Transcript The Ongoing Financial Crisis and its implications for LICs

The Financial Crisis and
Debt: Challenges for
Developing Countries
Carlos A. Primo Braga
Director, PRMED
MDB Meeting on Debt Issues
July 2009
1
A Perfect Storm
Presentation outline
 The financial crisis in a nutshell
 Policy reactions
 Implications for industrialized and
emerging economies: the debt challenge
 Debt sustainability and the crisis:
implications for LICs
 The importance of debt management
3
The financial crisis will cause a sharp decline in
global growth: the largest since the 1930s
Real GDP in 2000 USD,
(% annual growth)
12.5
Low Income
Countries
10
Middle Income
Countries
7.5
5
2.5
0
World: Total
Source: DEC Prospects Group.
2010
2008
2006
2004
1998
1996
1994
1992
1990
1988
1986
1984
1982
1980
1978
1976
1974
1972
1970
1968
1966
1964
1962
-5
2002
High Income
Countries
2000
-2.5
The crisis in a nutshell
Antecedents of the crisis:
Boom-bust credit boom, fueled by lax
monetary policy in developed countries
An asset price bubble and excess
investment in real estate (poor
assessment of risks)
Poor corporate governance
Macroeconomic imbalances
5
Additional considerations
 Financial innovation and increased
opaqueness
-- Reckless use of collateralized debt obligations
-- Growing reliance on the originate-to-distribute business
model/poorer risk assignment
 Financial integration
-- Much larger capital flows /cross-border positions
 Major regulatory and supervision
changes
-- The repeal of Glass Steagall (1999) to allow US conglomerates to
leverage their balance sheets like EU universal banks; transition
from Basel I to Basel II; SEC ruling on net capital (2004)…
Residential mortgage backed securities
versus other securitized assets
(% GDP USA)
Source: Blundell-Wignall and Atkinson (2008), Federal Reserve, Datasteam, OECD.
The crisis in a nutshell
Developing Countries: Main Transmission
Channels
•
Financial sector effects  impact on “domestic” financial sector and
“sophisticated” firms
•
Liquidity squeeze and lower risk appetite  higher financial costs
•
Lower commodity prices and trade volumes  lower export proceeds and
government revenues
•
Reduction in capital flows and remittances  tightened financial sources
8
Economic shocks and the world trading system
• The food and fuel price surges led to disorderly and sometimes
harmful trade policy responses
• Financial crisis has led to a trade credit crunch and sharp increases
in credit spreads
Trade
creditspreads
spreads (bp)(bp)
Trade
credit
• Contraction in trade finance was also 250
Brazil
Indonesia
Korea
China
fostered by loss of critical market
India
Russia
200
participants
Turkey
• Secondary market drying up, reducing150
ability of banks to sell trade finance
positions
100
• Concerns about protectionist measures
50
rising
• World trade volume (goods and services)
0
is likely to contract by more than 6% in 2003 2004 2005 2006 2007 2008 est
Source: Data collected by WB staff from private sources.
2009
Some good news: pace of decline in
trade is easing
goods exports, nominal, qtr/qtr ch% (saar)
Developing Countries
Source: Thomson/Datastream
But all types of private capital flows
to emerging economies are plunging
U.S. dollars, billions, net
2006
2007
2008
2009
Private Flows
565
929
466
165
•
Equity investment
222
296
174
195
•
Direct
171
304
263
198
•
Portfolio
52
-8
-89
-3
•
Private Creditors
343
632
292
-30
•
Commercial Banks
212
410
167
-61
•
Nonbanks
131
222
125
31
Official Flows, net
-58
11
41
29
•
IFIs
-30
3
17
31
•
Bilateral
-27
9
24
-2
Source: Institute for International Finance: “Capital Flows to Emerging Market Economies.” 01/27/09.
Changing composition of private capital
flows to developing countries
(Source: DECPG/GDF 2009)
1500
$ billions
1300
percent
Percent of GDP (right axis)
9
7
1100
900
Debt
5
700
3
500
Port Equity
300
1
FDI inflows
100
-100
-1
2000
2002
2004
2006
2008e
Relative to past downturns the decline of
capital flows has been even more
dramatic
Net private capital flows / GDP in developing
countries
Percent
8
6
1980-83
Projection
2007-10
1997-02
4
2
0
1970 1975 1980 1985 1990 1995 2000 2005 2010
P
Source: DECPG/GDF 2009
Corporate rollover needs are massive
External Debt Refinancing Needs ($ billions)
1000
25%
Corporate
900
800
700
600
As a percent
of U.S. dollar GDP
(right scale)
Sovereign and
Corporate
500
20%
15%
Sovereign
400
10%
300
200
5%
Asia
Emerging Europe
2012
2011
2010
2009
2008
2007
2006
2004
2005
2003
2002
2001
2000
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
2000
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
0
2000
100
0%
Latin America
Source: IMF
Over $1.5 trillion in rollover needs for 2009, with the private sector holding the lion’s
share
14
Potential declines in
remittances and ODA
(USD, % Change)
(% of GDP)
Remittance Flows to Developing Countries
Official Development Assistance
Source: World Bank data and staff estimates.
Policy reactions to the crisis
At country level:
Monetary easing
Recapitalization of financial systems
Bailout of household and corporate
sectors
Fiscal stimulus packages
Financial systems regulatory overhaul
And IFIs are intermediating more
funds than ever
16
G20 countries – fiscal stimulus and
financial sector support
Advanced economies:
Average discretionary fiscal expansion in 2009: 1.5% of GDP
Average financial sector support: 5.4% of 2008 GDP
Emerging economies:
Average discretionary fiscal expansion in 2009: 2.0% of GDP
1/ In percent of 2009 GDP. Excludes below-the-line operations that involve acquisition of assets.
2/ As of Apr. 15, 2009, in percent of 2008 GDP. Consists of capital injection, purchase of assets and lending by
Treasury, and central bank support provided with Treasury backing.
Source: IMF
17
Central Bank balance sheets in advanced
economies have been rapidly expanding
Central Banks’ Total Assets (Index, 12/29/06 = 100)
350
UK
300
US
250
Euro Area
Collapse of Lehman Brothers
200
150
100
12/29/06
1/29/07
2/28/07
3/31/07
4/30/07
5/31/07
6/30/07
7/31/07
8/31/07
9/30/07
10/31/07
11/30/07
12/31/07
1/31/08
2/29/08
3/31/08
4/30/08
5/31/08
6/30/08
7/31/08
8/31/08
9/30/08
10/31/08
11/30/08
12/31/08
1/31/09
2/28/09
3/31/09
Japan
Source: IMF WEO (2009)
18
50
Government Debt: medium term
prospects
 Significant expansion of public debt in advanced economies
Debt/GDP Ratios (Source: WEO, 2009)
2007
2009
2014
Advanced
G20
77.6
97.7
114.1
Emerging
G20
37.8
38.7
35.0
USA
63.1
87.0
106.7
Japan
187.7
217.2
234.2
UK
44.1
62.7
87.8
Korea
33.0
40.0
51.8
Brazil
67.7
65.4
54.1
China
20.2
19.8
17.9
India
80.4
86.8
76.8
19
Government Debt: medium and
long term challenges
 Macro considerations: evolution of the dollar
and interest rates, as well as the future of
export-led models of development;
 The importance of preserving long-term
growth potential (the composition of current
fiscal packages);
 Growing aging-related budgetary pressures
(fiscal costs likely to increase more than 10 %
of GDP in the next 40 years in Korea and
more than 5% of GDP in countries such as
Canada and Spain…)
20
Debt sustainability prospects in
LICs
 Debt sustainability indicators will
deteriorate due to the fall in exports and
government revenues, and the increase in
debt service;
 For some countries rollover and accelerated
repayment may be an issue;
 Debt sustainability indicators may
deteriorate even further as governments
implement fiscal stimulus packages.
21
Risk of debt distress
(FY10 grant allocation)
IDA-only countries
HIPCs
In the case of IDA, the graph reflects only countries for which a DSA is available. The graph for
HIPCs includes: Bolivia and Honduras (both Blend countries) and Somalia (for which a DSA is not
available)
HIPCs: recent progress and current
status
(as of end June 2009)
26 Post CP Countries
Benin
Bolivia
Burkina Faso
Burundi
Cameroon
Central African
Republic
Ethiopia
Ghana
Guyana
Gambia, The
Haiti
Honduras
Honduras
Madagascar
Malawi
Mali
Mauritania
Mozambique
Nicaragua
Niger
Rwanda
São Tomé and
Príncipe
Senegal
Sierra Leone
Tanzania
Uganda
Zambia
Congo, Rep. of
Côte d’Ivoire
Guinea
9 Interim Countries
Afghanistan
Chad
Congo, Dem. Rep.
of the
GuineaBissau
Liberia
Togo
5 Pre-DP Countries
Comoros
Eritrea
Somalia
Sudan
Kyrgyz
Republic
Nepal
Debt sustainability prospects
 A critical issue is how long the crisis
will last.
 A short lived crisis will have a small effect
on debt sustainability as relevant analysis
is of a long term nature (e.g., the Debt
Sustainability Analysis is forward looking,
20 yrs);
 In contrast, a protracted crisis will have a
more lasting effect on debt sustainability.
24
Debt sustainability and the crisis
Two scenarios/shocks with different financing
conditions
YEAR
(A) Exports: % deviation
respect to baseline
with
1
2
3
4
5
6
7
30
25
20
15
10
5
0
20
10
0
0
0
0
0
(i) IDA terms: 40 yrs; 10 yrs
(B)
Conditions
of
additional
grace period; 0.75% interest
financing incurred to maintain
consumption
and
expenditures
(ii) Commercial: 10 yrs.; no
constant
grace period; 5% interest
25
Debt sustainability and the crisis
26
Debt sustainability and the crisis
27
A protracted crisis?
Recessions, Crunches, and Busts
Output Trajectory During U.S. Recessions
Recessions
Credit
Crunches
46
Output Trajectory During US Recessions
(Pre-recession Output Peak = 1, at time = 0)
1.04
10
2008:2
1.02
1981 Recession
1
3
18
9
1973 Recession
1.00
4
House
Price Busts
Average of 7 previous
recessions
3 31
1
Equity
Price Busts
0.98
J.P Morgan
forecast through
2010:1
0.96
-2
-1
0
1
2
3
4
5
6
Quarters before and after the peak
Source: Claessens, Kose, Terrones (2008)
•
•
Source: JP Morgan
Current crisis is one of four of the past 122 recession to include a credit crunch, housing price bust, and
equity price bust
Average of past US recessions has shown that it has taken 5-6 quarters before pre-recession
output levels were regained; current recovery will take longer
28
7
Debt management and the crisis
While a debt sustainability analysis focuses on the long-term sustainability of
debt, which is influenced by both its level and composition, a debt management
framework focuses on how the composition of debt is managed.
The crisis creates particular challenges for debt managers:
 How to close an increasing financing gap and finance a country’s
development needs at low cost with a prudent degree of risk, especially at a time
when conditions in financial markets are severely constrained?
 Given limited external financing options, how can potential benefits from
developing domestic markets be exploited at a low cost and prudent degree
of risk?
 Given the efforts by many governments to strengthen their balance
sheets over the past decade, how can these sounder public debt structures be
protected?
 Since the crisis implies substantial macroeconomic adjustments, how
should debt management strategy reflect the new reality?
29
The Debt Management Facility
(a network of TA providers)
 Systematic application of the Debt Management
Performance Assessment (DeMPA)
 Country-led design of medium-term debt
management strategies (MTDS) jointly with the IMF
 Design of reform programs
 Training events
 Research and development of knowledge products
 Peer learning initiatives, such as a the Debt
Management Practitioners’ Program and the Debt
Managers Network
DeMPA results indicate that only 4 out of 27
assessed countries had a satisfactory
medium-term strategy in place
Legal Framework
27
Debt Reporting
Managerial Structure
24
21
Debt Records
Debt Management Strategy
18
15
12
Segr. of Duties, Staff Capacity and
9
Debt Management Operations
BCP
6
3
0
Debt Administration/ Data Security
Audit
Cash Flow Forecasting/ Balance
Management
Loan Guarantees, OL Derivatives
External Borrowing
DeMPA Score C and Higher
Coordination with Fiscal Policy
Coordination with Monetary Policy
Domestic Borrowing
DeMPA Score D
Concluding remarks
 Financial crisis: scale of policy responses is country specific, but,
given the procyclicality of the financial system, it is important to
coordinate financial sector reform and to synchronize macroeconomic
responses;
 The severity of the downturn highlights the need for an increase
in high-impact fiscal expenditures. But embedding stimulus packages
in a credible medium-term strategy, that safeguards fiscal sustainability,
is key;
 Expansion of public debt will be massive. Countries need to design
exit strategies to the ongoing fiscal interventions and to introduce
growth-enhancing reforms to reassure markets of the public sector’s
solvency. Needless to say, coordination of exit strategies pose major
challenges. The challenges are even greater for those facing significant
fiscal pressures associated with aging-related spending;
 Debt sustainability implications for LICs: a function of the crisis
duration. The role and the impact of non-concessional borrowing needs
to be carefully evaluated;
 Debt management: the crisis further underscores the importance of
debt management practices and makes the Debt Management Facility
even more relevant;
Concluding remarks
(cont.)
 WBG response: increase in IBRD lending (mix of Development Policy
Loans (budget financing/fast disbursing: financial sector restructuring;
contingent source of liquidity...) and Investment Loans (preserving
infrastructure spending; support for clean technology; social safety
nets...)); fast-tracking IDA funds; Vulnerability Financing Facility; INFRA
(support for infrastructure); guarantees via MIGA; new IFC facilities
(support for trade; recapitalization of banks; refinancing of microcredit
institutions).
World Bank Group Commitments
fiscal years 2009 and 2008 (in U.S. billions)
World Bank Group
• IBRD
• IDA
• IFC
• MIGA
TOTAL
FY09*
32.9
14.0
10.5+
1.4
58.8
FY08
13.5
11.2
11.4+
2.1
38.2
*Unaudited numbers as of July 1.
+Own account only. Excludes $4.5 billion in FY09 and $4.8 billion in FY08
mobilized through syndications and structured finance.