FeaturedInternationalVOLUME 15 ISSUE # 17

The global economy in deep recession

The World Bank, International Monetary Fund (IMF) and other international research organisations have come out with their assessments and estimates of the economic damage caused by the coronavirus.

The world economy is in a state of shock. According to them, the poor will get poorer – and there will be more of them – and even rich countries would struggle to keep businesses and households afloat. In China, where the outbreak began, the bank says the virus impact on the economy will see growth slow to 2.3% this year from 6.1% last year. But that’s if the pandemic doesn’t get worse. If it does, growth could be just 0.1% this year. The bank’s forecasts for other countries in East Asia are similarly grim.

There is a consensus of opinion that there will be a serious impact on poverty, both directly through illness and indirectly through lost incomes. Those in the informal sector will be the hardest hit, and would need the most help. Asia – and in particular China – has been the world’s economic engine for the past decade. The coronavirus pandemic has stopped the growth in its tracks.

The challenges are many and mind-boggling. These include large supply and demand-side shocks, extreme dislocations to the free association and movement of people, and significant upcoming hurdles to meet financial obligations across all sectors of the economy. Dislocations have shaken the interconnected, global production and finance system to its roots. All across the globe, production is impaired as workers are told to stay home to stem the spread of Covid-19. Even businesses that are relatively unaffected may not be able to source inputs to their production.

On the other hand, we are also witnessing a demand shock occurring due to lost household income, resulting from unemployment. Demand has also weakened due to the measures taken to stem the rate of Covid-19 infection, such as the collapse in travel. As regards finance, the extreme dislocations caused by “social distancing” and rapidly falling private-sector demand will inexorably lead to the inability of many households, businesses, non-business private entities, and local governments to meet their obligations. However, hypothetically speaking, where all credit and payments flowed via a few large banks, it might be possible for policy makers to intervene at the critical convergence point to prevent wholesale insolvency, financial disruption, and worse.

Expert opinion is that the global economic output will fall by at least a fifth and perhaps by a third or more during the next few months. Rates of unemployment will jump to between a quarter and a third of the labor force. Although measures will be taken to prevent insolvency, yet business and household bankruptcy will spike and, in all probability, overwhelm the legal system’s ability to process cases and claims. Moratoriums and suspensions on debt restructuring or liquidation would be necessary.

Nominal short and long-term interest rates will remain very low (in some cases negative). The financial system is probably not able to withstand deeply negative nominal interest rates—as seen in Europe or Japan—and the Federal Reserve is reluctant to pursue the option. It means there is a risk that real interest rates will rise if deflation expectations take root. As a result, central banks will use all available tools, including asset purchases, forward guidance, regulatory forbearance, and debt monetization to support growth and to lift inflation expectations. They will do so for as long as may be necessary.

The world economy is in the midst of a deep recession, but the greater risk is a longer-lasting one, compounded by the factors and the inability of policy to respond expediently and effectively. It may be added here that the size of the economic and financial losses corresponds to the speed and effectiveness of controlling the pandemic. This is not just about flattening the curve, at least not in the way that expression is now commonly understood.

The medical and even moral imperative to prevent an overload of the healthcare system has become the short-term supply constraint on the economy. But the length and severity of economic and financial losses depend on whether the pandemic curve can stay flat. The economy (and markets) will test new and deeper lows if rates of infection spike again after restrictions on the movements of people are lifted in the first phase of “curve flattening.”

It is crucial for the economy that durable pandemic curve flattening must ultimately be achieved without the need for social distancing. Some other solution—”herd immunity,” the development of effective vaccines or antivirals, or a different strategy altogether—will be required to end the economic and financial crisis.