Economists the world over have been monitoring the evolving financial scenario and the Global Financial Crisis (GFC) that is leading to tragic consequences for the comparatively poorer countries in the South as opposed to the developed countries in the global North.
Economic analyst J.K. Sundaram has recently drawn attention to this scenario very effectively. In this context he has observed that “if we fail to learn from past financial crises, we risk making avoidable errors, often with irreversible, even tragic consequences”. How true!
In this context one is reminded of the worldwide suffering that greatly affected millions of people during the 2008-2009 GFC and the accompanying Great Recession. However, the experiences of most developing nations were significantly different from those of the global North. Analysts in this regard have observed that the efforts undertaken to overcome the prevailing crisis by the developing nations reflected diverse responses to their emerging circumstances. In most cases, the limitations of their policymakers greatly affected their understanding of events and options. Consequently, according to Sundaram, the global South reacted very differently- “with more limited means, most developing countries responded quite dissimilarly to rich nations”.
Unfortunately, the evolving global situation over the last two years, resulting as a consequence of the Ukraine war and the continuing activities in Gaza has led to instability not only in the geo-political arena but has also resulted in an ensuing Great Recession. As a result, the financial positions of developing countries’ have been further weakened by lukewarm growth. This has generated a scenario where their foreign reserves and fiscal balances have declined and their sovereign debt has risen. A classic case of a developing nation facing such a crisis has been Bangladesh.
There is also another dimension within this spectrum. Analysts have drawn attention to the fact that most Emerging Market and Developing Economies (EMDEs) mainly try to save US Dollars within their foreign exchange reserve. This is so because this currency has no sanctions on it and is generally acceptable in all countries- both in terms of trade and repayment of loans. It may also be mentioned that the few countries with large trade surpluses have also for a long time been buying US Treasury Bonds. This, in turn, has a different connotation as it helps to finance US fiscal, trade, and current account deficits, resulting as a consequence of many denominators, including war.
However, there have also been some quirks within the financial dimension. Economists have pointed out that after the GFC, international investors were careful with regard to the handling of– pension funds, mutual funds, and hedge funds. This was so because they were not sure about the risks that existed within the matrix of of EMDEs. Consequently, such a lack of full trust has hit growth worldwide through various channels at different times. With the fall of EMDE earnings and prospects, investor interest also declined.
Nevertheless, according to Sundaram, “with more profits to be made from cheap finance, thanks to ‘quantitative easing’, funds flowed to the Global South. As the US Fed raised interest rates in early 2022, funds fled developing nations, especially the poorest”. Such a scenario also had other dimensions. Long sustained through easy credit facilities, it cast a long shadow on the paradigm of real estate and stock markets. With finance becoming more powerful and consequential, the real economy also suffered.
There were also other consequences. As growth slowed, export earnings of developing countries also fell because funds flowed out. This denoted that instead of helping counter-cyclically, capital flowed out when most needed. This evolving scenario has had different connotations for the Global South.
Economists have observed that one needs to recall that after globalization peaked around the turn of this century, most wealthy nations reversed earlier trade liberalization, invoking the GFC as the pretext. Consequently, growth slowed with the GFC. This downfall was taken further downwards through the terrible consequences of the COVID-19 pandemic.
Unfortunately, there has also been another dimension. Sundaram has observed that previously, supported by the Great Moderation’s easy money, stock markets in EMDEs plunged in the GFC. The turmoil arguably hurt EMDEs much more than rich nations.
It needs to be remembered that comparatively rich and middle-income households in EMDEs own equities, while many pension funds have increasingly also been invested in financial markets in recent decades. We have already seen in South Asia how financial turmoil directly impacts many incomes, assets and the real economy. In addition, afraid of the instability, Banks stop lending when their credit is most needed. This persuades firms to cut investment spending and instead use their savings and earnings to cover operating costs. This also persuades Banks to start laying off workers. As stock markets plummet, solvency is also adversely impacted as firms and Banks become overleveraged, hastening other problems. Falling stock prices trigger downward spirals, slowing the economy, increasing unemployment, and worsening real wages and working conditions.
This unwelcome scenario of decline in government revenues also forces them to borrow more from international financial institutions to make up the shortfall. Various economies cope differently with such impacts as government responses vary. Much depends on how governments respond with countercyclical and social protection policies. However, earlier deregulation and reduced means tend to erode their capacities and capabilities.
Currently, official policy response measures to the GFC endorsed by the US and IMF include those they had criticized East Asian governments for pursuing during their 1997-1998 financial crisis situation. Such efforts included requiring banks to lend at low interest rates, financing or ‘bailing out’ financial institutions and restricting short selling and other previously permissible practices.
It is interesting, but true, that financial authorities within the Global South tend to forget that the US Fed’s mandate is broader than most other central banks. It has a helpful side that entails that instead of providing financial stability by containing inflation, it is also expected to sustain growth and full employment.
One has to accept that with the world economy in a protracted slowdown since the GFC, tighter fiscal and monetary policies since 2022 have especially hurt developing countries. Effective counter-cyclical policies and long-term regulatory reforms have been discouraged. Instead, many had to conform with market and IMF pressures to cut fiscal deficits and inflation.
Nevertheless, appeals for more government intervention and regulation are common during crises- particularly from the private sector. However, procyclical policies tend to replace counter-cyclical measures once a situation is less threatening. This scenario took place in late 2009.
We need to remember that hasty fixes rarely offer adequate solutions. They do not prevent future crises. Instead, measures need to address current and likely future risks, not earlier ones.
At this juncture one needs to refer once again to economist Sundaram. The analyst has reiterated that financial reforms for developing countries should address three matters.
“First, needed long-term investments should be adequately funded with affordable and reliable financing. In addition, well-run development banks, relying mainly on official resources, can help fund such investments. Commercial banks should also be regulated to support desired investments. Second, financial regulation should address new conditions and challenges, but regulatory frameworks should be countercyclical. As with fiscal policy, capital reserves should grow in good times to strengthen resilience to downturns. Third, countries should have appropriate controls to deter undesirable capital inflows which do not enhance economic development or financial stability”.
In conclusion, monetary financing will also have to realize that valuable financial resources will be needed to stem the disruptive outflows that invariably follow financial turmoil. It is likely that such a measure will lessen the consequences.
Muhammad Zamir, a former Ambassador, is an analyst specialized in foreign affairs, right to information and good governance, can be reached at <muhammadzamir0@gmail.com>
