Global action needed if world want to avoid 'Great Depression'

The G20 Extraordinary Leaders' Summit on COVID-19 was held on March 26. President Xi Jinping called on G20 members to enhance international macroeconomic policy coordination to counteract the negative impacts and prevent the world economy from falling into a recession.

The G20 counties are injecting over $5 trillion into the global economy as part of targeted fiscal policies, economic measures and guarantee plans to counteract the social, economic and financial consequences of the virus outbreak.

Rising pressure on global recession

The novel coronavirus is highly contagious and its spread worldwide has been rapid. As of March 30, more than 610,000 people were infected in about 200 countries and regions outside China. The death toll exceeded 33,000 globally. Europe and the United States have become the new epicenters of the disease. Confirmed cases in the US and Italy surpassed that of China. Judging from the current situation, the global outbreak will continue, with speed and intensity exceeding earlier expectations.

The pandemic has hurt the real economy in an increasingly forceful way, which is reflected in the following four aspects.

First, consumption and service industries are hit hard and aggregate demand has shrunk sharply. Shop closures and halt of public activities shattered the service industries and consumption. The service industry accounts for 68 percent of the global economy. With a service sector larger than the global average, the damage in Europe and America may be even larger. The shock has materialized in certain sectors. Boeing and other companies have shut down certain factories for a limited period. Marriott hotels have announced suspension and reduction of top executive salaries and furloughed thousands of employees across the globe.

Second, aggregate supply has dropped sharply as the epidemic has halted production activities and normal operations of firms. The pandemic has affected almost all production facilities across the global value chain. In the severely affected areas in Europe and the United States, production of non-essential goods and services has come to a standstill. Production activities involving human interactions have been suspended, and international business activities have ceased due to travel bans. The impact of the epidemic will get transmitted worldwide through the global value chain, and global economy has wavered.

Third, employment pressure has intensified rapidly. Close-down of shops and factories have put the labor market under strain. The International Labor Organization projected on March 18 that around the world about 25 million people may become jobless due to the pandemic. On March 26, the US Labor Department reported a surge in initial jobless claims to 3.28 million, exceeding 700,000 for the first time since statistics were available and surpassing the peak of 667,000 recorded during the global financial crisis.

Fourth, market expectations have deteriorated. PMIs of major advanced economies plunged. In March, the Manufacturing and Service PMI was 49.2 and 39.1, respectively in US, 44.8 and 32.7 in Japan, and 48 and 35.7 in the UK. The Eurozone Composite PMI tumbled to an all-time low of 31.4. Those numbers all fell below the 50-points threshold that separate expansion from contraction.

As the pandemic’s impact on the global economy escalates, international organizations and market institutions lowered their projection of global growth in three rounds. The first round was in late February when it was generally believed that the epidemic would have a short-term impact on China and a limited impact elsewhere. The IMF revised the projection of global growth in 2020 from 3.3 percent to 3.2 percent on February 22, downward by just 0.1 percentage point from its January forecast. The second round of adjustment came in early March as a result of global spread of the epidemic. The OECD released, on March 2, a projection of global growth rate between 1.5 percent and 2.4 percent. The Institute of International Finance (IIF) projected a growth of one percent on March 5. The third round came after a global pandemic was declared. The consensus was that the world economy would fall into recession this year. The IMF projected growth to be in negative territory in 2020 and the contraction may be even larger than that seen in the global financial crisis. On March 23, the IIF revised its forecast of global growth from 1 percent to a negative 1.5 percent (-1.5 percent).

Financial market volatility

There was panic selling of all asset classes in financial markets. Between March 9 and March 21, circuit breaker was triggered in equity market in United States, Canada, Brazil, Korea, India, Indonesia, Thailand, Kuwait, and in some cases for several times. Between February 21 and March 23, the Dow Jones Industrial Average declined 35.9 percent, and the stock indices of Britain, France, Germany, Italy, Brazil and other countries all fell about 40 percent. There was panic selling of traditional safe-haven assets such as gold, in addition to risky assets such as stocks.

The pandemic has caused liquidity squeeze and US dollar shortage. The US dollar index rose sharply by 8.9 percent from 94.6 on March 9 to 103 on March 20. The euro, yen, and pound sterling depreciated against the US dollar by 6.3 percent, 8.0 percent, and 12.0 percent, respectively. The yuan lost 2.4 percent against the US dollar, the smallest fall among major currencies. In order to ease the dollar shortage, the US Federal Reserve enhanced the existing currency swap lines with the European Central Bank and four other central banks, and established dollar liquidity swap arrange lines with nine additional central banks.

The pandemic heightened capital outflow and debt servicing pressures of emerging markets. Capital outflows in emerging economies since the outbreak reached a record high of $83 billion, due to uncertainties from the pandemic, the plunge in oil prices and financial market volatility. Some heavily indebted countries have difficulties in interest and principal payment. Almost 80 member countries have requested IMF assistance.

The IMF announced that it stands ready to use its $1 trillion lending capacity to support countries in responding to the pandemic, with debt service relief for least developed countries (through Catastrophe Containment and Relief Trust), potentially enhanced access to its emergency facilities, and future additional options to help members with foreign exchange shortages. The World Bank also announced a $14 billion package. On March 25, the World Bank and the IMF jointly called on all official bilateral creditors to suspend debt payments from the poorest countries that request forbearance.

Recent global financial market volatility can be attributed to the negative impact of the pandemic on the real economy, lack of preparedness of the financial market for such shocks and the resulting panic. As developed economies rolled out market stabilization measures, financial market sentiment improved. However, amid intensified impact of the pandemic on the real economy, investors’ confidence remains weak, as further negative news may still trigger market turmoil.

We need to be alert that there are some potential risks in the current global financial system. First, elevated for years, stock prices in developed countries are under pressure of substantial adjustments. Second, the global liquidity is generally ample, but with structural shortage. Under the panic, liquidity shortage in some part of the market may cause cross-market risk contagion. Third, impacted by the outbreak, shrinking profitability and the already high corporate debt may lead to a rise in non-performing loans of banks and corporate bonds defaults.

Policy response

Across the world, monetary policy responses have been rapid and aggressive. Between March 3 and 26, about 40 central banks cut interest rates in a total of more than 50 moves. The US Federal Reserve cut interest rates by 150 basis points, returned to "lower zero bound", and launched unlimited quantitative easing. Central banks in Europe, Japan, the UK and other countries have significantly increased their easing. In addition, central banks and monetary authorities also increased liquidity support and launched targeted support tools.

For major economies, fiscal policy response was not as rapid or powerful as monetary policy. The US announced two rounds of fiscal package of $8.3 billion and $100 billion respectively on March 6 and 18, and launched the third round of $2.2 trillion on March 27. On March 23, the euro zone finance ministers agreed to temporarily relax the fiscal deficit rules of Maastricht Treaty, i.e. “fiscal deficit below 3 percet of GDP, public debt to GDP ratio no more than 60 percent”, to increase the flexibility of fiscal policy of member countries. In some economies, the space for large-scale fiscal response is limited due to high level of government debt.

In some economies, the policy responses at the initial stage failed to stabilize the market as expected, mainly because monetary policy responses, however rapid and aggressive, could neither contain the spread of the virus nor remove the uncertainties of the pandemic. Tougher virus containment measures and more aggressive fiscal policy support are needed to rebuild market confidence. Such measures were not as forthcoming as monetary policy responses in some countries due to the domestic political environment. At the same time, the pace and intensity of central bank measures overwhelmed the market.

Currently, G20 and other major countries have stepped up measures of pandemic containment and macroeconomic policies to mitigate the impact of the pandemic on the household, the real economy and the financial system. As the advanced economies are pulling out comprehensive response packages, their financial markets have improved in recent days. Some developing countries have limited capacity in disease treatment and pandemic prevention, constrained by inadequate medical system, and limited policy space to fend off downward economic pressures and financial market volatility. Faced with graver challenges, such developing economies need more attention and support from the international community.

It should be noted that some opinions from the market compared the impact of the pandemic with that of the "Great Depression” (1929-1933). Though too pessimistic, such opinions reminded policymakers all over the world to be vigilant about the risks, even from the occasions with a minimal probability.

A recession is generally defined as a “Great Depression” when the economic recession continues for more than 18 months, the GDP declines by more than 10 percent, and the unemployment rate of higher than 25 percent at the same time. The past century only saw Great Depression once, i.e. in 1929-1933. The "Great Recession” after the financial crisis in 2008 did not meet the standards of a "Great Depression".

Some institutions believe that the short-term economic recession this time may be worse than that in 2008, but it remains to be seen whether the duration, output decline and unemployment can meet the definition of a "Great Depression”. In a scenario where authorities of all countries work together to fight the pandemic, effectively contain its spread and support the global economy, the impact of the pandemic on the global economy could be largely mitigated.

However, if the pandemic spins out of control, the real economy may deteriorate with the outbreak of potential financial risks, then the possibility of a "Great Depression" cannot be ruled out. The international community should be fully alert to the risks of economic recession and systemic financial risks. Closer international cooperation and coordinated global response are needed.

Zhu Jun is the head of the International Department of People's Bank of China.

The views don't necessarily represent those of China Daily.