COVID-19 economic update – April 15, 2020

In the first part of this note, we examine the economic impacts of COVID-19 on the basis of the recently published projections by the IMF. We present several scenarios, underpinning a substantial uncertainty surrounding the global recession of 3% in 2020 from the baseline scenario. Due to a severe recession this year, global trade will weaken substantially, while unemployment and government deficits will soar as we show in Section 1.

Section 2 focuses on impacts by sector. Containment measures and the uncertainty surrounding them largely determine the impact of the crisis on different sectors. Some sectors are currently in full lockdown, entailing an almost complete halt to activity, which will gradually resume as measures are lifted. Some social distancing measures are likely to remain in place for the medium-term, however. For this reason, the recovery could be particularly slow for some consumer goods (apparel for instance) and services (restaurant and food services, arts and recreation, tourism). Over the long term, a key impact will be on global value chains, which will probably become less fragmented. But recovery efforts will need to address not only crisis impacts, but also pre-existing structural challenges, such as climate change and digitalisation. These structural challenges will have become yet more urgent, and will affect some sectors more than others. 

Section 3 analyses the short-term liquidity needs of the non-financial corporate sector at the current juncture. Despite reduced cash inflows, firms still need to honour their obligations towards employees, lenders, providers of intermediate goods and other services. As the crisis unfolds, firms are likely to increasingly deplete their cash holdings, face liquidity shortfall and ultimately fall into insolvency and bankruptcy. Therefore, it is paramount to prevent short-term liquidity problems from turning into solvency issues. Based on the ORBIS data, by comparing cash holdings with payment obligations, we find that between 19% and 26% of EU non-financial corporates could face liquidity needs after a month of financial distress. According to our analysis, the proportion would reach 51% to 58% after three months. The associated liquidity needs would range from EUR 16 billion to 55 billion at the end of the first month and from EUR 112 billion to 339 billion at the end of the third month as we show in our analysis.

Section 4 expands on the analysis of the EU banking sector provided in a past edition of this weekly report. As we have shown previously, the EU banking sector is stronger today than it was before the 2008-2009 financial crisis, but is not immune to risks of a deep, protracted recession. Non-performing loans might increase at a faster pace than in past crisis episodes, despite the payment deferrals put in place in most EU countries in case the recession is long-lasting and corporates and SMEs begin to fall.

Long-term recovery efforts need to be as much about addressing pre-existing structural challenges, as tackling the direct impacts of the crisis. Returning to the status quo is not a solution. In our view, there are three key challenges facing Europe:

• Rapid technological change amid increasing global competition, with digital technologies set to have a dramatic impact across all sectors of the economy.
• Climate change, with the next decade critical for achieving net zero carbon by 2050 and avoiding catastrophic warming.
• Rebuilding social cohesion in the face of multiple disruptive trends, including technological change and automation, the climate transition, an aging society and the impact of the COVID-19 crisis. 

The authors of this note are: Barbara Marchitto, Tim Bending, Joana Conde, Andrea Brasili, Matteo Ferrazzi, Aron Gereben, Fotios Kalantizis, Laurent Maurin, Rozalia Pal, Ricardo Santos, Simon Savsek, Christoph Weiss and Patricia Wruuck (all SG/ECON). Responsible Director: Debora Revoltella.

Economic forecasts for the global economy remain very bleak. According to the World Economic Outlook, released on April 14 by the Internationally Monetary Fund (IMF), global economic growth is expected to slip into a severe recession, with the world GDP shrinking by 3.0% this year (-6.1% for advanced economies and -1% for emerging markets) before recovering 5.8% in 2021. The IMF expects negative per capita income growth in over 170 countries in 2020, with financially constrained countries facing twin health and funding shocks. The most affected countries are those with more serious damage from the pandemic, and those more exposed to tourism, oil and gas exports, international capital flows and international trade.

Economic activity in the European Union is projected to decline sharply, by 7.1% this year, with a pick up to 4.8% in 2021. Among EU Member States, the steepest real GDP decline is projected for Greece (-10.0%), followed by Italy (-9.1%), Croatia (-9.0%), Latvia (-8.6%), Lithuania (-8.1%), Spain (-8.0%), Slovenia (-8.0%) and Portugal (-8%). France and Germany are expected to contract by 7.2% and 7.0%, respectively, as detailed in Annex 1.

In its baseline scenario, the IMF assumes that the pandemic fades in the second half of 2020 and containment efforts can be gradually unwound. In this scenario, disruptions to economic activity are expected to be concentrated mostly in 2020Q2 for almost all countries except China, where the peak of the disruption was already reached in 2020Q1 (Chinese GDP declined 6.8% year-over-year in Q1). Depending on the severity of pandemic and economic disruptions at the county level, which affect losses of working days, damage is compounded by impairment of financial conditions, fading external demand and terms-of-trade losses¹.

In addition to this baseline scenario, the IMF simulates three adverse scenarios². In the first one, containment measures to fight against the spread of the virus in 2020 take roughly 50% longer than assumed in the baseline, causing a more severe economic disruption also in the second half of the year. This scenario also entails somewhat tighter financial conditions. In this case, global output is 3% lower than in the 2020 baseline. Subsequently, GDP recovers, but remains roughly 1% below the baseline as of 2024. The second adverse scenario considers the impact of a second, but milder, COVID-19 outbreak in 2021. In this case, global GDP is almost 5% lower than in the baseline in 2021 and 2% lower in 2024. The third adverse scenario is a combination of the first and second: global output is 7.3% below the baseline in 2021 and about 4% lower compared to 2024 baseline (Figure 1). 

The impact of the crisis on the different sectors of the EU economy should be assessed based on its short, medium and long-run effects:

• in the short term, most sectors are suffering, albeit to a different extent, from the lockdown measures, with some sectors completely shut down, which is something unprecedented
• over the medium term, some social distancing measures are likely to remain in place, affecting especially the services sector, for which the recovery could be particularly slow and bumpy
• on the longer term, previously existing challenges (need for accelerating digitalisation, energy transition, environmental sustainability of business) will add to the COVID-19 crisis

Looking at the short term, some sectors are currently in full lockdown, causing an almost complete halt to activity (arts and recreation, aviation, tourism and travel agencies and tour operators). Also the automotive, oil and gas, real estate and construction sectors are suffering from the lockdown more than other sectors, because of an unprecedented collapse in demand. Most manufacturing sectors are in lockdown in various European countries (sub-segments of textile, building materials, chemicals, rubber and plastic, metal products, machinery, electrical equipment, and furniture) and they may be hit by a drop in production of 50% or more for a certain period of time. A limited number of sectors is benefitting from the current situation such as food and beverages, IT and digital services, health services, and pharmaceutical. The most affected sectors will hence have related short-term liquidity needs, as they are experiencing huge (if not complete) loss in revenues, but must still sustain some costs (all fixed costs and some variable costs). Rating agencies downgraded several automakers, aviation companies, oil corporations, hotel chains, banks.

On the medium term, consumption patterns will regain strength, but some social distancing measures are likely to remain in place. The recovery could be slow, particularly for some consumer goods (clothing for instance) and services (restaurant and food services, arts and recreation, tourism). At the same time, a rise in unemployment and a fall in corporate revenues will increase uncertainty for some time at least (depending crucially also on the policy reaction), and this will weigh on the demand for investment goods and durable consumption goods. Public health care spending and investment is bound to increase: keeping an excess capacity in normal times is likely to become the norm.

Over the long term, we must consider that some sectors were already in need of a structural transformation even before the COVID-19 outbreak. Digitalisation and environmental transition were the main drivers of change across all sectors, but they have a more considerable impact on some sectors (energy sector and automotive above all). To such trends we must add, following the COVID-19 crisis, the possible reconsideration of the global value chains. It seems likely that in the long run manufacturing value chains will be shorter and less international (the risks of disruption will raise the costs of an internationally fragmented production chain) and hence more resilient to possible shocks or frictions. Textile, chemicals, metals, electronic, automotive are the sectors that are more reliant on global value chains and hence potentially more affected by possible future changes. The health and pharmaceutical sectors will most likely need to keep an emergency capacity to produce the entire chain of essential goods and equipment in the home country.

Social distancing, population confinement and mandatory closures of commercial activities lead to a sharp contraction in economic activity. Despite reduced cash inflows, corporations still need to honour their obligations towards employees, lenders, providers of intermediate goods and other services. As the crisis extends, companies increasingly deplete their cash hoarding, face liquidity shortfalls and ultimately fall into bankruptcy if not supported by public intervention⁴.

In the current crisis, which did not originate from an economic shock, it is paramount to freeze the corporate ecosystem and contain bankruptcies due to short-term liquidity problems. This is a necessary condition for the economy to rebound strongly when containment measures are lifted. As experienced during the sovereign debt crisis, liquidity-driven bankruptcies damage production capacities and lead to persistent activity weakness. Indeed, drawing from this experience, in most EU economies policymakers have reacted quickly to support the flow of credit and prevent a sharp rise in unemployment. The domestic measures, however, may fall short of the needs. Moreover, loans increase indebtedness, which may bring other problems in the short-to-medium run⁵.

We use a comprehensive dataset of EU non-financial corporates balance sheet from all size classes⁶ (ECON computations based on ORBIS) to estimate the liquidity shortfall of non-financial corporates resulting from the economic recession⁷. The estimation starts with the initial cash position of corporates. We propose four scenarios regarding net cash outflows to illustrate the evolution of cash positions and then derive the proportion of corporations that would fall short of cash after a certain period⁸.We also estimate the resulting liquidity shortfall that corporations face to maintain positive cash balances.

We first consider two scenarios as benchmark cases of recession without policy intervention. The lockdown scenario is the harshest ne. There is no cash flow from sales and no policy support. Flexibility on cost reduction is almost inexistent, as labour, financial and other operating costs⁹ are kept unchanged compared to normal economic conditions, while 30% of production-related material costs continued to be paid. In the crisis scenario, businesses are sharply hit but still able to sell 30% of normal volumes. As production is not entirely stopped, half of the production-related material costs continue to be paid. We assume that firms continue to pay salaries, financial costs and other operating costs fully.

We then consider two alternative policy responses, taking into consideration the variety of measures already implemented by EU governments. We assume that all policy measures apply equally to all industrial sectors and firm sizes. As in the crisis scenario, sales shrink by 70%. The two alternative scenarios differ by the intensity of the adopted policy measures. In the policy support scenario, corporates reduce labour cost and other operating expenses by 40%, while financial costs decline even more, by 60%, because of loan moratorium. Intermediary consumption declines by 50%, given the reduced activity. In the heightened policy support scenario, costs come down more strongly: labour costs and other operating expenses drop by 60% and financial costs by 70% (reflecting loan moratorium). Intermediary consumption falls by 50%, just as in the previous scenario, given the reduced activity.

We report the results obtained for the four scenarios in Table 1.

The EU banking sector is stronger today than it was before the 2008-2009 financial crisis, but is not immune to risks of a deep, protracted recession. The current economic crisis did not originate in the financial sector and ten years of structural transformation led to a much stronger capital position for banks and a much deeper understanding of the various risks and interlinkage factors. Core tier 1 capital stands now at 18.3% of risk-weighted assets for the EU average, 8 percentage points higher than in 2008 (Figure 2). Moreover, while this aggregate figure masks some notable differences across countries, the countries that currently have a weaker capital position are still in a much stronger position than before the onset of the global financial crisis.

Funding markets for banks are showing some signs of distress, but the current situation is different from the global financial crisis. Central banks have been much more proactive in providing liquidity than they were in 2008/09, particularly the European Central Bank (ECB), which is now ensuring long term funding through different instruments. The total ECB lending to Euro area banks reached EUR 869bn in the first week of April, the highest level over the past seven years, but still below the maximum of more than EUR 1.2trn reached in the spring of 2012 (Figure 3). This figure could increase substantially in the future to cover virtually all the banks funding needs given the relaxation of the collateral requirements announced by the ECB on the 7th of April.

The COVID-19 pandemic represents an unprecedented shock to the European and global economies. Mitigating the economic impact of this shock on households, businesses, and the financial system is the priority, so long as severe measures are still required to slow down and stop the spread of the virus. But it is also necessary to begin planning a response that will ensure rapid and sustained recovery, with the European economy eventually emerging stronger, not weaker.

This crisis could exacerbate weaknesses in the European economy that stem from long-term underinvestment in areas critical for the continents future competitiveness and cohesion. EU Member States were not economically at their strongest at the onset of the  COVID-19 crisis, also due to low investment in the years following the global financial crisis. Looking forward over the next decade it is critical to put long-term, structural investment needs at the centre of our recovery efforts. We have identified three key challenges facing Europe:

• Rapid technological change amid increasing global competition, with digital technologies set to have dramatic impacts across all sectors of the economy.
• Climate change, with the next decade critical for achieving net zero carbon by 2050 and avoiding catastrophic warming.
• Rebuilding social cohesion in the face of multiple disruptive trends, including technological change and automation, the climate transition, an aging society and the impact of the COVID-19 crisis.

To stay competitive amid a technological revolution, Europe needs to be at the innovation frontier by closing the investment gap in research and development, intangible assets and the economy-wide adoption of digital technologies. It needs to create a more enabling environment for competitiveness, with a pro-active policy to enhance skills, particularly as a complement to digitalisation. Europe’s innovators also need a financial system that is better suited to their financing needs.

To meet the challenge of the transition to zero carbon, a dramatic acceleration of efforts is needed, with investment stepped up not only in the energy sector, but across industries  for technological adaptation and the circular economy, in the transport and agricultural sectors, and by households for energy efficiency and more sustainable lifestyles. The decarbonisation effect of COVID-19 will be short-lived and cannot be a source of complacency. Europe needs a mission-oriented approach to achieve significant breakthroughs for the transition to a zero-carbon economy, and must ensure this is a just transition.

To ensure that Europe works for everyone, new axes of regional divergence must be addressed. Persistent or rising income inequality within EU countries and increasing burdens on households are a concern. For younger generations in Europe, progress on social mobility may have stalled, which also has negative implications for competitiveness. In the wake of COVID-19, Europe must invest proactively in social inclusion, particularly in skills and in social infrastructure, including health. Only in this way can we build a more cohesive society while tackling the challenges of new technologies, sustainability and an aging society.

Competitiveness, sustainability and inclusion must be addressed together, and far-sighted investment plays a vital role in addressing all three. European-level collaboration is also critical for success, to achieve scale and harness positive spill-overs. Instead of merely reacting to change, we need to be proactive through timely reform and investment that sets us on a pathway towards a society that is productive, sustainable and inclusive, by design.

Digitalisation is not only relevant for large firms or fast-growing firms at the technology frontier. The recent COVID-19 pandemic is a sombre reminder of the relevance – and the necessity – of digital technologies for a variety of businesses and sectors: from health to retail, from manufacturing to education. The adoption of digital technologies is revolutionising the world of work in almost business structures and value chains – from the provision of digital products and services online to robotised production processes, the internet of things (IoT), big data and AI, and applications, including the use of digital systems to manage back-office tasks.

The costs of the disruption to the economy due to the COVID-19 are not shared equally across firms and workers. Some businesses and people are able to work online. Others, in particular manual workers or workers with low digital skills, cannot do so and have to stop working. While some services can be offered remotely and through digital channels, others need physical interactions.

The ongoing crisis is likely to exacerbate the trends of digital polarisation. But it may also accelerate adoption in more traditional areas (including public services), where people may be more hesitant to use digital solutions, or remote industrial applications. This will require substantial investment in cybersecurity to address concerns with trust and rights to privacy. When life goes back to normal, digital solutions that the consumers see as viable and useful will to continue, while a few that were only due to necessity will probably have to scale back.

The crisis is an opportunity for many businesses to start exploiting and investing in digitalisation. European firms first need to survive this crisis and will require additional financing to afford investing in digital technologies. If European firms are not able to better integrate digital technologies into their business models, they will lose out, even in those sectors where they are currently still leading, such as the automotive sector.

There is growing concern that EU firms lag behind in the adoption of digital technologies, especially in the services sector. This lag correlates with subdued EU productivity growth before the COVID-19 crisis. Recent evidence based on data from the European Investment Bank’s Investment Survey (EIBIS)  shows that digital adoption rates in the European Union are lower than in the United States. This may also explain the gap between the European Union and the United States in creating new leading global R&D companies, especially in the digital sector, where economies of scale, synergies and winner-takes-all dynamics dominate and tend to foster market concentration.

Even before the crisis, firms that had implemented digital technologies tended to perform better than non-digital firms. Analysis based on EIBIS data indicates that digital firms have better management practices, are more innovative, grow faster and create higher-paying jobs. The correlation between managerial practices and digitalisation underlines the importance of management skills for successfully enrolling in a profound transformation.

If policymakers want to close the gap in digital adoption across firms, they need to address structural barriers to investment in digitalisation. The fact that EU firms are smaller on average than those in the US is likely to be a major disadvantage for fast-tracking the adoption of digital technologies in the European Union. There are many old and small firms in the European Union that do not invest in digital technologies. Unlike in the United States, these firms are more likely to consider the lack of availability of finance as a major obstacle to investment, which may further exacerbate the delay in adoption rates (Figure 5). Financial diversification, e.g. raising equity instead of bank debt or making it easier to use intangible assets as collateral, can be an effective way to support innovation and frontload investment in the digitalisation of European companies, especially for small businesses. This can be as important as direct public R&D support. Policy action should also develop measures to fast-track the adoption of better management practices and improve the skills of workers through training.

The COVID-19 crisis is a game-changer for the existing EU energy and climate plans. In the short-run, it has a substantial impact on energy consumption, GHG emissions, energy and carbon prices, and in the long-run it might endanger the EU plans to transition to a net-zero carbon economy. The COVID-19 crisis will not change the need to focus on the consequences of climate change. There is no room for complacency if Europe aims to move towards a carbon-neutral economy by 2050, given that delayed actions will result into higher costs, emissions and lower growth prospects. However, the current crisis has shifted some of the existing policy priorities, and a smart adaptation of the EU climate plans might be necessary, especially now that discussion for a COVID-19 related stimulus package has begun.

Today almost all EU countries have experienced a significant drop in their energy consumption because of the various measures taken by governments to combat the spread of COVID-19. The stringency of these measures has affected the consumption mainly of the three major energy commodities: electricity, gas and oil. So far, the hardest-hit countries in terms of consumption appear to be Italy, France, Belgium and Spain, but, as the industry shutdown and the quarantine expands, many other EU countries are catching up, including Germany, Poland and the Czech Republic. The nationwide lockdowns caused peak-hour traffic levels to collapse across Europe (Figure 6). One outlier is Stockholm, where congestion levels have fallen less significantly because Sweden has adopted much lighter lockdown rules than the rest of Europe.

Economic policy has a strong influence on the projected length and extent of the economic downturn caused by the pandemic. While the immediate, first-round effects on economic activity (such as shutdowns due to the containment measures) are unavoidable, the second-round demand effects (e.g. job losses, lower demand) and longer term consequences (bankruptcies, broken supply chains, labour market frictions due to job search after layoffs etc.) can largely be mitigated by public policy measures. The coordinating role of the state in resource allocation in such a situation is crucial. Well-targeted and well-scaled policy actions will make a difference between a long-lasting L-shaped slump and a quicker, V-shaped recovery.

Within the European Union, policy coordination and joint action are crucial to preserve the single market. The interconnected nature of the European economy - stemming from the free movements of goods, services, capital and labour, the cross-border value chains, and more. - adds a sizable part to potential output and welfare in all EU economies. Hence, negative spillovers for one country are felt in others as well. Joint, coordinated EU action is therefore needed to prevent the links in trade, production, capital flows and labour markets to be disrupted and complement member states’ responses.

There is a strong economic rationale supporting prompt and coordinated policy intervention to sustain confidence, thereby helping to mitigate the depth of the shock and speed up recovery:  

• On the monetary policy side, the ECB had intervened early (18 March) with the launch of its EUR 750 bn Pandemic Emergency Purchase Programme (PEPP), expansion of the range of eligible assets under the Corporate Sector Purchase Programme (CSPP) and easing collateral standards to support market liquidity and credit provision to the economy.
• As exceptional circumstances require national fiscal intervention, the Growth and Stability Pact has been suspended temporarily, while member states have been granted exemptions in terms of state aid rules. Member states have been pro-active, continuously stepping up their policy responses with rising commitments in terms of fiscal measures, to counter the first immediate effects of the crisis. Interventions range from about 1.5% to 14% of GDP on the fiscal side¹¹. Interventions target households and companies and include tax forbearance, payroll subsidies to prevent layoffs, sick leave contributions, support for self-employed, business grants, or possibilities to defer rent or mortgage payments to support emergency liquidity for firms and individuals and mitigate social hardship.
• Most Member States have also set up guarantee schemes targeting SMEs and corporates, with interventions in some cases up to almost 20% of GDP to provide speedy support to firms under strain¹². Altogether, fiscal measures, deferred tax payments and guarantees are estimated to amount to about 19% of EU GDP. However, differences in the extent of economic policy responses and capacities to weather the downturn induced by the pandemic and support a speedy recovery persist.
• The response at the European level to complement efforts has been further stepped up with the finance ministers’ agreement on 9 April on an emergency plan setting out support measures totalling about EUR 500bn. The package includes:  

1. strenghening EIB activities by creating, a pan-European guarantee fund of EUR 25 bn, amounting to a support capacity of EUR 200 bn for the financing of companies, particularly SMEs, across the European Union,
2. an ESM credit line for Euro area members to support domestic financing of direct and indirect healthcare, cure and prevention-related costs due to the COVID-19 crisis (about 2% of the respective Member State's GDP),
3. SURE, a temporary loan-based instrument to provide financial assistance to Member States in the form of guaranteed loans on favourable conditions (up to EUR 100 bn in total) to support Member States' efforts to protect workers and jobs.

The COVID-19 shock has laid bare existing gaps and divergences within Europe. This is reflected in insufficient capacity in healthcare systems, and highlighted inequality of opportunities (for instance, learning and working via digital channels). Strategies for recovery in Europe will require reducing this fragmentation and the divides between and within EU countries, to sustain growth in Europe in the longer term.

11. Fiscal costs excluding guarantees. As of 8 April.

12. For a more detailed overview of guarantee schemes by country, see weekly COVID-19 table documentation.