Analysing the Global Crisis: ITC's Chief Economist Assesses the Impact of the Global Financial Crisis on Developing Countries, and Recommends Responses for International and Domestic Policy

Article excerpt

This crisis is not like a tsunami, a giant wave sweeping everything in its path, but rather like a series of smaller waves with their impact accumulating over longer periods.

I would expect to see three impact waves for developing countries. In the short run, the first wave has been the shelving or outright cancellation of planned foreign direct investment (FDI) to developing countries. Second has been a severe import contraction of the major Organisation for Economic Co-operation and Development (OECD) countries, with the mirror effect of declining exports of developing country suppliers and export prices dropping sharply. Third will be the laying off of people, translating to a sharp drop in incomes and remittances. Some developing countries will be impacted much more severely than others, but nobody will remain unaffected.

Impact analysis

We know little about how these impacts will correlate and hardly anything about their co-variances. Yet this will determine the depth and duration of the crisis for individual countries, producers and exporters. The trade and investment impact will accumulate, with reduced remittances and fewer workers migrating, adding further to the decline of national incomes. It is therefore possible that the crisis will continue to be felt in developing countries, even if signs of recovery become visible in OECD countries. At any rate, that is not expected for 2009. While there have been "green shoots" in the first weeks of July, with a few international banks, notably Deutsche Bank, reporting better-than-expected profits, the demand side remains bleak, with high unemployment and extremely weak consumer confidence.

Developing countries are the collateral damage of this crisis. They were largely absent in the "toxic" markets, except for a few Chinese and Singaporean sovereign wealth investments in the banking and insurance sectors. These have taken a severe hit, despite having focused on triple AAA-rated brand names such as Bear Sterns, Fortis and Lehmann Brothers. Under-regulated financial markets permitted over-exposure of financial institutions, most notably the United States investment banks. Their success in selling risky assets to other players, including pension funds around the world, was largely based on exploiting asymmetric information. Investors from all over the world were easily attracted, expecting steady and predictable returns.


The Washington-based institute of International Finance (IIF) has been monitoring the movements of private capital flows to developing countries, with disconcerting observations. According to the IIF, the level of private capital likely to be invested in developing countries in 2009 will be down by 82 per cent, relative to 2007. It is not a response to decreased profitability in the developing countries. I don't agree with the institute when it writes that investors have turned more riskaverse. It is primarily the credit crunch that finished lax finance and easy borrowing. The net lending of commercial banks is expected to be negative by $61 billion, withdrawing from emerging and developing markets, whereas it was positive to the tune of $167 billion during 2008. This is a watershed.

The United Nations Conference on Trade and Development (UNCTAD) further estimates that FDI will be down by 10 per cent in 2009. This is in sharp contrast to their 2007 survey of transnational corporations, with companies reporting an intention to increase their greenfield investments, especially in emerging markets. Calling off port folio investment and venture capital projects is the first-wave effect, followed by companies rescheduling their investment projects. This is also happening in the services sectors, with banks and insurers going slow on expansion. It is not only visible in the first tier of emerging markets, such as China, India and Brazil, but also particularly strong in the second tier such as Thailand, Kenya and the Philippines. …


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