The economic impact of the COVID-19 pandemic on emerging market economies far exceeded that of the global financial crisis. Unlike previous crises, the response has been decisive just like in advanced economies. Yet, conventional policies are reaching their limit and unorthodox policies are not without risks.
A pandemic still unfolding
COVID-19 is still to play out fully in the emerging market universe (see chart for country list), posing risks to both people and economies. While countries such as China, Uruguay, and Vietnam have managed to contain the virus, others such as Brazil, India, and South Africa continue to grapple with a rise in infections.
Emerging markets are likely to face an uphill battle.
The economic impact has been even more severe as emerging market economies were buffeted by multiple shocks. Compounding the effects of domestic containment measures has been a decline in external demand. Particularly hit are tourism-dependent countries due to a decline in travel and oil exporters as commodity prices plummeted. With global trade and oil prices projected to drop by more than 10 percent and 40 percent respectively, emerging market economies are likely to face an uphill battle. This is even as capital outflows have stabilized and sovereign spreads retreated compared to the sharply volatile market conditions seen in March.
Not surprisingly, the IMF’s latest June World Economic Outlook Update projects emerging market economies to shrink by 3.2 percent this year—the largest drop for this group on record. By way of comparison, in the global financial crisis, growth for the group took a significant hit but still bottomed out at a positive 2.6 percent in 2009.
A decisive policy response
The crisis would have been worse still without the extraordinary policy support. For sure, decisive policy actions in advanced economies led to a turnaround in market conditions that allowed emerging market economies to resume external financing efforts in April and May, which contributed to record levels of bond issuance so far this year—to the tune of $124 billion as of the end of June. But not all countries have seen improved fortunes. Fuel exporters, frontier countries and those with high debt are experiencing a greater financial shock that pushed up borrowing costs, or even worse, denied them further access to markets.
Policy support by advanced economies provided emerging market economy policymakers with wiggle room to soften the economic blow. Unlike previous episodes, where emerging market economies tended to tighten policy to avoid rapid capital outflows and the inflationary effect of exchange rate depreciations, the current crisis has seen emerging market economies’ policy reaction more in line with that of advanced economies (see the IMF’s policy tracker). Most emerging market economies used reserve buffers more sparingly and allowed exchange rates to adjust to a larger extent, while many countries injected liquidity as needed to ensure market functioning. Countries like Poland and Indonesia further eased macroprudential policies to support credit.

Image courtesy of the IMF.
Like their more advanced peers, many emerging market economies, including Thailand, Mexico, and South Africa, eased monetary policy during this cycle. In a few cases, limited room to cut policy rates further and distressed market conditions induced use of unconventional monetary policy measures for the first time. These included purchases of government and corporate bonds, although the amounts remain modest so far compared to the larger advanced economies. Conversely, the use of capital flow measures to deter capital outflows has been quite limited so far.
A similar picture is evident on the fiscal policy front. Emerging market economies have relaxed their fiscal stance in an attempt to tackle the health crisis, support people and firms, and offset the economic shocks. While more modest than that of advanced economies, these efforts were significantly greater than during the global financial crisis.
From conventional to unorthodox policies
Despite these actions, the outlook for emerging market economies remains clouded by considerable uncertainty. Chief among many risks is the possibility of a more prolonged health crisis, which would hurt more lives and could have dire economic consequences. Confronting a more severe downturn will be challenging because most emerging markets entered the current crisis with limited room for traditional fiscal, monetary, and external policy support. And much policy room has already been used up by actions undertaken in recent months.
Dwindling policy space may force some countries to take recourse to more unorthodox measures. From price controls and trade restrictions to more unconventional monetary policy and steps to ease credit and financial regulation. Some of these measures—which are also being implemented by some advanced and low-income economies—have significant costs, particularly if used intensively. Export restrictions, for example, could seriously distort the multilateral trading system, and price controls hamper the flow of goods to those who need it most.
The effectiveness of other unorthodox policies will depend on the credibility of the institutions; for instance, whether a country has a track record of credible monetary policy. As we navigate the contours of the ongoing crisis, little time is available to properly analyze the risks and benefits of these actions in a careful manner.
Not out of the woods yet
Emerging market economies have navigated the first phase of the crisis relatively well, but the next phase could be much more challenging. The virus remains present, financial conditions are still fragile, and policy space is lower, particularly for those countries facing high risks to debt sustainability. The latter group of countries is quite large. Approximately one third of all emerging market economies entered the crisis with high-debt levels and are assessed to have no space for undertaking additional discretionary fiscal policy, or as having that space significantly at risk.
Image courtesy of the IMF.
As the crisis develops, there is also a high risk that liquidity problems morph into solvency concerns. Besides sovereign debt stresses, corporate default risks are alarmingly high in a number of emerging market economies. Moreover, the crisis has hit poor people much harder, and this increase in inequality will amplify policy challenge in many countries.
The complexity of these challenges requires a multi-faceted policy response. First, domestic policies will need to be designed to allow for more durable and inclusive growth. Second, increased support from bilateral and multilateral lenders will be required where market access remains precarious. So far, the IMF has provided 22 emerging market economies with approximately $72 billion (SDR 52 billion) in financial assistance. Finally, for countries where debts prove to be unsustainable, timely and durable resolution of these problems will be needed, by seeking broad burden sharing across creditors including in the private sector. The latter two policy angles will be analyzed in two subsequent blogs on IMF lending and the IMF’s role in debt resolution.
AUTHORS:
Martin Mühleisen, Director of the Strategy, Policy, and Review Department (SPR) of the IMF
Tryggvi Gudmundsson, Economist in the IMF’s SPR
Hélène Poirson Ward, Deputy Division Chief in the IMF’s SPR
Compliments of the IMF.

In the wake of the Covid-19 crisis, the US authorities adopted an unprecedented set of fiscal measures, targeting households in particular. These measures aim at preserving the purchasing power of US households, but less than half of this additional income should be spent.

Chart 1. Compared fiscal policy responses 2020/2008, Source: Congressional Budget Office (CBO). Image courtesy of La Banque de France.
The Covid-19 crisis has led to a sharp deterioration in the US labour market
The coronavirus crisis has sent an unprecedented shockwave through the US labour market. Social distancing and other restrictions have paralysed many businesses, particularly in the service sector. Thus, the number of unemployment claims exploded between mid-March and the end of May 2020: 4 million on average per week, compared to around 220,000 in normal times. The rise in unemployment was very rapid, amounting in just two months to the equivalent of two years of job losses during the 2008-09 financial crisis.
The deterioration in the labour market required an urgent and forceful response from the US authorities. Especially given that household consumption remains the driving force behind the US economy and social safety nets are very minimal in the United States. For example, a significant difference between the US labour market and the European market is the lack of temporary job-retention schemes.
The impressive magnitude of the US package…
At the end of March, the US Congress adopted the Coronavirus Aid, Relief, and Economic Security Act (CARES), a vast economic assistance package of around USD 2.2 trillion, or 10% of GDP. This is the largest stimulus package in the history of the United States (see Chart 1). In addition, other support measures were introduced, totalling more than USD 2.7 trillion. During the 2008 financial crisis, fiscal measures amounted to USD 1.8 trillion, spread over 5 years. The magnitude is therefore greater today and the measures are concentrated on the last three quarters of 2020. The budget cost of these measures is estimated to exceed USD 2 trillion in 2020, excluding loan guarantees.

Chart 2. Stimulus decomposition by category targeted (for an estimated budget cost of USD 2050 bn) Source: CBO, BdF calculations. Image courtesy of La Banque de France.
While the measures target the economy as a whole, they are particularly aimed at households (60%, see Chart 2). Of particular note is the massive increase in unemployment insurance, in terms of amounts, eligibility criteria and duration. For example, an unemployed person will receive an additional USD 600 per week for up to 4 months. Other measures include direct payments to households of USD 1200 per individual, the introduction of paid sick leave in case of Covid-19, tax breaks, etc.
Furthermore, some schemes for businesses also aim to support employment. For instance, the Paycheck Protection Programme (PPP) provides SMEs with state-guaranteed loans that can be written off provided that 75% of the funds are used to pay salaries. This programme was widely and rapidly subscribed to.
… should compensate for the short-term loss of income
Using the NiGEM model, we carry out simulations to assess the impact of support measures on the income of US households and, more generally, on gross domestic product (GDP), in a Covid-19 shock scenario based on a single wave of contamination but with prolonged economic effects.
The disposable income of US households is not expected to be adversely affected in 2020 compared to its pre-crisis trend, as the stimulus measures should fully offset the loss of income caused by the Covid-19 crisis (see Chart 3). Households should even enjoy purchasing power gains (Real Personal Disposable Income – RPDI) thanks to lower inflation (see Table 1).

Chart 3. Impact of the Covid-19 shock and stimulus measures on household disposable income (% of pre-crisis trend) Source: BdF calculations (NiGEM simulations). Image courtesy of La Banque de France.
The increase in household disposable income in response to the different stimulus measures is already starting to be observed with a 13% increase in April compared to the previous month. This short-term rise is not surprising. It confirms the findings of recent microeconomic studies, such as Ganong et al, 2020, that estimate a median replacement rate of 134% for unemployment benefits, with two-thirds of eligible unemployed receiving benefits higher than their previous earnings.
In 2021, however, household disposable income is expected to contract compared to the pre-crisis trend, i.e. a negative shock of almost 3% on purchasing power, due to the relative persistence of unemployment and assuming that no new measures are taken.

TABLE 1. IMPACT OF STIMULUS ON HOUSEHOLD INCOME (% OF PRE-CRISIS SCENARIO)

2020

2021

 %

Covid-19 shock (without measures)

Impact of fiscal stimulus

Net change

Covid-19 shock (without measures)

Impact of fiscal stimulus

Net change

DISPOSABLE INCOME

-9.3

9.4

0.1

-12.4

6.6

-5.8

REAL DISPOSABLE INCOME

-8.0

8.9

0.9

-6.3

3.6

-2.7

Source: BdF calculations (NiGEM simulations)
Impact on GDP will depend on the savings behaviour of US households
Despite the relative stability of household income in 2020, it is not clear whether this replacement income will be fully spent, or even whether it will be spent in the same proportion as it was before the crisis. We assume that 40% of the additional income received by households would be consumed and the rest would be saved. All in all, the household savings rate is expected to average close to 20% in 2020, compared with an average of 8% in 2019.
This can be attributed to the high level of forced savings resulting from lockdown and changes in consumption habits; the savings rate reached a peak of 32% in April, after 8% in February and 13% in March. However, the households targeted by the stimulus payments mainly belong to the low-wage category, which traditionally have a higher propensity to consume and which, moreover, have benefited from a net increase in income (Muellbauer, 2020; Ganong et al., 2020). Furthermore, according to Karger and Rajan (2020), 48% of the cheques paid to households under the CARES Act were immediately consumed.
Overall, our results show that the stimulus should only partially absorb the shock to consumption and investment, thereby offsetting the loss of activity by 4.5 percentage points of GDP in 2020. Nevertheless, the US economy is expected to contract by between 6.5 and 8% in 2020 (according to our estimates as well as those of national and international institutions). The longer-term impact of these stimulus measures will depend on the consumption and savings behaviour of US households.
We analyse the sensitivity of our results to assumptions about the propensity of households to consume. With a lower marginal propensity to consume of 25%, similar to that observed during the recovery plans of 2001 and 2008 (Sham et al., 2010), the final gain in GDP would also be lower, i.e. around 3.4 percentage points.
The need for further stimulus measures is gradually becoming apparent
The measures were primarily taken by the US authorities in response to an emergency situation. Indeed, many of them are scheduled to end in July or at the end of the year. They are intended to temporarily make up for the lack of social safety nets and thus offset short-term income losses. However, they seem insufficient to allow the US economy to recover in the medium term, especially if the shock from the crisis proves to be relatively persistent. To this end, proposals have already been submitted to the US Congress on a new stimulus package to be adopted before the presidential election next November.
AUTHORS:
Annabelle de Gaye, CFA, Banque de France
Cristina Jude, Macroeconomist, Banque de France | cristina.jude[at]banque-france.fr
Compliments of La Banque de France.

The world entered the COVID-19 pandemic with persistent, pre-existing external imbalances. The crisis has caused a sharp reduction in trade and significant movements in exchange rates but limited reduction in global current account deficits and surpluses. The outlook remains highly uncertain as the risks of new waves of contagion, capital flow reversals, and a further decline in global trade still loom large on the horizon.
Our new External Sector Report shows that overall current account deficits and surpluses in 2019 were just below 3 percent of world GDP, slightly less than a year earlier. Our latest forecasts for 2020 imply only a further narrowing by some 0.3 percent of world GDP, a more modest decline than after the global financial crisis 10 years ago.
New trade barriers will not be effective in reducing imbalances.
The immediate policy priorities are to provide critical relief and promote economic recovery. Once the pandemic abates, reducing the world’s external imbalances will require collective reform efforts by both excess surplus and deficit countries. New trade barriers will not be effective in reducing imbalances.
Why imbalances matter
External deficits and surpluses are not necessarily a cause for concern. There are good reasons for countries to run them at certain points in time. But economies that borrow too much and too quickly from abroad, by running external deficits, may become vulnerable to sudden stops in capital flows. Countries also face risks from investing too much of their savings abroad given investment needs at home. The challenge lies in determining when imbalances are excessive or pose a risk. Our approach focuses on each country’s overall current account balance and not its bilateral trade balances with various trading partners, as the latter mainly reflect the international division of labor rather than macroeconomic factors.
We estimate that about 40 percent of global current account deficits and surpluses were excessive in 2019 and, as in recent years, concentrated in advanced economies. Larger-than-warranted current account balances were mostly in the euro area (driven by Germany and the Netherlands) with lower-than-warranted current account balances mainly existing among Canada, the United Kingdom, and the United States. China’s assessed external position remained, as in 2018, broadly in line with fundamentals and desirable policies, due to offsetting policy gaps and structural distortions.
Our report offers individual economy assessments of external imbalances and exchange rates for the 30 largest economies. Over time, these imbalances have accumulated, with the stocks of external assets and liabilities now at historic highs, potentially raising risks for both debtor and creditor countries. The persistence of global imbalances and mounting perceptions of an uneven playing field for trade has fueled protectionist sentiments, leading to a rise in trade tensions between the US and China. Overall, many countries had pre-existing vulnerabilities and remaining policy distortions heading into the crisis.
Image courtesy of the IMF.
COVID-19: An intense external shock
With the world economy still grappling with the COVID-19 crisis, the external outlook is highly uncertain. Even though we forecast a slight narrowing of global imbalances in 2020, the situation varies around the world. Economies dependent on severely affected sectors, such as oil and tourism, or reliant on remittances, could see a fall in their current account balances exceeding 2 percent of GDP. Such intense external shocks may have lasting effects and require significant economic adjustments. At the global level, our forecasts imply a more limited narrowing in current account balances than after the global financial crisis a decade ago, which partly reflects the smaller, precrisis global imbalances this time than during the housing and asset price booms of the mid-2000s.
Early in the COVID-19 crisis, tighter external financing conditions triggered sudden capital outflows with sharp currency depreciations across numerous emerging market and developing economies. The exceptionally strong fiscal and monetary policy responses, especially in advanced economies, have promoted a recovery in global investor sentiment since then, with some unwind of the initial sharp currency movements. But many risks remain, including new waves of contagion, economic scarring, and renewed trade tensions.
Another bout of global financial stress could trigger more capital flow reversals, currency pressures, and further raise the risk of an external crisis for economies with preexisting vulnerabilities, such as large current account deficits, a high share of foreign currency debt, and limited international reserves, as highlighted in this year’s analytical chapter. A worsening of the COVID-19 pandemic could also dislocate global trade and supply chains, reduce investment, and hinder the global economic recovery.
Image courtesy of the IMF.
Providing relief and rebalancing the world economy
Policy efforts in the near term should continue to focus on providing lifelines and promoting economic recovery. Countries with flexible exchange rates would benefit from continuing to allow them to adjust in response to external conditions, where feasible. Foreign exchange intervention, where needed and where reserves are adequate, could help alleviate disorderly market conditions. For economies facing disruptive balance of payments pressures and without access to private external financing, official financing and swap lines can help provide economic relief and preserve critical health care spending.
Tariff and nontariff barriers to trade should be avoided, especially on medical equipment and supplies, and recent new restrictions on trade rolled back. Using tariffs to target bilateral trade balances is costly for trade and growth, and tends to trigger offsetting currency movements. Tariffs are also generally ineffective for reducing excess external imbalances and currency misalignments, which requires addressing underlying macroeconomic and structural distortions. Modernizing the multilateral rules-based trading system and strengthening rules on subsidies and technology transfer is warranted, including by expanding the rule book on services and e-commerce and ensuring a well-functioning WTO dispute settlement system.
Over the medium term, reducing excess imbalances in the global economy will require joint efforts on the part of both excess surplus and excess deficit countries. Economic and policy distortions that predated the COVID-19 crisis might persist or worsen, suggesting the need for reforms tailored to country-specific circumstances.
In economies where excess current account deficits before the crisis reflected larger-than-desirable fiscal deficits (as in the United States) and where such imbalances persist, fiscal consolidation over the medium term would promote debt sustainability, reduce the excess current account gap, and facilitate raising international reserves where needed (as in Argentina). Countries with export competitiveness challenges would benefit from productivity-raising reforms.
In economies where excess current account surpluses that existed before the crisis persist, prioritizing reforms that encourage investment and discourage excessive private saving are warranted. In economies with remaining fiscal space, a growth-oriented fiscal policy would strengthen economic resilience and narrow the excess current account surplus. In some cases, reforms to discourage excessive precautionary saving may also be warranted (as in Thailand and Malaysia) including by expanding the social safety net.
AUTHORS
Martin Kaufman, Assistant Director in the Strategy, Policy and Review Department, IMF
Daniel Leigh, Deputy Division Chief in the Western Hemisphere Department, IMF
Compliments of the IMF.