## 4.4. <u>Global economic downturn (CRISIS)</u>

Although at present, the global economic downturn has had a limited effect on Rwanda’s economy, a continued global slowdown may have more pronounced negative effects. Given widespread poverty, Rwanda is also considered to be highly exposed to the poverty effect of the crisis while its capacity to cope with the impacts of the crisis on poverty is limited (World Bank, 2009). It is therefore critical to assess the impact of the global economic downturn on the macroeconomic as well as MDG indicators of the country. The main transmission mechanisms are expected to be decreases (or slower growth) in grants and, to a lesser extent, private remittances. Large volatility in commodity prices may (or may not) lead to negative terms-oftrade effects. Increased protectionism in export markets may stifle promising sectors. The effect of a negative terms-of-trade shock was felt in 2008 as the surge in fuel and food prices led to a widening of the current account deficit (see Table 2). Commodity prices have, however, started to decline towards the end of 2008, a trend which is expected to continue in 2009 and in the medium-term.

In contrast to the BASE scenario, where world prices remain unchanged from 2009 onwards, this scenario assumes a decrease in export prices of 5 percent (at constant prices) per year until 2015 and stable prices thereafter.<sup>13</sup> Import prices are assumed to remain constant after a decrease in 2009, reflecting a possible increase in fuel prices compensated by a decrease in food prices, the two main imported goods.<sup>14</sup> It is assumed in this scenario that development partners reduce their aid contributions to Rwanda, leading to a decline in foreign aid per capita to USD 50 starting from 2012 compared to USD 70 in the baseline.

The effects of the assumed developments due to the global crisis are quite pronounced. GDP growth is at 5.4 percent annually, 0.6 percentage points lower than in the BASE scenario. Given that government policies are unchanged, the required decline in absorption growth is absorbed by the private sector, with a slowdown of both private consumption and investment. Given the deterioration of the terms-of-trade (i.e. export prices decline more than import prices) and lower grant aid, the real exchange rate has to depreciate more than in the BASE scenario to maintain external balance (between inflows and outflows of foreign exchange). In response to the decline in export prices, the real exchange rate depreciates, mitigating the domestic price decline for exports and the incentive to reduce exports while discouraging imports. Compared to the BASE, the ultimate effect is slower growth for both exports and imports.

The growth path of the MDG indicators is significantly affected. The development of all indicators is worse when compared to the BASE scenario (Table 6). The share of the population living below the poverty line drops only to 40 percent. Wages as well as employment levels grow by less than in the other scenarios as well.

# **5. Conclusions**

In this paper, we used a Rwandan version of MAMS to simulate alternative scenarios for grant aid, world prices, government efficiency, and adjustments in government spending in response to changes in fiscal space. Given uncertainty about parameters and the detailed functioning of the Rwandan economy, the results should only be viewed as approximate indicators.

> 13 The BASE scenario does, however, take the global economic downturn into account by assuming a conservative growth rate.

> 14 The limitation to a change in only two instead of three variables also enables a clearer interpretation of the effects.

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