KFW-DEVELOPMENT RESEARCH

Views on Development

No 3, 9 July 2013 Real risks for developing and emerging nations Effects of the euro crisis on developing The ever-increasing integration of developing countries: Risks and future challenges and emerging nations into global does nonetheless also mean that they are not By Dr Kathrin Berensmann, Prof Helmut Reisen, entirely able to dissociate themselves from Dr Ulrich Volz what is happening in the industrialized coun- tries. Although the significance of south-south Kathrin Berensmann is a Senior Research Fellow at the German Develop- ment Institute (DIE). Helmut Reisen is Honorary Professor at the University of trade integration has greatly increased in Basel and a Senior Research Associate at DIE. Ulrich Volz is a Senior recent years (the share of south-south trade Lecturer in Development Economics at the School of Oriental and African now constitutes more then 50 per cent of Studies at the University of London and a Senior Research Fellow at DIE. from the south), the economic situa- tion of many developing and emerging coun- In the series "Views on Development“, KfW periodically publishes personal views from re- tries are still influenced by cyclical develop- nowned development researchers on current devel opment policy topics. The authors bear full ments in the major industrialized countries. responsibility for the contents of their texts. KfW does not necessarily share the views expres- For instance, to date, about two-thirds of sed. exports from Asian emerging economies have

been linked to demand from Europe and the Four years have passed since Lehman Broth- exist. US. ers went bankrupt, and the world economy The new role of stabiliser for the emerging As a result, the euro crisis holds serious risks still has not fully recovered. Many parts of the markets for developing and emerging countries be- are still stuck in and, cause the enduring problems in the Eurozone even in the US, the economy is only recover- In the wake of the global financial crisis, de- are not only having the effect of significantly ing slowly. By contrast, contrary to initial fears, veloping and emerging countries have taken slowing down the global economy but are also most developing and emerging countries had on an important role as stabilizing factors. affecting growth in developing and emerging until recently come through the global finan- Most developing and emerging nations recov- countries. In the Eurozone, growth rates are, cial crisis relatively unscathed. ered quickly from the global financial crisis and will continue to be, low. In its latest prog- and, already by 2010, had recouped and even The turbulences in the Eurozone, which are at noses for 2013, the IMF anticipates a drop in exceeded their pre-crisis growth rates, gener- least in part related to the distortions in global growth in the Eurozone by 0.3 per cent and a ating a large part of global growth. In particu- financial markets in the wake of the US sub- 1.1 per cent growth recovery in 2014. In a lar, emerging markets in Asia and Latin Amer- prime crisis, had thus far had only limited scenario such as this, the effects on develop- ica increased from industrialized effects on developing and emerging econo- ing and emerging nations should be limited, countries in line with their high growth rates mies. Although their real growth has also even if the recession in Europe and weak and thus supported their growth. Imports by recently collapsed, this has not diminished growth in the US have already led to a weaker developing countries formed a large part of their lead in terms of growth compared to economy in developing and emerging coun- driven GDP in industrialized countries. industrialized countries; the convergence tries, with growth rates estimated at 5.1 per Around 63 per cent of German and French process is unabated. Thus, as a result of the cent in 2012 and forecast at 5.3 per cent in export growth to countries outside Europe in crisis, the world economic power structure has 2013. However, an unforeseen worsening of 2012 was attributable to exports to developing further shifted in favour of developing and the crisis (a scenario that unfortunately cannot and emerging markets and not to other indus- emerging nations, which are rightly demand- be ruled out) would again plunge the global trialized countries. The high domestic demand ing greater influence in international financial economy into a precarious position. A drastic in developing and emerging markets has institutions like the International Monetary fall in demand in the Eurozone would hit therefore constituted a significant growth Fund (IMF) and the World Bank. But, even emerging nations hard. Even now, global driver for the world economy in the past few though the emerging nations' assertiveness trade is struggling due to the growth problems years. The disconnection between growth has greatly increased and their growth trends in industrialized countries, especially the rates of industrialized and developing coun- are clearly outstripping those of the industrial- Eurozone, which is after all the largest trade tries has led to an ever-increasing role for ized countries: the continuing cyclical weak- block in the world: whereas global trade developing countries in global trade in both nesses in the world economy and the endur- growth in 2011 still stood at 6.0 per cent, in absolute and relative terms. According to ing crisis in the Eurozone imply a whole range 2012 it slumped to 2.5 per cent. That was the World Bank estimates, the share of develop- of risks for developing and emerging countries lowest growth since 2009. ing countries in global trade will be around 35 owing to the strong mutual inter-relations that per cent in 2015.

1

KFW-DEVELOPMENT RESEARCH

Unabated is slowing down tries and poorer medium-income countries domestic exports. The upward pressure on global trade continue to be exposed to the danger of cur- the value of emerging nations' own rency risks and maturity incongruences be- is also affecting their foreign assets, e.g. The growth problems and the attendant high tween borrowing and investment. foreign reserves for which invest- levels of unemployment in many industrialized ments were made in dollars and euros. If it countries are leading to more vociferous calls The US 's announcement in actually should end up in a currency war with to protect production at home from foreign June 2013 that it is likely to begin tapering its a battle for reciprocal of curren- competition and are thus posing the risk of program and moderate the cies and trade-protectionist measures, the new protectionist measures. The new protec- pace of bond purchases later this year dem- entire global economy would feel the effects, tionist measures introduced between October onstrates a further danger for emerging na- with unforeseeable consequences, not least 2011 and May 2012 are affecting 0.9 per cent tions, to which billions of dollars of portfolio for developing and emerging nations. of total global imports, according to informa- investments previously flowed. In the middle tion from the . of June 2013, equity and bond funds under "Financialization" of the commodities the "emerging markets" label saw the biggest markets Monetary and financial risks for develop- outflows since the start of 2008, to the tune of ing and emerging countries A further consequence of the rise in global US$ 10 billion. liquidity as a result of the extremely loose Particular risks exist due to the extremely In addition, many European banks are being practised by most industrial- expansive monetary policies of most industri- forced to reduce their balance sheets in the ized countries due to the sub-prime and euro alized nations. Considerable advances were wake of the financial crisis, which has led to crisis is its effects on prices on the interna- made in integrating developing (and espe- lower growth and higher equity requirements. tional commodities markets. In past years, cially emerging) economies into the interna- This "deleveraging" by the European banks there has been a "financialization" of the tional financial markets over the past decade. has contributed to intensifying volatility on the commodities markets, including the foodstuffs The large increase in liquidity on the global markets and poses serious risks to the finan- markets. This has led to prices developing in financial markets stemming from the low- cial stability of emerging economies, for which a manner that is unrelated to fundamental interest policies and unconventional measures European banks are a significant source of data and is clearly more volatile. The great adopted by the world's major central banks is credit. A renewed deepening of the European mass of liquidity on the international financial now having direct and indirect effects in de- banking crisis could thus lead to contagion markets has further aggravated this process, veloping and emerging economies. effects in emerging countries, whose banking which was triggered by deregulation of the Low interest rates in industrialized countries systems are intertwined with the European commodities markets. Although high com- are whetting the appetite for capital flows banks, and could cause liquidity shortages modities prices can have a positive effect for towards developing and emerging countries, there. The solvency ratio of large, systemically export countries through rising export reve- where both interest rates and economic relevant banks in emerging countries could nues, the effects among commodities - growth are at much higher levels. At first sight, worsen considerably in the event they are ers are negative. They are particularly nega- this is no bad thing, though these capital flows unable to replace the capital from foreign tive in terms of price volatility, which has very also pose a number of potential risks. Firstly, banks. much intensified over the past five years. large capital inflows can contribute to sharp Especially on the foodstuffs markets, large Deleveraging could also further restrict the rises in the and credit and can price fluctuations can have grave conse- of European banks and thus overheat the economy, raise inflationary quences for developing and emerging nations, weaken trade. Restrictions in the commitment pressure on consumer prices and asset val- especially for the poorest levels of society. of European banks further to dollar shortages ues or even provoke the creation of a bubble already led to significant falls in trade finance Future challenges in the capital markets. Secondly, large capital in the period 2009-2012 by around a third inflows also hold dangers for the stability of There are therefore numerous risks posed by compared to the period 2005-2008. Further- the financial system if they lead to the forma- the way in which the problems of industrial- more, it is difficult to replace the financial tion of currency and maturity mismatches in ized countries, and especially the Eurozone, resources of European banks in certain spe- borrowing and investments. For example, the can affect developing and emerging econo- cific areas, such as for project finance. The emergence of short-term borrowing abroad mies. In order to further settle and stabilize deleveraging of European banks could, for and long-term investment in domestic real the growth rates in developing and emerging instance, affect wholesale financing on the estate was a major cause of the Asian finan- countries, what is needed is durable high local Asian banking system and its derivative cial crisis at the end of the 90s. A rapid with- productivity created by structural reforms, markets. drawal of portfolio investments can trigger investments in human capital and improved considerable drops in exchange rates and Currency war governance and investment conditions. Fur- lead to a collapse of financial markets. ther bolstering domestic demand by means of Not without cause, heated discussion has Whereas the foreign indebtedness of emerg- a shift to consumption by the rapidly expand- broken out about a so-called "currency war", ing economies at "investment grade" is in- ing middle classes in emerging economies will in which the emerging economies are accus- creasingly incurred in their own currencies contribute to reducing dependence on exports ing the central banks in the US, the Eurozone because international investors want to profit and thus the vulnerability for external demand and now also Japan of trying to apply lax from the structural increments in the values of shocks. Strengthening social security systems monetary policy in order to keep the exchange these countries' currencies, low-income coun- is also a means to help emerging markets value of their currencies down and so promote

2

KFW-DEVELOPMENT RESEARCH

reinforce domestic consumption, which in turn cations technology. The annual financial Bibliography reduces export-dependence and augments requirement to cover the lack of infrastructure Belke, Ansgar / Ingo G. Bordon / Ulrich Volz the resistance capabilities of those econo- in developing and emerging nations is put at (2013): Effects of Global Liquidity on Com- mies. US$ 2,000 billion. Of that, only two to three modity and Food Prices, World Development per cent is currently covered by multilateral To be able to absorb new, exogenous shocks 44 (April), 31-43 development banks and development aid. A stemming from enduring crisis problems in the new BRICS development bank could bring Berensmann, Kathrin (2011): African Devel- industrialized countries and especially the lasting change to the architecture and dynam- opment Trends: Lessons Learnt from the Eurozone, it is necessary for developing and ics of international development finance. The Global Financial Crisis, Bonn: German Devel- emerging nations to have room for economic combination of BRICS finance from various opment Institute (Briefing Paper 10/2011) manoeuvre, particularly in the area of fiscal BRICS sources (alongside the new BRICS policy. Before the outbreak of the global fi- IMF (2012): Regional Economic Outlook Asia bank, their national development banks, nancial crisis, many developing and emerging and Pacific. Managing Spillovers and Advanc- sovereign wealth funds and state pension nations had built up enough of a fiscal buffer ing Economic Rebalancing, April 2012, Wash- funds) would help to leverage the new BRICS but, in the wake of the crisis, the budget situa- ington D.C. development credits, alleviate project risks tion in many countries has worsened signifi- through collective action and thereby break - (2013): World Economic Outlook, April 2013, cantly. According to IMF data, the budget down the current risk aversion that besets Washington D.C. balance in low-income nations in 2007 still major infrastructure projects. stood at -0.4 per cent measured against GDP; Reisen, Helmut (2013): Yet Another Devel- by 2012, the budget deficit among this group To stimulate trade, the international financial opment Bank: The BRICS Bank, Bonn: Ger- of nations was at -3.3 per cent of GDP. The institutions should continue to support trade man Development Institute, The Current budget situations of emerging markets also finance. In this context, the Global Trade Column, 13 May deteriorated, from 0.0 per cent to -2.1 per Finance Program of the International Finance Rohner, Peter (2013), Sudden Stop: Wenn cent, over the same period. For this reason, Corporation and programs set up by other auf einmal kein Geld mehr kommt, Zürich: these countries in particular should be rein- multilateral, regional development banks such Finanz und Wirtschaft, 19 June forcing their revenue sources. This includes as the Asian Development Bank are playing a developing their systems and their domes- significant role. These programs offer guaran- Volz, Ulrich (2012): The Need and Scope for tic bond markets. tees against banks' risks in financing trade. Strengthening Co-operation between Re- gional Financing Arrangements and the IMF, In order to even up European banks' financial To increase the stability of the international Bonn: German Development Institute (Dis- resources in emerging countries, local banks financial system, it is necessary to construct a cussion Paper 15/2012) should be trying to attract as much local de- "global financial safety net" for countries posits as possible. Likewise, subsidiaries and susceptible to crisis, in the structuring of World Bank (2013): Global Economic Pros- branches of international banks in developing which the emerging nations have to assume a pects. Assuring Growth over the Medium and emerging nations should rely on local major role. To achieve this, a comprehensive Term, Washington D.C. deposits rather than wholesale funding. A governance reform of the international finan- World Trade Organization (WTO) (2012): further buffer against the credit crunch caused cial institutions is essential so that emerging Report to the TPRB from the Director General by European banks lies in the regional banks. countries not only rise to the global economic on Trade-related Developments, (mid-October In Asia, for instance, Japanese and Australian governance obligations commensurate with 2011 to mid-May 2012), Trade Policy Review banks have extended their loan facilities, thus their growing economic importance but also Body, Geneva partly offsetting the utilization of financial have an appropriate voice in these matters. resources from European banks. The lack of readiness on the part of the EU member states, often also including the The further development of domestic bond smaller EU countries, to relinquish their World markets in local currencies will also reduce Bank and IMF mandates constitutes the dependence on international banks and raise greatest barrier to a shift of voting rights from the financial markets' resistance capabilities. the industrialized to developing and emerging Support in developing robust banking systems nations. Because of the complex structure of and bond markets is an area in which devel- interests within the Eurozone, a rapid resolu- opment cooperation should also lend a hand. tion of the crisis is not within sight, and this is This would also foster the financing of infra- having negative effects on developing and structure projects and a green transformation emerging nations that are alluded to above. It in the respective economies, since it would is hence all the more important that Europe- improve and lend constancy to the generation ans wake up to their responsibility and clear of domestic resources. the way for a long-overdue reform of the Lasting growth, industrialization and urbaniza- international financial institutions. ■ tion need investment in energy, water and

waste-water disposal and transportation routes, as well as information and communi-

3