Innovation and belt tightening – survival instincts in the face of the financial and economic crises.

Innovation and belt tightening – survival instincts in the face of the financial and economic crises.

by / 2 Comments / 26 View / 21st July 2009

By Kaifala Marah, Governance and Institutional Development Division, Commonwealth Secretariat.

The ongoing financial crisis – which is no fault of the developing economies – has dealt a devastating blow to their stability, now teetering on the brink of the worst economic crisis ever recorded. The magnitude of the downturn has led the World Bank to estimate that about 4 million people will go hungry in the developing world. The Jubilee Debt Campaign has warned that there will be another round of debt crisis as witnessed in the 1980s – perhaps with unprecedented proportions – such that 38 of the 43 most vulnerable countries require debt cancellation even before the crisis is fully felt.

For developing Commonwealth countries, the economic picture is as grim as ever; for example, Zambia, which has
received a debt cancellation package, is on the brink of facing a debt-to-export ratio of 300 per cent, while a similar
unprecedented fall is imminent for Bangladesh, as the country relies heavily on the dwindling export of garments to Europe and North America.

Amid the heat of the simmering meltdown has come a call for the reform of the international financial institutions; but even this will not provide sufficient response energy to fire up trends in low-income economies; similarly the level of suggested financial bailout, being only one-tenth of what has been pumped into the financial markets of the developed world, is simply inadequate to cushion the effects of the crisis in poor and ailing economies. The G20 spoke of stringent regulatory reforms to be supported by a watching initiative for regional and global economies, but there was no clear statement proposing a remedy for the impact on the economies of the South. These challenges, among others, have meant that the future of nations is apparently dependent on rethinking fiscal and monetary policies; of robust innovations structured on discipline; and a requirement that calls for the political and bureaucratic class to move out of their comfort zones into new areas that push the traditional boundaries of planning, management and evaluation.

“These challenges have meant that the future of nations is apparently dependent on rethinking fiscal and monetary policies.”

Just as the September 11 carnage has left an indelible imprint on international security policies, so the financial crisis has engendered a new economic era that must be met with humility through collaboration among nations. In regard to the unsettling economic scenario, this paper suggests innovative actions at
country level to mitigate the impact of the crises – financial as well as economic. These remedies can be summarised under three interrelated propositions:

• First, that developing economies need to review their macroeconomic models. Those currently in use are inflexible
and lack sufficient manipulative capacity to provide an appropriate picture of the economic climate as well as reliable
forecasts in a crisis period.

• Second, that treasury controls and effective oversight are instituted to cut waste in the public sector, and

• Finally, that risk management be mainstreamed in the financial markets and budget execution backed by strong
regulations and oversight.

Review macroeconomic models – adopt flexible complementary tools.

National development is contingent on proper planning and budgeting, and keeping alert to evolving local and global
economic conditions. However, there is a capacity gap identified in about two-thirds of Commonwealth developing countries, where there is a lack of a reliable short-term business cycle, making it difficult to forecast the relationships between the key domestic and foreign macroeconomic variables – interest rates, foreign exchange, inflation and related dynamics.

One fundamental challenge the crisis has brought for many developing countries is the lack of information with regard to the actual impact of the crisis in terms of trade, external financing and economic growth and, in turn, how these may affect individual countries’ socio-economic objectives such as poverty reduction and achieving the other Millennium Development Goals (MDGs). Although the World Bank and IMF, using their large-scale economic models, do come up with projections on aggregate economic impacts (such as growth) for certain regions and countries, these are still subject to significant revisions, and policy makers in most low-income Commonwealth nations may be unable either to validate these forecasts or to translate their implications in terms of the effects on growth and development.

Also, these projections are not much help to planners in comparing the effects of available policy options. For instance, if tariff revenues are projected to fall because of falling import prices, it is not known if additional resource mobilisation from domestic sources (e.g. increasing the income tax or value added tax rate) would have mitigating effects on poverty. Countries are heterogeneous, and thus growth and other aggregate macroeconomic effects will be likely to differ between countries. Hence, reduced foreign assistance or remittances in the backdrop of the global economic crisis may not have similar poverty and welfare implications for all developing countries.

Thus the adoption of complementary models such as are being mainstreamed in the Sri Lanka Ministry of Finance with the inherent capacity to leverage appropriate and immediate response to short- or long-term shocks and volatilities – required. It not only cushions the global economic crisis but puts in place a credible mechanism for similar future volatilities. In short, countries develop an inherent instinct to respond to fluctuations when flexible tools are institutionalised – with a little recourse to external assistance for explanations.

Cut wastes – institute stringent expenditure controls and oversight

It goes without saying that this period demands innovative strategies to cut waste in public expenditures. One of the notable strategies is for developing economies to consider aggregate procurement as a device to manage bulk purchase within the public sector. In addition, adopting stringent measures for such expenses claims as overseas travel (see box above) is required more than ever before.

“One of the notable strategies is for developing economies to consider aggregate procurement as a device to manage bulk purchase within the public sector.”

In a number of developing economies there appears to be a gap in internal audit functions which are a vital component of expenditure management. At best, some jurisdictions have established internal audit units but with no committee structures to respond to audit reports; while a some others have instituted appropriate agencies at central government level. A key challenge worth considering is rolling out control mechanisms at local government level – where service delivery is core to the development aspirations of nations.

In addition, adequate financial oversight must be leveraged to strengthen accountability and transparency in expenditure management. Not only does the office of the auditor-general require appropriate budgetary, legal, as well as human and logistical support, but civil society and stakeholder participation in the budgetary process should guarantee transparency and accountability.

Risk management and strengthened regulatory frameworks

The failure of institutions responsible for risk assessment toprovide analysis and forewarn financial markets of theimpending crisis – because of indiscipline or deregulationpolicies – provides unmistakable lessons to be learnt by publicservices. In particular the most vital step would be for officialsresponsible for managing the public purse to harness resourcesto introduce risk management in public finance. There isabundant evidence in developing countries, including thosewithin the Commonwealth, that risk management has not beengiven the attention it deserves in budget planning, execution andprocurement, as well as in issues such as human resources.As a result, budget performance is characterised by limitedoutcomes with service delivery always on the low side.

Support for future progress

Noting the above inherent weaknesses, the Commonwealth Secretariat is providing support to enhance technical and human resource capacity in adopting flexible, complementary macroeconomic tools, as well as strengthening audit and risk management functions in public finances.

The implications of the financial crisis in developing economies have engendered the need for policy makers and
bureaucrats to internalise and rethink public finance processes. The revitalisation process requires decision makers to move out of their comfort zones to push the traditional boundaries in tandem with the changing international environment. The present situation demands that conventions are challenged with avid determination, sustained by the desire to achieve public objectives.