Joseph E. Stiglitz and Hamid Rashid write: Developing countries are bracing for a major slowdown this year. According to the UN report World Economic Situation and Prospects 2016, their growth averaged only 3.8% in 2015 – the lowest rate since the global financial crisis in 2009 and matched in this century only by the recessionary year of 2001. And what is important to bear in mind is that the slowdown in China and the deep recessions in the Russian Federation and Brazil only explain part of the broad falloff in growth.
True, falling demand for natural resources in China (which accounts for nearly half of global demand for base metals) has had a lot to do with the sharp declines in these prices, which have hit many developing and emerging economies in Latin America and Africa hard. Indeed, the UN report lists 29 economies that are likely to be badly affected by China’s slowdown. And the collapse of oil prices by more than 60% since July 2014 has undermined the growth prospects of oil exporters.
The real worry, however, is not just falling commodity prices, but also massive capital outflows. During 2009-2014, developing countries collectively received a net capital inflow of $2.2 trillion, partly owing to quantitative easing in advanced economies, which pushed interest rates there to near zero.
The search for higher yields drove investors and speculators to developing countries, where the inflows increased leverage, propped up equity prices, and in some cases supported a commodity price boom.
But the capital flows are now reversing, turning negative for the first time since 2006, with net outflows from developing countries in 2015 exceeding $600 billion – more than one-quarter of the inflows they received during the previous six years.
This is not the first time that developing countries have faced the challenges of managing pro-cyclical hot capital, but the magnitudes this time are overwhelming.
Of course, the East Asian economies today are better able to withstand such massive outflows, given their accumulation of international reserves since the financial crisis in 1997.
The stockpile of reserves may partly explain why huge outflows have not triggered a full-blown financial crisis in developing countries. But not all countries are so fortunate to have a large arsenal.
Once again, advocates of free mobility for destabilizing short-term capital flows are being proven wrong. Many emerging markets recognized the dangers and tried to reduce capital inflows. South Korea, for example, has been using a series of macro-prudential measures since 2010, aimed at moderating pro-cyclical cross-border banking-sector liabilities. The measures taken were only partially successful, as the data above show. The question is, what should they do now?
Corporate sectors in developing countries, having increased their leverage with capital inflows during the post-2008 period, are particularly vulnerable.
Governments need to take quick action to avoid becoming liable for exposures. Expedited debtor-friendly bankruptcy procedures could ensure quick restructuring and provide a framework for renegotiating debts.
Developing-country governments should also encourage the conversion of such debts to GDP-linked or other types of indexed bonds.
While reserves may provide some cushion for minimizing the adverse effects of capital outflows, in most cases they will not be sufficient.
In some cases, it may be necessary to introduce selective, targeted, and time-bound capital controls to stem outflows, especially outflows through banking channels. This is perhaps the only recourse for many developing countries to avoid a catastrophic financial crisis. It is important that they act soon.
illustrated by Joseph Depczyk