The Fallout from
the Credit Crisis:
Perspectives for
Development
Finance
Fourth Meeting of ACP
Ministers of Finance and
Economic Affairs Andrew Mold,
Brussels Senior Economist
12-13th November 2008 OECD Development Centre

Introduction – Observations from some
eminent economists
• “To some of us, the financial market turmoil that started in the summer of
2007 reflects the secular transformation of the global economy. There are
now economic and financial forces in play whose impacts are of great
consequence but that cannot as yet be adequately sustained by the world’s
current policy and market infrastructures.” Mohamed El-Erian (2008.4)
• “...the conclusion is unmistakable that financial failure has been more
extensive and pervasive in the last thirty years than in any previous
period.” (Kindleberger and Aliber, 2005:6)
• “In the past, major crises in developing countries usually had a regional
concentration.... But the epicenter of the current crisis lies deep inside the
developed economies, and therefore we would expect all developing
regions to be damaged by the shocks.” (Justin Lin, 2008: 11)
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Outline – Some key issues….
• Current account considerations
• Capital account considerations, especially
- Foreign Direct Investment
- Development aid
• Econometric work to underpin findings
• Policy issues arising (every cloud has a silver lining?)‫‏‬
– International Financial Architecture
– The policy reaction so far
– A final cautionary note on economic forecasting
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Current account considerations (1)
Current Account Balances – 1980-2008 as % of GDP
Developing Countries Sub-Saharan Africa
Source: IMF WEO October 2008
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Current account considerations (2)
Current Account Balances – 1980-2008 as % of GDP
Western Hemisphere Central Asia and Eastern Europe
Source: IMF WEO October 2008
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Current account considerations (3)
Is the era of high commodity prices over?
• Prior to crisis (and esp. the first 12 months after), commodities seen as an
“alternative asset” by hedge funds and other investors:
– Low or negative correlations with other major assets
– the fact that near futures prices and spot prices converge provide a
prima facie case that financial inv. increases prices.
• “Crises frequently emanate from the financial centers with transmission
through interest rate shocks and commodity price collapses.” (Reinhart and
Rogoff, 2008).
• Historical evidence? Favourable TOT (high prices for primary commodities)
→ ↑ borrowing → collapses into defaults when prices drop.
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Current account considerations (4)
Commodity Prices and New External Default
1800-1939
1940-2006
Source: Reinhart and Rogoff (2008)‫‏‬
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Current account considerations (5)‫‏‬
1940- 2007
Source: Reinhart and Rogoff (2008)‫‏‬
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Current account considerations (6)
Is the era of high commodity prices over? (2)‫‏‬
Only weak evidence of causality between financial positions and
commodity prices (IMF GFSR, 2008)‫ ‏‬but view is controversial.
,
Test of causality between commodity prices and Financial Position (IMF, GFSR, 2008.‫‏‬
)
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Current account considerations (7)
The Cost of Fuel and Food Subsidies as a % of GDP, 2008
Source: IMF WEO October 2008, page 103
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Current account considerations (8)
Commodities Prices for LDCs – Some Caveats...
– The surge in food prices transmitted in varying degrees from
international to local markets. E.g., in Tanzania, 81% in ↑
international maize prices 2003-2008 captured in local prices.
– In Ghana and the Philippines local rice prices have adjusted to
around 50% of the world price change.
– Prices of tea, tobacco and cotton lower in 2006 than in 2000
(even nominally). Coffee (both Arabicas and Robustas) higher,
but still lower than in 1995 (UNCTAD, 2008:16).
– Coffee prices in October suffered a 23% drop in Rwanda,
causing significant hardship to producers
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Current account considerations (9)
Wholesale Maize prices in selected Eastern Africa markets
Source: FAO, Crop Prospects and Food Situation, October 2008
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Current account considerations (10)
• International Trade....
• How vulnerable are countries through trade?
– Exports increased from 29 per cent in 2000 to 39 per cent in 2007 as
a share of developing countries‟ GDP.
– Credit-lines on trade are drying up: a serious predicament for many
exporters.
– US and EU generate 54% of world GDP, at market prices.+ Japan,
62% of GDP.
– US alone imports 16 % of world commodities.
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Current account considerations (11)
Source: Minella (2008)‫‏‬
Source: Carrera (2008)‫‏‬
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Current account considerations (12)
Source: UNCTAD LDC Report, p. 158
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Disturbances through exchange rate volatility
• Floating exchange rates since the 1980s – highly unstable – misalignment
• Sharp fluctuations in the exchange rate already causing difficulties in
some dev. countries (e.g. Brazil, South Africa)‫‏‬
• Knock-on impact of commodity price falls, e.g. copper prices → Zambia‟s
currency ↓24% against the dollar since August
• Carry trade unwinding
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Capital account considerations (1)
• Poorest countries still highly dependent upon foreign savings
– 15 LDCs had negative domestic savings rates in 2006
• E.g. Afghanistan, Burundi, Malawi, Liberia, and Sierra Leone
• Only one third of LDCs had gross domestic savings rates above 15
percent
• Dependence on external finance
– Aggregate net resource flows (% of GDP)‫‏‬
• 11-12 per cent for African and island LDCs
• 3 per cent in other developing countries
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Capital account considerations (2)
Aggregate net foreign resource flows to LDCs and ODCs, 2000-06
Source: UNCTAD LDC REPORT (2008:25)‫‏‬
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Capital account considerations (3)
Rising cost of Capital for the developing world…..
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Capital account considerations (4)
On Portfolio equity flows – sharp decline expected….
Source: Datastream Thompson, 2008
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Capital account considerations (5) –
The importance of FDI.....
Net flows in billions US$ to Latin Net flows in billions US$ to SSA,
America, 1999-2007 1999-2007
Source: World Bank, Global Development Finance, 2008
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On FDI (1)‫‏‬
Regression results of FDI forecasting model
Source: World Bank, Global Development Finance, 2004
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On FDI (2) – Is FDI Better?
– ↓Vulnerability to external financing difficulties when the CA deficit is
financed by FDI inflows (GDF, 2008: 68)‫‏‬ .
– BUT - FDI moves pro-cyclically and can intensify instability
• M&A activity is about 30-35 % of current flows.
– Use of derivative products by MNEs (currency forwards and options) as
investment hedge ↑ pressure on domestic currency (Stiglitz et. al,
2006:179).
– FDI outflows risen significantly in Hungary, Poland, and South Africa.
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On FDI (3) – Is FDI Better?
• Equity component more stable during crisis, but intra-company loans and
reinvested earnings not.
• “In most sectors, TNCs have ample liquidity to finance their investments,
as shown by the high corporate profits reported, at least until 2007. In
the UNCTAD 2008 survey of large TNCs, about one third of respondents
envisaged negative impacts on FDI flows in the short term, but about half
of them suggested no impacts” (WIR, 2008)‫‏‬ .
• Some „opportunistic‟ „fire-sale‟ FDI? Consolidation in banking sector. E.g.
Brazil‟s banks - merger of Itaú and Unibanco – creation of largest bank in
South America.
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On FDI (3)
Source: FT (2008)
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On FDI (4)‫‏‬
GDP growth and FDI outflows from US Outward FDI and GDP growth 1st
OECD countries, 1970-2007 Qtr 1995 – 2nd Qtr 2008 (4-period
moving average)‫‏‬
Source: World Bank, Global Development Finance, 2008
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On FDI (5)
FDI to Low Income Countries and Correlation between FDI outflows
Profit Remittances and GDP Growth for OECD
countries, 1970-2007
60
40
20
0
-20
-40
0 2 4 6
GDP growth
FDI Fitted values
Source: World Bank, Global Development Finance, 2008
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Financial contagion – Stock markets (1)
Source: Minella (2008)‫‏‬
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Financial contagion - Stock markets (2)
Source: World Development Indicators (2008)‫‏‬
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Development aid (1)
• Will „scaling up‟ be put on hold?
• OECD 'aid pledge' – we should not add to the financial crisis an 'aid
crisis'.
• In real terms, ODA in 2007 15% ↑ than the 2004 Gleneagles base year,
but compared to the 60% ↑ by 2010 to meet the Gleneagles
commitments (DCD/DAC, 2008).
• Like FDI (to some extent), aid is highly geographically concentrated. In
2006, Afghanistan, DRC and Sudan accounted for 1/4 of total net ODA
disbursements going to the LDC (UNCTAD LDC Report, 2008:27).
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Recent trends in ODA
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Development aid (2) Will budgets be hit?
In Finland during its banking crisis between 1990-93, when GDP fell by nearly 11
per cent, development aid fell by 60 percent (Roodman, 2008). Can this
experience be generalized?
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Development aid (3)
• No unambiguous relationship between economic growth in donor
countries and subsequent aid flows (e.g. Round and Odedokun, 2004)‫‏‬
.
• Under pressure to reduce expenditures, aid flows are one of the first
areas to be affected by cuts? Aid flows tend to be quite resilient to mild
recessions (e.g., Bertoli et al., 2008).
• Aid is a very small share of budgets, and vis-a-vis rescue packages of
domestic financial sector, very small (US$ 3 trillion already?).
• The best insurance against cutbacks in aid is to insure that policies are
adopted in OECD donor countries to avoid a deep slump.
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Development aid (4)
Source: OECD (2008) and World Bank (2008)‫‏‬
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Some important econometric work to
underpin findings…
• Izquierdo, Romero and Talvi (2007)‫‏‬
– LA-7 panel analysis . Concludes that without favourable extenral conditions
(improved terms of trade, high global growth, and cheaper financing) growth
would have been almost 2 percentage points less than the observed growth rate
• Akin and Khose (2008) Panel analysis of 106 countries over the period 1960–2005.
distinction between industrialised economies and 2 groups of dev countries, Emerging
South and Developing South, based on extent of their integration into the global
economy.
- the impact of the Northern economic activity on the Emerging South has declined
during the globalization period (1986–2005).
- in contrast, the growth linkages between the North and Developing South have
been stable over time. Thus may be more heavily affected by recession in North.
• IMF (2008)‫‏‬
– Analysis of national and international determinants of stock market performance in
Latin America, Asia, and EMEA indicates stronger spillover effects for Latin
America
• Cull and Peria (2007) Using data on the share of banking sector assets held by foreign
banks in over 100 developing countries during 1995-2002, authors find that countries
experiencing banking crisis tend to have higher foreign bank participation than those
that did not
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Some important econometric work to
underpin findings… (2)‫‏‬
Share of banking assets held by foreign banks with majority ownership,
2006
Country 0% - 10% Country 30% - 50% Country 50% - 70% Country 70% - 100%
India 5 Senegal 48 Rwanda 70 Madagascar 100
Nigeria 5 Congo, DR 47 Côte d'Ivoire 66 Mozambique 100
South Africa 0 Kenya 41 Tanzania 66 Peru 95
China 0 Bolivia 38 Ghana 65 Mexico 82
Bangladesh 0 Burkina Faso 65 Uganda 80
Ethiopia 0 Niger 59 El Salvador 78
Mali 57 Botswana 77
Zimbabwe 51
Modified from World Bank, Global Development Finance (2008)‫‏‬
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Policy issues arising from the crisis –
Measures taken recently.....
1. Fed cut interest rates to 1% on 5th Nov.
2.International currency swap facility by Fed up to US$30 bln for Brazil,
Mexico, Korea and Singapore.
3. IMF announced 29th October a new short-term liquidity facility for 'sound'
emerging economies (without usual conditionality)‫‏‬
But do the IFIs have enough resources? e.g. IMF has only $US200 bln
easily available.
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Every cloud has a silver lining? (1)‫‏‬
•China's fiscal stimulus package US$565 bn. Investment on infrastructure and
social welfare...A good precedent?
•What will future finance look like?
1. Feldstein and Horika (1980) finding about high correlation
investment/saving still valid (e.g. Aizeman et. al. 2004). More emphasis on
domestic resource mobilization in future?
2. Paradoxically, banking may benefit (in a shift towards
German/Japanese/Korean model?). But a more conservative structure, with
less innovation in financial innovations.
3. A shift in favour of more long-term investment and against short-terminism
in equity markets? (see the Michael Porter critique (1992) on allocative
efficiency of US market)‫‏‬
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Every cloud has a silver lining? (2) ‫‏‬
4. Desperate need for global standards – OECD has a major role to play here
in corporate and financial standards, etc.
5. Opportunity for reform of global financial architecture
6. Nothing is wrong in principle with CA deficits, especially when they reflect
the use of foreign savings to enhance investment, but since the 1990s deficits
have generally tended to favour consumption, and have often been associated
with falling savings ratios in rich industrialised countries (e.g. US, UK, the
Netherlands, Sweden, Italy, Finland, Canada and Australia) (Glyn, 2005:66).
Some order and discipline needs to be restored to international financial flows?
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Policy issues arising from the crisis –
Every cloud has a silver lining?
Current Account (Im)balances, 2007, billions US$
Source: IMF WEO October 2008
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Finally....
a cautionary note on economic forecasting
IMF growth projections vis-a-vis real performance, 1998-2008
Source: IMF WEO various issues
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Thank You
The Development Centre
www.oecd.org/dev
Andrew.Mold@oecd.org