Global Trends by Martin Khor††

Monday 9 March 2009

How developing countries are hit by global crisis

The financial crisis started in the West and now developing countries like Malaysia are being affected in many ways through the finance and trade transmission routes.


There doesnít seem to be respite to the global economic downswing, as the latest reports show another 651,000 jobs lost in the United States in February, bringing its unemployment rate to 8.1%, the worst in 25 years.

In the middle of last week, the stock markets briefly rose at a report that China was going to undertake a second fiscal stimulus package, but this proved to be wrong and after the correction by Chinese leaders there was a re-appearance of market gloom.

Although much of the global news of the crisis has focused on the West, it is the developing countries which are suffering more.

The GNP fell by 3-4 per cent in the US in the last quarter of 2008.† But the fall was sharper in many Asian countries such as Japan, Korea, Taiwan and Singapore.

The crisis began as a financial crisis in the US and Europe, and then this affected the Westís real economy as the credit crunch led to job losses and a fall in consumer spending.

There was a lag time before the effects reached developing countries, in the few months before the end of last year. Now the effects are really being felt.† The global crisis is like a train wreck in slow motion.

The developing countries are being affected in many ways.† But there is a diversity among them: no two countries are affected in the same way.

There are two main ways in which the Western crisis is being transmitted to developing countries Ė through the routes of finance and trade.†

In the finance route, firstly, some countries have been hit through investing in toxic or depreciating assets.† The sovereign wealth funds in Singapore and Middle East oil-producing states invested in some of the big US, Swiss and UK banks whose stocks have now lost mushy of their value.† China has also lost value in investments turned sour, or in some toxic assets.†

Some individuals in Hong Kong and Singapore invested in funds that in turn invested in Lehmann Brothers that went into bankruptcy.† Latin Americans invested in funds of the US-based Stanford Bank that is now mired in fraud charges.

Secondly, there has been a big drop in funds flowing to developing countries.† Net capital flows to emerging markets are estimated to fall from US$929 billion in 2007 to US$466 billion in 2008 and further to US$165 billion this year, according to the Institute of International Finance ((IFI).

Of these capital flows, portfolio investment which surged into developing countries has been flowing out, especially from the sale of shares in the stock markets.† Malaysia is one of the countries affected by portfolio investment outflow. And in the bond markets the business in emerging markets fell from US$50 billion in the second quarter of 2008 to only US$5 billion in the last quarter.

There is also a severe reverse flow in bank credit.† The IFI expects that this year the banks will take out more in debt repayment in emerging markets that they provide in new loans.†

Thirdly, the flow of FDI worldwide is slowing down. It fell by 21% to US$1.4 trillion last year, according to UNCTAD data.†† So far the developed countries have been affected more by this.† The FDI flow to developing countries still grew by 4% in 2008, but this was much slower than 21% in 2007.

In the trade transmission route, developing countries are also affected in many ways. Firstly, their exports to the US and Europe have dropped sharply, as consumers cut their spending.

Last week, it was reported that Malaysiaís exports fell by 28% in January, the fourth straight month of decline.† Some other Asian countries fared worse.† In the latest month where figures are available, exports fell (compared to 12 months previously) †by in Japan by 46%, Taiwan 44%, the Philippines 40%, Singapore 38%, and South Korea 34%.

In China, exports in January fell by 17.5%.† The fall in exports have caused thousands of factories to close, with 20 million losing their jobs, according to official estimates.

But Chinaís imports fell by even more (i.e. 43%) and this has hit many Asian countries, which export manufactured parts used in making the products which China then exports to the West.

Besides the fall in demand for developing countriesí manufactured exports such as electronic products and components and textiles and clothing, many countries have also seen a sudden drop in the demand and prices of their export commodities.

The most publicized fall is in the price of oil, which dropped from its peak of US$140 a barrel to around US$40 at present.† This is a blow to oil producing countries, but benefits oil importing countries.

Prices of a wide range of other commodities have also dropped sharply.† In Malaysia, for example, the palm oil price fell from a peak of MR4300 a tonne in March 2008 to a low of MR1,390 in October.† It has since recovered to about MR1900.

On 24 February, The Economistís commodity-price dollar index for all items had fallen by 42% compared to a year ago.† The index for food was 30% down, for non-food agricultural products 45% down and for metals 60% down.

For poorer countries, such as in Africa, the fall in commodity prices has been the main mechanism by which the global crisis is transmitted to them.† In the past four to five years the rising prices of commodities had fuelled economic growth and raised hopes of a structural shift in the commodities situation, but these hopes have been dashed by the recession.

Secondly, trade in services is also affected.† For example, global tourist arrivals fell by 1% in the second half of 2008. In the Caribbean, which depends heavily on tourism, arrivals are expected to fall by one third this season.

Countries like India that have benefited outsourcing by US multinationals (for services ranging from accountancy to being call centers) are expected to be affected as the business of the Western firms shrink.

India has also protested against the move announced in President Obamaís recent budget speech to remove the tax exemption of foreign profits made by US companies that outsource their business.

Many developing countries also depend on the remittances sent home by their migrant workers. So far the migrantsí flow of money home has been resilient to the crisis, with the World Bank estimating that remittances to developing countries actually rose from US$281 billion in 2007 to US$305 billion in 2008.†

The Bank however predicts a likely fall of 6% in 2009, as migration flow slows down or as workers are sent home.

Thirdly, developing countries are facing a worsening of trade financing as banks have tightened their supply of credit even for routine import and export business.† It was reported at a World Trade Organisation meeting that there is a US$25 billion shortfall in trade financing that now needs to be filled.

The reduced flows or outflows in finance and the fall in exports of goods and services have led to a deterioration in the balance of payments and the stock of foreign reserves in many developing countries.† Some have also seen their currencies devalued, making it more difficult to service their external loans.

A few countries (such as Pakistan and Sri Lanka) have had to go to the IMF for loans to avoid a debt default situation.† More countries may join them in the near future.

The developing countries have also experienced slower GDP growth (China, India, Brazil), zero growth (Malaysia) or a decline in GDP (Korea, Taiwan, Singapore).† And unemployment is rising as factories close and new entrants to the labour force chase scarce jobs.

Thus the transmission through the finance and trade routes is working its way through to the real economy of output, trade and jobs.† And this is only the beginning, as the recession in the US and Europe is now expected by many economists to last at least two years.†