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Coronavirus likely to push Eurozone economy into recession

Economic Quarterly Report

  • The coronavirus outbreak has led us to reduce our growth projection for the global economy to 1.6% y/y in 2020 (see: Global Economic Outlook: COVID-19 has taken a hold of the global economy)
  • We now expect the virus outbreak to pull the Eurozone into a recession as well
  • The Eurozone economy is projected to shrink with 0.1%, with negative growth in the first half of the year, followed by a mild recovery later in the year. A worse-case scenario is now definitely thinkable as well
  • There are several channels through which the corona-shock will hurt the economy; we look at a number of these channels by way of a ‘heatmap’
  • For member states such as Italy and Germany the impact is likely to be bigger than for some other member states
  • Inflation is likely to be volatile as supply and demand shocks work in opposite and asynchronous ways, but ultimately we expect downward pressure on inflation to prevail
  • Monetary and fiscal policy makers are working on measures to ease pressure on the economy. While measures are unlikely to prevent a recession, especially targeted measures for cash-strapped households and businesses can help to alleviate the immediate economic damage from this shock and prevent the situation from deteriorating quickly
  • Furthermore, measures can help the economy in the recovery phase
  • International coordination is slowly picking up, especially in the EU. Although it still mostly comes down to national governments to tackle the crisis

COVID-19 has now arrived in Europe

Figure 1: Eurodemic? - Number of confirmed COVID-19 cases (log-scale)
Figure 1: Eurodemic? - Number of confirmed COVID-19 cases (log-scale)Source: Johns Hopkins

No longer can Europe argue that it remains insulated from the COVID-19 virus that has been spreading from China into Asia and, by now, many other places around the globe. The sharp rise in the number of cases reported in Italy since the weekend of 22 February (figure 1) was the factor that has set-off one of the sharpest equity market routs in modern history – with the Eurostoxx 50 index shedding more than 25% since its peak on 19 February. Meanwhile, global bond yields have been pulled back towards historic lows, whilst rising credit and sovereign spreads show that investors’ concerns about a global recession have returned with a vengeance.

Whether we will see a similar spread in other Eurozone member states as we have seen in Italy still remains in doubt – and for now we are not yet assuming that as a base scenario. However, there can be absolutely no doubt that COVID-19’s here and that its impact will be felt in many ways as both sentiment and precautionary measures have already started to dent domestic activity. This comes on top of the economic shock stemming from Asia, China in particular.

Will a Eurozone recession finally arrive?

The shock couldn’t have come at a worse time. Although Q4 GDP growth actually disappointed with a meagre 0.1% gain (partly due to transitory factors), several indicators for the Eurozone economy had only just started to show hopeful signs in the final months of last year. Even though the industrial and export sector had been through two difficult years, the domestic economy had held up relatively well (see figures 2 and 3). Combined with the ‘upbeat’ news regarding the US-China trade deal, this had supported our view that the Eurozone would still be able to skid recession, despite our projection of a US recession in the second half of 2020.

Figure 2: Industrial sector sentiment has deteriorated the most since early 2018
Figure 2: Industrial sector sentiment has deteriorated the most since early 2018Source: Macrobond, RaboResearch
Figure 3: GDP growth continued to slow down in the final quarter of 2019
Figure 3: GDP growth continued to slow down in the final quarter of 2019Source: Macrobond, RaboResearch

However, things have changed quickly and we believe that the question of whether the Eurozone recession has finally arrived should now be answered by a “yes”.

Therefore, we now project Eurozone growth to shrink with 0.1% in 2020 (down from 1% previously). This is based on the assumption that the spread of COVID-19 and its containment measures do not follow the same pattern of fierceness as we saw in China. So even though we have clearly moved away from the ‘Bad’ scenario to our ‘Worse’ or even ‘Ugly’ scenario as explained here, we assume that the economic fall-out will not reach the one described in those scenarios. That also means that there is still downside risk to our projection[1].

There are several layers in how the spread of COVID-19 will affect the Eurozone economy. The first layer is purely linked to the spread of the virus itself (so to what extent it spreads to other countries etc.), the second is the economic impact (both domestically and from abroad) and the third is the policy response or containment measures. And these layers are interlinked (figure 4).

Figure 4: Many interactions that can either aggravate or attenuate the economic impact
Figure 4: Many interactions that can either aggravate or attenuate the economic impactSource: RaboResearch

Indeed, the response by the general public in the Eurozone and less aggressive containment measures by the governments and businesses are likely to make for an entirely different outcome than in China, where the economy virtually came to a standstill in February. But the risk of a slow normalization of activity after the dip in the first half of this year is significant as well. In the next paragraph we look at some of the issues in more detail.

A combined supply- and demand shock

The challenge for the Eurozone economy is that businesses are faced with a supply- and demand shock at the same time.

As output in China falls sharply, the import of Chinese consumer goods and semi-finished goods is hampered. So far, European businesses are mostly experiencing supply chain disruptions directly or indirectly caused by China[2]. In these supply-chains or Global Value Chains it is the weakest link that determines the strength of the whole chain. Although the growth of GVC’s has slowed since 2013, their complexity has likely increased.

Meanwhile, demand suffers as well. The lockdown of a substantial part of China and a slowdown in growth of the Chinese economy in general leads to lower Chinese demand for German capital goods and cars, for example. At the same time, the outbreak of the virus in Europe is leading to cutbacks in ‘non-essential’ business travel, holiday-breaks and events. Moreover, as the financial market reaction swells, households may postpone purchases of durable consumer goods.

Moreover, the more containment measures come into force within Eurozone countries, the more ‘domestic’ supply will also slowly be reduced. For now this effect is mostly visible in Italy, but it is unlikely to be confined to this member state.

Headline PMI surveys for January-February suggest the economy still has little to worry about, but rising delivery times (which push up the index) were not caused by rapidly increasing demand (which usually is the case), but by supply chain disruptions. Moreover the surveys were held prior to the rapid surge in confirmed cases in Europe. In other words, the picture emerging from the March survey is expected to look very different.

Shock absorbing capacity

Obviously, financial factors are also important as they can both attenuate as well as aggravate the situation. For the Eurozone as a whole, non-financial corporations have a lot more cash on their balance sheets when compared to 2008 (figure 5). Their debt-service ratios have generally improved as well.

This means that, generally speaking, businesses are in a good position to deal with temporary cash flow issues stemming from disruptions in trade and/or their supply chains.

As such, the risk of financial factors aggravating this COVID-19 shock is likely to be less than in 2008/’09. However, the distribution of liquidity (with large corporates likely to have bigger buffers) and the duration of the supply-chain disruptions will also play a key role.

Apart from this shock-absorbing capacity, we should also take into account the room that fiscal and monetary policy have to mitigate the COVID-19 impact. We do this in a separate section at the end of this publication.

Figure 5: Aggregate cash positions are strong: currency and deposits as % of GDP
Figure 5: Aggregate cash positions are strong: currency and deposits as % of GDPSource: Macrobond, RaboResearch
Figure 6: Interest paid as % of (disposable/operating) income
Figure 6: Interest paid as % of (disposable/operating) incomeSource: Macrobond, RaboResearch

All things considered, we believe that the COVID-19 spread is the proverbial straw that will break the camel’s back and pull the Eurozone economy into a recession.

We have penciled in a contraction in the first half of the year and then a gradual return to positive growth in the second half of 2020 in our base scenario. For the year as a whole we are now projecting a contraction of 0.1% growth (table 1) a 1.1%-pts reduction from our previous forecast.

As the COVID-19 spread tapers off in the second half of 2020 and containment measures are lifted, growth in 2021 is expected to be a bit stronger than previously projected. But growth will be tempered by the US recession in 2020 and a ‘tough’ Brexit at the start of 2021.

Our calculations suggest that Eurozone growth could easily fall below -0.5% in a full pandemic scenario (figure 7) (see also: Global Economic Outlook: COVID-19 has taken a hold of the global economy).

In the next paragraph we zoom in on the likely sensitivity of several Eurozone member states to the spreading of COVID-19.

Table 1: Base scenario Eurozone
Table 1: Base scenario EurozoneNote: Cut-off date forecast is 11 March
Source: RaboResearch
Figure 7: Things could be significantly worse… GDP growth simulations
Figure 7: Things could be significantly worse… GDP growth simulationsSource: RaboResearch, NiGEM

COVID-19 sensitivity heatmaps

In the following heatmaps we look at a number of indicators that provide a gauge of the sensitivity of member states to the COVID-19 shock. We look at this from three different angles (see figure 8):

  • The exposure of the economy to both external demand and imports from China; including exposure to supply-chains in which China is integrated
  • The sensitivity to a global slowdown and less tourism activity on the back of a domestic outbreak. In short, vulnerability of the economy beyond its exposure to China
  • Demographics, the healthcare system and the economy’s shock-absorbing capacity, as factors that could dampen or amplify the Covid-19 shock

Exposure to China

So first we look at how sensitive countries are to the shock stemming from China itself. Some member states’ export sectors depend heavily on Chinese demand whilst others depend more on imports from China, which have been disrupted by the large outages in China’s affected areas. But also supply-chain disruptions are likely to be a distinguishing factor. Not only direct trade with China is affected, but also imports from other countries, which in turn depend on inputs from China for example. The latter is harder to gauge, however.

Figure 8: Degree of impact determined by…*
Figure 8: Degree of impact determined by…* *) In absence of policy response
Source: Rabobank

To assess export dependence on China, we look at the value added that is created in a country and that ultimately ends up in China’s final demand. This could happen via direct trade between a country and China but also via the delivery of inputs to a country that processes them for export to China.

For example, the car part that is produced in the Netherlands and exported to Germany, to be used in a car that is exported to China. From the first row in table 2 we can see that the German economy is much more vulnerable to a slowdown in Chinese demand than other Eurozone countries, although also in Finland and Austria nearly 2% of their total value added ends up in China.

Another key source of direct export income is coming from Chinese tourists. Tourist accommodations in Austria and Italy receive many Chinese travelers, which, given the substantial contribution of this sector to these countries’ overall GDP, means that these economies will likely be relatively hard hit by the effective stop of Chinese travelers since the beginning of this year (row 2 in table 2).[3]

The third and fourth row of table 2 shed some light on countries’ relative exposure to supply shocks originating in China. It shows countries’ dependence on both Chinese inputs in their manufacturing industry and final goods. Again, Germany is among the most exposed only to be superseded by France due to the latter’s dependence on Chinese industry inputs. What is interesting is that whereas Spain relies relatively little on China for its exports, it seems relatively vulnerable to a supply side shock originating in China.

Getting a complete picture of countries’ vulnerability to the supply side shock originating in China is a challenge in this exercise due to the existence of international supply chains.

Table 2: Germany and Austria most vulnerable to the combined demand and supply shock in China
Table 2: Germany and Austria most vulnerable to the combined demand and supply shock in ChinaSource: Macrobond, OECD, IMF, RaboResearch

As a proxy we have combined trade to GDP with the size of the manufacturing sector in the economy (row 5). The thinking here is that both the manufacturing sector in general and a large open economy are more heavily integrated in international supply chains. This proxy also serves to show countries’ vulnerability to the risk of a supply shock originating in other countries due to quarantine and containment measures.

This indicator shows that Belgium, Austria, Germany and the Netherlands are much more exposed to international supply chain disruptions than other countries. Obviously, this indicator is not more than an incomplete and imprecise proxy.

Exposure beyond China

In the second place we look at how sensitive member states are to falling international travel due to travel bans and fear of travelers catching the virus and to the global trade slowdown fueled by the economic slowdown in China. If we assume that all member states are affected more or less in the same way in terms of the spread of the virus, we should conclude that member states such as Greece and Portugal, which depend more heavily on tourism, are more exposed. This is shown in table 3 (first column).[4] Clearly, tourism in Italy at this point is more heavily impacted and that will not change if it remains to be the country with the most severe domestic outbreak.

To gauge countries’ exposure to the expected global trade slowdown, we look at countries’ domestic value added in their exports relative to total value added in the country: Belgium, Austria, the Netherlands and Germany are most vulnerable from this perspective.

Table 3: Exposure beyond China
Table 3: Exposure beyond ChinaSource: Macrobond, OECD, WTTC, RaboResearch
Table 4: Demography and healthcare risks
Table 4: Demography and healthcare risksSource: Euro Health Consumer Index, Macrobond, World Bank, RaboResearch

Demographics and healthcare

In addition, we could argue that, given the nature of the virus, economies with a higher share of elderly people are more at risk of an outbreak over-burdening the country’s healthcare system. So the ‘interaction’ of that share and the quality of the health care system and number of beds per capita is likely to be key should the spread of the virus turn into a true Eurodemic. For the quality of the healthcare system we use the Euro Health Consumer Index, which scores countries on a wide set of indicators, from waiting time to expertise of doctors.

Table 4 shows that in Italy and Portugal a higher share of people is at risk of getting sick because of COVID-19, while Italy, Greece and Spain have relatively weaker health care systems than their Northern Eurozone peers.[5] Greece clearly is at the bottom of the European ranking, while Italy and Spain are just below average. Important to note is that regional differences are large in Spain and Italy. Health care in the North of Italy, for example, compares with that in Northern Eurozone peers, while it performs poorly in the South. Also when looking at the number of beds available, Northern Eurozone member states generally seem to be in a better position to deal with a large COVID-19 outbreak. This highlights the key role for containment.

Shock absorbing capacity of businesses

As discussed above, financial factors can both attenuate as well as aggravate the economic shock stemming from the virus outbreak. Without government or central bank support, companies with lower debt, higher cash buffers and a high profit share are likely to be more resilient in case of a fall in both external and domestic demand.

To assess the shock-absorbing capacity of non-financial corporations we look the following indicators in table 5 below:

  • The amount of cash and deposits as a percentage of income (column 1)
  • The interest coverage ratio, i.e. income over interest payments; where it is often assumed that a level below 2 is an indication that a business is in trouble (column 2)
  • The profit share, i.e. income as a percentage of value added; as an indicator of ‘room’ to temporarily adjust profit margins without losing market share (column 3)
Table 5: Financial shock-absorbing capacity
Table 5: Financial shock-absorbing capacitySource: Macrobond, RaboResearch

The heatmap in table 5 shows that non-financial corporates in Austria, Spain and the Netherlands seem to be more resilient to temporary shocks to liquidity. While Austrian firms have relatively less cash, they also have little interest obligations a relatively large profit share. Dutch companies have much cash, but also large debt (obligations). In France companies also combine much cash with a relatively low interest coverage ratio. On top of that the profit share of French companies is relatively small.[6]

Given the relatively high heterogeneity between financial shock absorption indicators, we would caution against drawing strong conclusions from the ranking within this heatmap.

To sum up

There is quite some heterogeneity among member states when looking at how vulnerable their economies are to the outbreak of COVID-19. Among the larger Eurozone member states, the German and Austrian economies appear to be most exposed to the combined demand and supply shock in China. They are also relatively exposed to a global trade slowdown and supply chain disruptions. The tourism sector is a potential weak spot for the Austrian economy as well. On average, Austrian and German firms also seem to have relatively less cash to mitigate a liquidity shock stemming from a temporary reduction in income. Although it helps that they have a very high interest coverage ratio.

Spain and France are relatively vulnerable to the supply shock originating in China, but less so to the demand shock. An additional challenge for Spain is its substantial dependence on tourism income. Italy is relatively less exposed to disruptions in goods trade with China, although industrial inputs from China are essential to some parts of its industry. Clearly, Italy differs from the others in that it has to deal with a large domestic outbreak. This will make for a large impact on its substantial tourism sector and domestic activity in general. And while on average cash positions of companies look rather healthy, profit margins have been contracting for some years now and balance sheets of SMEs are generally weaker.

For the Netherlands and Belgium the global economic slowdown and supply chain disruptions seem to be the weakest spots. In both countries, the healthy cash position of companies is accompanied by high debt and interest obligations, making it a bit difficult to get a clear picture of companies’ ability to absorb a temporary fall in cash flow.

Inflation impact: down, up and down again?

Given that this COVID-19 crisis is both a sequence of supply and demand shocks, the impact on inflation is even harder to gauge. Our best guess is that inflation is likely to be volatile as supply and demand shocks work in opposite and asynchronous ways, but ultimately we expect downward pressure on inflation to prevail. In the very near-term the sharp decline in oil and other commodity prices is likely to depress headline inflation (see figure 9). The same goes for travel and holiday prices. A glance on current airline ticket prices supports that point.

In contrast, import and supply chain disruptions could lead to temporary price hikes in goods that are difficult to obtain and/or where inventory levels are low. Household goods and electronic devices are examples here. This may lead to some upward price pressures on certain items, especially if China’s economic recovery remains slow because of virus concerns.

However, as the Eurozone economy slows down further, the output gap declines and labour markets deteriorate, wage growth and core inflation are likely to slow down as well. Corporate profit margins have been under pressure already since 2018. 

As such, downward forces on inflation are likely to exceed the upward pressures. This is clearly what market participants have in mind, as the 5y/5y inflation swap forward has sunk below 1%, its lowest level since measurement began. Although this indicator is sensitive to risk-off sentiment in markets, the closing of the gap with actual core inflation is striking (figure 10).

Figure 9: If oil prices stay at current levels, headline inflation is likely to fall further
Figure 9: If oil prices stay at current levels, headline inflation is likely to fall furtherSource: Macrobond
Figure 10: Inflation expectations hitting fresh record-low
Figure 10: Inflation expectations hitting fresh record-lowSource: Macrobond, Bloomberg

What about the policy response?

The ECB’s standard toolkit is mainly aimed at demand-side shocks to the economy, and these instruments are not very effective when companies are being hit by disruptions to their supply chains. After all, if companies have no inventory to sell, the ECB can boost demand all they want but that won’t actually boost the economy. Moreover, the longer such supply chain disruptions persist, the more companies will face cash flow issues. Similar thinking would also apply to budgetary stimulus by the government, especially if it is ‘just’ a tax cut or some other blunt instrument to revive demand. At best such a response would support confidence and/or speed-up the recovery once the virus threat subsides, although for certain cash-strapped households that are directly hit in their income by the virus-fallout, such as the self-employed, direct financial government support could still prove helpful.

ECB: No rate cuts, but ‘targeted measures’

On 12 March, the ECB announced that it will keep interest rates unchanged, but will scale up asset purchases remains an option and introduce some new TLTROs, to keep liquidity available to companies that will face temporary cash flow issues due to COVID-19, e.g. through supply chain disruptions. As we highlighted above, the liquidity position of companies is better now than it was during the global financial crisis, but this is measured in aggregate and especially SMEs may have lower cash buffers.

Government interventions, options?

With monetary policy arguably being a blunt instrument and limited in both effectiveness and scope, we are likely to see further pressure on governments and international bodies to intervene.

10 March the European Council announced several EU wide support measures. There will be an investment fund of 25 billion for research, health care and support to companies that face liquidity constraints. And rules for state aid will temporarily be made more flexible. Furthermore, the EU has formed a coronavirus response team and the European Commission is urged to facilitate member states’ access to ‘personal protective equipment’ and medical equipment and to protect the functioning of the internal market. These measures are a step towards a more coordinated approach in the EU. Yet for now, national government remain the main responsible for support measures in their own country. 

Although the room for fiscal maneuver in the Eurozone remains constrained by the relatively strict debt and deficit rules, the Stability and Growth Pact leaves quite a bit of flexibility in the case of an adverse shock caused by external factors. The European Council confirmed that there is a need to be flexible with the rules at the moment.

That does not take away from the fact that some member states have more room to act than others and as such ‘fiscal space’ can still be an impediment to the construction of a support package that is required to stave off a deeper recession. The chart[7] below underscores that this fiscal space is much more significant in Germany, Austria and the Netherlands than in Italy, Spain, France and Portugal. The latter member states therefore remain at risk of market volatility (read: higher risk premiums) which only underscores the need for a coordinated response.

Table 6: Fiscal space heatmap 2019/2020**
Table 6: Fiscal space heatmap 2019/2020***) Or government bond spread over Germany + German CDS
**) Gap between MTO (2019) and structural balance (2020), all other variables 2019
Source: Rabobank

Getting concrete!

Step by step European governments are announcing measures to fight the economic impact of the virus. Italy has been among the first. So far it has pledged a EUR 25bn support package, which according to government sources will lead to a deficit over 3% of GDP this year. The size of the planned package has already been revised upwards several times, in line with the enlargement of quarantine and containment measures. Upon time of writing (11 March), some measures are still being discussed, but the government has already announced that the package will consist of the deferral of tax, utility and loan payments for hard-hit companies and households. Furthermore, it will increase financial resources for the wage supplementation fundand guaranty emergency loans to firms with liquidity problems. There will also be additional funding for the health-care sector and security.

Meanwhile, French economy minister Bruno Le Marie has said that if companies are not able to fulfill their contractual obligations towards SMEs, companies can declare a force majeure. Which essentially means these companies would enjoy some legal protection for breaking the contract. In the Netherlands companies that expect to have at least 20% less work in the next 2 to 24 weeks can ask the government for a compensation of part of the hours employees work less. This arrangement is not entirely new. It exists for exceptional circumstances outside of the control of a business. And now the coronavirus has been labeled as such an event. The government is also introducing a scheme via which companies that need an emergency loan can ask the government to guarantee that loan. The German government has announced it will provide financial support to companies that face liquidity constraints due to COVID-19, ease the rules for companies to temporarily lower working hours for employees, and invest 16 billion euro in the coming four years, financed from the surplus of 2019. And finally, the government in Spain is also preparing a package of measures to mitigate the negative economic impact in the tourism sector and other sectors they think will be hart hit. Details are yet to be presented.

What about real intervention?

Despite a lack of details so far, it seems governments are now aware that targeted measures are needed. While they may not prevent a crisis, such targeted measures could help prevent the cascade effect of liquidity-constrained households or businesses halting spending and leading to further demand destruction. Furthermore they can help the recovery ones the supply side shock and quarantine measures have receded.

Another potential array policymakers will be looking at if the outbreak gets worse is that of non-financial measures. Admittedly, this is potentially a broad array of things, but we believe it cannot be excluded as we explored in this piece. We have already seen the state impose lockdowns in various regions of various countries, and/or international travel bans totally at odds with traditional freedom of movement: more seem very likely.

If the virus outbreak gets worse, one could easily imagine the government acting even more significantly via price controls or rationing of key goods, or by compelling companies to act in certain ways. Temporary nationalizations may even be required. In fact, the German and French government have already forbidden the export of medical supplies, In addition, France has capped the price of antibacterial hand gels.

Financially, given the huge blow that airlines and other service-sector firms are likely to suffer, we are also likely to see state aid and/or bailouts to key firms. Especially since EU heads of state have argued for less strict regulation of state-aid.


[1] A downward adjustment of around 1.6%-points instead of 0.8%-points would seem warranted in case we would see an ‘uncontrolled’ spread of COVID-19 in the Eurozone. This scenario will be explored in a forthcoming piece.

[2] China plays a significant role in ‘forward’ Global Value Chains for European companies (such as in Germany) and in ‘backward’ GVC’s for Asian companies (such as in Vietnam).

[3] The higher the Z-score, the more a country is exposed to supply and demand shocks originating in China

[4] The higher the Z-score, the more a country is at risk of an economic slowdown due to demand shocks originating outside of China

[5] The higher the score in the healthcare index (column 2), the better. As a reference, the weakest performer in the health care index is Albania with 544 points. The best performer is Switzerland with 893 points. The higher the Z-score the more vulnerable a country to a domestic outbreak based on the age of the population and quality of health care.

[6] A higher Z-score suggests a higher shock-absorbing capacity at non-financial corporations. Yet heterogeneity among the indicators troubles a comparison only based on the z-score. Furthermore, more indicators could be taken into account, but we think these provide a good overview. 

[7] This is an updated version of our fiscal space heatmap created and explained in more detail in a piece we published in June last year.

Elwin de Groot
RaboResearch Global Economics & Markets Rabobank KEO
+31 6 1389 2916
Maartje Wijffelaars
RaboResearch Global Economics & Markets Rabobank KEO
+31 6 2257 0569

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