Business in strict confidence COVID19 Economic Brief Assessing

Business in strict confidence COVID-19: Economic Brief Assessing implications for economies, sectors and markets 22 May 2020 Grant Colquhoun and Marie-Louise Deshaires

Business in strict confidence Developments and implications summary – 22 nd May Overview n n Sectors n n Markets n n Forecasts n n Cases are rising rapidly in emerging markets such as Brazil, Mexico, India and Russia. Nevertheless, the direction of travel is towards looser restrictions, which could have economic and political consequences. Several European governments have taken steps to open their borders from June onwards and all 50 US states have partially reopened. Timely indicators are still running at a fraction of previous levels. In April, United States single-family housing starts saw their largest monthly drop since records began in 1970, but we are relatively optimistic that starts will recover as more builders are able to return to work. Rents in the major Canadian cities have been falling fast in April. With investors basing their price expectations on the assumption that rents would keep rising strongly, this represents a risk to house prices. Net capital outflows from emerging markets eased markedly last month and remained relatively modest so far in May. Turkey, however, is still experiencing major stress with risks of a currency crisis rising fast. The Franco-German proposal to issue common European Union debt pushed the yields of euro-zone periphery sovereign bonds a bit lower this week and we expect these to fall back over the rest of the year. Our forecasts are little changed this week. China will return to growth this quarter but elsewhere recovery will show in gross domestic product data for the third quarter, led by a rebound in Europe. We expect world gross domestic product to contract by 6. 0 per cent this year, then rebound by 8. 7 per cent in 2021. 2

Business in strict confidence Coronavirus tracker: Latest new cases and containment policy developments New cases per million people* Trend in new cases Latest virus containment policy developments Asia China 0. 01 Korea 0. 4 Students began returning to school on Wednesday. Japan 0. 3 Prime Minister Abe on Thursday lifted the state of emergency in Osaka, Kyoto and Hyogo, as the spread of the novel coronavirus has slowed enough to justify the gradual easing of curbs on economic activity. Singapore 85. 0 India 3. 9 Nationwide lockdown extended until end of May, albeit some containment measures have been loosened further by the government allowing some travel to resume. Germany 6. 6 The government decided to exempt all nationals of the European Union from the quarantine rules, including United Kingdom passport holders when borders will reopen. France 4. 7 Borders due to reopen, initially with Switzerland Germany, from 15 June. Italy 10. 7 Spain 9. 6 Spanish Congress votes to extend ‘state of alarm’ until 7 June. 8. 9 Borders are likely to be open to international tourists from 13 June and international flights are due to begin operating again on 23 May. No new policy development. Improving / Less restrictive Measures to be gradually eased from June 2 onwards in three phases. Europe Poland United Kingdom Americas 43. 4 Restaurants, bars, non-essential shops and museums reopened on Monday and foreign tourism to resume from 3 June. Worsening / More restrictive No new policy development. United States 104. 0 Mexico 17. 4 On Monday, approximately 300 municipalities were given the green light to restart economic activities and lift recommendations. Similar measures to start 1 June in the rest of the country, with classes to resume the same day. Brazil 57. 3 Sources: Capital Economics and various President Bolsonaro is rallying his supporters to back his call to end the lockdown. Note: *Change in confirmed cases per million people, three day average. All 50 states have partially reopened from Wednesday after a two-month shutdown. 3

Business in strict confidence Easing of restrictions proceeding whether virus containment achieved or not Some emerging markets easing lockdowns even as new cases rise Total confirmed cases globally have risen to almost five million due to the rising number of cases in emerging markets. Brazil’s number of new case has averaged more than 10, 000 per day over the past week, second only to the United States. The Brazilian trajectory reflects a public health crisis that is triggering political turmoil and which will see its economy recover more slowly than in other emerging markets. Daily new infections continue to rise in Mexico, too, but the government is easing lockdowns in parts of the country and allowing the automotive and construction sectors to reopen. Russia’s containment measures have been removed despite having failed to bring the virus under control. Restarting the economy before the virus is not contained may have important long-term implications, both for the economy and (potentially) domestic politics. While India’s lockdown has been extended, some travel restrictions have been eased. A further acceleration and spread in virus infections will exacerbate existing strains on the local medical systems, and containing the virus at a nationwide level could become even more difficult than it already is. Total confirmed cases of coronavirus, selected countries, thousands China Spain Italy South Korea 250 1 600 1 400 1 200 1 000 800 600 400 200 150 100 50 0 20 -янв 9 -фев 20 -мар 9 -апр 29 -апр 19 -май Daily reported change in confirmed cases of coronavirus, selected countries, five-days moving average, thousands Italy Spain South Korea Japan United States (RHS) Europe take steps to open borders 12 50 Euro-zone governments have eased restrictions further, as new daily cases continue their downward trend. Borders are set to reopen for selected European partners in June in countries including Italy, France and Germany. However, the return to prior activity levels will be slow. For example, Germany’s restaurant reservations are rising, but are still 80 per cent below last year's level. 10 40 In the United States, all 50 states have now partially reopened after a two-month shutdown. Timely indicators, however, suggest that air travel and in-person restaurant dining are still running at a fraction of previous levels. 8 30 6 20 4 10 2 0 20 -янв 0 9 -фев 20 -мар 9 -апр 29 -апр 19 -май Sources: Capital Economics and Refinitiv. Note: Case numbers subject to revision. 4

Business in strict confidence Number of cases still on a sharp upward trajectory in major emerging markets Total confirmed cases of coronavirus, selected countries, thousands Australia United Kingdom Canada France Total confirmed cases of coronavirus, selected countries, thousands Poland Germany India South Africa 350 300 250 200 150 100 50 50 0 20 -янв 9 -фев 20 -мар 9 -апр 29 -апр 19 -май 0 20 -янв 9 -фев Mexico Turkey 29 -фев 20 -мар 9 -апр Russia Brazil 29 -апр 19 -май Sources: Capital Economics and Refinitiv. Note: Case numbers subject to revision. 5

Business in strict confidence Indian economy contracted in Q 1 and far worse will follow in Q 2 Indian partial lockdown loosening provides slight boost India daily electricity consumption, terawatts hours With almost all Indian activity indicators having collapsed in March after a nationwide lockdown began on the 24 th, we think the economy will have contracted last quarter. Electricity consumption has started to pick up, suggesting that the partial loosening in containment measures this month has provided a slight boost. But it is still around 10 per cent lower than its levels from last year. 2019 4, 25 2020 3, 75 Nationwide lockdown starts A strong pick-up in these indicators is unlikely, given that the lockdown has most recently been extended to 31 st May. Most parts of the economy are likely to remain inactive for the rest of the month. Beyond that, there’s a good chance that some form of widespread shutdown will stay in place too. After all, despite India’s stringent containment measures, reported coronavirus cases are still rising sharply. 3, 25 Selected India activity indicators, annual change, per cent Coronavirus government response stringency index (T = Day of 10 th Confirmed Case) March 2020 2015 -19 Average 2, 75 2, 25 11 -мар 23 -мар China 120 Tourist Arrivals 100 Tractor Sales 80 Railway Passengers 60 Vehicle Production 40 Non-oil/gold imports 20 Rail Freight Revenue 4 -апр Brazil 16 -апр 28 -апр Russia 10 -май India 0 -80 -60 -40 -20 0 20 T T+10 T+20 T+30 T+40 T+50 T+60 T+70 Sources: Capital Economics, CEIC, Power System Operation Corporation Limited, Oxford University and World Health Organisation. 6

Business in strict confidence Deepening Russian contraction but political stability supports currency, in contrast to Brazil Russian economy sputters in Q 1, collapse coming in Q 2 The slowdown in Russian gross domestic product growth to 1. 6 per cent year-on-year in the first quarter of 2020, from 2. 1 per cent in the fourth quarter of 2019, is consistent with a small quarterly contraction of 0. 1 per cent. However, the figure released almost certainly failed to capture the extent of virus containment measures as the government did not implement lockdown measures until late -March. The implication is that, as elsewhere, activity probably fell off a cliff in April. We expect a thirteen per cent quarterly contraction in gross domestic product in the second quarter of the year. What’s more, with the authorities still struggling to contain the outbreak and fiscal support worryingly limited, any recovery once lockdown measures are lifted will be sluggish. This will put more pressure on the central bank to ease policy – we expect an additional 100 basis points of rate cuts this year. Russia gross domestic product 6 Quarter-on-quarter (% SA, RHS) Year-on-year (% NSA, LHS) 2, 0 1, 5 1, 0 0, 5 0, 0 -0, 5 -1, 0 CE estimate Q 1 2020: -1, 5 -0. 1 quarter-on-quarter -2, 0 2016 2017 2018 2019 2020 3 0 -3 -6 2012 2013 2014 2015 Brazilian real and Russian ruble, local currency/US dollar Brazilian real rallies, but political pressure is not likely to go away 6, 0 Russian ruble (LHS) 90 Weaker vs US dollar 5, 5 85 80 5, 0 75 70 4, 5 18 -май 11 -май 60 4 -май 27 -апр 20 -апр 13 -апр 6 -апр 30 -мар 23 -мар 16 -мар 9 -мар 24 -фев 17 -фев 10 -фев 3 -фев 4, 0 65 27 -янв We doubt that the big bounce in the beleaguered Brazilian real early this week is a sign of things to come. The mounting political crisis in Brazil has increased the likelihood that the coronavirus outbreak causes long-term economic harm – and the political situation does not seem likely to be resolved soon. Brazilian real (RHS) 20 -янв Despite its jump on Monday, Brazil’s currency has clearly underperformed since the coronavirus started to spread around the world early this year. That is probably due in part to the rapid increase in coronavirus cases in the country recently. Investors have been more forgiving of other countries, like Russia, where outbreaks have not yet peaked. This is because, in Brazil, more than elsewhere, the pandemic has challenged the stability of the government, and with it the hard-won prize of fiscal sustainability. Sources: Capital Economics, Refinitiv and Bloomberg. 7

Business in strict confidence Signs of improving market sentiment on European peripheries and Emerging markets Common debt proposal adds further support for periphery bonds The news that Germany and France have agreed on a proposal for the European Union to fund a joint fiscal response to the coronavirus pandemic by issuing common debt backed by the European Union budget has pushed the yields of euro-zone periphery sovereign bonds a bit lower this week. The move, however, is relatively small, and the spread between the yields of periphery sovereign bonds and German Bunds remains much higher than before the pandemic hit, which suggests investors remain to be convinced that this is a game changer. Ten-year government bond yields, per cent Spain 2, 5 Italy Portugal PEPP launched 2, 0 Lagarde “not here to close spreads” 1, 5 1, 0 While the proposal to issue common debt is limited in size and some way from gaining final political agreement, it adds support to our view that the yields of euro-zone periphery sovereign bonds are likely to fall back over the rest of the year. 0, 5 Net capital outflows from EMs eased markedly in April Foreigners’ net purchases of bonds and equities*, billion US dollars, one-month sum, based on daily data Our Capital Flows Tracker suggests that net capital outflows from emerging markets eased markedly last month. And daily data on non-residents’ net purchases of equity and bonds suggest that net outflows may have slowed further so far in May, although much of the improvement happened in April. One country which is still experiencing major stress, however, is Turkey. With the central bank burning through its foreign exchange reserves and confidence in policymaking evaporating, another currency crisis is fast approaching. A handful of low-income emerging markets, notably Angola, Ecuador and Zambia are also experiencing distress as their governments grapple with unsustainable debts. But, overall, the coronavirus seems to have pushed few large emerging markets into outright balance of payments crises. 0, 0 янв-20 фев-20 мар-20 апр-20 май-20 20 Net inflows 10 0 -10 -20 Net outflows -30 * Includes data from India, South Africa, -40 Korea, Indonesia, Thailand, Philippines, -50 Turkey, Mexico, Hungary -60 янв-19 май-19 сен-19 янв-20 май-20 Sources: Capital Economics, CEIC and Refinitiv. 8

Business in strict confidence Weak confidence and rising unemployment point to slow consumption recovery in Europe Slight improvement in EZ confidence but gradual recovery ahead Euro-zone consumer confidence rose slightly in May reaching -18. 8, from a revised -22. 0 in April. This suggests that households are a little less depressed about their prospects and the wider economic outlook than they were in April. But the index remains very low and consistent with only a gradual recovery in the coming months. Over the coming months, assuming that there is no major resurgence of the virus, we think consumption should recover, but only gradually. While the success of the short-time work schemes suggests that the unemployment rate may not spike as sharply as we initially feared, many firms will be unable to avoid bankruptcy which will involve many job losses. Many households will still be reluctant to spend as freely as they did in the past, while others will want to keep their savings higher than they were previously for precautionary reasons. Overall, household consumption is likely to fall by around twelve per cent in 2020. Euro-zone European Commission consumer confidence and household spending EZ consumer confidence (LHS) 0 -2 -4 -6 -8 -10 -12 -14 -16 -18 -20 -22 -24 -26 2007 2010 2013 Household consumption (RHS) 3, 0 2, 5 2, 0 1, 5 1, 0 0, 5 0, 0 -0, 5 -1, 0 -1, 5 -2, 0 2016 2019 United Kingdom unemployment rate, per cent First signs of the incoming wave of unemployment in UK The headline ILO unemployment rate for the United Kingdom covers the three months to March and does reflect the fall in employment revealed in the timelier data. The claimant count unemployment rose from 1. 2 million in March to 2. 1 million in April, meaning the claimant count unemployment rate rose from 3. 5 per cent to 5. 8 per cent. We forecast that the unemployment rate will continue to rise in the coming months, particularly from August when employers must start contributing to furloughed employees’ wages. Our forecast is that the unemployment rate will rise to almost nine per cent. While much of that jump should be reversed when businesses start to get back to normal, we still expect the unemployment rate to remain elevated over the next few years. Claimant count unemployment rate 12 ILO* unemployment rate *International Labour Organisation definition 9 6 3 0 1987 1992 1997 2002 2007 2012 2017 Sources: Capital Economics, Refinitiv, Eurostat and Office for National Statistics. . 9

Business in strict confidence Housing markets in north America tumbled in April Record fall in United States single-family housing starts The shutdown of large parts of the United States meant singlefamily housing starts recorded their largest month-on-month fall on record in April. Total housing starts dropped 30. 2 per cent last month. Both single and multifamily starts saw large month-onmonth declines, of 25. 4 per cent and 40. 5 per cent respectively. At 650, 000 and 241, 000 annualised, single and multi-family starts are at their lowest level since early 2015 and mid-2013, respectively. Compared to February, single-family starts in the Northeast were down 71 per cent in April. The declines in the other regions, where the lockdowns were less severe, are 30 to 35 per cent. But strong fundamentals mean building activity should resume as the country starts to re-open. We expect starts will have recovered to around 900, 000 annualised by the end of the year. With lot and labour shortages still acting as constraints, however, the loss of output in the second quarter will not be made-up. Tumbling rents in Canada a big risk for house prices Rents in major Canadian cities seem to be falling fast. There are several reasons why rents have been quick to fall. Rising unemployment has most affected low-wage earners, who typically rent, and few people will commit to a new property if they are unable to view it in person. Moreover, immigration has all but stopped and the halting of tourism has caused a slump in demand for short-term rentals. The situation looks very concerning in Toronto and Vancouver, which receive the bulk of new arrivals and which have the highest share of short-term rentals. With property investors basing their price expectations on the assumption that rents would instead keep rising strongly, this represents a big risk to house prices. United States single-family housing starts by region, change Feb-20 – April-20, per cent 0 -10 -20 -30 -40 -50 -60 -70 -80 Northeast West South Midwest Rents for two-bedroom units in selected Canadian cities, monthly change, April 2020, per cent Rentals. ca Padmapper 0 -5 -10 -15 -20 Toronto Vancouver Ottawa Montreal Calgary Sources: Capital Economics, Rentals. ca, Padmapper and Census Bureau. 10

Business in strict confidence Japan’s recession to deepen in current quarter as investment collapses Non-residential business investment to collapse Japan’s machinery orders excluding the volatile ships and utilities sectors held up surprisingly well in March, falling by just 0. 4 per cent on the month. That said, excluding some huge one-off orders from the transportation and postal sectors, “core” machinery orders fell ten per cent month-on-month. The decline in orders in March, however, is likely to give way to a collapse in investment across this quarter. The ominous plunge in the more-timely domestic machine tool orders in April suggests “core” machinery orders fell sharply last month. We’re forecasting a huge sixteen per cent quarter-on-quarter fall in business investment in the April to June period. Only part of that is likely to be recovered in the second half of the year. We suspect it will take years before non-residential investment returns to the level it was at before the sales tax hike in October 2019. Q 1 Preliminary 0, 5 0, 0 -0, 8 * Consumption and investment spending et E xp or ts en t* N iv. nm In ve n to. v. . . In es Pr N on - R In ve st R es. C at e . . on s P iv . . -1, 6 D -0, 2 ov er -0, 9 -1, 9 0, 1 0, 0 -0, 1 G -0, 4 Pr The fall in output in the first quarter suggests the spread of the virus had already dealt a significant blow to economic activity in March. We are forecasting a further twelve per cent quarterly fall in gross domestic product in the second quarter. But we think output will only rise by seven per cent quarter-on-quarter in the next quarter as the threat of a third wave of infections and labour market scarring puts the handbrake on the recovery in consumer spending. Q 4 0, 5 0, 0 -0, 5 -1, 0 -1, 5 -2, 0 G According to Monday’s preliminary estimate, Japan’s first quarter gross domestic product fell by 0. 9 per cent quarter-on-quarter, -3. 4 per cent annualised. The 0. 7 per cent quarterly fall in private consumption came on top of a 2. 9 per cent plunge in the final three months of last year following October’s sales tax hike. The fourth quarter decline was driven by the sharpest quarterly fall in services consumption since 1994 when the series was first published. Japan contributions to quarterly gross domestic product growth, percentage points Japan machinery orders and business investment Thousands Economy in recession before full force of corona containment hit Investment in machinery and transport equipment (Yen tr, current prices, Lat. = Q 4, LHS) Core machinery orders (Yen bn, quarterly average, Lat. = Mar. , RHS) 70 1300 1200 60 1100 1000 50 900 800 40 700 30 600 1995 2000 2005 2010 2015 2020 Sources: Capital Economics, Refinitiv and Japan Cabinet Office. 11

Business in strict confidence Gross domestic product forecasts, selected countries Latest forecast for year-on-year change in gross domestic product in 2020, alongside pre-virus forecasts, per cent Forecast as of 22 nd May Pre-crisis forecasts 9 6 3 0 -3 -6 -9 -12 -15 -18 or ld W il Br az o M ex ic S U K U ai n Sp ly ce Ita er m G Fr an an y a di In n pa Ja re a Ko C hi n a n pa Ja re a Ko C hi na * -21 Source: Capital Economics. Note: * China Activity Proxy, not official measure of gross domestic product. 12

Business in strict confidence Gross domestic product forecasts in detail, selected countries – 22 nd May Real economic growth rate, quarter-on-quarter, per cent Forecasts, year-on-year, per cent Revisions since pre-crisis, percentage points Q 1 Q 2 Q 3 Q 4 2020 2021 China* -19. 5 13. 5 7. 0 3. 5 -5. 0 15. 0 -10. 0 Korea -0. 6 -8. 0 5. 8 1. 7 -3. 0 6. 0 -5. 5 3. 5 Japan -0. 9 -12. 0 7. 2 2. 5 -7. 0 5. 0 -6. 8 4. 1 India -6. 2 -4. 5 11. 0 -4. 0 8. 0 -9. 7 1. 5 Germany -2. 2 -11. 0 4. 0 3. 0 -8. 0 4. 5 -8. 2 3. 9 France -5. 8 -20. 0 21. 7 7. 2 -10. 0 7. 5 -10. 8 6. 5 Italy -4. 7 -25. 0 9. 0 7. 5 -18. 0 15. 0 -18. 2 14. 8 Spain -5. 2 -28. 3 24. 5 7. 3 -15. 0 10. 0 -16. 3 8. 5 United Kingdom -2. 0 -23. 0 15. 0 4. 5 -12. 0 10. 0 -13. 0 8. 2 United States -1. 2 -11. 5 4. 8 5. 3 -5. 5 7. 0 -7. 5 4. 6 Mexico -2. 0 -12. 0 5. 0 4. 0 -8. 0 5. 0 -8. 5 3. 0 Brazil -0. 5 -10. 0 3. 0 2. 5 -5. 5 2. 5 -7. 0 0. 7 World -6. 3 -7. 0 3. 8 -6. 0 8. 7 -8. 8 5. 5 Asia Europe Americas Source: Capital Economics Note: * China Activity Proxy, not official measure of gross domestic product. 13

Business in strict confidence Summary of containment measures in place, selected countries Lockdown Summary of containment measures in place Large Schools Borders Social events closed distancing banned Non-essential businesses closed Asia China Korea Japan Singapore India * * * * * * * * * * * * * Europe Germany France Italy Spain Poland United Kingdom Americas United States Mexico Brazil Legend * Indicates partially in place Indicates (largely) not in place Sources: Capital Economics and various agents. 14

Business in strict confidence Contact details Grant Colquhoun Head of Consultancy Grant. Colquhoun@capitaleconomics. com Marie-Louise Deshaires Economist Marielouise. deshaires@capitaleconomics. com 15

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