World Development Report 2022

FINANCE FOR AN EQUITABLE RECOVERY

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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.

World Development Report 2022: Finance for an Equitable Recovery examines the central role of finance in the economic recovery from the pandemic. It highlights the consequences of the crisis most likely to affect emerging economies, and advocates a set of policies to mitigate the interconnected financial risks stemming from the pandemic and steer economies toward a sustainable and equitable recovery.

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Main Messages

The report highlights four pressing economic risks and concrete steps that policymakers can take to address them and support a robust and equitable recovery:

Rising nonperforming loans. 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.
Delayed resolution of distressed loans. 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.
Tighter access to credit. 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.
Elevated levels of sovereign debt. The proactive management and reduction of sovereign debt can free up fiscal resources needed to support the recovery. Delays in addressing debt sustainability are associated with protracted recessions, rising inflation, and reduced spending on social safety nets, public health, and education, which have disproportionate impacts on the poor.

Chapter Summaries

The economic impacts of the pandemic and emerging risks to the recovery
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.
Resolving bank asset distress
Debt moratoria, loan forbearance, and relaxed reporting rules reduced transparency about the health of bank balance sheets, particularly in the recognition of non-performing loans (NPLs). This affects the financial sector’s capacity to lend. To mitigate this risk, governments and financial institutions need to ensure transparency, management of distressed loans, and proactive interventions for distressed banks.
Restructuring firm and household debt
A sudden increase in NPLs and bankruptcies poses a significant challenge for the capacity of insolvency systems to resolve bankruptcies in a timely manner. Furthermore, borrowers cannot declare themselves insolvent in countries with nonexistent or limited insolvency mechanisms. Creating or improving formal legal insolvency systems, facilitating out-of-court workouts, tailoring certain rules for small businesses, and promoting debt forgiveness and long-term reputational protection for former debtors, can help avoid the risk of long-term and unresolvable debt distress.
Lending during the recovery and beyond
The ongoing impact of the crisis on business performance and household incomes could inhibit new lending because of increased credit risk, reduced visibility into borrower viability, and diminished ability to realize value from collateral. However, innovations in alternative sources of data, product design, and lending context, can help keep credit flowing in regulatory environments that both support it and ensure consumer and market protections.
Managing government debt
Many governments borrowed to pay for the massive economic support programs, leading to a roughly nine percentage point increase in total debt burdens among low- and middle-income countries during the pandemic. There is a risk of protracted recession in countries unable to service their debt. Preventing that requires active debt management through reprofiling or restructuring debt, and longer-term reforms for debt transparency and tax policy.
Policy priorities for the recovery
Few governments have the resources and political leeway to tackle all of the economic challenges related to the pandemic at once. Countries will recover at different rates and governments will need to focus on both the most urgent risks experienced by countries in different contexts and global issues, such as exchange rate risk.