House of Commons - Aid under Pressure - International Development Committee

Aid under Pressure - International Development Committee Contents

2 Impact of the downturn on developing countries

11. The current economic downturn has its roots in weaknesses in the US mortgage market, but it has had global repercussions. The Secretary of State told us that there had initially been:

Such optimism no longer exists. Although the exact extent of the impact on developing countries is still unclear, there is no doubt that adverse effects on the real economy in poor countries are now being felt.

12. According to the World Bank, almost 40% of the 107 developing countries are highly exposed to the financial crisis and the rest are moderately exposed, with less than 10% facing little risk.[13] Despite the low level of Africa's integration into the global economy, it is likely to be the region worst hit by the downturn, which it is estimated has already cost the continent $50 billion in lost growth alone.[14] The Bank predicts that the financing gap that developing countries will face could be anywhere between $270 and $700 billion depending on the severity of the crisis and the strength of policy responses.[15]

13. The effects of the financial crisis have been compounded by coming so soon after the food and fuel crises of 2008, as many countries used their financial reserves then to subsidise food and fuel to cushion the impact of price rises on the poor.[16] Food and fuel prices rises had already pushed 100 million people back into poverty before the onset of the global recession.[17]

14. The economic downturn is affecting the developing world in a number of ways.

Reductions in trade

a) The economic slow-down in the US and most European countries has led to reduced demand for goods produced in developing countries. For example, Cambodia has already experienced a sharp decline in the value of exports from the garment sector, from a monthly average of $250 billion in 2008 to $100 billion in January 2009.[18] The reduced value of key commodities has also hit income from trade and this has been especially acute in countries that are heavily dependent on a small range of exports. Nigeria has suffered from the sharp drop in oil prices;[19]Zambia has been similarly affected by the decreased value of copper.[20] In some cases decline in trade has been compounded by a reduction in the availability of trade finance.[21]

Decreased foreign investment

b) Foreign direct investment (FDI) in several developing countries has reduced because investors are less willing to become involved in markets that are perceived to be high risk, with portfolio investments being particularly affected.[22] Kenya experienced net portfolio outflows of about $48 million in June 2008 and $12 million in October 2008. FDI decreased by 26% in Benin and 16% in Ghana between 2007 and 2008. The Institute of International Finance estimates that global financial flows to developing and emerging market countries will fall from $929 billion in 2007 to $165 billion this year.[23] The withdrawal of foreign investors has resulted in interest rate rises for developing countries on global capital marketswhich has made it more expensive for governments and businesses in those countries to borrow money.[24]

Fluctuations in exchange rate

c) The sudden withdrawal of foreign capital from several developing countries has caused "dramatic" falls in their exchange rate.[25] This has further affected their income from trade: firms have seen their costs increase, while their incomes are reduced. For example, firms exporting to the UK are suffering as revenue is priced in British pounds, but airfreight and many input costs are priced in dollars.[26] Changes in exchange rates have also affected the purchasing power of donor country aid in developing countries. We will examine the impact of currency fluctuations when we look at the effect of the downturn on aid budgets in Chapter 4.

Decreased remittances

d) The slow-down in growth and the rise in unemployment in developed countries have resulted in a decline in remittances from migrant workers back to their families in developing countries. At their peak in 2008 remittances were worth $305 billion,[27] with India, Pakistan, Nigeria, Jamaica and Ghana being the primary beneficiaries of remittances originating from the UK.[28] The Secretary of State told us that the fall in remittances was estimated at between 5 and 15%."[29] In Kenya, levels fell from $316.6 million in 2007 to $281.7 million in 2008. This income is normally used by recipients to supplement household consumption, so this reduction is expected to have "an immediate impact on the living standards of the poor, having a direct impact on diet, school attendance and healthcare."[30]

Development assistance

e) There was an expectation at the outset of the recession that official development assistance (ODA) budgets in developed countries would be reduced as donor governments reassessed their fiscal priorities. In practice, there has been a mixed response from donors with some countries scaling back their ODA budgets, while others, including the UK, having pledged to continue to meet their commitments. We will explore aid levels in more detail in Chapter 4.

15. When we met Robert Zoellick, President of the World Bank, ahead of the G20 meetings, he said that this downturn should not be seen as a single event but rather as a series of waves of impact. The next wave was likely to be a slow-down in the real economy in developing countries which in turn could lead to problems in their financial sectors—the reverse of the effects which have been seen in developed countries. If this is the case, the overall impact on the economies in poor countries may well be prolonged and serious.

The human cost

16. Behind the statistics lies the true cost of the global recession in the developing world—the millions of people who will fall back into poverty and who may even die as a result. An additional 90 million people are expected to be living in extreme poverty by the end of 2010,[31] and the World Health Organisation has warned that child mortality could rise by 400,000 deaths a year.[32] The World Bank has set out the series of impacts which families in poor countries are likely to experience:

These trends could take years to reverse: it is estimated that progress towards the fulfilment of Millennium Development Goal 1, the eradication of hunger and extreme poverty, has been set back by three years.[34]

17. The Institute of Development Studies (IDS) has painted a similar picture of the real effects the downturn is having on the most vulnerable. Its research found that people were eating less frequently, and that diets had become less diverse. In Nairobi, signs of acute malnutrition in children were reported. People were also "resorting to self-medication and avoiding expensive procedures" to reduce medical costs.A more common coping mechanism was the withdrawal of children from school or college so that they could work and help support their family. This included unconfirmed reports from Kenya and Zambia of "growing numbers of children and young girls selling sex."[35]

18. IDS found that, in addition to the health and educational impacts of the crisis, there had been a number of societal impacts. The downturn had resulted in increased domestic violence as well as "incipient signs of inter-group tensions." In particular, "minority groups have been criticised for taking advantage of the crisis, but are typically disadvantaged compared to the majority in terms of access to official resources." Petty crime and drug and alcohol abuse were also reported to have risen.[36]

Assessing the impact

19. Since the onset of the financial crisis several studies have been commissioned to try to identify which countries will be at most risk from the recession. Dr Neil McCulloch, a research fellow from the IDS, told us that the downturn had created "a little cottage industry […] in trying to define vulnerability."[37] He emphasised the importance of examining each country's situation separately because "the nature of the impact on different countries is going to be heterogeneous."[38]

20. DFID has pursued this course of mapping the particular impact of the downturn on each country in which it operates using a newly devised vulnerability matrix which the Secretary of State first described to us last October.[39] In its written evidence, DFID told us that this matrix contained indicators grouped around:

This information was being supplemented by World Bank and IMF reports in addition to information from DFID country offices. Anthony Smith, DFID's Director of European and Donor Relations, told us in April that the matrix had now moved beyond the theoretical analysis of structural issues as the Department received "more hard data about what is actually happening in those countries."[41]

21. DFID has built on this first step towards gaining a better understanding of the nature of the crisis by commissioning research. The Overseas Development Institute (ODI) has carried out "a piece of quick response research" to examine the impact of the downturn on 10 developing countries.[42] DFID has also funded broader research on developing country interests in financial regulation, trade effects, trade credit in Africa, China's response to the crisis and attitudes to the crisis in the developing world.[43]

22. In March, DFID announced another analytical tool: the Global Poverty Alert System. This is intended to "link international organizations, aid agencies and research groups into a single network that would provide instant updates on the impact of the economic crisis on the poor" and provide "real-time" up-dates using text messaging and e-mails.[44] The system was subsequently endorsed at the G20 summit in London in April and will be led by the UN.[45] The Department told us that the motivation for this new initiative arose from a concern that "there was not sufficient effort and attention going into monitoring the impact of the crisis, particularly on the poorest and most vulnerable people."[46] Rachel Turner, DFID's Director of International Finance and Development Effectiveness, told us that the intention was to ensure the available data reached political leaders:

The system was expected to make its first main report in September in time to inform the meeting of the UN General Assembly.[48]

23. The rapidly changing nature of the economic crisis makes it essential that DFID is able to respond quickly and flexibly to the different impacts on partner countries. To do this, it needs reliable and frequently updated information. We are impressed by steps DFID has taken to date to analyse the impact on developing countries and its recent efforts to ensure research findings are communicated to policy-makers through the creation of the Global Poverty Alert System. However, the first findings from the new Alert System are not expected to be available until September. Given the real and serious effects that the downturn is having on the poorest people in the world, we would expect DFID to take this initiative forward with greater urgency. We recommend that the Department works with the UN to ensure that the benefits of this new system are available to inform high level political decision-making within the next few months. We also request the Department to provide further details, in its response to this Report, on how the Alert System is operating in practice, how it will influence policy and the extent to which DFID is able to respond quickly and flexibly to increased pressure.

12 Q 239 Back

13 http://www.worldbank.org/html/extdr/financialcrisis/bankinitiatives.html Back

14 "Africa likely to be worst hit by financial crisis" World Bank, April 23, 2009 ;"Keeping Africa's turnaround on track", The Washington Post, 9 April 2009 Back

15 World Bank, Swimming against the tide, March 2009, p 1 Back

16 http://www.worldbank.org/html/extdr/financialcrisis Back

17 Q 13 Back

18 Overseas Development Institute, The Global Financial Crisis and Developing Countries: Preliminary Synthesis of Ten Country Draft Reports, April 2009, pp 16-17 Back

19 From an average of $100 a barrel in 2008 to $40-45 a barrel since December 2008 Back

20 ODI, The Global Financial Crisis and Developing Countries, April 2009, p 16 Back

21 Short term loans that facilitate trade. Back

22 ODI, The Global Financial Crisis and Developing Countries, April 2009, p 13 Back

23 Institute of International Finance, Capital Flows to Emerging Market Economies, January 2009 Back