This article is from our April 2020 edition of MarketWatch.
14th April, 2020
We had expected another solid year of Irish Gross Domestic Product (GDP) growth in 2020, helped by the buoyant multinational sector, with another 2.5% rise in employment and a €3bn budget surplus forecast for the year ahead. The early signs were encouraging, suggesting a modest post-Brexit bounce was underway in the services sector and in property market transactions. However, it is now clear that coronavirus will lead to a sharp contraction in economic activity in the second quarter, and perhaps even an outright contraction of Irish GDP in 2020.
Christine Lagarde reported to have warned EU leaders that a 3-month lockdown could lead to a 5-percentage point reduction in euro area GDP growth in 2020, with many commentators suggesting that a ‘double-digit’ contraction may be likely in the second quarter.
The key factor determining the near-term economic outlook is whether the virus can be brought under control and social distancing measures relaxed. There is very little data to gauge the hit to economic activity. Hence, we have decided for now to delay revising down our forecasts for the Irish economy.
However, the immediate hit to GDP from reduced activity in the wholesale and retail, hospitality, and transport sectors will be substantial. These sectors accounted for €36bn, or 11% of GDP in 2019 and 587,000 jobs, i.e. 25% of employment.
At the time of writing, minister for Social Protection, Regina Doherty, has already revealed 118,000 social welfare applications have been received, equivalent to 5% of employment. To make another comparison, in February 2020 the CSO (Central Statistics Office) estimated that 120,000 people were unemployed, an unemployment rate of 4.8% of the labour force.
It is important to remember that close to 45% of GDP is now accounted for by the multinational sector; dominated by Information and Communications Technology (ICT), pharmaceutical, med-tech and business services exports. It is possible coronavirus will have a smaller impact on these sectors. In the past, Irish exports, concentrated in defensive sectors, including agri-food, have proven less sensitive to large movements in global trade.
Crucially, whilst enormous in the near-term, the impact of the virus should have a temporary impact on the Irish economy. Hence, the Irish governments €6.7bn fiscal package is focused on helping companies and households through a difficult period when their cash flows may be impaired. This involves the 70% income replacement scheme, higher social welfare payments, but also the ability of companies to defer paying bank debts, VAT, and PAYE tax payments and business rates.
The prospects for UK GDP growth in 2020 were modest even before the outbreak of coronavirus. GDP was flat in the three months to January, betraying signs that the manufacturing sector was suffering from the broader slowdown in European industrial production. In its projections for the March Budget, the Office for Budgetary Responsibility only expected 1.1% GDP growth in 2020, with business investment still held back by the lingering uncertainty of the EU/UK trade negotiations and fresh ‘cliff-edge’ on January 1st, 2021.
Boris Johnson’s solution to this bleak outlook was to prepare a bold stimulus package, planning to boost public investment towards 3% of GDP in the March Budget. In political terms, this formed part of an effort to ‘level-up’ the UK, focusing on infrastructure projects to shore up political support for the Conservative’s in the ‘red-wall’ of seats in northern England that were won in the December election.
This is a risky strategy – new Chancellor Rishi Sunak, prepared to run substantial budget deficits of 2.8% of GDP in 2021 to fund public expenditure, tearing up the fiscal rules, and only just sufficient to keep the UK debt/GDP ratio stable, and dependent on no unforeseen surprises.
In fairness, the UK government may have been criticised as being slow to close schools, colleges and impose the lockdowns seen in Europe, but their fiscal response has been to the fore. So far, £80bn (4.5% of GDP) has been found to increase NHS spending, implement an income replacement scheme, up welfare payments, and provide a range of supports for businesses.
The Bank of England has joined in the effort – cutting interest rates to 0.1%, unveiling another £200bn of quantitative easing (QE), and other measures to support lending such as a new commercial paper facility.
Still, despite these measures, there is no doubt the UK faces a very substantial contraction in activity in Q2 2020. In March, the flash composite Purchasing Managers Index (PMI) fell to 37.1 in March - a survey record low, albeit not as bad as the euro area reading of 31.4.
The UK survey was taken before the stricter social distancing measures were implemented. It also probably doesn’t account for sector specific factors, for example the shutdown in retail activity.
For these reasons many commentators still expect a contraction in UK GDP in excess of 10% in Q2 2020, despite the large fiscal stimulus. As in other countries, the key question facing the UK economy is when the outbreak will dissipate and when restrictions on economic activity and travel will be eased.