TWN Info Service on UN Sustainable Development (Mar20/03)
16 March 2020
Third World Network

Coronavirus will slow growth to below 2.5%, cost $1 trillion
Published in SUNS #9087 dated 12 March 2020

Geneva, 11 Mar (Kanaga Raja) -- The shock caused by the outbreak of coronavirus (COVID-19) will trigger a recession in some countries and a deceleration of global annual growth this year to below 2.5 per cent, resulting in a hit to global income of around $1 trillion, the UN Conference on Trade and Development (UNCTAD) has said.

In an update to its Trade and Development Report analyzing the economic impact of COVID-19, UNCTAD said that the coronavirus crisis is first and foremost a public health threat, but it is also, and increasingly, an economic threat.

The so-called "COVID-19" shock will trigger a recession in some countries and a deceleration of global annual growth to below 2.5 per cent -- often taken as the recessionary threshold for the world economy, it said.

The resulting hit to global income compared with what forecasters had been projecting for 2020 will be around the trillion-dollar mark.

The bigger question is could it be worse, it asked.

"DEJA VU ALL OVER AGAIN"

At a media briefing on 9 March, Mr Richard Kozul-Wright, Director of the UNCTAD Division on Globalization and Development Strategies, said: "I guess it is deja vu all over again.

"Obviously we were concerned in the last Trade and Development Report that the global economy was already showing signs of weakness and fragility.

"We were looking then for all kinds of potential shocks that could cause a further slowdown in the world economy back in September.

"Obviously, we did not foresee that a health scare in a central Chinese food market would be the source of a serious shock but that is essentially what has happened and obviously we are concerned now about the scale of the likely shock over the coming months and particularly the impact on developing countries where there are some very serious vulnerabilities that could cause significant problems for those countries.

"We envisage a slowdown in the global economy to under 2.5% for this year and that will probably cost in the order of $1 trillion compared with what people were forecasting back in September," said Mr Kozul-Wright.

He noted that the IMF, for example, was forecasting a growth rate this year of around 2.7%. They have since downgraded their forecast as have other leading international institutions.

The real question now is whether that prediction (of a slowdown in the global economy of under 2.5%) will prove optimistic, he said.

In this context, he pointed to the panic situation on 9 March in the financial markets in Asia and subsequently in Europe. The collapse of oil prices has been a contributing factor to that growing sense of unease and panic.

"It is very difficult obviously to predict the course of markets. But what they do suggest is a world that is extremely anxious. There is a degree of anxiety now that is well beyond the health scares which are very serious and concerning. But the economic ramifications of this are obviously causing a major concern," said Mr Kozul-Wright.

He said that "one of our simple messages in this report is that this should not be happening. Ten years after the global financial crisis, the major economies of the world have not been able to establish a robust growth path out of the crisis."

They have piled up debt and relied almost exclusively on monetary policy as the policy of choice to orchestrate a stable recovery and that has not proved sufficient in terms of doing so and they constantly rely on what they call "structural reforms", which is essentially a code word for further rounds of liberalization in labour markets and goods markets as a promise that things will get better if these kinds of measures are enacted.

The evidence is that that simply has not worked. There needs to be a serious change of course both in terms of macroeconomic policy and a far more activist fiscal agenda, said Mr Kozul-Wright.

"Governments need to spend at this point in time to prevent the kind of meltdown that could be even more damaging than the one that is likely to take place over the course of the year in a kind of "doomsday" scenario where the world economy grows at only 0.5%. You are talking about a $2 trillion hit to the global economy."

"For many developing countries that are stretched to the limit in terms of high levels of debt and debt servicing, I think we need to consider a moratorium on debt servicing for developing countries that are particularly vulnerable to a debt shock," he emphasized.

In this context, he highlighted the need for proper mechanisms to handle debt restructuring at the international level to make sure "we have a fair and timely system that can handle precisely these kinds of shocks and their ramifications in developing countries."

ECONOMIC CONSEQUENCES OF COVID-19

According to the UNCTAD report, the duration and depth of the crisis will depend on three variables: how far and fast the virus spreads, how long before a vaccine is found, and how effective policy makers will be in mitigating the damage to our physical and economic health and well-being.

The uncertainty surrounding each of these variables is adding to people's sense of anxiety, which is a fourth variable that will shape crisis outcomes, it said.

The report highlighted two possible readings of the economic consequences of the COVID-19 shock.

The consensus view is that the shock has the potential to upset what was a spluttering but otherwise well-aligned global recovery that had set in during the second half of 2017, with the policy task at hand to nullify the new threats to a renewed economic confidence that had underpinned a string of optimistic growth forecasts for the coming years.

From this perspective, if the outbreak is short-lived, a familiar mix of accommodative monetary policies (ideally limited to cuts in the central bank's rate but possibly involving more unorthodox measures to lower long-term interest rates) and automatic fiscal stabilizers should be sufficient to save the day, with the recovery assuming the  "V" shape that followed, for example, the SARS virus shock of 2003.

If, however, the crisis is more long-lasting, most likely due to disruptions on the supply-side of the economy through crippled production networks and squeezed profit margins, hopes of recovery will hinge on more sustained and coordinated liquidity injections by Central Banks, more active fiscal policies (where space is available) and by renewed efforts to bolster free trade and foreign investment.

UNCTAD said: "The recovery will then more likely assume a U-shape, like the oil shocks of the 1970s, with some serious economic casualties along the way, but with the organizing principles of the world economy preserved... until the next crisis!"

According to UNCTAD, an effective response to the economic consequences of COVID-19 will require not only active and targeted macroeconomic measures, but a series of remedial policies and institutional reforms needed to build a robust, sustained, equitable and climate-friendly growth trajectory that would reduce the chances of a subsequent economic breakdown.

It noted that a spluttering recovery in the North and a general slowdown in the South have been hanging ominously over the global economy since the 2008-9 financial crisis.

It said that combined with heightened market volatility, a fractured multilateral system and diminished room for policy manouevre, the past decade has been marked by a growing sense of economic anxiety.

Behind this lies a more prolonged period of sluggish investment and growth, punctuated by intermittent booms and busts, and underpinned by rapid private debt accumulation, stable prices and low interest rates, which emerged well before the financial crisis in the advanced economies and has characterised much of the rest of the global economy since then.

Sluggish growth and a heightened economic anxiety have been closely associated with an unprecedented rise in inequality, across almost all countries, reflecting a combination of wage suppression, corporate rentierism and wealth concentration.

Financial boom-bust cycles generated by attempts to overcome sluggish growth by monetary easing and financial deregulation has exacerbated the inequality-stagnation nexus by creating waste and distortions on the supply side and reducing potential growth.

According to UNCTAD, over the second half of 2019, and before the outbreak of the COVID-19 crisis, it became increasingly clear that the global economy had entered more troubled waters with slower growth across all regions and a number of economies contracting in the final quarter.

Still, and despite the (self-fulfilling) talk of limited room for policy manoeuvre, there was a widely shared expectation that things would gradually improve in 2020, led by the large emerging economies, with a return to potential global growth by 2021.

The gap between the reality on the ground, which was calling for bold and concerted policy action, and a persistent belief in sound fundamentals and a self-correcting world economy, stigmatized suggestions of a need for bolder policy interventions, deferring instead to monetary tweaking and "structural reforms".

With a percentage point drop in global growth costing some $900 billion in lost income, most forecasts have wiped a trillion dollars of global income for this year and if growth comes in at 1.7 per cent, the cost of the virus will be closer to $2 trillion, said UNCTAD.

THREE CHANNELS OF ECONOMIC DISRUPTION

According to the UNCTAD report, to understand the potential damage from the virus it is useful to distinguish three main channels of disruption: demand, supply and finance.

On the demand side, a combination of declining income, shifting sentiment (fear of contagion) and the absence of a vaccine can be expected to negatively impact private spending, particularly in the service sector, with tourism and entertainment being more affected, especially in activities associated with large public events and catering services.

The increase in uncertainty about the effects of the shock will also delay private investment, but government demand can go up in many countries, to fight contagion through emergency health-assistance initiatives.

Despite the latter, the net demand effect of the COVID-19 shock is generally assumed to be negative in the short run, said UNCTAD.

On the supply side, a sudden stop of manufacturing activity in the most affected regions will cause bottlenecks in global value chains.

Inventory de-cumulation can support supply for a while, but with today's just-in-time globalized production structures, it seems reasonable to assume that the duration and magnitude of the COVID-19 outbreak has already exhausted inventory stocks.

"Such disruption will in turn trigger widespread factory closures for lack of intermediary inputs, even in zones still immune to the virus."

According to UNCTAD, the concern is that exports of both manufactured final goods and of commodity inputs will begin to weaken sharply, further affecting earnings and employment.

Despite all unknowns, a moderate hypothesis is that profits will be initially hit and, if the crisis persists, employment and wages will also decline.

The consequences of disruptions on the supply side can therefore contaminate aggregate demand, reinforcing the first channel (demand) mentioned above, as well as threatening financial stability, said UNCTAD.

It noted that the shock is coming after an unprecedented splurge in borrowing, both public and (particularly) private, with total debt stocks reaching $229 trillion at the end of 2018, over two and a half times global GDP, and up from $152 trillion at the onset of the global financial crisis.

Heavily-indebted commodity exporters are likely to be on the front-line of debt-related economic stresses from the spread of the virus, particularly where foreign exchange reserves have been on a falling trend.

But loans to the corporate sector have been a prominent feature of the post-crisis period, including to firms in emerging economies, and with so-called leveraged loans - characterised by a very high debt to earnings ratio - which have doubled in size over their pre-crisis peak becoming a growing source of concern, particularly in advanced economies.

According to the OECD, the global outstanding amount of non-financial corporate bonds reached US$13.5 trillion, more than double their (real) value at the end of 2008, with non-investment grade issuance reaching 25 per cent of total issuance.

Profit warnings and adjustments in the horizon of returns on investment by highly leveraged firms will likely trigger margin calls, tighten borrowing conditions and increase the risk of a stampede to sell those assets not hit in the first round of heightened risk aversion.

This is likely to be particularly stressful in sectors and for firms caught up in the disruption to supply chains caused by the virus spread, said UNCTAD.

This raises the prospect of a credit crunch in a period of high indebtedness, declining global growth, falling foreign exchange earnings and despite very low interest rates, it added.

Depending on how far this pattern is stretched out and how policies respond, the projected growth and financial forecasts could range from a curbing of financial exuberance through to a deflationary panic to another "Minsky moment" (the sudden collapse of asset values marking the end of the growth phase of a cycle) and subsequent global financial crisis.

The UNCTAD report also said that over the past decade, developing countries have experienced deepening financial and debt vulnerabilities against a backdrop of tepid economic growth, slowing trade, sluggish real investment, including greenfield FDI, and growing income inequalities.

In 2018, the total debt of developing countries - private, public, domestic and external - reached 191 per cent of their combined GDP, the highest level on record.

"As a result, fast growing developing country indebtedness has come with specific features that do not bode well for their ability to withstand another external shock, such as caused by COVID-19."

A major concern is therefore that developing countries, already facing deteriorating debt positions, will not have the reserve cushion to withstand a temporary but possibly pronounced impact of the COVID-19 shock on their real economies.

How large the real COVID-19 shock to debt-ridden developing economies will be, and therefore the extent to which they may or not be able to sit this out by liquidizing their rather meagre reserve cushions, is also a function of their economic integration with China.

According to UNCTAD, data for some 117 developing countries shows that around a fifth of these economies are highly vulnerable to direct impacts of the COVID-19 shock due to a combination of deteriorating debt sustainability (captured by a growing share of public revenues going to service public debt obligations) with high exposure of their economies to trade and wider economic relations with China, including Mongolia, Angola, Gabon, Philippines, Mozambique, Vietnam, Cambodia and Zambia.

These developing economies are closely linked to the Chinese economy through their participation in Chinese- led global value chains and also are reliant on commodity exports to China.

In addition, China has become an important source of financing for developing countries, with loans to emerging market and frontier economies increasing 10-fold (from US$40 billion in 2008 to US$400 billion in 2017).

For countries like Zambia, Mongolia, Ecuador, Venezuela, Angola, Kenya, Pakistan, Sri Lanka, Bolivia and Jamaica, China is now the largest official creditor.

UNCTAD said that recipient countries may be affected in future should the COVID-19 shock to the Chinese economy prove to have prolonged consequences, including for its ability to maintain long-term lending into developing countries.

POLICY RESPONSE

UNCTAD said it should be clear that if a virus outbreak in a food market in Southern China, significant as it is in terms of public health, is causing such global disruption, the most fundamental flaws in the current economic system cannot be any longer ignored.

If the COVID-19 crisis has negative impacts on household and corporate spending, governments can avoid a slump by increasing their own demand, especially for goods and services that aren't in short supply, such as construction and social services.

A temporary boost to emergency health spending - with free care for those affected by COVID-19 - is an obvious response, and the same holds for emergency cash transfers for those hit by a sudden loss of income, especially in the informal economy.

The welcome announcement by the IMF to provide $50 billion to mitigate the effects of the crisis should take the form of grants for the most vulnerable countries, and zero interest loans for others.

Calls for increased public spending always raise fears of profligacy and financial trouble down the road, said UNCTAD.

"These are inappropriate in the face of massive waste for macroeconomic mismanagement (fiscal austerity stunting growth and eroding tax revenues), central banks' bail-outs of private banks, fossil fuel subsidies and the scale of international tax evasion and avoidance."

UNCTAD said that reducing some of this waste would be enough to launch a Global Green New Deal including improvements to public health systems.

Governments who are willing to do "whatever it takes" to stabilize the economy have to increase their spending until private-sector demand and employment return to healthy growth rates.

The lessons of the previous decade are clear: the combination of aggressive monetary policy and timid fiscal interventions leave private investors in a "wait-and-see" limbo and encourage speculative spirits.

In the current crisis, there is also the additional risk that a slow fiscal response could increase the high risk of contagion; governments should give a clear signal that public debt concerns are secondary to public health concerns.

UNCTAD also said that addressing economic inequalities should be a central part of the policy response with a recognition of both short and long-term benefits. Growing inequalities over several decades have eroded most households' spending power since long before the COVID-19 outbreak, and they now pose serious headwinds against a robust post-outbreak recovery.

It said the restrictive business practices of large international pharmaceutical companies should be subject to independent examination to assess any potential obstacles they might pose to addressing the health emergency.

In addition, central banks should do "whatever it takes" in the face of COVID-19 including directing credit for production and employment creation (rather than financial speculation or bailouts), reinforcing public infrastructure and development banks, and providing tailored credit lines for financially distressed SMEs.

At the international level, said UNCTAD, multilateral institutions like the IMF should offer concrete low-cost hedging mechanisms for governments of developing countries to manage exchange-rate risks coming from international shocks, averting the boom-bust financial cycles of recent decades and putting the global economy on a sustainable path.

The financially reckless tendency of reducing corporate tax rates and marginal rates paid by the wealthy will need to be reversed, said UNCTAD.

Reverting to progressive taxation and reducing reliance on Value Added taxes that erode private spending is viable financially, economically desirable and socially fair.

The need to implement the recommendations of independent bodies such as the UN Committee of Experts on International Tax Matters and the Commission for the Reform of International Corporate Taxation have become urgent, it noted.

For many debt-distressed developing countries already spending up to one third of government revenue on debt servicing, an immediate moratorium is merited when a health emergency on this scale is declared, it concluded.
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