And worse may well be on its way; in the midst of a debt, equity and policy crisis, confidence is sliding amidst lags in global policy responses. A path out of the crisis is still possible – including through a G20-led rebalancing from the public to the private sector and from current account surplus to deficit countries – but the path is narrower because interest rates are already low and government balances have deteriorated significantly. So far the markets have not yet reacted very favourably (although share prices rebounded on Friday) to yesterday’s G20 commitment ‘take all necessary actions to preserve the stability of banking systems and financial markets as required’ but it still needs to be followed by action.
Even though their growth prospects are still relatively strong (IMF forecasts growth of an average of 6.2% over 2011-12), developing countries may find themselves once again affected by a crisis originating in developed countries. Latin American countries are already preparing for a global slow-down. How worried should the poorest countries be? What can the international community do to help? Or will China come to the rescue?
During the course of the past week, four panels have been convened by ODI in collaboration with others to discuss responses to different types of shocks. The first panel on Monday discussed two new ODI papers (with my colleague Isabella Massa) on the role of development finance institutions (DFIs) in tackling the effects of global shocks on poor countries. Two panels on the European Report on Development 2011-2012 (prepared with DIE and ECDPM) discussed how we can respond to the resource crunch in the future. A final panel (organised by my colleague Jodie Keane) at the EADI/DSA conference in York considered the twin shocks of climate change and a possible double-dip.
Are developing countries and the international community prepared for another round of crises? And what is different this time? And who can come to the rescue?
First, what conditions remain the same?
As in 2008, low-income countries are still growing faster than developed countries, though more slowly than emerging powers. African policies have responded well to the global economic crisis of 2008 and the institutional setting within which responses to shocks have been formulated has improved. Similarly, we are now well aware of the complex linkages between developed and low-income countries through financial, trade and other linkages. For example, ODI’s observation that ‘vulnerability = exposure – resilience’ is now well embedded in thinking about shocks. Shock facilities such as those provided by the IMF have been significantly enhanced and reformed, the European Union’s V-FLEX proved a success although future changes still need to be decided.
What makes it easier now for the poorest countries to respond?
There is now more experience in responding to global shocks, including the watching of high frequency data. More positively, low-income countries are now relatively less dependent on developed countries because of the increased economic links between emerging powers and low-income countries (disregarding direct and indirect knock-on effects), although some of the smallest and most vulnerable countries have made very fewer inroads in the emerging powers.
But what makes it more difficult this time around?
Whilst exposure seems lower, economic resilience is also lower. Low-income countries are in a weaker position now in macro-economic terms, because reserves and government finances have not yet fully recovered from the previous crisis. Developed countries are also in a weaker position to support developing countries – we have already seen aid come under pressure, and a new crisis is not going to provide good news. Further, the IMF notes that private capital flows, which had been gaining importance as a source of external financing before the crisis, have resumed only to a handful of emerging and frontier economies in Africa: Ghana, Mauritius and South Africa. It is clear that the private sector still needs further encouragement.
So what is the answer now?
The key to surviving a global growth crisis remains to grow out of that crisis. But this needs to be done smartly so that it can be sustained in the long run (financially as well as environmentally) and does not put unsustainable future pressures on the planet or sovereign wealth. Indeed, because solutions to one crisis may cause the next one (e.g. poorly targeted stimuli add to the crisis, whilst smart growth stimuli will enable a country to resolve the crisis; biofuels ease pressures on carbon space, but cause scarcity in water and land) we need to consider the range of crises simultaneously and optimise a joint solution, not maximise the solution to one crisis and then move on to the next. Such an approach needs significant re-thinking of the governance systems in charge of responding to crises – a key issue discussed in the preparation for the European Report on Development 2011-2012.
Can developed countries do more to help poor countries respond to shocks beyond the usual instruments of recently enhanced shock facilities? Our DFI roundtable discussed the feasibility of retooling private sector DFIs to tackle global challenges. By enhancing blending between DFI finance and grants such as project preparation funds for privately-led green infrastructure, the private sector could be enabled to lead a rapid crisis response in low-income countries. Whilst the DFIs themselves suggested that they are currently not set up to act counter cyclically, this is exactly what G20 finance and development ministers can contribute to: as shareholders they could encourage and enable new investment policies to ensure DFIs can act counter cyclically (by blending, rather than lowering interest rates) and support sustainable investment to encourage new capital flows to the poorest.