The Coronavirus pandemic has had a costly impact on world economies – one that has pushed individual countries, including Australia, into recession. But what does this all mean?
After spending months in lockdown to curb Coronavirus, many countries have been able to assess the impacts on their economies – a cost shock that has led some nations, including Australia, into recession. This may sound concerning, but as the Investments team explains, expansion and contraction in an economy is normal – meaning recessions form part of a regular economic cycle.
Firstly, what is a recession?
In Australia, a recession is often defined as two consecutive quarters (or six months) of contraction – that is, a significant decline in economic activity.
However, two quarters of contraction alone is not always enough to determine a recession; a number of key indicators may also be considered before a recession is declared, such as increased unemployment, decreased business and consumer spending, financial market volatility, and lower gross domestic product output (referred to as GDP – a leading economic indicator that measures the sum value of all goods and services in an economy).
What causes a recession?
There are many factors that can cause a recession – such as a crash in financial markets, falling house prices and sales, a significant rise in interest rates, or a shocking “black swan” event (for example, a pandemic), but they generally fall within three categories:
Disruptions to (or even an oversupply of) money from central banks and financial institutions can lead to increased financial risk in an economy. For example, the Global Financial Crisis in 2008 occurred partially as a result of an oversupply of money in the United States – with a house price crash resulting from “cheap money” that was made too easily accessible to people who couldn’t really afford to pay more than interest-only loans.
Confidence is psychological, but it can have a real impact on an economy. If the outlook that market participants (like consumers, investors, economists and businesses) have for economic conditions is poor, this could have flow-on effects to the economy. For example, if the unemployment rate is slated to rise, this could lead to a loss of confidence from consumers and result in decreased household spending in an economy.
Changes to economic fundamentals in one part of an economy can have flow-on effects to others – for example, disruptions to supply chains, which can have material impacts on businesses. Real changes can also be linked to financial factors (above). For example, central banks’ interest rate changes can influence the operating environment of financial markets, cash flow for businesses, and consumption decisions.
What could happen during a recession?
When an economy is in a recession, several interconnected issues may play out at once:
- decreased demand for goods and services driven by consumers who tend to be more cautious with their funds in a downturn due to financial uncertainty
- as a result, fewer sales for companies and small businesses – leading to those businesses closing and potentially defaulting on their loans
- poor performance in financial markets (for example, struggling companies listed on share markets experiencing a fall in their share price)
- an increase in unemployment and a decrease in wages growth due to a slowdown in activity
- central banks, such as the Reserve Bank of Australia (RBA), reducing the cash rate
- tightened lending conditions from financial institutions as financial risks increase for businesses and consumers.
The likelihood of recession in some of the world’s largest economies is also very high. In the United States, for example, first quarter GDP decreased 1.3% (down 5% at an annual rate in contrast to an increase of 2.1% in the fourth quarter of 2019), while unemployment reached 14.7% in April (up from 3.5% in February, before the pandemic), figures that could worsen by year’s end.
So, is Australia in a recession?
Because of its contagious nature, Coronavirus led to social-distancing and lockdown measures that shut down much of the world’s economy, including Australia’s – and this has had an impact on Australian life. So, is Australia experiencing a recession? Based on the technical definition of two consecutive quarters, as well as government confirmation, yes – Australia is in a recession. Data from the Australian Bureau of Statistics has provided more insight into the state of the economy:
- Following a 0.3% contraction in the March quarter, Australian GDP fell 7% over the June quarter, representing the largest decline in quarterly GDP since records began in 1959.
- Over the quarter, a 12.1% decrease in consumer spending and a 17.6% decline in spending on services (e.g. transport, tourism and hospitability) were key contributors to the decline – reflecting the government’s movement restrictions and temporary closure of businesses.
- The decrease in spending led to an increase in household savings, with households saving 19.8% (or about one in five dollars). This was partially supported by a 41.6% increase in social assistance benefits as part of the government’s economic response to Coronavirus.
- Over the financial year, most industries recorded a fall in the gross value they contributed to GDP. Hospitality and tourism made particularly negative contributions to growth, while mining and financial services made positive contributions over the same period.
- During the year, spending on transport services fell 88% due to travel restrictions, while spending on accommodation services (77.5%), catering (55.7%), and recreational and cultural services (54.5%) was also down due to social-distancing and containment measures.
- At the same time, spending on household tools (30%), appliances (21%), and recreation and culture goods like audio-visual and exercise equipment (21%) rose as consumers were mandated to stay indoors and/or work from home.
It’s natural to feel concern about a recession, particularly when it comes to one’s financial wellbeing. But while the Australian economy has been impacted by the pandemic, it can be helpful to remember that as with any cycle, conditions fluctuate over time.
And according to the RBA, Australia has fared better compared to some other countries – for example, the UK contracted 20% while the US contracted 10% over the June quarter. While the Australian economy is experiencing its biggest economic contraction since the 1930s, the RBA believes the downturn is not as severe as previously anticipated. With a gradual – albeit uneven – recovery underway across most of the country, the RBA’s future outlook suggests:
- economic output falling by 6% over the remainder of 2020 but growing by 5% in 2021
- an unemployment rate that rises to 10% by the end of 2020 (exacerbated by job losses in Victoria) but gradually declines to about 7% over coming years
- inflation remaining between 1%–1.5% over the coming years
- ongoing financial stimulus support given continued uncertainty as to the outlook for both the Australian economy and labour market
- a potentially stronger recovery that could occur depending on Coronavirus containment measures and a less cautious approach to spending. Additional containment measures and a decline in spending could impact future economic growth to some degree.
The depth of this recession and the speed of an economic recovery are uncertain at this time – and this could continue to be the case until a vaccine is developed and distributed. But it may be helpful to remember that although Australia is not out of the woods, the country’s last recession lasted less than two financial years (1990–1991) – followed by nearly 30 years of economic growth thereafter.
Helpful resources to keep you informed
No matter the circumstance, Colonial First State remains dedicated to supporting members – regularly sharing market updates and helpful resources to assist members on their financial journey.
Colonial First State Investments Limited ABN 98 002 348 352, AFSL 232468 (CFSIL) is the issuer of super, pension and investment products. This document may include general advice but does not take into account your individual objectives, financial situation or needs. The Target Market Determinations (TMD) for our financial products can be found at www.cfs.com.au/tmd and include a description of who a financial product is appropriate for. You should read the relevant Product Disclosure Statement (PDS) and Financial Services Guide (FSG) carefully, assess whether the information is appropriate for you, and consider talking to a financial adviser before making an investment decision. The PDS and FSG can be obtained from www.cfs.com.au or by calling us on 13 13 36.