Developing Countries Have Greater Resilience Now
Nevertheless, developing countries entered this crisis with advantages that they lacked during the shocks of the 1980s or 1990s. These included stronger macroeconomic policies and better-managed sovereign debt. Also, the move to flexible exchange rate arrangements has enhanced their ability to absorb shocks through exchange-rate adjustments.
The number of people worldwide living in extreme poverty has fallen by more than 300 million since the 1998 Asian crisis. The onset of the current crisis has also diminished inflationary pressures and reduced commodity prices, which has been a benefit for some developing countries.
Policymakers in the developing world will need to tap into all these advantages if they are to limit the fall-out from this crisis. Their first priority has been to prevent financial contagion from crippling their domestic banking sectors. Stock markets have declined sharply, some currencies have depreciated, and sovereign interest-rate spreads have risen with the “flight to safety” in world markets.
In the case of countries that entered the crisis with large balance of payments and fiscal deficits, many vulnerabilities are looming. Their larger financing and adjustment needs have strained the balance sheets of domestic firms and banks, raising the risks of a cascade of bankruptcies and bank failures. If fiscal resources are strained, they may find it difficult to mount domestically financed rescues of their financial sectors.
In the case of a prolonged credit crisis, the global economy could enter a period of deflation, similar to that experienced by Japan in the 1990s. In this scenario, the emerging economies would have greater scope for credit-financed industrial upgrading than their more developed counterparts.
The chances that monetary easing would ease the effects of the crisis are of course greater in countries that can afford such measures. However this tool is not available to all emerging economies. Some will, in fact, be forced to tighten their monetary policy and raise interest rates in a bid to avoid currency depreciations or capital outflows.
On the fiscal side, developing country governments have a number of tools at their disposal. Governments that still have the fiscal headroom can inject some fiscal stimulus into their economies, for example by boosting much-needed infrastructure investment, in order to stimulate domestic demand and offset the fall in foreign demand.
A second area of fiscal stimulus entails investing in social protection and human development to ensure that a temporary shock does not prompt permanent declines in the welfare of poorer households. There are many programs that have proved effective in this regard; governments should prioritize those that most effectively buffer the impact of crises on the poorest households.
In sum, policymakers in the developing countries face some difficult dilemmas. Solving them successfully will depend on how they behaved during the boom. Their ability to respond depends on whether they have freedom of maneuver to act in a prudent counter-cyclical way by boosting domestic demand without sacrificing the fundamentals. Some developing countries are going to find this much easier than others.