Covid-19: Growth Shock, V Shaped Recession and Policy Response

1. Introduction: Growth Shock

A raging pandemic unleashed by a highly contagious COVID-19 virus has triggered unprecedented restrictions not only on the movement of people but also on a range of economic activities, and the declaration of national emergencies in the worldwide. Growing demand for urgent healthcare and rising death tolls are straining national healthcare systems. The pandemic is disrupting global supply chains and international trade.  With nearly 100 countries closing national borders during the past month, the movement of people and tourism flows have come to a screeching halt. Millions of workers in these countries are facing the bleak prospect of losing their jobs. Governments are considering and rolling out large stimulus packages to avert a sharp downturn of their economies which could potentially plunge the global economy into a deep recession.

In the worst-case scenario, the world economy could contract by 0.9 percent in 2020 (Figure 1). The coronavirus outbreak has dealt a massive blow to global activity, and the associated costs and spillovers will significantly erode the global outlook. The pandemic also compounds other downside risks, such as further disruptions to trade relations, spillovers from sharp downturns in major economies, and disorderly commodity and financial market developments. Against this backdrop, many economies are not adequately prepared to confront the negative shocks related to the materialization of these risks.

 

Whereas the economic growth of Nepal in FY2020 is anticipated to contract from pre-COVID estimate of 6.3% to 5.3% as shown in the following figure 2. However, growth could further contract if the lower remittances, trade and tourism, and broader disruptions caused by the COVID-19 outbreak. Economic growth during FY21 is also likely to remain subdued due to the lingering effects of the pandemic with some recovery expected in FY22. Therefore, the urgent and bold policy measures are needed, not only to contain the pandemic and save lives but also to protect the most vulnerable in our societies from economic ruin and to sustain economic growth and financial stability.

               

Figure 2: Nepal's GDP growth rate at Market Price (%)

 

 

 Source: ADB, April Report

 

                                        2. V-Shaped Recessions and Predication

V-shaped recessions are recessions that begin with a steep fall but then quickly find a bottom, turn back around and move immediately higher. A V-shaped recession is a best-case scenario. The recession of 1990 to 1991 and the recession of 2001—both of which only lasted eight months—are considered to be V-shaped recessions. Firstly, a fairly sharp drop due to health shock, economic slowdown, corporate defaults, corporate bankruptcies, as well as layoffs. Secondly, a fairly speedy recovery may be expected using measures like support for health system, shield people and firms, reduce financial stress and plan for recovery by using true economic policy measures.

Figure 3: V-Shaped Recessions

 

If the virus spreads to most countries and efforts to contain the outbreak spill into the third quarter of 2020, financial market pressures continue, commodity prices remain weak, and domestic healthcare systems are strained, the growth impacts will be more severe. Either way, the region is bracing for a recession. Assuming that prior epidemics such as SARS, the 1968 H3N2 (“Hong Kong”) flu, 1958 H2N2 (“Asian”) flu, and 1918 Spanish flu all are V-shaped. Partial recovery in 2021 almost after a year which is based on the direction of curve as shown in following diagram.

Hence, a V-shaped scenario depicts a Covid economic shock where growth may be eventually rebounds.

 

                                            3. Long- Term policy Response

While confronting the near-term impact of the coronavirus pandemic is the primary focus of policy efforts, the economy eventually need to return to targeted structural reforms that are essential to improve long-term productivity and generate long-term growth. Specifically, reforms are needed to strengthen governance, reassess the role of the state in the economy, improve the business climate, and promote the appropriate diversification of commodity-dependent economies. Weak external demand highlights the importance of policies that expand domestic sources of productivity and long-term output growth, such as investment in human and physical capital. Mitigating the risks associated with climate change and other disasters, such as pandemics, highlights the need for emergency preparedness.

The following are six priorities need to be followed.

·         First, continue with essential containment measures and support for health systems.

• Prioritizing health spending for testing and medical equipment; pay doctors and nurses; make sure hospitals and makeshift clinics can function i.e. carefully reallocating limited public resources.
• It also means increasing the flow of resources to these countries. That includes the flow of vital goods: we must minimize disruptions to supply chains and, with immediate effect, refrain from export controls on medical supplies and food.

·         Second, shield affected people and firms with large, timely, targeted fiscal and financial sector measures. 

• It includes tax deferrals, wage subsidies and cash transfers to the most vulnerable; extending unemployment insurance and social assistance; and temporarily adjusting credit guarantees and loan terms.
• Some of these measures have been taken in the first wave of policy supportive measures i.e. lifelines for households and businesses are imperative. 
• Need to prevent liquidity pressures from turning into solvency problems and avoid scarring of the economy that would make the recovery so much more difficult.

·         Third, reduce stress to the financial system and avoid contagion. 

• Banks have built up more capital and liquidity over the past decade, and their resilience will be tested in this rapidly changing environment.
• Monetary stimulus and liquidity facilities play an indispensable role. Interest rates have been lowered in many countries.
• Central banks have activated swap lines and created new ones to reduce financial market stress.
• Enhancing liquidity for a broader range of emerging economies would provide further relief. Importantly, it would also lift confidence.

·         Fourth, even as we move through this containment phase, we must plan for recovery.

•  Minimizing the potential scarring effects of the crisis through policy action now. This requires careful consideration of when to gradually ease restrictions, based on clear evidence that the epidemic is retreating.
• As measures to stabilize the economy take hold and business starts to normalize, we will need to move swiftly to boost demand. A coordinated fiscal stimulus will be essential. Where inflation remains low and well-anchored, monetary policy should remain accommodative. Those with greater resources and policy space will need to do more; others, with limited resources will need more support.

·         Fifth, redefined the role of the state

o    Governments must invest in, and in some cases create, institutions that help to prevent crises, and make us more capable to handle them when they arise.

o    Injecting stimulus into the economy while desperately trying to slow the spread of the disease, to protect vulnerable populations, and to help create new therapies and vaccines.

o    Governments need to better coordinate research and development activities, steering them towards public health goals.

o    Governments need to structure public-private partnerships to make sure both citizens and the economy benefit

·         Sixth, enhancing the environment for growth by strengthening governance and fostering competitive markets.

o    Addressing these weaknesses requires reforms to improve governance and the business climate.

o    Growth was only stronger in the economy with higher levels of government accountability

 

                                                                4. Concluding Remarks

Lessons from previous infectious disease outbreaks, as well as the experiences of the countries that were hit early by COVID-19, clearly show that severe containment measures, such as social distancing requirements, shutdowns of nonessential businesses and entertainment, and school closures, are important measures in saving lives by “flattening the curve” of infections and preventing health care systems from being overwhelmed. Policy makers face difficult trade-offs between the health benefits of these policies and their economic costs, however, since the more successful the containment policies are, and the flatter the infection curve is, the deeper the economic recession becomes. The immediate policy priorities are bolstering health care systems to save lives, strengthening safety nets to provide relief to households, and providing support to the private sector to cushion the downturn and preserve jobs. To the extent fiscal space is available, broad-based fiscal stimulus can also help lift aggregate demand, but it will probably be more effective after the immediate crisis has passed and business operations begin to normalize .Monetary policy can also play an important role. Central banks should be ready to provide ample liquidity to banks and nonbank financial institutions, particularly to small and medium-size enterprises, which are prone to suffer more from the sharp disruption. Broader monetary stimulus, such as policy rate cuts or asset purchases, can lift confidence and support financial markets to offset the risk of a sizable tightening in financial conditions, given the volatility in markets. International coordination in monetary easing could further alleviate the volatility.