Effects of global financial crisis on developing countries

[presented @ ATN12, Accra, August’09]

Michael HerrmannEconomic Affairs Officer

Macroeconomics and Development PoliciesUNCTAD, Geneva, Switzerland

UNITED NATIONS

CONFERENCE ON TRADE AND

DEVELOPMENT (UNCTAD)

CONFÉRENCE DES NATIONS

UNIES SUR LE COMMERCE ET LE

DÉVELOPPEMENT (CNUCED)

This presentation

• Financial effects• Economic effects

– Economic slowdown– Commodity price decline– Possible aid effects

• Political effects• Concluding thoughts

– The make-up of crisis– Policies to discourage future crisis– Policies to address unraveling crisis

Financial effects

Figure 2. MSCI Emerging Markets Price Index

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Figure 3. Emerging Markets Spread

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Economic effects: Economic slowdown

Real GDP growth (annual percent change)

2008 2009 2008 2009 2008 2009World 3.7 3.8 3.2 -1.3 -0.5 -5.1

Developed economies 1.3 1.3 0.9 -3.8 -0.4 -5.1Developing economies 6.7 6.6 6.1 1.6 -0.6 -5.0

Africa 6.3 6.4 5.2 2.0 -1.1 -4.4Asia 8.2 8.4 7.7 4.8 -0.5 -3.6Latin America 4.4 3.6 4.2 -1.5 -0.2 -5.1Middle East 6.1 6.1 5.9 2.5 -0.2 -3.6

Note: 2008 are estimates, 2009 are projections

IMF WEO, April 2008 IMF, WEO, April 2009 Difference

Economic effects: Economic slowdown

Economic slowdown…

… discourages exports of all countries, but especially of countries with high exports to developed countries.

… encourages fall commodity prices, which affects many of the poorest developing countries.

… discourages investment in all countries, but especially in poorer developing countries which are perceived to be riskier.

… encourages increased profit remittances from developing countries to developed.

… discourages workers’ remittances from developed countries to developing countries.

Economic Effects: Commodity price decline

Commodity price deveopments, major categories, Jan. 2000 - Sep. 2008

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Food Tropical beveragesVegetable oilseed and oil Agricultural raw materialsMinerals, ores and metals Crude petroleum

Political effect: Possible aid effect

Finland Banking Crisis

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ODA Commitments ODA Disbursements

Finland Banking Crisis

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GDP Growth

Political effect: Possible aid effect

MDG financing needs, ODA disbursements and estimated ODA pledges, 2000–2015(Billions of current dollars)

ODA disbursements less bilateral debt relief (2000–2007)

Estimated ODA pledges (2008–2010)Estimated ODA needed to meet MDGs (Sachs Report )

Estimated ODA needed to meet MDGs (Zedillo Report )

Source: UNCTAD secretariat calculations, based on OECD-IDS;G-8 (2005); Zedillo Report (United Nations, 2001); and Sachs Report (UN Millennium Project, 2005).

Note: The data, as reported by donors, are in current dollars and represent net disbursements. 40

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ODA disbursements lessbilateral debt relief(2000–2007)

Estimated ODA pledges(2008–2010)

Estimated ODA needed tomeet MDGs (Sachs Report)

Estimated ODA needed tomeet MDGs (ZedilloReport)

Trend (ODA disbursementsless bilateral debt relief,2000–2007)

Concluding thoughts

The make-up of financial and economic crisisDuring boom During bust

Perceived risk is low Sell of assets by multiple institutionsErosion of credit standards Fall of asset prices

Rise of risk premiumLoad-up on exposure Rise of interbank rates

(Otherwise perception of underutilization and decline of the institutions' stock values) Failures of over-leveraged institutions

Increase of leverage (gearing)(Use of debt to supplement equity) Reluctance/ inability to provide credit

Increase of maturity mismatch Onset of credit crunch (Use of cheap, short-term funds for long-term investment)

Possible Increase of currency mismatch Spillovers to the real sector(Use of foreign currency loans for local spending) Fall in investment

Accumulation of (overvalued) assets Rise of unemployment/ underemployment(Increase of reckless, speculative lending) Fall in demand, exports, commodity prices

Accumulation of (unsustainable) debt Deceleration of economic growth

Increase of non-performing loans

Shedding of exposureSell of assetsDe-leveraging

Concluding thoughts

Policies to discourage future crisis:• Strengthen micro-prudential regulations

– Focus: Stability of individual financial institutions – Risk management (capital adequacy ratio, i.e. capital/ risk, where risk is assets), corporate governance, accountability, transparency, long-term horizon of management

– Agency: Financial supervisory agencies

• Strengthen macro-prudential regulations – Focus: Stability of financial system – Risk management (counter-

cyclical regulations, incl. capital adequacy requirements, reserve requirements), moral hazard, buy-in of financial institutions

– Key agencies: financial supervisory agencies and central banks

Concluding thoughts

Policies to discourage future crisis (contd.):• Consider prudential controls on capital inflows

– Tobin-type taxes: Reduce reliance on short-term, volatile capital inflows; exposure to maturity and currency mismatches; volatility of exchange rates; upward pressure on currencies.

• Encourage timely alignments of exchange rates – International macroeconomic coordination to encourage prevent

large and prolonged exchange rate misalignments and build-up of large and sustained external imbalances; companies can go out of business, countries cannot.

Concluding thoughts

Policies to address unraveling crisis:• Controls on capital outflows• Blank guarantees for deposits• Rescue of systemically relevant financial institutions • Pursuit of counter-cyclical macroeconomic policies• Leakages in open economies• Risk of protectionism• Risk of other bagger-thy-neighbor policies• Importance of intl. policy coordination• Importance of social protection

Concluding thoughts

“Financial markets have for some time had an independent capacity to destabilize developing countries; there are now increasing indications of the vulnerability of all countries to financial crisis. […] Overall, there appears to be a need for more collective control and guidance over international finance. ”

The Trade and Development Report 1990.