How will economies trace their recovery pathways in the wake of Covid-19?

The key epidemiological data about the pandemic points to important, shared trends across countries, amid major differences in national experiences. The pandemic has followed an exponential trajectory – although at very different rates around the world. It is also clear that lockdowns have ‘flattened the curve’ of infections and fatalities in most major economies.

So far, then, it seems a bad situation has improved. However, it seems unlikely that the pandemic’s steep rise will be followed by a peak and then a sudden and exponential decline in most countries. Indeed, while China’s data shows a sharp fall in cases and deaths, every other country seems to have experienced a plateau, then a gradual declining trend with ups and downs. Several Asian countries have even experienced secondary waves. Such epidemiological factors in turn may well slow the economic recovery.

The good news is that the available information all suggests that most developed markets (DMs) should be able to withstand moderate secondary waves – assuming the virus does not mutate significantly and that other major new facts do not come to light. Now that the first wave seems to be passing, there are reasons to think that capacity has been improved for personal protective equipment, testing, hospitals, and ventilators. All these factors suggest that a secondary wave should be lower and more manageable than the first.

The not-so-good news is that the situation in many emerging markets (EMs) remains much more challenging. Testing, hospitalisation, and fiscal capacity are all significantly more constrained in most EMs compared to DMs, and the buildup of surge capacity for potential secondary waves is also more constrained. With greater congestion in urban areas and large extended-family households in rural areas, public health policy, social distancing and fiscal support are unlikely to improve these factors in any timeframe to help deal with the pandemic.

That said, some EMs, such as India, South Africa and most of Africa and South Asia, have much younger average age structures and smaller cohorts of the elderly vulnerable. Fatality rates should prove significantly lower than in many DM countries.

Epidemiological ‘scenario uncertainty’ persists. Different models argue for different policies: those predicated on rapid spread and potentially high fatalities, called for very strict lockdowns initially and for partial lockdowns in case of second waves. Competing models, based on earlier start dates, wider spread and lower fatality rates, suggest isolating vulnerable groups while allowing for general normalisation.

THE ‘GREAT COMPRESSION’
The lockdowns have precipitated a global ‘great compression’ of economic activity – a deliberate public policy choice to sacrifice growth, national income, private wealth and public debt ratios for public health, as a large, upfront, societal life insurance premium.

This compression is thus very different from the recession, precipitated by a financial crisis and contained by fiscal and monetary easing; it is also very different from the great depression – the result of the opposite policy choices, to allow financial crises to cascade, not to loosen policy, even to tighten it at times.

Were these extraordinary measures worth it? Probably too early to say. But we have made progress in testing, treatment and capacity, which should help us absorb future waves much better than the first wave of Covid-19. This progress suggests that future, ‘adaptive lockdowns’ will very probably not need to be nearly as severe as the first effort.

Lockdown stringency has diverged across countries. The more stringent the lockdowns, the steeper the decline in activity over the course of Q1 – confirming the nature of the downturn as a great compression. As the lockdowns are released, some, but not all, of this effect is likely to reverse.

Scientific understanding and the containment of Covid-19 seems to have progressed enough for lockdown relaxation despite clear and present risks and incomplete information. Implications and uncertainties rising from variations in testing rates and results may weigh on the speed and extent of the recovery as lockdowns are relaxed.

Looking forward, then, based on our central expectation of gradual, partial, sectoral and regional reopening with downside risks of moderate secondary waves, we would expect the path of GDP to look like what we call a ‘square-root’ recovery – a sharp downturn, almost freefall in activity, stabilised by fiscal and monetary support and the need to sustain basic needs; a limited release in pent-up demand; and a levelling off given the constraints to complete or synchronised reopening.

While the widely shared public health policy of lockdowns caused a rapid, deliberate and largely synchronised compression in economic activity starting in Q1 into Q2, the reopening will not be like flipping a switch back “on” – it will be gradual and uneven, taking time to gain traction (all the more so if there are differentiated second waves).

We expect continued differentiated performance across economies and asset classes during the recovery.

Arnab Das is the global market strategist, EMEA at Invesco