In this briefing, Bluebird's Co-Editor Carola Ducco looks back at the 2022 economic downturn in Western countries and draws lessons for this year. She argues the economic crises significantly impacted development in the Global South, with severe consequences that can only be addressed through structural reforms in international economic goverance institutions such as the IMF and World Bank. This article was republished from December 2022. This briefing was edited by Malou van Draanen Glismann (Managing Editor).
In October, the International Monetary Fund (IMF) warned policymakers that they needed a “steady hand” to deal with the global economic downturn. This warning came after they published their World Economic Outlook, lowering the projection of global growth for 2023 to 2.7 percent, warning of a “broad-based slowdown” and forecasting that one-third of the global economy would shrink over this year or the next. At the same time, UNCTAD published its Trade and Development report. In it, UNCTAD chief Rebeca Grynspan warned of a looming global, “policy-induced” debt crisis potentially more severe than the global financial crisis. She called out Western nations for excessive monetary tightening and insufficient financial support, which risk triggering already vulnerable economies.
The global economic downturn is disproportionately affecting emerging and developing economies, many of which have been on the brink of sovereign debt defaults since before the pandemic. According to the UNCTAD report, 60% of low-income countries and 30% of emerging economies are currently in or near debt distress, and growth is expected to slow across the developing world.
In East Asia, growth is expected at 3.3% this year, compared to 6.5% last year. Sri Lanka is experiencing the most severe conditions in Asia: after defaulting on its debt in May, its GDP is now expected to fall by 9.2% by the end of the year and by a further 4.2% in 2023.
In Latin America, growth is forecast to plunge from 6.6% in 2021 to 2.6% in 2022, and then to 1.1% in 2023: the countries most at risk are the South American economies, with a deceleration from 9.1% growth in 2021 to 3.1% in 2022. In Argentina, this year inflation reached a thirty-year high of 70%, and with the increasing weakness of the peso, every week billions of dollars in foreign reserves are lost.
In Africa, according to the UN Food and Agriculture Organization (FAO), more than 60 percent of countries are nearing debt distress and need external assistance for food. Among these nations, 18 are likely to experience further food insecurity by next year.
The US and Europe are also battling high inflation and sluggish growth, and have introduced anti-inflationary measures such as fiscal tightening. The US Federal Reserve has repeatedly raised interest rates – the latest hike was in November, when the Fed raised rates by 0.75% for the fourth time in a row this year, bringing the total of rate hikes in 2022 to six and consistently strengthening the dollar.
But in the Global South, a stronger dollar means sharply rising costs of servicing debt and importing food and energy. Foreign exchange reserves are falling, bond spreads are widening, and foreign capital is pulling out. 90 developing countries have seen their currencies weaken against the dollar by as much as 10% this year. According to UNCTAD, a large part of the inflationary pressure in developing economies is being driven by exchange rate depreciation.
Developing economies are not only feeling the ripple effects of these policies, but paying higher prices. While average inflation in the West is 6.6%, in emerging and developing countries it is 9.5%. And especially in low-income countries, the impact of inflation is more devastating, since a larger proportion of ordinary people’s incomes is spent on food and other essentials.
Additionally, the international aid available is not enough to face the issues. An important source of financing comes from the allocation of Special Drawing Rights (SDRs) from the IMF. SDRs are a reserve asset that the IMF issues to all countries to supplement their official reserves. During a period of increased financial need, they are designed to inject liquidity into a country without adding to its national debt. SDRs can be traded for a hard currency and then be used to meet external debt obligations, tackle foreign exchange shortages or plug fiscal gaps.
In August 2021, the IMF allocated a historic US$650 billion in SDRs, which have partly helped developing economies slow down the crisis. However, SDRs are granted according to member countries’ IMF quotas, which depend on the size of their economies. Therefore, advanced economies receive the largest share of SDRs even if they need it the least. Of the US$650 billion, Africa as a whole only received 5%, around US$33 billion. According to UNCTAD, developing countries have already spent around US$379 billion of foreign exchange reserves to defend their currencies against inflation this year. This amounts to more than half the SDRs allocated to them.
Historically, economic crises in the West have strongly impacted developing and emerging economies, and the policies used to tackle the crises have widely disregarded their impact on the Global South. During the global financial crisis, which was caused by a housing bubble in the US, the Global South suffered strong consequences. Many developing countries were less exposed to complex financial instruments and did not experience a banking crisis, but they were hard hit by the negative effects on growth and trade.
For instance, in Sub-Saharan Africa, the policy response to the crisis caused a reversal in private capital flows, credit squeeze affecting even trade finance and a sharp decline in commodity and manufactured export earnings. Overall, developing economies’ projected growth fell by 3.8% in 2009. This slowdown considerably decelerated economic growth. In many lower-income countries, these impacted efforts of poverty alleviation, reversing the effects of hard-earned policy successes.
Just as in the current crisis, the response of international financial institutions like the IMF did not satisfy many in the Global South. In the wake of the global financial crisis, the South Centre, an intergovernmental research institution, pointed to the IMF’s ineffective governance. The main criticism to the Fund was that they had failed to recognise the crisis in time. The South Centre pointed out that the Executive Director of the IMF also has a responsibility to their country’s authorities, creating a conflict of interest and leading them to drop their standards of surveillance for their own countries.
Governance issues like these are still widespread in global financial institutions, often leaving the Global South to suffer the consequences. Overall, there is a systemic power imbalance between Western countries and the rest of the world. For instance, at both the IMF and the World Bank, voting shares are based on a country’s economy. Therefore, the US controls around 16% of all voting in both institutions, while Africa as a whole only has a voting share of about 7%. This creates a power imbalance in many ways. First, it leads to the directors and presidents of these institutions being chosen mainly by Western countries, which potentially generates a biased view. It also makes it much more difficult for developing and emerging economies to promote policies that benefit them, even if they attempt collective action.
A reform in international institutions is the most effective way to contain the current crisis and set up a more effective system for the next, according to UNCTAD. Among other policies, they are calling for a larger and more permanent use of SDRs, an increase in Official Development Assistance (ODA), and a more pragmatic strategy that includes strategic price controls. More aid could also be made available: according to other research, multilateral development banks, including the World Bank, could mobilise up to US$1 trillion without compromising their AAA credit rating. As UNCTAD chief Rebeca Grynspan commented in November, a windfall of recessions and sovereign debt defaults can be avoided, but the choices rests in the political will of the most developed economies.