Impact of the Global Crisis on Emerging Economies

1. Impact of the Global Crisis on Emerging Economies Lorenzo Giorgianni Chief of the Emerging Markets Division Strategy, Policy and Review Department International Monetary Fund Yerevan, Armenia July 7, 2009

2. Outline • Origin of the global crisis • Impact of crisis on Emerging Economies • Global crisis response • Emerging Economies’ crisis policy response • Conclusions

3. I. Origin of the Global Crisis

4. Heating economy—above trend growth Cooling economy—below trend growth Global warming (output) 2006

5. Heating economy—above trend growth Cooling economy—below trend growth Global cooling (output) 2009

6. Root of crisis • Financial regulation: perimeter, procyclicality • Macroeconomic policies: asset prices, capital inflows • Global architecture: coordination, warnings, insurance The period of high growth and low interest rates masked market as well as policy failures:

7. Propagation of crisis 1. Financial centers • Complexity of assets led to mispricing of risks (subprime lending) • Realization of risks with fall in U.S. house prices 2. Advanced countries • Globalization spread risks across assets, institutions, and countries • Counterparty risks led to further tightening of banking standards and cross-border flows 3. Emerging market countries • Increase in EM spreads and sudden stop turned the financial crisis in advanced countries into a full-fledged global economic crisis • Feedback loops from EMs to advanced country banking systems

8. Feedback loops:Eastern Europe to Western banks Losses from 20 percent loss on loan portfolio in CEE (in percent of GDP) Reduction in claims of international banks (in percent of recipient country GDP) First Round (from East to West) Second Round (from Belgium and Austria)

9. II. Impact of Crisis on Emerging Economies

10. EMs hit by multiple shocks • Sudden stop in capital flows • External demand shock • Terms of trade shock for commodity exporters • Drop in remittances

11. 1. Deleveraging in advanced countries…

12. …led to a sudden stop in capital flows to EMs, notably Emerging Europe… Source: IMF, World Economic Outlook

13. …where stronger financial linkages amplified the shock transmission.

14. Deleveraging means not only less availability financing, but also higher borrowing costs.

15. 2. An external demand shock worse than in past crises…

16. …is leading to severe output contractions..

17. …which tend to be amplified by strong trade linkages…

18. …as in Armenia’s case

19. 3. Fall in commodity prices hitting commodity exporters very hard

20. 4. Lower incomes in advanced countries also means lower remittances to some EMs

21. Emerging Europe and CIS hit worst Source: IMF, World Economic Outlook

22. But, are EMs innocent by-standers? Vulnerabilities explaining market spreads…

23. …and cross-country differentiation in recessions

24. II. Global crisis response

25. Global crisis requires global response Coordinated G-20 policy response IMF reforms: resources and lending framework IMF lending

26. A. G-20 fiscal response Source: IMF Fiscal Affairs Department Note: Discretionary stimulus (average, 2009-10, based on measures announced through early March) plus automatic stabilizers (average, 2008-10)

27. A. G-20 Monetary policy easing

28. A. Liquidity injections/asset purchases since January 2008

29. A. Banking recap since January 2008

30. B. IMF Reforms—Increase in resources • Size of war chest in relation to potential needs • Triple lending resources to $750 billion • Raise $500 billion in bi-/multi-lateral agreements • Commitments so far over $400 billion • General SDR allocation of $250 billion • Boosts country reserves by 75% of quota • Some $100 billion of liquidity to EMs and LICs • Later, quota increase

31. B. IMF Reforms—More effective lending • IMF as first port of call for EMs in stormy weather • More flexible lending: large, frontloaded, contingent access to deal with all financing needs • Conditionality better tailored to countries’ circumstances to reduce stigma • Flexible Credit Line (FCL) • High Access Stand-By Arrangements (HAPAs)

32. C. Increase in IMF lending

33. C. Fund financing can play useful role • Reduces need for adjusting to liquidity shock • Allows orderly adjustment to solvency shock • It does so by • increasing reserves and catalyzing private lending • bailing-in the private sector (Vienna initiative) • creating room for spending reserves to (i) ease private sector’s FX liquidity constraints, (ii) recap banks, and (iii) ease budget financing constraints • Caveat: to safeguard Fund resources, policies need to be consistent with capacity to repay

34. IV. Emerging Economies’ Policy Response (as seen through the lens of the recent Fund-supported programs)

35. EMs policy response often constrained • Exchange rate regime • Degree of dollarization • Fiscal sustainability and credibility • Bank solvency • Institutional weaknesses • Social considerations • Political, electoral cycles

36. Focus: fiscal policy in crisis • Much emphasis has been placed on fiscal stimulus to counter effects of global financial crisis • But many EMs face stricter constraints on their fiscal space than advanced economies: • Financing constraints • Debt levels (for some) • Credibility issues • Accommodating bank recapitalization costs (for some) • Strictures of Euro entry criteria (for some)

37. Reflecting these constraints, fiscal deficits were allowed to widen, but not fully…

38. …given the stock of public debt and other initial conditions

39. Even so, fiscal programs are being flexibly adapted to evolving macro conditions

40. Conclusions • Global crisis spreading from advanced countries to EMs • hit Armenia and other CIS/CEE countries particularly hard • Required a coordinated global response • fiscal and monetary stimulus where feasible • emergency measures to support financial sectors • The Fund has played a central role • endowed with more resources; overhauled lending framework • launched substantial lending programs across the world • New programs have had to adapt to the new crisis • Exchange and monetary policies according to country circumstances • Accommodative fiscal stance as possible given financing/sustainability issues; attention to social safety nets • Focus on maintaining financial sector health

41. Thank you

42. Back-Up Slides

43. Crises are costly, come in waves; andrequire strong, comprehensive response

44. When will markets normalize?

45. Recent IMF lending in context

46. Large Access, Short Duration

47. Access is large and front-loaded

48. Structural Conditionality Non-core Core Core measures: financial/monetary, exchange rate and fiscal policy

49. Issues in crisis management • Early diagnosis is key (liquidity vs. solvency) • Deal with uncertainty (size of output gap?): adapt plans; develop contingencies (abandon peg?) • Secure legal authority to act • Ensure good interagency coordination • Premium on coherent communications • Ensure adequate safety nets for disadvantaged • Plan exit strategy

50. Evolving circumstances: downgrade in growth projections