While promising vaccine developments have dispelled fears of a global depression, the outlook remains exceptionally uncertain. Prospects depend critically on the degree to which new COVID-19 outbreaks can be contained and the timing of an effective and widely deployed vaccine. On the upside, an effective vaccine produced at scale and distributed faster than expected worldwide at affordable prices would lift sentiment and yield higher growth, including by allowing for a fuller recovery in tourism and contact-intensive sectors. Conversely, challenges in vaccine uptake would prolong ongoing outbreaks and deepen uncertainty, delaying the return of consumer and business confidence. Precautionary saving by consumers would increase and business investment would weaken. The OECD’s upside scenario would see pre-crisis output levels restored by mid-2021, while the downside scenario would delay this outcome until the end of 2022 (Chart).
Beyond COVID-19 related concerns, the outlook is vulnerable to four key downside risks discussed below.
Insufficient or premature withdrawal of policy support
Public consumption is expected to make an important contribution to the recovery next year (Chart). However, financial and political constraints could curb the scope for further stimulus and income support that has so far enabled demand for consumer goods and services to rebound.
In particular, a longer fiscal impasse in the US would weigh on the recovery. While bipartisan support may secure a circa US$900 billion COVID-19 relief package this month, the scale and contents of further US policy support depends on which party wrests control of the Senate following two Georgia run-off elections on January 5. The Republicans need to win only one seat in order to secure a majority, which would challenge President-elect Biden’s ability to implement the Democrats’ proposed US$2.2 trillion HEROES Act.
Even China and other Asian economies will face pressure to curb spending in order to preserve financial stability. While 13 major emerging market central banks have adopted forms of quantitative easing, further stimulus may stoke fears of inflation and capital outflows, forcing central banks to tighten policy and thereby derailing recoveries.
Financial conditions may tighten, exposing pre-existing sovereign and corporate debt vulnerabilities
The pace of global debt accumulation has been unprecedented since 2016. The Institute of International Finance expect global debt to reach a record US$277 trillion or 365% of GDP by end-2020 (Chart). Moreover, the ability for countries to grow themselves out of debt is waning amid weak investment and productivity gains and corporate zombification.
Even with interest rates at historically low levels, the ratio of government interest payments to revenues rose to a near-record 10% in emerging markets this year. High interest payments risk crowding out spending on social services and infrastructure. Worse, global recession and weak commodity prices, tourism, remittances and foreign investment could see many lower income countries enter debt distress. There are currently 35 countries judged to be in, or at high risk of, debt distress. The G-20 Debt Service Suspension Initiative runs to mid-2021 but is restricted to the 76 lowest-income countries and delays rather than restructures payments. Unless multilateral and bilateral lenders, notably China, and private creditors agree to further debt relief, more defaults are likely to follow Zambia’s last month. This raises the risk of contagion and higher borrowing costs for other emerging markets, precipitating a self-reinforcing debt spiral.
Considering the severity of the recession and the possible withdrawal of emergency support in some countries, the risk of widespread corporate bankruptcies is also tangible. This would presage large job and income losses, further weakening demand. This would also deplete the capital buffers of banks and constrain credit supply, thereby compounding the downturn.
Intensifying social unrest
Countries that achieve widespread vaccination sooner will likely find it easier to maintain social and political cohesion. So too will those countries able to afford remedies to the workforce disruption caused by physical distancing, which have been concentrated in employment-intensive industries (Chart). This includes improved social safety nets and reskilling programs to raise labour participation and productivity. Without a widely distributed vaccine or adequate policy response, the risk of renewed lockdowns could cause more widespread or prolonged protests that dent confidence and further weigh on activity. Intensifying social unrest may also derail economic and political reform efforts, and impede efforts to tackle growing inequalities, frustrating medium term growth and the sustainability of public finances.
Geopolitical tensions and trade policy uncertainty
While global geopolitical tensions seemingly de-escalated during the pandemic, future flared tensions could weigh on growth outcomes (Chart). In particular, tensions between the world’s two largest economies are likely to remain elevated on numerous fronts. While President-elect Biden will likely shift the tone towards China, trade measures and protectionist pressures will probably continue, particularly given bipartisan consensus regarding China as a strategic competitor. Issues like human-rights abuses in Xinjiang could generate sharper confrontations, while the situations in Hong Kong and Taiwan will continue to strain relations. China’s increased drive for technological self-sufficiency and emphasis on the domestic economy may also dent import demand, potentially aggravating the relationship.
Further, the transitional period agreed in the UK-EU Withdrawal Agreement expires on December 31. The rapidly increasing prospect that the two sides fail to agree a trade deal before then would see trade barriers rise significantly, increasing business costs and weighing on growth prospects.
More broadly, recourse to trade distortions increased this year. According to Global Trade Alert, during the first 10 months of 2020, 2,031 policy interventions affecting international commerce were imposed by governments globally—up 74% from the same period last year and 147% higher than the average for 2015-2017, prior to the escalation of US-China trade tensions. For over 170 economies—including Australia—goods exports now face weaker access to foreign markets. An ongoing high rate of tariff and non-tariff barriers threatens to limit the recovery in global trade. Inward-looking policy interventions that aim to localise supply chains may also drag on world trade and enfeeble the recovery by eroding firms’ productive capacity, forfeiting economies of scale and hurting domestic consumers. On the upside, the US veto of the WTO dispute settlement mechanism may be reversed given President-elect Biden’s more conciliatory approach towards multilateral institutions, allowing cases to progress and ensuring enforceability of World Trade Organization legal commitments.