The current financial crisis, which originated from the USA’s housing market, is surging across the public-private boundary in the area of deficit financing and the demand for goods and services. It has surged across national borders within the developed world, and now there are reasons to fear that the crisis will swamp emerging markets and other developing countries, cutting into the considerable economic progress of recent years. However, until quite recently, many people doubted whether we faced a major crisis in the real economy. Many analysts we even saying that African and other developing countries will be immune to this crisis. When analysts pointed out to Brown and other EU Leaders that the world was in the middle of the greatest financial crisis since the great depression, they denied it at first, until when unemployment figures started rising in these countries. So by the beginning of the fourth quarter of 2008 this optimism or maybe one should call it complacency, vanished.

As the months wore on it became apparent that the financial crisis was deepening to a point where it would inescapably have major spillovers on the real economy. Housing values continued their decline, but meanwhile stock markets fell precipitously worldwide and credit markets virtually dried up, resulting in many who relied on borrowing suffering from acute solvency. Everyone had known from the start that a slowdown in the core of the world economy was bound to suppress demand everywhere, but until this point it seemed that the slowdown was to be welcomed rather than something that was going too far. Quite suddenly it seemed that the world was facing a real danger of a depression rather than a welcome alleviation of inflationary pressure. Moreover, the markets decided that while many of the emerging economies might no longer have any need for an inflow of loans, many heavily indebted poor countries (HIPCs), like Sierra Leone, are still significant net debtors to the rest of the world and therefore still vulnerable to a sudden withdrawal of foreign credit. Compounding this is the fact that one may have a balanced overall position and still be vulnerable because debts are concentrated at short maturities.

Impacts on the Sierra Leone Economy

So, these facts compel one to assess the probabilities of Sierra Leone suffering seriously in this crisis. The fall in world demand is liable to impact the Sierra Leone economy primarily through the balance of payments. It will both diminish the prices of raw materials (diamonds, cocoa, etc.), which constitute a major part of Sierra Leone exports. It is the past strength of raw material prices, which provides the one logical basis for the stable value of the Leone (Le) in the past three years, and quite recently the most reasonable forecast was that the price of materials might likely continue to slip back from the very high levels of recent months. This is so because a major worldwide recession would be consistent with a longer period reverting to weak commodity prices.

The prospects for exports of manufactures are also gloomy, maybe, even worse. The decline in the manufacturing output of the country over the years only points to the fact that the manufacturing sector is an unreliable sector for growth and development. Also the increasing protectionist measures of the west would mean that Sierra Leone products still have a long way to go in penetrating the EU and other western markets. The net effect is bound to be a significant contraction in the demand for manufactures. A resultant effect of this contraction is the decline in the value of the Le on the exchange market in recent times; and for an import-dependent country like Sierra Leone, this depreciation is expected (in the medium-to-long term) to raise prices of imported goods, which form a major component of our consumption basket. Under normal circumstances, depreciation of the Le is expected to boost the demand for domestic goods (such as exports and domestic demand), however, given the low production base of the country, such depreciation would fuel inflation to galloping levels; thus exposing the country’s vulnerability to external shocks. Of course, for a free floating exchange rate system like the one we operate in this country, a depreciation of the Le would spark a whole lot of rates in the black market economy, which the central bank is unable to monitor, regulate and control at present.

There are other channels through which Sierra Leone is suffering besides the current account of the balance of payments. First, it is well known that capital inflows to developing countries like Sierra Leone are highly cyclical. One must therefore expect to see a diminution of the past few years’ inflows. In part this will involve a fall in foreign direct investment and therefore in investment, but most of the fall will probably be elsewhere. One expects a reduction in portfolio equity; one also expects it to become more difficult for Sierra Leonean enterprises to borrow in the international market; and with a very weak financial position of the Sierra Leone Government, the public sector would not be able to offset much of this with an expansion of domestic credit. Secondly, the remittances from Sierra Leoneas and Sierra Leonean assets from abroad are said to have fallen very sharply, thus affecting a major source of foreign exchange through the banking system. This in turn is impacting negatively on the revenue base of financial institutions (through the fall in the commission charged) and the expenditure pattern of households as well as businesses, which are the normal beneficiaries.

Of course the contraction of employment and out put are already visible in the country. The closure of Bauxite mines and the fall in diamond and rutile outputs represented a major cut in the number of employees working in those mines. Consequently, the gross domestic product (GDP) is estimated to decline from 5.5% growth rate in 2007 to around 4% in 2008, with dire consequences on poverty and poverty reduction programmes. Poverty is expected to rise above the 2005 estimate of 70% of the population by the end of 2009.

One positive effect of the global financial crisis is rapid cline of the fuel pup prices from the peak of $147 a barrel to as low as $40 a barren. This, coupled with the decline in food prices has gone a long way in alleviating the suffering of many people in this country. For example, we have noticed visible fall in transport fare from Le 1000 to now Le 700. Consequently, inflation has decline from 17% in July 2008 to 7.5% in March 2009. the declining inflation means that with the same amount of money, one can buy more goods and services in March 2009 than in July 2008.

The Global trend

The IMF recently projected growth in world trade volumes of just 4.1 percent in 2009, down from 9.3 percent as recently as 2006; which means that the deceleration is much more rapid and could in fact lead trade volumes to fall in 2009 (World bank Forthcoming). While the fall in export volume growth is projected to be greater for advanced economies than for developing economies, the latter may also suffer more from declines in the terms of trade – especially in the case of commodity exporters, given that we expect non-oil commodity prices to fall by perhaps one-fifth in 2009. In addition, the crisis will deal a negative shock to investment in emerging markets in the developing world. All of the main external sources of funds for investment are likely to drop off sharply in the first round of effects. Portfolio investment will fall, as greater risk aversion keeps capital closer to home. While foreign direct investment (FDI) is historically more resilient to shocks, it too is expected to decline. In addition, developing countries that are able to gain access to capital will pay higher interest rates, because of the flight to safety and greater risk aversion of lenders. As noted above, the global slowdown will reduce demand for commodities and manufactured goods, cutting into export earnings. And as labor markets slacken, foreign workers are likely to suffer disproportionate impacts on their earnings, which will reduce remittances. About half of all developing countries have been running current account deficits of 5 percent of GDP or more, and in some cases the deficits are around 10 percent.

These economies will be highly vulnerable to swings in these various sources in external financing. Overall, we now expect investment in middle-income countries in 2009 to grow at less than half the 2007 rate of 13 percent.

Second round effects will likely deepen the slowdown. Because of the investment surge of the past five years, an especially large number of investment projects are already underway. As investment financing drops off, two outcomes are possible, neither of them attractive. In some cases, the projects will not be completed, making them unproductive and saddling banks’ balance sheets with non-performing loans. In other cases, when the projects are completed, they will add to the excess production capacity that will result from the global slowdown, and thereby add to the risk of deflation. As a result of all these factors, we now expect that developing countries’ collective GDP growth will decline to less than 5 percent, compared with an average of more than 7 percent in 2004-07. Moreover, the effects on developing countries may not be limited to a drop in investment and export earnings and a slowdown of GDP growth. There is a distinct danger that emerging markets could go through crises of their own, for example if their own domestic asset-market bubbles burst (or even if fair-market values collapse) and weaken their own banking sectors. Sharp drops in stock markets in developing countries have already signaled investors’ concerns about the medium-term future, and the decline in portfolio values may also have substantial wealth effects on consumption, exacerbating the effects of the slowdown. Countries with high balance-of-payments and fiscal deficits will be especially vulnerable. What will exacerbate the troubles of developing economies is the simultaneous nature of these shocks. In the past, major crises in developing countries usually had a regional concentration – as in the case of the East Asian financial crisis of 1997-98 or the Latin American tequila crisis of 1995. But the epicenter of the current crisis lies deep inside the developed economies, and therefore we would expect all developing regions to be damaged by the shocks. This simultaneity increases the risks of a serious global downturn.

The way forward

While a serious global recession appears inescapable at this point, there is still a great deal of uncertainty as to whether this is likely to be a short V-shaped recession similar to that experienced by Korea in 1997–98, or a protracted depression on the model of Indonesia after 1997, or Japan in the 1990s, or the world in the 1930s. The IMF has argued that the omens are bad because recessions accompanied by a collapse of the housing market have typically lasted longer than normal. However, this is not the only factor, and the collapse of the housing market is limited to certain countries rather than being a general phenomenon. In particular, I would argue that the United States and EU countries are likely to recover relatively rapidly due to the correction of a previously–overvalued currency, and China is likely to have a relatively brief recession as it has plenty of scope for fiscal expansion. I would expect recovery to be somewhat slower in many places elsewhere, but I do not anticipate a collapse similar to the 1930s. That was a result of ignorance from which we no longer suffer.

There may well be proposals for concerted fiscal expansion to combat the world recession. The question would then arise as to whether Sierra Leone should join other major countries in such an exercise, similar to (but broader than) the concerted interest rate cut of 0.5 percent by all the leading industrial countries in 2008; or where there should be broader fiscal expansion to stimulate growth of the economy, whose growth rate is currently forecast at 4%. Of course I would wish the fiscal expansion to take a form that can easily be reversed and I would wish it to be strictly temporary, but the fact is that these are not normal times and we need to make some adjustments from customary behavior. The cost of not doing so would be to prolong the recession further.

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