The Financial Crisis and Developing Economies Robert Lensink
Outline The Financial Crisis and Emerging Markets The Financial Crisis and Sub-Saharan Africa How to Solve the Crisis
The crisis and Emerging Markets: Initial resilience Strong fundamentals underpinned most Emerging Markets’ initial resilience to deteriorating financial conditions. • total developing-country foreign exchange reserves amounted to $3.2 trillion • many countries were posting strong economic growth • emerging equity markets were rallying • spreads on emerging-market sovereign bonds had reached record low levels Banks held few mortgage-based securities and banks heavily regulated Several countries (e.g. in Latin America) benefited from the rise in international prices of minerals, crude oil, and food.
….No longer The crisis is spreading to Emerging Markets all over the World. Foreign capital fled and confidence evaporated • Stock markets plunged • Currencies tumbled • Foreign banks abruptly stopped lending Private capital flowsto Emerging Markets will decline: A 30% decline in net flows from last year is expected. Moreover, exports of goods and services will suffer as world economy slows
The IMF, the Crisis and Emerging Markets Until some weeks ago, the IMF had been absent from the financial crisis But, the IMF is back in business, already helping Iceland ($1 billion), Pakistan ($10 over 2 years) and Ukraine (a $14 billion package). Other countries talking to the fund include Belarus, Bulgaria, Hungary, Latvia, Romania and Sebia.
The IMF and the Crisis Press release on October 29. The IMF will launch a new short-term lending facility for Emerging Markets (with track record of good polices) hit by the Crisis The new facility comes with no conditions attached once a loan has been approved and offers large upfront financing to help countries restore confidence and combat financial contagion.
Eastern Europe Eastern European countries are particularly at risk during this financial crisis The reason is that many Eastern European countries have double digit current account deficits Moreover, many banks are integrated in global markets, so that even countries with surpluses may run into problems In addition, most central banks and governments in Eastern Europe do not have the financial means to stop the crisis
Eastern Europe Many Eastern European countries are in trouble. In Russia, the stock market went down by two-thirds since may 2008; In the Ukraine the stock market went down by 80%. Inflation went up. Fortunately, Russia, has a huge amount of foreign exchange reserves ($550 billion), thanks to gas and oil revenues. This should enable Russia to stop a run on the rouble. Falling oil prices may be problematic for Russia: The oil price went up from $11 dollar a barrel in 1998, to $147 in july 2008. Since then it is halved.
Asia Growth rates as high as 10% (China) and 8% (India) During 2000-2006 period, GDP per capita growth in East Asia 8%! However, financial crisis will certainly affect Asia. Growth rates will probably go down by 1-2% Compared to other regions, Asian countries are probably most resilient: p.c. growth rates around 6%.
China China is in good shape • $2 trillion reserves • A current-account surplus • Little connection to foreign bonds • Governement Budget Surplus The impact of this crisis on China is probably limited • Its banks have only limited involvement in global markets Economic growth in China is likely to slow-perhaps to 8%- but not collapse. China will benefit from cheaper oil.
India Until recently, India has not been seriously affected by the recent financial turmoil The Indian current account has been opened fully, but more calibrated approach has been followed to the opening of the capital account prudential policies have attempted to prevent excessive recourse to foreign borrowings None of the Indian banks had any direct exposure to the sub-prime markets However, India has a weak fiscal position, which is a risk.
India India will certainly feel some impact of the financial crisis • Reduced availability of international capital, both debt and equity • Pressure on the exchange rate: the roepie depreciated by 20% this year • Stock markets are going down: this year by 50% Therefore, a decline in Indian growth rates is expected. The IMF forecasts a reduction by 1.1% to just below 7% growth. India will benefit from cheaper oil.
Latin America Latin America is in a better position to avoid a downturn in the economy than some decades ago Most countries do not have huge budget deficits, have built up considerable currency reserves, and have adopted flexible exchange rate Nevertheless, the high growth rates across Latin America (above 5% from 2004-2008) will fall hard, probably to below 3% next year (about 1.5% per capita).
Latin America Developments of commodity prices are crucial Many Latin American countries depend on prices of minerals, oil and food (grains and livestock) Due to the fall in food prices, the trade surpluses that averaged almost $100 billion a year between 2004-2008, are likely to fall to around $23 billion next year Especially Argentina, Venezuela, Bolivia and Ecuador are expected to face tough times due to their dependence on commodity exports, and the needs for external financing
Latin America Mexico is most directly affected by the US economy: more than 80% of the exports are to the US. Moreover, remittances from US will decline. Economic growth is expected to even fall below 2%. But a recession will probably be avoided Brazil probably in somewhat better position
Sub-Saharan Africa: a forgotten continent? The international press hardly pays attention to the crisis and Africa If Emerging Markets’ growth drops, the Western Economies will be hurt. Not so if Africa drops Some argue that Africa will not be affected since the African financial system is not integrated with the World Economy
Sub-Saharan Africa On average, growth rates in Sub-Saharan Africa high during the last two years: about 6% (about 3.5% per capita) This is much higher than in earlier periods: average of 4.5 between 2000-2006 (2% per capita); and even much lower in earlier periods. Many countries in Sub-Saharan Africa already hit by food crisis. Moreover, progress on poverty reduction still low
Growth elasticity of headcount poverty Percentage decline in headcount due to percentage increase in average income, varies between 1 and 2 For Sub-Saharan Africa, with a headcount of 50%, the index will fall by 1.75-3.5 percentage points with current per capita growth rates of 3.5%. The population growth is about 2.5%, so that high growth rates are needed to stabilize the amount of poor. With current growth rates of about 6% this may be the case. However, if growth declines, the amount of poor will definitely rise!
How is Africa affected by the financial crisis ? • Indirectly via a decline in global growth • A decline in aid • A decline in remittances • A decline in private flows (FDI, Loans) I will concentrate on 1, 2 and 3.
Decline in global growth Without offsetting macroeconomic policy changes, global growth could decline by 3-6 percentage points The global trend growth is now about 4% Hence, a global decline of about 2 percent may result
Growth decline in Africa The IMF suggest that for every 1% decline in global GDP growth, growth in Sub-Saharan Africa will decline by 0.5 percentage points Hence, if global growth declines somewhere between 3 and 6 percent, African growth will decline by 1.5-3 percentage points. GDP per capita growth in Sub-Saharan Africa is now about 3.5%. Due to a global decline in growth, this may result in GDP per capita growth rates of somewhere between 0.5 and 2% In addition, negative effects of declines in capital flows may be expected. Therefore, without offsetting policies, growth in Africa may go down to 0% per capita: recession!
A decline of Aid Total ODA to Sub-Saharan Africa: $33 billion (25 billion Euro; 5% GDP; $43 per capita) Total ODA world wide: 88 billion Euro Boneses financial workers at Wall Street this year: $70 Billion Total Dutch development aid: 4.25 billion Euro Facility of Wouter Bos to support Banks: 20 billion Euro. Financial rescue package in US: $700 billion Resources used to support the poor are very modest compared to the sums being spent to bring stability to the international financial system!
A decline in Aid Due to the enormous amounts used for preventing a financial meltdown, the Western World would be under severe pressure to cut international aid Some politician may even use the current situation to plea for a decline in aid. The G8 committed itself to double the aid flow to Africa by 2010. However, it is almost sure that the G8 will not honor this commitment.
Remittances Remittances now have the same amount as FDI: $15 billion per year. The amount of remittances that will be send back to Africa, will decline considerably if there is a drastic worsening of European (and South African) labor markets This will especially hurt countries with a high dependency on remittances (in percent of export earnings): Lesotho (60%); Uganda (40%), Senegal, Guinnea-Bissau, Benin, Burkina-Faso (15-25%).
Expectations Asia: growth will decline by 1-2 percent. However, given current high growth rates, GDP per capita growth will still be around 6%. Latin America: more seriously affected. Growth will decline by 2%, may be even more. Per capita growth rates expected of about 1-2% Africa: may even drop into recession. Growth may decline by 2-3%. Due to relatively high population growth, this may result in very low per capita growth rates, just above 0%. Is this forecast unavoidable?
What to do? • The US, Europe, and the surplus economies of Asia and the Middle East should coordinate macroeconomic policies to stop a global recession: • Expansionary fiscal policies • No protectionism • More export credits to developing countries • More funding of investment projects in developing countries • Special role for China
What to do? 2. The IMF should extend low-conditionality loans to developing countries • The pressure to reduce aid flows should be withstood. The crisis must not be an excuse to cut aid flows. 4. Institutional investors (e.g. pension funds, insurance companies) should invest more in developing countries, for instance in microfinance institutions.