Coronavirus is killing people, economies alike
Adnan Shafi
The coronavirus outbreak, which originated in China, has infected lakhs of people around the globe. Its spread has left businesses around the world counting costs.
Big shifts in stock markets, where shares in companies are bought and sold, can affect many investments in pensions or individual savings accounts. Investors fear the spread of the coronavirus will destroy economic growth and that government action may not be enough to stop the decline.
In response, central banks in many countries, including the United Kingdom, have slashed interest rates. That should, in theory, make borrowing cheaper and encourage spending to boost the economy.
Global markets did also recover some ground after the US Senate passed a $2 trillion (£1.7tn) coronavirus aid bill to help workers and businesses. But some analysts have warned that they could be volatile until the pandemic is contained. In the United States, the number of people filing for unemployment hit a record high, signaling an end to a decade of expansion for one of the world’s largest economies.
The travel industry has been badly damaged, with airlines cutting flights and tourists cancelling business trips and holidays. Governments around the world have introduced travel restrictions to try to contain the virus.
Supermarkets and online delivery services have reported a huge growth in demand as customers stockpile goods such as toilet paper, rice and orange juice as the pandemic escalates.
In order to stop the spread of the Covid-19 outbreak, many countries across the world have started implementing very tough measures. Countries and world capital have been put under strict lockdown, bringing a total halt to major industrial production chains.
In China, where the coronavirus first appeared, industrial production, sales and investment all fell in the first two months of the year, compared with the same period in 2019. China makes up a third of manufacturing globally, and is the world’s largest exporter of goods.
From an economic perspective, the key issue is not just the number of cases of COVID-19, but the level of disruption to economies from containment measures,
Widespread lockdowns such as those imposed by China have been enacted in some virus hotspots, adding that such measures — if taken disproportionately — could induce panic and weaken the global economy even more.
Fears of the coronavirus impact on the global economy have rocked markets worldwide, plunging stock prices and bond yields. China’s gross domestic product growth saw the largest downgrade in terms of magnitude, according to the report. The Asian economic giant is expected to grow by 4.9% this year, slower than the earlier forecast of 5.7%.
Meanwhile, the global economy is expected to grow by 2.4% in 2020 — down from the 2.9% projected earlier. China is not the only country where the services sector has weakened. The services sector in the U.S., the world’s largest consumer market, also contracted in February, which compiles the monthly PMI data.
One reason behind the US services contraction was a reduction in “new business from abroad as customers held back from placing orders amid global economic uncertainty and the coronavirus outbreak.
China, the epicenter of the coronavirus outbreak, is the world’s largest crude oil importer.
The spread of the virus in Italy and other parts of Europe is particularly worrying and will likely dampen demand in OECD countries as well.
Fear surrounding the impact of COVID-19 on the global economy has hurt investor sentiment and brought down stock prices in major markets.
Concerns over the global spread of the new coronavirus has also driven investors to bid up bond prices, resulting in yields in major economies to inch lower. US Treasuries which are backed by the American government are considered safe haven assets that investors tend to flee to in times of market volatility and uncertainty.
Yields on all of the U.S. Treasury contracts fell below 1% in the past week — a development not seen before. The benchmark 10-year contract also touched its historic low of around 0.3%. There is no longer doubt that the longest global expansion on record will end this quarter. We now think that the COVID-19 shock will produce a global recession.
The coronavirus outbreak is a large and unexpected supply and demand shock both for the Chinese and global economy, given the important role China now plays in global growth. China now accounts for around 17% of global GDP, compared to only 4% in 2003 at the time of the SARS episode. In 2003, China accounted for less than 4% of global tourist spending compared to just under 20% at present. In the U.S., the list of affected activities is already long and includes the cancelation or suspension of major U.S. sports leagues and the closure of Broadway theaters.
Overall, we think the consumer spending categories that are most at risk of virus-related disruptions account for around 7% of GDP. We assume activity in this group falls to 63% of normal activity in March, followed by 25% in April, 63% in May, and fully recovers to 100% of normal activity in June.
The impact from the shutdown is in addition to the other canceled sailings year-to-date. This has taken place mostly in Asia and worth 6-8% of pre-virus earnings before interest, tax, depreciation and amortization (EBITDA) and due to ongoing damage to future sailings from increased cancelations and a sharp drop-off in bookings activity.
This hit to earnings is severe, even when compared to the impact September 11th had on the industry. Cruise bookings declined around 40-50% in the immediate aftermath of 9/11 and normalized after 2-3 months, leaving a hole in the region of 5% net revenue yields over the next 12 months; a move that impacted industry EBITDA by around 12.5% according to J.P. Morgan estimates. By comparison, the Global Financial Crisis impacted net yields in 2009 by around 10%, but the sensitivity here is not linear and operators will start cutting when net yields breach below 5%.
We don’t see the cruise lines tripping debt covenants anytime soon, but a cash shortfall becomes a greater risk as the shutdown persists later into the year. Taking into account recently announced financing actions and the latest capital expenditure (capex) plans, the team estimates Royal Caribbean and Norwegian would have to lose 70% and 65% of pre-virus EBITDA, respectively, before there would be a cash shortfall in 2020. This assumes flat working capital, an increasingly optimistic case, given the large deferred revenue liability in the form of customer deposits, which could become a significant drag and depends on how many customers choose to rebook at a later date (and take the incentives, in the form of extra cruise credits) or opt for a full refund.
KV Network
