International capital flows
The financial crisis and its impact on developing countries
Impacts & responses to financial crisis on developing countries
Authors:
S. Jones; J. Ocampo
Publisher:
International Policy Centre for Inclusive Growth, 2009
One of the key channels for transmission of the crisis from developed to developing countries has been via private capital flows though the impact of this has been more severe for emerging markets than for low-income countries, which are less integrated into international private capital markets. Foreign direct invest (FDI) flows will likely fall sharply. A key challenge is for aid flows to augment at the very least according to existing commitments, though if the recession in the developed countries is very serious, there is a risk that aid budgets may not increase enough or could even fall, with negative effects on poor countries and poor peoples. The main channel of transmission of the crisis to exporters of manufactures and services is through a decline in trade volumes.
Countries with stabilisation funds (generally, energy exporters and some metal exporters) will be able to use past savings to cushion the effect of commodity price downswings. Broadly, national responses should aim to mitigate the contractionary effects coming from abroad and to rethink their trade strategies. The nature of the policy packages to be adopted will vary. For those countries with a strong debt and foreign exchange reserve position but weak fiscal stance the room for manoeuvre lies more in monetary than with fiscal policy. Most emerging economies have the capacity to avoid the traditional pro-cyclical monetary policies of past crises and follow the expansionary policy trajectories of industrial economies.
The magnitude of the current crisis is clearly associated with inadequate regulation and supervision of banks and financial markets. The new regulatory governance needs to be based on a well-functioning network of national and regional authorities and include truly international supervision of financial institutions with a global reach. The institutional structure that responds to this challenge should have adequate representation from developing countries to ensure not just greater legitimacy, but also greater efficiency.
In all of the areas of reform, the International Monetary Fund (IMF) should collaborate more closely with regional institutions, such as the Chiang Mai Initiative or the Latin American Reserve Fund. Developing countries are also in an excellent position to contribute to this task, given their large foreign exchange reserves.
