Evgeny Vinokurov (29.07.2021)

The global economy is on the rise today after a major setback caused by the pandemic. According to our estimates, China's GDP will increase by 8.5% this year, the eurozone — by 4.3%, and the United States — by 6.5%. But this is now. And what will happen next? Yevgeny Vinokurov, Chief Economist of the EDB and the EFSR, discusses this in the author's column in Vedomosti.

Macroeconomists operate with rather complex models, trying to give as accurate a forecast as possible. But any macro model is like soup: the skill of the cook means a lot, but the quality of the products is also important. Dozens of external (exogenous) parameters enter the model, they are scrolled through the meat grinder of the system of equations and expert assessments, the result is obtained.

In a normal situation, we face such uncertainty, for example, on oil prices. It's a familiar thing. But now everything has become much more complicated. The main uncertainty is related to the course of the COVID-19 pandemic. Over the past quarters, macro forecasters around the world have assumed that the situation will fully normalize in 2021 and the world will meet 2022 with a clean slate, with a defeated virus. But the emergence of new strains suggests that the pandemic may stay with the world for a long time. Can anyone now guarantee that the pandemic will end completely at least in 2022 or even in 2023?

The uncertainty is so great that the global economy is simultaneously recovering and may lose the potential for future growth if the pandemic is in fact far from over. This is reminiscent of Schrodinger's famous thought experiment. The world economy is now that cat in a closed box. In this regard, it makes sense to discuss what to expect if the fight against the pandemic does not bring decisive results and high-intensity coronavirus outbreaks remain part of reality for the foreseeable future.

In 2021, the global economy is recovering rapidly. This is a recovery growth "on steroids" largely due to government support measures and a noticeable easing of fiscal and monetary policy last year. An important factor is also the gradual easing of restrictive measures in the largest economies of the world against the background of the vaccination campaign. The countries of the Eurasian region did not stay away from global trends in the first half of this year, which is facilitated by high prices for raw materials – from oil and gas to industrial metals and agricultural products. The economies of Russia and Kazakhstan have already reached the pre-pandemic level by the end of the second quarter.

Source: EDB Forecast, Our World in Data (Mathieu et al., 2021)

Monetary and fiscal policies of the world's largest economies will remain ultra-soft on the horizon for up to one year, despite the increase in inflation. The ECB and the Fed are showing patience for a temporary acceleration of inflation and are striving to provide maximum support for economic activity that weakened during the pandemic. It is likely that in 2022 a gradual transition from a super-soft policy towards neutral conditions will begin. The estimates are based on the key assumption that the rate of vaccination will increase and the rate of spread of the coronavirus in the world will slow down.

But what can we expect if we cannot defeat the pandemic quickly? In terms of vaccination rates, developing countries and low-income countries lag significantly behind developed countries. New strains of coronavirus are emerging. It is possible that in the future there will be mutations of the virus with increased resistance to vaccines. The uncertainty of the course of the pandemic calls into question the sustainability of the successes achieved in the recovery of the global economy. A protracted pandemic, even at the level of constantly emerging local outbreaks, will generate general uncertainty, force businesses to postpone investments, put pressure on the tourism and air travel industries, which, with such a development of events, risk not recovering from losses in the foreseeable future.

Do not forget about the social aspects. A protracted pandemic will primarily affect low-income countries that do not have sufficient financial buffers to support the economy and citizens. Adverse developments may further exacerbate the problems of migration, food shortages, inequality in access to education and digital technologies. The negative social consequences of delaying the pandemic will lead to a decrease in the growth rate of the global economy. And it is not at all a fact that their impact will be less pronounced in the long term compared to the direct effects of the pandemic on business activity.

The prolongation of the pandemic and the constant pressure of uncertainty (and uncertainty, being immaterial in nature, puts pressure on growth very materially) can lead to the fact that central banks of developed countries will persistently postpone the normalization of monetary policy. And this may result in steadily higher inflation than the market used to see in the 2010s. Not 0-2%, but perhaps 2-4%. This is what was the norm in the world in the 1990s and 2000s - before the global financial crisis of 2008. Increased inflation may eventually force the central banks of developed countries to act - to raise rates and stop distributing "free" money.

There is a significant threat here for middle-income countries that are accustomed to relying on market instruments for accumulating public debt. Today, low interest rates in the world and large-scale injections of liquidity by central banks of developed countries provide a fragile balance in the global debt market.

In the current conditions, developing countries have the capacity to refinance debts and even accumulate new liabilities. But they have already gained a significant level of debt burden: according to the IMF, public debt in middle-income countries increased by an average of 10 percentage points to 64% of GDP in 2020. If monetary incentives in developed countries are curtailed, the risks of debt sustainability for developing countries will increase. Interest rates in the world will rise. The cost of servicing new debt for middle-income countries will increase. This could trigger a wave of local debt crises in 2023-2024, especially in countries with insufficiently stable macroeconomic fundamentals. This will be another factor of pressure on the growth of the global economy in the medium term.

What is happening now with the global economy is well described by Schrodinger's thought experiment. The pandemic can either decline or drag on with constant outbreaks of morbidity and new strains. We can't be sure of either. In the scenarios of macroeconomists, the world economy is growing in the next two years, recovering from losses in 2020. And at the same time, the potential for global growth may already be declining if the pandemic stays with us for a long time.

Macroeconomists often use the word "uncertainty" to justify the vagueness of the forecast and to lay straws. But right now, uncertainty has become a basic factor that we have to reckon with and learn to live with. The experience of the last year and a half has clearly demonstrated the critical importance of conducting a balanced macroeconomic policy and accumulating financial buffers. After all, those countries that had gunpowder in their flasks and managed to instantly use the available reserves suffered the least losses from the pandemic. These are developed countries, primarily the USA and the EU, and individual developing countries, including Russia and Kazakhstan. Now it is important not to fall into euphoria, receiving operational data on strong recovery growth.