MACROECONOMICS - BASICS

 

The Most Powerful Economies in Europe - Real GDP 1960 - 2021

 

Gross Domestic Product and GDP per capita in 2020 USD values. 

Looking beyond the pandemic: Could the world economy gain more than it lost to COVID-19?

 

Safeguarding lives and livelihoods in the next phase could usher in an age of health and prosperity.

For more than a year, the world has been battling SARS-CoV-2 and the economic impact of this great pandemic. While there is an enormous amount of work left to do across the globe, countries leading the COVID-19 exit have given us a glimpse of how hearts and minds can shift to reunions with friends and family, and a return to more normal work and life. As we emerge, what is the right paradigm to guide our collective effort of transitioning through the end of the pandemic to a better future for all?

In March 2020, we suggested that the imperatives of our time were the battles needed to flatten two curves: the curve of the viral spread and the curve of the economic shock. Today, after two terrible peaks of viral spread, and with the vaccine rollout progressing, some regions are finally close to flattening both curves (Exhibit 1). Many others have seen three or even four peaks; their situation remains difficult, and in some countries is as bad as it has ever been. Even some countries that flattened their curves early are again at risk, as new variants spread and vaccination rates are low. The battle is far from over.

Exhibit 1

Of course, governments have applied public-health measures and economic stimulus with varying intensity, and experienced different impacts on mortality and their economies. But one thing is now clear. In early 2020, there was a debate on the trade-off between the virus and the economy. At that time, we suggested that the question was off the mark: there was no trade-off. The facts are now clear: as this article will show, no country kept its economy moving well without also taking control over the virus spread.

The big question now is what should public- and private-sector leaders focus on next? Is the agenda still about how we deliver on the twin imperatives of safeguarding lives and livelihoods? We think so. But what do the twin imperatives mean when we translate them into the current reality and the possibilities for the next decade? Three broad beliefs shape our answers.

• First, 3 to 4 percent global economic growth is achievable with available technology—a “productivity miracle” is not needed.

• Second, we do not have to choose between sustained and inclusive growth—quite the opposite, these goals can be complementary. Past periods of sustained growth have shown across countries and over time that “a rising tide” is a tried and true way to “lift all boats.”1

• Third, the medical advances and process accelerations achieved in response to this pandemic open the possibility that we spark a renaissance in public-health innovation and delivery and make rapid and unprecedented progress tackling persistent health problems.

If global leaders set the expectations that these outcomes are possible, and act on them, then the world could be on the cusp of a new age of prosperity: an economic recovery that will add 30 to 50 percent to GDP over the next decade, with better quality of life for more people, and a more sustainable future for the planet. If not, then the recovery could end up adding only 10 to 20 percent to GDP, less equitably distributed, less sustainable, and with worse outcomes for global health and the environment.

It’s an extraordinary opportunity—and a commensurate challenge. The road ahead will be rough in places. The first year of the pandemic and the policies designed in response have had a profound impact on how people regard their governments, on how well economies are positioned to rebound from the crisis, and how much public and private debt has been accumulated through weathering the economic disruption. However, provided the world’s public- and private-sector leaders make the right moves, a new age of prosperity for all could become a reality.

Reality check: The costs of the pandemic

One year on, how did the world fare in containing the spread of the virus, and in cushioning the economic impact it had on people everywhere? As Exhibit 1 shows, despite early optimism, even OECD countries experienced at least two peaks of COVID-19 cases and related deaths, and economic activity is not yet fully back.

Exhibit 2

While OECD countries managed to cap the exponential spread of the virus, they weren’t able to crush it. Depending on the effectiveness of their response, countries and regions wound up with distinctly different economic outcomes (Exhibit 2). No country grew its economy while also suffering high mortality. The best economies are found in countries with the lowest mortality and the most economic stimulus.

Many factors played a role in shaping the outcomes of the pandemic, including how early the outbreak happened, the readiness to respond, the need for lockdowns, as well as the degree of economic support provided to the economy through fiscal and monetary interventions. Initial conditions also mattered—the underlying health and age of populations as well as the momentum of economies prior to the pandemic.

Countries and regions that controlled the virus, and those that supported their economies the most, fared better. A few that were well prepared and had the means to act swiftly weathered the crisis best. The often-mentioned trade-off between the virus and the economy did not materialize (for more on these outcomes, see the sidebar “Four pandemic outcomes”).

Four pandemic outcomes

Our analysis of mortality and economic growth shows four distinct clusters of GDP outcomes, depending on their public-health and economic responses:

Box 1: Effective total response. These countries and regions either controlled the virus from the onset or crushed it after an initial outbreak with one massive lockdown. Those that resorted to a big lockdown also intervened heavily with stimulus to mitigate negative individual and economic outcomes. This fast response produced better health and economic outcomes. For one of these countries, its economy in 2020 was stronger than before the pandemic.

Box 2: Effective total response, with external shock. In these countries, the viral impact was more limited, but they suffered the consequences of global lockdowns (such as the collapses in goods trade, tourism, and remittances).

Box 3: Ineffective total response. In these countries and regions, severe virus outbreaks produced a high toll on lives that required multiple stringent lockdowns and other tough and recurring public-health measures. Stimulus packages were either ill-timed or insufficient, the underlying pre-COVID-19 economy was weak, or additional factors exacerbated the situation.

Box 4: Ineffective public-health response, but effective stimulus. In these countries, the virus had a moderate to severe impact on lives. But they were able to limit the economic damage with stimulus programs that complemented the incoming momentum in their economies. One large economy suffered from high viral impact, but a large stimulus combined with a strong prepandemic economy to deliver a smaller decline in GDP than countries with a similar disease profile. Another large country saw a moderate viral impact and had slower underlying economic momentum, but a significant stimulus program and better health preparedness similarly limited the extent of GDP decline.

What can we learn from the events of 2020? While there are many lessons, the overriding insight is that acting with determination and speed mattered most. That’s true for protecting lives from the virus, and for the vigor required to protect livelihoods from the subsequent economic shock. The faster governments moved, and the greater the scale of the intervention, the better outcomes for citizens were. How we convert these learnings to better manage future pandemics will undoubtedly be the subject of many debates.

A crossroads for lives and livelihoods?

Fortunately—and this was by no means a given—COVID-19 vaccines were developed in record time, and they work. In early 2021, real-world data from Israel and the United Kingdom validated the clinical-trial results by showing a sharp reduction in hospitalizations and deaths. Other countries are now experiencing similar results. The vaccines also appear to be effective in reducing transmission and against the variants of concern encountered thus far. Furthermore, the global vaccine rollout has made real strides in scaling production and setting up supply chains to support massive inoculation programs that are now accelerating in many countries. Just as important: sentiment about vaccine adoption is improving.

To be sure, there have been setbacks, and risks abound; the formation of new virus mutations is of particular concern. Endemicity is almost certain in various parts of the world, most likely in places where vaccine access is limited, where few people choose to be vaccinated, or where virus variants reduce vaccine efficacy. Endemicity might include cyclic, seasonal waves of disease, broadly like the flu, or even a multiyear cycle of resurgence. But on balance, safe, effective vaccines are changing the game. We are witnessing one of the true miracles of modern science.

On the economic front, government support through fiscal and monetary policies has also unequivocally worked. Employment is recovering in all countries, though at different rates. As a result, uncertainty is receding and losing the paralyzing grip it took in the early part of the pandemic (Exhibit 3).

There now is a keen sense that the world is moving steadily to the next stage of the pandemic. Progress on reducing the virus spread differs depending on where you live. But it seems that in some countries, such as the United States and the United Kingdom, the transitional return to normal is under way. Herd immunity in some regions might be reached well before the end of 2021. Most of Europe is on a similar path, though on a slightly slower timetable.

The outlook for economic progress is also brightening for countries leading the COVID-19 exit, with positive results now being reported for Q1. But the virus still dictates the economy—Japan, which has experienced a recent resurgence and a set of lockdowns, reported negative growth in Q1. Even some countries that have yet to fully reopen and are currently facing challenges are likely to see strong headline GDP growth in 2021 in the scenarios that will most likely bound the outcomes during the next two years (Exhibit 4). (For more on our scenarios, see sidebar “Nine scenarios for COVID-19.”)

The real question is not so much about whether and when economies around the world will exit from the disruptive crisis—they will—but whether the exit will be strong enough to reinvigorate widespread growth in jobs and income and avoid a return of inflation or debilitating burdens from increased debt.

Nine scenarios for COVID-19

In March 2020, we published a set of nine COVID-19 scenarios to gauge developments in public health and the economy (exhibit). Recently, the global executives we surveyed have favored scenario A1; A2 and other scenarios also get votes.

Are we heading for a 20 percent or 40 percent economic expansion?

Not all businesses, industries and economies face the same circumstances today and will certainly fare differently in the years ahead. But some fundamental questions that will affect almost everyone are now emerging with more clarity:

• Will the pace of economic growth return to its pre-COVID-19 path, even if the composition of the next-normal economy turns out to be different?

• Will the pandemic have lasting negative impact on growth, for entire economies and specific sectors in particular?

• Is it possible that the pandemic will have a galvanizing positive impact on growth and productivity in the global economy?

History suggests that there are essentially two types of economic expansions after recession: those that see GDP grow by 10 to 20 percent cumulatively in postcrisis years, and those that see 30 to 50 percent cumulative growth (Exhibit 5).

Exhibit 5

In the United States, the expansions in the 1960s, 1980s, and 1990s all delivered cumulative increases of total GDP of 30 to 50 percent. Call them “40 percent recoveries.”2 Other countries performed similarly during some or all of these periods including Australia, Canada, Singapore, South Korea, and the United Kingdom. All were aided by some combination of demographic tailwinds, higher investment, and productivity surges, underpinned by supportive economic and business policies.

Other US recoveries, like those in the 1970s, 2000s, and 2010s, have delivered only half that growth. The tepid pace of recovery coming out of the financial crisis was not limited to the United States; GDP in France and Germany did not return to 2008 levels for three to four years, the United Kingdom took five years, Spain nearly nine years, and Italy’s GDP was still 5 percent below its 2008 level when the pandemic hit in 2020.

Forty percent recoveries do not happen by accident. They are the result of choices made by leaders in government and business and by individuals, families, and households.

Regression to pre-COVID-19 limitations

A 40 percent recovery is by no means guaranteed. Any near-term spending surge could easily prove temporary, returning the global economy to a 2 to 3 percent growth trajectory, mirroring our worst performance over the past decade. In this case, growth would be constrained in new and old ways:

• Vaccination campaigns avert the worst outcomes, but COVID-19 becomes endemic in most countries, causing cyclic, seasonal waves of disease.

• Productivity gains from accelerated digitalization trigger layoffs to save costs, not new opportunities for job creation. The transition toward sustainability is halting.

• Labor-market tensions persist, driven by skill mismatches, rising unemployment (especially among the young), and stagnant wages. Social tensions over the distribution of a limited and shrinking set of resources remain a polarizing force.

• Innovation slows to “below COVID-19 speed,”—the rapid pace of progress defined by vaccine development—thus limiting advances in health and technology.

Millions of workers have dropped out of the labor force. Some industries have been left with significant and persistent overcapacity. The rise of the digital economy could suppress investments in physical assets as companies capitalize on productivity gains. The global economy could be stuck in a mediocre growth trajectory. But a 20 percent recovery is also not preordained.

The possibility of a new age of prosperity for all

Imagine a recovery that delivers 3 to 4 percent sustained global GDP growth over at least a decade. Such a recovery starts with a well-managed exit from the pandemic that masters the tricky hand off from demand led by government stimulus to private-sector-led spending, income, and job creation. If we make good choices, it might look like this:

• Increasing vaccination rates drive uncertainty even lower and unleash the large cache of accumulated savings and pent-up demand to engage in “real life” again.

• Accelerated digitization and important transitions toward sustainability trigger new demand, new jobs, and higher productivity growth.

• Significant reskilling and smart assistance to vulnerable populations support a broad-based recovery in workforce participation, human capital, and wages. The economy becomes more inclusive.

• Better public health and lower mortality rates become the norm as many positive new behaviors from the COVID-19 crisis are incorporated into everyday lives (better hygiene, more concern for the health of others, faster and more decisive reactions to public-health threats).

• Medical innovation accelerates, for example by bringing mRNA-related and other cures to major diseases like cancer and malaria (a new malaria vaccine has reported promising data from its Phase 2 trial).

Our analysis shows that in a new age of prosperity for all, global growth reaches 3.6 percent annually by 2030, nearly 1.5 percentage points above the “limitations” scenario at that time (Exhibit 6). It’s a seemingly small difference, but from acorns grow mighty oaks. Momentum builds as businesses invest and create jobs in response to rising demand and the need to catch up on postponed upgrades to equipment, structures, and training. About 30 percent of net new growth comes from investment and another 20 percent from more people working with better skills. This kind of recovery is sustained by the higher living standards of households and profits of businesses that stronger productivity, which accounts for the remaining 50 percent of growth, delivers.

Exhibit 6

Concerns about debt and inflation

To deliver on a new age of prosperity for all, the global economy will have to deal with two concerns raised as part of the debate about “going for growth”: first, that newly accumulated debt will become unsustainable and constrain growth, and, second, that there is a potential for higher inflation. Both are a possibility—but both can also be dispatched.

Problems from a debt overhang are not inevitable. In the United States, for example, outstanding debt in 2020 reached 133 percent of GDP, topping the previous record of 123 percent in 1946, just after World War II. But in the post-war years, and in many other examples over time, the debt burden was reduced by driving nominal growth, not by cutting debt (Exhibit 7).

Exhibit 7

Similarly, in a new age of prosperity for all, the debt burden could again fall, as nominal GDP growth exceeds debt growth and the nominal interest rate (Exhibit 8).

Exhibit 8

The second issue is inflation. The stimulus pumped into the system by fiscal authorities and central banks is creating a snapback in spending and raising concerns about an uncontrolled rise in inflation. We are seeing price increases and higher wages in many geographies and markets and will likely see more as supply scrambles to catch up with surging demand. But as major central banks have continued to emphasize, these near-term shifts are not expected to turn into an ongoing inflationary threat. Inflation may well be above ~2 percent targets for the near term in major economies including the eurozone, the United Kingdom, and the United States, but this is viewed as tolerable and potentially even desirable, given the deflationary pressures of the past several years. If inflation surprises and threatens to become more persistent, major central banks will “take away the punch bowl from the party” and move to keep inflation expectations in check. They have the tools to do so. Central banks in countries with less credible inflation-fighting track records could be forced to tighten policy earlier to manage near-term price increases and long-term expectations.

Safeguarding lives and livelihoods beyond the pandemic—an age of health and prosperity

It’s time to shift the conversation again—and with the same intensity as the world did a year ago when it pivoted from the single imperative of safeguarding lives to the twin imperatives of safeguarding lives and livelihoods. The world now needs to focus on the next battleground.

For the first imperative of safeguarding lives, it was clear before the pandemic that longer, healthier lives for vast portions of the world’s population is a realistic goal. Medical advances and the process acceleration achieved in response to this pandemic have only increased our ability to accomplish this. We now know that it’s possible to spark a renaissance in public-health innovation and delivery, and to make unprecedented progress in tackling persistent health problems.

For the second imperative, safeguarding livelihoods, the impact of shifting to a higher growth path would raise global GDP to about $122 trillion by 2030, 45 percent above the $84 trillion recorded in 2019—a strong acceleration even when compared with our pre-COVID-19 trajectory. A bigger global income does not by itself solve the problems of inequality and sustainability, but it opens a wide range of possibilities for families, businesses, and governments to consider. With it comes a hope to alleviate some of the societal tensions and polarization that have become common within and across countries.

Similarly, faster economic growth need not slow down the drive toward sustainability; it might even accelerate it as we mobilize the investment required to make the transition to clean energy. If we play our cards right, the world might well come to a point where clean energy is fully deployed at a truly global scale. All of this will take enormous resources. But the interest and ability to organize for more sustainable growth are markedly higher in wealthier economies.

We are not dismissing the potential risks to a sustained and sustainable recovery. And the next few years are critical for sustainability. If businesses and governments don’t climb aboard the transition to the net-zero economy, they risk being left behind, unable to reap the advantages of sustainable growth. But, based on our observations across countries and over time, the prosperity scenario is possible if we make the right choices. This optimism is bolstered by the unprecedented actions that were taken during the pandemic. There was no trade-off between the virus and the economy in the pandemic, and there might very well not be one between growth and sustainability, and equality.

For business leaders this is an urgent call to action, too. It’s now that strategic moves will be made to propel companies ahead of these mega trends; it’s now that the direction will be set for years to come; and it’s now that many organizations, “unfrozen” by the pandemic, are ready to adapt to the new requirements for future success. Plenty of business leaders are already eagerly stepping up to help shape our societies and build a new age of health and prosperity for all. Many more will have to join the fight.

This is a true strategy moment for governments and businesses alike, a chance to set the switches for the next decade. Depending on their choices, the outcomes could not be more different.

The trauma of this pandemic will be with us for a long time to come. The big question for humanity is whether we can now turn this crisis into a pivotal moment, where we harness the innovations, the new insights, and the crisis-fortified determination to improve the world. The time for these choices is now. It’s up to all of us whether we will move into the 2020s with a new paradigm for safeguarding lives and livelihoods: a new age of health and prosperity for all.

ABOUT THE AUTHOR(S)

Sven Smit is a senior partner in McKinsey’s Amsterdam office and a coleader of the McKinsey Global Institute; Martin Hirt is a senior partner in the Greater China office; Ezra Greenberg is a partner in the Stamford office; Susan Lund is a partner in the Washington, DC, office; Kevin Buehler is a senior partner in the New York office; and Arvind Govindarajan is a partner in the Boston office.

The authors wish to thank colleagues Jeffrey Condon, Krzysztof Kwiatkowski, and Tomasz Mataczynski, and Neil Walker of Oxford Economics, for their contributions to this article.

https://mck.co/3yohFG8

This article was edited by Mark Staples, an executive editor in the New York office.

The Big Mac index

 

Global price of a Big Mac as of July 2020, by country(in U.S. dollars) - https://www.statista.com/

Many people have tried a famous Big Mac at McDonald’s fast food restaurants at least once in their lives (even though it’s not quite healthy food).

This hamburger is probably the most famous in the product line of the American fast food industry. However, few people know that it gave rise to the so-called Big Mac Index, which is used to compare the value of currencies of different countries.

What is the Big Mac Index?

The Big Mac Index is the price of the burger in various countries that are converted to one currency (such as the US dollar) and used to measure purchasing power parity.

It all started in 1986 when The Economist magazine decided to estimate the currencies’ value by countries based on the prices of Big Mac at McDonald’s fast-food restaurants.

Thus, The Economist introduced a simple indicator of the fundamental value of currencies globally.

Why exactly was the Big Mac taken as an indicator?

The reason is very simple. Big Mac is the most well-known product in McDonalds’ fast-food chain. Besides, the same ingredients are used for Big Mac in any country: meat, bread, cheese, lettuce, onions, etc. Therefore, The Economist experts use Big Mac alone instead of determining the cost of a consumer basket (more complex method) for each country.

Big Mac Index Table as of Q2 2020

The most relevant Big Mac Index so far (as of July 2020) is presented in the table below.

Let's analyze these data a bit.

The South African Rand exchange rate expressed in terms of the Big Mac Index in 2020 is 5.43 rand per dollar.

Considering that the current market rate of the South African currency is about 16.67 rand, rather than 5.43 per US dollar, the rand is undervalued by approximately 67.44%.

Thus, the South African Rand is the world’s most undervalued (cheapest) currency according to the Big Mac Index.

In 2019, the Russian ruble was the most undervalued (by 64.5%) currency worldwide.

Now, Big Mac costs $1.91 in Russia. While the price of the burger in the United States is $5.71, the Russian currency exchange rate is 23.64 ruble per dollar in terms of the Big Mac Index.

However, the ruble is much cheaper in Forex – about 70.59 ruble per US dollar (as of July 2020). Therefore, we can conclude that the Russian currency is undervalued by the market by almost 66.51%.

In the list of world’s most undervalued currencies, Russian ruble and the south african rand are accompanied by the turkish lira (undervalued by 64.28%), the ukrainian hryvnia (by 61.28%), and the mexican peso (by 60.97%). Notably, the currencies of India, Pakistan, Philippines, and other low-income countries are not in the top five most undervalued currencies in 2020.

As for the most highly valued currencies, the statistics by countries shows that the world’s most overvalued (expensive) currency is the Swiss franc.

Considering that Big Mac costs 6.91 francs in Switzerland, the USD/CHF rate expressed in the Big Mac Index terms should be 1.14 francs per dollar. However, the value of this pair is currently quoted around 0.94 in Forex, which makes the Swiss currency overvalued by the market by 20.94%.

Lebanese pound overvalued by the market by 4.25%. Swedish krona overvalued by the market by 0.80%. Besides the lebanese pound and swedish krona, The Economist’s experts identified other overvalued currency in their previous rating – Norwegian krone. However, today, things are not the same for these currency as well – they have also become undervalued, although not as much as the rand and ruble.

According to the Big Mac Index authors, Euro is also undervalued by the market. The average price of Big Mac in the Eurozone is 4.79 euros, meaning the currency is undervalued by 16.18%.

Notably, according to the Big Mac Index, all major currency pairs, except the Swiss franc, Swedish krona and Lebanese pound, are undervalued against the US dollar.

https://bit.ly/32gYe4E

The Big Mac index

Global exchange rates, to go

THE Big Mac index was invented by The Economist in 1986 as a lighthearted guide to whether currencies are at their “correct” level. It is based on the theory of purchasing-power parity (PPP), the notion that in the long run exchange rates should move towards the rate that would equalise the prices of an identical basket of goods and services (in this case, a burger) in any two countries. For example, the average price of a Big Mac in America in July 2016 was $5.04; in China it was only $2.79 at market exchange rates. So the "raw" Big Mac index says that the yuan was undervalued by 45% at that time. 

Burgernomics was never intended as a precise gauge of currency misalignment, merely a tool to make exchange-rate theory more digestible. Yet the Big Mac index has become a global standard, included in several economic textbooks and the subject of at least 20 academic studies. For those who take their fast food more seriously, we have also calculated a gourmet version of the index.

This adjusted index addresses the criticism that you would expect average burger prices to be cheaper in poor countries than in rich ones because labour costs are lower. PPP signals where exchange rates should be heading in the long run, as a country like China gets richer, but it says little about today's equilibrium rate. The relationship between prices and GDP per person may be a better guide to the current fair value of a currency. The adjusted index uses the “line of best fit” between Big Mac prices and GDP per person for 48 countries (plus the euro area). The difference between the price predicted by the red line for each country, given its income per person, and its actual price gives a supersized measure of currency under- and over-valuation.

Raw index

How it works

Purchasing-power parity implies that exchange rates are determined by the value of goods that currencies can buy

Differences in local prices – in our case, for Big Macs – can suggest what the exchange rate should be

Using burgernomics, we can estimate how much one currency is under- or over-valued relative to another

GDP-adjusted

Varying labour costs and barriers to migration and trade may undermine purchasing-power parity

To control for this, our adjusted index predicts what Big Mac prices should be given a country’s GDP per person

The difference between the predicted and the market price is an alternative measure of currency valuation

Source data

Our source data are from several places. Big Mac prices are from McDonald’s directly and from reporting around the world; exchange rates are from Thomson Reuters; GDP and population data used to calculate the euro area averages are from Eurostat and GDP per person data are from the IMF World Economic Outlook reports.

The GDP-adjusted index addresses the criticism that you would expect average burger prices to be cheaper in poor countries than in rich ones because labour costs are lower. PPP signals where exchange rates should be heading in the long run, as a country like China gets richer, but it says little about today's equilibrium rate. The relationship between prices and GDP per person may be a better guide to the current fair value of a currency.

https://econ.st/38lZHdT

2020 External Vulnerability and Resilience rankings for 63 countries: COVID-19 Crisis Update

Amid the 2020 global pandemic, Georgia, Turkey and Argentina are the “risky-3” in Scope’s biennial update of its external vulnerability and resilience framework, whereas Taiwan, China and Switzerland are the 2020 “sturdy-3” of the most well positioned economies against external shocks from a sample of 63 economies.

Fraught global trading and “risk-off” market conditions exacerbated by the coronavirus outbreak and oil price declines of 2020 expose vulnerabilities that many economies face due to balance of payment pressures. This year, Lebanon defaulted on a USD 1.2bn Eurobond, Argentina and Ecuador’s debts re-entered selective default, and Zambia is on the brink. There are concerns about a wider emerging market crisis. Meanwhile, with Brent prices at below USD 30 a barrel, this level is significantly under prices all oil exporters require for balanced budgets. With severe stressing factors in play, external vulnerabilities are key to monitor in assessing countries’ debt repayment capacities.

In this report, Scope provides an update of its external vulnerability and resilience two- axis coordinate grid, introduced in 2018, which assesses countries on a) vulnerabilities to balance of payment crisis and b) degrees of resilience in the advent of such crises.

Figure 1: Top 5 weakest and strongest countries, external risk framework

Top 5 strongest

Top 5 weakest

1Of 63 countries. Full scores and rankings for 63 countries in Annex I. ²Change in axis rank since 2018 update.

Scope’s 2020 external vulnerability and resilience rankings indicate a fresh “risky-3” of Georgia (rated BB/Negative), Turkey (BB-/Negative) and Argentina (unrated) – three economies that not only have vulnerability to the onset of balance of payment issues but also show significant weakness in abilities to withstand crises. Argentina slides into this year’s risky-3, edging out Ukraine, which was in the original 2018 risky-3 roster. Ukraine, Colombia, Indonesia, Egypt and Pakistan (all unrated) are highly at-risk economies just outside the riskiest 3. In addition, Scope observes a 2020 “sturdy-3” of Taiwan (unrated), China (A+/Negative), and Switzerland (AAA/Stable) – economies that are the most robust to external shocks. Taiwan replaces Japan (A+/Stable) in this year’s sturdy-3.

Scores for major Western economies vary: the United States (AA/Stable) receives strong marks on external resilience, supported by dollar primacy (4th most resilient of 63), and Italy (BBB+/Stable) and Germany (AAA/Stable) continue to display external sector strengths – supported by current account surpluses. France (AA/Stable) has average scores but Spain (A-/Stable) continues to score weakly on both framework axes. The UK (AA/Negative) displays deficits especially on external vulnerabilities.

Inside the EU, Scope finds that Cyprus (BBB-/Stable), Croatia (BBB-/Stable) and Romania (BBB-/Negative) are the three EU member states facing the greatest external sector risks. On the other end, Malta (A+/Stable), Luxembourg (AAA/Stable) and Denmark (AAA/Stable) are the EU sturdy-3.

Scope’s external vulnerability and resilience framework

Scope’s sovereign credit rating assessments are based on five analytical pillars, of which “external economic risk” represents one of these five dimensions, with a 15% weight in the overall sovereign rating review process. However, the significance of external sector risks may be disproportionately important in 2020 as global trade flows weaken to multi- decadal lows and capital outflows escalate amid a global sudden stop due to the Covid- 19 crisis. Emerging economies exchange rates have been hit hard, making their foreign- currency-denominated debt more difficult to repay, while foreign and local currency borrowing rates have increased as investors become more sceptical about the most vulnerable issuers. International reserves decline as the crisis wears on and sources of FX revenues and capital inflows dry, threatening countries’ capacities to source  and repay external loans. With these risks to remain significant over the course of 2020, a lens on economies especially vulnerable to sudden deterioration in external trading and financial conditions is warranted.

In this spirit, this report presents a biennial update on Scope’s external vulnerability and resilience two-axis evaluation framework that assays countries on: i) their respective external vulnerabilities to the onset of balance of payment crises and ii) the extent of their resilience in the event of a balance of payment crisis.

Figure 2: External vulnerability and resilience framework (design)

While external vulnerability assessments and rankings have traditionally centred on emerging markets, Scope notes that external risks are not unique to developing  countries, but rather shared across nations, as evidenced over the European sovereign debt crisis when risks from large current account deficits, increasing Target 2 liabilities and external competitiveness gaps were exposed across peripheral Europe – instigating capital outflows and increases in bond yields. As such, this report is based on assessing a global set of economies – including advanced and emerging.

External vulnerability and resilience framework: global results

Figure 3 (next page) displays the external vulnerability and resilience framework results for 63 countries1. The graph is divided into four quadrants: Quadrant I. countries that are vulnerable and not resilient to external shocks; II. countries that are not vulnerable to external shocks but also not resilient; III. those that not vulnerable to and resilient in the advent of a crisis; and IV. countries that are vulnerable but resilient. The dividing lines between quadrants reflect the median country scores on the vulnerability and resilience axes. Individual country scores and rankings are summarised in Annexes I and II, underlying data is summarised in Annex III, and the summary of component variables is located in Annex IV.

In considering overall country rankings on the basis of a two-axis framework, we take into account the sum-score of the two axis-level scores.

Scope’s two-axis framework identifies a 2020 “risky-3” of:

1) Georgia

2) Turkey

3) Argentina

These are economies in Quadrant I of Figure 3 that not only show vulnerability to the onset of balance of payment crises but also exhibit prevailing weaknesses in abilities to cope with crisis. Other countries amongst the most at risk in Quadrant I include Ukraine, Colombia, Indonesia, Egypt and Pakistan.

In addition, Scope observes a 2020 “sturdy-3” of economies in:

1) Taiwan

2) China

3) Switzerland

These are countries in Quadrant III of Figure 3 that are not only less vulnerable to the onset of balance of payment crises but are also well positioned to deal with a crisis were one to take place. Thailand, Malta and Singapore are further economies amongst the least at risk.

Furthermore, Quadrant IV portrays a set of countries that are vulnerable to crisis but highly resilient in one, notably incorporating the US, the UK and Japan – reserve currency countries able to bridge global external shocks and paper over prevailing external vulnerabilities through currencies’ safe haven statuses. Russia (BBB/Stable), with much enhanced FX reserve coverage (Figure 4), cushioning vulnerabilities from sharp drops.

Brent crude prices in 2020 to under USD 30 a barrel, alongside Brazil and New Zealand (both unrated) are also Quadrant IV countries.

Scores for major Western countries vary. As noted, the United States is in Quadrant IV of Figure 3 as the 20th most vulnerable (of 63 nations) to external crises – in view of a significant current account deficit of 2.3% of GDP in 2019 (moreover the world’s largest current account deficit in nominal dollar terms), however anchored by the fourth highest resilience score in the 63 country-set, related to dollar primacy and limited foreign currency debt. Germany ranks strongly overall as the 7th least vulnerable economy – boosted by a 2019 current account surplus of 7.8% of GDP alongside a strong net international investment asset position – but Germany has only middling scores on resilience owing in part to high non-resident holdings of German government bonds. France is mid-table as the 33rd most vulnerable economy but 23rd most resilient. Italy is only the 41st most vulnerable, weakened though by capital outflows of recent years, but receives a very strong resilience mark (11th most resilient), helped by not only the euro reserve currency but also a high share of Italy’s government debt held domestically (almost 70% as of Q2 2019). Spain is a Quadrant I economy and receives a weak overall score – as the 17th most vulnerable economy, weakened by net international investment liabilities of 78% of GDP as of Q3 2019, alongside receiving the 24th poorest mark on external resilience due to high non-resident holdings of government debt and significant foreign-currency-denominated lending in the Spanish banking system.

Among Scandinavian economies – Sweden, Norway and Denmark (all rated AAA/Stable) receive strong scores, with healthy current accounts and robust net international investment positions (NIIPs), as well as developed-market, safe-haven currencies.

The UK ranks as the 9th most vulnerable economy (a modest improvement from 8th most vulnerable in the 2018 report), but nonetheless weighed upon by a wide current account deficit (of 3.8% of GDP in 2019), and sterling volatility in recent years related to Brexit uncertainties. While the UK’s resilience mark is bolstered by sterling’s reserve currency status (4.6% of all global allocated reserves were held in sterling in Q4 2019), the UK ranks overall as only the 25th most resilient country, weakened by high foreign-currency lending in the City of London.

Scope’s Risky-3 in more detail

We next discuss the 2020 risky-3 of Georgia, Turkey and Argentina, as well as Ukraine (as the fourth weakest country in the 2020 rankings) in greater detail.

As was the case in the 2018 update, the weakest country in the 2020 report is Georgia (BB/Negative). Georgia displays high external vulnerability and low resilience to balance of payment crises. The economy has displayed elevated current account deficits, reflecting high investment needs of a developing economy with inadequate domestic savings, a narrow export base, and a dependence on goods imports. The current account deficit has, however, declined from -6.8% of GDP in 2018 to -5.1% in 2019 and has been, moreover, predominantly financed over the last decade by more reliable foreign direct investment (FDI) flows. Nevertheless, Georgia’s small, open economy depends on external financing, as reflected in a large, negative NIIP, amounting to USD 23.8bn or -135% of GDP as of Q4 2019 – a core driver of the weak vulnerability score, alongside the Georgian lari’s volatility in recent years.

External public sector debt, amounting to around 80% of total public debt (with total public debt of 41.4% of GDP in 2019), is denominated in foreign currency (mostly in US dollars or euros), leaving the government balance sheet vulnerable to significant exchange rate fluctuations. Moreover, 58% of government debt does represent concessional multilateral loans, and an ongoing IMF Extended Fund Facility programme institutes a buffer against balance of payment disturbances over the programme duration to April 2021.

While foreign currency transactions inside the Georgian banking sector have declined through the proactive actions taken by authorities in recent years, the level of FX lending and deposits nonetheless remains very elevated at 55% of all loans and 62% of all deposits (mostly in US dollars and euros). FX reserves stood at USD 3.2bn as of March 2020, down slightly compared with USD 3.3bn in March 2019. While reserves’ coverage level of short-term external debt had previously improved, it remains below an IMF adequacy threshold of 100%.

Turkey (BB-/Negative) remains a member of the risky-3 in this year’s list. The Turkish lira is 27% weaker compared with recent August 2019 peaks vs the dollar (trading near 7 against the dollar), which represents a dilemma given 52% of central government debt denominated in foreign currency (meaning FX devaluation automatically feeds through to impairment of public debt serviceability) alongside a significant private sector net FX debt position, which, while cut from February 2018 peaks of USD 223bn, totalled nonetheless USD 175bn as of January 2020. In addition, non-residents hold 39% of Turkey’s government debt.

In data through March, past improvements in Turkey’s trade balance had sharply reversed since 2019 – with much wider recent monthly trade deficits. Official reserves declined to USD 89bn as of 10 April, compared with a 2013 peak of USD 135bn, while – netting out Turkey’s short-term FX borrowings – official net international reserves had declined to USD 26.3bn as of 10 April, from USD 41.1bn at end-2019. Weakened FX reserves mean Turkey is less resilient should capital outflows escalate – and will be an area requiring constant monitoring going forward. Turkey has rejected suggestions of turning to the IMF for support over this crisis.

External sector risks in Turkey are also exacerbated by mismanagement of the economy, in part due to ongoing consolidation of power in the hands of President Recep Tayyip Erdoğan. The policy one-week repo rate has been reduced to 9.75% (from 24% as recently as July 2019) – partly under suspected political influence, resulting in a negative real policy rate in view of March inflation of 11.9% YoY. Accommodative monetary policy had brought lira lending to the domestic economy to elevated levels of +19.1% YoY as of March. Such prevailing macro-economic imbalances sap foreign investor confidence especially in moments of weakness in global sentiment, making Turkey more susceptible to capital outflows that drain reserve stocks, weaken the currency and inhibit the economy. Turkey (BB-/Negative) is the lowest rated issuer in Scope’s rated sovereign universe.

Argentina rounds out Scope’s 2020 risky-3, performing weakly on both assessment axes. Argentina’s public debt increased to nearly 90% of GDP at end-2019, from 56% in 2017, with around 53% of public debt denominated in US dollars. Amid a deep recession in 2020 – exacerbated by nationwide lockdowns since 20 March to impede a coronavirus outbreak in Argentina – President Alberto Fernández announced on 5 April that the government will suspend payments on foreign-currency securities issued in the domestic market for potentially the remainder of 2020 to save remaining resources to support the economy – sliding the government back into selective default – while restructuring talks continue on the side-lines over USD 69bn in foreign-law debt.

Since July 2019 peaks, the Argentine peso has depreciated around 37% against the US dollar and international reserves have dropped by USD 24bn to USD 43.6bn as of March 2020.

Argentina’s private sector is exposed to currency fluctuations in view of elevated foreign- currency-denominated loans outstanding, accounting for 23% of total bank loans.

Moving just off this year’s risky-3 is Ukraine, displayed in Figure 3’s Quadrant I. Ukraine needs to repay around USD 10.7bn in dollar debt over 2020-21, which is significant relative to FX reserves of only USD 23.6bn as of March 2020 (FX reserves have nonetheless increased compared with March 2019 levels of USD 19.6bn). Inadequate FX reserve coverage represents a core danger to Ukraine’s resilience in external crises. Against this backdrop, a continued commitment to reform and cooperation with international financial institutions are keys to maintaining external debt sustainability. The IMF and Ukrainian authorities reached agreement on a new three-year Extended Fund Facility programme of USD 5.5bn in December, which will replace the 14-month Stand-By Arrangement of USD 3.9bn approved in December 2018.

Scope’s Sturdy-3 in more detail

The sturdy-3 represents three economies with the lowest levels of external risk: Taiwan (unrated), China (A+/Negative) and Switzerland (AAA/Stable) – each displaying limited external vulnerability and greater resilience in the event of an external shock.

Taiwan is this year’s most robust economy to external sector risks. Taiwan’s low vulnerability is helped by a very large current account surplus of 10.6% of GDP in 2019. In addition, low volatility of the Taiwan new dollar and a large net international asset position (Figure 6) support vulnerability marks. On resilience, Taiwan’s scores are secured by a robust 2.7x reserve coverage of short-term external debt, low non-resident holdings of government debt, a lack of FX debt in overall government debt and low foreign currency loans in the domestic banking system (with FX loans totalling only 5% of GDP). Taiwan has been one of the most successful countries to date with respect to government mitigation actions in response to the Covid-19 crisis, including aggressive containment, quarantine, and monitoring measures that started early on (in December 2019), creating a response framework for emulation elsewhere in the world. Supported by this, the Taiwan dollar has been stable through this crisis.

China maintains its placement within the sturdy-3 in 2020 with the second strongest overall score in this year’s rankings. This includes status as the most resilient economy in the 63-country sample to external stress factors (up from 3rd most resilient in the 2018 report) alongside 12th least vulnerable of 63 economies (up from 19th). China’s foreign currency reserve stock of USD 3.06trn – by some distance the world’s largest nominal reserve stock – represents 26% of all global FX reserves, presenting the People’s Bank  of China an abundant resource to preserve macro-economic stability and stem balance- of-payment issues. This is even though FX reserve levels declined sharply in March amid global economic stress and remain well off 2014 peaks of USD 3.99trn. Strong reserve adequacy bolsters China’s external resilience, a key credit strength considered in China’s A+/Negative sovereign ratings.

The increased use of the renminbi in the global economy enhances China’s significant external strength. The internationalisation of the renminbi has in the past seen its inclusion in the IMF’s Special Drawing Rights basket of currencies (of five currencies) since October 2016 and the establishment of a new renminbi-denominated Shanghai oil futures market in March 2018. Presently, the share of yuan claims in total global FX reserves stands at 2.0% as of Q4 2019, double the 1.1% as of Q2 2017.

The supervision of China’s financial system remains in a transition stage and the capital account remains largely closed (although gradually opening up), with investors in China’s onshore bond market still predominantly being domestic institutions. Foreign currency denominated government debt amounts to only 2.4% of general government revenues (although foreign currency borrowing is increasing). While China’s comparatively closed, mostly renminbi-premised financial system shields the government from global financial volatility, increased opening to foreign investors and rising demand for foreign currency borrowing from domestic institutions might lower this resilience in the future.

China’s net international investment position peaked in 2007 (at 33.4% of GDP) and has dropped to a still robust +15% of GDP as of Q4 2019. The current account balance has dropped from a peak surplus of 9.9% of GDP in 2007 to 1.0% in 2019, weighed upon moreover by trade conflicts with the United States, higher tariffs on Chinese goods and tariff impacts on export volumes. While reductions in China’s current account support global rebalancing and reduce global risks, a nearly balanced Chinese current account represents a major change in the global economy as China posted the world’s largest nominal current account surplus as recently as in 2015.

However, slower economic growth this year due to the Covid-19 pandemic – which we estimate at about 4% in China with significant downside risk (China grows, for example, only 2% under one alternative scenario) – may nonetheless endanger ambitious goals of purchases of an extra USD 200bn of US goods over the next two years as part of the phase-one trade compromise with the United States and has contributed to weakening the yuan, which now trades above 7 to the dollar. Such events could risk that an unpredictable US government might re-visit the trade truce – which, if so, could test China’s external resilience. Higher capital outflows since H2-2018 are another relevant risk area to track.

Switzerland maintains its role within Scope’s sturdy-3 in 2020 (though falling from the #1 overall rank), ranking as the second least vulnerable economy of 63 countries (down one spot from first in 2018) and the 20th most resilient (up one rank). Since 1981, Switzerland has persistently generated large current account surpluses, which have averaged almost 10% of GDP since 2015, underpinned by the high competitiveness of its exporting sector alongside a large portion of fairly price-insensitive export products, such as in pharmaceuticals. This has helped shape a prodigious net international asset position of 116.2% of GDP at end-2019. Switzerland’s economic resilience to international shocks, including to the 2020 corona crisis (even as cases and mortalities in Switzerland have increased significantly), is supported by the franc’s reserve-currency status and highly liquid capital markets that provide unabated access to liquidity in times of international financial market volatility.

Switzerland’s high national savings, totalling 33% of GDP, support a predominantly resident holding of the country’s government debt, at over 85% ownership of the total. Foreign exposures (claims) of Swiss banks fell steadily after the global financial crisis to USD 1.08trn in Q3 2019 (from USD 2.66trn in Q2 2007). However, a sizeable share of loans denominated in foreign currency (around 40% of total loans) weakens Switzerland’s resilience score.

Most and least at-risk countries in the EU-27

Figure 7: 2020 EU risky-3 and sturdy-3

Top 3 strongest

Top 3 weakest

¹Of the 27 EU member states. ²Change in axis rank since 2018 update adjusting the 2018 results to exclude the

UK from EU rankings (to have a like-for-like comparison).

In the EU, among the least vulnerable countries to external shocks include an EU sturdy- 3 of:

1) Malta

2) Luxembourg

3) Denmark

In addition, Italy, Estonia, Belgium and Germany score well. For Malta, Luxembourg, Denmark and Germany, large positive net external financial assets (with an average NIIP of +66% of GDP in 2019), sustained current account surpluses that averaged 7.5% of GDP in 2019, as well as strong safe haven currencies (in the euro and the Danish krone), liquid capital markets and moderate levels of public debt underpin external positions.

On the other hand, the three most at risk member states of the EU (Figure 7, previous page) are:

1) Cyprus

2) Croatia

3) Romania

Cyprus (BBB-/Stable) is displayed in Quadrant I in Figure 8; Croatia (BBB-/Stable) and Romania (BBB-/Negative) in Quadrant II. Hungary drops off the EU risky-3 roster in this year’s report, with Cyprus taking its place. Greece (BB/Positive), Spain (A-/Stable) and Poland (A+/Stable) represent three other EU countries with comparatively high vulnerabilities to external shocks.

The EU Risky-3 in detail

Cyprus leads the EU risky-3. Cyprus’s current account deficit widened to 6.7% of GDP in 2019, from 4.4% of GDP in 2018. The economy’s external position is characterised by high deficits in its trade in goods (21.5% of GDP in 2019), offset by very high surpluses in services trade (21.3% of GDP), the latter due to Cyprus’s standing in tourism services and as a financial services hub. Nonetheless, current account deficits have resulted in one of the largest negative NIIP levels among EU economies at -116%, alongside very high gross external debt levels of 936% of GDP in Q4 2019, which, nonetheless, still represent deleveraging against a 2015 peak at 1,263% of GDP. In addition, well above 70% of government debt is held by non-residents (Figure 9, next page).

We, however, note that special purpose entities (SPEs) in Cyprus considerably distort the economy’s external position while having limited links to real economic activity: excluding SPEs, the NIIP and gross external debt were more modest at -34.3% of GDP and 262% of GDP respectively as of Q3 2019, even if nonetheless still worse than the euro area average. Importantly, Cyprus benefits from euro area membership, unlike in the cases of peers in the 2020 EU risky-3: Croatia and Romania, giving Cyprus access to credit strengths in crisis moments such as reduced FX volatility and capped borrowing rates deriving from the common reserve currency.

Croatia stands out as a Quadrant II economy in Figures 2 and 8, a characteristic shared, for instance, by Bulgaria (BBB+/Stable). Croatia and Bulgaria are economies with lesser balance of payment vulnerabilities but also less resilient than most nations were a balance of payment crisis to nonetheless occur. As such, while risks for a balance of payment crisis might be lower than in most countries with both economies holding current account surpluses alongside successful, long-standing fixed or managed floating exchange rate regimes against the euro, resilience in a currency crisis, however unlikely, would be more subject to question, with both economies highly euroised – meaning any break in Croatian kuna or Bulgarian lev exchange rates against the euro could threaten financial stability.

Croatia is the 4th least vulnerable economy in the EU (and 10th least vulnerable overall in the 63-country set) but is the EU economy with the weakest scores on external resilience (and 2nd least resilient overall of 63). Croatia’s current account surpluses have averaged over 2% of GDP over the past two years, driven by large surpluses in services trade, while goods trade has been in deficit. Current account surpluses have helped to curtail Croatia’s negative NIIP to -50.8% of GDP as of Q4 2019, from -65.6% in Q3 2017.

Any unforeseen depreciation in the kuna would adversely impact government and private sector balance sheets by raising the value of foreign-currency debt in local currency terms, with 51% of private sector loans and almost 70% of government debt denominated in foreign currency. Croatia’s (as well as Bulgaria’s) resilience to short-term external shocks will be materially enhanced after the countries join the EU's Exchange Rate Mechanism II (ERM II) and, eventually, adopt the euro, a process which both countries are making important progress towards.

Romania remains in the 2020 EU risky-3 as an economy in Quadrant II of Figure 8. Romania’s current account deficit widened modestly to 4.7% of GDP in 2019, from 4.4% in 2018. The current account is expected to remain below -5% of GDP over the 2020-21 period. A high share of foreign-currency-denominated public debt (amounting to 18% of 2019 GDP) and widening fiscal deficits constitute significant risks to Romania’s debt sustainability. The country’s negative NIIP was relatively unchanged at -43.5% of GDP in 2019. Romania’s external sector competitiveness remains a weakness due to high inflation, which is only partly compensated for by depreciation in the Romanian leu.

Annex II: Country external vulnerability score (sorted by rank) and resilience score (sorted by rank)

Source: Scope Ratings GmbH

Source: Scope Ratings GmbH

Annex III: Vulnerability/resilience grid by components, hard figures (sorted by world region)

Source: IMF, Eurostat, BIS, Bloomberg, JP Morgan, national central banks, national statistical offices, ministries of finance, Haver Analytics, Scope Ratings GmbH; *for Venezuela and Vietnam, the data is equal to (total reserves - total external debt) as a % of GDP; **for countries not covered by BIS, data is calculated by multiplying their GDP share in the world by the BIS OTC turnover for residual currencies; ***for Belgium and Japan, data equals foreign-currency-denominated deposits, % GDP.

Annex IV: Indicator definitions and rationale

*The exception is for euro area countries, which receive a fixed score of 7.5 on the resilience against currency crises variable, owing to a lack of currency adjustment flexibility in the event of balance of payment issues (from being in a currency union). This is despite having a strong reserve currency in the euro.

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