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FINANCE: The Poor Will Pay Too

Gustavo Capdevila interviews UNCTAD expert MICHAEL HERRMANN

GENEVA, Nov 18 2008 (IPS) - Developing countries are not safe from the damaging effects of the current financial crisis, as had initially been forecast, but so far the impact has not been “dramatic,” according to UNCTAD economist Michael Herrmann.

In this interview with IPS, Herrmann says countries of the developing South that have run high current account deficits, allowed their local currency to become overvalued against the dollar, and thus weakened the international competitiveness of their exports are the most exposed.

The world’s poorest countries will also feel the effects of the crisis due to the drop in commodity prices, because many of them depend on exports of raw materials, said the expert with the UNCTAD (United Nations Conference on Trade and Development) Division for Africa, Least Developed Countries and Special Programmes.

IPS: What repercussions will the U.S.-originated financial crisis, which is already affecting much of the rich world, have in the countries of the developing South? MICHAEL HERRMANN: (T)he global financial crisis…(will have) direct effects (on developing countries), that are transmitted through the capital markets and through the behaviour of financial institutions following the crisis.

But (there will also be) indirect effects, namely the implications of a global economic slowdown for developing countries, the implications of falling commodity prices and the possible effects of the global financial crisis on development assistance.

I need to emphasise there is no economic logic that tells us that Official Development Assistance (ODA) should fall in response to an economic crisis, (although there are) various political reasons of course why this may happen.

IPS: What are the most salient aspects of these direct effects? MH: (W)e see that the stock markets in developing countries have dropped…and that emerging market spreads (costs of financial operations) have increased. We see that financial institutions are less willing to lend to other financial institutions and that companies are less willing to invest. So basically these are signs of this decreasing willingness to lend and to invest.

IPS: At the start of the crisis, it was said that developing countries would not be hit so hard due to their weaker links to the main markets. MH: We see that the idea of the decoupling of the developing world from the rest of the world is not true. However, the effects on the developing world as of yet are also not as dramatic as we may have thought just a while ago.

IPS: What would you attribute that to? MH: (T)he relatively strong resilience of some developing countries is basically due to the fact that some of them have very high current account surpluses, plus slightly undervalued exchange rates, and they have very strong export competitiveness, as well as sufficient financial resources to finance themselves. They don’t rely so much on external financial resources.

So these countries are quite resilient to the shocks. But countries that are likely to be badly affected are those with large current account deficits, overvalued exchange rates and weak export competitiveness.

IPS: What does the crisis have in store for the Least Developed Countries (LDCs)? MH: (A) number of Least Developed Countries will be affected. Now, they are not really heavily integrated into global financial markets, but they will be affected to some extent by the changing behaviour of banks that operate in LDCs.

In Central and West Africa, many French banks operate there; I think that in Southern Africa we have many English banks operating. Now these banks are under stress in their home countries, and they may be less willing to upkeep operations in LDCs.

IPS: Will the LDCs continue to grow? MH: (I)n many ways the indirect effects are much stronger on the LDCs (such as in the case of the) global economic slowdown

The IMF has revised its forecast for the year 2009 for the world economy. In April, (it) projected a global growth rate of 3.8 percent. Now, in October, the IMF has projected a growth rate of 3.0 percent for 2009. So global economic growth is down, and growth will be down in all developing regions. (But) it will be down in the developed countries and in the transition economies as well.

IPS: What effects of this tendency have begun to appear? MH: This has of course negative effects on investment in general. Because with less demand, there will be less investment. It has negative effects on exports…(and) on remittances. Interesting we are already seeing some signs of that…as guest workers in developed countries become unemployed they will send less money back home, or will themselves migrate back home.

IPS: And what is occurring now in the case of commodity prices? MH: (O)f course as the global economy slows, we see a fall in commodity prices, we see a fall in the oil price. Other commodity prices have followed.

So we have a number of effects that are associated with the slowdown of the world economy, and all countries and all economic sectors will be affected by this. But not all countries and economic sectors to the same extent. For example, the recession in the U.S., with the decrease in (domestic) demand (and) depreciation of the dollar, (will lead to a drop in imports by that country, which)…will affect different countries that are heavily dependent on exports to the U.S., such as China, Mexico and a few other countries (which) will be affected most in absolute terms.

IPS: What about the LDCs? MH: We shouldn’t forget that a number of LDCs have significant exports to the U.S., and especially to the EU. A very large share of their exports go to these two. And exports account for a very large share of their own GDP. LDCs are also very likely to suffer from falling commodity prices, as many of them are commodity exporters.

And if indeed the global economic slowdown, the costs associated with the rescue package of banks and the costs associated with countercyclical economic policies encourage major donors to decrease their ODA, this will mostly affect the poorest countries, the LDCs which most strongly depend on development assistance.

IPS: Summing up? MH: So overall, decoupling is not happening. Everybody will be affected. But we have to be aware that countries will be affected to different degrees and extents. Countries that are integrated in global financial markets will be more directly affected.

But also the effects will depend on where they are, (whether they have a) current account surplus or…a current account deficit, and (whether) their exchange rate is overvalued or undervalued.

And for the other countries that are less heavily integrated in global financial markets, including LDCs, effects are mostly indirect but no less difficult.

IPS: So the outlook is grim? MH: We have to certainly be aware that the effect could get much worse. We know that. But (this) will depend on macroeconomic responses by both developed and developing countries. And with countercyclical economic policies, for instance, it may very well be possible to lessen the impact of the economic slowdown.

IPS: What would you specifically recommend for developing countries? MH: The policies that developing countries can pursue will depend on the country. I think that there is no general policy recommendation for all them. I think developing countries should avoid, if they can, overly tight monetary and fiscal policies. That could be a general prescription.

Of course if (they are indeed threatened by) high inflation rates, if it is not manageable for the countries, I’m not saying that they should loosen monetary or fiscal policies. In order to stimulate their economies, countries may consider public investments, in infrastructure, etc.