The COVID-19 pandemic has, with alarming speed, delivered a global economic shock of enormous magnitude, leading to steep recessions in many countries. The baseline forecast envisions a 5.2 percent contraction in global GDP in 2020—the deepest global recession in eight decades, despite unprecedented policy support. Per capita incomes in the vast majority of emerging market and developing economies (EMDEs) are expected to shrink this year, tipping many millions back into poverty. The global recession would be deeper if bringing the pandemic under control took longer than expected, or if financial stress triggered cascading defaults. The pandemic highlights the urgent need for health and economic policy action—including global cooperation—to cushion its consequences, protect vulnerable populations, and improve countries’ capacity to prevent and cope with similar events in the future. Since EMDEs are particularly vulnerable, it is critical to strengthen their public health care systems, to address the challenges posed by informality and limited safety nets, and, once the health crisis abates, to undertake reforms that enable strong and sustainable growth.
The spread of the pandemic has essentially halted international travel and disrupted global value chains, resulting in a sharp contraction in global trade. A flight to safety has triggered sharp falls in global equity markets, unprecedented capital outflows from EMDEs, rising credit-risk spreads, and depreciations for many EMDE currencies. Falling demand has led to a sharp decline in most commodity prices, with a particularly substantial plunge in oil prices.
Recent indicators suggest that global trade is on track to fall more in 2020 than it did during the global financial crisis, partly owing to the disruptions the COVID-19 pandemic has caused to international travel and global value chains. Trade is typically more volatile than output, and tends to fall particularly sharply in times of crisis.
Investment, which is more cyclical and more trade-intensive than other categories of expenditure, has declined worldwide as firms face financing problems and China Output contracted sharply in the first quarter, with private consumption and non-financial services being especially hard-hit by the pandemic and an extended period of restrictions to stem it. Exports plunged, more than imports, as a result of temporary factory closures. Activity has been normalizing gradually in the second quarter following the relaxation restrictions.
Exporting firms tend to be particularly active in credit markets, and more adversely affected when the cost of credit increases. Disruptions in credit markets played an important role in the contraction in global trade during the global financial crisis and the subsequent weakness of the rebound. This pattern is at risk of being repeated. The fall in activity has been concentrated in services sectors that are typically stable.
Travel restrictions and concerns about COVID-19 have led to a precipitous fall in tourism—a sector that in recent years has accounted for about 6.5 percent of global exports of goods and services—with sharp declines in economies with the most severe outbreaks.
As the pandemic has spread, stringent border controls and production delays have weighed on trade. Measures to slow the outbreak have limited or delayed the supply of critical inputs, particularly in the automotive and electronics industries. The collapse of air traffic has resulted in a steep rise in air freight costs, putting further strain on industries that rely on just-in-time delivery of foreign-sourced intermediate goods. Supplier delivery times have lengthened considerably and inventories have been depleted.
The sharp fall in activity in the first half of this year is expected to contribute to a contraction in global trade of about 13.4 percent in 2020. A gradual recovery is assumed to start during the second half of the year as controls are lifted, travel returns to more typical levels, and manufacturers rebuild inventories. This recovery is expected to be historically feeble, however, reflecting the exceptional character of the present crisis, as well as the length of time that it will take to restore confidence, to replace bankrupted firms, and to establish virus-safe working and entertainment environments.
In particular, services do not benefit as much as manufacturing when inventories are restocked, and when purchases of durables pick up after a period of being deferred. International air travel may take a very long time to re-attain the levels of recent years, as businesses and tourists make fundamental reassessments of the trade-off between foreign trips and infection risks, airlines reduce passenger loads to increase spacing, and governments maintain tighter border controls.
Financial markets witnessed a historic flight to safety as the economic consequences of widespread measures to contain COVID-19 became apparent. Global equity valuations took an unprecedented plunge early in the year, while market volatility spiked to its highest level since 2008 EMDEs suffered from record capital outflows accompanied by a rise in sovereign borrowing spreads, which was especially severe for countries with high government debt . To contain financial stress, central banks injected liquidity into financial markets through a combination of direct credit provision to large investment-grade companies, expansion of the range of assets they accept as collateral, and large-scale asset purchases—including of corporate debt in some countries. To alleviate the sharp rise in demand for U.S. dollars for currency hedging and dollar-denominated debt financing, the Federal Reserve provided access to its U.S. dollar liquidity swap arrangements to a larger group of countries, including Brazil, Mexico, and the Republic of Korea (Ghana has also benefitted from this).
These measures appear to have successfully averted a severe liquidity crisis that appeared possible earlier in the year. Capital outflows from EMDEs have stabilized, while equity market valuations have retraced a considerable share of their earlier losses.
Nonetheless, financial conditions remain fragile for many market participants. Disruptions in activity have interrupted cash flows and interfered with debt financing around the world. Spreads on high-yield debt have risen substantially amid widespread corporate bond downgrades, suggesting investors may have become more skeptical about the ability of riskier borrowers to finance their debt. Many EMDEs have also experienced significant pressures on their currencies, with depreciations broadly correlated with current account deficits. Foreign direct investment in many countries is expected to fall considerably. Remittances—the largest source of foreign exchange earnings for EMDEs in 2019—are also envisioned to contract sharply across most EMDEs.
In a number of EMDEs, banking system profitability is being eroded by a rise in nonperforming loans.
Most commodity prices declined in the first half of the year because of the sharp fall in global demand. Brent crude oil prices fell almost 70 percent from late January to mid-April, before retracing some of these losses in recent weeks. The decline in oil prices since January has been larger than in the aftermath of the September 11, 2001
Controls to slow the spread of the pandemic have resulted in a sharp fall in travel and transport, which accounts for two-thirds of oil consumption. Oil demand is expected to fall by 8.6 percent in 2020. Such a decline would be unprecedented, surpassing the previous record fall of 4 percent in 1980 Global oil production is also starting to fall, although at a slower pace than demand.
In April, OPEC and its partners agreed to new production cuts, starting with a reduction of 9.7mb/d in May and June, and gradually tapering thereafter. Production in non-OPEC+ countries is also starting to decline. The U.S. Energy Information Administration expects U.S. production to fall by regions as travel restrictions and widespread losses of service sector jobs discourage labor migration and weigh on incomes of migrant workers.
Overall, oil prices are expected to average $32 per barrel in 2020 and $38 per barrel in 2021—$26 and $21 per barrel below January forecasts, respectively.
Demand for metals has also fallen. Prices are anticipated to decline 16 percent in 2020 before showing a modest increase in 2021. This forecast is predicated on a recovery of Chinese demand, which accounts for around 50 percent of the consumption of base metals.
Agricultural prices, which weakened over the first half of the year, are expected to decline only marginally in 2020 as a whole, as they are less sensitive to economic activity than industrial commodities, particularly at higher-income levels. Despite production levels and stocks for most staple foods being near all-time highs, there are growing concerns about food security. Food availability is being strained due to supply chain disruptions and restrictions on movement.
Further, in EMDEs with a large number of poor, income losses from disruptions in economic activity could increase food insecurity. Some countries have announced temporary restrictive trade policies such as export bans, similar to those that contributed to spikes in international food prices in 2007-08 and 2010-11. While ample supplies mean that prices are likely to remain stable at the global level, localized price spikes could further erode food security.
Emerging market and developing economies
EMDEs are forecast to contract this year due to the COVID-19 pandemic. The impact is expected to be most severe for EMDEs with large domestic outbreaks and those that rely heavily on global trade, tourism, commodity exports, and external financing. Per capita incomes are projected to contract deeply as a result, causing the first net rise in global poverty in more than 20 years. Growth in EMDEs is projected to pick up in 2021, on the back of firming trade and investment as the effects of the pandemic wane. Prospects for subdued commodity prices, however, are expected to temper the recovery in commodity exports.
Uncertainty over the spread of the virus and the lifting of restrictions have coincided with the erosion of business confidence and a decline in investment. Businesses have also had to contend with delivery delays in intermediate inputs, plunging demand, and limited access to financing. Domestic COVID-19 outbreaks are beginning to overwhelm health care systems in a rising number of EMDEs because of the small size of their health care systems and limited hospital capacity. EMDEs have also faced unprecedented external headwinds from much weaker activity in major economies, sharp declines in commodity prices, disruptions to global supply chains and tourism, markedly lower remittances, and financial market turmoil. Manufacturing activity and new export orders have sharply contracted, particularly in EMDEs with a large presence of manufacturing or export-oriented firms. Increasing supply-chain disruptions are likely, as shipments are interrupted by temporary export bans or border restrictions. Tourist arrivals collapsed in the first half of 2020 alongside widespread international border closures and travel restrictions. EMDEs that rely heavily on tourism faced large declines in services activity, particularly in hospitality, food, entertainment, and retail services. In EMDEs where remittances are an important source of income, private consumption has fallen sharply as migrant workers became idle or furloughed as a result of the downturn in business activity in host countries.
The drastic reduction in demand and prices for oil and industrial metals is a major headwind for commodity exporters, as commodities accounted for more than 75 percent of exports in 2019 in the average member of this group. Extraction investment has fallen sharply, loss of revenues has forced some governments into procyclical fiscal tightening, and the deterioration in terms of trade has weighed on consumption, particularly in regions with large numbers of commodity exporters.
In addition, commodity exporters are grappling with domestic outbreaks and the side effects of mitigation measures.
Activity indicators in EMDE commodity exporters have declined to multi-year lows. Whereas three-quarters of commodity-exporting EMDEs managed to avoid recession in 2009 despite collapsing commodity prices, more than two-thirds of them are expected to contract in 2020. This is largely due to the wider global spread and the larger magnitude of the shock. In addition, it reflects the lingering weakness and eroded buffers from the 2014-16 commodity price collapse. Commodity exporters entered this year with weaker external and fiscal positions than before the global financial crisis, as subdued external demand and low commodity prices reduced current account balances, while persistent fiscal deficits contributed to rising debt levels. A number of commodity exporters have announced fiscal stimulus, while some have also partially reallocated spending to provide targeted support. Several central banks have provided monetary support, despite currency depreciations and substantial capital outflows. Growth in most commodity importers has been curtailed by severe domestic virus outbreaks and restrictions to stem the pandemic, all of which have heavily weighed on consumption and investment.
The pandemic, and the associated domestic disruptions and global spillovers, has dealt a significant blow to EMDEs. Many have adopted restrictions to stem the pandemic, including economy-wide lockdowns, international border and school closures, and restrictions on domestic travel In many EMDEs, efforts to slow the spread of the virus have weighed heavily on private consumption.
In addition, commodity exporters are grappling with domestic outbreaks and the side effects of mitigation measures. The number of these measures was initially higher in commodity exporters than in commodity importers, in part reflecting greater fear about the consequences of domestic outbreaks in countries where the capacity of the public health system is low. As a share of GDP, government health care spending among commodity exporters is on average 30 percent lower than in commodity importers (Figure 1.10.C). Activity indicators in EMDE commodity exporters have declined to multi-year lows. Whereas three-quarters of commodity-exporting EMDEs managed to avoid recession in 2009 despite collapsing commodity prices, more than two-thirds of them are expected to contract in 2020. This is largely due to the wider global spread and the larger magnitude of the shock. In addition, it reflects the lingering weakness and eroded buffers from the 2014-16 commodity price collapse.
Growth in low-income countries (LICs) slowed sharply in the first half of 2020 . The COVID-19 pandemic has spread to almost all LICs, and domestic mitigation measures have severely disrupted activity. Spillovers from recessions in major economies have added to the problem—particularly in those LICs with strong trade linkages to China and the Euro Area. In the average LIC, commodities account for two-thirds of goods exports, and the deterioration in world markets has weighed heavily on industrial commodity exporters. Reduced tourism amid global travel restrictions has also tempered growth in some countries (Ethiopia, Madagascar, Uganda). Heightened investor risk aversion has tightened financial conditions for the few LICs that have borrowed from international capital markets, while contractions in major economies have reduced remittance flows—an important source of foreign funding in a number of LICs.
Aggregate EMDE activity is expected to contract by 2.5 percent in 2020—6.6 percentage points below previous forecasts, and the worst rate since at least 1960, the earliest year when aggregate GDP data are available ( The projected fall in activity is broad-based, with nearly 80 percent of EMDEs expected to register negative growth this year. All EMDE regions will be affected (Chapter 2; Special Focus). Forecast downgrades are larger and the recessions are deeper in EMDEs with the most severe COVID-19 outbreaks or those most susceptible to global spillovers, such as economies that are heavily dependent on tourism (Croatia, Maldives, Seychelles, Thailand), economies deeply embedded in global value chains (Bulgaria, Mexico, Poland), and major exporters of industrial commodities (Chile, Nigeria, Russian Federation, South Africa; Figure 1.11.B). Growth in EMDEs is projected to rebound in 2021, to 4.6 percent, supported by the expected pickup in China and a recovery of trade flows and investment. Excluding China, EMDE growth is envisioned to recover at a more modest pace next year, reflecting headwinds for commodity exporters amid subdued commodity prices and a weak rebound in services. Economies dependent on tourism will be subject to an additional drag on growth (Figure 1.11.C). Through its effect on investment, as well as the loss of human capital among idled and furloughed workers, COVID-19 is likely to dampen long-term growth prospects and productivity.
The fallout from COVID-19 will be particularly severe in countries with widespread informality and limited safety nets (ILO 2020a). In the aver-age EMDE, informal activity accounts for one-third of output and two-thirds of employment. In EMDEs with large informal sectors, workers and firms have limited options to buffer temporary income losses, while also being more vulnerable to adverse health impacts. Additionally, temporary workers in the formal economy suffer from gaps in social safety nets and social protection. Growth in LICs is projected to fall to 1 percent in 2020—the lowest rate in more than 25 years. Among fragile LICs, activity will slow to a crawl, reflecting the pandemic’s severe disruption to activity in countries least equipped to lessen its impact. The expected growth pickup in LICs in 2021 assumes that both domestic activity and external demand recover as the pandemic fades, weakness in private investment that has been a feature of the past decade (Figure 1.11.D; World Bank 2018a). In previous epidemics, investment declined by nearly 10 percent five years following the event, reflecting substantial risk aversion amid heightened economic uncertainty. In many EMDEs, deep recessions will weigh on potential output for a prolonged period (Figure 1.11.E; Chapter 3). The pandemic has also disrupted schooling at all levels, with many EMDEs having fully or partially closed their education systems in an effort to contain its spread (UNESCO 2020). Extended school closures, along with disruptions to early childhood development programs, are expected to set back learning, raise dropout rates, and slow human capital development (Figure 1.11.F; Armitage and Nellumns 2020; Burgess and Sievertsen 2020; Wang et al. 2020; World Bank 2020k, 2020l). Growing food insecurity, including disruptions to school feeding programs, could also lower long-term productivity, as malnutrition early in life can permanently impair learning abilities. The fallout from COVID-19 will be particularly severe in countries with widespread informality and limited safety nets (ILO 2020a). In the aver-age EMDE, informal activity accounts for one-third of output and two-thirds of employment. In EMDEs with large informal sectors, workers and firms have limited options to buffer temporary income losses, while also being more vulnerable to adverse health impacts. Additionally, temporary workers in the formal economy suffer from gaps in social safety nets and social protection. Growth in LICs is projected to fall to 1 percent in 2020—the lowest rate in more than 25 years. Among fragile LICs, activity will slow to a crawl, reflecting the pandemic’s severe disruption to activity in countries least equipped to lessen its impact. The expected growth pickup in LICs in 2021 assumes that both domestic activity and external demand recover as the pandemic fades.
CHAPTER 1 G LO BAL ECO NO MIC PROSPECTS | J UNE 2020 34 and that commodity prices firm from current levels as global demand recovers. Among exporters of industrial commodities, growth is projected to be spurred further by investment in new production capacity (Chad, Mozambique, Niger), while continued reforms to improve business environments will aid the recovery in some others (Benin, Ethiopia, Nepal, Rwanda, Togo). Per capita income growth and povertyEven before the pandemic, it was increasingly unlikely that the Sustainable Development Goal (SDG) of reducing global extreme poverty to 3 percent of the global population over the next decade would be achieved (World Bank 2018b). This goal is now even further out of reach. Household incomes are expected to be weighed down by sharp income losses from diminished employment opportunities and lost earnings due to illness, as well as reduced remittance receipts. As a result, per capita incomes among more than 90 percent of EMDEs are expected to contract in 2020, markedly affecting living standards and causing many millions to fall back into poverty (ILO 2020a; Lakner et al. 2020; World Bank 2020a; Figures 1.12.A and 1.12.B). The crisis is also likely to worsen inequality, as various factors render the poor more vulnerable to the effects of the pandemic, including their limited access to health care and lack of resources to cushion income losses (Furceri, Loungani, and Ostry 2020). Per capita income losses are forecast to be steepest in ECA, LAC, MENA, and SSA. These four regions are home to many oil exporters, which will be severely affected by the precipitous fall in oil prices. Commodity exporters, particularly those in Sub-Saharan Africa, typically have sizable populations living in extreme poverty (Figure 1.12.C). Falling per capita incomes in Sub-Saharan Africa—home to 60 percent of the world’s extreme poor—are likely to further concentrate global poverty in the region (Lakner et al. 2020; World Bank 2020i). In some countries, constrained fiscal revenues due to commodity prices remaining lower over the long term are likely to further weigh on needed development spending—particularly on health, education, and infrastructure—pushing even more SDGs out of reach (Figure 1.12.D). Global outlook and risksThe pandemic is pushing the global economy into recession, with a projected contraction of 5.2 percent in 2020—the worst rate in post-war history. Any numerical forecast for the period ahead, however, is subject to unprecedented levels of uncertainty. Risks are firmly tilted to the downside and include a more protracted pandemic and hence a prolongation of CHAPTER 1 G LO BAL ECO NO MIC PROSPECTS | J UNE 2020 35 Since the contraction in advanced economies is much more pronounced than that of EMDEs, the use of PPP weights—which assign greater weight to EMDEs than market exchange rate-based weights—yields a less severe global recession. Global output is projected to shrink 4.1 percent in 2020 using PPP weights, consistent with the baseline contraction of 5.2 percent using market exchange rates. Advanced economies account for essentially all of the 1.1 percentage point difference between the two methods. Regardless of the weighting methodology, this year’s contraction will be highly synchronized internationally, with mitigation measures, financial crises, a further drop in commodity prices, and a slower recovery due to lasting impacts on consumers and firms and a retreat from global value chains. These factors could lead to a substantially greater loss of output in the near term. Global outlookLockdowns and other restrictions, while necessary to slow the spread of the virus, have been accompanied by a sharp reduction in economic activity (Baldwin and Weder di Mauro 2020; Boissay, Rees, and Rungcharoenkitkul 2020; Eichenbaum, Rebelo, and Trabandt 2020; Gourinchas 2020). Their gradual removal is expected to pave the way for a partial recovery in the second half of the year. On this assumption, the world economy is projected to contract by 5.2 percent in 2020. If this forecast materializes, the fall in global output would be more than double that of the 2009 global recession. The severity and speed of the disruptions to the global economy have been reflected in the strikingly steep downgrades, for advanced economies and EMDEs, by all major forecasters (Figures 1.13.A and 1.13.B). Within one month, as widespread restrictions were implemented in large segments of the world economy, consensus forecasts for global growth in 2020 were downgraded by more than 5 percentage points—a magnitude of forecast downgrades that took nine months in the wake of the global financial crisis. The projected depth of the 2020 global recession depends on the weighting methodology used to compute the rate of global growth. Advanced economies account for 60 percent of global activity using market exchange rate weights, as in these baseline projections, while they account for only 40 percent when using purchasing power parity (PPP) weights. Major advanced economies—in particular, the Euro Area—are expected to contract precipitously this year. In contrast, some large EMDEs—most notably China—are projected to continue to expand, albeit more slowly than previously anticipated. As a result, advanced economies are expected to shrink by 7 percent in 2020, while EMDEs are envisioned to contract by 2.5 percent.
Since the contraction in advanced economies is much more pronounced than that of EMDEs, the use of PPP weights—which assign greater weight to EMDEs than market exchange rate-based weights—yields a less severe global recession. Global output is projected to shrink 4.1 percent in 2020 using PPP weights, consistent with the baseline contraction of 5.2 percent using market exchange rates. Advanced economies account for essentially all of the 1.1 percentage point difference between the two methods. Regardless of the weighting methodology, this year’s contraction will be highly synchronized internationally, with CHAPTER 1 G LO BAL ECO NO MIC PROSPECTS | J UNE 2020 42 sharp disruptions to real and financial activity in many economies and across many sectors. Historically, global recessions have tended to be followed within a year by a global recovery—characterized by a broad-based rebound in activity—as was the case immediately after the global financial crisis. While a global recovery is envisioned in 2021, it is likely to be subdued. Output is not expected to return to its previously expected level (Figure 1.13.C). This reflects the fact that the pandemic will likely lead to a slow and incomplete return to activities that require face-to-face interaction, such as tourism, as some degree of social distancing continues. Many firms, households, and governments are weathering the 2020 global recession by relying on savings and debt; as a result, a period of deleveraging is likely to follow as they rebuild precautionary savings and strengthen their balance sheets. At the same time, the large and sudden loss of income in 2020 has pushed many individuals into unemployment and companies into bankruptcy, destroying valuable economic relationships that will take time to rebuild. Lower spending and continued uncertainty will likely lead to persistent weakness in investment and the innovation embodied therein, with consequences for growth and productivity. Moreover, the financial turmoil and commodity price collapse engendered by the pandemic will likely have significant long-term effects on potential growth in many economies (Chapter 3). Risks to the outlook The global economy is experiencing one of the sharpest recessions on record and, given the unprecedented nature of the shock, forecasts are subject to a large degree of uncertainty. Downside risks could deepen the recession or delay the recovery. In the short run, the contraction would deepen if a protracted pandemic required an extension of control measures. Policy support might fail to soften the economic blow to households and firms to the degree assumed in the forecast. A prolonged disruption to economic activity could exacerbate financial stress, which could lead to widespread financial crises. Lower-for-longer commodity prices could trigger economic and financial distress among commodity producers. It is less likely but also possible that activity is stronger than expected if a combination of positive news on the flattening of the curve, new treatments and vaccine development, and aggressive and effective policy support set the stage for the beginning of a solid rebound in economic activity during the second half of 2020. In light of the large uncertainties around the near-term outlook, Box 1.3 provides illustrative scenarios that describe how the baseline forecast—which envisions a 5.2 contraction in global activity this year—would be adjusted if various combinations of these risks to near-term activity were to materialize. In all, depending on the ultimate outcome, global output in 2020 might decline by about 4 percent under an upside scenario, but by more than 7 percent under a worst-case scenario (Figure 1.13.D). Even in the best-case scenario, the 2020 global recession will be about twice as deep as the global financial crisis. There is also a possibility that activity will remain very weak beyond the near term, even after restrictions are lifted. The aftermath of the pandemic may cause lasting changes in consumer and business behavior, and high debt burdens could hold back investment. The crisis could catalyze a retreat from, and fragmentation of, global value chains. Social unrest could erupt. If these risks materialize, long-term growth prospects will be dampened, and goals for development and poverty reduction would be in severe jeopardy. More protracted pandemic Despite the best efforts of policymakers, a renewed surge in cases remains a real possibility, especially if there are delays in the development and rollout of test-and-trace measures and vaccines. Recent events and model-based analyses show the toll of uncontained pandemics on human and economic development (McKibbin and Fernando 2020; Verikios et al. 2011; Burns, van der Mensbrugghe, and Timmer 2006). A sharp rise in the number of patients requiring hospitalization amid a second wave of infections could overwhelm even the most robust health care systems in advanced economies, let alone those of EMDEs
In these circumstances, the necessary extension of policies to slow the spread of the outbreak and save lives would likely precipitate a renewed collapse in private consumption. The ability of households to procure the funds needed to maintain consumption at a basic level would be further strained, given previous income losses and already low levels of savings (Figure 1.14.B). The ability of welfare systems to cushion income losses varies considerably by country, and is considerably lower in LICs (Figures 1.14.C and 1.14.D). Meanwhile, domestic investment would grind to a halt amid extreme uncertainty, and development outcomes would worsen appreciably. Prolonged restrictions would severely limit the ability of fiscal or monetary policy to cushion the blow to activity. Firms would be hampered by a chronic lack of demand, by a growing shortage of inputs, and by the need to provide more space and virus safety precautions for employees. Fiscal stimulus may be less effective when some sectors are completely shut down (Guerrieri et al. 2020). In such a case, the result would be a deeper-than-expected global recession, with particularly pernicious effects in economies burdened with more elevated debt-to-GDP ratios. Financial crises and debt burdens Thus far, an extraordinary policy response has prevented the slowdown in activity from becoming a financial crisis. In many countries, fiscal measures have replaced a proportion of lost incomes and mitigated default risk, loan guarantees have helped keep businesses afloat, and liquidity provision by central banks have kept the financial system functional. However, should the impact of the pandemic continue to grow, financial crises may follow, resulting in a collapse in lending, a longer global recession, and a slower recovery. Rising levels of debt have made the global financial system more vulnerable to financial market stress. Since the global financial crisis, global debt has risen to 230 percent of GDP, with EMDE debt reaching a historic high of 170 percent of GDP by 2019 (Figure 1.15.A). In almost 40 percent of EMDEs, government debt is now at least 20 percentage points of GDP higher than it was in 2007 (Kose et al. 2020). In addition, more than a quarter of corporate debt in the average EMDE is denominated in foreign currency. The need to service and roll over this sizable debt increases EMDEs’ vulnerability to spikes in CHAPTER 1 G LO BAL ECO NO MIC PROSPECTS | J UNE 2020 44 borrowing costs and falls in domestic currency values, both of which have already taken place (Figures 1.15.B and 1.15.C). Large and prolonged flights to safety, or a series of ratings downgrades, could trigger cascading debt defaults and financial stress. Full-fledged financial crises would cause further declines in consumption and investment. Financial systems in advanced economies also contain pockets of vulnerability. Yields on lower quality corporate borrowing have surged, reflecting a higher perceived risk of default, particularly on the rapidly growing share of debt issuances in the form of leveraged loans. These are loans to firms that are highly indebted, have high debt service costs relative to earnings, and are typically below investment grade (Figure 1.15.D; BIS 2019). Even if the global financial system avoids a crisis, the debt accumulated in response to the pandemic may weigh on growth in the longer run. As global activity rebounds, interest rates are likely to rise. Higher debt service costs must be financed through higher taxes, additional borrowing, or by a reduction in other expenditures. In circumstances of scarce domestic savings, and limited access to foreign funds, additional borrowing may crowd out private investment. In addition, the loosening of macroprudential standards to support credit provision during the crisis may reduce balance sheet transparency and weaken market discipline in the longer term, potentially contributing to future financial instability. Lasting effects on consumers and firmsThe damage to economic activity from the pandemic could also extend well beyond the near term through a lasting negative effect on both consumers and producers (Chapter 3). Precipitous losses of income brought on by lockdowns, firm closures, and travel restrictions could erode the confidence of both workers and firms about prospects for future labor income and profits. A protracted erosion in confidence could cause households to cut back on spending and firms to curtail investment, weighing heavily on both aggregate demand and supply (Ilut and Schneider 2014; Bhandari, Borovicka, and Ho 2019). For workers, recessions can cause a substantial and permanent loss in lifetime earnings (Oreopoulos, von Wachter, and Heisz 2012). Consumption would also be reduced if greater uncertainty and a higher perceived risk of unemployment permanently increase consumers’ savings rate (Mody, Ohnsorge, and Sandri 2012). Chronically higher unemployment would dampen human capital accumulation, weighing appreciably on long-term growth. For firms, greater uncertainty could discourage investment as well as new market entry and CHAPTER 1 G LO BAL ECO NO MIC PROSPECTS | J UNE 2020 45 permanently lower productivity (Aghion and Durlauf 2014). Subsidized or government-guaranteed credit provided in response to the pandemic may help unprofitable firms to persist, deterring newer entrants and suppressing aggregate productivity (Caballero, Hoshi, and Kashyap 2008). Retreat from global value chainsThe initial spread of the pandemic was fastest in three economies closely integrated in global value chains: China, the Euro Area, and the United States. Global value chains expanded rapidly until the global financial crisis, and decelerated—in some cases reversed—thereafter as business investment decelerated and the pace of trade reform slowed (Figure 1.16.A; World Bank 2020o). The spread of the pandemic has significantly disrupted the supply of key intermediate inputs and threatened the viability of many transportation companies (Figure 1.16.B). This threatens to lead to a more permanent retreat from global value chains if it bankrupts large numbers of participating companies or causes firms to consider reshoring production (Special Focus). In addition, global value chains are at risk through financing stress. Export-oriented firms tend to be larger and more dependent on borrowing to finance operations (Bruno, Kim, and Shin 2018). An inability to service debt due to currently high borrowing costs and weak cash flow could cause firms to exit the market, leaving gaps in value chains that new entrants may not be able to fill in a timely manner. Global value chains could also come under pressure from renewed trade tensions. Before COVID-19, rising tariffs were already straining the networks of companies that undertake U.S.-China trade, only partly alleviated by the Phase One agreement. The centerpiece of this agreement is China’s commitment to buy $200 billion in additional products from the United States (Figure 1.16.C). A renewed set of trade restrictions between the two countries, linked to either a shortfall in purchases or policy disagreements, could trigger a rise in uncertainty and a further fall in trade at a time when the global economy is already fragile. Trade tensions between other countries have also been simmering. Tensions between the Euro Area and the United States have so far affected a small amount of trade, but a tit-for-tat escalation of tariffs could have effects on global trade on a similar scale to the disruptions from previous U.S.-China tensions (Figure 1.16.D). More broadly, many governments concerned about the shortages of essential products revealed by the crisis have imposed trade restrictions to protect domestic supplies of these items.
CHAPTER 1 G LO BAL ECO NO MIC PROSPECTS | J UNE 2020 46 knowledge diffusion and the economies of scale that come with specialization. Lower-for-longer commodity prices and other region-specific risksThe global economy remains vulnerable to a variety of regional risks, many of them stemming from the pandemic. A persistent period of low oil prices could weigh on activity in regions with a large number of oil exporters, particularly MENA. Current prices are below the fiscal break-even level for many producers. Some oil exporters may be able to maintain spending during a lengthy period of low prices, but many more would be forced into pro-cyclical austerity at the same time the domestic economy needs support. More generally, the combination of more persistent effects of the pandemic at the global level, widening domestic outbreaks, and lower commodity prices could result in severe economic damage in commodity-exporting EMDEs, leading to falling investment, declines in consumption and confidence, and procyclical fiscal tightening (Frankel 2011). While a wide range of countries have suffered from domestic outbreaks, some regions are vulnerable to more severe outbreaks and macroeconomic effects. This risk is particularly acute for SSA, which lacks the necessary infrastructure, personnel, and government funding to contain a wider outbreak. Should economic costs escalate, simmering social unrest in some regions could worsen. Social unrest could also be triggered by food shortages. The number of people facing acute food insecurity could double to more than 260 million in 2020, with serious consequences for health (WFP 2020a, 2020b). While global food stocks are elevated, the combination of falling household incomes and currency depreciation is contributing to food insecurity in many EMDE regions, particularly SSA. Disruptions to the supply of agricultural inputs such as chemicals, fertilizers, seeds or labor shortages could diminish next season’s crop (World Bank 2020c). Natural disasters and climate events could also result in localized shortages, as exemplified by the plague of locusts currently threatening harvests in East Africa. The experience of pandemic-related disruptions and persistent trade policy uncertainty may cause some businesses to re-assess whether the gains from participation in global value chains are worth the risk of further disruptions. A retreat of export-oriented firms, which tend to be more productive than their domestically oriented counterparts, would have persistent adverse effects on economy-wide productivity (Barattieri, Cacciatore, and Ghironi 2019). A large-scale shrinking from global value chains has the potential to further reduce already-low growth and productivity, by slowing CHAPTER 1 G LO BAL ECO NO MIC PROSPECTS | J UNE 2020 46 knowledge diffusion and the economies of scale that come with specialization. Lower-for-longer commodity prices and other region-specific risksThe global economy remains vulnerable to a variety of regional risks, many of them stemming from the pandemic. A persistent period of low oil prices could weigh on activity in regions with a large number of oil exporters, particularly MENA. Current prices are below the fiscal break-even level for many producers. Some oil exporters may be able to maintain spending during a lengthy period of low prices, but many more would be forced into pro-cyclical austerity at the same time the domestic economy needs support. More generally, the combination of more persistent effects of the pandemic at the global level, widening domestic outbreaks, and lower commodity prices could result in severe economic damage in commodity-exporting EMDEs, leading to falling investment, declines in consumption and confidence, and procyclical fiscal tightening (Frankel 2011). While a wide range of countries have suffered from domestic outbreaks, some regions are vulnerable to more severe outbreaks and macroeconomic effects. This risk is particularly acute for SSA, which lacks the necessary infrastructure, personnel, and government funding to contain a wider outbreak. Should economic costs escalate, simmering social unrest in some regions could worsen. Social unrest could also be triggered by food shortages. The number of people facing acute food insecurity could double to more than 260 million in 2020, with serious consequences for health (WFP 2020a, 2020b). While global food stocks are elevated, the combination of falling household incomes and currency depreciation is contributing to food insecurity in many EMDE regions, particularly SSA. Disruptions to the supply of agricultural inputs such as chemicals, fertilizers, seeds or labor shortages could diminish next season’s crop (World Bank 2020c). Natural disasters and climate events could also result in localized shortages, as exemplified by the plague of locusts currently threatening harvests in East Africa
Upside risk: Swift recovery and unleashed pent-up demandAlthough global growth will be sharply negative in 2020, it is possible that the lifting of the aggressive policy measures put in place in response to the pandemic sets the stage for the start of a robust recovery in economic activity at some point in the second half of 2020. A breakthrough in the development of vaccines against COVID-19 is also possible. The promise of an earlier-than-expected end to the pandemic could reinvigorate consumer and investor confidence, unleashing pent-up demand for a broad range of goods and services. This recovery would be boosted by lagged effects from the substantial fiscal and monetary policy support already in place. The resumption of activity could extend across EMDEs, as they benefit from a policy-fueled recovery in major economies, renewed capital inflows, and firming global commodity demand
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