The past year has offered a vivid lesson in the problems that high volatility presents for developing countries. Only a few months ago, poor countries that import fuel and food were hit with sudden price surges. Now demand and prices are falling, and poor countries that depend heavily on commodity exports—or indeed on exports generally—face the prospect of a sharp drop in demand. Many developing countries are also confronting sharp upticks in financial market volatility and some face sudden reversals of capital flows. Although this extreme volatility did not originate in developing countries, they are being hit hard. Developing countries—and poor people—are highly vulnerable to such volatility because they lack the coping mechanisms that are common in high-income economies.
Drawing on a forthcoming report by Guillermo Perry, the brief argues that the World Bank and other MDBs can play an important role in helping developing countries to better cope with such risks.
For example, as broad regional or global public institutions, MDBs are well placed to play a central role as market developers for new risk-management financial products. They can assume part of first-mover market-development costs and help overcome initial liquidity challenges. They can use their convening and risk-pooling power to help foster regional and global markets for developing countries’ domestic currencies and debt, indexed, for example, to terms of trade or GDP. At the same time, they can help governments to improve their institutional and policy environments, strengthen their technical capabilities, and overcome inhibiting political economy problems that are limiting the use and penetration of existing and new products in developing countries.
That is, MDBs can help solve both demand and supply market limitations for risk-management solutions. But doing so will mean looking beyond their traditional financing tools.