Just as the world was finally showing some signs of recovery from the 2008-09 recession, the global economy is once again on the brink of meltdown. Unemployment in Europe is on the rise, reaching its highest level for 17 years in the UK, and prospects are no better in the United States where the Senate has blocked President Obama’s jobs bill. On the currency side, the euro has been losing ground against the dollar, while the Chinese yuan has been threatened recently by the US Congress to revalue or face trading sanctions.

What does this mean for developing countries, and in particular for low-income countries (LICs)? What makes the euro zone sovereign debt crisis different from the recent global financial crisis? Through what channels could the European debt crisis spread to the developing world? Are LICs prepared to weather a new global downturn? What policy options may be adopted by developing country policy-makers?

This Background Note explores some of the key characteristics of the euro zone crisis before progressing to discuss the possible channels through which its effects may be transmitted to developing countries, and identify potential policy responses.