According to the economists at Institute of Development Studies UK, for the first time in many years a financial crisis with global repercussions has been originated at the heart of the global financial system and it will have major implications for the developing world. An economic recession in the rich countries, if deep and prolonged, will certainly affect the current economic performance of developing countries. Developing country growth already seems to be decelerating, partly as a result of the current slow down in the US and Europe. This trend will probably be reinforced if the slowdown becomes a full-blown recession. The crisis may impact the developing world through financial channels.

As the crisis deepens and uncertainty among international investors heightens, a major capital reversal may take place as investors look for safer places for their capital. This could be a particular problem for developing economies that are already vulnerable to capital reversals due to their large current account deficits – as is the case in Eastern Europe and some Latin American countries. Sub-Saharan Africa does not attract significant portfolio capital, but in many countries foreign direct investment (FDI) has been playing an important role, and this could decline as well. Moreover, most countries in the sub-region are aid dependent. If rich countries enter into deep recession and reduce their aid budgets, then Sub-Saharan Africa will be hit by reduced aid as well.

The magnitude of the impacts will depend on how developing countries respond to the changing conditions in the world economy. Unlike in previous crises, many emerging market economies have large amounts of international reserves and balanced fiscal positions, giving them the financial and fiscal space to stimulate domestic demand and compensate for a declining external demand for exports. Moreover, in many cases their domestic financial systems are in healthy conditions and thus able to support their economies’ growth through continued credit provision to consumers and the corporate sectors. However, the room for manoeuvre may be restricted by the threat of inflation, which in some countries has been rising due to the oil and food price shocks.

Before the current financial crisis, emerging market economies, such as Brazil, China, India and South Africa, were debating plans for further liberalisation of their capital accounts. Since in most cases inflows for different categories of capital had already been liberalised considerably, these plans were aimed at liberalising mainly capital outflows by residents. The policy goals underlying further liberalisation differed from country to country, but the ultimate consequence would be to permit domestic savers to pursue international portfolio diversification – therefore allowing major shifts away from domestic and towards foreign assets.

Among low-income countries, which in many cases still have restricted capital accounts on the inflows side, the policy issue has been how to go about liberalising portfolio inflows in order to meet their external financing needs and strengthen their still incipient capital markets to boost the financing opportunities of their domestic companies. Previous crises have shown that developing countries can be vulnerable to highly volatile international capital flows even when their ‘fundamentals’ look alright. Volatile capital flows can cause a lot of distress to their domestic economies – this may take the form of a rapid deterioration in their macroeconomic variables and their firms’ balance sheets.

The World Bank president says the global economic crisis could hurt poor people in developing countries most severely. A prolonged credit crunch or a sustained global slowdown raises the risk that poor nations will be seriously hampered in efforts to improve the lives of their citizens. High food and energy prices have already pushed another 100 million people into poverty this year alone. The current economic crisis puts additional strain on countries that are already suffering.

The leaders of India, Brazil and South Africa have expressed fears that developing countries will not escape if the West is hit by a deep recession triggered by the financial crisis. They have also criticized rich countries for failing to act quickly to prevent the global financial meltdown. The leaders further say that ill-conceived decisions of a few have brought the international financial system to the brink of collapse, with dire consequences for developing countries. Poorer nations will have to pay for the irresponsibility of financial speculators in rich countries.

However, consequences of the international economic rescue effort will not be felt for several months. But African countries, which so far have only been indirectly shaken by the financial institution collapse, stand to lose long-term pledges of aid, which many international groups have fought long and hard to obtain. The World Bank has pointed out that high food and fuel prices would raise the number of malnourished people worldwide by 44 million to boost starvation levels to 967 million by the end of the year.

In the industrialised countries where some of the leading banks have collapsed and the value of stocks has fallen by nearly a third, there is panic among investors concerning their savings and investment in stocks.

Every where, including Russia, Japan, and China, governments and the central banks are trying to solve the problem of illiquidity in the banks and the ensuing credit crunch by bailing out the financial sector, particularly the banks, with a massive and unprecedented infusion of capital into the banking sector.

The US, despite some domestic opposition, is leading the rescue operation by offering the commercial banks some $700 billion. The governments consider it necessary to restore confidence in the financial system so as to prevent a total collapse of the world economy. Until now these advanced economies had taken the benign view that in a free economy there is no need for the public sector to bailout any private sector organisation facing a financial crisis. With the bailouts, they have turned their own capitalist economic orthodoxy upside down. The policy of deregulation, actively promoted in the poor countries by the rich, is being put on hold.

Africa

The impact of global financial crisis on African economies will depend on the level of the integration of African economies into the world economy. Through the process of globalisation into which African states are being dragged, African economies are being increasingly sucked into the global economic and financial systems. But because of the inherent weakness of African economies the process of African integration into the global economy has been generally slow. Africa’s total share of world trade is less than three per cent, lower than that of even Belgium and most of this consists of the export of minerals, oil, and agricultural products.

Unlike China and India, Africa has not yet plugged into the global manufacturing circuit where most of the world trade takes place. The policy of import substitution denounced by most development economists as obsolete has consigned African economies to the periphery of world trade dominated by manufactured exports. From that perspective, the global financial crisis may have only a limited direct financial impact on Africa. But undoubtedly, African economies will suffer from the global credit crunch as foreign banks and investors will be obliged to restrain the extension of any new financial credits to Africa which is still desperately short of finance capital for its development.

Planned investment in Africa, still tardy, will have to be put on hold indefinitely. Happily, most African banks have only minimal links with foreign banks, most of which are used only as corresponding banks. Foreign equity in Nigerian banks is generally low. Nigerian banks are in the comfortable situation of not being over exposed to foreign banks now in trouble. Most of them prefer short term local loans for imports and not long term loans to the real sector of the domestic economy. Despite the bank consolidation most of the local banks are still relatively under capitalised. None of them plays a significant role in the world financial system.