Next week’s annual meetings of the IMF and World Bank come at a key inflection point for the global economy as partial recoveries across major economies have stalled and Covid infection rates rising or remaining high in many developed economies and some emerging markets. This post surveys some of the trends I’m watching for at the meetings and some risks ahead. The path forward will remain highly dependent on policy – fiscal policy, which is waning or becoming a drag in many economies and on the management of the virus including any vaccine or therapeutic rollout. The successful management of financial shocks so far – despite rising corporate defaults and unemployment – as well as cross-country divergence in outcomes challenges coordination. That would be a mistake given the significant balance sheet effects from the crisis, which reinforce some of the faultlines that already existed within and between countries.
The recovery so far has already diverged across the globe, with China leading the way out, manufactured goods demand leading services, tech-enabled services leading hospitality, housing outpacing other construction/real estate, governments lifelines playing a key role. Liquidity is ample, avoiding some of the worst case financial crises, but the also adding to inequality of outcomes and associated social pressures. With the health crisis far from over, the divergent outcomes may make it harder to come to consensus, assess the credit market and banking challenges, even as the costs of investment, trade restrictions and other coercive policies prompt greater national or regional focus.
Move beyond 2020, Focus on 2021
While global forecasts are likely to edge up (report less bad recessions) for most countries for 2020 compared to April and July forecasts, in part due to reopenings and the success of fiscal lifelines, officials are likely to signal a tougher outcome for 2021. Part of this may be purely technical as the base effects from 2020 will be lower (less technical bounceback), but mostly it reflects the risk of tapering of fiscal lifelines, a lack of transition to outright productivity enhancing stimulus in the US and some emerging markets and the persistence of weaker demand for in-person services in many economies.
Developed economies have stalled, but the EM Story differentiated (see regional picture below. Across most economies there has been a partial recovery, of as much as 80% of the drop in March, though recovery stalled.
A Year of two parts?
2021 is likely to be a year of two parts, one of weak public sector led growth as credit cycles diverge, followed by some improved expectations when/if a vaccine or effective therapeutics become available. While the timing of an eventual vaccine and therapeutics remains a key driver of the scenario, policy matters, both in addressing the health crisis, managing implementation/execution of any vaccine and broader fiscal policy/incentives across other sectors. Its likely that rollout across major economies will face challenges, suggestion that recovery may lag. This will put more pressure on government fiscal and credit policies to address the interlinked economic challenges. The resurgence of covid in many countries leaves key sectors performing at less than their capacity and the waves of employment loss may still be ahead of us, putting more pressure on countries like the US and some emerging markets that have weaker social safety nets. As a result, expect more business cycle volatility and credit selectiveness.
Some glimpses beyond 2021?
Expect more discussion/concern about post 2021 outlook and risks of inaction on structural reforms, but little willingness to assess long-term sustainability. This in turn makes any long-term financial lifelines more difficult and suggests IFIs may stick to more shorter-term financing with less conditionality. With many mid-term forecasts showing close to trend reversion, I’d see downside risks given the limited economic reforms and some plans for fiscal restraint. Its hard enough to forecast near-term macro outlook, its even harder economically and especially politically to forecast the impact of Covid and other shocks on the medium-term economic outlook. Still, expect the IMF and others to give some guidance on the path beyond 2021, perhaps via some central scenarios. The April economic forecasts, finalized just as much of the global economy was locking down, did not include medium-term forecasts for the first time I can remember. The IMF forecasting team did incredibly difficult work to generate forecasts under uncertainty and it was wise not to make meaningful inferences about the medium-term at that point. Now, looking further ahead will be necessary, especially as the IFIs grapple more with fraught fiscal and debt sustainability (more below). In general, weaker medium-term forecasts as reforms are delayed, fiscal constraints delay infrastructure buildout, many countries experience labor force declines and hysteresis (loss of skills) weakening productivity growth.
Focus on Fiscal policy, but what sort?
Expect to hear a lot about the importance of fiscal response and the risks of early withdrawal. Watch for the IMF to urge more fiscal support and suggest some, especially some oil exporters to be more expansive.
Central banks, especially the Fed, averted a global financial crisis in March, allowing other countries to move into uncharted support including many EM central banks. A crisis did allow more lifelines as countries reclaimed some important policy space both monetary and fiscal. Across EM though, outright stimulus is rare, credit measures more likely, and fiscal restraint more the matter of the day than post-GFC. In General fiscal balance sheets are weaker than pre-GFC, though external balance sheets are either mixed or stronger – itself a symptom of weaker growth.
Global central bankers are singing from the same sheet in calling for more fiscal support – not all their counterpart governments are acting. Even those that have responded, face the challenge of pivoting to more longer-term social and infrastructure support.
Trade and Investment restrictions in play, Managed Trade here to stay
Sovereign funds and government to government investment rise as many companies continue to require govt support, but expect more governments to use their mandates to support key sectors including pharmaceutical supply chains. Similarly, the growing use of export and investment controls for both security and economic goals is likely to persist. European leaders continue to look for ways to boost their resilience to US unilateral measures and their concern about Chinese investments that might strip more European IP, while use of such coercive measures will likely persist in the US even if (or when) there is a change of administration. The persistence of higher tariffs, greater risk of changing such costs and taxes will make it more difficult for businesses to plan.
Avoid premature Celebrations on debt
Back in the Spring, many worried about the risks of a wave of EM sovereign defaults as revenues dropped and spending needs, health and otherwise rose sharply. This hasn’t occurred – with only countries that already began restructuring pre-Covid – Ecuador, Argentina, Lebanon, generally engaged in restructuring. Why not – policy support. First the Fed broad support of asset markets which helped other central banks, including in many emerging markets to be supportive, and then supported first investment grade credits (corporate and sovereign) to retain/regain market access, eventually feeding through to weaker credits. Secondly, IFI support and G20 debt service relief. While the IFIs struggled to keep up with the demand for emergency financing, and some support was late and limited in volume and to the poorest countries, the number of countries receiving help was unprecedented and did help, especially as it came with few if any conditions. Many of the poorest countries not only got this emergency support, but also were able to defer debt service payments. The challenges ahead are significant as some borrowers still fear the pressure on their credit ratings, lending from Chinese policy banks remains on a separate track and the clock is about to start ticking again on debt service for next year. At a minimum, expect an extension of the debt service initiative, but it remains almost as difficult to calculate a long-term debt sustainability as in March, which makes negotiations with public and private creditors that much more difficult.
Avoiding a cascade of sovereign defaults is a good thing, given collateral damage at home and abroad, but there are costs to the sort of fiscal restraint that keeps debt sustainable. In short the can will be kicked further as global credit conditions remain relatively easy. Expect tough decisions on burden sharing especially among private creditors to be put off. Another short-term solution is likely.
Meanwhile, even as sovereign debts have generally been managed – so far – private sector balances have weakened with bankruptcies on the rise across many jurisdictions and a downgrade wave increasing as many entities move into higher yield territory. Many ratings agencies assume a significant increase in defaults among those in high yield.
East Asia and Goods Exporters Generally lead, Service Story split.
China and countries linked to their supply chains, especially in East Asia will likely outperform, both because of the prioritization of production channels, but also because of seemingly more effective covid response. While demand for goods (specially consumer goods) has partly recovered in many jurisdictions, service demand is weaker as restaurants remain at lower capacity, international travel is weak, and commercial real estate underperforms housing. EM Asia, which already had some of the highest rates going into 2020, looks to have the more resilient balance sheets, being more leveraged to global goods demand and benefiting from some improvement in local services demand. India is likely to remain an outlier, with the 2021 recovery failing to bounce as much due to persistent drag from the banking system. Europe’s fiscal measures might provide some support to investment, but expect the slow drag of job losses and reductions in hospitality to lag on overall growth. Implementation of these new projects is also likely to stall.
Americas, and Energy producers to Lag
Latin America, already struggling and lagging behind peers ahead of the covid19 crisis, will likely lag its peers in 2021 as well. Aside from Brazil and to some extent Colombia, fiscal policy has remained constrained, with little scope for temporary expansion. However the region epitomizes a broader trend – improvement in external financing even as fiscal finances weaken. The hit to demand including weaker imports, helped by currency depreciation and drop in buying power has kept external balances from weakening too far. This weaker growth, including limited domestic credit growth, hits activity, boosts inequality, but reduces sovereign default risk.
Oil exporters continue to face some of the toughest times – even though supply cuts have helped stabilize prices. OPEC+ cohesion is set to become more difficult, as serial overproducers like Iraq, Algeria, Nigeria struggle to cut. The drop in output from higher cost more market-sensitive producers including in North America has helped bring some balance – but these countries also have more scope to squeeze their supply chains including oil service companies and their own workforce. The Gulf, CIS and Russia have chosen a mixture of debt issuance, asset drawdowns and fiscal restraint. Saudi Arabia and Russia in particular stand out for their recent plans to hold the line or cut spending next year to reduce external financing. Overall, this will put more pressure on their sovereign funds, increase the importance of their domestic investments. Overall, economic growth is likely to be more driven directly and indirectly by government funds on or off balance sheet. This will also leave less funds for regional players like Egypt, Lebanon, and African targets.
By contrast some of the more demand driven economies in Africa – Senegal, East Africa, who have managed the crisis well will benefit from some relocation of supply chains and links to Asian supply chains, some increased regional demand.