Jamal Saghir | Friday, March 27, 2020
When some experts described the COVID-19 pandemic as the most dangerous global challenge since World War II, potentially overshadowing the 2008-2009 financial crisis- they were correct. Although disasters diverge in their causes and scope of impact, they are connected by the necessity for coordinated international, regional, national, and local responses. The world is on the verge of a major economic recession and the impact on every country, rich or poor, will be tremendous unless early actions are taken.
With markets experiencing levels of volatility not seen since the 2008 financial crisis, the current pandemic crisis has evolved differently from other major crises faced in recent decades. In fact, this pandemic’s impact on the economic and financial sector will be deep and lasting unless exceptional fiscal and monetary large stimulus packages are put forward. Not only is it occurring in a world of unprecedented financial globalization, where the financial sector plays a historically large role in economic activity, but it is also an “imported” crisis. The COVID-19 pandemic crisis is an “exogenous shock” provoking a major global shock that will significantly increase poverty and vulnerability.
“The world is on the verge of a major economic recession and the impact on every country, rich or poor, will be tremendous unless early actions are taken”
It is worth noting that what is different about the COVID-19 shock is that it is affecting the supply chain – production/distribution of goods and services – and demand/consumption – sides of the economy at the same time. Worldwide economies and systems are failing. The uniqueness of the current configuration of economic challenges has important policy implications and action options available to country governments. It implies that the policy responses maybe ineffective in stemming the looming global crisis. However, actions of individual countries can affect the impact of the crisis on their own economies. Policymakers around the world need to react forcibly and quickly at the signs of domestic weakness, including the rapid involvement of external assistance as necessary. Only few countries including the US, EU, UK , China and Japan are heading into that direction whereas the rest of the World is in a “wait and see” mode.
As the global economy comes to a grinding halt, many countries and particularly developing countries, could be moving into a new danger zone, with heightened risk to exports, investment, credit, banking systems, budgets, and to the balance of payments. With border closures and import restrictions, exports are falling, capital could be withdrawn from emerging markets and short-term credit could also dry up. Sharply tighter credit conditions and weaker growth are likely to cut into government revenues and their investment ability to meet the education, health, and infrastructure sectors’ needs. Countries dependent on exports, remittances, or foreign investment (as many of the Arab countries), exhibiting high current account deficits or rising inflation, and those with extensive fuel/food subsidies are most vulnerable to a sharp slowdown—especially if accompanied by a significant tightening of financial market conditions.
Virtually no country, developing or industrial, would escape the impact of the widening COVID-19 crisis on the financial and economic situation. Past crises show that the deterioration in financing conditions has been most severe for countries with large current account deficits. Of the several countries whose economies have reacted most sharply to the deterioration in conditions, the US is moving quickly toward a substantial initial fiscal stimulus package, which is focused on practical steps. European countries are also moving to prevent the economy freezing up. But this is only the beginning and we should expect more as the crisis unfolds.
“As the global economy comes to a grinding halt, many countries and particularly developing countries, could be moving into a new danger zone, with heightened risk to exports, investment, credit, banking systems, budgets, and to the balance of payments”
During the 2008 financial crises, the IMF and World Bank Group stepped up with a commitment of over $1 trillion in finance to countries. These international organizations should quickly assess the impact of COVID-19 on sustainability and external financing on the international and national levels and should increase support for the health response in countries. The World Bank Group has approved a $14 billion package of fast-track financing to assist companies and countries in their efforts to prevent, detect and respond to the rapid spread of COVID-19. The package will strengthen national systems for public health preparedness, including disease containment, diagnosis, and treatment, and support of the private sector. The IMF has also announced that it will make available up to $50 billion in rapid disbursing emergency finance.
However, I believe that as a knock-on effect, with the crisis taking its toll on even the most well-off countries, a serious risk could be the withdrawal of donors from aid commitments when they are most needed.
In my opinion, the impact of the financial crisis caused by COVID-19 is felt the most as per the following:
- Many countries can expect to see a decline in GDP per capita; unsustainable debt will make it impossible to execute their budgets and will reduce their capacity to pay public sector wages, severely disrupting public services, including first and foremost education and health. As the economy worldwide continues to face uncharted territory, recovery will come from aggressive action in term of policy response and size of stimulus. On the other hand, most countries’ tight fiscal positions will limit their ability to respond to the crisis. They will need international support and aid beyond current development budgets allocated to countries by International Financial Institutions and bilateral partners.
- Investment is expected to suffer as it bears much of the direct impact of the financial crisis having been the main driving force for developing-country growth over the past few years. There is a risk that investment in developing countries may be headed for a “perfect storm,” with a convergence of slowing world growth, withdrawal of equity and term lending from the private sector, with a further risk that commodity prices fluctuation in the medium term will deter new investment in natural resource sectors.
- Financing conditions are deteriorating rapidly. Sound domestic financial sectors could find themselves unable to borrow or unwilling to lend both internationally and domestically, and domestic productive sectors would be deprived of working and long-term capital.
- Remittances from host countries are expected to decline in response to the expected recession and global slowdown but the impact on flows to recipient countries will depend significantly on exchange rates.
What does it mean for Lebanon?
Lebanon is already in situation of ‘sudden stop’. It is facing a deep accumulation of interrelated political, social, economic, financial, and environmental crises mutually feeding off of each other at different levels. Adding COVID-19 health crises on top of an already perfect storm, Lebanon is now in the emergency room and steroid decisions and actions are not enough to treat the country. A major economic and political structural reform program is needed now.
“The challenge for policymakers in Lebanon is not to solely prevent the escalation of the crisis heightened by COVID-19 and mitigate the impending downturn, but also to implement quick and sound policy reforms”
Lebanon imports vastly more goods and services than it exports. The import-export imbalance is creating current account deficit around 25 percent of GDP. We are witnessing an unsustainable currency peg to the US dollar, with devaluation, hyperinflation, and a looming economic depression. Another factor that comes into play is the inability of Lebanon to repay international financial commitments while the banking system is completely paralyzed and is no longer able to serve its clients and the economy.
Lebanon macroeconomic fundamentals are the worst among previous crises-stricken countries. It is the third most indebted country in the world, after Japan and Greece, with a Debt-to-Gross Domestic Product (GDP) ratio over 150% and a gross public debt of over US$ 80 billion.
The challenges faced by Lebanon are now compounded due to COVID-19 health and financial crisis. Policymakers are responding to the short-term COVID-19 health crises while having to deal with financial and economic collapse. Without question, current circumstances have revealed in Lebanon as well the world important weaknesses in crisis preparedness arrangements. COVID-19 tests the reliability, sustainability, and strength of health systems and their ability to respond and mitigate current and potential repercussions.
The challenge for policymakers in Lebanon is not to solely prevent the escalation of the crisis heightened by COVID-19 and mitigate the impending downturn, but also to implement quick and sound policy reforms. This means responding rapidly and forcefully to current weaknesses in the financial sectors, including resorting to international assistance. It also means pursuing a prudent counter-cyclical policy, relying on automatic stabilizers and a social safety net that address bottlenecks that have become binding constraints to economic growth. Solutions to deal with the financial crisis are available. Now is the time to act quickly with determination and perseverance.
 A stimulus package is a package of economic measures put together by a government to stimulate a floundering economy. The objective of a stimulus package is to reinvigorate the economy and prevent or reverse a recession by boosting employment and spending.The theory behind the usefulness of a stimulus package is rooted in Keynesian theory which argues that the impact of a recession can be lessened with increased government spending.This would include direct cash payments, support for small businesses, aid for industries and make it easier for companies to borrow money.
 Sudden stop is an abrupt reduction in net capital flows into an economy. It is usually characterized by a reversals of international capital flows, declines in production and consumption. It is also accompanied by a currency crisis or a banking crisis or both.
Jamal Saghir, Distinguished Senior Fellow, Economic and Development, Issam Fares Institute for Public Policy and International Affairs, American University of Beirut.
This article is part of a new series launched by the AUB Issam Fares Institute to reflect on the impact of the #COVID-19 pandemic on various levels: the economy (global, and national), globalization, multilateralism, international cooperation, public health systems, educational system, refugee response, among other topics.
Opinions expressed in these articles are those of the author and do not necessarily reflect the views of the Issam Fares Institute for Public Policy and International Affairs at the American University of Beirut.