OVER the past couple of months, financial markets have fluctuated wildly due to the Covid-19 pandemic and collapse of crude oil prices since early March. Warnings of an imminent global recession have been ringing louder than ever.
The pandemic has hammered the global economy leading to significant job losses and business closures due to unprecedented measures implemented to contain the spread of the virus.
With disappointing economic indicators worldwide, a considerable downturn is expected, potentially worse than the 2009 Global Financial Crisis (GFC).
The global economy was already trending downwards prior to Covid-19. The private sector will likely take the biggest hit. Business investments and overall economic activities will likely be delayed or scaled down.
The 2009 GFC was triggered in the United States and spread to the rest of the world through trade and investment linkages. Although GFC technically lasted around two years from December 2007 to June 2009, many important components of the US economy did not regain its pre-crisis levels until between 2011 and 2016.
According to World Bank data, US real Gross Domestic Product (GDP) fell by 4.3% or US$650bil and did not recover its US$15 trillion pre-recession level until the third quarter of 2011.
Shockwaves
However, the GFC was not evenly felt around the world. While developed economies such as North America and Europe fell into recession, many newly developed economies were less impacted, especially in China and India which grew considerably during this period.
Malaysia’s GDP declined 5.8% year-on-year (y-o-y) in 1Q09. Although Malaysia had no direct exposure to the US debt market then, it still felt the shockwaves through disruptions in global trade and investment linkages. Malaysia’s industrial output contracted 14.7% y-o-y on average from October 2008 to March 2009 as demand fell in export-oriented sectors.
Exports dipped about 20% y-o-y on average between October 2008 and September 2009. However, the recession was brief in Malaysia as real GDP growth rebounded by 10.3% y-o-y in 1Q10 on the back of expansionary macroeconomic policies.
Nevertheless, the global recession this year is expected to be worse. Economies around the world are expected to suffer from major demand and supply shocks.
Pre-Covid-19, the global economy was already weakened due to turmoil in the financial markets, weaker trade, lower industrial output and decline in new investments. The pandemic that began in China and quickly spread to other countries has led to demand and supply shocks globally. A further economic downturn and risk of financial instability are expected.
The immediate economic cost of Covid-19 is mainly attributed to the preventive measures taken by governments to contain the pandemic including quarantines, border lockdowns, travel bans, and movement control. These unprecedented measures first disrupted China’s economic supply and demand. Economies have also been hit in other ways such as restrictions on trade and tourism.
While the number of new Covid-19 cases is decreasing in China, it is still increasing rapidly in other parts of the world. Unprecedented measures taken by these countries are now hitting demand and supply. This will lead to mutual shocks, not just to flows of trade and tourists, but also disruptions in major economic sectors and disequilibrium in labour markets.
Notably, a record 22 million US workers have applied for unemployment benefits since mid-March due to the Covid-19 pandemic. This marks an abrupt end to the nation’s historic decade long run of job growth. The country’s unemployment rate increased to 4.4% in March from 3.5% in February.
The US Labour Department has projected unemployment rate to climb between 15% and 20% in April and May. The US could face its worst unemployment crisis since the Global Depression in the 1930s.
In March, US retail sales plunged 8.7% month-on-month (m-o-m) (February: -0.4% m-o-m), its biggest decline since 1992. This was mainly due to mandatory business closures and depressed demand for a wide range of goods. Industrial production fell 5.4% m-o-m, its steepest decline since 1946.
With weaker domestic and external demand, Bloomberg is forecasting US GDP to decline 2.5% y-o-y in 1Q20 followed by a drastic decline of 25% in the second quarter. Full-year 2020 GDP growth is projected to contract 3.2% despite an optimistic assumption of recovery in 2H20. The crisis has already triggered unprecedented response from monetary and fiscal policymakers.
China’s economic activity contracted by 6.8% y-o-y in the first quarter due to the massive domestic quarantine and lockdown imposed to contain COVID-19. This marks the worst decline since 1992.
In view of weakness in China’s domestic demand alongside an extended period of global downturn, the country’s economic growth is unlikely to return to its pre-Covid-19 crisis level, at least until mid-2021. Recovery will depend on the effectiveness of China’s policies and measures to cushion the economic impact of the pandemic. Despite some signs of recovering economic activities in China, downside risks are likely to persist in upcoming months with labour market strains and lingering concerns about the virus continuing to weigh on discretionary consumer spending. This is evident in tumbling retail sales (-15.8% y-o-y) in March, almost twice higher than consensus expectations of an 8.0% decline.
In addition to domestic economic challenges, any adverse impact on major economies such as the US and China would also trickle down to emerging and developing markets through trade and investment linkages.
For many countries, the biggest shock will be the drop in external demand which will translate into lower exports, tourism and commodity revenues. Highly leveraged governments and large clusters of businesses will face difficulties in servicing their debts within shrinking fiscal space, making it more difficult to finance social assistance and public projects in the medium term.
Overall, the International Monetary Fund (IMF) is projecting the global economy to contract sharply by 3% y-o-y in 2020, much worse than the 0.7% y-o-y decline during the 2009 GFC. Nevertheless, global economic recovery could be weaker than expected even after the pandemic is eventually contained.
This is largely due to rising uncertainty about the contagion, deteriorating consumer confidence, closure of businesses as well as structural shifts in consumption by firms and households. This could lead to a prolonged disruption of supply chain and sluggish aggregate demand.
Major headwinds
Malaysia has experienced multiple unprecedented events since the beginning of the year. Just weeks after the first Covid-19 cases were reported, political events led to a change of federal government.
This was followed by a sudden dip in global oil prices due to the failed negotiations between Saudi Arabia and Russia on production cuts. Global crude oil prices are now hovering at less than half of the Malaysian government’s US$62 per barrel assumption. This is widely expected to affect Malaysia’s fiscal position, at least in the short term.
The other worry is the economic repercussions due to the ongoing quarantine and Movement Control Order (MCO) which have prevented people from leaving homes (except those working in essential services), and forced some small and medium enterprises (SMEs) and micro businesses to close. All these restrictions will drag the domestic economy beyond the initial impact of the first wave of the outbreak in China.
Based on recent economic indicators, the country’s industrial production (-0.6% y-o-y) and exports (-1.5% y-o-y) performed adversely in January.
Nevertheless, February industrial production and exports rebounded strongly, expanding 5.8% y-o-y and 11.8% y-o-y respectively, primarily due to a low base last year. Malaysia has heavily integrated into global supply chains and is highly dependent on international trade. Its industrial production and external trade activities will likely face numerous headwinds in upcoming months as global growth falls and supply chains are severely disrupted.
Hardest hit
In addition, Malaysia’s Manufacturing Purchasing Managers Index (PMI) declined further to 48.4 in March from 48.5 in February. Despite falling to its lowest level since June 2016, the PMI shows that new orders and exports in the manufacturing sector were less impacted compared to other regional economies. Nevertheless, further deterioration is expected this quarter for exports and demand, due to the suspension of businesses and private consumption regionally.
The Manufacturing PMI survey also shows worsening sector prospects over the next 12 months with Malaysian manufacturers expecting further production cuts largely due to a sustained supply disruption. Pending further clarity on containment of the pandemic, businesses will likely remain highly risk averse.
On the services front, the pandemic has already dealt a severe blow to tourism related sectors such as aviation, logistics, hotels and travel agencies.
According to the Malaysian Association of Hotels (MAH), about 15% of 4,880 hotels registered under the Ministry of Tourism, Arts and Culture may have shut down their operations due to the pandemic. With Malaysia’s tourism sector contributing around 5% to the country’s total output, any adverse impact on the sector could directly translate into a slowdown of our GDP growth, at least in 1H20.
Despite the government’s various stimulus packages to help the affected sectors, tourism will be one of the hardest hits with many hotels shutting down or downsizing due to restrictions on domestic and worldwide travel. As a major job generator, coordinated mitigation and recovery plans to support the tourism sector could generate massive returns in the overall economy post-COVID-19.
Unemployment could hit new highs
Disequilibrium in the labour market is widely expected. Unemployment rates during the 1997 Asian Financial Crisis (AFC) and GFC were 3.2% and 3.7% respectively, still considered at full employment level.
On the contrary, the ongoing MCO and business closures may force many employers, especially SMEs, to retrench workers to cut their losses. The Malaysian Economic Research Institute (MIER) estimates around 1.46 million job losses this year, mainly non-salaried and unskilled jobs, translating into 12.5% unemployment rate. Sectors such as tourism, aviation, manufacturing and services will likely see the highest number of job losses.
MIER is also anticipating 500,000 new workers to enter the labour market this year. The government could collaborate with private firms on traineeship schemes to assist new graduates amid a weakening job market.
With mounting job losses and rising unemployment, a serious distortion in labour market would push the real economy into a severe recession. Therefore, it is important to prepare new job entrants for an eventual recovery to ensure that the labour force remains resilient and robust.
Most Malaysian firms, especially SMEs with liquidity difficulties, will have to come up with contingency plans if the situation continues to deteriorate. The long term sustainability of SMEs requires huge technological capabilities to survive the post-Covid-19 world. SMEs need to evolve rapidly into digital marketing to sustain their businesses.
On the other hand, the MCO has affected the country’s household spending patterns. Household expenditure is estimated to have decreased by 55% from RM6,317 to RM2,813 during the first two phases of the MCO. Spending by Top 20% income (T20) households dropped 63%, followed by Middle 40% (M40) and Bottom 40% (B40) declining by 54% and 49% respectively.
The normalisation of consumer spending will likely be restrained with safety measures such as social distancing and restriction on mass gatherings likely to be extended beyond the present lockdown period.
Current consensus is shifting to a probable extension of the MCO beyond the Hari Raya festive season at the end of May.
A prolonged MCO could affect consumption recovery further due to loss of jobs and income. This will pose challenges to the country’s economy despite the RM260bil stimulus package, almost half of which will go to households (RM128bil).
On the monetary front, Bank Negara has taken pre-emptive action with a total of 50 bps Overnight Policy Rate (OPR) cut in the first two policy meetings this year. Also, the central bank cut the Statutory Reserve Requirement (SSR) to 2.00% in March to release an additional RM30bil liquidity into the banking system.
With the US Federal Reserve (US Fed) rate at 0.00% and 0.25%, there is ample room for Bank Negara to cut OPR further to cushion the economy.
More OPR and SSR cuts could also be on cards if the economy dips further. All in all, we expect the domestic economy to contract 2.5% y-o-y this year, with GDP remaining in negative trajectory of between -5% and -3% in at least three quarters of this year.
Manokaran Mottain is the chief economist at Alliance Bank Malaysia Bhd. The views expressed here are the writer’s own.