Analyzing the global crisis

ITC - International Trade Forum Chief Economist Willem von der Geest:

ITC's chief economist assesses the impact of the global financial crisis on developing countries, and recommends responses for international and domestic policy.

This crisis is not like a tsunami, a giant wave sweeping everything in its path, but rather like a series of smaller waves with their impact accumulating over longer periods.

Willem von der Geest

I would expect to see three impact waves for developing countries. In the short run, the first wave has been the shelving or outright cancellation of planned Foreign Direct Investment (FDI) to developing countries. Second has been a severe import contraction of the major Organization for Economic Co-operation and Development (OECD) countries, with the mirror effect of declining exports of developing country suppliers and export prices dropping sharply. Third will be the laying off of people, translating to a sharp drop in incomes and remittances. Some developing countries will be impacted much more severely than others, but nobody will remain unaffected.

Impact analysis

We know little about how these impacts will correlate and hardly anything about their co-variances. Yet this will determine the depth and duration of the crisis for individual countries, producers and exporters. The trade and investment impact will accumulate, with reduced remittances and fewer workers migrating, adding further to the decline of national incomes. It is therefore possible that the crisis will continue to be felt in developing countries, even if signs of recovery become visible in OECD countries. At any rate, that is not expected for 2009. While there have been "green shoots" in the first weeks of July, with a few international banks, notably Deutsche Bank, reporting better-than-expected profits, the demand side remains bleak, with high unemployment and extremely weak consumer confidence.

Developing countries are the collateral damage of this crisis. They were largely absent in the "toxic" markets, except for a few Chinese and Singaporean sovereign wealth investments in the banking and insurance sectors. These have taken a severe hit, despite having focused on triple AAA-rated brand names such as Bear Sterns, Fortis and Lehmann Brothers. Under-regulated financial markets permitted over-exposure of financial institutions, most notably the United States investment banks. Their success in selling risky assets to other players, including pension funds around the world, was largely based on exploiting asymmetric information. Investors from all over the world were easily attracted, expecting steady and predictable returns.

Investment

The Washington-based Institute of International Finance (IIF) has been monitoring the movements of private capital flows to developing countries, with disconcerting observations. According to the IIF, the level of private capital likely to be invested in developing countries in 2009 will be down by 82 percent, relative to 2007. It is not a response to decreased profitability in the developing countries. I don't agree with the institute when it writes that investors have turned more risk-averse. It is primarily the credit crunch that finished lax finance and easy borrowing. The net lending of commercial banks is expected to be negative by $61 billion, withdrawing from emerging and developing markets, whereas it was positive to the tune of $67 billion during 2008. This is a watershed.

The United Nations Conference on Trade and Development (UNCTAD) further estimates that FDI will be down by 10 percent in 2009. This is in sharp contrast to their 2007 survey of transnational corporations, with companies reporting an intension to increase their greenfield investments, especially in emerging markets. Calling off portfolio investment and venture capital projects is the first-wave effect, followed by companies rescheduling their investment projects. This is also happening in the services sectors, with banks and insurers going slow on expansion. It is not only visible in the first tier of emerging markets, such as China, India and Brazil, but also particularly strong in the second tier such as Thailand, Kenya and the Philippines.

Trade

To gauge the impact of the crisis on developing countries' trade, one has to examine high-frequency indicators, such as monthly trade and investment data ITC reports monthly trade data for many countries, based on a country's own reporting, double-checked against the mirror data from major importers. Monthly data for the whole of 2008 are now available for most of Latin America, the BRIC countries (Brazil, Russian Federation, India and China) and the OECD. (ITC provides this free of charge to developing country users at www.intracen.org). Major importing countries and regions are reporting up to May-June 2009, including all the member states of the European Union, other OECD countries such as the United States, Japan, Australia and European Free Trade Association (EFTA) members including Norway and Switzerland.

The different types of trade shocks developing countries are experiencing may be distinguished as follows:

* Commodity price shocks, with prices falling sharply due to the steep decline in demand from the OECD and BRIC economies; much of sub-Saharan Africa, including Benin, Kenya, Uganda and Zambia, is affected.

* Manufacturing demand shock, with orders drying up. Cambodian garments in the United States market are an acute case, with imports in February 2009 amounting to $99 million, whereas in the same month the previous year, garment imports totalled $207 million; consolidated figures for the first five months of 2009 indicate a 20 percent drop.

* Services-demand shocks, for example for tourism, are another important sector, with Cambodia, Gabon, Kenya, Mauritius and Zambia among the countries severely affected.

Countries that are better diversified both geographically and in terms of the mix of product and services in their export basket are better able to withstand the shocks, because the impact across sectors is not uniform, nor of the same intensity. An important example is to compare Cambodian with Bangladeshi garments; while the first targeted upperend United States markets, the latter focused on rather basic clothing in both the European Union and the United States. We now see that Cambodia is more severely affected than Bangladesh. The price-elasticity of demand for different types of garments in OECD markets can differ significantly. It is still too early to draw general implications, but it may be wise to try to develop different product lines within the same industry for this very reason.

Remittances

There is little doubt remittances to developing countries will decrease sharply in 2009. The importance of remittances for developing countries has increased dramatically over the decade from 1997 to 2007. For developing countries overall, the importance relative to Gross Domestic Product (GDP) increased from 1.2 percent to 1.9 percent. Least Developed Countries (LDCs) derive as much as six percent of their income from remittances.

About 53 percent of all (recorded) migrants from developing countries hold domicile in developed countries. But this 53 percent yields 84 percent of the remittance receipts for developing countries (63 percent in LDCs). With OECD employment and incomes falling sharply, the pressure on jobs will be enormous. Lower wages coupled with marginalization will affect the social status of the migrant workers and significantly erode their ability to support their families and next of kin, as well as to save and invest for their future in their countries of origin.

The picture is indeed bleak so far. Kenya has reportedly experienced a decline of its remittances by 12 percent during the second half of 2008 and in Cambodia remittances dropped from 4.2 percent of GDP to 3.4 percent, with further declines expected. For some LDCs, remittances originate predominantly from one single emerging economy - for example, Lesotho and South Africa (81 percent) or Nepal and India (79 percent). Evidently, these countries face a high risk for their remittances.

Policy Responses

Two key variables in the official assistance scenario for developing countries are the flow of overseas development assistance (ODA) and the availability of International Monetary Fund (IMF) credits. The OECD's development assistance committee observes that 2008 was actually a good year for ODA. Net official ODA rose by 10 percent to $119.8 billion and of this, net bilateral aid to sub-Saharan Africa amounted to $22.5 billion. ODA commitments have remained largely unchanged, but the actual disbursement, already behind schedule in 2008, may slip even further.

With regard to the IMF credits for developing countries, the G-20 decision of April 2, 2009 enables additional resources for cash-strapped governments. However, several months later, the picture on the ground is not yet settled.

Since the beginning of April 2009, the IMF has made substantial fresh loans to emerging economies in Latin America and Central and Eastern Europe, to the tune of $59 billion and $45 billion respectively in 15 operations. Furthermore, the IMF approved the doubling of borrowing limits for the poorest countries and also overhauled its conditionality, making it more appropriate for the present crisis context. The "IMF has approved various credits under different arrangements such as "Flexible credit Line", "Poverty Reduction and Growth Facility Arrangement", "Exogenous Shocks Facility" and "Stand-By Arrangement".

For instance, it has approved the $47 billion arrangement for Mexico under its Flexible Credit Line, and a $ 209 million disbursement to Kenya under its Exogenous Shocks facility. Nevertheless, since the G-20 decision of April, fresh lending to 18 African countries amounted to $2.2 billion only in 18 operations. It still remains an open question whether the new facilities will not be too little, too late for many LDCs and low-income developing countries.

Source: ITC Sri Lanka Exporter

To be continued