The global nancial crisis and developing countries

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Dirk Willem te Velde et al
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When the global financial crisis broke out in earnest in September 2008, it quickly became clear that developing countries would also be affected, but that the impacts would vary markedly. The Overseas Development Institute (ODI) coordinated a multi-country study over January-March 2009 involving developing country teams in 10 countries. This showed that, while the transmission mechanisms were similar in each (trade, private capital flows, remittances, aid), the effects varied by country, and much was not yet visible. As such, further country-specific monitoring was required. Most findings suggested that, as a result of time lags, the worst effects were yet to come. This synthesis of the effects of the global financial crisis on developing countries updates the description of the economic and social situation during the course of the crisis in 11 countries.

The synthesis includes a series of easy-to-read comparative tables of how the 11 countries have been affected. Below we summarise some key facts.

Portfolio flows were hit particularly hard by the crisis in late 2008 and early 2009 which points to the fact there was (global) financial contagion effect: a flight to safety everywhere. In Bangladesh, $159 million worth of portfolio investment was withdrawn in FY 2008/09. The Nairobi Stock Exchange (NSE) 20 Share Index had declined by 46% by February 2009 compared to the previous year. In Sudan, portfolio investment fell from $30.5 million in 2007 to -$33.4 million in 2008. In Zambia, portfolio investment in equities and government securities have been adversely affected by the global crisis and the resulting fall in copper prices over 2008. Net flows truned negative in 2008 and remained to until at least September 2009.

However, there have been some signs of a recovery since the second quarter of 2009. In Bangladesh, portfolio investment outflows reduced to $25 million in July-August of FY2009/10. In Kenya, the NSE 20 Share Index recovered by 17.5% between March and June 2009, even though it slumped again by 8.8% in the period July-September 2009 In Zambia, the net position in portfolio investment slowly improved from April-July 2009, but reversed again in August. The All Share Index rose from 2143.4 points at the end of the first quarter of 2009 to 2615.8 points at the end of August 2009. Stock market capitalisation increased by 22% from April-August 2009. In Tanzania, total stock market turnover increased by 228% between Q2 and Q3 of 2009.

FDI long regarded as resilient to the crisis fell dramatically in several countries. In Cambodia, net FDI inflows fell by 50% in 2009, hitting in particular the garment and tourism sectors. In Bolivia, FDI flows reduced sharply in the fourth quarter of 2008 and this pattern continued in the first two quarters of 2009. In DRC, FDI decreased sharply from $1713 million in 2008 to $374 million in 2009. Uganda experienced a drop in FDI by 6.2% in 2007/08-2008/09. In Ethiopia, FDI flows declined by 31% from Q2 of 2008 to Q1 of 2009. The Tanzania Investment Centre recorded a drop of about 30% in the value of new investments during the first half of 2009 compared with the same period in 2008.

Banking stresses did become visible in low income countries. In Tanzania, the average capital adequacy ratio (CAR) stood well above its benchmark. In Kenya, the CAR stood well above the minimum required. However, the NPLs/assets ratio, which had declined significantly in 2008, increased from 3.4% in August 2008 to 3.7% in August 2009. The non-performing loans (NPLs) to total assets ratio almost doubled in Zambia, from 7% in the first quarter of 2009 to 13% in the third quarter of 2009.

Remittances grew substantially up to 2008 in all case studies (for which there were data), but the crisis led to a decline or greatly reduced growth in remittances during the second half of 2008 (Bolivia, Kenya, Uganda) and/or at the beginning of 2009 (Bangladesh, Bolivia, Ethiopia). Remittances in Bolivia were down by 8% in first three quarters of 2009 compared to the same period last year. Bangladesh was the only country for which remittances have continued to grow throughout the period (22% in FY 2008/9 compared to a year ago), although at a lower rate than in the pre-crisis period.

Trade declines were visible in a wide range of sectors. Garment export values in Cambodia were down by 19% for the first nine months of 2009 compared with the same period in 2008; volumes over the same period declined by about 16%. In the case of Ethiopia, declines in wholesale market prices for cut flowers in the Netherlands meant that the country earned only 47% of a projected $280 million from flower exports in FY2008/09, which resulted in the inability of some producers to service debts to the Development Bank of Ethiopia. Between January and August 2009, Kenyan horticultural exports declined by 35% in volume terms compared with the same period in 2008. There was a reported 10% decline in the number of tourists arriving in mainland Tanzania in January to April 2009 compared with January to April 2008. Consequently, the revenue obtained from arrivals declined to $302.1 million in the period January to April 2009 compared with $388.2 million for the same period in 2008. Oil accounts for more than 95% of Sudan’s total exports. As a result of reduced oil prices on world markets, it was projected the total value of Sudan’s exports would decline from $12.9 billion in 2008 to $5.3 billion in 2009. In Mozambique, the value of exports of goods between January and September 2009 fell by 37% compared with the same period in 2008Reserves in some countries had become dangerously low. By end of February 2009, gross official reserves in DRC had plunged to a level of $33 million, the equivalent of less than 1 day of imports. IMF support (ESF) helped to raise the reserves to nearly 2 weeks of imports.

The growth effects are highly varied. Cambodia saw a double digit growth rate reduce to zero in 2009. Kenya has had a low growth rate of 2% last year, compared to 7% in 2007, although other crises play a role as well. Uganda, Zambia and Tanzania saw their growth rate reduce by much less.

Employment effects due to the crisis were mostly apparent in garment and mining sectors. At least 25,000-30,000 garments workers lost their jobs in the last eight months of 2009 in Bangladesh. Cambodia lost 102,527 jobs (either permanently or temporarily) over the period since September 2009, or one-third of the garment employment. Zambia lost 10,o00 out of 30,000 jobs although some lost ground has been made up. Three quarters of artisanal miners in DRC, or some 18,000, lost their jobs (dominated mainly by Chinese small scale enterprises). 44 out of 75 mining companies in Katanga had closed by March 2009 after the fall in mineral prices.

However, overall, with a few exceptions effects were manageable on a macro scale. For example, despite a weakening current account, and severe effects in Zambian mining, the economy grew at 6.2% per annum. There is also positive news from the crisis. Remittances to Bangladesh increased markedly throughout the crisis. Tanzania’s gold exports saw prices increase while prices of oil imports fell. Aid has continued to increase in most countriesEmerging markets helped low income countries during the crisis. China is an important or the most important donor in Cambodia and Sudan, and is becoming important in Kenya, and it played a key role during the crisis in these countries. At the China–Africa summit in November 2009, China’s Premier pledged $10 billion in new low-cost loans to Africa over the next three years, double the commitment made in the 2006 summit. China is a key export destination for Sudan, Zambia and DRC, although it is a competitor in third markets for garments from Bangladesh and Cambodia. China is a key (private) investor in Cambodia, DRC, Sudan and Zambia. The economic position of other emerging countries (Brazil, Russia, India, China) is also important for low-income countries. Brazil imports gas from Bolivia, South Africa is responsible for remittances to and exports from Mozambique and Russia is an emerging destination for Cambodian garments, Tanzanian tea and Ethiopian flowers. India has links in most countries: Sudan (financing deficit); Tanzania and Mozambique (cashew nuts imports) and Zambia (FDI).

In the rest of this executive summary, we focus on the key implications of the research:

• The effects are larger and smaller than expected depending on the underlying perspective one takes. Compared with original suggestions that developing countries would somehow be shielded from the financial crisis, the effects are likely to be very large, with some 50-100 million new poor people. But the effects on average are manageable (e.g., on the basis of recent International Monetary Fund (IMF) data and forecasts, sub-Saharan African gross domestic product (GDP) will have lost 7% by the end of 2010 compared with forecasts pre- crisis, or some US$84 billion), with some outliers (Cambodia and certain oil and mineral exporters, such as the Democratic Republic of Congo (DRC), which needed external support). For individual countries, this is not very large compared with previous domestic shocks, although the global nature and scale of this shock have been unprecedented since the Great Depression in the 1930s.

• While all countries are being affected by the financial crisis, it should immediately be added that the impact is highly varied, from very small or no macro effects in some countries (even though disaggregated effects at sector level and in some groups may be visible) to very large effects in others.

• Financial transmission mechanisms to low-income countries initially appeared limited, and attention quickly focused on the real (trade and remittance) transmission mechanisms; however, it is now clear that bank lending, stock market contagion and worsening banking systems did propagate the crisis. One lesson is that some low-income countries are more integrated financially than is often thought.

• Another myth expelled by the crisis is that foreign direct investment (FDI) is always resilient in crises (or more resilient than other flows). In fact, FDI fell significantly in countries such as the DRC (even before security problems occurred), Cambodia and Bolivia. In some other countries, such as Uganda and Kenya, portfolio flows changed quickly.

• While certain types of openness have left countries more exposed to crisis, this may not always have meant increased vulnerability, as some countries have also become more resilient (e.g. Tanzania and Bolivia through good macroeconomic management, including using mineral resources to build up reserves). It is important that countries promote crisis-resilient growth, as in this way they are better prepared for recovery.

• In particular, diversification (products and destinations) is important for growth and resilience to crises. This should be promoted and could draw more attention than has previously been the case – of course in a market-friendly way, so that new policy interventions are not completely delinked from private sector needs. It may also be important to diversify sources of capital flows, such as FDI inflows. For example, Chinese FDI is now making up for some of the losses in mining in Zambia.

• Good macroeconomic management allows more scope for policy responses later. This requires good institutions in managing finances.

• Indeed, the crisis highlights that flexible institutions are important in dealing with crises. There are examples of task forces that led to policy responses to the crisis in Bangladesh, Tanzania and Mauritius, and these were set in a more institutionalised way.

• This global financial crisis has increased the importance of links between emerging markets and low-income countries.

• Policy responses in many country case studies were well designed (even though in the previous phase we asked why there had been no responses): they used fiscal, financial and monetary policies to address short-run economic management (fiscal policies constrained by resources; monetary policies lagged owing to previous inflationary pressures), and they did not engage in major policy reversals. In fact, so-called ‘doing business’ reforms continued.

• Protectionism did not affect the case study countries much, and trade finance was not mentioned as a binding constraint to trade.