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Impact of the Global Economic Crisis on Developing Countries

Ever growing poverty, unemployment, huge inequality between rich and poor countries are witnessed to the nightmare and failure of world economy first time in the 21st century. The present economic crises across the globe are said to be the result of neo-economic theories such as Thatcher-Regan free market model which dominated world economic philosophy more than 30 years. The series of the current global financial crisis, particularly in USA and the European countries service industry, Automobiles industry and Information Technology and its related services, are become a global threat where it swallows developing countries economies one by one. Many studies said that this is the result of failure of free market model where the government intervention in trade and commerce is negligible. In a free market economic model, there is a close collision among trade, commerce and Politics which leads to manipulation of market by a few market leaders with the cost of a huge number. In this juncture, this is the time to find out an appropriate solution to cue and accelerate the economic growth. In this paper an earnest attempt is made to study the impact of global economic crisis on developing countries which are often become puppets in the hands of developed countries. This paper speaks in three core areas where the first section deals introduction of the study, the second section deals, heart of this paper, impact of the global economic crisis on developing countries particularly South Asia, Africa and India and the last section speaks out some possible conclusions.

Section – I


The global financial crisis has become a full-fledged crisis of the real economy as much deeper than the ‘Great Depression’ of 1930s. The global recession has set in with all its ill effects on employment, loss of livelihood and houses for people around the world. The demand, especially private consumption, is daily being fall at national and international levels. Investment, output, employment and trade are falling sharply worldwide. Poverty is rising, the middle classes are threatened, and the wealthy and retirees find their assets shrinking dramatically. In most developed countries, new waves of bank rescue packages follow the previous, unsuccessful ones. Conservative central bankers of the USA take on risky assets, their balance sheets and prospective losses swell. Some warn of deflation, others worry that fiscal and monetary stimuli will bring back inflation. Even countries that have accumulated high levels of foreign exchange reserves are concerned by capital outflows, while those without queue at the IMF.

The latest ‘World Economic Outlook’ (Update in November 2008); suggest that the world economy will grow only at 2% in 2009, with the advanced economies taken together, experiencing negative growth (-0.3%) during the year. The US GDP is projected to contract by 0.7%, Euro Area GDP by 0.5% and UK GDP by 1.3% during 2009. According to the IMF, this will be the first annual contraction, i.e., absolute fall in output, experienced in the advanced economies in the post-war period. All the major capitalist Centers – USA, Europe and Japan – are simultaneously in recession. The unemployment rate in the US had already risen to 6.7% in November 2008, with 18.7,00,000 people jobs being lost there since November 2007. The unemployment rates in France and Germany had risen to 8.2% and 7.1% respectively by October 2008 (ILO). With the recession deepening in 2009, unemployment in the advanced capitalist economies would rise further. The initial response of the Governments in the advanced capitalist countries to the financial crisis was to announce bailout packages for the financial companies, which had made enormous losses. Recapitalization of private financial institutions with public funds took the shape of part nationalization of several banks and financial companies. This was accompanied by coordinated interest rate cuts by Central Banks across the world. These financial and monetary policy measures, however, have failed to prevent a deepening recession, which is now generally believed to be the worst ever since the Great Depression. The Governments of the advanced capitalist countries are now falling back upon fiscal interventions to salvage the situation. Even the bastion of neo-liberal orthodoxy, the IMF, has recently called for a “large fiscal stimulus totaling 2% of global GDP”, to address the crisis. While the $700 billion bailout package announced in the US in October 2008 was primarily meant to compensate the losses made by the private financial institutions and other corporates. After much debate between Britain and Germany, the EU has also adopted a nearly $ 280 billion fiscal package including tax cuts and public spending plans. The crisis is exposing the hazards of neo-liberal economic policies and the advanced capitalist countries are being compelled to resort to direct State intervention as the way out of the crisis. However, the extent of the crisis is such that these fiscal measures may turn out to be insufficient. There is also apprehension that the extent of financial losses by banks and other private companies are yet to be revealed. More financial shocks would only aggravate the crisis and worsen the prospects of economic recovery. All efforts would be made by the rich capitalist countries to shift the burden of crisis on to the third world and for the ruling classes to shift the burden on to the working class and the peasantry.

USA is a Root Cause for Present Crisis

The clear victory for Obama was a rejection of the policies of Bush regime. The growing economic crisis which has badly affected the American people was a prime reason for the victory. The American people are more concerned about how Obama will tackle the economic crisis and revive the economy and jobs. History shows that the ‘Depression,’ it always comes from American ‘Wall Street.’ A major promoter of globalisation was the Washington consensus based the network of the ‘Wall Street,’ the US money lending agencies in the Euro-currency markets. Nevertheless, the new US Govt. led by Obama is trying to revive the economy, has approved a special $800 billion fiscal package to be spent over the coming years in short-term, and it is estimated around $10 trillion to spend in the long-term in the areas like infrastructural development and housing projects to create new job opportunity and so on. It means each American will intervene with USD 2.25 thousand for helping to bail out firms threatened by the fall-out of sub-prime crisis. However, the White House, the Treasury and the Federal Reserve, who were saying that intervention was inevitable to avoid a financial meltdown, were making the case for a specific kind of intervention that favoured Wall Street. Having made huge profits on speculation big finance wanted the State to pick up the losses when the bubble burst.

Section – II

Impact of Global Crisis on Developing Countries

Many developing countries are moving into a danger zone. Growth in developing-countries had been expected to reach 6.4 per cent in 2009, but has been marked down to 4.5 per cent. In the coming period, developing countries will see growing fiscal pressures both on the expenditure side (growing demands for social protection, recapitalization, etc) and the revenue side (as exports and economic activity slow). The appropriate response to falling domestic demand may, in some cases, be a measured fiscal stimulus. However, the credit crunch and flight from risk is already reducing the ability of formerly market-access countries to meet their gross financing needs (rolling over amortized debt and financing their net borrowing requirements). Some developing countries will be hit much harder than the average – experiencing growth which is negative in per capita or even absolute terms. Coming on the heels of food and fuel price shock, the global financial crisis could significantly set back the fight against poverty. Sharply tighter credit conditions and weaker growth are likely to cut into government revenues and governments’ ability to invest to meet education, health and gender goals. The poor will be hit hardest. Current estimates suggest that a one per cent decline in developing country growth rates traps an additional 20 million people into poverty. Already 100 million people have been driven into poverty as a result of high food and fuel prices. Already, sharp cuts in capital flows to developing countries are expected. Even if the waves of panic that have inundated credit and equity markets across the world are soon brought under control, deleveraging in financial markets and an extended period of banking-sector consolidation is expected to cut sharply into capital flows into developing countries.

Private flows into developing countries are projected to decline from $1 trillion in 2007 to around $530 billion in 2009 (or from 7.7 to 3.0 per cent of developing country GDP). The food and fuel price shocks have already imposed large fiscal costs on developing countries, undermining their ability to respond to fall-out from the financial crisis. Policymakers responding to high food and fuel prices made extensive use of tax reductions to offset higher prices and increased spending on subsidies and income support. Data from a recent IMF survey covering 161 countries shows that nearly 57 per cent of countries reduced taxes on food while 27 per cent reduced taxes on fuels. Almost one in five countries increased food subsidies while 22 per cent increased fuel subsidies. Recent declines in food and fuel prices do not imply that pressures and problems have disappeared.

Although most of the hike in commodity prices that occurred in 2007 and the first half of 2008 has dissipated, commodity prices remain above their 2004/05 levels, and currency depreciation is raising the local cost for many food and fuel importing countries. For the very poor, reducing consumption from already very low levels, even for a short period, can have important long-term consequences. The poorest households may have had to reduce the quantity and/or quality of the food, schooling, and basic services they consumed, leading to irreparable damage to the health and education of millions of children. Poor households forced to switch from more expensive to cheaper and less nutritional foodstuffs or cut back on total caloric intake altogether, face weight loss and severe malnutrition.

During 2008-09, higher food prices may have increased the number of children suffering permanent cognitive and physical injury due to malnutrition by 44 million. Many of the countries most exposed to rising global food and fuel prices are those with high pre-existing levels of malnutrition. Financial institutions in developing countries are beginning to suffer from a lack of short term liquidity, as retail deposits exit and non-deposit funding dries up. As the effects of the global recession spreads, the impact will be felt on financial sector asset quality, leading to the need for recapitalization of financial institutions. Lack of liquidity will also reveal underlying weaknesses in regulatory frameworks and in the management of financial institutions, requiring regulatory reforms and capacity building. Tight credit markets in developing countries are rapidly affecting the real sector, especially sectors reliant on trade, finance and working capital.

Impact on the South Asia

While some countries in South Asia had relatively less exposure to the crisis through adverse effects on capital flows, they remain vulnerable to global economic slowdown through export earnings, remittances and external financing of infrastructure. Growth in South Asia decelerated in 2008, falling from 8.6% in 2007 to below 7% based on estimate as of last December 2008. It is projected to decline further to around 6% or below in 2009, before recovering to around 7% in 2010. Even at these reduced growth rates, South Asia stands out compared to the recession in the developed economies. Nevertheless, with 900 million people in developing Asia surviving on $1.25 a day – more than half of those in South Asia – any tempering of growth is a serious case of concern. We believe, there are four inter-related impacts of global economic downturn on Asia. First, economic slowdown would result in reduction of exports with the attendant effects, not only on export-oriented, value-added industries themselves, but industries across the value chain. This impact could manifest itself in the form of unemployment and a reduction in GDP. Second by, the impact is being felt through the financial system. By this, we mean that the outflow of foreign direct investment from Asia’s financial markets result in depressed domestic equity markets and contribute to conservative lending strategies. Third by, impact relates to liquidity in domestic financial markets. If credit availability remains constrained, it is likely to be even more constrained for the lower end of the market, i.e., credit for labor-intensive small and medium enterprises and micro enterprises with its serious impacts. Fourth by, impact, though not fully evident yet, could be on informal social safety nets by virtue of reduced remittances received from overseas migrant workers as the host country economy slows down and capital expenditures are reduced.

Impact on African Continent

The poorest countries of Africa will be significantly affected by the crisis. African countries will be harmed through slower export growth, reduced remittances and lower commodity prices. The crisis may also lead to a reduction in private investment flows, making weak economies even less able to cope up with internal vulnerabilities and development needs. Some African countries are facing serious macroeconomic imbalances quite independently of the financial crisis, mostly brought on the fuel and food crises-such as Ethiopia having 60 per cent inflation and so on. Burundi, Madagascar, Niger, Timor Leste, Ethiopia, Somalia and Yemen are among the ten most affected countries for both stunting and wasting indicators. All of these countries experienced double-digit food inflation during 2008-09.

Impact on the Indian Economy

India has already entered into recession though late a little bit compared to west. India’s exports had been expected to reach USD 200 billion by 2008, but unfortunately has been marked down to USD 180 billion in December, 2008 (when it was growing 30.9% during the last six months, but it is reported to 12% in December, 2008). According to Mr. Shaktiwel, President of Federation of Indian Exports Organization (FIEO); “India’s export share (which is 20% of the GDP) is going down, and it is expected to be 10 million job losses in March, 2009. Indian exporters have mainly been depending on North American and European markets, and both markets have entered into recession. Indian Govt. has announced an extra rescue package (around $4 billion) for the producers and exporters to revive the economy. The Indian financial system has remained relatively immune from the devastating crisis afflicting the advanced capitalist countries, mainly due to the extant regulations and public sector domination of the financial sector. The stock markets have witnessed a meltdown though, with the FIIs being net sellers worth $13.1 billion in the year 2008, which has also led to a decline in India’s foreign exchange reserves.

The real impact of global recession on the Indian economy, however, is mainly being felt in terms of a slowdown in exports and industrial growth. Dollar value of exports in November 2008 ($11.5 billion) was almost 10% lower than that in November 2007 ($12.7 billion). The Index of Industrial Production recorded a 0.4% fall in October 2008 compared to October 2007, with the manufacturing index registering a 1.2% fall. The prices of cash crops have also declined adversely affecting the farmers. Job losses have escalated. At least 1, 00,000 gem trade workers have been rendered jobless in Gujarat. It is estimated that around a million jobs have been lost. As per estimates by Assocham and others in the coming period, job losses will mount to ten million. The economic managers of the Government, who till not so long ago were boasting about attaining 10% GDP growth, have now downgraded their GDP growth forecast to 7% for 2008-09. Economic growth is likely to slow down sharply in 2009. However, the UPA Government has neither learnt the proper lessons from the financial crisis nor is it willing to shed its neo-liberal dogma and adopt effective steps to deal with the slowdown.

The basic demand was for a fiscal package directed at increasing public expenditure in ways, which increases the income and consumption of working people and ensures broad-based growth. Increased public investment in agriculture, expansion of the NREGA, higher allocations for health and education, infrastructure like rural roads, housing for the middle and lower income groups and universalisation of PDS were specifically demanded, apart from a reduction in fuel prices, regulation of organized retail, tariff protection for farmers and small industries and reversal of financial liberalization. A moratorium on job and wage cuts was also demanded.

Price rise and food supply

Though the rate of inflation is going down, there is no reduction in the prices of food items and other essential commodities. People continue to suffer from high prices in retail items. Petrol and diesel prices were marginally reduced by the Government in early December 2008, by Rs. 5 and Rs. 2 per liter respectively, but the reduction was inadequate considering that crude oil prices have come down to below $50 per barrel from the peak of $147 dollar per barrel in July 2008. Further, reduction of oil prices has to be done by the government. Food insecurity has had a devastating impact leading to increased malnutrition and hunger as a direct result of faulty food policies of successive governments. Deaths due to malnutrition and hunger have taken place in tribal areas in Maharashtra and Jharkhand. With the increased procurement of wheat this year, stocks with the government are at 22 million tonnes; double that of the buffer norm for the month of October. Taken together, the rice and wheat stocks of the government are 29.8 million tonnes against the minimum combined buffer norm of 16.2 million tonnes, a 84 per cent surplus over the required buffer. According to data supplied by the Ministry, between 2005-2006 and 2007-2008, the average annual allocation for “Above Poverty Line” ration card holders to the states was cut by 73.36 per cent. Yet, the government refuses to restore the allocation preferring instead to sell the stocks to traders at subsidized rates.

Inadequate Government Measures

The fiscal package announced by the UPA Government on 7th December 2008 increased Plan expenditure by only Rs. 20000 crore, which is less than 0.5% of India’s GDP. Such a weak fiscal stimulus would not succeed in reversing the slowdown and arresting the consequent job losses and growing unemployment in the economy. The Government primarily relied on tax cuts, like the 4% cut in the CENVAT rate, to stimulate the economy. The Government has failed to link the concessions to industry to conditionality preventing layoffs and retrenchment. The State Governments were totally neglected in the fiscal package. With tax revenues falling due to the economic slowdown, the State Governments are experiencing great difficulties in maintaining the desired level of Plan expenditure. A debt relief package for States along with interest rate subsidy on their borrowings, relaxation of fiscal responsibility norms and greater transfer of resources from Centre to States are required, in order to enable the State Governments to step up expenditure to create jobs and expand welfare measures.

A second stimulus package was announced by the Government on 2nd January 2009. Not a single rupee of additional spending was announced over and above the amount of Rs. 20,000 crore additional Plan outlay announced on 7th December 2008. In fact, the Government ruled out any further increase in public spending in the current financial year. By announcing that further fiscal measures will only be contained in the annual Plan for the next financial year, the UPA Government is shifting the burden of addressing the economic slowdown on to the next Government, after having imported the global recession into the domestic economy by pursuing neo-liberal policies. The Government is basically trying to salvage the situation by infusing liquidity into the financial system through interest rate cuts and other monetary policy measures. It is also doling out tax concessions to the corporates in order to protect their profits and trying to ensure that they do not abandon their investment plans. These measures would not succeed since recessionary fears have already gripped the private corporate sector as well as middle-class consumers, who are cutting down on investment and consumption spending. Neo-liberal dogma prevents the UPA Government from embarking upon a substantial fiscal intervention that can provide some succor to the slowing economy.

What is more disturbing is the fact that in the name of announcing a stimulus package on 2nd January 2009, the UPA Government has pushed further capital account liberalization measures like easing External Commercial Borrowing norms for corporates, especially for the real estate sector. The investment limit for FIIs in corporate bonds has also been raised. This shows that the Government has learnt no lesson from the global financial crisis and continues to repose its faith upon speculative international finance capital. The UPA Government’s stubborn refusal to learn from global experiences and its recklessness in pushing ahead with financial liberalization was also visible during the winter session of Parliament when two Bills – The Insurance Laws (Amendments) Bill and The Life Insurance Corporation (Amendment) Bill – were introduced in the Rajya Sabha and the Lok Sabha respectively on 22nd December 2008. The first legislation seeks to raise the FDI cap in the insurance sector from 26% to 49% and allow the same foreign players, who have played havoc with the global financial system, to expand their control in the Indian insurance sector and gain access to the savings of the people. Another amendment is to allow foreign companies in the reinsurance business. These legislations are meant to keep the process of insurance sector liberalization and privatization alive despite the global shift in favour of public ownership of financial institutions in the wake of financial crisis. It is clear that the response of the UPA Government to the global economic crisis would be limited to defending the interests of big businesses, international finance capital and the affluent sections. On the other hand, the working class is coming under increasing assaults in the form of lay-offs and retrenchment. With a deepening recession, prices of agricultural products particularly, cash crops like coffee, rubber, pepper etc. are falling drastically, adversely affecting the peasantry. The brunt of the crisis will be borne by the peasantry and leads to suicides by farmers are recurring. Small-scale producers and traders, especially those in the unorganized sector, would be badly hit.

Section – III

Is a Practical Solution for the Current ills Possible?

Though, on 2 April, 2009, the G-20 summit held in London address the current financial crisis. There is no guaranty of bang of world economy once again. Instead of finding of roots of dearth of the economy, they came with some sops for the global economy. If you go throughout history, one can know that people are not ready to learn. There is no doubt in saying that any financial and monetary measures of the USA and EU will bring more inflation, more devaluation of national currencies, more unemployment, more painful losses of the markets and lower prices of export commodities of the developing and poor countries, more unequal exchange. The society is organized on the principle of division of labour if its health is to be ensured, then all the three dimension of an economy namely; production, exchange and distribution should be taken care of. It is, therefore, necessary that production should be guided not by market forces e.g., demand and supply but the need of the society. There were three essential functions to be performed namely; to adept production according to need, to maintain the volume of production up to the limits set by available resources and to distribute equitably the common product among the producers. Production is guided by demand and not by need of the societies and hence it is governed and measured by income, which is very low as compared to need. Again, the level of production is not maintained according to the existing resources. It was carefully directed by the capitalist proprietors who according to their own wishes, controls its volume and size motivated chiefly by the ideal of maximization of profits. Consequently, the distribution of wealth was unjust and there was exploitation of masses by a few. The diminishing purchasing power of working classes, total consumption fails to keep pace with total production leading to unemployment, further diminishing of purchasing power and ultimately to an intensification of crisis. This leads to in the volume of production of those commodities which the labourers are unable to purchase. Consequently, prices go on falling, size of production is reduced, factories are closed and unemployment is created leading to further crisis.

Developing countries, particularly India has to spend more on areas like housing projects for low-income urban residents, farmers’ livelihood and rural infrastructure, the construction of railway, road and airports, education and public health care, ecological construction, technological innovations and disaster relief more systematically. It is an opportunity to change this current global economic and political order. Need to address global imbalances by creating a new global currency, should be widely accepted at international level along with credible insurance mechanisms for countries that forego reserve accumulation and stimulate domestic expansion, along three possible lines: more central bank swap lines; ‘reserve pooling’; and a major expansion of IMF resources, together with IMF emphasis on a large, flexible, fast-disbursing facility that would come with little or no conditionality to countries that are adversely affected by global shocks. Accelerate the development of financial systems in emerging markets, in particular local currency bond markets and foreign currency hedging instruments. Promote regional cooperation in the design of common institutional standards for financial market development and work to lift barriers to cross-border asset trade within regions would be helpful to avoid any further economic crisis in future.

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