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How COVID-19 Will Increase Inequality in Emerging Markets and Developing Economies

By Gabriela Cugat and Futoshi Narita

Emerging markets and developing economies grew consistently in the two decades before the COVID-19 pandemic hit, allowing for much-needed gains in poverty reduction and life expectancy. The crisis now puts much of that progress at risk while further widening the gap between rich and poor.

Despite the pre-pandemic gains in poverty reduction and lifespans, many of these countries have struggled to reduce income inequality. At the same time, they saw persistently high shares of inactive youth (i.e., those not in employment, education, or training), wide inequality in education, and large gaps remaining in economic opportunities for women. COVID-19 is expected to make inequality even worse than past crises since measures to contain the pandemic have had disproportionate effects on vulnerable workers and women.

As part of our latest World Economic Outlook we explore two facts about the current pandemic to estimate its effect on inequality: a person’s ability to work from home and the drop in GDP expected for most countries in the world.

The impact of where you work

First, the ability to work from home has been key during the pandemic. A recent IMF study shows that the ability to work from home is lower among low-income workers than for high-income earners. Based on data from the United States, we know that sectors with activities more likely to be performed from home saw a smaller reduction in employment. These two facts combined tell us that lower-income workers were less likely to be able to work from home and more likely to lose their jobs as a result of the pandemic, which would worsen the income distribution.

Second, we use the IMF’s GDP growth projections for 2020 as a proxy for what the aggregate decrease in income will be. We distribute this loss across income brackets in proportion to their ability to work from home. With this new income distribution, we compute a post-COVID summary measure of income distribution (Gini coefficient) for 2020 for 106 countries and compute the percent change. The higher the Gini coefficient, the greater the inequality, with high-income individuals receiving much larger percentages of the total income of the population.

What this tells us is the estimated effect from COVID-19 on the income distribution is much larger than that of past pandemics. It also provides evidence that the gains for emerging market economies and low-income developing countries achieved since the global financial crisis could be reversed. The analysis shows that the average Gini coefficient for emerging market and developing economies will rise to 42.7, which is comparable to the level in 2008. The impact would be larger for low-income developing countries despite slower progress since 2008.

Welfare will suffer

This widening inequality on average has a clear impact on people’s well-being. We assess the progress made before the pandemic and what we can expect for 2020 in terms of welfare using a measure that goes beyond GDP. We use a welfare measure that combines information on consumption growth, life expectancy, leisure time, and consumption inequality. Based on these measures, from 2002 to 2019, emerging markets and developing economies enjoyed welfare growth of almost 6 percent, which is 1.3 percentage points higher than per capita real GDP growth, suggesting many aspects of peoples’ lives were seeing improvement. The increase was mostly due to improvements in life expectancy.

The pandemic could reduce welfare by 8 percent in emerging markets and developing countries with more than half of it stemming from the excess change in inequality as a result of a person’s ability to work from home. Note that these estimates do not reflect any income redistribution measures after the pandemic. This means that countries can dampen the effect on inequality and on welfare more generally by policy actions.

 

What can we do about it?

In our latest World Economic Outlook, we outlined some policies and measures to support affected people and firms that will be essential for keeping the inequality gap from widening further.

Investment in retraining and reskilling programs can boost reemployment prospects for adaptable workers whose job duties may see long-term changes as a result of the pandemic. Meanwhile, expanding access to the internet and promoting financial inclusion will be important for an increasingly digital world of work.

Relaxing eligibility criteria for unemployment insurance and extending paid family and sick leave can also cushion the impact the crisis is having on jobs. Social assistance in the form of conditional cash transfers, food stamps, and nutrition and medical benefits for low-income households must not be withdrawn prematurely.

Policies to prevent decades of hard-won gains from being lost will be critical to ensuring a more equitable and prosperous future beyond the crisis.

This blog draws on the work conducted under a research collaboration on macroeconomic policy in low-income countries supported by the United Kingdom’s Foreign, Commonwealth and Development Office (FCDO). The views expressed here do not necessarily represent the views of the FCDO.

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Chart of the WeekFirms’ Environmental Performance in Times of Crisis

By Pierre Guérin, Fabio Natalucci, Felix Suntheim

Leaders are often called upon to “rise to the challenge” in times of crisis. As firms and their leaders rise as best they can amid the ongoing health and economic crises, yet another crisis lies on the horizon. A looming environmental crisis, obscured by the exigency of the pandemic, requires action be taken by firms (and others). So how will business leaders and companies respond?

Our latest analysis looks at past episodes of financial and economic stress to gauge the likely impact of the current crisis on firms’ environmental performance.

On the one hand, the COVID-19 pandemic could increase awareness of environmental risks and bring about a shift in consumer preferences, corporate actions, and investor behavior that could accelerate the transition to a low-carbon economy. On the other hand, there is a risk that financially weakened firms, amidst heightened economic uncertainty, will reduce their investments in long-horizon, capital-intensive green projects, slowing down the transition.

Past as predictor

Looking at a large international sample of listed firms over the period 2002 to 2019, our analysis shows that the environmental performance of financially constrained firms is significantly weaker than for unconstrained firms.

Our analysis incorporates various factors that commonly serve as proxies for financial constraints—smaller, unrated firms are more likely to be financial constrained than are larger firms with ratings. Similarly, firms that are financially constrained may be less willing to pay out dividends. Our main measure of environmental performance is a score based on various key performance indicators, such as resource usage, emissions reductions, and product innovation.

For firms that do not pay dividends, are not rated, or are smaller, the environmental performance score is, on average, 10 to 30 percent lower than the score of large, dividend-paying, or rated firms.

A shock with large macroeconomic and financial implications, such as the COVID-19 pandemic crisis, increases uncertainty and disrupts economic activity, a development that tends to amplify firms’ financial constraints. This, in turn, is likely to adversely affect firms’ green investments.

As shown in our chart of the week, a sudden jump in global financial stress and uncertainty—comparable to the average level that prevailed in the first half of 2020—would lead to a drop in firms’ environmental performance, reversing gains made over the last decade. Critically, the pre-shock environmental performance level is not regained even three years after the shock. Similarly, our analysis found that when economic output declined, so too did firms’ environmental performance.

Present insight

These results have important implications in the context of the COVID-19 crisis and the urgent need to reduce global greenhouse gas emissions:

First, absent climate policy actions, such as a green investment push as called for in the recent World Economic Outlook, tighter financial constraints and adverse economic conditions can be detrimental to firms’ environmental performance, reducing green investments, and potentially slowing down the transition to a low-carbon economy. Therefore, to offset any potential deterioration in firms’ environmental performance, it will be crucial to put in place climate policies that alleviate firms’ financial constraints and aid green investment.

Second, in addition to green recovery packages, policies aimed at fostering sustainable finance will be key:

  • Comparable, consistent corporate reporting on sustainability would enable a more effective assessment of firms’ environmental performance. Only accurate and adequately standardized reporting and disclosure will allow investors to determine actual exposures of companies to climate-related financial risks.

  • It is important to instill confidence in investors that sustainability be not just an attractive label, but that it reflect underlying sustainable investment decisions. To achieve that, further standardization and clarification of what constitutes a sustainable investment fund is needed.

  • International cooperation and a collaborative approach to the initiatives taking place globally are crucial to leverage efforts and to avoid fragmentation of sustainable asset markets. The IMF will be contributing to this endeavor.

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Emerging and Frontier Markets: Policy Tools in Times of Financial Stress

By Dimitris Drakopoulos, Rohit Goel, Fabio Natalucci, and Evan Papageorgiou

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After the unprecedented hit to economic activity in emerging market economies from the COVID-19 pandemic, their economic output is projected to shrink by 3.3 percent in 2020. Central banks across emerging markets responded swiftly and forcefully with an unprecedented response of their own. They did this by using a variety of policy tools and, to a great extent, helped stabilize markets and keep them functioning.

Asset purchases may be suitable for some central banks, depending on the market conditions they face.

Nearly all central banks cut rates, most of them intervened in currency markets, and about half of them cut reserve requirements for banks, which provided liquidity to the financial system and eased credit conditions. And some 20 emerging market central banks for the first time launched quantitative easing—formally known as asset purchase programs—by buying government and private sector debt to alleviate stress and help keep markets functioning. Our recent analysis in the Global Financial Stability Report shows these asset purchase programs have generally proven effective, including by helping to stabilize local financial markets.

Quantitative easing—a first for emerging markets

The motivation for quantitative easing by emerging market central banks varied across countries. As shown in the chart below, these asset purchases can be grouped into 3 main policy objectives. First, central banks with policy rates well above zero tended to use asset purchases as a tool to improve bond market functioning (India, South Africa, Philippines). Second, central banks with policy rates closer to the “zero-lower bound” (Chile, Poland, Hungary) partially sought a course similar to advanced economy central banks, where they used quantitative easing to ease financial conditions and provide additional monetary stimulus, as well as for market functioning and liquidity objectives. And, third, some central banks explicitly stated that one of their objectives was to temporarily ease government financing pressure in the face of the pandemic (Ghana, Guatemala, Indonesia, and the Philippines).

Did asset purchases work?

After almost 6 months of quantitative easing in action, our analysis suggests that these purchases had a generally positive impact on local financial markets. Importantly, this was the case even when accounting for policy rate cuts, additional large-scale asset purchases by the Federal Reserve, and the strong rebound in global risk appetite. In particular, asset purchases by emerging market central banks helped lower government bond yields without seeing accompanying depreciations in local currencies. They also gradually helped lower local market stress.

An expanding policy toolkit

Beyond the current pandemic, the positive experience with asset purchases may motivate more emerging market central banks to consider unconventional monetary policy as a key part of their policy toolkit, especially when conventional policy space is limited. Asset purchases may be suitable for some central banks, depending on the market conditions they face, and their ability to implement them successfully.

But policymakers should consider both the benefits and potential significant costs of quantitative easing. If asset purchases—especially if large-scale and open-ended—are used regularly in the future, then several risks may arise: institutional and central bank credibility may be weakened; capital outflow pressure may intensify, especially in countries with weaker fundamentals; and concerns about fiscal dominance may arise among investors. These risks need to be weighed before central banks embark on a shift in their policies and their implementation.

More work to do

To sum up, emerging market asset purchase programs can be helpful, but further evaluation is needed as more data become available on their effectiveness, especially if these purchases continue.

A few lessons are already emerging: Asset purchases appear to be more effective when used jointly as part of a broader macroeconomic policy package. Transparency and clear communication are crucial to minimize risks to the credibility of central banks with asset purchases—especially in countries with weaker institutional frameworks. In most cases, asset purchase programs should be limited in time and scale and should be linked to clear objectives. Finally, purchases should preferably be made in secondary markets, as purchases in the primary market or at below market rates can affect the process of determining the fair price of bonds. Primary market purchases can also raise concerns that central banks will sacrifice their price stability mandated objective in order to finance the government (fiscal dominance).

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