What states can do to survive recession

Wednesday February 24 2016

A Malaysian trader monitors stock movements at

A Malaysian trader monitors stock movements at a private trading firm in Kuala Lumpur on August 25, 2015. The big worry for developing countries is not just falling commodity prices but also massive capital outflows, argue economists Joseph E. Stiglitz and Hamid Rashid. MOHD RASFAN | AFP

Developing countries are bracing themselves for a major slowdown this year. According to the UN report World Economic Situation and Prospects 2016, their growth will average only 3.8 per cent this year — the lowest rate since the global financial crisis in 2009 and matched in this century only by the recessionary year of 2001.

True, falling demand for natural resources in China (which accounts for nearly half of global demand for base metals) has had a lot to do with the sharp declines in these prices, which have hit many developing and emerging economies in Latin America and Africa hard. And the collapse of oil prices by more than 60 per cent since July 2014 has undermined the growth prospects of oil exporters.

The real worry, however, is not just falling commodity prices, but also massive capital outflows. During 2009-2014, developing countries collectively received a net capital inflow of $2.2 trillion, partly owing to quantitative easing in advanced economies, which pushed interest rates there to near zero.

The search for higher yields drove investors and speculators to developing countries, where the inflows increased leverage, propped up equity prices, and in some cases supported a commodity price boom.

But the capital flows are now reversing, turning negative for the first time since 2006, with net outflows from developing countries in 2015 exceeding $600 billion — more than one-quarter of the inflows they received during the previous six years.


The largest outflows have been through banking channels, with international banks reducing their gross credit exposures to developing countries by more than $800 billion in 2015.

Capital outflows of this magnitude are likely to have myriad effects: drying up liquidity, increasing the costs of borrowing and debt service, weakening currencies, depleting reserves, and leading to decreases in equity and other asset prices.

This is not the first time that developing countries have faced the challenges of managing pro-cyclical hot capital, but the magnitudes this time are overwhelming. During the Asian financial crisis, net outflows from the East Asian economies were only $12 billion in 1997.

Of course, the East Asian economies today are better able to withstand such massive outflows, given their accumulation of international reserves since the financial crisis in 1997.

The stockpile of reserves may partly explain why huge outflows have not triggered a full-blown financial crisis in developing countries. But not all countries are so fortunate to have a large arsenal.

Once again, advocates of free mobility for destabilising short-term capital flows are being proven wrong. Many emerging markets recognised the dangers and tried to reduce capital inflows. The measures taken were only partially successful. The question is, what should they do now?


Corporate sectors in developing countries are particularly vulnerable. Capital outflows will adversely affect their equity prices, push up their debt-to-equity ratios, and increase the likelihood of defaults.

Many developing-country governments failed to learn the lesson of earlier crises, which should have prompted regulations and taxes restricting and discouraging foreign-currency exposures. Now governments need to take quick action to avoid becoming liable for these exposures.

Expedited debtor-friendly bankruptcy procedures could ensure quick restructuring and provide a framework for renegotiating debts.

Developing-country governments should also encourage the conversion of such debts to GDP-linked or other types of indexed bonds. Those with high levels of foreign debt but with reserves should also consider buying back their sovereign debt in the international capital market, taking advantage of falling bond prices.

Developing countries should resist the temptation of raising interest rates to stem capital outflows. Historically, interest-rate hikes have had little effect.

In some cases, it may be necessary to introduce selective, targeted, and time-bound capital controls to stem outflows, especially through banking channels. This is perhaps the only recourse for many developing countries to avoid a catastrophic financial crisis. It is important that they act soon.

Joseph E. Stiglitz, a Nobel laureate, is a professor at Columbia University and chief economist of the Roosevelt Institute. Hamid Rashid is chief of global economic monitoring at the United Nations Department of Economic and Social Affairs. Copyright: Project Syndicate, 2016.