Covid has caused a recession
- New Zealand’s inevitable recession officially started in the first quarter. The starting point was worse than expected. And the largest contraction has yet to be recorded. But we are bouncing back.
- More targeted policy is still required from the Government and RBNZ to lessen the impact.
Our economic activity contracted by more than we expected in the first quarter. The Kiwi economy recorded a -1.6%qoq fall in output, (Kiwibank and consensus -1%) the worst in 30-years. And that’s before the severe contraction we’re going to record in the current quarter. We believe we will see a massive contraction of around -18%qoq in the June quarter. Annual economic growth came in at a worse than expected -0.2%yoy (consensus +0.2%). The service sectors were hit hard with border and travel restrictions. Manufacturing and construction were hit as non-essential services were shuttered in level 4. Forestry was severely impacted by early closures of Chinese ports, and a global supply glut. The dairy industry was also hampered by the drought. There wasn’t much in the way of positive, or even less negative news in the numbers. We’re more focussed on the damage done during the second quarter. And we’re starting from a weaker base. Although there are signs that the bounce back into the third quarter is well and truly underway.
GDP per capita declined 2.2%qoq, as the economy shrank while population growth jumped. Leading into the lockdown we saw a spike in Kiwi arrivals, and a sharp decline in Kiwis headed offshore. Our terms of trade also decline in the first quarter, as export prices weakened.
Cleary Covid-19 caused
The fall in activity is of course Covid-19 related. The damage wrought by Covid-19 on Q1 activity was widespread across industries. Service sectors (representing two thirds of the economy) were hit hardest by measures to protect NZ from the virus. Border restrictions were successively tightened over the quarter and NZ experienced six days at alert-level 4 at the end of March. Tourism and travel related services experienced the biggest contraction among service industries. Fewer foreign tourists arrived in NZ, and kiwis shied away from moving around the country moved closer to lockdown. Transport, retail and accommodation, and arts and recreation services contracted 5.2%, 2.2%, and 2.2% in Q1 respectively.
All goods producing industries recorded falls in output as factories and construction sites were shuddered and non-essential activity halted. Construction activity fell 4.1%qoq and was 5% lower compared to March 2019. Primary production managed a 1%qoq fall. The drought in the north of the country wiped 0.3% off dairy production at the start of 2020. And forestry and logging activity was hammered – down 5.2%qoq – by port closures in China as the country responded to the virus. Forestry activity was already waning, with a global supply glut sapping the strength out of world prices.
Households spend up large on essentials, but not much else
Expenditure GDP contracted by -1.4% in the quarter. Household spending was clearly soft, with a reading of -0.3%qoq. Business investment too was weak at -2.2%qoq. The March numbers are ugly. And it’s only the beginning. For 50 days we were forced to spend only on essentials. Kiwibank transaction data show that spending on groceries grew from 20% to ~30-40% (see our report here). And today’s GDP report confirms our insights, noting a substantial increase in non-durable goods by 5.4%. Elsewhere, spending flat-lined at near zero. The March quarter only captured 6 days (4 working days) of lockdown and already weak consumption is evident. We’re concerned about the current quarter. The ramifications of another 47 days under level 4 and 3 are yet to be seen. A historic decline is likely. However, it’s possible that the numbers won’t be as bad as initially feared. Because spending spiked almost immediately once we emerged from lockdown. We were expecting a release of pent-up demand but surprised to see how it’s held up. A full week into level 1 and spending has begun to stabilise at pre-Covid levels. Most importantly, we’re pleased to see the retail and hospitality industries experience a decent lift in activity. But it’s too early to definitively rule out the rebound as a sugar rush. Job security is still front of mind for many Kiwis. There’s an understandable reluctance to go out and spend big. A new couch may be where they draw the line. Expenditure on durable goods fell by 2.8% in the quarter and will likely stay lower for longer.
Fleeting relevance
Interest in March quarter GDP is fleeting. The data provides us with a starting point before the economy experienced weeks of unprecedented social distancing measures. The starting point is certainly weaker than we had been expecting. But the fall was not as strong as the 2.4%qoq drop the RBNZ has forecast at the May MPS. Markets are focused on future developments, such as a potential second wave of infections. We know that the current quarter will post a record contraction, ~18%qoq. And the third quarter is likely to record a record jump.
Beyond the September quarter there is a growing sense, albeit small, that the outlook is looking brighter. NZ got on top of Covid-19 much sooner than most had expected. Allowing the rapid reopening of the economy. We have been buoyed by the strength in the rebound in spending amongst Kiwibank’s own customers (see our latest analysis). NZ looks as it will avoid the worst of worst-case scenarios – some pointing to an unemployment rate of over 20%. Nevertheless, the second half of 2020 will still be tough one. The unemployment rate will continue to rise. And we are wary of a spike in job losses as firms start to roll off the extended wage subsidy scheme sometime in August. We fear a ‘w’ shape recession, as households and business lose the confidence and the appetite to spend.
And the threat of another wave of infection has been hammered home in recent days. Countries such as China and the US are once again grappling with a rising number of cases. And here in NZ Covid-19 is turning out to be one hard bug to squash. This week NZ recorded two new cases of the virus from people coming into the country. As pressure to ease border restrictions mounts so does the risk of more Covid-19 cases coming into NZ.
Cautiously optimistic for now
The elimination of the virus has enabled the Kiwi economy to open back up to 95% capacity. The move into level 2 occurred earlier than expected. The move into level 1 has come a lot sooner than forecast. The recession we’re in may be shallower than our central forecast. And the downside risks have receded, at least a little. We have been pleasantly surprised by the bounce in spending, mostly back to pre-lockdown levels.
Despite the increasingly levels of optimism, damage has been done. The lockdowns have caused the deepest recession in a generation, and will leave no industry untouched. From this upheaval will likely come a change to the economic landscape as trends already in train are accelerated. We explore the damage and the opportunities here. There will be winners and losers, and as the wage subsidies are phased out, unemployment will rise.
The policy response to date has been commendable. The RBNZ has done a good, but incomplete job. LSAPs should include more council debt beyond LGFA. We’re also strongly voicing our concerns with negative rate policy, in favour of doubling LSAPs and term lending to banks. The Government has the enormous task of trying to plug the gaps the lockdown opened up in our economy. Simulating domestic tourism can only go so far, and is likely to fall well short of offsetting the decline in foreign tourism.
The financial system has the armour plating to deal with the Covid-19 inflected damage, but chinks can still form – see our take. The financial system is being protected by the response to date by the RBNZ, Government and commercial bank support packages. And the de-risking of the system in the years leading into the crisis has strengthened banks and lowered the share of highly indebted households. The removal of the LVR restrictions for 12 months has enabled some indebted households (and small businesses) to defer payments, without triggering LVR limits. And investor activity may be fuelled by the greater availability of credit. But the financial system isn’t impervious to stresses placed on it. The RBNZ noted some existing vulnerabilities on the fringes of the financial system including non-bank lending institutions and life insurance providers.