Abstract: As the fight against the COVID-19 pandemic has entered the third phase since mid-April, advanced economies are showing signs of passing the peak of the pandemic but are faced with the difficult trade-off between reopening the economy and risks of virus-relapse. Meanwhile, emerging markets are feeling multiple severe shocks simultaneously with rapid spread of the virus. Some suggest that it may take 2-3 years for the size of the global economy to return to the pre-pandemic level. And more importantly, the pandemic will bring about profound structural changes to the global economic landscape in the mid- to long-term.
Entering the third phase in fighting against Covid-19, global economy shows the following features. First, major advanced economies are gradually passing the peak of the pandemic, and are facing the tough trade-off between reopening the economy and risks of virus-relapse. Second, emerging market economies are seeing a rapid spread of the disease, beckoning multiple shocks simultaneously. Some suggest that the global recession may last until some point in 2021, and a V-shaped rebound seems not very likely.
I. The third phase of the Covid-19 curve and its new features
The first phase of the pandemic spanned from January to early March 2020, when China took rapid and effective measures to contain the spread of coronavirus and brought the pandemic largely under control. The second phase lasted from March to mid-April, when Europe and the United States became the "epicenters". The third phase started from mid-April, when the advanced economies such as the U.S. and EU are seeing signs of passing the peak, while emerging market economies are still seeing rapid spread. So far the "third phase" has shown two important features.
First, advanced economies are facing a tough trade-off between reopening the economy and risks of virus-relapse.
The United States, Europe and other advanced economies have already or are preparing to ease lockdowns. On April 16, the U.S. federal government announced a three-phase guideline to reopening the economy, leaving the decision to state governments to make. Georgia, Texas, South Carolina, and Tennessee have already reopened their economy. The State of New York, which was hit the hardest by the virus, has also planned to phase out control measures in some areas from May 15. On April 23, the EU rolled out a roadmap for "coordinated exit" from the confinement measures, underlying the importance of a well-coordinated and gradual exit process. Germany and Switzerland started to resume production on April 20 and 27 respectively, while Italy and France plan to relax controls on May 4 and 11.
Rising economic pressure is the driving force behind their decision to restart the economy when COVID-19 situation just began to show signs of improvements. One is the record high unemployment rate. In the U.S., more than 26 million people have filed for unemployment benefits over the past five weeks, wiping out all new jobs created in the past decade. Around 18 million people in Europe have been furloughed or laid off, including about half of private-sector employees in France and about one third of the Irish workforce. Second, a large number of small and medium-sized enterprises have closed. A survey by the U.S. chamber of Commerce in early April found that more than half of small businesses had temporarily closed or were about to close. Energy company Whiting Petroleum (WLL) has filed for bankruptcy, while other large companies such as Neiman Marcus, Lord & Taylor are also on the brink of failure.
But a premature exit decision could risk a second-wave outbreak. As a global pandemic rebounds easily, a widespread second wave will be more costly. The "Spanish flu" broke out in the spring of 1918 and eased slightly in the summer. However, due to lack of strict anti-epidemic measures, the influenza quickly rebounded and reached a second peak in August when the virus mutated, becoming much more fatal, taking the lives of a large number of young adults. A third wave hit in the winter of 1919, with relatively fewer cases of infection and death due to better preparedness in many countries. The three waves resulted in 25-40 million deaths, most of which occurred in the second stage.
Second, the rapid spread of the virus in emerging markets has created multiple pressures.
The pandemic broke out in emerging markets about a month later than in the U.S. and Europe, and is still spreading further. Emerging markets are often densely populated, with poor sanitation and anti-epidemic conditions, and limited medical facilities. If the pandemic went out of control in these countries, the world may risk a new wave of infection. On April 28, 6,411, 3,379, 2,131 and 1,543 new cases were confirmed in Russia, Brazil, Turkey and India respectively, bringing the total confirmed cases in these countries to 94,000, 62,000, 112,000 and 29,000. Numbers for some countries may still be underestimated due to inadequate testing.
Even with the outbreak still unfolding, emerging markets are already feeling multiple economic pressures. First, the contraction of external demand has severely affected export-oriented economies. The WTO has projected a 13-32% drop in global trade of goods in 2020, and export-dependent emerging market economies will bear the front. Trade dependence ratios are over 100% for Vietnam, Malaysia, Thailand and Poland, and over 60% for Mexico, the Philippines and Turkey. Second, the collapse in oil prices has hit the oil exporters hard. The global recession has led to a contraction in demand and a severe imbalance between oil supply and demand. The International Energy Agency estimated that global oil demand fell to the 1995 level in April. As a result, international oil prices slumped, and the WTI crude oil futures prices once entered the negative territory. Third, the hampered movement of people has blowed those emerging markets relying on remittance. According to the World Bank, the share of remittances in GDP for Ukraine, the Philippines, Vietnam and Mexico reached 10.5%, 9.9%, 6.5% and 3.0% respectively in 2019.
Weak economic fundamentals have caused capital flight and financial market turbulence. Since January 21, capital outflows from emerging markets have exceeded $100 billion, exceeding the scale during the global financial crisis. For many countries, the equity, debt and foreign exchange markets were shocked simultaneously. Major stock indices nearly plummeted by half in Colombia and Argentina. Brazil, Indonesia, India and Russia have seen largest equity price slumps this year as much as 48.4%, 45.1%, 38.1% and 35.7%, wider than the 34% drop of the S&P 500 in the U.S. The 10-year T-bond yields in Turkey, South Africa, Brazil and Russia rose by as much as 433, 365, 339 and 244 basis points this year. Panic in the financial market led to a “U.S. dollar shortage", and the currencies of emerging markets were dumped on a large scale. The maximum depreciation of Brazilian Real, South African Rand, Mexican Peso and Russian Ruble posted 28.8%, 26.7%, 26.1% and 24.7% respectively.
In the medium term, emerging markets will face great pressure when the debt service peak arrives. Due to loose financing conditions globally over the years, total external debt of emerging market economies reached 10.1 trillion U.S. dollar in 2018, more than double the amount in 2008, of which 85% are in U.S. dollar. According to UNCTAD, developing countries debt service will peak in 2020 and 2021 when about $2.7 trillions of sovereign debt become due. With decline in income, rise in expenditure, and depreciation of local currencies, some developing countries and low-income countries will be unable to service their debt. Debt relief and restructuring for some countries may be inevitable.
II. A slow global recovery is expected with a low probability of a V-shaped recovery
The global recession may continue into 2021. Since the Great Depression, the average length of a recession in the U.S. is about 14 months while the recession following the subprime mortgage crisis lasted 18 months. Some expect the U.S. to recover in 2021. Economic growth in the Eurozone and Japan already slowed down significantly before the pandemic, so it may take even longer for them to recover. The recession in most emerging market economies may last 18 months. In Latin America, the sovereign debt crisis in the 1980s, a recession normally lasts for 2 years on average in Mexico and Brazil. The economic downturn in Republic of Korea, Thailand and Indonesia continued for 18 months after the Asian financial crisis.
Global growth is very likely to be depressed after a recession, with little chance of a rapid rebound. After a deep recession, recovery is usually slow. After the burst of the bubble in Japan in the early 1990s, sluggish growth continued for an extended period of time. After the subprime crisis in U.S., annual growth was 2.1% in 2010-2013, significantly lower than the 3.3% during 2002-2006. World Bank research shows that global economic growth did not return to its pre-crisis potential level until 2018, 10 years after the global financial crisis.
Many economists estimate that it may take 2 to 3 years for the global economy to return to the pre-pandemic size. Seven years after the Great Depression, the US real GDP returned to its 1929 level. After the subprime crisis, the US real GDP did not exceed the 2007 level until 2011. COVID-19, as a global public health crisis, affects every country in the world in ways different from a financial crisis. This time around, a global recovery led by emerging market economies is not likely to repeat itself. Even assuming relatively rapid growth in countries like China and India, it may still take 2-3 years for global GDP to return to the 2019 level.
III. Mid- to long-term impact of COVID-19 on global economic landscape
In addition to causing a temporary economic shock and standstill, COVID-19 has also brought about profound structural changes, which are reflected in the following aspects.
First, the pandemic has altered the behavior of market players and consequently the economic structure. Consumption behavior and business models are changing. Social distancing may inhibit certain traditional offline service industries for a long time, especially those offered by small and medium-sized firms. However, it will also stimulate new demand and bring opportunities to emerging industries. The number of diners and shoppers will be significantly lower than before the pandemic, but industries such as e-commerce, logistics, and electronic payment are seeing new growth opportunities. Demand for business travel, convention and exhibition, air transportation, hotel accommodation, and etc. has declined, but that for remote office, video conferencing, and telecommunications services has surged. Traditional labor-intensive manufacturing sectors may slow down, but industries such as pharmaceutical R&D, technological innovation, and medical equipment manufacturing will grow rapidly.
Second, trade protectionism and deglobalization may gain momentum. The pandemic has exposed the vulnerabilities related to globalization. On the one hand, cross-border movement of people has accelerated the global spread of the virus. On the other hand, due to the globalization of production, a considerable number of countries rely on imports of medical supplies and equipment such as masks and ventilators. Lack of domestic capacity has added to their difficulty in coping with the health crisis.
Up till now, more than 80 countries and regions have imposed export bans or restrictions on masks, medicines, and medical equipment such as ventilators. Some countries have also restricted the export of food and toilet paper. Meanwhile, now aware of the risk associated with the excessive concentration of the supply chain in a few countries, some countries have begun to bring factories home or diversify production sites. Protectionism and deglobalization might pick up steam in the medium term, undermining global trade and economic growth.
Third, rising debt pressure holds back growth momentum. After the global financial crisis, as the household and corporate sectors spent less to deleverage and improve balance sheets, the private savings ratio in the US rose from 4% to 8%, and the share of private investment in GDP declined from 19.6% to 13.3%. This was a major factor behind the slow recovery. In the COVID-19 pandemic, economic shutdown has led to a sudden stop in income and debt expansion in the household and corporate sectors. In addition, short-term fiscal deficits and government debt have surged as a result of relief and stimulus measures. Many emerging market economies already have sizable debt-service obligations. Those advanced economies that had high public debt levels before the pandemic are under increasing fiscal pressure. Therefore, it is reasonable to expect most countries will face high leverage and debt levels and take a long time to digest the debt overhang. The dynamics of growth will be depressed.
Note:
1. This article was published in Chinese on April 29, 2020.
2. Data as of April 28th, 2020.
