Impact of the Global Impact of the Global Slowdown on Developing Slowdown on Developing

CountriesCountries

Jeffrey Lewis

Senior Advisor, The World Bank

Presentation to the OECD Global Forum on Development

December 9, 2008

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2222 Impact of the Financial Crisis on Impact of the Financial Crisis on Developing CountriesDeveloping CountriesImpact of the Financial Crisis on Impact of the Financial Crisis on Developing CountriesDeveloping Countries

3333 Policy Challenges and ResponsesPolicy Challenges and Responses Policy Challenges and ResponsesPolicy Challenges and Responses

Current Status of the World EconomyCurrent Status of the World EconomyCurrent Status of the World EconomyCurrent Status of the World Economy

The world economy entering a major downturn The world economy entering a major downturn OECD countries in recession, enormous financial sector dislocation, OECD countries in recession, enormous financial sector dislocation, unknown fiscal costs of bailouts, severe real economy dislocations, unknown fiscal costs of bailouts, severe real economy dislocations, stagflation potentialstagflation potentialDeveloping country growth rate ex China & India down by half Developing country growth rate ex China & India down by half Emerging markets witnessing international reserves declining, volatile Emerging markets witnessing international reserves declining, volatile equity and foreign exchange marketsequity and foreign exchange marketsWeakening global trade - world trade likely to decrease in 2009 for Weakening global trade - world trade likely to decrease in 2009 for the first time since the 1982 recession, remittances dropping the first time since the 1982 recession, remittances dropping Volatile commodity prices pose risks for importers & exportersVolatile commodity prices pose risks for importers & exporters

Current Status of the World EconomyCurrent Status of the World EconomyCurrent Status of the World EconomyCurrent Status of the World Economy

50

100

150

200

250Emerging markets

USA

Euro Area

Oct-2007

MSCI equity price indexes, January 2005=100

Financial stress Financial stress sweeps through global marketssweeps through global markets

Source: World Bank, Source: World Bank, Global Economic Prospects,Global Economic Prospects, 2009 2009

0

2

4

6

8

1980 1985 1990 1995 2000 2005 2010

Developing countries

High-income countries

Real GDP, percentage changeReal GDP, percentage changeForecast

Shape of the coming recession: V, U or L?Shape of the coming recession: V, U or L?

Deteriorating growthDeteriorating growth conditions in major markets will conditions in major markets will depress expansion in developing countriesdepress expansion in developing countries

% change

??

Source: World Bank, Source: World Bank, Global Economic Prospects,Global Economic Prospects, 2009 2009

Massive capital outflows, drastic drop off from previous record highs Massive capital outflows, drastic drop off from previous record highs (from $1 trillion to nearly $500b, from 7.6 to 3 percent of GDP)(from $1 trillion to nearly $500b, from 7.6 to 3 percent of GDP)Many hard hit developing countries already had:Many hard hit developing countries already had:– Fiscally precarious positionsFiscally precarious positions– High levels of initial poverty and malnutritionHigh levels of initial poverty and malnutrition– Limited capacity to implement targeted policy responseLimited capacity to implement targeted policy response

Crisis transmission channelsCrisis transmission channels– Affect wages and employment as inflation passes through (headline Affect wages and employment as inflation passes through (headline

inflation up 5% in most, >10% in more than half)inflation up 5% in most, >10% in more than half)– Sharp drop in investment, which has been driver of growthSharp drop in investment, which has been driver of growth– Falling remittances Falling remittances – Long term cost of coping mechanisms, loss of fiscal cushionsLong term cost of coping mechanisms, loss of fiscal cushions

Impact of the Financial Crisis on Developing CountriesImpact of the Financial Crisis on Developing CountriesImpact of the Financial Crisis on Developing CountriesImpact of the Financial Crisis on Developing Countries

Financial flowsFinancial flows are likely to drop precipitouslyare likely to drop precipitously

$ billions

0

200

400

600

800

1000

Net private capital flows to developing countriesNet private capital flows to developing countriesPossible Possible 2008-092008-09

$998 billion in 2007

Source: World Bank staff estimates

East Asia CrisisEast Asia Crisis

Trade financeTrade finance has dried up and is dragging down exportshas dried up and is dragging down exports

Banks are refusing to honor letters of credits from other banks Banks are refusing to honor letters of credits from other banks and holding back guarantees commodity buyers and sellers and holding back guarantees commodity buyers and sellers need to ship their commodities need to ship their commodities

For agriculture commodity traders, it is reported that the price For agriculture commodity traders, it is reported that the price has risen to 4 percent of the value of the contract, up from 1 has risen to 4 percent of the value of the contract, up from 1 percent before the collapse of Lehman Brothers percent before the collapse of Lehman Brothers

As market confidence is eroding, there is a growing risk of As market confidence is eroding, there is a growing risk of resurgence of barter trade between countriesresurgence of barter trade between countries

Source: World Bank, staffSource: World Bank, staff

RemittancesRemittances are likely to slackenare likely to slacken

Remittances have been one of the most dependable sources of Remittances have been one of the most dependable sources of finance for developing, especially poor onesfinance for developing, especially poor onesOften bigger than largest commodity earnings, or larger than Often bigger than largest commodity earnings, or larger than capital inflowscapital inflowsThese have often gone to the poorest segments of recipient These have often gone to the poorest segments of recipient countries, with strong poverty reduction impactcountries, with strong poverty reduction impact

But these may not be sustainable at the high levels of 2007…But these may not be sustainable at the high levels of 2007…As labor markets weaken in rich countries, unemployment As labor markets weaken in rich countries, unemployment adversely affects unskilled workers, a principal source of adversely affects unskilled workers, a principal source of remittancesremittancesCrackdowns on illegal border crossing are already beginning to Crackdowns on illegal border crossing are already beginning to take effect in the US and perhaps Europe.take effect in the US and perhaps Europe.Transactions costs may raise as banks fear counter-party riskTransactions costs may raise as banks fear counter-party risk

The effect of the crisis on poverty alleviation efforts and MDGs is still The effect of the crisis on poverty alleviation efforts and MDGs is still being felt – up to 100m at risk of poverty from food and fuel, being felt – up to 100m at risk of poverty from food and fuel, financial crisis still working throughfinancial crisis still working through

What should global community focus on?What should global community focus on?Aid flows from donors should not weaken:Aid flows from donors should not weaken: with the current liquidity with the current liquidity squeeze, capacity of countries to obtain external finance already weaksqueeze, capacity of countries to obtain external finance already weakTrade financing should not dry upTrade financing should not dry up: developed countries should maintain : developed countries should maintain export credits to developing countries and ensure that capacity is sufficient export credits to developing countries and ensure that capacity is sufficient to support international trade flowsto support international trade flowsCreate conditions for recovery: Create conditions for recovery: Need to help Governments ensure that Need to help Governments ensure that capital (physical and human) investment is not crowded out, as this will be capital (physical and human) investment is not crowded out, as this will be key to restoring long-run growthkey to restoring long-run growth

Policy Challenges and ResponsesPolicy Challenges and ResponsesPolicy Challenges and ResponsesPolicy Challenges and Responses

Policy optionsPolicy options for developing countries for developing countries

Counter-cyclical policies: But only open to countries with Counter-cyclical policies: But only open to countries with access to noninflationary sources of finance and a sound access to noninflationary sources of finance and a sound investment climateinvestment climate

Policies to support the poor: tariff reductions on food Policies to support the poor: tariff reductions on food imports, conditional cash transfers, stay in school imports, conditional cash transfers, stay in school programs, and possibly public employment programsprograms, and possibly public employment programs

Public investments: in labor-intensive and trade-related Public investments: in labor-intensive and trade-related infrastructure, such as rural roadsinfrastructure, such as rural roads

Policies to reduce trade costs: border reforms, customs Policies to reduce trade costs: border reforms, customs reform, port reforms, and improving logistics managementreform, port reforms, and improving logistics management

The capacity for fiscal response (and exploring fiscal space) is The capacity for fiscal response (and exploring fiscal space) is influenced by debt management (including debt strategy)influenced by debt management (including debt strategy)

Weak debt management capacity in many LICs curtails debt Weak debt management capacity in many LICs curtails debt management strategies based on prudent cost-risk considerationsmanagement strategies based on prudent cost-risk considerations

Challenges for debt management in the current crisis includeChallenges for debt management in the current crisis include– Widening fiscal deficits (higher expenditures; lower revenues)Widening fiscal deficits (higher expenditures; lower revenues)– Rollover risk in difficult global financial environmentRollover risk in difficult global financial environment– Realization of contingent liabilitiesRealization of contingent liabilities

While only borrowing LICs can ensure that debt remains While only borrowing LICs can ensure that debt remains manageable over the long term, international community must manageable over the long term, international community must support efforts to improve debt management practices in LICssupport efforts to improve debt management practices in LICs

Fiscal and debt sustainabilityFiscal and debt sustainability has become an even bigger has become an even bigger issue in the current contextissue in the current context

Multilateral efforts to stem financial crisis and reignite growth in Multilateral efforts to stem financial crisis and reignite growth in home markets – including fiscal stimulus and coordinated home markets – including fiscal stimulus and coordinated monetary policies as well as new consistent regulationmonetary policies as well as new consistent regulation

New commitments for development assistance to finance fiscal New commitments for development assistance to finance fiscal expansion in poor countries in next two yearsexpansion in poor countries in next two years

Maintain market access or open markets further, particularly in Maintain market access or open markets further, particularly in textile, clothing, and agricultural productstextile, clothing, and agricultural products

Conclude Doha Development AgendaConclude Doha Development Agenda

World Bank pursuing measures to triple IBRD lending, accelerate World Bank pursuing measures to triple IBRD lending, accelerate IDA access, and expand IFC support to trade finance, bank IDA access, and expand IFC support to trade finance, bank recapitalization, and infrastructure investmentrecapitalization, and infrastructure investment

Policy responsesPolicy responses where developed countries can help where developed countries can help

Impact of the Global Impact of the Global Slowdown on Developing Slowdown on Developing

CountriesCountries

Jeffrey Lewis

Senior Advisor, The World Bank

Presentation to the OECD Global Forum on Development

December 9, 2008