Taking Stock of the Credit Crunch:

Implications for Development Financein Sub-Saharan Africa

OECD Development Centre

• This crisis has been provoked by

• Massive accumulation of global macroeconomic imbalances

• Poor regulation of financial markets

• The epicentre lies deep inside the developed economies and it has a global dimension

• In some areas, developing countries have been hit harder than OECD countries

Why is this crisis different?

Why the poorer developing countries have been initially overlooked?

Africa initially seemed to be insulated from the financial crisis• Subsistence agriculture • Structure of financial markets

• Limited integration with global financial markets

• Minimal exposure to complex financial instruments

• Improved macroeconomic fundamentals

Why initial assessments were misleading?

• In recent years, there have been some successful cases of niche export sectors (e.g. textiles, cut-flowers, vegetables, tourism)

• Even if SSA countries are not directly exposed to financial contagion, dangers arise from pure contagion: the overall collapse in confidence in the financial system world-wide will, even in low-income countries

• raise borrowing costs

• sharply curtail revenues

• threaten the solvency of domestic financial systems

• The banking sector in some low-income countries is largely under foreign ownership

5

Modified from World Bank, Global Development Finance (2008)

Share of banking assets held by foreign banks with majority ownership, 2006

The banking sector in some low-income countries is largely under foreign ownership

Country 0% - 10% Country 30% - 50% Country 50% - 70% Country 70% - 100%

India 5 Senegal 48 Rwanda 70 Madagascar 100

Nigeria 5 Congo, DR 47 Côte d'Ivoire 66 Mozambique 100

South Africa 0 Kenya 41 Tanzania 66 Peru 95

China 0 Bolivia 38 Ghana 65 Mexico 82

Bangladesh 0 Burkina Faso 65 Uganda 80

Ethiopia 0 Niger 59 El Salvador 78

Mali 57 Botswana 77

Zimbabwe 51

In countries like Tanzania, Côte d’Ivoire, Rwanda, Madagascar, Botswana, Mozambique and Uganda over two thirds of the banking sector assets are in the hands of foreign banks

Why the financial crisis will severely affect low-income countries?

•Low-income countries are highly dependent on external financial flows

•High degree of dependence on foreign savings. Of UNCTAD’s classification of 49 Least Developed countries, 15 (mostly small) countries had negative domestic savings rates in 2006

•Pervasive lack of social safety net

•Lack of capacity to adopt counter-cyclical policies to compensate for the fall in demand for exports from abroad

Sub-Saharan Africa is increasingly externally vulnerable

Current Account Balances – 1980-2011 (as % of GDP)

Source: IMF World Economic Outlook. October 2008. Estimated 2008. Forecasts are in light blue.

• In some countries, positive current account balances, buoyed up by strong commodity prices

• But in some cases surpluses have been small, and even prior to the crisis, already converted into deficits

• Many developing countries particularly affected by the combination of exceedingly high food import bills and oil prices in 2007-8: 33 out of 78 low-income countries now have reserve holdings equivalent to less than 3 months of imports-6

-5

-4

-3

-2

-1

0

1

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

0 5 10 15

YemenEcuador

EgyptVenezuela

TurkmenistanIndonesiaMorocco

JordanTunisia

CambodiaOman

PakistanMalaysiaBurundiBolivia

United Arab EmiratesAngola

EthiopiaIndia

NigeriaDominican Republic Food

Fuel

Source: IMF World Economic Outlook October 2008

Favourable effects of the drop in commodity prices?

The Cost of Fuel and Food Subsidies as a percentage of GDP, 2008

• Pressure on current accounts and government budgets relieved (particularly oil and food) for net commodity importers

• Price subsidies for fuel and food prices are reduced

• This positive effect may be mitigated by currency depreciation

Any chance to avoid for developing countriesa large collapse in export volumes?

S o u r c e : U N C T A D L e a s t D e v e lo p e d C o u n t r ie s R e p o r t , p . 1 5 8

others , 29%

EU 25, 20%

Japan, 5%

USA & Canada, 24%

China , 19%

India, 3%

Destination of exports in Least Developed Countries, 2006

•Some low-income countries have decreased in recent years their dependence on developed country markets and their trade has been reoriented towards the emerging markets

•African LDCs now export more to China than to the European Union

•If growth remains positive in the emerging markets there are chances for some developing countries to avoid a complete collapse in external trade

What about remittances and tourism receipts?

• Foreseeable reduction in remittances • For Sub-Saharan Africa, the total income from remittances

has been put as high as USD 19 billion for 2008, higher than estimates for either FDI inflows or country programmable aid

• During disasters or post-conflict situations, there is usually a counter-cyclical dimension to remittance flows.

• Fall in tourism receipts • Tourism bookings are already reportedly down 40 per cent

in Cambodia, while visitor arrivals (and revenues) to Kenya fell 30 per cent over the first 9 months of 2008 (Willem te Velde, 2008).

A threat to external debt sustainability

• Debt ratios may increase because• USD appreciation (liabilities are denominated in foreign

currency)• Drop in export revenues• Need to increase social spending and safety nets and to support

the fiscal stimulus to mitigate the consequences of the crisis

• Debt relief process may slow down• Unforeseen cuts in donors’ pledged and commitments

• Conditions for eligibility will be harder to be satisfied

• New channels of financing for low-income countries will be closed down (as sovereign bond issues)

SSA heavily depends on aid flows

Aid as an average Percentage of Net Capital Flows (2000-06)

Developing countries Sub-Saharan Africa

Private flows 84.9 38.4

Overseas development aid 19.5 65.4

Other official flows -4.4 -3.9

Total 100.0 100.0

Source: McCulloch (2008)

Despite the enormous increase in private flows to the emerging markets in recent years, the poorest developing countries are still heavily dependent on aid flows

Africa is most at risk on this score: aid averages around 9 per cent of GDP

Challenges and opportunities for bilateral aid budgets: avoid an aid crisis

13

• OECD 'aid pledge' – we should not add an 'aid crisis‘ to the financial crisis

• In real terms, ODA in 2007 15% ↑ than the 2004 Gleneagles base year, but compared to the 60% ↑ by 2010 to meet the Gleneagles commitments (DCD/DAC, 2008)

• Like FDI (to some extent), aid is highly geographically concentrated. In 2006, Afghanistan, DRC and Sudan accounted for 1/4 of total net ODA disbursements going to the LDC (UNCTAD LDC Report, 2008:27)

Will aid budgets be compromised by the financial crisis?

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• No unambiguous relationship between economic growth in donor countries and subsequent aid flows (e.g. Round and Odedokun, 2004)

• Under pressure to reduce expenditures, aid flows are one of the first areas to be affected by cuts? Aid flows tend to be quite resilient to mild recessions (e.g., Bertoli et al., 2008)

• Aid is a very small share of budgets, and vis-à-vis rescue packages of domestic financial sector, very small (USD 3 trillion already?)

15

Bilateral aid budgets: The future ahead

• Development aid at its highest level ever in 2008 (119.8 USD billions)

• The 2008 ODA data as well as forward spending plans suggest that with some further effort, most donors are within reach of their 2010 targets

• The countries that have already met the UN ODA target of 0.7% of GNI are expected to continue to do so

• Most other DAC members are expected to meet, or nearly meet, their 2010 targets. However, there are likely to be large shortfalls in a few countries. For example, ODA in 2008 from Austria, Italy and Greece, excluding debt relief, is well under half their ODA/GNI target for 2010

FDI constitutes the major form of capital inflow for many developing countries

16

Net flows (billions US$) to Sub-Saharan Africa, 1999-2007

Source: World Bank, Global Development Finance, 2008

-5

0

5

10

15

20

25

30

1999 2000 2001 2002 2003 2004 2005 2006 2007

Net FDI inflows Net portfolio equity inflows

Net debt flows official creditors Net debt flows private creditors

• FDI has been one of the principal beneficiaries of the liberalisation of capital flows

• FDI flows to Africa have been estimated at USD 62 billion in 2008 • M&As in Africa rose by an estimated 157 per cent to USD 26 billion

Can FDI flows help to cope with the effects of the crisis?

– ↓vulnerability to external financing difficulties when the external deficit is financed by FDI inflows (GDF, 2008: 68)

– BUT - FDI moves pro-cyclically and can intensify instability

• M&A activity is about 30-35 % of current flows

• Equity component more stable during crisis, but intra-company loans and reinvested earnings not

– Use of derivative products by MNEs (currency forwards and options) as investment hedge ↑ pressure on domestic currency (Stiglitz et. al, 2006:179).

17

FDI may represent an “expensive” form of financing

Source: Authors’ calculations based on World Bank, Global Development Finance, 2008

Net FDI inflows and profit repatriation mln USD

• If profit remittances are taken as a proxy for its “price”, FDI can be an “expensive” form of financing, especially for low- income countries.

-400-200

0200400600800

10001200

1990

1992

1994

1996

1998

2000

2002

2004

2006

Bolivia

Foreign direct investment, net inflows (US$)Profit remittances on FDI (US$)

-400-200

0200400600800

10001200

1990

1992

1994

1996

1998

2000

2002

2004

2006

Botswana

0

50

100

150

200

250

300

350

1990

1992

1994

1996

1998

2000

2002

2004

2006

Burundi

0

5000

10000

15000

20000

25000

1990

1992

1994

1996

1998

2000

2002

2004

2006

Chile

-10000

-5000

0

5000

10000

15000

1990

1992

1994

1996

1998

2000

2002

2004

2006

Indonesia

0

2000

4000

6000

8000

10000

1990

1992

1994

1996

1998

2000

2002

2004

2006

Malaysia

Sub-Saharan Africa: Real GDP Growth Correlations – 1980-2007

(1) Excluding Sub-Saharan Africa

Source: IMF, Regional Economic Outlook: Sub-Saharan Africa April 2008

Rest of the World (1) 0.60

European Union 0.32

United States 0.01

Developing Countries(1) 0.54

Asia 0.30

Latin America 0.32

Can South-South linkages compensate for the economic slowdown in the North?

• Correlation of growth rates in SSA with growth rates in Latin America and Asia is just as high as the correlation with its traditional trading partners in Europe

• Correlation of growth rates in SSA with growth rates in the US amounts to only 0.01

•The ability of low-income countries to withstand the crisis has become more contingent on the fortunes of the rest of the world

The crisis will hit countries in unexpected ways

• Income sources not always from obvious sources, for example

• Ethiopia is vulnerable to a slowdown in international air traffic (Ethiopian airlines is one of the country’s main earners of foreign exchange)

• Mozambique could be adversely affected by the worldwide decline of the automobile industry (its leading export is alumina)

• Rule of Thumb? Expect the unexpected

To sum up: Implications for development finance

• Low-income countries in particular, are vulnerable through trade, remittances, FDI, tourism

• Some low-income countries are still vulnerable through external debt

• Expected FDI inflows may also fail to materialise

• Aid may not suffer major falls in 2009 (↑ 10.2% 2008!), but the prospects for the 2010 budget cycle are not at all encouraging.

Every cloud…

• Developing country policy makers need to focus much more attention on domestic resource mobilisation (opportunity to convert a long-standing wish into reality)

• Prospects of low-income economies will become increasingly reliant on the fortunes of the rest of the developing world. If growth rates remain positive in the main southern “drivers” (countries like Brazil, China and India), the current crisis may accelerate the reconfiguration of the global economy in favour of the developing world

… has a silver lining

• The crisis provides a unique opportunity to deliver on pledges regarding aid efficiency

• Developing countries have the possibility of more policy space

• Opportunity for revisiting global governance issues in a way which takes better into account the Southern countries

Thank YouFor more information

OECD Development Centre

www.oecd.org/dev/gdo

Mold, A., S. Paulo and A. Prizzon (2009), Taking Stock of the Credit Crunch:

Implications for Development Finance and Global Governance, OECD Development Centre Working Paper, no. 277 , March.