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The macroeconomic impact of Covid-19

Since the COVID-19 outbreak was first diagnosed, it has spread to over 190 countries. The pandemic is having a noticeable impact on global economic growth. Estimates so far indicate the virus could trim global economic growth by as much as 2.0% per month if current conditions persist. Global trade could also fall by 13% to 32%, depending on the depth and extent of the global economic downturn. The full impact will not be known until the effects of the pandemic peak.

The economic damage caused by the COVID-19 pandemic is largely driven by a fall in demand, meaning that there are not consumers to purchase the goods and services available in the global economy. This dynamic can be clearly seen in heavily affected industries such as travel and tourism. To slow the spread of the virus, countries placed restrictions on travel, meaning that many people cannot purchase flights for holidays or business trips.

This reduction in consumer demand causes airlines to lose planned revenue, meaning they then need to cut their expenses by reducing the number of flights they operate. Without government assistance, eventually airlines will also need to reduce lay off staff to further cut costs. The same dynamic applies to other industries, for example with falling demand for oil and new cars as daily commutes, social events and holidays are no longer possible.

As companies start cutting staff to make up for lost revenue, the worry is that this will create a downward economic spiral when these newly unemployed workers can no longer afford to purchase unaffected goods and services. To use retail as an example, an increase in unemployment will compound the reduction in sales that occurred from the closure of shopfronts, cascading the crisis over to the online retail segment (which has increased throughout the crisis). It is this dynamic that has economists contemplating whether the COVID-19 pandemic could lead to a global recession on the scale of the Great Depression.

On April 29, 2020, Federal Reserve Chairman Jay Powell stated that the Federal Reserve would use its “full range of tools” to support economic activity as the Commerce Department reported a 4.8% drop in U.S. GDP in the first quarter of 2020. In assessing the state of the U.S. economy, the Federal Open Market Committee released a statement indicating that, “The ongoing public health crisis will weigh heavily on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.”

The Organization for Economic Cooperation and Development (OECD) lowered its forecast of global economic growth by 0.5% for 2020 from 2.9% to 2.4%, based on the assumption that the economic effects of the virus would peak in the first quarter of 2020. However, the OECD estimated that if the economic effects of the virus did not peak in the first quarter, which is now apparent that it did not, global economic growth would increase by 1.5% in 2020. That forecast now seems to have been highly optimistic. In addition, the IMF estimated that the global economy could decline by 3.0% in 2020, before growing by 5.8% in 2021; global trade is projected to fall in 2020 by 11.0%.

As concerns U.S., in a sign of growing concern over strains in financial markets and economic growth, the Federal Reserve has taken a number of steps to promote economic and financial stability involving the Fed’s monetary policy and “lender of last resort” roles. Some of these actions are intended to stimulate economic activity by reducing interest rates and others are intended to provide liquidity to financial markets so that firms have access to needed funding. In announcing its decisions, the Fed indicated that “the COVID-19 outbreak has harmed communities and disrupted economic activity in many countries, including the United States. Global financial conditions have also been significantly affected.

To date, European countries have not had the kind of synchronized policy response they developed during the 2008-2009 global financial crisis. Instead, they have used a combination of fiscal policies and bond buying by the ECB. Individual countries have adopted quarantines and required business closures, travel and border restrictions, tax holidays for businesses, extensions of certain payments and loan guarantees, and subsidies for workers and businesses.

The economic effects of the pandemic reportedly are having a significant impact on business activity in Europe, with some indexes falling farther then they had during the height of the financial crisis and others indicating that Europe may well experience a deep economic recession in 2020. France, Germany, Italy, Spain, and the UK reported steep drops in industrial activity in March and April 2020.

The impact of the price war and lower energy demand associated with a COVID-19-related economic slowdown is especially hard on oil and gas exporters, some of whose currencies are at record lows. Oil importers, such as South Africa and Turkey, have also been hit hard; South Africa’s rand has fallen 18% against the dollar since the beginning of 2020 and the Turkish lira has lost 8.5%. Some economists are concerned that the depreciation in currencies could lead to rising rates of inflation by pushing up the prices of imports and negatively economic growth rates in 2020.

Initial efforts at coordinating the economic response to the COVID-19 pandemic across countries have been uneven. Governments are divided over the appropriate response and in some cases have acted unilaterally, particularly when closing borders and imposing export restrictions on medical equipment and medicine.

An emergency meeting of G-7 (Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States) finance minister fell short of the aggressive and concrete coordinated action that investors and economists had been hoping for, and U.S. and European stock markets fell sharply after the meeting. However, the leaders of the G-7 countries held an emergency summit by teleconference to discuss and coordinate their policy responses to the economic fallout from the global spread of COVID-19.

COVID-19 could trigger a wave of defaults around the world. In Q3 2019—before the outbreak of COVID-19—global debt levels reached an all-time high of nearly $253 trillion, about 320% of global GDP. About 70% of global debt is held by advanced economies and about 30% is held by emerging markets. Globally, most debt is held by nonfinancial corporations (29%), governments (27%) and financial corporations (24%), followed by households (19%).

Debt in emerging markets has nearly doubled since 2010, primarily driven by borrowing from stateowned enterprises. High debt levels make borrowers vulnerable to shocks that disrupt revenue and inflows of new financing. The disruption in economic activity associated with COVID-19 is a wide-scale exogenous shock that will make it significantly more difficult for many private borrowers (corporations and households) and public borrowers (governments) around the world to repay their debts. COVID-19 has hit the revenue of corporations in a range of industries: factories are ceasing production, brick-and-mortar retail stores and restaurants are closing, commodity prices have plunged (Bloomberg commodity price index—a basket of oil, metals, and food prices—has dropped 27% since the start of the year and is now at its lowest level since 1986), and overseas and in some cases domestic travel is being curtailed.

Households are facing a rapid increase in unemployment and, in many developing countries, a decline in remittances. With fewer resources, corporations and households may default on their debts, absent government intervention. These defaults will result in a decline in bank assets, making it difficult for banks to extend new loans during the crisis or, more severely, creating solvency problems for banks. Meanwhile, many governments are dramatically increasing spending to combat the pandemic, and are likely to face sharp reductions in revenue, putting pressure on public finances and raising the likelihood of sovereign (government) defaults. Debt dynamics are particularly problematic in emerging economies, where debt obligations denominated in foreign currencies (usually U.S. dollars).

By Domenico Greco

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