Europe, like the rest of the world, faces an extended crisis. An element of social distancing—mandatory or voluntary—will be with us for as long as this pandemic persists. This, coupled with continued supply chain disruptions and other problems, is prolonging an already difficult situation. Based on updated IMF projections released last month, we now expect real GDP in the European Union to contract by 9.3 percent in 2020 and then grow by 5.7 percent in 2021, returning to its 2019 level only in 2022. If an effective treatment or vaccine for COVID-19 is found, the recovery could be faster—but the opposite would hold true if there are large new waves of infection.
Some European countries will face a tougher recovery path than others. Several went into the crisis with entrenched product and labor market rigidities, holding back their growth potential. Others depend on industries that are tightly integrated into cross-border supply chains, leaving them deeply vulnerable to disruptions of such links. In several large euro area countries, slow growth has coexisted with high public debt and limited fiscal space, constraining the ability to cushion shocks. Inescapably, sharply divergent initial conditions are likely to result in a highly uneven recovery across Europe.
Europe’s high-debt countries will bear the brunt of the social impact. For decades, several of these countries have seen their public debt burdens ratchet up in times of trouble and stabilize—but not fall—in good times. The stepwise pattern of rising debt speaks to a weak record of addressing structural deficiencies, whether due to institutional rigidity or insufficient political will. Results have included high unemployment and emigration, especially among the youth, and a trend toward less-progressive taxation, but pensions have largely been protected. COVID-19—a disease that calls for protection of the elderly but leaves the young shouldering much of the cost—complicates an already difficult demographic situation.
Fiscal policies for a transforming Europe
Against such backdrops, policies—especially national fiscal policies—need to start being repositioned for a longer crisis. At the outset of the pandemic, lockdowns were a vital tool to save lives. To help economic capacity survive a short but extreme disruption and allow activity to promptly bounce back afterwards, fiscal policies were eased sharply. Months later, fiscal support remains as vital as at the onset. But, as dislocations persist, resources will become stretched. Now is the time, therefore, to think ahead and reassess how best to use limited fiscal space without unduly burdening future taxpayers. The longer the slump, the greater will be the need to carefully target support for firms and households in the high-debt countries.
The longer the slump, the greater will be the need to carefully target fiscal support in the high-debt countries.
Policymakers must also recognize that the post-crisis economy may look very different from the economy of 2019. It is becoming clear that we are in the throes of—and that we need—permanent change. COVID-19 has reminded us that nature still reigns supreme, that environmental degradation must stop, and that investing in resilience is good policy. Moreover, prudence requires us to consider that this pandemic could last several years, and may well be followed by future pandemics. Europe must strive for a new, greener economy, one that can operate efficiently even with prolonged social distancing. It may take many years to complete, but transformation needs to be nurtured starting now. We cannot just return to the way things were before.
Change is already underway, with winners and losers. Digitalization has emerged as a key bulwark of resilience, yet also as a divide. Across Europe and beyond, countless employees are adapting to remote work, students to remote learning, doctors and patients to telemedicine, and firms to internet-based sales and door-to-door delivery. Countless others, however, are shut out. Many contact-intensive activities—hospitality, travel, and more—could take years to recover. Some outputs—take coal-fired power or carbon-emitting vehicles—may slip into terminal decline. Again, some countries will be hit harder than others, and inequalities could grow both across and within national borders. We may not yet be able to fully envision the new normal, but the transition has begun.
Public funds must be used to steer the needed resource reallocation while protecting the most vulnerable. In labor and product markets, the focus should be on flexibility, including by ensuring that short-time work schemes that tie workers to their employers are kept temporary. In the corporate sector, support programs must embed incentives that encourage uptake by firms with strong business plans and discourage uptake by firms on a path to failure. As liquidity needs become solvency needs, state aid may need to include equity injections—various European initiatives are already moving this way. Clarity on carbon pricing will also be important to set the stage for a climate-friendly recovery of private investment. Finally, public investment can and should take the lead, focusing on greening, digitalization, and other aspects of resilience.
Given divergent national conditions, there is a strong case for joint EU fiscal action. Supporting the recovery will continue to require substantial fiscal resources. By focusing EU funds on countries hardest hit by the pandemic or with less fiscal space, lower income levels, and greater environmental damage, the “Next Generation EU” package stands to improve outcomes for the single market as a whole. To do so, however, it is vital that it serve as a catalyst and not a substitute for structural reforms and prudent fiscal policies. With fundamental limits to the size of any joint EU assistance, the responsibility for ensuring that debt burdens are sustainable will remain squarely at the national level. Even with low borrowing costs, all countries will need to partner upfront stimulus provision with credible medium-term policy plans.
Preserving financial stability and the supply of credit
Through the acute crisis phase and beyond, monetary policy will need to remain strongly accommodative. With crisis-related demand shortfalls further weakening the inflation outlook, central banks must continue to deliver substantial stimulus and ensure that financial markets remain liquid. In practice, this means policy rates must remain at extraordinarily low levels for now, supported by net asset purchases that implicitly look to bond spreads and issuance volumes. Once the period of stress has passed, however, there will be a need for introspection—reflecting on the many years of missed inflation objectives, on how to properly demarcate monetary policy from fiscal policy, on the global decline in equilibrium real interest rates as savings outpace investment, on the choice of monetary instruments, and more. The European Central Bank’s strategic review remains as essential as ever.
Finally, another key priority in the coming period will be to ensure an uninterrupted supply of bank credit to the economy. History has taught us that, when efficient savings allocation breaks down, crises tend to last longer. For now, most European banks have the capital and liquidity they need to expand credit. But, as this crisis wears on, there will be many defaults, and these could erode bank buffers and lending capacity. Potentially, therefore, one feedback loop of this crisis may simply be time: the longer the pandemic, the greater the credit disruption, and the slower the post-pandemic recovery. It is vital that supervisors prepare banks for the coming test. Robust lending standards must be upheld, losses provisioned for fully and transparently, and restructurings of bad assets pursued actively to preserve value. In some cases, bank recapitalization may prove necessary.
A calibrated policy mix
With many difficult challenges lying in wait, managing this vast crisis will call for an increasingly calibrated approach going forward. The initial emphasis on opening the fiscal and monetary floodgates had its place. As time passes, however, policymakers must reflect also on longer-term considerations. Even as low borrowing costs soften some of the tradeoffs, responsible policymaking will still need to weigh immediate imperatives against future burdens on young taxpayers and new generations. Difficult reforms must be pursued with renewed determination.
The overarching policy goals are not one, but two: to save lives now, and to ensure that Europe emerges with a greener and safer economy for the long run, one where future generations can thrive equitably.
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Courage under Fire: Policy Responses in Emerging Market and Developing Economies to the COVID-19 Pandemic
The coronavirus crisis is a crisis like no other, and for emerging market and developing economies (EMDE), it has triggered a policy response like no other, both in scope and magnitude.
Despite their diversity, and in some cases, strained resources, this large group of countries—consisting of emerging markets and low-income countries—have bolstered the provision of health services and extended unprecedented support to households, firms, and financial markets. While limited policy space has kept the response at a smaller magnitude than in advanced economies, some even managed to help other countries.
A whole new world
Economic activity in EMDEs has decelerated at a pace unseen in at least 50 years as the impact of the COVID-19 pandemic ravages the global economy. Several countries are experiencing a sharp decline in trade and capital flows, and the impact of an unprecedented decline in oil and other commodity prices. A spate of sovereign downgrades has occurred.
The IMF’s Policy Tracker summarizes key policy responses to the COVID-19 pandemic, and within these responses, there are some common threads.
Fiscal policy to save lives and protect livelihoods
Fiscal policy has been at the forefront of the EMDE response. Within EMDEs, the health crisis is necessitating massive health spending, though this increase has been dwarfed by the resources needed to support the broad economy. Countries have provided loans, guarantees, and tax breaks to corporations and SMEs, and extended support to vulnerable households with higher unemployment benefits and subsidies on utility prices.
Financing for these new measures emerged from a variety of sources, including borrowing, drawing down buffers, reprioritizing within existing budgets, and multilateral support.
Some economies entered this crisis in a vulnerable state with already sluggish growth, high debt levels and limited fiscal space to support the health sector and the flagging economy. About half of all low-income countries were considered in debt distress or at a high risk of debt distress even before the crisis, as assessed by the IMF’s Debt Sustainability Framework. Partly reflecting these constraints, the total discretionary fiscal response to the shock has been lower (although still sizeable) in both emerging market and low-income economies at 2.8 and 1.4 percent of GDP respectively in extra spending and tax reductions, compared with 8.6 percent of GDP in advanced economies.
Monetary and financial sector support—an anchor for stability
EMDE central banks cushioned the impact of the shock on credit conditions through policy rate cuts and liquidity injections. Unlike previous episodes of capital outflow pressures—including the early stage of the Global Financial Crisis—most emerging market economies lowered policy rates (most of them by 50 basis points or more) rather than raising them. This could be attributed to lower inflation pressures and generally more credible monetary policy frameworks.
Like many advanced economies, some emerging markets possess little room to cut interest rates further and implemented “unconventional monetary policy” responses—such as purchases of government and corporate bonds.
Regulatory restrictions including on liquidity and loan classification have been loosened to help banks play a more supportive role during the pandemic.
In addition, some countries including China and Colombia have relaxed select macroprudential measures—constraints on lending and borrowing introduced to contain excessive loan growth, and the build-up of systemic risk in the financial sector that can occur in good times. Now, a relaxation can support the supply of credit to hardest-hit individuals and economic sectors.
Currencies of EMDEs with flexible exchange rates have depreciated in response to outflow pressures and heightened risk aversion—over 25 percent in a few cases.
Many economies took advantage of their buffers to offset some of the pressure by intervening in the foreign exchange market and drawing down their international reserves. A few countries eased existing capital controls on inflows, while recourse to measures to curb capital outflows has been very limited.
Digitization—a lifeline to protect the vulnerable
Countries such as Bolivia and Indonesia are using digital technology to counteract the sudden economic distress on households and small and medium-sized enterprises, and to limit the spread of the disease by encouraging cashless payments. Others, such as Colombia and Kenya, are ensuring affordable access to digital (easing restrictions on internet access) and financial services (mobile money and electronic payments charges). Zambia provided subsidies to small-scale farmers through the digital platform.
Digital solutions have helped target relief to the vulnerable and enhance the effectiveness of traditional macro policies.
Managing supply disruptions
As the pandemic and prolonged lockdown hampered global supply chains, many countries took steps to ensure food security and continued access to medical supplies, mostly on a temporary basis. For example, several countries introduced price controls and issued regulations against price gouging for basic food items and medical supplies. Some eased import controls. Unfortunately, in several cases restrictions were introduced on the exports of food and pharmaceuticals.
International solidarity—helping countries reach further
In response to the COVID-19 shock, the global financial safety net has been activated and strengthened. The U.S. Federal Reserve has established new swap lines with central banks in several major advanced and emerging economies.
The G-20-led debt moratorium initiative, and financial assistance from the IMF and other institutions are helping EMDEs cope with the challenges. The IMF has quickly provided emergency assistance to more than 60 countries. Further, as demand for liquidity increased, the IMF recently established a new Short-term Liquidity Line as part of its COVID-19 response to augment its lending toolkit. In addition, massive liquidity provision by major advanced economy central banks, while directed primarily at domestic financial conditions, has also alleviated pressures on emerging market and developing economies.
At the same time, EMDEs are also extending assistance to each other and other countries in need. In particular, Regional Development Banks are providing support for private sector enterprises, trade finance and continued access to medical supplies. Examples of bilateral assistance include Albania, which dispatched a team of doctors to Italy, and Vietnam, which donated medical supplies to neighboring countries as well as advanced economies.
EMDEs have been heavily affected by the COVID-19 shock and market reaction that it triggered. The analysis of the IMF Policy tracker shows an extraordinary policy response, bolstered by innovation and international cooperation. In this unprecedented and fast-moving situation, countries can benefit from learning from their peers, and the Fund is committed to collecting and sharing best practices and incorporating this data into its own analysis to continue to assist our membership.