This Week in COVID-19 and Economic Diplomacy: ‘Shrinking Emerging Economies’

Our weekly COVID-19 and Economic Diplomacy tracker looks at policies that impact the coordination of international governments and central banks, ongoing commentary and analysis, and asks what these turbulent times mean for economic diplomacy. 

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The Highlights

• Treasury Secretary Mnunchin testified that the administration may be willing to agree to a stimulus package as large as $1.5 trillion. The Democrats’ proposed plan is $2.2 trillion; Senate Republicans seem to be leaning towards a $500-$700 billion plan. 
   
• The eurozone slid into deflation with a headline consumer price inflation of -0.2%. 
   
• Emerging economies’ GDPs have shrunk significantly. Brazil has entered a recession; India’s economy contracted by an annualized 23.7%; and Turkey’s GDP shrank 11%. Argentina has successfully restructured its $65 billion debt with private creditors.

Global Developments

• The falling value of the dollar is likely to benefit advanced economies and harm emerging economies, threatening to undermine the global economy’s resilience. The dollar index has fallen more than 9% since its peak in March. Reasons for the decrease in value are the Fed’s interest rate cuts and U.S. failure to keep the pandemic under control. For advanced economies, a weaker dollar improves the competitiveness of U.S. exports and makes imports from other advanced economies more expensive. However, the dollar has still gained in value against most developing and emerging country currencies since March 2020. Given that their trade is priced in USD, their exports are less competitive and imports priced in dollars are more expensive. 

U.S. Developments

• Federal Reserve governor Lael Brainard warned that the U.S. economy is still at risk and that additional government support is needed. Brainard said that the Fed should use regulation and other forms of oversight to decrease risks to financial stability, stating that banks “should [not] be paying out dividends.” Richard Clarida, the Fed’s vice chair and head of the policy framework review, highlighted that unemployment numbers alone will not trigger a change in interest rates. 
   
• Treasury Secretary Steven Mnuchin stated that the administration may be willing to agree to a stimulus package as large as $1.5 trillion. Testifying in front of the House Select Subcommittee on the Coronavirus Crisis, Mnuchin voiced support for enhanced unemployment benefits and additional money for state and local governments. Democrats have proposed a $2.2 trillion package. Senate Republicans seem to be converging on a scaled-back stimulus plan totaling $500-$700 billion.

European Developments

• The eurozone slid into deflation for the first time in four years with a headline consumer price inflation of -0.2%. Core inflation, which excludes energy, food, and tobacco prices, fell to a record 0.4% in August and annual price growth in services fell to 0.7%. Deflation affected 12 of the 19 eurozone countries. At next week’s ECB meeting, it is expected that they will further lower their forecast for inflation to reach 1.3% by 2022. 
   
• Germany is expected to experience a V-shaped recovery from the pandemic and will recover faster than expected. Germany’s economic minister, Peter Altmaier, stated that he forecasts that the economy will shrink by 5.8% this year, a smaller contraction than the previous projection of a 6.3% contraction. He also predicted that the economy will return to pre-pandemic levels in 2022. Some experts warn against the optimism stating that there could be a delayed impact on the labor market if a significant number of furloughed jobs are eventually lost. 

Emerging Markets

• Brazil’s economy has officially entered a recession with GDP shrinking 9.7% quarter-on- quarter. The fall in GDP is greater than the total loss in any of the nine recessions that have struck Brazil in the past 40 years. As President Jair Bolsonaro contemplates loosening or abandoning a spending cap, finance minister Paulo Guedes is an increasingly lone voice supporting fiscal rectitude. Investors are concerned that eliminating the spending cap will cause capital outflows. However, economists are optimistic that the worst is over and that the economy will shrink by 5-6% as opposed to the previously predicted 8-9% contraction. They also predict 3% growth for next year.
   
• India’s economy contracted by an annualized 23.9% in the quarter ending in June. In the April to June quarter, private consumption contracted 27% and investment decreased 47.5%. GDP contraction was far larger than experts’ expected; the pandemic resulted in the loss of 140 million jobs. Prior to the pandemic, India’s economy was faltering, with GDP falling for four consecutive years. The pandemic has severely impacted the country, which is expected to soon surpass Brazil in terms of cumulative COVID-19 cases, second only to the US. 
   
• Argentina has successfully restructured most of its $65 billion debt with private creditors. The deal, which will put an end to the country’s ninth sovereign debt default, extends maturities on the debt and lowered interest rates payments from an average of 7% to 3%. The debt exchange will enable creditors to swap their old bonds for new ones. Now, Argentina is focused on restructuring its $70 billion debt with multilateral institutions, formally requesting to begin negotiations with the IMF. 
   
• Turkey’s GDP shrank 11%, the steepest decline on record. On an annualized basis, GDP shrank 9.9%. Part of the government's economic response was to accelerate a credit stimulus which contributed to the destabilization of the lira. Manufacturing activity shrank by more than 18% from the first quarter and services contracted by 25%. However, economists note that the economy is slowly recovering. 
   
• Dubai returns to the global debt market for the first time in six years to blunt the pandemic’s impact on its economy. Bankers estimate that the issuance will reach $2 billion. In addition to the economic fallout from the pandemic, Dubai has had to contend with additional expenditures like the postponement of the World Expo. The government has raised $3.6 billion thus far; the IMF estimates Dubai’s overall debt burden to be more than $120 billion or 110% of GDP.
   
• The Paris Club group of creditor countries stated that the pandemic will likely send some of the world’s poorest economies into debt distress. This will force creditors and private-sector lenders to accept a reduction or restructuring of loan repayments, going beyond the current debt service suspension initiative (DSSI) by the G20. No country has yet applied for a moratorium on repayments from private sector creditors but any relief beyond DSSI will require IMF lending support. Credit rating agencies have warned that asking for private sector involvement (PSI) could potentially lead to a ratings downgrade.

Odds and Ends

• Pilita Clark in the Financial Times writes that women workers have faced a significant brunt of the economic recession. The U.S. has experienced a “she-cession” with the unemployment rate among women was 1 percentage point higher than men. In Australia, the so-called “pink recession” shows that the number of employed women fell 5.3% compared to 3.9% of men. Globally, McKinsey estimates that women’s jobs are 1.8 times more vulnerable than men’s.
   
• Diana Enriquez, Sebastián Rojas Cabal, and Miguel A. Centeno write in Foreign Affairs on the universal, applicable lessons learned from Latin America’s pandemic experience. 
   
• Stephanie Aaronson analyzes the Fed’s new framework emphasizing maximum employment. 
   
• Branko Milanovic writes in Foreign Affairs that the world is becoming more equal but is hurting middle-class Westerners. Compared to middle-class Asians, middle-class Westerners saw less income growth.  
   
• Ashfaq Zaman writes in Foreign Policy that the developing world is faring better than developed countries due to demographics, health response, and digitization efforts.