Transcript Eduardo Cavallo

Dealing with an Credit Crunch:
Past Lessons, New Challenges
Eduardo A. Cavallo
Inter-American Development Bank (IDB)
Reforming the Bretton Woods Institutions,
Copenhagen, 16-17 September 2009
Outline
 Lessons from past financial crisis: the
experience of LAC.
 Applying the past to the present.
Lessons Learned
 IDB (2009) analyses policy responses to
sudden stops episodes of the late 1990s for 8
LAC countries, bringing in also cross-country
analysis.
1) Expansionary fiscal and monetary policy that does
2)
3)
4)
5)
not affect credibility or solvency can reduce output
collapse in the aftermath of a sudden stop. However
countries need to be able to afford these policies.
Initial conditions matter.
Initial conditions are not destiny.
The persistence of the shock is key.
External financial packages are essential when initial
conditions do not help.
1) Expansionary Policies can Help
 Characterizing expansionary fiscal policy
Structural Fiscal Impulse
Observed Fiscal Impulse
ARG 94
THA
PHL
ARG 98
HRV
CHL
CHL
M YS
ECU
HRV
BRA 97
ARG 94
PER
PHL
TUR 98
PER
POL
TUR 98
M EX
IDN
KOR
POL
M YS
BRA 97
THA
M EX
COL
COL
TUR 93
KOR
IDN
ECU
ARG 98
RUS
RUS
TUR 93
-3.0%
-2.0%
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
-5.0%
-4.0%
% PBI
Source: Ortiz, Ottonello, Sturzenegger and Talvi (Chapter 2)
-3.0%
-2.0%
% PBI
-1.0%
0.0%
1.0%
1) Expansionary Policies can Help
 Monetary Policy Dilemmas and Taylor Rules.
 Conjecture: in Emerging Markets’ prone to
financial crises, Central Banks care about:
 Inflation
 Output Gap
 Nominal Exchange Rate (“original sin” & “fear of
floating”)
 Anatomy of financial crises in Emerging
Markets.
1) Expansionary Policies can Help
Fiscal Policy
Monetary Policy
(GDP variation and Structural Fiscal impulse
partialling out the effects of monetary policy)
(GDP variation and Monetary Policy Regime index
partialling out the effects of fiscal policy)
0.12
0.10
0.08
0.10
POL
0.08
COL
0.00
-0.04
CHL
HRV ECU
THA
ARG 98
-0.02
PHL
TUR 98
KOR
-0.06
TUR 93
MYS MEX
-0.08
IDN
RUS
-0.035
-0.025
-0.015
-0.005
0.06
0.04
POL
RUS
PHL BRA 97
COL
PER
CHL
KOR
HRV
TUR 93
ARG 94
0.02
0.00
-0.02
MEXMYS
-0.04
-0.06
-0.10
-0.045
Y)
0.02
BRA 97
PER
GDP Variation (
Y)
0.04
GDP Variation (
0.06
0.005
0.015
ECU
TUR 98
ARG 98
THA
IDN
-0.08
-6.00
-4.00
I t*
Source: Ortiz, Ottonello, Sturzenegger and Talvi (Chapter 2)
-2.00
0.00
T  , S / Y t
2.00
4.00
6.00
8.00
2) Initial conditions matter
 Stringent preconditions need to be met in order
to afford policy flexibility:
 Fiscal Policy: fiscal policy rules that guarantee intertemporal consistency; maintaining low levels of
public debt.
 Monetary policy: maintaining low levels of financial
and debt dollarization; high degree of credibility in the
policy framework; trade openness in a context of
open capital markets.
 Evidence shows that those that were better
prepared did better during the crisis.
3) Initial Conditions are not Destiny
 Peru’s policy of reserve accumulation and
disbursement
Domestic Liability Dollarization: Selected LAC Countries
Domestic Liability Dollarization Measure
Before the Crisis
Net Domestic Liability Dollarization Measure Before
the Crisis
COL
CHL
CHL
COL
BRA
BRA
ECU
PER
MEX
ECU
ARG
ARG
PER
MEX
URY
URY
0.0%
10.0%
20.0%
30.0%
% of GDP
40.0%
50.0%
60.0%
-30.0% -20.0% -10.0%
0.0%
10.0% 20.0% 30.0% 40.0% 50.0%
% of GDP
3) Initial Conditions are not Destiny
 Brazil: selective use of international reserves to
finance trade credit.
 Chile: the capacity to switch gears without
generating a crisis.
 Colombia: fear of floating
4) Shock Persistence is Key
 Vodka is stronger than Tequila
5) External financial packages are essential
when initial conditions do not help.
 Mexico 1994: $51 billion IMF/USA rescue
package.
 2.8 times the total stock of short-term US$ debt by
December 2004.
 Argentina 2001/2002.
 There is reason to believe that with international
support, the restructuring process could have been
much more orderly.
The Great Crisis of 2008/2009
 ¿What is different this time around?
 The epicenter of the crisis: center vs. perifery.
 Countries in the LAC region appear to be better
prepared. But: will it be enough?
 This time around, the initial response of
countries in the region has been strongly
countercyclical, just like in the developed world.
 But unlike the developed world, LAC is not a
safe haven for global savings that can provide
billions of dollars to pump into a stimulus
package.
 Precarious market access.
Coordinators
Alejandro Izquierdo, IDB
Ernesto Talvi, CERES
Outlook for LAC in the context of the crisis
 It makes all the difference if the world economy
reaches its pre-crisis levels of industrial
production in 2010 or in 2013.
 This scenario could trigger a liquidity crisis in
quite a few countries. If a country does not have
sufficient international reserves to cover the
debt service, it could generate a stampede by
everyone who believes that the reserves are not
going to be there when needed.
The Role of Multilaterals
 Precarious access to credit markets for many
emerging market governments calls for
multilaterals to step in and play a key role as a
lenders (and borrowers)-of-last resort, akin to
the role that credible governments, such as the
US government, play domestically.
 The question then is not whether multilaterals
should play a key role in the current crisis, but
which is the most effective way to channel their
intervention and at what financial cost .
Policy Principles
 Strengthen the role of multilateral institutions.
Multilateral support will be vital under
precarious access to credit markets.
 Move away from short-term financing.
Multilaterals should avoid short-term
emergency financing and only consider medium
to long-term financing in order to partially
“complete” markets in terms of maturities.
Policy Principles (cont.)
 Redefine the emphasis of multilateral support.
Multilaterals should not only provide medium to
long-term financing for fiscal stimulus –when
fiscal sustainability is not at stake– but more
importantly, they should provide for long-term
refinancing of maturing debt obligations.
 Ensure that countries work towards sustainable
fiscal policy while strengthening social
protection. Multilateral support should be
complemented with incentive-compatible
conditionality, to ensure fiscal sustainability and
strengthen social protection.
ILR Dynamics Under Alternative Policies
(LAC-7, L-Shaped Scenario, ILR2)
Refinancing Public Debt Stocks vs.
Financing Fiscal Deficits
125%
Normal
International
Financial
Conditions
120%
115%
110%
105%
100%
95%
Full Financing of
Flows and
Precarization of
Stocks
90%
85%
Precarization
of Flows and
Stocks
80%
75%
2008
2009
2010
2011
2012
LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru
and Venezuela. These countries represent 91% of Latin America’s GDP.
ILR 2t = Reservest / (Public Debt Amortizationst+1 + Short Term Private External Debt Amortizations)
Source: IDB (2009) Policy-trade-off for Unprecedented Times: Confronting the Global Crisis in LAC. A. Izquierdo and E. Talvi, coordinators.
Concluding Remarks
 A strategy by the IMF and multilaterals that only
pays attention to financing countercyclical
fiscal policies is incomplete and ignoring the
impact of expansionary policy on liquidity ratios
can be a costly mistake.
 It is necessary that lender (and borrower)-oflast-resort functions, similar to those that
governments perform in developed economies,
be recreated for LAC by multilateral institutions,
so that liquidity concerns are kept at bay.
Concluding Remarks
 Recent responses:
 IMF´s Flexible Credit Line
 IDB´s Growth Facility
Thank You
2) Initial Conditions Matter
?
Fiscal Position Under Two Hypotheses on the
Global Economy: Are Debt Dynamics Sustainable?
Fiscal Balance
Public Debt
(LAC-7, % of GDP)
2%
(LAC-7, % of GDP)
53%
1.6%
49%
1%
0.3%
48%
L-Shaped
Scenario
0%
43%
V-Shaped
Scenario
-1%
-2%
38%
V-Shaped
Scenario
-2.6%
34%
-3%
-3.7%
33%
L-Shaped
Scenario
-4%
-5.0%
28%
-5%
27%
-6%
23%
2006
2007
2008
2009
2010
2011
2012
2013
2006
2007
2008
2009
2010
2011
2012
2013
LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela.
These countries represent 91% of Latin America’s GDP.
Source: IDB (2009) Policy-trade-off for Unprecedented Times: Confronting the Global Crisis in LAC. A. Izquierdo and E. Talvi, coordinators.
Latin America:
Monetary and Fiscal Policy Response
Fiscal Stimulus Announcements
in Latin America
Monetary Policy
(LAC-7*, Interbank interest rate and Nominal
Exchange Rate, in % and Sep-15-08=100)
(% of GDP)
126
9.9%
ON - BUDGET
OFF – TOTAL
BUDGET
Revenue-side Expenditure-side
122
9.7%
118
114
9.3%
110
9.1%
Exchange Rate
Interest Rate
9.5%
Argentina
5.1
0.2
1.1
6.4
Brazil
0.3
0.1
3.3
3.6
Chile
1.0
1.1
0.7
2.8
Mexico
0.5
1.0
0.0
1.5
Peru
0.0
1.4
1.1
2.5
106
8.9%
Source: Credit Suisse
Exchange Rate
102
Interest Rate
8.7%
8.5%
98
Sep-08
Oct-08
Nov-08
Dec-08
Jan-09
Feb-09
LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela.
These countries represent 91% of Latin America’s GDP.
*Excludes Argentina and Venezuela
Source: IDB (2009) Policy-trade-off for Unprecedented Times: Confronting the Global Crisis in LAC. A. Izquierdo and E. Talvi, coordinators.
Monetary and Fiscal Policy Response:
Russian Crisis vs. Current Crisis
Monetary Policy
Fiscal Policy
(LAC-7*, Interbank Interest Rate and Nominal
Exchange Rate, in % and Jul-98=100)
40%
118
38%
116
36%
114
0.0%
-0.5%
34%
112
32%
110
30%
108
28%
106
26%
104
Exchange Rate
24%
-1.0%
Exchange Rate
Interest Rate
Interest Rate
(LAC-7, Structural Fiscal Balance, % of GDP)
-1.2%
-1.5%
-2.0%
-2.5%
102
-3.0%
Sep-99
Jun-99
Mar-99
Dec-98
Sep-98
Jun-98
Sep-98
Mar-98
Aug-98
Dec-97
Jul-98
-3.5%
Sep-97
98
Jun-97
20%
Russian
Crisis
-3.2%
Mar-97
100
Dec-96
22%
LAC-7 is the simple average of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela.
These countries represent 91% of Latin America’s GDP.
*Excludes Argentina and Venezuela
Source: IDB (2009) Policy-trade-off for Unprecedented Times: Confronting the Global Crisis in LAC. A. Izquierdo and E. Talvi, coordinators.
The End of the Panglossian Period:
International Financial Conditions
Corporate Bond Spreads
Corporate Bonds: Issuance
(Latin CEMBI; 01-Jan-07 = 100)
(LAC-7, billions of USD)
25
Variation in bps
900
Jan-07 Jan.07May.08
800
CEMBI
221
Jun.08Mar.09
Total
06-Mar-09
516
603
824
87
21.2
20
700
600
15
500
400
10
300
200
5
2.5
100
0
Mar-09
Dec-08
Sep-08
Jun-08
Mar-08
Dec-07
Sep-07
Jun-07
Mar-07
Mar-09
Jan-09
Nov-08
Sep-08
Jul-08
May-08
Mar-08
Jan-08
Nov-07
Sep-07
Jul-07
May-07
Mar-07
Jan-07
0
Source: IDB (2009) Policy-trade-off for Unprecedented Times: Confronting the Global Crisis in LAC. A. Izquierdo and E. Talvi, coordinators.
External Factors:
International Financial Conditions
Sovereign Bonds: Maturity
Sovereign Bonds: Issuance
(LAC-7, issuances with maturity less than 1 year, % of
total issuance)
(LAC-7, billions of USD)
100
97.8
65%
63.3%
60%
90
55%
80
50%
45%
70
40%
60
56.6
35%
28.6%
30%
50
LAC-7 is the simple sum of the seven major Latin American countries, namely Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. These countries
represent 91% of Latin America’s GDP.
Source: IDB (2009) Policy-trade-off for Unprecedented Times: Confronting the Global Crisis in LAC. A. Izquierdo and E. Talvi, coordinators.
Mar-09
Dec-08
Sep-08
Jun-08
Mar-08
Dec-07
Sep-07
Mar-09
Dec-08
Sep-08
Jun-08
Mar-08
Dec-07
Sep-07
Jun-07
Mar-07
20%
Jun-07
40
Mar-07
25%