Friday, December 05, 2008

Recession and Developing countries from

The economic downturn in developed countries may also have significant impact on developing countries. The channels of impact on developing countries include:
• Trade and trade prices. Growth in China and India has increased imports and pushed up the demand for copper, oil and other natural resources, which has led to greater exports and higher prices, including from African countries. Eventually, growth in China and India is likely to slow down, which will have knock on effects on other poorer countries.
• Remittances. Remittances to developing countries will decline. There will be fewer economic migrants coming to developed countries when they are in a recession, so fewer remittances and also probably lower volumes of remittances per migrant.
• Foreign direct investment (FDI) and equity investment. These will come under pressure. While 2007 was a record year for FDI to developing countires, equity finance is under pressure and corporate and project finance is already weakening. The proposed Xstrata takeover of a South African mining conglomerate was put on hold as the financing was harder due to the credit crunch. There are several other examples e.g. in India.
• Commercial lending. Banks under pressure in developed countries may not be able to lend as much as they have done in the past. Investors are, increasingly, factoring in the risk of some emerging market countries defaulting on their debt, following the financial collapse of Iceland. This would limit investment in such countries as Argentina, Iceland, Pakistan and Ukraine.
• Aid. Aid budgets are under pressure because of debt problems and weak fiscal positions, e.g. in the UK and other European countries and in the USA. While the promises of increased aid at the Gleneagles summit in 2005 were already off track just three years later, aid budgets are now likely to be under increased pressure.
• Other official flows. Capital adequacy ratios of development finance institutions will be under pressure. However these have been relatively high recently, so there is scope for taking on more risks.

Which countries are at risk and how?
The list of channels above suggest that the following types of countries are most likely to be at risk (this is a selection of indicators):
• Countries with significant exports to crisis affected countries such as the USA and EU countries (either directly or indirectly). Mexico is a good example;
• Countries exporting products whose prices are affected or products with high income elasticities. Zambia would eventually be hit by lower copper prices, and the tourism sector in Caribbean and African countries will be hit;
• Countries dependent on remittances. With fewer bonuses, Indian workers in the city of London, for example, will have less to remit. There will be fewer migrants coming into the UK and other developed countries, where attitudes might harden and job opportunities become more scarce;
• Countries heavily dependent on FDI, portfolio and DFI finance to address their current account problems (e.g. South Africa cannot afford to reduce its interest rate, and it has already missed some important FDI deals);
• Countries with sophisticated stock markets and banking sectors with weakly regulated markets for securities;
• Countries with a high current account deficit with pressures on exchange rates and inflation rates. South Africa cannot afford to reduce interest rates as it needs to attract investment to address its current account deficit. India has seen a devaluation as well as high inflation. Import values in other countries have already weakened the current account;
• Countries with high government deficits. For example, India has a weak fiscal position which means that they cannot put schemes in place;
• Countries dependent on aid.
While the effects will vary from country to country, the economic impacts could include:
• Weaker export revenues;
• Further pressures on current accounts and balance of payment;
• Lower investment and growth rates;
• Lost employment.
There could also be social effects:
• Lower growth translating into higher poverty;
• More crime, weaker health systems and even more difficulties meeting the Millennium Development Goals.

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