Global Trends by Martin Khor

Wednesday, 29 October 2008

Crisis spreads to developing countries

The global financial crisis started in the West, but developing countries are now being hit hard as their stock markets and currencies fall and billions of dollars of foreign funds start to move out.


In recent days, the world financial crisis has expanded as stock markets continued to tumble to new lows, currencies have gyrated wildly, while more developing countries are now affected by currency, financial and economic crises.

On Monday, the Asian stock markets continued to plunge, with the Nikkei index in Tokyo closing 6.4% down to its lowest level since 1982. The indices in other markets also fell sharply, Hong Kong by 12.7%, Shanghai by 6.3% and India by 6.1%.

This follows the bad performance of stock markets globally last week, especially the rout on Friday (24 October) which saw falls of 8 to 11 per cent in Japan, Korea, Singapore and Hong Kong, 5% in Britain and Germany, and 3.6% in the US Dow Jones industrial average.

Each day brings news of new signs of recession. The United Kingdom's economic output shrank 0.5% in the third quarter, and an index of private sector output in the euro-zone (15 European countries) fell in October at the sharpest rate in 10 years.

J.P. Morgan economists estimated the US gross domestic product fell 0.5% in the third quarter and will fall 4% in the fourth quarter, and that European countries will have steeper GDP falls until mid-2009.

There is also news of a fall in sales in retail shops, and of motor vehicles, signs of a decline in consumer spending as the recession bites into household incomes in rich countries. Profits of European companies are expected to fall by 40% by the end of 2009, according to a report in today's Financial Times.

Many developing countries and East European economies have quickly slid into deep trouble, with a few already entering the debt-default zone and others nearing it.

Some prominent people are no longer describing the situation as the worst since the Great Depression, but as being worse than that. "This is a once in a lifetime crisis and possibly the largest financial crisis of its kind in human history," said Bank of England Deputy Governor Charles Bean.

Developing countries were once thought to be "decoupled" from a Western recession but that theory has been shot to bits as the crisis is hitting them even harder than the developed countries.

The crisis has jeopardised everything the United Nations has done to help the world's poor, warned UN secretary general Ban Ki Moon at a meeting last Friday of the UN's top officials in its chief executives' board.

"It threatens to undermine all our achievements and all our progress," he said. "Our progress in eradicating poverty and disease. Our efforts to fight climate change and
promote development. To ensure that people have enough to eat...It could be the final blow that many of the poorest of the world's poor simply cannot survive."

The developing countries have been affected through various routes -- the sharp fall in prices of commodities, reduced demand for their exports, the sudden outflow of foreign capital, currency depreciation in many countries.

The fall in commodity prices has been deep and sudden, moving in opposite direction from record high prices just a few months ago. For example, palm oil exporting countries in Southeast Asia have been hit by the shocking price fall. Crude palm oil futures in Malaysia tumbled from an all-time high of Malaysian ringgit 4,500 per tonne in early March to about RM1,700 presently.

Other examples: the price of copper on 22 October was 54% below its peak in July
and 39% below a year ago, while the price of wheat has fallen by 45% between March and the first week of October.

The oil price has plunged from a peak of $140 a barrel just a few months ago to $61-62 on 24 October despite OPEC's announcement of a production cut. While reducing the import bill of importers, this has adversely affected revenues of oil-exporting developing countries.

Developing countries which have significant trade and current account deficits are having their currencies come under attack. Foreign capital is also moving out of many developing countries.  Those countries like Pakistan that have low foreign reserves are especially susceptible to debt difficulties or default. But even other countries like South Korea that have high reserves but current account deficits are also coming under pressure, and their currency depreciation worsens the situation.

There were large movements of foreign capital last week due to the unwinding of the "yen carry trade" as funds returned to Japan from other countries as hedge funds and other speculative investors liquidated their investments in these countries to re-pay their yen loans.

The speculators had borrowed yen in Japan due to its very low interest rate and invested in assets in other countries that yielded higher interest. As these countries' currencies depreciated and the yen value rose, it became unprofitable to keep these assets and there has been a stampede to re-pay the yen loans, which has in turn further boosted the yen's value (in just one week, by 8% against the US dollar, 13% against the euro and 18% against the Australian dollar).

The stock market fall has also been sharp in emerging markets, with the MSCI emerging equities index dropping 15% over last week to levels of four years ago.

Emerging market stocks, bonds and currencies suffered steep falls amid growing risk aversion, reported the Financial Times. Among those hit hard were South Korea, South Africa, Argentina, Ukraine, Hungary, Serbia and Turkey. They are considered extremely risky because of their large debts while even stronger economies like China and Brazil have been savaged, according to the report.

In the past few days, political leaders have announced intentions to act against the crisis. First was US President George Bush's invitation to a summit meeting in Washington for the G20 countries in Washington on 15 November to discuss the crisis and possible changes to the financial architecture. Details of the agenda are still to be defined.

Second was the UN General Assembly President's announcement of the formation of a UN task force led by American economist Joseph Stiglitz to recommend reforms to the system.

Third was a meeting of the UN Chief Executives Board (comprising heads of UN agencies, the IMF, World Bank and WTO) on 24 October which issued a statement calling for immediate action to protect people, jobs, shelter and livelihoods.

It said the crisis should not deflect attention from other challenges like climate change and the Millennium Development Goals, while ODA is even more important to poor countries facing declining liquidity and worsening balance of payments positions.

UN Secretary General Ban Ki-Moon told the meeting that drastic measures are needed, including the IMF and major central banks setting up substantial standby lines of credit so that banks in developing countries have adequate funds to draw on during an emergency, according to a UN press release.

Last Saturday (25 October), a summit meeting of European and Asian leaders in Beijing (the 7th Asia-Europe Meeting) issued a statement on the international financial situation pledging to take national measures and to strengthen coordination to take comprehensive measures to restore market confidence, stabilize markets and promote growth.

On international reform, the statement said: "Leaders pledged to undertake effective and comprehensive reform of the international monetary and financial systems. They agreed to take quickly appropriate initiatives in this respect ...The IMF and other international financial institutions should bring into play their mandated role in the international financial system, to help stabilize the international financial situation."

A meeting of leaders of ASEAN-plus-3 (ASEAN countries, China, Japan and South Korea) held in Beijing on the eve of the ASEM meeting reaffirmed their intention (originally made in May) to set up a regional crisis fund to help countries in financial distress by enabling them to defend their currencies.

The $80 billion fund is understood to be a foreign-exchange reserve pool. ASEAN Secretary-General Surin Pitsuwan said that the fund is meant to enable the defence
of the region's currencies but this original mandate could be widened to also cover
domestic liquidity issues.

The operational details and the timeline for establishing the fund is however still under discussion.  In May, the ASEAN-plus-3 leaders had agreed on such a fund, which would supersede the Chiang Mai Initiative (formed in 2000).

The preliminary agreement in May was to create a foreign exchange reserve pool of $80 billion, with China, Japan and South Korea to provide 80% or $64 billion, and ASEAN members providing the remaining $16 billion, according to a report by Xinhuanet, a Chinese news agency.

The above measures are signs of world leaders and global agencies trying to get their act together to stem the carnage caused by this worst-ever financial crisis. However, the crisis is moving faster than almost anyone anticipated, shifting towards the developing countries and extending into a real-economy recessionary crisis, which in turn has a negative impact back on the world of finance.

In fact, the crisis -- both of finance and the real economy -- is only at the beginning stage and will have a long way to go, and the really serious problems still ahead, especially for the developing countries.