Rob M Pt. 2

Second half or Rob's analysis:

The main economic effects of the current financial crisis will reveal themselves in developing countries in the form of reduced economic activity in developing countries. A reduction in consumption in the developed world will lead to a fall in the demand for exports in the developing world. As demand falls prices will also fall eroding away gains previously earned from high commodity prices.

Lower Commodity Prices

In Africa, the price of coffee (a commodity exported by more than 21 African countries nearly half the continent) has fallen by 26% since July 2008. Similarly, there has been a 65% fall in the price of crude oil per barrel over the same period with other commodities such as gold, silver and platinum experiencing falls in price but of lower magnitudes. This decline in the terms of trade has reduced vital export revenues and will slow down economic growth in these countries, undoubtedly pushing some people back into absolute poverty.

Reduced remittances

The financial crisis will also reduce remittances to developing countries. Remittances are a particularly important source of finance for developing countries and help reduce poverty and inequality in what are predominantly capital scarce and labour abundant countries. In 2007, the World Bank estimates that remittances to Africa totalled nearly $10 billion. As the financial crisis deepens Labour markets will slacken and as developed countries go into recession employees will be laid off and incomes will be cut hereby indirectly reducing remittances.

Reduced FDI flows

Even Foreign Direct Investment (FDI) that is usually stable will be negatively affected. The African Development bank estimates the continent received close to US$ 35 billion in FDI in 2007 and about US$ 15.73 billion in portfolio flows. As credit lines tighten, investors will cut back or postpone planned investments in domestic (developed markets) and external (emerging/developing markets). Planned investment is more likely to be postponed in the external markets as investors seek greater security.

Portfolio Investments

Developing countries will also experience capital flight as risk adverse investors move short-term investments to more established markets in Western economies. Portfolio outflows will be shown in the form of declines or even collapses in the value of stock markets in developing countries. According to the African Development Bank, which monitors stock markets on the continent, the 8 main stock markets on the continent were all down from their benchmark value on the 31/07/2008 some as much as 50%. The effect of this type of capital flight will be higher interest rates as countries try to hold on to capital, this will lead to capital account deficits and rising exchange rates further reducing the policy space in which governments can act.

Overseas Development Assistance

The financial crisis will weaken the fiscal positions of donor countries. This is likely to result in donors not meeting agreed promises to increase aid made at the Gleneagles summit in 2005. As such ODA at best is likely to stay the same if not reduced. Another channel through which developing countries will be affected will be tourism. Tourism will fall as people have less money to spend and cut back on holidays abroad.

Potential policies and alternatives to the current financial crisis

• Where possible Government’s that have the policy space could pursue expansive fiscal policy to dampen the recession and limit its effects. Where this policy space is available, government expenditure should be on public infrastructure and social services that will create and sustain wealth in the future;

• Developing countries could also look towards regional integration and the development of regional monetary agreements such as the Chiang Mai Initiative and the Banco del Sur. This would reduce the potential for speculative attacks and the negative impact of capital flight in economic downturns and protect these countries better from similar events in the future;

• Reject traditional IMF prescriptions, in the current economic conditions, infant industries should be protected from external competition, where suitable the government should ignore privatisation and free market policies of prescribed by the Bank and IMF; and

• The focus should be on more long-term policies that promote sustainable development and bring economic independence