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    The Developing Crisis


    International Trade Forum - Issue 1/2009

    Illustration by Giles Kershaw

    As the world's financial epicentres crash across various continents, what impact is this having on developing countries? 

    'The stark reality is that developing countries must prepare for a drop in trade, capital flows, remittances, domestic investment, as well as a slowdown in growth.'

    The words of Robert Zoellick, President of the World Bank, are as realistic as they are ominous. Although not at the centre of the world's economy, developing countries are at its mercy, dependent on trade, investment and aid; never is this felt more than in times of crisis.

    Trade finance, fundamental to the working of the global financial system, is about four things: payment facilitation, financing, risk mitigation and the timely flow of information. The effects of the global financial crisis have been felt on all counts. And naturally, with the current emphasis on risk-avoidance, the consequences of reduced trade finance are most severe for small and medium-sized enterprises (SMEs) and emerging markets.

    Relationships between banks, export credit agencies, investment banks and other providers of trade finance are critical to its timely availability. These relationships are built on trust in the integrity and financial viability of trade finance providers; trust that has evaporated in the current climate. Consequently the trade financing gap, estimated at US$25 billion, is affecting developing countries around the world.

    Offshore banks, which previously provided credit, have collapsed. Even the increased recourse to export credit agencies, and the higher-profile involvement of International Financial Institutions (IFIs) and their various trade facilitation programmes, cannot fully address the problem.

    A further concern, common among developing countries, is a lack of diversification in export markets. A small handful of industries tend to make up the bulk of each country's exports, and the problem is compounded by limited export markets, with the European Union, the United States and Asia the key players. As these markets face economic crisis, so too do the developing countries that rely on their trade. Consumer demand is decreasing, and there's a threat of growing protectionism in the West. The repercussions are felt by every link in the supply chains.

    But the impact of the financial crisis isn't limited to export markets; national incomes are threatened on several fronts. Developing countries are being told to prepare for steep declines in aid donations and remittances. In Tonga in the Pacific, for example, there has been a reported decline of 40% in remittances since the beginning of the global crisis. Foreign investment is slowing, driven by the desire to minimize spending and mitigate risk. Even those developing countries whose future projections looked healthy a matter of months ago, can expect trade and investment to weaken in the face of the worsening crisis.

    'The global credit crunch has worsened an already bad situation,' comments Chinyemike Torti, CEO of the Federation of Nigerian Exporters. 'Even when Nigerian banks were sitting on a cornucopia of funds, credit was not made available to exporters, due to an ingrained suspicion of SMEs. Now that the squeeze is on, the consequences for the sector will be devastating.'

    Despite the concern, some experts already speak of a return of liquidity, and the combined efforts of IFIs, export credit agencies and some non-traditional providers of trade finance, will facilitate access to financing in support of global commerce. Many developing countries are looking toward strategic planning and restructuring of financial systems, to bolster their economies in difficult times.

    Sri Lanka

    By Subhashini Abeysinghe, Economist, Ceylon Chamber of Commerce, Sri Lanka

    Lack of diversification needs to be managed

    Like most developing countries, Sri Lanka has a poorly diversified basket of exports, with four sectors accounting for around 70% of exports: apparel (41%), tea (13%), rubber and rubber products (8%), and gems and jewellery (7%). The problem is further aggravated by poorly diversified export markets; the European Union and the United States together account for over 60% of the country's total exports.

    The dangers of this lack of diversification are felt acutely in times of crisis. The two main markets for Sri Lankan exports are in recession. The demand for imports from these countries has declined. Exporters are finding it difficult to not only secure orders, but also to secure payments for the orders they get. At the same time, there are fears of growing protectionism in the West, which will add to the difficulties faced by exporters from developing countries.

    A rapid rise in the price of commodities saw the value of Sri Lankan exports increase during 2007/08. However, commodity prices came down towards the last quarter of 2008, which is having a negative impact on export revenues of the country.

    Due to liquidity constraints faced by banks and the increasing risk of default, exporters are finding it increasingly difficult to obtain trade credit from banks. The payment delays, cancelled orders and declining prices have sent shock waves along the entire supply chain, making the pinch for cash felt even at the corner shop in a remote village.

    Times like this require flexibility in laying off workers, in order to maintain long-term sustainability and employability. But Sri Lanka is one of the costliest countries to separate from workers, with an estimated 169 weeks of salary paid as compensation. Such rigid labour regulations can make it difficult for some companies to effectively adjust to face the crisis.

    A reduction in prices is a natural phenomenon when there is excess supply in the face of declining consumer demand. Sri Lanka is a relatively high-cost manufacturing destination compared with most other developing countries, and therefore exporters are finding it difficult to remain profitable while giving into buyers' demand for discounts.

    The government's fiscal deficit has been relatively high, making it difficult to provide a stimulus package for the economy. However, it is imperative that the private sector and the government work together in this time of crisis, to sustain businesses with minimum job loss, and to promote strategies that will convert prevailing challenges into opportunities for future growth.

    One such example is that exporters are beginning to explore new emerging markets such as China, India, the Association of South-East Asian Nations (ASEAN) and the Middle East, with the help of government and business support organizations. Export companies are also looking at the possibility of increasing their domestic sales.

    In addition, government-guaranteed concessional funds have been proposed, in order to overcome the problem of access to and cost of finance. There have also been requests to reschedule the repayment of loans and temporarily suspend or reduce penal interest on delayed repayments and default loans. In order to help exporters deal with cash flow problems, the sectors worst hit by the crisis have requested the government to temporarily withdraw taxes. The private sector has also been lobbying with the government to reduce electricity tariffs for all industries, and to remove an existing surcharge. Low global fuel prices could facilitate such a reduction without any fiscal strain on the government. Challenge is the need to balance the government's need for revenue and reducing the cost of doing business.

    Adapted from: "Coping with the Financial Crisis - Experience of Sri Lankan Exporters", World Trade Net Business Briefing, ITC


    By Ernest Aryeetey Director, Charles Godfred Ackah Research Fellow, The Institute of Statistical, Social and Economic Research University of Ghana, Legon

    Guarding against reduced trade and donor support

    While the long-term economic growth prospects for Ghana appear to be generally favorable, recent developments in the global financial markets are likely to have some impact on the near-term growth prospects. As the threat of global recession will affect Ghana's trading and investment partners, so too will it affect the country's own economy. There is growing uncertainty around how long Ghana can maintain a strong pace of economic growth in the face of sluggish demand in the major developed markets.

    Commenting on the global financial crisis earlier this year, then-President John Kufuor was glad that it had not yet affected the country directly, and assured the nation that government was keeping a watchful eye on the unfolding events in order to anticipate and forestall any danger to the economy. Meanwhile, the Ministry of Finance and Economic Planning has already indicated what to expect: donor support to developing countries will decline, and thus the global financial crisis will hit Ghana's economy badly. It has therefore made urgent calls for the country to strengthen its domestic revenue mobilization and its management.

    Most analysts believe that the most damaging potential effect will be from reduced remittances and capital flows. Inward remittances received by individuals and households have been a powerful anchor for the Ghanaian economy, amounting to some $1.6 billion in 2007. But as the flow starts to slow down, fingers are being pointed at the global crisis.

    Furthermore, international investors are likely to delay their commitment to commercial projects in the country. The Ghana Investment Promotion Centre warned that the fourth quarter of 2008/09 could be tough for the country's investment climate, despite impressive gains in the third quarter.

    Another consideration is the impact of declining crude oil prices. Ghana is currently an oil importer, and should ordinarily be happy about the sharp drop in oil price. But the country expects to begin exporting crude oil very soon and officials have made a number of macroeconomic future projections based on high revenue expectations driven by high oil prices. That is where the long-term effects of the financial crisis will be most felt.

    Despite Ghana's current strong economic fundamentals, the Central Bank is not optimistic about the odds of containing the external shocks. Weakening commodity markets are a particular concern, as the recession slows down the aggregate demand.

    Ghana relies heavily on the European Union, the United States and Asia for its export markets, remittances, tourism and development aid. A steep decline in these sources will severely affect the nation's economy.

    The bank has said that the effect of the turmoil has so far been limited. On the financial sector, it notes that outstanding external borrowing by banks as a source of funding for their activities, as well as the composition of existing credit lines and the industry's low net open position, indicate that the banking system is not over-exposed.

    Adapted from: "The Global Credit Crunch - Implications for Ghana", Voices from the South - the Impact of the Global Financial Crisis on Developing Countries, Institute of Development Studies, Sussex


    By Otaviano Canuto, Vice-President for Countries Inter-American Development Bank

    Restructuring the financial sector

    As the global financial crisis entered its acute phase in mid-September 2008, Brazil faced a sudden negative shock in its foreign capital flows. Portfolio equity outflows and the unwinding of carry trade abruptly accelerated. Even low-risk trade credit lines vanished. As a result, not only did domestic stock markets dive, but the local currency underwent a sharp depreciation in a matter of days, while the Emerging Markets Bond Index and Credit Default Swap spreads both rose substantially.

    The rush to the exit was triggered by external factors, such as the cover of losses and margin calls elsewhere; foreign banks preserving liquidity; or simply as a response to systemically heightened risk aversion. Nevertheless, it was followed by a rapid halt in the domestic interbank market, and of credit in general.

    Domestic credit conditions deteriorated, a peculiar form of the credit freeze happening in the core-advanced economies. Local currency devaluation and the sudden drought of foreign finance together sparked a spurt of uncertainty regarding local corporate health, both in banking and non-banking sectors. News arose that corporations and smaller banks would face unexpected vulnerability to exchange rate depreciation, due to exposure through derivatives, and this immediately led to doubts about hidden 'toxic assets' and fragile balance sheets.

    The Brazilian public sector had availed itself of the current-account surpluses and foreign-capital bonanza of the last few years to reduce its foreign debt and retire dollar-denominated domestic debt, to the point of acquiring a negative dollar-exposure. Indeed, the recent exchange rate depreciation even contributed to a shrinking public-debt-to-GDP ratio. Conversely, in the private sector, confidence in a strong local currency had become so entrenched that some corporations accepted providing dollar put-options to banks in exchange for lower funding costs. The reversal of the dollar trend was followed by a surprising revelation of - realized and unrealized - corporate losses and a domestic generalized credit squeeze.

    The response by monetary authorities has been twofold, on both foreign exchange and domestic credit fronts. As of 6 November 2008, the Central Bank had sold US$5.2 billion (2.6% of international reserves) in the spot market, combined with derivative sales of $25.8 billion through currency swaps. Additionally, temporary dollar liquidity had been provided through repo agreements, both in the spot market ($4.8 billion) and abroad ($3.3 billion).

    The war chest for interventions received a confidence boost, in the form of the inclusion of the Brazilian Central Bank in the United States Federal Reserve's network of currency swap lines. By November 2008, trade credit lines had returned to half the level they were at prior to mid-September, while the exchange rate had receded from the peak and hovered around non-dramatic levels. The latter mitigated fears of a deeper corporate financial stress, as well as those of rising credit risks for the counterparty banks that were on the other side of corporations in structures of currency derivatives.

    On the domestic credit side, besides extending its rediscount policies, the Central Bank has eased on its long-held stiff reserve requirements, in a series of moves that may end up liberating liquidity of more than 5.7% of GDP and 5.6% of total bank assets. The government has also announced its intention to resort to public-sector majority-owned banks to fill in the blanks for credit to agriculture, automobiles and others, as well as to acquire partnership shares in Brazilian-based companies.

    The phase of panic and financial absolute freeze seems to have ceased, but not without consequences. Preliminary figures for domestic credit in October pointed to a steady reversal of the long path of expansion that was previously in course. Most leading indicators of industrial production and demand, as well as business and household confidence surveys, have also suggested a sharp economic deceleration in the last quarter of 2008/09.

    Domestic absorption was running above potential GDP growth prior to the credit crunch, and doubts remain about whether the deceleration in consumption and investment will be enough to counteract the inflationary effects of the now prevailing, more depreciated levels of the exchange rate. On the other hand, the Brazilian government retains an arsenal of monetary foreign reserves, and fiscal and quasi-fiscal instruments that can be used if new external shocks occur and/or the deceleration in domestic demand becomes too deep.

    Adapted from: "Impacts of The Financial Crisis on Brazil", Voices from the South - the Impact of the Global Financial Crisis on Developing Countries, Institute of Development Studies, Sussex