April 7, 2020
“Derasat” Center has published a report titled: “Economic Implications of the Coronavirus Crisis: An Economic Outlook”, authored by the Director of Studies and Research, Dr. Omar Al-Ubaydli, and Research Analyst Ghada Abdulla. The report analyzes the economic damage caused by the coronavirus crisis, including sectors with the worst impact, and the differences between the short-run and long-run effects. The report also examines the economic stimulus packages launched by governments across the world in response to the crisis, including monetary and fiscal policies; as well as analyzing the risks associated with these policies, stemming from the complexity of the crisis.
Implications of the Coronavirus Crisis: An Economic Outlook
- Introduction and Summary
The coronavirus crisis has caused grave economic damage that surpasses the direct health implications of the virus. This report monitors and analyzes the main economic developments, with a separate report detailing the implications related to oil markets. The main deductions are:
- The global economy will be largely harmed by the coronavirus pandemic, in both growth rates and living standards, and some implications will have a lasting impact, such as fundamental changes to the world trade system.
- Currently, due to complications of the crisis, and the uncertainty around viral outbreaks and the policies governments will adopt, the accuracy of economic models that can be used to assess the expected impact of the crisis will diminish. However, the most accurate forecasts at present indicate as significant fall of 2.6% and average economic growth in the United States and the European Union.
- There is a large segment of monetary and fiscal policies to help counter this crisis. Fiscal policies are considered more effective than monetary policies, but are more difficult and slower to implement. However, all these policies come with their own significant long-term economic risks.
- Economic Implications
- The Difficulty of Financially Assessing the Size of Economic Damage
For some developments that harm the economy, economic experts can assess the size of negative economic impact on a financial basis. For example, when oil prices fall sharply, or one country slams tariffs on another country’s exports, then the impact assessment process requires creating advanced economic and statistical models, and significant time to collect data and develop models.
In the case of the coronavirus crisis, the time necessary for these requirements has doubled, due to the size and complication of this crisis, the lack of data and difficulty of creating models, and the fact that the crisis continues to develop in an unpredictable manner. Therefore, estimations are limited in assessing the economic damage caused by the crisis, and it is essential to carefully deal with any estimation circulated by the media, since experts are certain there are grave economic damages.
- Short-term Economic Implications: the Health Sector
- The cost of healthcare procedures, including quarantine and tests, special equipment, and overtime hours for specialized workers.
- Health-related preventative measures, including sanitizers, masks and vaccines (when made available).
- Non-health-related preventative measures, including security arrangements at borders and public facilities, and executing a general quarantine and curfew.
- Lost work hours for those infected and practicing preventative absence, and absence to care for children during suspended schooling.
- Short-term Economic Implications: Other Sectors
All sectors will suffer damages, but five sectors will bear the grunt of the pandemic’s direct impact, and the effects of preventative health procedures:
- Aviation, such as KLM’s plan to lay-off 2000 employees.
- Point-to-point transport, such as taxi cabs and buses.
GCC countries will be twice affected by these developments, because they largely depend on these sectors, as religious tourism – especially Hajj – play an important role in the Saudi economy, and the economy of Dubai revolves around tourism, retail, restaurants and Civil Aviation.
Additionally, chains of production will witness large disorders, due to closed cross-points and factories as a preventative measure. Therefore, countries that depend on international trade, among which are GCC countries, will see more damages than countries with a minimum level of self-sufficiency, because their exports will be met with a fall in demand, and their imports will have higher costs.
The greatest economic damage will appear in countries most reliant on the economies of China, South Korea and Italy (currently, this image might change with the virus spreading), as these economies are the most damaged by the virus. GCC countries fall within this category, since China and South Korea are among the most important oil consumers in the world, especially Gulf oil. This has reflected on the big drop in oil prices surpassing 50%, affecting all sectors of Gulf economies.
In case central banks do not provide monetary assistance, the coronavirus crisis will cause a financial crisis due to the liquidity squeeze, originating at the banks serving the aforementioned five sectors. Share prices have largely dropped during 2020, wiping away earnings from three or more years, and resulting in huge budgetary pressures on banks, families and pension funds.
According to estimations from the latest economic and statistical models, US and European economic growth in 2020 will fall by 2.6% from direct coronavirus implications, along with commercial dividends by 25-28% in both economies.
- Long-term Economic Implications
Due to the short while since the beginning of the crisis, no long-term economic implications have appeared yet, but in case it continues without adopting fiscal and monetary policies to deal with it, the global economy is expected to face the following:
- The bankruptcy of companies that default on covering their financial obligations, as part of a vicious economic recession cycle.
- The bankruptcy of individuals unable to settle their debts, such as mortgages and car loans, also as part of a vicious economic recession cycle.
- Laying-off employees by companies that could no longer pay their wages, again as part of a vicious economic recession cycle.
- Collapse of the financial system due to a squeeze on liquidity.
- A retreat in globalization, and an increase in self-sufficiency in each country’s production chains, to avoid similar future economic crises, but at the expense of the higher living standard caused by globalization.
Due to the rapid implementation of monetary and fiscal policies (see below), these implications will only appear limited. However, there are other risks related to these policies, also mentioned below.
Notably, the coronavirus crisis will lead to a decrease in global inequality, since wealthy nations and individuals are the most affected. Throughout history, diseases and epidemics usually spread more among the poor, but today we see – especially outside China – that the wealthy are more prone to disease, with those infected being people on cruise ships, politicians, entrepreneurs and celebrities. The wealthy and elite are more susceptible to contract the coronavirus, because they travel more, live in large urban centers, and interact with a lot of people.
The fortunes of the wealthy have also been the most affected by the coronavirus outbreak, as stock markets fell, and companies owned by the wealthy recorded a sharp decline in profits. The combined net worth of the wealthiest 500 people in the world lost 500 billion US Dollars as the outbreak continues. The world’s richest three: Jeff Bezos, Bill Gates and Bernard Arnault accumulated the biggest losses of 30 billion US Dollars.
- Economic Packages to Counter the Crisis
- General Principles
In economic crises, governments provide economic support packages to mitigate the negative impacts and revive the economy. However, negative economic impacts of epidemics are drastically different from those of conventional economic crises, and require special procedures, especially when planning support packages to address the impacts of the coronavirus crisis, where governments abided by the following principles:
First: the goal isn’t aggregating demand in the economy, such as launching massive government investment projects, nor reducing wages, but rather providing social insurance by helping those with a reduced or lost income, whether companies or individuals. Due to the difficulty of instantly establishing a system to separate those largely affected from those with minor losses, packages could include direct unconditional money transfers to families and businesses without complications.
Second: due to the magnitude of the crisis, packages most likely will not be affected by the size of direction of public debt, because economies are facing an existential threat.
Third: packages should motivate people to abide by directions to practice home quarantining and observe curfews to curb the spread of the coronavirus, due to the psychological stress these steps inflict on people, driving them to rebel against them with time.
Fourth: monetary authorities should provide enough liquidity for individuals and companies to avoid an economic melt-down. In particular, demand for financial facilities saw a sharp increase due to the fall in corporate revenues and personal wages, while financial obligations stand, and also as a precautionary measure to ensure companies have liquidity. Therefore, banks’ ability to respond to an increase in demand must be guaranteed. Notably, developed economies adopted loose monetary policies since the global financial crisis of 2008, focused on low interest, thus leaving very little room for further lowering of interest rates, and pushing for other means of enhancing liquidity. This is a problem faced by European nations that deal in Euros, since interest rates have reached near-zero before the crisis.
- Monetary Policies
- Lowering interest rates to zero or near-zero, and offering collateralized credit at zero interest to all financial institutions with a very high ceiling, such as what the UAE provided at 50 billion Dirhams. This policy aims to guarantee liquidity in the financial system, and help banks avoid having to reject facility requests or liquidate solid investments to satisfy demand.
- Lower capital buffers imposed on banks that usually reduce their capacity to provide financial facilities, made stricter following the 2008 global financial crisis.
- Implementing an asset purchased program at high prices to provide an additional liquidity channel to banks.
- Rescheduling loan payments, especially mortgages.
Several countries adopted these policies as a whole or specific subset, with different specifications according to their internal economic situation, among which is the United States, United Arab Emirates, Saudi Arabia, the European Union and the United Kingdom. The International Monetary Fund also offered to provide direct financial support to affected countries through low-interest loans. In some countries, like the UAE, a ceiling was specified for certain types of financial support, while in other countries – with the US leading – central banks were explicitly keen not to cap support, to enhance trust.
In GCC countries whose currencies are pegged to the US Dollar, Central banks strived to support the economy through these procedures, and to enhance consumer trust around a fixed exchange rate, by indicating the size of foreign reserves. even though, pressure had risen on GCC transactions in financial markets.
Notably, central bank governors assured the secondary role the monetary policy played in countering the crisis, and that the fiscal policy took the main role. However, monetary policies are an important launch point because they do not require intergovernmental coordination or parliamentary approval; a time-consuming process that slows down financial policies compared to monetary policies. This is a problem that obstructs the US Government’s ability to implement feasible financial policies, since both Republicans and Democrats have become unable to agree on any policy, due to deep and continuous political conflicts.
- Fiscal Policies
- Policies to support leave days for sickness, family obligations and quarantine, through legislation that permit prolonged holidays, as well as direct financial support to employers in the form of direct transfers to cover salaries during these periods, in addition to tax exempts paid by employers to the government. These policies partially aim to encourage people to follow instructions involving home quarantining and observing curfews.
- Supporting budgets for programs that support living standards of those with limited income, such as food vouchers, basic good subsidies and unemployment benefits.
- Direct unconditional money transfers to families, and to companies in the form of exemptions from – or discounts on – usual taxes.
- Supporting the budget for public health systems to ensure adequate staffing, equipment and medicine in the necessary quantities.
- Nationalizing large affected corporations, such as Alitalia.
Countries around the world either adopted or will adopt different sets of these policies, based on their specific circumstances. China, South Korea and Singapore began implementing such policies, and economic packages moved west with the virus, where European countries and the US are still in a parliamentary consultation phase regarding financial policies.
- Other Policies
Regarding GCC countries, oil policy is relevant, under OPEC’s umbrella. With shale oil’s increasing market share and flexible production, OPEC countries are now unable to collectively raise prices without cooperation from non-OPEC countries, under the OPEC+ deal. This deal succeeded in supporting oil prices from December 2016 to March 2020, but Russia announced it will exit the deal, causing member countries’ production to return to its normal levels.
Saudi Arabia sought cooperation under the umbrella of OPEC+ as a method to counter the coronavirus crisis, and it was joined in this vision by GCC countries like Kuwait, the UAE and Bahrain. However, Russia’s withdrawal led to the end of the cooperative policy to raise oil prices, since OPEC’s market share comprised less than half the market, therefore, any attempt to cut production will in turn lead to an increase in market share for shale oil at the expense of OPEC’s share, leading to a huge economic loss. Russia might reconsider its position, yet for reasons mentioned in an associated report, that is unlikely to happen.
In all the world economies, the crisis forced organizations to develop their regulations to work remotely. With investments that took and will take place in the coming months, societies could witness a fundamental change in work methods, with a notable shift to working remotely. This direction is also supported by environmental considerations, since working remotely reduces the carbon footprint. This will affect several services, especially education and retail, and will increase dependence on merchandise shipping companies like Amazon, which is now planning to recruit 100 thousand new employees, which could motivate companies to rely on international outsourcing.
Despite the urgent need for these policies, they carry several risks. In terms of monetary policy, financial facilities might generate irresponsible commercial and financial activities, like continuing with economically unfeasible commercial activities, or misusing low-interest loans, causing a future financial crisis. Therefore, restrictions have been previously applied to counter the spread of unfeasible investments that led to past financial crises, in turn requiring smart monitoring and massive preventative efforts from financial system authorities.
In terms of financial policies, there is great concern on how they would be financed over the long-term, especially with the continuing rise in public debt after the 2008 global financial crisis. In countries like the US, public debt surpassed 100% of the GDP before the coronavirus crisis, and society will not accept more taxes. Therefore, with a new set of financial policies, society might face a colossal financial crisis, such as state bankruptcy in 10 years, or a political crisis due to society’s refusal to pay taxes. There are similar considerations in European and East Asian countries.
In GCC countries, this problem is twofold, due to the fixed exchange rate that depends on low public debt, and the lack of large deficits in public budgets.