastructure”, and the Central Bank has delivered liquidity through a cut in the requirement reserve ratio (RRR), it will be difficult for these incentives to meet the badly needed orders of Chinese companies, especially for those export-oriented enterprises. The disruption of overseas orders and the loss of cash flows will be the biggest threat to the survival of these companies. If China’s export-oriented enterprises, which employ more than 100 million people, cannot continue operating, the Chinese economy will further shrink and the unemployment rate will rise significantly. Although the Chinese government has introduced tax cuts, loan interest relief and other measures to reduce the burden on enterprises, commercial banks’ capacity and willingness to lend will be tested given the large number of enterprises under shock, and the government’s fiscal constraints will also limit its ability to stimulate investment on a large scale. Therefore, Chinese enterprises and the Chinese economy need to understand the situation clearly and take precautions for a cold winter. The recovery of overseas demand may need to wait until the fourth quarter of this year, so the reversal and recovery of the Chinese economy may not occur until the end of the year. The second quarter will stand as the biggest test for China’s economy.
(Credit: South China Morning Post)
However, opportunities always coexist with challenges. The pandemic will lead to not only a recession, but also a shift in the structure of the economy as well as an upgrade in the mode of economic growth. China’s economy also has inherent problems. That is exorbitant corporate leverage and relatively low productivity. Affected by the pandemic, a large number of low-efficiency enterprises will be eliminated, while high-efficiency companies can use the opportunity to buy good assets at lower prices. When this pandemic is over, the growth and profit models of enterprise will change accordingly.
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