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The euro zone crisis and developing countries

Working papers

Written by Isabella Massa, Jane Kennan, Jodie Keane

This ODI Working Paper simulates the potential effects of trade shocks due to the crisis on lower-income economies, and establishes a set of stylised facts on the actual impacts of the European debt crisis on poor countries. Policy responses at the country and international level are also discussed.

From the analysis it emerges that the developing countries likely to be more at risk from the euro zone crisis are those which:

  • direct a significant share of their exports to European crisis-affected countries
  • export products with high income elasticities
  • are heavily dependent on remittances, foreign direct investment, cross-border bank lending and aid flows from European countries
  • have limited policy room to counter the effects of the crisis.

The European debt crisis is likely to hit poor countries hard through the trade channel. Simulation results show that a drop of 1% in export growth could reduce growth rates in low- and lower-middleincome
countries by an average of 0.4% and 0.5% respectively.The impact of the crisis on developing countries is already visible in the form of reductions in exports, declining portfolio flows, cancelled or postponed investment plans, and falling remittances and aid flows.

This Working Paper posits that, in order to weather the crisis, developing countries should - whilst maintaining fiscal soundness and macroeconomic stability as long-term targets - spur aggregate domestic demand, promote export diversification in both markets and products, improve financial regulation, endorse long-term growth policies, and strengthen social safety nets.

For their part, multilateral institutions should ensure that adequate funds and shock facilities are put in place in a coordinated way to provide effective and timely assistance to crisis-affected countries.

Isabella Massa, Jodie Keane and Jane Kennan