April 2020 - Monthly Economic Letter
Unprecedented economic measures in a time of crisis
We know that the COVID-19 pandemic is hitting entrepreneurs hard. More than one million Canadians have lost their jobs and 90% of small and medium-sized businesses are experiencing significant negative impacts, according to a BDC survey. In response, the federal government has announced unprecedented measures to help workers and businesses get through the crisis. When the crisis ends, there will be an economic recovery. But for now, the most important things are the health of you and your employees and protecting your business. This letter provides analysis to help you navigate the crisis and describes resources to help your business.
It’s still too early to measure the full extent of the crisis on the Canadian economy. However, the initial shock has been extraordinary with several sectors of activity almost coming to a standstill. It’s just as difficult to determine how long the crisis will last and when the economy will recover. The current recession is unlike any we’ve ever experienced. The slowdown, due to containment measures in Canada and other countries, is faster and more severe than in previous recessions. However, we expect the economic recovery to be faster than those following other major recessions, particularly the one caused by the financial crisis in 2008-09.
Recovery in China
The situation in China may shed some light on how the economic recovery in Canada will unfold. China was the first country to be hit by COVID-19, but also the first to emerge from the crisis. Containment measures had an immediate and severe impact on the Chinese economy. For example, retail sales fell by 20% and manufacturing output by 13%. The initial recovery from the end of containment was strong, especially in the manufacturing sector, which has almost reached its pre-crisis level of activity. However, this initial recovery has given way to a slower pick-up, reflecting continuing caution by Chinese consumers. It will likely take several months for the economy to return to normal.
The Chinese experience could serve as a guide to our recovery. At the end of this period of containment, several sectors should quickly resume their activities, but others will take months to return to normal.
For now, the most important thing is to follow public health directives and work to stabilize your business for the next few months. To help you weather the storm, check out this article on how to sustain your business.
The Canadian government has put in place a series of measures to help Canadian businesses. These include:
- wage subsidies of up to 75%
- interest-free loans up to $40,000
- up to $12.5 million for your cash flow from operations
- BDC working capital loans of up to $2 million
Extraordinary measures that will support the recovery of the economy
It may be hard to imagine today, but the economy will recover. The government support measures will not only help Canadians and businesses get through the next few months but also contribute significantly to the economic recovery. These measures total $200 billion, which represents 10% of Canada’s GDP. Once the period of containment is over, they will help the economy get back on its feet.
Canada's economy in an induced coma
Historically, most recessions have been rooted in the manufacturing sector. However, the two recessions in Canada over the past two decades had a completely different origin. The first began in the financial sector in 2008, while the other was caused by a sharp drop in oil prices in 2014-15.
In 2020, the world is facing a new type of recession, one that began with a sudden stop in all non-essential consumption due to social distancing measures imposed by various governments in Canada and elsewhere around the world. The result has been massive job losses that will increase the magnitude of the economic contraction. What’s more the duration of the crisis is unknown. The only sure thing is that the longer people are confined to their homes, the greater the economic turmoil and liquidity challenges will be for individuals and businesses.
While an economic contraction is expected this year in countries around the world, Canada faces a second major challenge: The collapse of oil prices. A price war unleashed by Saudi Arabia and Russia has sent prices to generational lows and will add to the economic difficulties of oil-producing provinces. Our oil market update looks at the evolution of this situation.
In the midst of the coronavirus crisis, economic projections are difficult to make and are subject to significant revisions from week to week. Economic activity has declined sharply, with the exception of a few sectors such as food and other essential goods, and forecasters agree the contraction will be at an unprecedented rate. Some economists have drawn a parallel with a patient being put into an induced coma in an attempt to save his or her life. What policymakers are trying to avoid at all costs is that this planned economic shutdown leads to a vicious cycle over the longer term with negative effects on investment and business viability.
Canadian entrepreneurs are obviously well aware of the challenges they face. The proportion of entrepreneurs reporting a negative impact of COVID-19 on their operations rose from 39% in mid-March to 90% two weeks later, according to BDC surveys.
If the patient (the Canadian economy) recovers within a reasonable period of time, the economic rebound should be equally impressive. With this goal in mind, various levels of government have announced unprecedented measures in recent weeks to support workers and businesses.
A workforce locked at home
Just a few weeks ago, entrepreneurs were mainly concerned about labour shortages. The tide has never turned so quickly.
With the service sector accounting for nearly 80% of the country's workforce, millions of Canadians are currently not working—especially those who interact with the public. Statistics Canada’s Labour Force Survey for March showed a record number of 413 200 unemployed people were added to the 1.1 million Canadians already out of work on average in 2019, an increase of 36 per cent. Since the survey was conducted during the week of March 16, we can expect another significant jump in job losses due to COVID-19 in April. Indeed, the Canadian government reported that for the period of March 16 to 25, 1.6 million Canadians made new unemployment claims.
Depending on how long the crisis lasts, the unemployed could quickly return to work. However, consumer confidence is likely to be shaken for several months, even in the best of cases.
What does it mean for entrepreneurs?
- This is the challenge of a generation. The key issue is liquidity to survive the crisis. It's imperative to be familiar with the government assistance programs your business may be eligible for in order to navigate these troubled waters.
- In addition to measures offered by the federal government, it's worth checking out what your provincial government is offering.
- In the best of cases, the recovery will begin in the third quarter. However, the situation is evolving rapidly and economic forecasts remain even more tentative than usual. The current battle is first and foremost against the virus and its health effects. We will therefore have to be patient and realistic, but also be ready to take advantage of the desired rebound.
- BDC Chief Economist Pierre Cléroux and Senior Business Advisor Alka Sood recently recorded a webinar, offering our outlook for the economy and tips on how you can best deal with the crisis in your business.
The U.S. economy on the back burner
The longest sequence of net job creation in the U.S. has come to an end. After a string of 113 positive monthly readings that began in September 2010, the U.S. economy posted a loss of 701,000 jobs in March 2020. As an indication of the magnitude of the run that just ended, the previous record was 48 months in the late 1980s.
Economic data will get worse before it gets better
The economic situation is obviously very gloomy. However, the size of the shock still isn’t fully reflected in the employment data. The most recent employment numbers were collected in the week of March 9, well before generalized containment measures were introduced in several of the most populous states.
This is why analysts are paying more attention to the explosion of initial unemployment claims, which are published on a weekly basis. These statistics give us a better idea, in the short term, of the strength of the headwinds facing American consumers and businesses.
Here, new claims for employment insurance increased a remarkable 30-fold to 6.9 million during the week of March 23 (a combined 10 million new claims were also filed the weeks of March 16 and March 30). During the 2008-2009 economic crisis, the peak was reached at 665,000 claims (10% of the rate at the end of March).
Of course, the nature of this economic crisis is different. The 2008-2009 crisis was the result of a financial shock, followed by a slow and painful recovery. The current crisis is characterized by its rapidity and enormous scale but could also be followed by an equally vigorous recovery. Another key difference is that the U.S. consumer is in much better financial position than at the onset of the previous recession, which should allow for a less difficult recovery than the one that began in 2009.
The economic damage caused by this crisis will depend first and foremost on how effectively the pandemic is controlled and the duration of the containment measures. Data from China suggest an upturn is possible within a few months. While the second quarter of 2020 is expected to see the largest contraction in U.S. GDP since the 1940s, the recovery could be just as impressive if businesses hold up well through the current difficult months. That’s why governments around the world have announced massive aid measures for companies.
Confidence as the first signal
It will take several months before the extent of the damage to the economy can be measured. For the time being, we also have consumer confidence and business confidence as thermometers. These are doing a little better than expected at the moment, especially compared to the levels observed in the wake of the 2008-2009 crisis.
The Conference Board’s most recent consumer confidence index, which ended on March 19, showed the largest one-month decline (-12.6) since August 2011, when the government was at an impasse in its renegotiations to raise the national debt ceiling.
According to monthly indicators from the Institute for Supply Management (ISM), companies in the manufacturing and service sectors were not losing hope either. Indeed, the manufacturing indicator showed resilience in the first half of March. While a reading of 49.1 is certainly a decline, it’s similar to the level observed since last summer. As for services, some observers were surprised to see that the indicator remains above 50, which generally denotes an increase in the volume of activity. This interpretation might be misleading due to distortions in a component related to supply chains.
Both monetary and fiscal policy join the fight
The monetary and fiscal authorities have not skimped on pouring resources into the fight. There have been successive decreases in the federal funds rate to the range of 0% to 0.25%, and unprecedented fiscal measures on the part of the central government. The White House and Congress have agreed to more than $2 trillion in fiscal stimulus—equivalent to nearly 10% of U.S. GDP.
There are provisions for large businesses, including airlines ($525 billion), support for small businesses (over $350 billion), direct transfers to households, including an increase in unemployment insurance (over $550 billion), as well as assistance to states, hospitals and certain other measures that will ensure greater liquidity in the markets. The Federal Reserve has also committed to provide the liquidity needed to ensure the smooth functioning of financial markets.
What does it mean for entrepreneurs?
- The saying "when the U.S. sneezes, Canada catches a cold" has never made more sense. A strong U.S. economic recovery is critical to the many Canadian entrepreneurs doing business south of the border.
- Uncertainty surrounding economic projections will continue until we have a better idea of how long it will take for physical distancing measures to be relaxed. In the meantime, it’s critical to manage cash flow needs—many government programs have been announced in recent weeks (see main article).
- Border crossings may remain less fluid even for some time after the end of containment measures.
- Consumer confidence and finances may also be fragile for some time. Depending on your industry, it may be appropriate to lower your volume of activity in the first few quarters after the end of the crisis.
COVID-19 and the price war: The situation one month later
Oil prices have continued to fall since the meeting of OPEC member countries in early March, and Brent and West Texas Intermediate are now down more than 50% since the beginning of the year.
Our last Monthly Economic Letter reported the two main factors behind the significant reduction in oil prices: A reduction in anticipated demand, due to the spread of COVID-19 in China, South Korea, Iran and Italy; and a price war between Russia and Saudi Arabia over the production levels to be maintained in the midst of the pandemic. This article provides an update on developments on these two fronts.
Half of humanity at home
Reaching only a few countries in early March, COVID-19 then rapidly spread across the globe. With nearly four billion people now confined to their homes, half of the world's population, demand for oil by 2020 could decline to levels that were previously unimaginable.
With airplanes grounded, huge numbers working from home and several industries in pause mode, the British consulting firm Capital Economics predicts a 10% drop in oil demand for 2020. Under this scenario, global daily demand would fall from 100 million barrels per day (Mb/d) to 90 Mb/d. Current demand is already 5 Mb/d lower than projected, according to the International Energy Agency, which sees the possibility of a floor of 80 Mb/d in 2020—a level lower than that observed during the last economic crisis.
Uncertainty about the duration of containment measures across OECD countries should limit upward pressure on oil prices for at least the spring period. Therefore, the ball is in the producers' court at least in the short term.
Game of chicken: Who will give in first?
Before a deal over the Easter weekend in which parties agreed to contribute to cuts totaling 10% of global supply, Russia and Saudi Arabia were engaged in a war of attrition in which each side hoped to see their initial conditions accepted. But they had much to lose if the stalemate continued.
Each country hopes to eventually increase their market shares, but current oil prices are still far from sufficient to finance their respective social programs.
In Russia, oil revenues finance about 40% of the national budget, while in Saudi Arabia the ratio is estimated to be at least 60%. The drop in prices in 2020 has meant that Russia—which needs a much lower price than its rival to balance its budget, about $40—is unlikely to balance its budget this year.
The Financial Times reported last month that Russia believes it can handle a price environment below $30 for more than five years. Both it and Saudi Arabia hold large foreign exchange reserves and have relatively low national debt ratios.
While Saudi Arabia needs a price per barrel above $80 to balance its budget, it has a marginal cost of production that is much lower than that of its rivals. This competitive advantage would allow Saudi Arabia to offset its lower margins with higher volumes.
The Easter weekend agreement may prove insufficient to increase prices substantially. However, it should put a floor under current prices because it shows producers can negotiate in light of the collapse in oil demand.
How long before a turnaround?
Before we have a better idea of how long it will take for the oil market to return to some degree of strength, we will first need more certainty about the duration of the COVID-19 containment measures in place. Depending on the evolution of infection curves around the world, we should know more by the end of the month.
More discussions between oil producers may also be needed to limit oversupply, which was already an issue before the price war of early March began.
However, once these problems have been resolved, other factors could limit the extent of the recovery in the oil market.
- Oil-importing countries are building up reserves, which will help to keep prices lower for longer.
- Consumer confidence and savings could be battered for some time, which could have an impact on global tourism, among other things.
- Changes in work habits could accelerate, including less commuting due to teleworking and a reduction in business travel due to the widespread adoption of video conferencing within companies.
The oil market continues to be affected by the collapse in demand caused by COVID-19. The drop in initial demand caused by the virus has exacerbated oversupply already present in the market.
For Canadian producers, this double whammy has pushed the price of Western Canadian Select below $5, well below the cost of production for a barrel and what’s needed for the long-term profitability of producers. It’s expected that production will slow rather than stop altogether, as a shutdown and restart cycle may be too much of a technical risk for many producers.
Floor rates for the Bank of Canada
Following a 0.5 percentage point cut announced on March 4, the Bank of Canada repeated the exercise twice more on March 16 and 27, dropping its key policy rate from 1.75% to 0.25%. In addition to lowering interest rates, the central bank announced a number of measures to ensure well-functioning financial markets.
The loonie's wings have been clipped
In the wake of the drop in oil prices and the U.S. dollar's status as a safe haven in times of crisis, the Canadian dollar was trading at the end of March around US70 cents. On a monthly basis, the exchange rate has not been this weak since April 2003. A resolution of the Russian-Saudi oil price conflict and a flattening of the COVID-19 infection curve will be the first steps in the Canadian dollar’s recovery.
SME confidence shaken
According to the Canadian Federation of Independent Business, business optimism is below levels seen during the 2008-09 financial crisis. At BDC, our most recent surveys show that Canadian entrepreneurs are well aware of the impact of the crisis on their company, with 90% reporting a deterioration in their business conditions (see Canada section). How long before things get back to normal? In 2009, it took eight months to return to the level of optimism that prevailed before the recession. This time, the recovery will depend primarily on the evolution of the pandemic, which is more a matter of public health than economic conditions.
Chinese data at the forefront
Increasing infection rates, physical distancing measures and abrupt shutdown of the economy, followed by a return to (near) normal. This is how the situation is unfolding for countries dealing with COVID-19, with China leading the way (see main article). Monthly data from China will be scrutinized over the next few months to get a better idea of what the future holds, both from a societal and economic perspective. A PMI index above 50 shows an improvement in the situation over the past month. After flirting around this mark throughout 2019, the index fell sharply in February 2020 to 35.7. Then, surprisingly, it rebounded to 51.9 in March. It is important to remain cautious when interpreting this indicator. Even though the index reached an all-time low in February, followed by a slight improvement in March, this does not mean the economy has returned to its normal pace. As mentioned in the main article, activity has certainly picked up, but at a pace that remains far below normal.