Small States and the Financial Crisis: Challenges and Responses

Transcription

1 Sustaining Development in Small States in a Turbulent Global Economy Commonwealth Secretariat Symposium, 6-7 July 2009 Small States and the Financial Crisis: Challenges and Responses Chair, honored guests, colleagues, Less than a decade ago, the focus on small states issues was significantly sharpened with the acceptance by the Development Committee of the Report of the Joint Commonwealth Secretariat/World Bank Task Force on Small States. The report identified the characteristics that had important implications for the development of small states: remoteness and insularity; susceptibility to natural disasters; limited institutional capacity; limited ability to diversify economies to minimize risks; open economies that are especially vulnerable to shocks; and the challenge of access to external capital (with higher spreads and more difficult access being the norm). Those characteristics clearly endure, and indeed in recent years new challenges for small states have emerged, most notably the HIV/AIDS pandemic; faster than anticipated preference erosion; rising concerns about security and crime; and in some cases, significantly rising debt burdens. More recently still have come the food and fuel shocks of last year and now the financial crisis. In the regrettable absence of a new superhero to fly to the rescue, small states and their partners have been tackling these cascading challenges in a number of ways, and today I want to speak briefly, first about some of these small state initiatives and then briefly to speak to some of the Bank s efforts, in both cases setting the details in a context of pre-crisis endeavors. Henry Chase, Program Coordinator, World Bank, ,

2 2 A. Pre-Crisis Small State Initiatives SSNED. As many of you here know, about a year-and-a-half ago the Small States Network for Economic Development was activated as a South-South small state mechanism, with support from the World Bank and the Commonwealth Secretariat. Its purposes are (i) to promote the sustainable development of small state economies and their more effective integration into the rapidly evolving global economy, and (ii) to promote the increased integration of the concerns and interests of small states into the policies and programs of the international community. The Network s operational interventions are selectively focused on five core themes: building the capacity of public sector institutions to modernize the domestic economy and facilitate its more effective integration in the global economy developing private sector capacity needed to promote international competitiveness encouraging public-private partnerships to support the efficient provision of public services addressing environmental sustainability and natural disaster concerns strengthening outreach and knowledge building/sharing among small states. The Network s approach is principally built on South-South peer exchanges of expertise among small states, in recognition of the fact that the particular challenges common to small states have necessarily encouraged them to devise appropriately focused and scaled approaches to their challenges. In the year-and-a-half since its activation, the Network has been registered as a legal entity with its headquarters in a developed small state, Malta; expanded its membership to 26; formulated and begun to implement a work program; organized a proto-secretariat (one full-time administrator and one part-time assistant administrative officer);

3 3 activated its website ( and held two workshops and implemented its first three projects. It s the projects about which I d like to speak briefly. To date, the Seychelles Ministry of Education has benefited from South-South peer learning in the field of e-learning from Mauritius; St Lucia s Ministry of Public Service and Human Resources Development has benefited from peer learning in the field of e-government from Malta; and Malta s Transport Authority has benefited from South-South peer learning in the area of building regulatory capacity from Singapore in all these cases with results that met with the approbation from the recipients. In each case, these small twinning project proposals were reviewed, approved, and implemented in the space of months, in part because of their limited, focused scope and attendant funding, and in part because one of the Network s comparative advantage is that it is a lean Network remember the proto-secretariat with only one full-time administrator and one part-time assistant administrative officer not an organization with a formal organagram and the accompanying structured process of multiple clearances, bureaucratic inertia, and so forth. Finally, I should note that the Chair of the Board of Trustees of the Small States Network, Prof. Briguglio, is here today, and I would encourage participants to make his acquaintance. Isle of Man. Another important new initiative undertaken by small developed economy that of the Isle of Man has immediate relevance for the financial crisis and for the more enduring issue of supporting small states in addressing the challenges arising from their challenge of integrating into the rapidly evolving global economy. Comprehensive studies of small states have reached conclusions that vindicate the views of the states themselves: they are disproportionately challenged both by capacity

4 4 constraints (most notably or consequentially in the management of public sector finances and the financial sector) and in the ability to engage and negotiate with larger state actors and international institutions. Both challenges have become more acute in the context of faster-than-expected preference erosion, the expanded role of the WTO and other international standards-setting bodies in framing the international trade and regulatory environments, and the widely shared view that small states must adopt positive adjustment measures and shift attention to designing and implementing export-based development strategies, seeking comparative advantage in the service sectors. In the context of the global financial crisis, two imperatives will come into play more forcefully for small states. First, those small states with active financial sectors integrated into the global economy will face an imperative to demonstrate that this sector operates efficiently and is well-regulated. Second, in the context of crisis-induced reductions in ODA and heightened competition for such resources, all small states will increasingly be expected to demonstrate that they can properly, effectively, and efficiently absorb, use, and account for funds received. In this context, I want to call your attention to an initiative that emerged from a conversation more than a year ago between the Bank and the Treasury of the Isle of Man one that will lead, this September, to the inauguration of an annual, fully funded, two-week training course for financial sector staff and public financial management staff from developing small states. The Government of the Isle of Man the first Associate Member of the Small States Network has worked with Oxford University s Saïd Business School, the Small States Network, the World Bank, the Commonwealth Secretariat, and others, to provide a world-class executive education program for government officials working in the finance and line ministries, treasury departments, central banks, and regulatory bodies of small states. One element of the course will an extended role-playing session that will draw from Oxford University s Course on Negotiations, to help address the critical imbalance of power when small states interact with larger economies and with international standards setting body on which the voices of larger economies are so prominent. For further details on this program, you may consult brochures that are, I believe, available at this gathering.

5 5 I should most certainly add that the Government of the Isle of Man has committed 1 million Pounds Sterling to support this initiative over the next five years and has formally included the annual tranche in the budget recently submitted to, and accepted by, the Manx Parliament; and that further funding, of a more limited nature, has been committed to by the Commonwealth Secretariat. B. Pre-Crisis World Bank Initiatives Now, briefly, on to some recent World Bank initiatives with respect to small states. Background. As way of context let me mention that World Bank active engagement with small states in the last several years has included: IDA15 negotiations, where the Bank worked to ensure that the final agreement had three changes from IDA14 that disproportionately benefited small states: (i) a near 50 percent increase in the annual base allocation; (ii) a 50 percent increase in the cap on per capita allocations (which has a disproportionate affect because small states have small overall allocations); and (iii) a reduced cumulative ceiling of an individual country s cost of participation in regional projects, now capped at 20 percent of its annual allocation. Lending. IBRD commitments to small states increased by more than half between FY06-08; and disbursements almost doubled. IDA commitments and disbursements were stable between FY05-07, dipping slightly in FY08, the final year of IDA14. Economic and Sector Work and Technical Assistance. ESW is increasingly prepared in collaboration with small states and our development partners the share of such joint work has risen from 38 percent (FY06) to 62 percent (FY08). Just above 80 percent of all TA to small states in this period has responded to specific small state requests.

6 6 WDI Small States Supplement. More recently, the Bank s Development Economics Data Group has agreed to markedly expand the data coverage of key economic, financial, and social indicators of small states. This will lead sometime in the fall, well before the Annual Meetings to the inauguration of what will be an annual Small States Supplement to the World Development Indicators. Coverage will likely consist of 14 tables that capture data on the size of the economy; people and poverty; participation in education; health; the labor market; agriculture and forestry; energy; economic activity; the private and public sectors; transport, communications services, and technology; aid dependency; trade; global links; and the MDGs. Crisis-Related Challenges. A recent World Bank review of the impact of the financial crisis on 107 developing countries found that almost 40 percent were highly exposed 1 to the poverty effects of the crisis, and that fully 75 percent were unable to raise funds domestically or internationally to finance programs to curb the effects of the downturn. Almost 20 percent of the highly exposed countries were small states which is hardly surprising since these countries are relatively susceptible to exogenous shocks, with 1 Countries are considered highly exposed when real per capita economic growth is expected to be lower in than in and where 20 percent or more of households were below the $1.25 per day poverty line in See The Global Economic Crisis: Assessing Vulnerability with a Poverty Lens, 3~piPK:437376~theSitePK:4607,00.html.

7 7 economies that are simultaneously open and unable easily to diversify and thus minimize risks, and are subject to diseconomies of scale and the problem of indivisibility (i.e., the inability to downsize functions to population size). Although the World Bank s 40+ developing small states broadly share these common characteristics, they are also significantly diverse: nine of them are fragile states with notably poor policy and institutional performance, while others are among top economic performers; per capita GNI ranges from below $400 to above $10,000; and population sizes range from fewer than 50,000 to above 1.5 million. Despite a shared vulnerability to the crisis often expressed through declining foreign direct investment, remittances, and tourism that collectively have adversely affected economic growth the impact of this exogenous shock on small states has manifest itself in various ways, as this symposium will explore. Looking at the crisis on the broadest level, GDP growth in developing countries is expected to slow sharply, from 5.9 percent in 2008 and 7.7% in 2007 to 1.2 percent in However, when India and China are removed from the total, developing countries as a group will experience a contraction in GDP of 1.6 percent, a real setback for poverty reduction. The crisis-related growth slowdown in developing countries implies that there are estimated million more extremely poor people in 2009 those living on less than $1.25 a day than expected before the crisis. We know that external financing requirements for developing countries as a group are anticipated to increase to $1.3 trillion in With a decline in capital flows to developing countries underway, this would generate an estimated financing gap of between $370 and $700 billion, depending on the assumptions we make on debt rollover rates. The reversal of capital flows, collapse in stock markets (African stock markets have fallen by an average of 40 percent in the small state of Mauritius, for example, the SEMDEX index has declined 44 percent since July 2008), and the general deterioration in financing conditions have brought investment growth in the developing countries to a halt, and in many developing countries investment is sharply declining. Net capital flows

8 8 into developing countries fell to $700 in 2008 from $1.2 trillion in 2007, leaving a large gap to fill. The growing financing gaps are staggering especially for the fragile and conflict-affected states among which are counted nine small states. The small state of Guinea Bissau, for example, is looking at a 40 percent of GDP deficit. Moreover, for all countries where remittance inflows are large relative to GDP, a condition applicable to many small states, remittance declines could be devastating. This is true, for example, for Tonga (35 percent) and Lesotho (29 percent). Crisis-Related Responses. The recent failures of financial supervision, including in middle-income small states, have dented confidence in regulators and in financial systems, including across the Caribbean; and it will be essential to repair this not least given OECD moves to increase pressures on countries that fail to comply with laws on tax havens. (Fifteen Caribbean countries are included in a list compiled by the G20 group this year of jurisdictions that have failed to implement standards on transparency and information exchange.) However, these governments have started to move on a number of fronts: Barbados is considering the establishment of a Financial Services Commission. Trinidad and Tobago has rushed through legislation that would allow the central bank to regulate insurance companies. Guyana has introduced legislation to transfer regulation of insurance companies and building societies to the central bank. The member countries of the Eastern Caribbean Currency Union are pressing ahead with the legislation on the regulation of the non-bank financial sector, including money services and building societies The World Bank, too, has moved in response to the crisis. To help developing countries weather the impacts of the crisis, the World Bank this year proposed a Vulnerability Fund a call to action for each developed country to pledge the equivalent of 0.7 percent of its economic stimulus package as additional aid, whether through their own bilateral aid agencies, UN agencies, the World Bank Group and other multilateral development banks, or non-governmental organizations. The World Bank Group received a strong

9 9 response to this call, with donor support to Bank Group crisis initiatives totaling $6.8 billion over and above previous commitments to the institution. The Bank has also established the Rapid Social Response Program, which focuses on helping countries address urgent social needs stemming from the crisis, emphasizing immediate interventions in the areas of (i) access to basic social services (prioritizing maternal/infant health and nutrition and school feeding programs); (ii) building or scaling up targeted social safety net programs; and (iii) active and passive labor market policies to assist in the income support of the unemployed. I would emphasize here that the Rapid Social Response Program is very much is an inception stage, and that it impact for small states remains to be established. Indeed, the last point applies as well to the Vulnerability Fund; so I think it will be more useful to consider actual commitments and disbursements as expressed in the Bank s country interventions. In FY09, the World Bank Group committed $58.8 billion to help countries struggling amid the global economic crisis, a 54 percent increase over the previous fiscal year and a record high for the global development institution. This included some $19.5 billion in infrastructure financing, a critical sector to provide the foundation for rapid recovery from the crisis and job creation. Support for safety net programs, such as conditional cash transfers, totaled $4.5 billion. Of these total commitments, IBRD commitments rose sharply in FY09, to a record $32.9 billion from $13.5 billion the previous year. IDA commitments totaled a record $14 billion in FY09, up 25 percent from FY08. To rapidly support countries affected by the crisis, almost $1 billion of this latter lending was provided under an IDA Fast-Track facility, and the Bank anticipates another $1 billion may be disbursed under this facility. Significantly, fast-disbursing Development Policy Loans, providing critical budget support at a time of rising financing gaps, comprised nearly 47 percent of the overall total commitments for FY09. Even more significantly for small states, is the comparison between the combined FY07-08 DPL commitments and those of FY09: total FY07-08 DPL commitments to small states amounted to some $111 million, while in FY09 alone, $254 million was committed. Expressed another way, the small state share of DPL

10 10 commitments within total DPL commitment essentially tripled for FY09 as compared to the combined total for FY07 and FY08. As the largest provider of multilateral financing for the private sector in the developing world, the Bank Group s International Finance Corporation has played an important role as the crisis deepened. IFC launched an array of crisis-response initiatives, including: A $3 billion IFC Capitalization Fund to strengthen systemically important banks, with a leveraged impact of as much as $75 billion; A $5 billion Global Trade Liquidity Program to help reverse the decline in trade flows to support as much as $50 billion in trade; and A $2.4 billion Infrastructure Crisis Facility to ensure that projects critical for development are actually built. On the operational front, expressed through its country programs, the World Bank has responded on several fronts. Africa. The World Bank Group is helping countries through lending, technical assistance, and advisory services. Small states hit by the tourism shock are seeking budget support, and the Bank is providing fast-disbursing lending to hard-hit countries (Cape Verde, Gambia, Gabon, Mauritius, and Seychelles) to address the global crisis. Small oil economies still feel cushioned and are not demanding fast-disbursement projects. The Bank is engaging in demand-driven technical assistance and (for middleincome countries) fee-based services and is preparing short, focused policy notes (rather than longer-gestating economic work) on extractive industries, macroeconomic and fiscal frameworks, the growth potential of non-traditional sectors, and capital expenditure for growth (Lesotho, Seychelles). Partnerships with MIGA and IFC are emerging. In the Seychelles, IDA has worked closely with a MIGA team preparing a large tourism guarantee.

11 11 Caribbean. The World Bank Group is helping countries through lending, technical assistance, and advisory services. Development policy loans aimed at providing budget support to countries hit hard by the crisis are under preparation for Grenada and St. Lucia. Technical assistance for strengthening safety nets, improving financial sector supervision and regulation, and improving the quality of spending is ongoing or planned in Barbados and the countries of the Organization of Eastern Caribbean States. IFC is scaling up its investment and advisory staff in the region, and expects to increase its portfolio and provide crisis-related support, with a particular focus on IDA countries. Support is being coordinated with, and leverages the assistance, of other development partners (Caribbean Development Bank, Inter-American Development Bank, the European Union, and bilateral organizations) and is closely coordinated with the IMF. Pacific Island Countries. The World Bank Group is helping countries through lending, technical assistance, and advisory services. The Bank has stepped up economic monitoring and policy dialogue, especially in the Solomon Islands and Timor-Leste. Options to scale up fast-disbursing sector support through rapid employment programs are being developed in the Solomon Islands and Timor-Leste (these could also potentially provide a foundation for more structured engagement to help the countries deal with significant urban and peri-urban poverty issues). A development policy grant is under preparation for Kiribati (food policy) and similar support could potentially be provided to other countries if requested. Efforts to help reduce Pacific islands structural vulnerability to external economic shocks, launched during the food and fuel price hikes of 2008, have taken three forms: > energy buffering: developing sub-regional bulk oil purchasing and storage arrangements and developing national energy efficiency/renewable energy

12 12 programs (most notably in Fiji, Kiribati, Palau, Solomon Islands, Tonga, and Vanuatu); > improving the productivity of domestic agriculture and fisheries (Samoa, Solomon Islands, Timor-Leste, Vanuatu); and > technical assistance for governments to improve the targeting of social protection schemes and safety net management (Fiji, Timor-Leste), as well as potential financial support for national employment schemes (Solomon Islands, Timor- Leste). The Bank is also looking at ways to encourage the broadening of pilot temporary labor migration programs in Australia and New Zealand (e.g., to include the Solomon Islands).