In the midst of exceptional uncertainty, policy makers around the globe are grappling with the delicate task of scaling back the economic support measures put in place during the early stages of the COVID-19 pandemic while encouraging creation of the conditions needed to restore economic activity and growth. One significant challenge is the lack of transparency—created or reinforced by the pandemic and (unintentionally) exacerbated by policy actions—about the risks in the balance sheets of the private and public sectors.
What we do know is that the pandemic induced recession of 2020 led to the largest single-year surge in global debt in decades. Before the pandemic, private debts were already at record highs in many advanced economies and emerging economies, leaving many households and firms poorly prepared to withstand an adverse income shock. Many governments were also facing record-high levels of debt prior to the pandemic, and many more significantly increased their debt burdens to fund vital response policies. In 2020, the average total debt burden of low- and middle-income countries increased by roughly 9 percentage points of the gross domestic product, compared with an average annual increase of 1.9 percentage points over the previous decade. Fifty-one countries (including 44 emerging economies) experienced a downgrade in their sovereign debt credit rating.
The COVID-19 pandemic triggered the largest global economic crisis seen in more than a century, with especially severe impacts for emerging economies. Governments responded with large economic programs that were successful in the short run. However, they exacerbated a number of pre-existing fragilities that will need to be actively managed to promote an equitable recovery. Economic vulnerabilities in one sector of the economy can affect others through multiple, mutually reinforcing channels that connect the financial health of households, firms, financial institutions, and governments. Yet sector interconnections can also benefit the broader economy if swift and effective policy action is used to manage economic risks that have arisen during the pandemic.
The COVID-19 pandemic triggered the largest global economic crisis in more than a century. In 2020, economic activity contracted in 90 percent of countries, the world economy shrank by about 3 percent, and global poverty increased for the first time in a generation. Governments enacted a swift and encompassing policy response that alleviated the worst immediate economic impacts of the crisis. However, the government response also exacerbated a number of economic fragilities.
A latest report compiled by the World Bank highlights four pressing economic risks and concrete steps that policymakers can take to address them. Increasing transparency and reducing the share of non-performing loans enables financial institutions to remain stable, well-capitalized, and able to provide credit, especially to low-income households and small businesses. Effective insolvency procedures, including out-of-court options, can reduce the social costs of widespread debt distress, prevent the misallocation of resources, and limit government interference in debt resolution. Delayed action can reduce access to credit, discourage entrepreneurship, and delay the recovery of economic activity. Innovations in digital finance and lending models can help financial institutions reliably assess and manage risk and continue to provide credit, especially to low-income borrowers. Households that maintain financial access are more likely to sustain consumption, while businesses can invest and create jobs.
