Campus WU

What consequences does the corona crisis have for developing countries?

08/04/2020

Answer by Jesus Crespo Cuaresma, Head of the Institute for Macroeconomics.

Lev. P.: I would like to ask you about the consequences of the pandemic for developing countries.  Developing countries are perceived as the most vulnerable part of the world in terms of the current situation. What is the most likely scenario for these countries? Is there a possibility that some countries will declare financial default?

Answer by Jesus Crespo Cuarema, head of the Institute for Macroeconomics:

The current COVID-19 pandemic poses particularly important challenges to developing economies. In particular in Sub-Saharan Africa, the COVID-19 crisis adds to existing public health problems related to other infections (malaria, measles or HIV, for instance) and a fragile public health system. While the short-term effects of the looming economic crisis are expected to be large in the developing world, the uncertainty about the extent of the medium-run and long-run recovery is especially worrisome for low-income economies.

Measures against the pandemic reduce financial resources for long-term measures (f.e. education) against poverty

The severity of the crisis in developing economies will be exacerbated by the lack of widespread access to social protection, which will possibly lead to impacts on the determinants of long-run economic growth such as investments in education. In addition, the focus on combatting the potentially dramatic short-run effects of the crisis will imply a drain of resources currently utilized for long-run policies aimed at poverty eradication and inclusive economic growth. Shutting down economies with prevalent extreme poverty can thus have negative effects which go beyond those observed in developed economies.

Less demand from industrialised countries weakens economy in developing countries

In addition to the macroeconomic effect from disruptions in domestic production and demand emanating from policies to contain the contagion, many developing countries are highly exposed to demand shocks in highly developed economies through trade and tourism. As demand from richer economies falls abruptly due to the effect of the COVID-19 crisis, these demand spillovers will have an additional negative effect on the economies of poorer countries. In the current context of falling oil and commodity prices, the mobilization of resources to combat the negative economic effects of the pandemic is also particularly difficult in many African and Latin American countries, where natural resources are prominent sources of revenue.

An existing modelling exercise carried out by McKinsey projects the growth rate of GDP in Africa for 2020 to be between 0.4 and -3.9 percent, depending on the assumptions concerning the containment of the spread of the virus both globally and in the continent. Predictions from the African Union range between -0.8 percent and -1.1 percent, more than 4 percentage points below the expected growth rate in a scenario without the COVID-19 crisis.

Rapid assistance to developing countries crucial

The cooperation efforts of the international community will be central to overcoming the most disastrous effects of the crisis in the developing world. The United Nations Development Program, for instance, has launched the COVID-19 Rapid Response Facility, which should provide a first tranche of help to countries in need.  Leaders of the G20, after virtual meeting on March 26, agreed to mobilize development and humanitarian financing to counteract the effects of the pandemic in developing economies in general and Africa in particular. The long-term size of the shock that poorer economies will experience will strongly depend on the success of such cooperation initiatives.

The picture painted above leads to the obvious conclusion that the risk of default will increase significantly across developing countries because of the COVID-19 crisis. Several African economies have already started plans for the renegotiation of external debt payment plans, including reductions in interest rate payments and extensions of plan duration. Such efforts to avoid sovereign default will only be fruitful in the context of global cooperation across economies, a scenario whose likelihood is difficult to predict today but whose necessity has recently been highlighted by many world leaders.

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