| The
past two weeks have made it clear that the developing
world is far from immune to the storms raging in financial
markets in industrial countries. Stock prices in emerging
markets have gone on similar roller coaster rides to
those in New York and Europe. Indeed, they have shown
such very high volatility, going sharply up and down
on a daily basis around an overall declining trend,
that the pattern is reminiscent of the behaviour of
stock indices in the last major international financial
upheaval in 1929/30 – the Great Depression. And the
credit crunch and freezing of interbank lending have
been only too evident even in developing countries whose
economic “fundamentals” are apparently strong and whose
policy makers believed that they could de-couple from
the global trends.
This almost immediate diffusion of bad news is the result
of financial liberalisation policies across the developing
world that have made capital markets much more integrated
directly through mobile capital flows, as well as created
newer and similar forms of financial fragility almost
everywhere. But the international transmission of turbulence
is only one of the ways in which the global financial
crisis can and will affect developing countries.
A medium-term implication is the impact on private capital
flows to developing countries, which are likely to reduce
with the credit crunch and with reduced appetite for
risk among investors. The past five years witnessed
an unprecedented increase in gross private capital flows
to developing countries. Remarkably, however, this was
not accompanied by a net transfer of financial resources,
because all developing regions chose to accumulate foreign
exchange reserves rather than actually use the money.
Thus, there was an even more unprecedented counter-flow
from South to North in the form of central bank investments
in safe assets and sovereign wealth funds of developing
countries, a process which completely shattered the
notion that free capital markets generate net financial
flows from rich to poor countries.
The likely reduction of capital flows into developing
countries is generally perceived as bad news. But that
is not necessarily true, since the earlier capital inflows
were mostly not used for productive investment by the
countries that received them. Instead, the external
reserve build-up (which reflected attempts of developing
countries to prevent their exchange rates from appreciating
and to build a cushion against potential crises) proved
quite costly for the developing world, in terms of interest
rate differentials and unused resources. While some
developing countries may indeed be adversely affected
by the reduction in net capital inflows, for many other
emerging markets thus may be a blessing in disguise
as it reduces upward pressure on exchange rates and
creates more emphasis on domestic resource mobilisation.
Similarly, it is also very likely that the crisis will
reduce official development assistance to poor countries.
It is well known that foreign aid is strongly pro-cyclical,
in that developed countries’ “generosity” to poor countries
is adversely affected by any reversal in their own economic
fortunes. But in any case development aid has also been
experiencing an overall declining trend over the past
two decades, even during the recent boom.
In fact, the developed countries were extremely miserly
even in providing debt relief to countries whose development
prospects have been crippled by the need to repay large
quantities of external debt that rarely contributed
to actual growth. Notwithstanding the enormous international
pressure for debt write-off, the G-8 countries have
provided hardly any real debt relief. When they have
done so, they have provided small amounts of relief
along with very heavy and damaging policy conditionalities
and in a blaze of self-serving publicity. So the speed
and extent of the debt relief provided to their own
large banks by the governments of the US and other developed
countries, even when these banks have behaved far more
irresponsibly, has not gone unnoticed in the developing
world.
One major source of foreign exchange that will certainly
be affected is remittance incomes, especially from workers
based in Northern countries. Already, the Inter-American
Development Bank estimates that 2008 will be the first
year on record during which the real value of inward
remittances will fall in Latin America and the Caribbean.
Remittances into Mexico (which are dominantly from workers
based in the US) in August were already down 12 per
cent compared to a year previously, and this will only
get worse. There is also evidence of declining remittances
from other countries that relied strongly on them, such
as the Philippines, Bangladesh, Lebanon, Jordan and
Ethiopia. In India, where around half of inward remittances
currently come from the US, the same pattern of decline
is likely.
Exports of goods and services, like remittances, are
going to be affected by the global economic downturn.
For most developing countries, the US and the European
Union remain the most important sources of final export
demand, and as they inevitably tip into recession, exports
to these markets will also decline. There has been much
talk of China emerging as the alternative engine of
growth for the world economy. But this is highly unlikely,
for several reasons.
First, Chinese growth, which has pulled along many other
Asian developing countries in a production chain, has
been largely export-led. The US, EU and Japan together
account for more than half of China’s exports, and as
their economic crisis intensifies, it is bound to affect
both exports and economic activity in China.
Second, even if China’s policy makers respond by shifting
to an emphasis on the domestic economy, this is unlikely
to generate levels of international demand that will
come anywhere near to the meeting the shortfall created
by recession in the developed countries. China’s share
of global imports is still too small for it to serve
as a growth engine on the same scale.
Fond hopes have been expressed by some western policy
makers and economists, that China can use the $2 trillion
of foreign reserves that it controls (directly and through
Hong Kong SAR) to bail out the bankrupt US financial
system. But these hopes are also misplaced. Certainly
it is likely that eventually some of the shares purchased
by the US Fed and Treasury in their troubled banks may
be eventually auctioned off to Chinese and other sovereign
wealth funds among other investors. But this is not
anything like a solution to the basic problem of dealing
with the “toxic assets” held by the various troubled
financial institutions of the West, especially as even
the full amount of such assets is still not known given
the complicated entanglement of such institutions.
Across the developing world, one additional detrimental
effect of the current crisis is likely to be the postponement
or even cancellation of large investment projects whose
ultimate profitability is now in doubt. This will have
negative multiplier effects, as cancelled orders and
lost jobs further reduce demand. The construction sector
has already been hit, and many large projects are being
cancelled even in economies that are still growing.
The aviation sector is going through a major shakeout,
which is evident even in India where there has already
been a tendency towards mergers and worker retrenchment.
The tourism and hospitality sector, which had emerged
as an important employer in many developing countries,
is facing cancellations and declining demand across
both luxury and middle class segments.
The recent crisis has also signalled the end of the
commodity boom, which is bad news for those developing
countries dominantly reliant on commodity exports, and
good news for commodity-importing developing countries.
This follows a period of unprecedented increase in oil
and other commodity prices, led largely by speculative
investor behaviour. On 14 October oil prices (Brent
Crude futures) fell to less than $75 per barrel from
nearly $150 in early July. One important index of commodity
prices, the Reuters-Jefferies CRB index, on 14 October
was 40 per cent below its all-time high in July. While
speculative behaviour was clearly behind the volatility
in commodity prices over the past year, it is likely
that such prices will continue to decline now because
of the broader economic slowdown.
This may provide some breathing space in terms of inflation
control for importing developing countries, especially
oil importers. But remember that even at $75 a barrel,
oil prices are still 300 per cent of their nominal level
of only five years ago. And while world prices of important
food items have also declined in the recent past, they
are still too high for many developing countries with
low per capita incomes and a large proportion of already
hungry people. Indeed, the financial crisis may actually
make it more difficult for many governments of poor
developing countries to secure adequate commodity supplies
to meet their people’s needs. The food crisis seems
to have gone off the international media map, but it
still rages for possibly a majority of the population
of the developing world, and the current global economic
crisis will certainly not make it better.
These are forces that will affect all or most developing
countries, but they will be felt differently in different
places. In particular, the extent of financial contagion
and possible local financial crisis depends on how far
the developing country concerned has gone along the
road of financial liberalisation. It is worth noting
that those countries that have gone furthest in terms
of deregulating their financial markets along the lines
of the US (for example Indonesia) have been the worst
affected and may well have full blown financial crises
of their own. By contrast, China, which has still kept
most of the banking system under state control and has
not allowed many of the financial “innovations” that
are responsible for the current mess in developed markets,
is relatively safe. In India, where we still have a
nationalised banking system and greater degree of regulation,
we are better off than Indonesia, but recent reforms
that the NDA and UPA government have pushed through
despite Left protests, along with our growing current
account deficit, have rendered us more fragile and potentially
vulnerable than China.
In addition, countries with large external debts and
current account deficits will face particular problems.
Already, it is apparent that financial markets are estimating
the risk of default (in the form of the price of credit
default swaps) for countries such as Pakistan, Argentina
and Ukraine as high as 80 per cent or more. Sometimes,
as in Kazakhstan and Latvia, it is because of their
highly leveraged banking systems. In other cases, as
for Turkey and Hungary, it is because of the very high
current account deficits.
Of course, developing countries are still bit players
in this global drama. This particular financial crisis
has so many ramifications mainly because it is occurring
in the very core of capitalism, and originated in the
US, the country that had the global power and influence
to impose its own economic model on almost all of the
rest of the world. And the depth and severity of the
crisis are likely to signal global political economy
changes that will shape the world for the next few decades.
Geopolitical shifts are likely to result from such glaring
exposure of economic vulnerability in the global hegemon.
While the drama is still being played out and the ultimate
denouement is still unclear, what cannot be denied is
that US dominance of world economics and politics is
now under severe question, and has suffered a blow from
which it may not recover. There was certainly some symbolism
in the fact that on the day when a Chinese man was walking
in space for the first time, the US Treasury Secretary
was down on his knees pleading for a bailout. The changes
in the world in the next decade will not be linear or
unidirectional, and there are bound to be savage conflicts
over resources and much else, but the recent pattern
of global imperialism has been severely disturbed.
This is not a conclusion that will be easily drawn in
Washington, or even in Europe. Financial crises were
things that happened in the developing world, after
the breaking of which western officials, consultants
and others could lecture the governments of the crisis-ridden
countries on their past profligacy and wrong policies,
and proceed to administer the severe “Washington Consensus”
medicine that they felt was essential. Now, of course,
the wrongdoing and the collapse are most evident in
the US and Europe, and they are following the opposite
of what they had prescribed for developing countries,
by rescuing banks and going in for Keynesian countercyclical
macroeconomic policies. So it should be difficult, at
least for a while, for even the most hard-boiled and
insensitive such western policy adviser to take the
same high moral tone with developing countries as in
the past.
The global financial and trading system is one that
for many generations has been almost exclusively determined
by the governments of western former colonial powers,
and their writ still runs large in all the global institutions.
Thus, the G-7 which leaves out Russia and China, not
to mention India and Brazil, still presumes that it
has the right to redesign the international financial
architecture. The Financial Stability Forum of the Bank
for International Settlements excludes any representation
from developing countries. The tiny countries of Belgium,
Netherlands and Luxembourg, with a total population
of less than 28 million, have more votes in the IMF
than China, Brazil or India.
But even more than the geopolitical or economic shift,
a bigger shift may come about from the clear failure
of the economic model of neoliberalism. The notions
that markets know best, and that self-regulation is
the best form of financial regulation, have now been
completely exposed for the frauds that they are. And
so this pervasive financial crisis, which is still to
fully play out and work itself through in real economies,
may have led to one very positive shift. It has created
a genuine opportunity not only for questioning the economic
paradigm that has been dominant for far too long, but
also replacing it with more progressive and democratic
alternatives.
|
