Week in Review

What We're Reading:

April 12, 2021

US considering sending warships to Black Sea amid Russia-Ukraine tensions. The United States is considering sending warships into the Black Sea in the next few weeks in a show of support for Ukraine amid Russia's increased military presence on Ukraine's eastern border. (CNN)

Global supply lines struggle to clear container backlog after Suez chaos. A backlog of container ships carrying consumer goods has grown in some key strategic ports after a near week-long blockage in the Suez Canal, adding to ongoing disruptions to global trade, industry sources say. (Reuters)

'Price rises likely' due to UK shipping problems. Businesses say a global shipping crisis is causing freight costs to soar and UK consumers may soon see price rises for imported goods. (BBC)

Exit of Cuba’s last Castro brings curtain down on revolutionary era. Retirement of Fidel’s brother Raúl as party chief comes as country faces severe economic crisis. (Financial Times)

Turkey's Erdogan, After Ousting Cenbank Chief, Targets Single-Digit Rates. Turkish President Tayyip Erdogan said on Wednesday his government was determined to bring inflation down to single digits and also set his sights on lowering interest rates to below 10%. (UNWR)

World will face "more intense and cascading global challenges" over next two decades, U.S. intelligence report warns. More frequent and intense global challenges—in the form of disease outbreaks, financial crises, or the negative effects of climate change or new technologies—are likely to stress already brittle systems of government and international organizations over the next two decades, according to a comprehensive forecast compiled by U.S. intelligence officials and released on Thursday. (CBS)

More money poured into stocks in past 5 months than last 12 years. Equity funds have attracted more than half a trillion dollars in the past five months, exceeding inflows recorded over the previous 12 years, according to data from BofA, which has likened the stampede to a “melt-up” in markets. (Reuters)

Why Shortages of a $1 Chip Sparked Crisis in Global Economy. To understand why the $450 billion semiconductor industry has lurched into crisis, a helpful place to start is a one-dollar part called a display driver. (Bloomberg)

IMF World Economic Outlook: Managing Divergent Recoveries. Global economy on firmer ground, but with divergent recoveries amid high uncertainty. (IMF)

The West’s row with China over human rights threatens to upset trade. Tensions between China and the West are running high following the Asian giant imposing sanctions on the UK, EU, US and Canada after a crackdown by Western states on Beijing over human rights issues. (Global Trade Review)

Ireland: EU-Mercosur trade deal ‘unlikely’ during Portuguese presidency. Ireland considers it “unlikely” that the EU-Mercosur trade agreement will be concluded during the Portuguese presidency of the Council of the European Union and insists on guarantees that deforestation of the Amazon will be halted. (EurActiv)

The forgotten shipping pallet is staging a pandemic-era rally. After carrying the weight of the global economy since World War II with little fanfare, the lowly shipping pallet is finally commanding some respect. (Business Mirror)

The status of the Republic of China is by far the most complicated in the world. Better known as Taiwan, this is an independent nation in every respect except diplomatically.

The government of the People’s Republic of China in Beijing has demanded that every nation in the world accept it as the legitimate ruler of all of China and that includes Taiwan. To the Chinese in Beijing, the Republic of China is illegitimate and someday the renegade province will be brought into the fold.

A tense standoff between China and the majority of the world exists because Taiwan is allowed to function as a fully independent state, while seemingly acknowledging the Chinese claim. The U.S. elected to recognize the PRC as “China,” but it has maintained a relationship with the ROC since. The U.S. has pledged military support in the event it is attacked by the PRC, but the extent of that support is vague.

For years this awkward relationship has been maintained, and it seemed the authorities in Beijing were somewhat content with the status quo. The fact is that billions in Taiwanese investment go to mainland China and vice versa. The business community in both nations like things just as they are. That truce situation has been eroding over the last few years. There is more potential for a conflict than has been the case in decades.

Several important changes have taken place over the last decade; they all have an impact on Taiwan. The first and most obvious is that China has become a major world power—second only to the U.S. in terms of economic power, military capability and diplomatic reach.

Everything China has done in the last few years has been designed to consolidate that power and impress upon the world that it has arrived. The crackdowns on internal dissent have been brutal because Beijing has made it clear that nationalism in Tibet or Uighur territory will not be tolerated.

The fiction of Hong Kong’s autonomy has been utterly shattered, and China has become increasingly confrontational in the South China Sea. There have been conflicts with Japan over disputed islands as well as with India over borders in the Himalayans. China has aggressively supported any number of nations that have been in conflict with the U.S.—Iran, North Korea, Myanmar, Venezuela and so on. Trade conflicts have been more complex, but it is clear the Chinese have become the primary rival to U.S. business interests around the world.

Military analysts in the U.S. and elsewhere assert that an outright invasion of Taiwan in the next five to 10 years is a very distinct possibility. It is more than apparent that China has been preparing for that day. The military exercises that took place in the last several weeks were as aggressive and threatening as they could be short of an actual war.

Dozens of Chinese planes violated Taiwanese airspace. Many of these were bombers. Missile firings were aimed very close to Taiwan and ships sailed into Taiwanese waters with impunity. These ships were loaded with troops; all the gear needed for an invasion. It would have been extremely simple to have converted this “exercise” into an all-out attack before any other nation would have had time to react. A U.S. response would have taken place after the invasion. The question is whether the U.S. can behave more aggressively without triggering a response. It would likely involve positioning U.S. warships directly in the invasion path and even stationing troops in Taiwan, which would be interpreted as an aggressive act by Beijing. To assert this has become a hair trigger situation is an understatement.

Prospects for a quick recovery in world trade have improved as merchandise trade expanded more rapidly than expected in the second half of last year. According to new estimates from the WTO, the volume of world merchandise trade is expected to increase by 8.0% in 2021 after having fallen 5.3% in 2020, continuing its rebound from the pandemic-induced collapse that bottomed out in the second quarter of last year.

Trade growth should then slow to 4.0% in 2022, and the effects of the pandemic will continue to be felt as this pace of expansion would still leave trade below its pre-pandemic trend.

The relatively positive short-term outlook for global trade is marred by regional disparities, continued weakness in services trade, and lagging vaccination timetables, particularly in poor countries. COVID-19 continues to pose the greatest threat to the outlook for trade, as new waves of infection could easily undermine any hoped-for recovery.

Short-term risks to the forecast are firmly on the downside and centered on pandemic-related factors. These include insufficient production and distribution of vaccines, or the emergence of new, vaccine-resistant strains of COVID-19. Over the medium-to-long term, public debt and deficits could also weigh on economic growth and trade, particularly in highly indebted developing countries.

The forecast illustration in Chart 1 shows two alternative scenarios for trade. In the upside scenario, vaccine production and dissemination would accelerate, allowing containment measures to be relaxed sooner. This would be expected to add about 1 percentage point to world GDP growth and about 2.5 percentage points to world merchandise trade volume growth in 2021. Trade would return to its pre-pandemic trend by the fourth quarter of 2021. In the downside scenario, vaccine production does not keep up with demand and/or new variants of the virus emerge against which vaccines are less effective. Such an outcome could shave 1 percentage point off of global GDP growth in 2021 and lower trade growth by nearly 2 percentage points.

For the whole of 2020, merchandise trade was down 5.3% (Table 1). This drop is smaller than the 9.2% decline foreseen in the WTO's previous forecast in October 2020. The better-than-expected performance towards the end of the year can partly be explained by the announcement of new COVID-19 vaccines in November, which contributed to improved business and consumer confidence. Box 1 below discusses reasons for the forecast upgrade in more depth.

The volume of world merchandise trade plunged 15.0% year-on-year in the second quarter of 2020 (revised up from -17.3 % in October) as countries around the world-imposed lockdowns and travel restrictions to limit the spread of COVID-19. Lockdowns were eased in the second half of the year as infection rates came down, allowing goods shipments to surge back to near 2019 levels by the fourth quarter.

Faster trade and output growth in the second half of 2020 was supported by major government policy interventions, including significant fiscal stimulus measures in the United States. These measures boosted household incomes and supported continued spending on all goods, including imports. In addition, many businesses and households adapted to the changing circumstances, finding innovative ways to sustain economic activity in the face of health-related restrictions on mobility. Effective management of the pandemic limited the extent of the economic downturn in China and other Asian economies, allowing them to continue importing. These actions helped prop up global demand and may have prevented an even larger trade decline.

Trade in nominal US dollar terms fell even more sharply than trade in volume terms in 2020. World merchandise export values were down 8% compared to the previous year, while commercial services receipts tumbled 20%. Services trade was especially weighed down by international travel restrictions, which prevented the delivery of services requiring physical presence or face-to-face interaction.

The impact of the pandemic on merchandise trade volumes differed across regions in 2020, with most regions recording large declines in both exports and imports. Asia was the sole exception, with export volumes up 0.3% and import volumes down a modest 1.3%. Regions rich in natural resources saw the largest declines in imports, including Africa (-8.8%), South America ( 9.3%) and the Middle East (-11.3%), probably due to reduced export revenues as oil prices fell around 35%. In comparison to other regions, the decline in North American imports was relatively small (-6.1%).

In 2021, demand for traded goods will be driven by North America (11.4%) thanks to large fiscal injections in the United States, which should also stimulate other economies through the trade channel. Europe and South America will both see import growth of around 8%, while other regions will register smaller increases.

Much of global import demand will be met by Asia, exports from which are expected to grow by 8.4% in 2021. European exports will increase nearly as much (8.3%), while shipments from North America will see a smaller rise (7.7%). Strong forecasts for export growth in Africa (8.1%) and the Middle East (12.4%) depend on travel expenditures picking up over the course of the year, which would strengthen demand for oil. Meanwhile, South America will see weaker export growth (3.2%), as will the Commonwealth of Independent States (CIS), including certain former and associate Members (4.4%).

The pandemic has hit small and medium enterprises particularly hard. Partly because they are predominant in some contact-intensive sectors like hotels, restaurants, and entertainment. As a result, many advanced economies risk experiencing a wave of liquidations that could destroy millions of jobs, damage the financial system and weaken an already fragile economic recovery. Policymakers should take novel and swift action to alleviate this wave.

Compared to past crises, this time around there is a clearer case for solvency support by governments.

Abundant liquidity support through loans, credit guarantees and moratoria on debt payments have protected many small and medium enterprises from the immediate risk of bankruptcy. But liquidity support cannot address solvency problems. As firms accumulate losses and borrow to keep carrying on, they risk becoming insolvent—saddled with debt well over their ability to repay.

New IMF staff research quantifies this solvency risk, and the findings are concerning. The pandemic is projected to boost the share of insolvent small and medium enterprises from 10% to 16% in 2021 across 20 of the most advanced economies in Europe and the Asia-Pacific region. The increase would be on a magnitude similar to the rise in liquidations in the five years after the 2008 global financial crisis, but it would take place over a much shorter period of time. Projected insolvencies put about 20 million jobs at risk (i.e., over 10% of workers employed by small and medium enterprises) – roughly the same as the total number of currently unemployed workers, in the countries covered by the analysis.

Further, 18% of small and medium enterprises may also become illiquid (they may not have enough cash to meet their immediate financial obligations), underscoring the need for continued liquidity support.

The implications for banks are another cause for concern. Rising small and medium enterprise insolvencies could trigger defaults and cause significant write-offs which would depleting banks’ capital. In hard-hit countries—mostly from Southern Europe—banks’ capital tier 1 ratios (a key measure of their financial strength) could decline by over 2 percentage points. Smaller banks would be hit even harder, as they often specialize in lending to smaller businesses; a quarter of them could experience a drop of at least 3 percentage points in their capital ratios, while 10% could face an even larger fall of at least 7 percentage points.

'Quasi'-equity injections

Compared to past crises, this time around there is a clearer case for solvency support by governments. Because of the sheer magnitude of the problem, the costs of bankruptcies to society far exceed their costs to individual debtors and creditors. For example, if a wave of insolvencies overwhelms the courts, these could fail to restructure viable firms and push them into liquidation instead. Undue losses in valuable productive networks, human capital, and jobs would follow.

In practice, countries with adequate fiscal space, transparency and accountability could consider quasi-equity injections into small and medium enterprises. Indeed, several are already actively exploring this option, notably in Europe. One approach is for governments to extend “profit participation loans” through fresh loans or conversion of existing ones. These loans would be junior to all other existing debt claims and their payoff could be partly indexed to the firm’s profits. Targeting the right businesses—those that are insolvent as a result of the pandemic but have viable business models—is very hard. For this reason, governments might consider conditioning their support on private investors (like banks) injecting equity – which would let the market take a leading role in identifying a firm as a viable business. France, Italy and Ireland have proposed or enacted policies to incentivize private investors to contribute equity. Support could also be staggered over time, and new tranches deployed only as viability uncertainty dissipates.

Targeted quasi-equity injections would be far more efficient and powerful than providing support to all firms. Across-the-board (blanket) injections benefit two types of firms that should not receive solvency support; those that do not need it because they are solvent even amid the crisis and those that would have been insolvent even without the pandemic—that also happen to be less productive. As an illustration, a targeted support program with a budget of roughly half a percent of the overall GDP of the 20 countries analyzed could bring back over 80% of the right firms (viable but currently insolvent) to zero net equity (a minimal definition of solvency). This is over four times more than would be achieved under a blanket approach supporting all small and medium enterprises without distinction.

Beefing up insolvency and debt restructuring mechanisms

Even with public support measures, small and medium enterprise insolvencies are likely to rise. Therefore, a comprehensive set of insolvency and debt restructuring tools will be needed for the insolvency proceedings system to cope with the added strain. These tools include dedicated out-of-court restructuring mechanisms, hybrid restructuring, and strengthened insolvency procedures—for instance, simplified reorganization for smaller firms. Since liquidations may be excessive even under well-functioning insolvency procedures, governments could provide financial incentives to tilt the balance towards restructuring.

To secure a strong recovery, governments in advanced economies need to address the risks of small and medium enterprise distress. Combining continued liquidity support, quasi-equity injections and enhanced restructuring mechanisms could go a long way toward that goal.

Reprinted with permission by the IMF Blog.

Federico J. Díez is an economist at the structural reforms unit of the IMF’s research department. Prior to joining the Fund, he was at the Federal Reserve Bank of Boston. His research interests include structural issues, firm dynamics, corporate market power, innovation, entrepreneurship, international trade, and international macroeconomics. He holds a PhD in Economics from the University of Wisconsin—Madison.

Romain Duval is an assistant director in the IMF’s research department, where he leads the agenda on structural reforms. Previously, he worked in the IMF’s Asia and Pacific department and, prior to joining the IMF, at the OECD. He has published extensively in leading academic and policy-oriented journals on a wide range of topics including the economics and political economy of labor and product market regulations, economic growth, productivity, trade, monetary policy, exchange rates, and climate change economics. He holds a PhD from University Paris-I Pantheon Sorbonne.

Chiara Maggi is an economist at the Middle East and Central Asia department of the IMF, where she works on the Morocco desk. Previously, she was in the structural reforms unit of the IMF’s Research Department. Her research focuses on the macroeconomic impact of structural reforms, firm dynamics and corporate market power. She holds a PhD in Economics from Northwestern University.

Nicola Pierri is an economist at the macro-financial division of the IMF research department. His research investigates causes and consequences of productivity, technology adoption, and quality heterogeneity across firms, banks, and hospitals. He holds a PhD in Economics from Stanford University.

 Week in Review Editorial Team:

Diana Mota, Associate Editor and David Anderson, Member Relations