- Whither the global economy and financial markets?
The International Monetary Fund (IMF) recently published two reports a) ‘World Economic Outlook’ (WEO) titled ‘The Great Lockdown’, and b) ‘Global Financial Stability Report’ (GFSR) titled ‘Global Financial Stability Overview: Markets in the Time of COVID-19’. Both these April 2020 reports are dedicated editions of IMF’s flagship reports to assess the current and future directions of impact of covid-19 on the global economy and its markets; while full reports of both WEO and GFSR will follow in May 2020.
The current report of the WEO brings forth a very grim situation of the global economy as a result of the pandemic, indicating ‘It is very likely that this year the global economy will experience its worst recession since the Great Depression, surpassing that seen during the global financial crisis a decade ago. The Great Lockdown, as one might call it, is projected to shrink global growth dramatically. A partial recovery is projected for 2021, with above trend growth rates, but the level of GDP will remain below the pre-virus trend, with considerable uncertainty about the strength of the rebound. Much worse growth outcomes are possible and maybe even likely. This would follow if the pandemic and containment measures last longer, emerging and developing economies are even more severely hit, tight financial conditions persist, or if widespread scarring effects emerge due to firm closures and extended unemployment.’
WEO expects that the global economy will post a real GDP growth of -3 percent in 2020. At the same time, in advanced economies, the IMF expects the impact will be even more severe where the real GDP growth is likely to be -6.1 percent for 2020, while for emerging markets and developing economies (EMDE), IMF forecasts, will be -1 percent. At the same time, WEO points out that in case the pandemic recedes in the coming months, and with it the lockdowns ease out, then optimistic prospects are likely to be possible for growth in real GDP, in terms of all three regions, whereby for 2021 it is expected to be 5.8 percent globally, 4.5 percent in advanced economies, and 6.6 percent in EMDE. That being said, this optimistic view is only one scenario of IMF, while WEO brings forth even grimmer possibilities depending on the stickiness in terms of comeback attacks of covid-19, and with it, the tightening of the lockdowns.
Oil-importing economies have generally fared better, but lower remittances, reduced external funding availability, and lower external demand may outweigh the positive impact of lower oil prices
Moreover, regarding Pakistan specifically, a recent report of IMF, titled ‘Request for purchase under the rapid financing instrument’, points out ‘Pakistan is facing unprecedented health and economic shocks from the rapid propagation of the Covid-19 outbreak. Growth is expected to contract sharply, by -1.5 percent in FY 2020, as the economy is buffeted by demand and supply shocks. Exports and remittances are expected to decline sharply, which together with a temporary loss of market access, create an urgent balance of payments (BoP) need. In addition, public finances are expected to come under significant pressure from the sudden increase in health- and mitigation-related expenditures as well as the decline in tax revenues.’
With regard to the financial markets in the wake of the covid-19 crisis, GFSR points out ‘This crisis presents a very serious threat to the stability of the global financial system. Following the COVID-19 outbreak, financial conditions tightened at unprecedented speed, exposing some “cracks” in global financial markets. Market volatility spiked and borrowing costs surged on expectations of widespread defaults. Signs of strain emerged in major funding markets, including the global US dollar funding market. Historically large capital outflows exacerbated domestic shocks in emerging market economies. These developments have raised the risk that the inability of borrowers to service their debts would put pressure on banks and cause credit markets to freeze up. A prolonged period of dislocation in financial markets could trigger distress among financial institutions, which, in turn, could lead to a credit crunch for nonfinancial borrowers, further exacerbating the economic downturn.’
An important policy focus of State Bank of Pakistan (SBP) for many months has now been on building the amount of portfolio investment, but in the wake of covid-19 crisis, emerging markets overall have seen a significant outflow of portfolio flows, and GFSR calls this ‘a big reversal’, and points out ‘Portfolio flows to emerging markets have experienced a very sharp reversal. Nonresident portfolio outflows from emerging markets reached a record level in dollar terms (more than $100 billion since January 21) and the highest ever relative to their aggregate GDP in the first quarter of 2020. Outflows from Asia and from equity markets were initially particularly strong, given their sensitivity to the growth outlook. But outflows from bond markets have become significant more recently.’
Overall, with regard to the impact of the pandemic on emerging markets, GFSR indicates ‘An unprecedented combination of external shocks (COVID-19 pandemic, oil price decline, increased global risk aversion, and a prospect of global recession) led to a broad-based sell-off in emerging and frontier markets. Emerging market equity prices have fallen by about 20 percent, on net, since mid-January despite the most recent rebound. Currencies of commodity-producing economies (such as Brazil, Colombia, Mexico, Russia, and South Africa) tumbled by more than 20 percent against the US dollar in the first quarter of 2020. Currencies of other emerging markets have been relatively less affected… But for some weaker economies, the current shock was particularly severe as the number of distressed sovereign issuers (those with spreads over 1,000 basis points) rose to record levels. Oil-importing economies have generally fared better, but lower remittances, reduced external funding availability, and lower external demand may outweigh the positive impact of lower oil prices.’
