Development finance is usually associated with sustained economic growth, whether as a catalyst supp

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Development finance in turbulent times. James
Copestake 20/3/09

• Development finance is usually associated with
  sustained economic growth, whether as a catalyst
  (supply-leading finance) or retardant (financial
  repression). What insights arise when it is
  viewed instead in the context of economic
  regress?
• Outline
• What is development finance?
• 2007 and 2009 an ocean apart
• Multiple shocks
• National responses
• International responses
• How resilient is microfinance?

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Defining development finance

• (1) Finance for developing countries
• or
• (2) Transfers with more than a profit motive,
  often on non-market terms
• Multiple levels global (public goods),
  international, national, regional, interpersonal
• Diverse agencies international development
  finance institutions, aid agencies, public banks,
  NGOs, governments, microfinance institutions

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Oceans apart

• 2007
• Five years of strong export-led growth
• Surge of investment esp. in BRIC (domestic
  foreign financed)
• Debt reduction and rising foreign reserves
• Food and fuel price hikes
• Rising inequality
• Brave talk of decoupling.

• 2009
• Global recession and trade contraction
• Sharp contraction of private investment
• Worsening balance of payments
• Delayed reduction in domestic inflation
• Rise in absolute poverty
• Financial contagion?

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Shocks (a) export revenue

• IMF global growth forecast for 2009 in Jan09 of
• -1 (compared to nearly 3 in Jul08).
• Global trade forecast to fall by 2
• First round effects of high income country
  recession on demand for commodities and mass
  manufactures.
• Second round effects of falling BRIC investment
  (e.g. on capital exports from Japan, US and
  Germany) .
• Richard Goodwins multi-country trade multiplier
  models
• Price effects especially primary commodities.
  (e.g. halving of copper price variable effects
  of rise fall in all prices).

Source theFinancials.com
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Shocks (b) remittances and tourist receipts

• World Bank estimate of 281 billion in 2007,
  rising to 305 billion in 2008, but it fell
  everywhere except South Asia.
• 2007 flows amounted to 4.6 of GDP in MENA, 3.1
  in South Asia, 2.6 in SSA.
• Falls in 2008 Kenya -38, Mexico -4.2 to August
• Estimated global fall for 2009 of -6.
• Sharp fall in tourism revenue in 2008 e.g. Kenya
  30, Cambodia 40.

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Shocks (c) private capital flows

• Net private capital inflows (credit equity)
  into emerging economies for 2007-9 estimated as
  929, 466 165 billion respectively (Institute
  for International Finance).
• Unprecedented falls in international bank lending
  during 2008 e.g. 1.1 trillion fall from Q1-Q2,
  especially in trade finance (Bank for
  International Settlements)
• Portfolio investment 91 international public
  offerings withdrawn or on hold in 2008.
• Stock exchanges falling everywhere (see next
  slide).
• Mining investments on hold (e.g. in Zambia and
  South Africa with halving in the price of copper).

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MSCI Emerging Markets Index
Twenty year return 13 p.a.
5 years rising
5 years declining
10 years rising
38 p.a.
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Shocks (d) banking vulnerability

• Widespread fear of spread of solvency and
  liquidity difficulties from parent banks to
  affiliates.
• e.g. foreign majority ownership of banking sector
  greater than 50 in Zambia, Uganda, Madagascar,
  Mozambique
• Effect of currency depreciation on cost of
  servicing foreign currency denominated loans
  (esp. Eastern Europe and Latin America where
  foreign loans have a larger share of domestic
  credit).

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Variable vulnerability (ODI)
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National responses (a)

• Some prior build up of international reserves
  following East Asian crisis.
• But limited capacity for expansionary
  macro-policies due to residual inflationary
  pressure, fear of capital flight and IMF
  conditionality (e.g. Ethiopia CPI to Jan09
  45.6).
• High returns to investment in infrastructure and
  food sectors, but heavily reliant on external
  finance.
• Key test of the new growth diagnostics analysis
  of binding constraints (Rodrik) how to untangle
  effects of capital rationing, confidence and
  aggregate demand?

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National responses (b)

• Issue of commitment and capacity to sustain
  social assistance programmes to protect the
  poorest.
• Public unrest arising from the combined effect of
  rising prices and falling income.
• Resurgent nationalism? Parallels with Karl
  Polanyis analysis of WW1 after the long
  century of prosperity.
• Role of deliberative politics in determining how
  hardship is shared.

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National responses (c)

• Need for bureaucratic instruments for burden
  sharing revival of developmental states and
  dirigisme, including new roles for directed
  credit through state owned banks?
• Interesting precedents
• nationalisation of banks in India in 1969
  (Burgess Pande)
• Role of state banks in Chinas economic growth
  since 1978 (Guariglia Poncet)

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International responses (a)

• Official aid Gleneagles G8 (2005) commitment to
  increase it to 130 billion in 2010 (2004
  prices). Likely shortfall of 50 billion
  (Oxfam). In contrast, there was no absolute fall
  aid flows during the 2000-02 downturn.
• DFI commitments of around 50 billion in 2006/7
  and growing. Many new if small measures (IFC,
  EBRD, IMF, CDC etc). Scope for making capital
  adequacy rules more pro-cyclical. But tension
  between scaling up of flows and loss of quality
  (cf recycling of petro-dollars in the 1970s).

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International responses (b)

• Gap between commitments uptake capacity
  constraints vs host country caution due to
  uncertainty of sustained flow (C Adams).
• Alternative global reflationary mechanisms to
  counter the implosion of the global money supply
  
• massive global investment by newly nationalised
  banks? (Terry Barker)
• Increase in allocation of IMF special drawing
  rights? (Graham Bird)
• Green (env technology), blue (to private sector)
  or red (to consumers) packages or a rainbow? (ODI)

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Resilience of microfinance?

• Demand side constraints
• Curtailed growth of disposable income, especially
  where linked to tradable sectors.
• Rising delinquency if dynamic incentive of
  progression to larger loans is broken.
• Supply side constraints
• Increased reserves, especially for MFIs exposed
  to foreign exchange risks.
• Demise private sector lending vehicles.
• Reduced donor funding (MF perceived as relatively
  able to survive cuts)

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Concluding thoughts (a)

• The current global crisis is an opportunity to
  confront theory with history and reassert the
  primacy of macroeconomics over microeconomics.
  discuss!
• State control of financial institutions can
  provide necessary levers for restoring overall
  system stability. Their relative allocative
  efficiency is of secondary importance in the
  short-term.

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Concluding thoughts (b)

• Is turbulence the norm?
• Capitalism is almost always to be found in
  non-steady state, the explanation for this being
  that it is a game played simultaneously by
  millions of players who cannot possibly have the
  information necessary to play well, let alone
  optimally. The result is a system that bifurcates
  back and forth between a stable and an unstable
  state.
• Goodwin (1987)

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References

• Andrianova, A P Demetriades A Shortland (2008)
  Government ownership of banks, institutions and
  financial development. JDE, 85(1-2)542-557.
• Barker, T (Jan 2005) Understanding and resolving
  the credit crunch. Cambridge Trust for New
  Thinking in Economics.
• Bird, G (Feb 2009) The IMF and low income
  countries. Semianr Presentation. DEID, University
  of Bath.
• Burgess, R R Pande (June 1995) Do rural banks
  matter? Evidence from the Indian social banking
  experiment. AER, 95(3)780-95.
• Desai, M and P Ormerod (1998) Richard Goodwin a
  short appreciation. EJ, 1081431.
• Guraiglia, A S Poncet (forthcoming) Could
  financial distortions be no impediment to growth
  after all? Evidence from China. Journal of
  Comparative Economics (available on line)
• International Centre for Inclusive Growth (March
  2009) The rich expand, the poor contract the
  paradox of macroeconomic policy in Ethiopia. One
  pager No.78.

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References

• Lin, J Y (Oct 08) The impact of the financial
  crisis on developing countries. World Bank
  Korea Development Institute.
• Littlefield L C Kneiding (Jan 2009) The global
  financial crisis and its impact on microfinance.
  CGAP Focus Note No.52.
• Massa, I D W te Velde (Dec 2008) The global
  financial crisis will successful African
  countries be affected? ODI Background Note.
• Oxfam International (June 2008) Credibility
  crunch food, poverty and climate change an
  agenda for rich country leaders. Oxfam Briefing
  Paper 113.
• Velde, D W te (Dec 2008) Effects of the global
  financial crisis on devloping countries and
  emerging markets policy responses to the crisis.
  ODI Conference note.
• Velde, D W te (Feb 2009) Blue, green or red? A
  rainbow stimulus to tackle global recession. ODI
  Opinion paper 125.