Impact of the Global Slowdown on Developing Countries Jeffrey Lewis Senior Advisor, The World Bank Presentation to the OECD Global Forum on Development December 9, 2008

11 22 Impact of the Financial Crisis on Developing Countries Impact of the Financial Crisis on Developing Countries 33 Policy Challenges and Responses Current Status of the World Economy

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

Emerging markets USA Euro Area Oct-2007 MSCI equity price indexes, January 2005=100 Financial stress sweeps through global markets Source: World Bank, Global Economic Prospects, 2009

Developing countries High-income countries Real GDP, percentage change Forecast Shape of the coming recession: V, U or L? Deteriorating growth conditions in major markets will depress expansion in developing countries % change ? Source: World Bank, Global Economic Prospects, 2009

Massive capital outflows, drastic drop off from previous record highs (from $1 trillion to nearly $500b, from 7.6 to 3 percent of GDP) Many hard hit developing countries already had: –Fiscally precarious positions –High levels of initial poverty and malnutrition –Limited capacity to implement targeted policy response Crisis transmission channels –Affect wages and employment as inflation passes through (headline inflation up 5% in most, >10% in more than half) –Sharp drop in investment, which has been driver of growth –Falling remittances –Long term cost of coping mechanisms, loss of fiscal cushions Impact of the Financial Crisis on Developing Countries

Financial flows are likely to drop precipitously $ billions Net private capital flows to developing countries Possible $998 billion in 2007 Source: World Bank staff estimates East Asia Crisis

Trade finance has dried up and is dragging down exports Banks are refusing to honor letters of credits from other banks and holding back guarantees commodity buyers and sellers need to ship their commodities For agriculture commodity traders, it is reported that the price has risen to 4 percent of the value of the contract, up from 1 percent before the collapse of Lehman Brothers As market confidence is eroding, there is a growing risk of resurgence of barter trade between countries Source: World Bank, staff

Remittances are likely to slacken Remittances have been one of the most dependable sources of finance for developing, especially poor ones Often bigger than largest commodity earnings, or larger than capital inflows These have often gone to the poorest segments of recipient countries, with strong poverty reduction impact But these may not be sustainable at the high levels of 2007… As labor markets weaken in rich countries, unemployment adversely affects unskilled workers, a principal source of remittances Crackdowns on illegal border crossing are already beginning to take effect in the US and perhaps Europe. Transactions costs may raise as banks fear counter-party risk

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

Policy options for developing countries Counter-cyclical policies: But only open to countries with access to noninflationary sources of finance and a sound investment climate Policies to support the poor: tariff reductions on food imports, conditional cash transfers, stay in school programs, and possibly public employment programs Public investments: in labor-intensive and trade-related infrastructure, such as rural roads Policies to reduce trade costs: border reforms, customs reform, port reforms, and improving logistics management

The capacity for fiscal response (and exploring fiscal space) is influenced by debt management (including debt strategy) Weak debt management capacity in many LICs curtails debt management strategies based on prudent cost-risk considerations Challenges for debt management in the current crisis include – Widening fiscal deficits (higher expenditures; lower revenues) – Rollover risk in difficult global financial environment – Realization of contingent liabilities While only borrowing LICs can ensure that debt remains manageable over the long term, international community must support efforts to improve debt management practices in LICs Fiscal and debt sustainability has become an even bigger issue in the current context

Multilateral efforts to stem financial crisis and reignite growth in home markets – including fiscal stimulus and coordinated monetary policies as well as new consistent regulation New commitments for development assistance to finance fiscal expansion in poor countries in next two years Maintain market access or open markets further, particularly in textile, clothing, and agricultural products Conclude Doha Development Agenda World Bank pursuing measures to triple IBRD lending, accelerate IDA access, and expand IFC support to trade finance, bank recapitalization, and infrastructure investment Policy responses where developed countries can help

Impact of the Global Slowdown on Developing Countries Jeffrey Lewis Senior Advisor, The World Bank Presentation to the OECD Global Forum on Development December 9, 2008