Macroeconomic Prospects and Policy Coordination in Asia to Overcome the Challenge of COVID-19

Obviously, the global economy is going through a very difficult period. In the latest Global Economic Prospects report, we looked at the state of the global economy and examined the COVID-19 crisis from different perspectives. We looked at the global, regional, short-term, and long-term implications. We also analyzed what the consequences will be for emerging market and developing economies (EMDEs) under certain scenarios. In today's presentation, I am going to focus on three points: first, the short-term implications of the pandemic; second, the long-term implications of COVID-19; and third and finally, policy priorities.

In the short-term, we are expecting a very serious recession; the deepest and most synchronized global recession episode since the Second World War. EMDEs are going to experience their first ever recession since the war. As bleak as the prospects look, further deterioration is possible.

The growth implications are quite serious. We are expecting weaker potential output, weaker investment and weaker productivity growth over the long term because of the pandemic. Policymakers need to address the immediate health crisis. Policies should of course be coordinated globally.

The global economy has not experienced a crisis like this over the past century. It has already translated into a serious global recession. The Global Economic Prospects report published in June shows that this year the global economy will contract by about 5.2%. Advanced economies will contract 7% and see growth decline relative to last year by more than 8 percentage points. EMDEs will experience outright recession with about a 2.5% contraction. When it comes to regions, the story is also quite difficult to narrate. Almost all regions will see contractions, except East Asia and the Pacific. Latin America and the Caribbean—a region that depends on trade, commodities, tourism revenues, etc.—will see a collapse in every factor I mentioned. This region will see contraction of more than 7% this year; the region's deepest contraction in the past 120 years. Other regions—Europe and Central Asia, and Sub-Saharan Africa, for example—will feel the impact of the health and economic crises in different ways but will all see serious recessions. In the case of South Asia, a region with no oil exporter, there will be a contraction of about 2.7% and the region will experience a serious recession. Almost all regions will see growth resume next year.

In the case of East Asia and the Pacific, the story is a bit more optimistic for the region as a whole, partly because of China's recovery. China is the only major economy we are expecting to deliver growth in 2020. That growth is now around 1%, but recent developments suggest that this number could surprise on the upside. The rest of the region will see its first recession since the 1997-1998 East Asian Financial Crisis. The region has handled the pandemic reasonably well so far, although some countries have recently begun to see increasing case numbers. In China, activity recovered in the second quarter and growth resumed. Manufacturing activity is now expanding. For other EMDEs in the region, the high frequency indicators still indicate a recession, and difficult recoveries lie ahead. China had the pandemic earlier and was able to contain it, so it is recovering earlier.

Fourteen global recessions have occurred since 1870. Each has seen contraction in per-capita global income. The present global recession is the deepest episode since the Second World War and the fourth deepest since 1870. The other three episodes were 1914, 1930-32 and 1945-46. Two were associated with world wars. If you take out those two, the 2020 episode is the most harmful and deepest over the past 150 years since the Great Depression. This episode is also exceptional in being the only one triggered purely by a pandemic. It is also the most synchronized in that it will see the largest ever share of economies experiencing contractions in per-capita income this year. Even at the height of the Great Depression the share experiencing contraction was lower than what we will see this year.

Two of the risks we face are critical. The first is a more protracted pandemic. Advanced economies—with the exception of the US—have basically been able to control the pandemic. In EMDEs, the pandemic is still in full force. Some regions are seeing more daily new cases than others. Latin America and the Caribbean and the South Asian region, etc. still have rising caseloads, and in terms of testing capacity, etc., these regions are disadvantaged relative to the advanced economies. We may still be underestimating the gravity of the pandemic in these regions. In East Asia and the Pacific, excluding China, the numbers stabilized but have been rising.

The second risk is that deep recessions are often associated with large output losses that persist for an extended period of time. When you have a recession, uncertainty increases, confidence collapses and investment declines dramatically. In the present case, we also have a big problem with human capital accumulation. Children are unable to go to school, curtailing their ability to acquire the skills they need. High levels of unemployment will also result in a loss of skills. After these types of episodes, the economy does not return to pre-crisis trend levels. The world economy never recouped the losses associated with the 2009 global recession. This global recession is much deeper and the losses are likely to be with us for a long time. The ability of economies to generate growth will be diminished. There will be declines in potential output associated with the collapse in investment and human capital, and there will be, of course, the types of fiscal and financial challenges I am going to discuss.

Long-term growth prospects have been getting downgraded for an extended period of time. Even before the pandemic, 2019 saw the lowest growth for the global economy since the global financial crisis. One measure of the prospects for long-term growth is the ten-year-ahead global growth forecasts, which suggested reasonably good growth in the 2000s. In 2000, the forecast for growth ten years out was around 3.5%. In 2010, this number was 3.3%, and the long-term forecast began getting downgraded this year. In other words, pessimism has increased about the global economy's ability to generate growth over the long term. It declined from 3.3% to 2.9% in 2014. In 2018, it was 2.5%. That number is now around 2.4%.

Financial stress could be triggered by already very high debt levels that will only increase in the coming years. Prior to the crisis, we already had record levels of debt in EMDEs. This year we will see very large increases in deficits in EMDEs and in Low Income Developing Countries (LIDCs). In EMDEs and LIDCs, government debt levels will significantly increase. Even if interest rates remain low, it will be difficult for these economies to roll over their debt obligations unless they can generate sufficient growth.

The short-term policy priority is to deal with the immediate health and economic crises by supporting healthcare systems and helping vulnerable groups and viable corporate entities. At the global level, policies need to be coordinated to ensure a smooth flow of critical goods. The global community needs to provide debt relief for the poorest EMDEs. At the recommendation of the G20, international financial institutions have been implementing a suspension initiative for low-income countries to mitigate the impact of the pandemic and let them allocate their expenditures to the immediate health service needs. We should all acknowledge that what these countries did in terms of fiscal and monetary policy was necessary. They were large-scale interventions but they were absolutely critical to stabilize economies and get ahead of the health crisis.

As soon as the crisis abates, policymakers need to put policies in place that promote sustained, long-term growth. It is critical that they improve the fiscal and monetary policy frameworks, enhance debt and investment transparency to attract new investment and design robust financial regulation and bankruptcy procedures. The pandemic should be a teachable moment on the importance of reforms and laying a foundation for stronger growth in coming years. At the global level, it is critical for countries to coordinate policies to address global challenges, including those related to public health and information transparency. Climate change risks should be taken very seriously. We have learned that even low-probability risks can materialize and trigger a global recession.

Commentator:
I agree that we have to face reality and conceive of the future constructively. My questions will attempt to recontextualize Ayhan's comments for East Asia and the Pacific. First, we have to remove the restrictions on the domestic and international movement of people but we are now realizing that it may take a long time to do so. In light of this, the models need to be reset and therefore, should the forecast be revised downward? In addition, we are thinking about a second wave of the pandemic and this may change the forecast, particularly for 2021. Also, up to this point, we have mostly been discussing the real economy, but what about the possibility of a collapse in the financial sector or asset markets? All of these issues are related to model setting, so I am interested to hear more about these issues.

Secondly, I would like to offer an interpretation of your talk related to East Asia and production networks. How will this crisis affect production systems and logistics networks? So far, production systems and logistics networks seem almost intact. Will the next major difficulty be a demand shock or do you expect a substantial erosion of the production systems? This is important for East Asia and the Pacific. Also, what is the possibility of a macroeconomic crisis in emerging markets, particularly in East Asia and the Pacific? The availability of foreign currencies may be a trigger, as well as long-term fiscal health. What types of issues should we be especially careful about, particularly on the macro side, in East Asia and the Pacific?

Finally, turning to policy, what should the priorities be for East Asia and the Pacific? What are the major issues in East Asia and the Pacific related to enhancing debt and investment transparency? Given the expected size of the impending shock, what should our main areas of concern be? In terms of coordinating policies globally, I think the current situation is quite different from the global financial crisis, when we had pretty strong leadership from the US. This time, we do not really see this. What could be an effective move from the viewpoint of East Asia? Can we strengthen regional initiatives? How can we approach global forums to emphasize the need to strengthen this kind of coordination?

KOSE:
The first issue you mentioned relates to the impact of the fact that it may take more time to remove these restrictions than originally thought. The second question is what impact a massive second wave would have on the forecast, and the likelihood of the collapse of the financial sector. These are very serious risks. Our baseline forecast— 5.2% contraction at the global level—assumed that after June, the global economy would start basically normalizing in terms of the extent of the mitigation measures. In many parts of the world there are signs of recovery, but at the same time, the pandemic is still in full force. Policymakers are trying to calibrate their policies to ensure continued economic activity while trying to control the pandemic. These forecasts are made with a very large degree of uncertainty because of the possibility of a more protracted pandemic and/or mitigation measures if we don't have a vaccine in the coming months. If that scenario materializes, and we see a protracted pandemic and financial stress in some economies, then of course we are looking at a much worse outcome in terms of growth this year and possibly next year. We looked at a more protracted pandemic scenario and the possibility of a second wave that also could trigger financial stress episodes in different parts of the world. If that materializes, our growth forecast worsens to -8% globally. In the case of advanced economies, I mentioned a baseline of -7%, which would decline to -10%. The -2.5% that I mentioned for EMDEs would worsen to -5%. We are already in July. I'm hoping that this bad scenario does not materialize, but of course we are worried about uneven recovery as well. If you would like to see global broad-based turnaround in activity, you need to see a global broad-based decline in numbers. We are not there yet.

In terms of your second point which is the interpretation, is this crisis being triggered by demand shock or supply shock? In this case, we have both. We have a clear supply shock because we are asking people not to work. And then we are creating a demand shock as well because people are unable to consume in the way they used to consume. In the context of global trade and supply chains, this crisis for many countries is a wake-up call to think about how they are integrated into the global supply chain. We may see shortening of these chains or countries trying to diversify their suppliers rather than relying on just one country. All of these are continuing to evolve, but there are serious supply chain disruptions. The supply chains are still present, but this year, for example, we are expecting to see a historic contraction in global trade of about 13.4%. This episode will leave a lasting mark on global trade flows and global supply chains. Even before the crisis we saw weakening global trade flows: global trade growth was declining and global supply chains were not growing as they formerly had been.

In relation to your question, "What would a macroeconomic crisis in emerging economies and in East Asia and Pacific look like?" The debt problem needs to be a focus of efforts. In 2019, global debt was around 83% of GDP. In 2021, the current projection suggests global debt levels will reach 103% of global GDP. In the case of emerging markets, we will see close to a 24% increase. The challenge for EMDEs is to calibrate their policies to ensure that they have a medium-term strategy to deal with the debt problem and large fiscal deficits. The East Asia and Pacific region faces challenges but is in a better position than some others. Policy frameworks in many East Asia and Pacific countries have improved significantly over the years, especially since the Asian financial crisis. Since the global financial crisis, more serious attention has been given to stability in the financial sector and in corporate balance sheets. This does not necessarily mean that the region doesn't have problems. Some countries still have sizable sovereign and corporate debt levels that need to be carefully monitored. It's going to be important for this region to continue getting the benefits of global trade and global financial flows that it has so long enjoyed. Another risk we need to monitor is the trade tensions in the region which have the potential to escalate further in the coming months.

Enhancing debt and investment transparency will be more critical in some countries than in others. We are basically seeing downgrades in some countries' credit ratings. These countries need to step up their efforts to put their financial houses in order. With regard to coordinating policies globally, this crisis is a clear case where policymakers need to understand the necessity of coordinating their policies. Serious threats to global public health require information transparency, and information sharing by all countries is critical to get ahead of these types of threats and ensure they are contained and don't turn into pandemics.

Q: Are there any long-term policies that should be added to the policy toolbox going forward to improve future responses?

KOSE:
Previous crises saw serious debate about the nature and size of government intervention, whereas in this case we saw serious, rapid responses in many countries. That is a welcome development. After bringing the pandemic under control and bringing economic activity back to reasonable levels, policymakers will need to think about how to end these extraordinary accommodation measures. They will need to be very careful to make sure that the economy is stabilizing before lifting support. This crisis has demonstrated the importance of a resilient healthcare system that can protect the most vulnerable members of a society. Hopefully policymakers will use this as a teachable moment and improve their health care systems and social safety nets. Some countries are in much better shape in terms of their response to the crisis while others really struggled because of their inability to provide basic health services due to a lack of beds and medical personnel. All of these things will require serious interventions in coming years. Some countries—especially low-income countries—simply lack the resources. This means that the global community needs to provide the necessary support. It's clearly no longer possible to contain these problems within borders. Countries can try to turn their backs on issues in other countries, but sooner or later they become global issues.

This episode has complicated childhood education. This can have a cascading impact, eroding human capital at critical early ages. It will be important to take measures that give children ample opportunity to make up the ground they lose. Digital technologies will be critical—providing the necessary access to technology is of utmost importance nowadays. Some households only have one cell phone or one computer for multiple children. We need to find ways to get these households the necessary equipment so children can at least get their education while staying away from school. This boils down to the bigger challenges of inequality of opportunity that policymakers will need to consider in the coming months. We can't quickly fix these issues, especially in low-income countries. They will require serious resources and reforms. Every crisis brings significant pain but also significant opportunities. We hope that this crisis is used as an opportunity to transform how we think about education by broadening the base of education and providing high-quality education digitally.

Commentator:
I think the report was very successful in quantifying the seriousness of this crisis and in identifying the short- and long-term risks in emerging economies.

KOSE:
Obviously, this is a difficult period and we should not sugarcoat anything. We should be frank in our assessment and hope that it turns out to have been overly pessimistic. But I think we should all understand the opportunity here. Before this crisis, we were thinking that we would have a technological transformation within the coming decade. In what may be a silver lining, this episode has probably greatly accelerated that. If we are able to use technology effectively and ensure that a larger number of people around the world—especially the most vulnerable segments of society—can participate in using technology, this crisis may have a better outcome. We could see a productivity surge accompanied by much better growth prospects and forecasters may become more optimistic about the future rather than increasingly pessimistic. Whenever these crises take place, history is watching. How policymakers respond will determine how the history of this episode is written. Let's hope that policymakers respond in the way we are hoping and that this crisis is used as an opportunity for technological transformation.