The world economy is in turmoil and developing countries are likely to bear the brunt of the turbulence. An unexpectedly strong recovery from the pandemic recession of 2020 has resulted in inflationary surges and supply chain bottlenecks across the economy, especially in the food, fertilizer, and energy sectors. The cascading crises of the COVID pandemic, coupled with the war in Ukraine, have resulted in supply chain issues and other supply-side shocks. Efforts to combat inflation with rising interest rates and fiscal tightening in advanced economies have induced a slowdown in economic growth and stoked fears of an impending global recession and international debt crisis. All regions are affected by the slowdown, but it is especially of concern for developing countries where the average growth rate is forecasted to drop below 3%, insufficient for sustainable development and further binding them financially.(1)
The United Nations Conference on Trade and Development expects the world economy to have grown 2.5% in 2022, and forecasts that growth will fall to 2.2% in 2023.(2) This would result in a cumulative global shortfall of more than $17 trillion, just shy of 20% of the world’s income.(3) With 60% of low-income countries and 30% of emerging market economies in or near debt distress, the risk of a global debt crisis is at its highest level in recent years.(4) David Malpass, the president of the World Bank warns that with global growth slowing sharply, more countries are likely to fall into a recession, creating long-lasting consequences that are devastating for people in emerging markets and developing economies.(5) As signs point to a global recession in 2023 and business and political leaders issue warnings for the financial gloom ahead, we can understand the potential impact of a global recession on developing economies by examining the data from the fallout of the Great Recession of the late 2000s. In doing so, the global economy may also be better able to understand how to mitigate or even avoid the devastation in 2023.
The inflationary surges caused by the recovery from the pandemic caused prices to rise across the globe, but its impact on the United States has an outsized role due to the dollar’s importance in the international economy. In March of 2022, United States consumer prices 8.5% higher compared to a year prior.(6) The risks of inflation are best illustrated by the global recession of 1982 when high inflation and weak growth triggered debt crises in more than 40 countries and was followed by a decade of lost growth for developing economies. Even as growth slows, persistent inflation–particularly in areas of the economy such as energy, food, fertilizer, and commodities–has spurred policymakers to prioritize the battle against inflation rather than implementing policies to encourage growth.
To combat rising prices in the United States, the Federal Reserve has rapidly raised interest rates. In 2022, US interest rates went from 0% to 4% at the fastest rate since the late 1980s.(7) Interest rate hikes in the United States can have catastrophic effects on developing economies. As US interest rates rise, the dollar appreciates in value. This is bad news for countries that have outstanding debts held in US dollars, as their debt suddenly becomes more expensive. Rising interest rates also result in a decrease in money supply, thereby contracting lending and credit markets. Furthermore, commodities that are commonly priced in US dollars such as oil, gold, and cotton, among others, also become more expensive as interest rates are raised and the dollar appreciates. All of these byproducts of interest rate hikes will be potentially catastrophic for developing economies and emerging markets if the United States and other advanced economies continue on their current fiscal and monetary policy trajectories. According to UNCTAD projections, these interest rate hikes in the United States are set to cut an estimated $360 billion of future income for developing countries.(8)
Of particular concern for US policymakers and the international economy as a whole is the emerging debt crisis. Over half of all low-income countries are experiencing debt distress. Countries that were already facing debt distress prior to the pandemic such as Sri Lanka – which has already experienced domestic tumult as a result of economic strife – are especially being devastated by the global slowdown. More debt is held in US dollars than any other currency, and US dollar-denominated debts have been increasing steadily over recent years. When the US hikes interest rates – as they are currently doing – and the dollar appreciates, the foreign exchange rates between the dollar and other currencies widen, meaning these debts become more difficult to pay off, increasing the risk of defaults by foreign governments. 90 developing countries have already seen their currency weaken against the dollar, with more than 30 experiencing depreciation of over 10%. Developing countries have already spent $379 billion thus far in efforts to combat weakening currencies.(9) Even middle-income countries such as Turkey, Brazil, and South Africa, all of whom perpetually run trade deficits and have to finance their debts in US dollars, will see their economies suffer greatly as a result of the appreciating dollar.
In addition to making debt more expensive for developing countries, a rise in US interest rates also reduces the supply of US dollars in circulation, causing credit and lending markets to contract. As interest rates increase, the cost of borrowing money becomes more expensive, and the cost of capital increases correspondingly. Expensive capital results in reduced investment in manufacturing and production and reduced consumption. This impact will be the most profound in Asian economies which have a heavy reliance on foreign capital. China, which has already been experiencing financial disruption in its economy, will likely experience even more turbulence. Furthermore, commodities that are commonly priced in dollars, such as oil, gold, and cotton, among others, will also become more expensive as the dollar appreciates. Developing economies that rely heavily on these natural resources and commodities will be adversely affected.
Food and energy prices have risen over the past two years, but have seen their price increases accelerate due to a stronger dollar and the war in Ukraine, significantly disrupting the oil, food, and fertilizer markets. Large multinational corporations (MNCs) — having substantial market power — have also contributed to these price increases by unduly raising prices to boost profits. This is particularly challenging for farmers as the cost of fertilizer, their main input for production, has shot up. While commodity-exporting countries such as oil-producing Nigeria and soybean-producing Brazil will see those industries rake in increased windfall profits, their consumers will still be hurt by the upward pressures in other aspects of the economy. Meanwhile, countries that rely heavily on importing these commodities, particularly oil imports – such as Sri Lanka, Tunisia, Turkey, and Mozambique – are especially vulnerable to any further shocks in the commodity market.
These are all typical consequences of a recession. Due to the United States hegemony in the global economy, shocks in the US economy have ripple effects across economies all over the world. These ripples may turn to tsunamis as countries already on the brink of disaster are suddenly pushed over the edge. This is apparent when examining the causes and outcomes of the Great Recession during the late 2000s. During the Great Recession, countries with vulnerable economies preceding the economic dip fared much worse. Countries rated to have high economic vulnerabilities as rated by the IMF’s vulnerability report entered into recession earlier and exited recession later.(10) This means that the 60% of low-income countries that are suffering from debt distress currently are all at risk of severe contractions. Additionally, during the Great Recession, real GDP growth in emerging and developing economies fell from 8.3% in 2007, to 6.1% in 2008, and to just 2.9% in 2009.(11) The cumulative nominal GDP loss for these countries between 2008 and 2010 was around $2.6 trillion.(12) It is believed that 120 million more people are living on less than $2 a day as a result of the Great Recession, highlighting the urgency for world leaders to curtail this downward spiral.(13)
Countries that relied on exports were significantly exposed to the fallout from the crisis. Exports in 2010 were about 20% lower than originally forecasted in 2007, reflecting over $1 trillion in losses as a result of the recession.(14) Countries that specifically relied on labor exports for remittances also suffered greatly as a result of the global slowdown. Remittances fell 6% after consecutive years of double-digit growth, a $100 billion loss for countries that rely on these cash flows.(15) The notable reduction of income for these countries most significantly impacted by the recession had tremendous consequences for their long-term growth and catastrophic immediate consequences for the people living within their borders. The IMF believes that potential growth has been permanently lowered due to the crisis, with no chance of recovery.(16) This loss in income also meant that ⅔ of countries had to cut their 2010 budget allocations in at least one of the areas of education, health, agriculture, and social protection, hindering development and cutting lifesaving necessities for some of the world’s poorest.(17)
Recessions have tragic consequences for developing countries, and central banks and policymakers across the world should be doing everything possible to avoid one. The only benefit of the Great Recession is that the lessons learned from a “once-in-a-lifetime economic recession” can help to mitigate or avoid another disaster barely a decade later.(18) Advanced economies’ central banks, and particularly the Federal Reserve, should opt for more precise policy tools rather than relying on wieldy measures such as ever-increasing rate hikes. Policymakers should prioritize policies to increase labor-force participation and international cooperation to alleviate supply chain bottlenecks. Regulations to reduce commodity speculation would prevent volatility and price-gouging for necessities such as food products and fertilizers. UNCTAD has also implored for greater multilateral assistance to reduce vulnerability before a possible recession. Fiscal stimulus from organizations such as the IMF helped to mitigate the effect of the crisis in the short term and prevented much worse outcomes for poverty.(19) Vulnerable countries should cooperate through multilateral institutions to increase their foreign currency reserves as this was shown to help dampen the effects of the financial crisis.(20) Moreover, it would be extremely beneficial for the health of the global market if multilateral organizations developed a comprehensive framework for debt restructuring in order to reduce fiscal pressure on developing countries. A globally coordinated response during the Great Recession was very effective in helping to mitigate the effects and provide large amounts of financing quickly to the countries that direly need it. Readiness for any scenario is of the utmost importance. As warnings about the global economy reach cacophonous levels, developing countries need to heed these warnings and take proactive measures to protect their economies. Their long-term growth and the fates of billions of people rely on the ability of policymakers across the country to coordinate their policies and cooperate to prevent economic disaster. Fortunately, there already seem to be signs of improvement in preparation for a potential recession. Many developing countries have increased their foreign currency reserves, increasing their ability to pay back debts in the event of a crisis. Robin Brooks, the chief economist of the Institute of International Finance notes that though there is still vulnerability, many emerging market economies are positioned much better financially than they were leading up to the Great Recession and that the international framework for dealing with these events has been strengthened as a result of the upheaval from a decade prior.(21) So while the outlook for the international economy looks grim, there is still a chance to avoid catastrophe, and at the least, to prevent the crisis from reaching the magnitude of the Great Recession.
Endnotes:
- UNCTAD. “UNCTAD warns of policy-induced global recession.” October 3, 2022. Accessed January 14, 2023, https://unctad.org/news/unctad-warns-policy-induced-global-recession
- Ibid
- Ibid
- UNCTAD. “Trade and Development Report 2022.” Accessed December 29, 2022, https://unctad.org/tdr2022
- World Bank. “Risk of Global Recession in 2023 Rises Amid Simultaneous Rate Hikes.” September 15, 2022. Accessed December 27, 2022, https://www.worldbank.org/en/news/press-release/2022/09/15/risk-of-global-recession-in-2023-rises-amid-simultaneous-rate-hikes
- Ibid
- Brookings Institution. “Key economic policy developments in 2022 and what to expect in 2023.” December 21, 2022. Accessed December 29, 2022, https://www.brookings.edu/blog/up-front/2022/12/21/key-economic-policy-developments-in-2022-and-what-to-expect-in-2023/
- UNCTAD. “Trade and Development Report 2022.” Accessed December 29, 2022, https://unctad.org/tdr2022
- UNCTAD. “UNCTAD warns of policy-induced global recession.” October 3, 2022. Accessed January 14, 2023, https://unctad.org/news/unctad-warns-policy-induced-global-recession
- IMF. “IMF-FSB Early Warning Exercise – Design and Methodological Toolkit.” September 1, 2010. Accessed December 29, 2022, https://www.imf.org/external/np/pp/eng/2010/090110.pdf
- Ricardo Llaudes, Ferhan Salman, and Mali Chivakul. “The Impact of the Great Recession on Emerging Markets.” IMF. October 2010. Accessed January 4, 2023, https://www.imf.org/external/pubs/ft/wp/2010/wp10237.pdf
- Ibid
- Ibid
- Ibid
- UNCTAD. “UNCTAD warns of policy-induced global recession.” October 3, 2022. Accessed January 14, 2023, https://unctad.org/news/unctad-warns-policy-induced-global-recession
- Ibid
- Ricardo Llaudes, Ferhan Salman, and Mali Chivakul. “The Impact of the Great Recession on Emerging Markets.” IMF. October 2010. Accessed January 4, 2023, https://www.imf.org/external/pubs/ft/wp/2010/wp10237.pdf
- Buly Cardak and Vance Martin.”Once in a Lifetime? The Effects of the Global Financial Crisis on Household Willingness to Take Financial Risk.” Econ Rec, 95: 442-46. November 16, 2019. Accessed January 7, 2023 https://doi.org/10.1111/1475-4932.12506
- Ricardo Llaudes, Ferhan Salman, and Mali Chivakul. “The Impact of the Great Recession on Emerging Markets.” IMF. October 2010. Accessed January 4, 2023, https://www.imf.org/external/pubs/ft/wp/2010/wp10237.pdf
- Ibid
UNCTAD. “Trade and Development Report 2022.” Accessed December 29, 2022, https://unctad.org/tdr2022
