In the latest edition of World Economic Outlook (WEO, April 2021), the IMF states that without the extraordinary fiscal and monetary policies, the pandemic would have resulted in an economic contraction three times larger than the current estimates.
GDP growth
The IMF is projecting the global economy to grow at 6% in 2021, up from an estimated contraction of 3.3% in 2020, and moderate to 4.4% in 2022. These revised projections are higher than earlier estimates owing to the favorable effect of easing of lockdowns, adapting to new ways of working, substantial fiscal support in advanced economies, and an anticipated vaccine-led recovery in the second half of 2021. The IMF projects global growth to moderate to 3.3% over the medium term as the damage to supply chains scars output capacity and aging in advanced economies slows down labor force growth.
Inflation
Inflation in advanced economies is projected to rise to 1.4% in 2021, up from 0.4% in 2020, and 1.9% in 2023. In EMDEs, inflation is projected to remain stable at around 3% from 2021-2023, up from 2.8% in 2020.
The IMF expects price volatility to be short lived and that inflation will return to its long-term average as remaining slack subsides gradually and commodity-driven base effects fade away. Commodity prices, particularly oil, are expected to firm up in the months ahead. But, overall subdued inflation outlook reflects labor market conditions as well, especially subdued wage growth and weak worker bargaining power that are compounded by high unemployment, underemployment, and lower labor force participation rates.
The IMF notes that unless output gaps become positive and very large for an extended period of time, and monetary policy does not react to rising inflation expectations, inflation is unlikely to increase much. It also does not expect monetary policy to be used primarily to keep government borrowing costs low at the expense of price stability as most economies have independent central banks.
External sector
On external sector, the IMF projected global trade to accelerate to 8.4% due to the rebound in merchandise goods. But, cross-border services trade (travel and tourism) is expected to remain subdued.
Divergent effects
The output losses have been divergent. The most affected are the economies that rely on tourism and commodity exports and those with limited fiscal space to respond to the crisis. Many countries entered the crisis without much fiscal space and the ability to mount an effective healthcare policy response. The WEO states that economic situation now (and eventual recovery) is influenced by factors such as the proportion of ‘teleworkable’ jobs, share of employment in small and medium enterprises, capital market deepening, size of informal sector, and quality of and access to digital infrastructure.
The economic recovery since the second half of 2020 has been led by strong demand for products suitable for working from home and pent-up demand for durable goods such as automobiles. Industrial output is now at pre-pandemic level, but contact-intensive services activities have remained depressed. Likewise, although merchandise trade is back to the pre-pandemic levels, cross-border trade in services remains subdued.
Unemployment and underemployment remain at elevated level. Labor force participation rate has dropped despite wage and jobs retention programs in many countries. The report notes that youth, women, less educated workers, and informally employed are hardest hit by the pandemic. Poverty (additional 95 million people) and income inequality are likely to increase. The unequal setback to schooling could further exacerbate inequality.
Asset markets have been surging, thanks to policy stimulus and expectations of a vaccine-driven normalization. However, the IMF notes that the divergence between valuations and broader economic prospects raise financial stability risks.
GDP loss
The IMF projects the average annual loss in per capita GDP over 2020–24, relative to pre-pandemic forecasts, to be 5.7% in low-income countries and 4.7% in emerging markets. In advanced economies the losses are expected to be 2.3%. Unlike the global financial crisis in 2008, the substantial policy support in response to the pandemic has averted a financial crisis, and medium-term losses are expected to be lower than in 2008 (about 3% lower). However, the emerging markets and low-income countries are expected to face greater scarring owing to their limited policy space.
Fiscal authorities provided relief to households and firms in the form of transfers, wage subsidies, liquidity support, expansion of safety net such as unemployment insurance and nutrition assistance. Financial regulators facilitated credit provision by easing classification guidelines for nonperforming loans, relaxing provisioning requirements for banks, reducing risk weights on bankruptcy proceedings, and flexibility regarding bank capital requirements.
The IMF estimates that policy actions such as automatic stabilizers, discretionary measures, and financial sector measures contributed about six percentage points to global growth in 2020.
Economic outlook
There is considerable uncertainty over the economic outlook though. The WEO notes that it is contingent on the path of the health crisis including vaccine effectiveness against new variants, the effectiveness of policy actions to limit persistent economic damage (scarring), the evolution of financial conditions and commodity prices, and the adjustment capacity of the economy.
Vaccine procurement and distribution are uneven with broad vaccine availability in advanced economies and some emerging market economies. Since vaccine deployment will be staggered across regions, spread of new variants forcing occasional and localized lockdowns is possible. However, the IMF notes that these may not constrain economic activities like in the initial lockdowns because they will be more targeted and that people and firms have adapted to remote work.
The size of fiscal package will also drive the nature of recovery. The fiscal package unveiled by the US government will boost growth in the US in 2021 and provide sizable positive spillovers to its trading partners, the WEO states. The IMF expects debt service costs to remain manageable across advanced economies because their debt profile is largely dominated by long-term and sometimes negative-yielding bonds. However, it notes that EMDEs will have limited fiscal support now, but as revenue mobilization improves with pickup in economic activities and crisis-related expenditures unwind, they will have lower fiscal deficits than now. But high debt service costs are expected in EMDEs.
The crisis could still result in substantial and persistent damage to supply potential and extend scarring due to diminishing labor force participation, bankruptcies, and disruption of production networks. It argues that the longer the recession, the more likely that the effects will be permanent, especially in EMDEs where the prevalence of relatively small firms and shallow capital markets could dampen investment and employment for an extended period of time. These may cripple productivity growth too.
The IMF expects monetary policy to remain accommodative and tighten only gradually as recovery takes hold. It also expects oil prices to increase as OPEC+ producers curb supply. The strong rebound in PRC will put upward pressure on metal prices. Food prices are also expected to increase in 2021.
Policy response
Against this backdrop, the IMF recommends policymakers to prioritize policies prudently including strengthening social protection with wider eligibility for unemployment to cover the self-employed and informally employed; adequate resource for healthcare, early childhood development programs, education, and vocation training; and investment in green infrastructure to accelerate the transition to lower carbon dependence. Policy support should be flexible such as shifting lifelines, reallocations, and linked to improvements in activity, but they should safeguard social spending and avoid inefficient spending outlays. Anchoring short-term support in credible medium-term frameworks is key. Economies facing high debt burden should consider creating fiscal space through increased revenue mobilization and reduced wasteful subsidies.
It recommends policy responses to be tailored to the stage of the pandemic, strength of the recovery, and structural characteristics of the economy. As the pandemic continues, policies should focus on prioritizing the healthcare spending, providing well-targeted fiscal support, and maintaining accommodative monetary policy. As recovery progresses, policymakers should limit long-term economic scarring by broadening productive capacity and increasing incentives for an efficient allocation of productive resources.
