Global cycle: Uniform shock, uneven fiscal response

While most economies face a similar threat from the coronavirus, their fiscal responses have varied widely. Macro Strategist John Butler believes this will present investment opportunities in the years ahead.

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MANY PARAMETERS WILL DICTATE WHAT DIFFERENT COUNTRIES’ ECONOMIES look like coming out of their respective lockdowns — from the timing of any vaccine release to how fast containment measures are eased. But one critical element will be the fiscal response.

Given the nature of this shock, how should we judge a good fiscal response? In my view, the nearer the response gets to absorbing all the private-sector losses on to the public-sector balance sheet, the stronger the subsequent recovery can be.

Global response improving but inadequate

At the global level, although the fiscal response so far has been quicker and bigger than during the global financial crisis and continues to grow, it is still smaller than the size of the shock. The measures so far amount to 4.1% of global GDP, against a likely hit to global GDP of 7%. That is one of the reasons why, after the undoubted bounce in activity we will see once the lockdowns are softened, I’d expect the pace of growth over the next few years to be slower than the previous few. My best guess on the likely path for global growth over the next two to three years remains that the loss of GDP will be severe and it will take many years to recover the lost output.

Relative country responses are key

Although the shock has been broadly uniform across countries, the fiscal responses have not (Figure 1). This is obviously only partial information, as the outlook will crucially depend on each country’s health policy and the strategy for relaxing its containment measures. But it is worth comparing the magnitude of fiscal responses across countries, as I believe the disparities will present investment opportunities over the next few years.

FIGURE 1

Fiscal measures by country% GDP Aus US UK Norway NZ Global Canada S Korea Euro area Japan Switz China 0 2 4 6 8 10 Sources: National finance ministries, Wellington Management | Latest data as at 22 April 2020

Many countries have concentrated their response on loan guarantees for small and medium-sized enterprises (SMEs), rather than direct fiscal measures (Figure 2).

FIGURE 2

Loan guarantees/grants to SMEs by country

Potential winners…

For most developed countries, the hit to GDP in 2020 is probably going to be around 10%. Australia is closest to announcing a fiscal response that matches the shock. The US is getting there and, what’s more, its loan scheme is generous and could turn into grants, which would be different from other countries.

…and potential losers

The fiscal responses from China, the euro area and Japan are still small relative to the size of the shock. China may have done a better job of containment and is clearly further along the path to easing restrictions, while Japan has had surprisingly low contagion rates. However, the euro area sticks out with a fiscal response that is inadequate relative to the size of the shock. The fiscal measures announced across the euro area amount to around 2.75% of GDP (versus 7.5% in the US). Although the euro area leads the way in offering subsidised short-time worker schemes designed (rightly) to keep workers in jobs in the near term, its fiscal response still relies heavily on the area’s more generous automatic stabilisers.

Within Europe, there is also a very wide disparity between countries (Figure 3). Germany is at one end of the spectrum, with a large fiscal response (5%) and a loan guarantee scheme that equates to €329,000 per SME. At the other end are Spain and Italy, with a fiscal response that is nearer 1.5% of GDP. And Spain’s loan guarantee scheme equates to just €30,000 per SME, while Portugal’s is only €15,000.

FIGURE 3

Fiscal measures vary widely in the euro area

Conclusion

The distribution of possible outcomes is wide. Clearly, other important factors that will determine the shape of the outlook require consideration. But I think there are two key takeaways. One, the fiscal response is building, which is a very positive development, but global growth in aggregate is still likely to be lower cyclically as the private sector rebuilds its balance sheets and potentially structurally as it runs a higher level of precautionary savings in the future. Two, the disparity in the fiscal responses across countries is likely to be critical in determining the cyclical and structural relative winners and losers coming out of the lockdowns. In some countries, the fiscal response has not been either big enough or rapid enough.

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