Implications of the Financial Crisis for Developing Countries


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Maximo Torero (IFPRI)
30th April 2009, International food Policy Research Institute, Washington D.C.

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Implications of the Financial Crisis for Developing Countries

  1. 1. Implications of the Financial Crisis for Developing Countries David Laborde d laborde@cgiar org and Maximo Torero t @ i IFPRI Washington 30th of April 2009
  2. 2. Origins of crises or sources of dynamism • Developed economies • Expansionary US monetary policy and very low interest rates in the wake of IT bubble burst • Expansionary US fiscal policy of tax cuts and defense/ security spending after September 11 • Emerging countries/oil producers have excess savings • Risk assessment based on wrong assumptions or g p models… • Lead to excess credit and leverage: • I fl ti of housing market bubbles i US and other d Inflation f h i k t b bbl in d th developedl d economies=> consumption boom • Subprime mortgages • High levels of financial innovation in search of higher yields
  3. 3. Origins of crises or sources of dynamism • Developing economies • Improvements in macroeconomic p p policies • Increase in competitiveness • Investment boom fueled by: • Strong export demand and high commodity prices, thanks to large US commercial account d fi it and strong growth i Chi l i l t deficit d t th in China and India • Surge in FDI, as well as other private flows • Strong remittances form workers abroad • Investment surge increased demand for capital goods from developed countries, fueling virtuous cycle of growth
  4. 4. We have Three Crises • Food crisis forced 200 million people into extreme poverty, half of them still there. - Food crisis is not over: prices are still high - Incentives for protectionist measures • Fuel crises: rise and fall of price of oil (variability), impact (variability) of food for fuel, climate change, • Financial crisis: Reduction in exports, commodity prices, crisis: remittances, tourism, FDI, and aid - Hit public revenues in developing countries - Second round effects can worsen the situation even more - Private capital flows fell more than $700 billion between 2007 and 2009 - Limited availability of domestic financing to businesses
  5. 5. Effects over developing countries • Sharp decline in the sources of financing for investment in developing countries - Possible decline in world trade volumes in 2009, combined with further fall in commodity prices - Fall in inward FDI and portfolio investment (already seen in 2008), together with higher interest rates on capital - Drop in remittances as developed-country labor developed- markets slacken - Second-round effects that could exacerbate crisis Second- • Threat: not just slowdown, but crises of their own
  6. 6. GDP growth and Employment • Average projected GDP growth in developing countries is 1/4 of what was expected during the first half of 2008. - Still downside risks to this estimate • Average growth in Eastern Europe, Central Asia, and LAC is projected to be negative • (Un)Employment - ILO projects 30 million more people will be unemployed in 2009 worldwide (23 million in developing countries) - Worse-case scenario: 50 million people Worse-
  7. 7. 2005 Source: IMF
  8. 8. 2007 Source: IMF
  9. 9. 2009 Source: IMF
  10. 10. Poverty and Hunger • Poverty rates may not increase, but the poverty count is likely to rise in SSA, East Europe, Central Asia and LAC. • The number of chronically hungry people in the world is increasing (World Bank): Bank): - 2007 – 850 million - 2008 – 960 million - 2009 – more than 1 billion
  11. 11. Mechanisms on Trade Financial crisis → C dit crunch • Fi i l i i Credit h - Less investments - Restriction on trade finance, especially for developing countries and small producers: direct impact on exports • Financial crisis → Economic Crisis → Under-employment Under- of resources (Labor, Capital) ( , p ) - Low utilization rate of capital → Less investments - Lower Income → Lower demand → Lower Trade Elasticity of trade to GDP > 1: taste for diversity as a luxury goods, goods fixed trade costs foreign activities reduce in priority costs, • Deflation and specific tariffs in agriculture → mechanical increase of the protection - Difficulty to disentangle the price correction related to the end of the bubble and medium term path - A EUR93/ton tariff represents 40% if prices are at EUR332/ton but 80% if price falls to EUR116/ton • The end of the global imbalances?
  12. 12. Financial crisis, Economic slowdown and Rising p g protectionism • Since September 2008, several observers have noticed the implementation of new protectionist measures • However, these measures are consistent with the natural “cyclicity” of trade policies: cyclicity” policies: - Bouet and Laborde (2009) have computed t at in the ouet a d abo de ( 009) a e co puted that t e last 13 years, 4.5% of tariff lines have increased on two subsequent years. - If a protectionist wave in the current context is a threat, threat, it i not a f t yet. T iff increases do not explain trade is t fact yet. Tariffs i t d t l i t d decline. • The potential cost of rising protectionism (with and without a successful Doha Round) has been investigated in other IFPRI works (see Bouet and Laborde 2008, 2009) - Up to -10% in world trade (volume) if tariffs increase to their current WTO limits (bound level)
  13. 13. Why some exporters are more affected than the others? • Geographical specialization - Does your main markets are more affected than the others? • Sectoral specialization - Do your main products have a strong income elasticities? elasticities? - Do you export capital goods? • International division of labor - Does your production chain highly disaggregated? (= Strong exposition to rising ( trade costs) • Trade financing - Can your financial system support your exporters?
  14. 14. Analytical tool • Short term analysis y • Modified version of MIRAGE - Computable General Equilibrium are not macro-econometrics model macro- for forecast - But they are good to deal with trade and see how countries, based on their trade specialization and comparative advantages, can react to a shock • What have we modified? - Utilization of resources (labor and capital) based on IMF, OECD and ILO estimates and forecasts • Related to short term business cycle and institutional aspects: not the comparative advantages of the CGE • We ensure consistency of utilization rate of resources and GDP forecasts in MIRAGE and in the IMF - Changes in investment behavior (OECD and IMF sources) g ( ) - Short term closure of current account: endogenous trade balance and fixed real exchange rate - Specific tariffs modeled as specific tariffs - Trade finance as a trade cost - New demand structure with better measurement of income and price elasticities (from Gouel, 2009) Gouel,
  15. 15. Simulations design (1) • Core scenario - Step 1: Impacts of the demand and investment p 1: p shocks IMF, OECD and ILO estimates/forecasts - Step 2: Impacts of the trade finance restriction 2: IMF and ICC qualitative assessments (we assume 0% costs in OECD, 1% costs in BRICs, and 2% for other developing countries) - Step 3: External constraint: introducing the 3: current account constraint (change in the ( g model closure) - Step4: Reduction in the global imbalances: Step4: Cut by 1/3 in 5 years (from 6% to 4%, IMF estimates) %
  16. 16. Simulations design (2) • Two variants - A deeper recession. Same schedule but recession. secessionist effects increased by 50% - A delayed recovery. Recovery will start in recovery. 2013.
  17. 17. Core Scenario - Exports (volume) 160 North ‐ Agro ‐ Baseline  North ‐ Agro ‐ Crisis  150 North ‐ Manu ‐ Baseline  North ‐ Manu ‐ Crisis  South ‐ Agro ‐ B li S th A Baseline  140 South ‐ Agro ‐ Crisis  South ‐ Manu ‐ Baseline  South ‐ Manu ‐ Crisis  130 120 110 100 90 80 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: MIRAGE simulations, Laborde and Torero (2009)
  18. 18. Export volume Focus on 2012 (compared to baseline) ( p ) Source: MIRAGE simulations, Laborde and Torero (2009)
  19. 19. Export volume - Asia Focus on 2012 (compared to baseline) ( p ) Source: MIRAGE simulations, Laborde and Torero (2009)
  20. 20. Export volume – Sectoral results (world) Focus on 2012 (compared to baseline) ( p ) Source: MIRAGE simulations, Laborde and Torero (2009)
  21. 21. Trade surplus/deficit Focus on 2012 (compared to baseline) - % of GDP ( p ) Source: MIRAGE simulations, Laborde and Torero (2009)
  22. 22. Agricultural Real Value Added (2012, volume, % changes) Recession scenario – Selected countries Source: MIRAGE simulations, Laborde and Torero (2009)
  23. 23. Long term effects – Total real income 2015 compared to baseline p Source: MIRAGE simulations, Laborde and Torero (2009)
  24. 24. Long term effect scenarios (2015) Agricultural Export volume– Selected countries volume– Source: MIRAGE simulations, Laborde and Torero (2009)
  25. 25. Export volume Alternative scenarios – Developing countries p g 160 Agro ‐ Baseline  Agro ‐ Core Scenario 150 Agro ‐ Deeper  Agro Deeper Recession Agro ‐ Delayed  Agro Delayed Recovery Manu ‐ Baseline  Manu ‐ Core Scenario 140 Manu ‐ Deeper Recession Manu ‐ Delayed Recovery 130 120 110 100 90 80 2007 2008 2009 2010 2011 2012 2013 2014 2015 Source: MIRAGE simulations, Laborde and Torero (2009)
  26. 26. Final remarks On who is affected: • Small producers -> Should be more affected by credit crunch • “High value crops” strategy: ambiguous effects during economic crisis (high income elasticity) • Role of trade finance-> Extremely importan finance- • Even if the recovery takes place, several years of growth (and investment ) are lost-> Mill th ( d i t t lost- Millennium l t i goals? Public policy to compensate
  27. 27. Final remarks On what to do: • Increase demand counter-cyclically to the counter- y y extent that is consistent with protecting fundamentals - Finance creation and upgrading of infrastructure – useful to catch up, after period of rapid private-sector growth - Trade finance is essential - Pro-poor spending, pro-poor tax cuts: • Fund social safety nets and investments in education and health – investment in future productivity of the economy • Insure those who are uninsured or who face high costs of self g insurance