The world economy under COVID-19: Can emerging market economies keep the engine running?

COVID-19 has severely disrupted our lives and economies. After coronavirus first spread from China to other East Asian economies and then crossed over to Europe and the United States, emerging market economies (EMEs) in Latin America and South Asia became the pandemic’s new epicentre. This article reviews the recent economic developments in EMEs, their vulnerabilities, policy responses, and near-term prospects. The focus is on those EMEs that have been systemically important for the world and/or euro area economy: China, India, Brazil, Russia and Turkey. A decade ago, EMEs succeeded in weathering the global financial crisis (GFC) rather well and were driving the subsequent global recovery. Will EMEs again be the world economy’s locomotive this time around?

The article concludes that, despite greater-than-usual uncertainty about future growth paths, EMEs will most likely not play the same supportive role for the world economy throughout the COVID-19 crisis as at the time of the GFC. Several reasons stand out.

First of all, the COVID-19 crisis is fundamentally different from the GFC, or other large crises for that matter. The pandemic-induced global recession is projected to be the deepest since World War II and the most synchronised ever. With the notable exception of China, nearly all major EMEs are expected to experience strongly negative growth in 2020, unlike in 2009. This is the combined result of the severe direct impact the spread of coronavirus and associated containment measures have had on economic activity in EMEs, as well as of the multiple external shocks that have hit them more indirectly. The pandemic has negatively impacted EMEs through its bearing on world trade, including commodity trade and tourism, and international financial markets.

Second, certain structural characteristics of EMEs, including weaker health systems and relatively large informal sectors, are making it more difficult for these countries to bring and keep the pandemic under control and are contributing to the economic damage it is wreaking in places such as Brazil and India, where coronavirus is still thriving. Without international support, some countries may also struggle to get access to and/or quickly distribute vaccines against COVID-19 once they become available.

Third, major EMEs were already suffering from idiosyncratic stress factors, macroeconomic vulnerabilities, and slowing economic growth before the COVID-19 crisis struck. For example, Brazil was slowly recovering from a deep recession in 2015-2016 and was held back by uncertainty surrounding planned reforms, while Turkey had only just bounced back from recession in 2018 following capital flight and sharp currency depreciation. In fact, if one excludes China and India, EMEs’ percentage point contribution to world economic growth had shrunk considerably in recent years, compared to its post-GFC highs.

Fourth, while EMEs have resorted to countercyclical monetary and fiscal stimulus, often exceeding their policy responses during the GFC, overall their support to the economy remains several times smaller than the rescue packages that advanced economies have unleashed. The ongoing deterioration of fiscal and external positions, exacerbated by the COVID-19 crisis, implies that for many EMEs the initially modest policy space is shrinking even further. So, EMEs will depend to a large extent on the policy actions of advanced economies for their recovery, including a resumption of demand for their exports and a continued accommodative monetary policy stance by advanced economy central banks (in addition to multilateral support initiatives such as IMF lending for the most vulnerable EMEs). Even China, which for now seems to be recovering from the crisis largely on its own thanks to a State-led boost to domestic investment, still needs the extra growth impulse from external demand for a solid anchoring of its recovery.

Finally, while the summer projections at the time of writing still assume a relatively swift recovery and positive contribution of EMEs to world growth in 2021, bringing and keeping the virus under control is a necessary condition for such a scenario to materialise. In addition, high and rapidly rising sovereign and corporate debt levels will require deleveraging at some point, weighing on growth over the medium term.