Transcript The Ongoing Financial Crisis and its implications for LICs

The Ongoing Financial Crisis:
Implications for Debt
Sustainability in Developing
Countries and the Future of
the DSF
Carlos A. Primo Braga
Director, PRMED
April 25, 2009
1
Presentation outline
• The ongoing financial crisis in a
nutshell
• Debt sustainability: a summary
• Debt sustainability and the crisis
• Debt management and the crisis
• The ongoing crisis: a protracted
one?
• Room for improving the DSF?
2
The crisis in a nutshell
• Antecedents of the crisis:
– Boom-bust credit boom, fueled by lax
monetary policy in developed countries
– Underestimation (poor assessment) of
risks
– Poor corporate governance
– Macroeconomic imbalances (low savings
in some developed countries,...)
– An asset price bubble and excess
investment in real estate
3
Additional considerations
• Financial innovation and increased
opaqueness
-- Reckless use of colaterized debt obligations relying on
mortgages as collateral
-- 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 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
Three Contagion Channels
• 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
6
The crisis in a nutshell
• Countries reactions to the crisis:
– Loose monetary policy
– Recapitalization of financial systems
– Bail out of household and corporate
sectors
– Fiscal stimulus packages
– Financial systems regulatory overhaul
• And IFIs are intermediating more
funds than ever
7
The crisis in a nutshell
Impacts and responses
• Higher financial costs, although benchmark interest rates
will remain low for a while;
• New intermediation channels, although financing gaps
remain significant;
• Renewed focus on fiscal stimulus: fiscal space
considerations.
Bottom line
• Full impact depends on countries’ initial conditions
(fundamentals) and exposure to shocks;
• Final outcome depends on the depth and length of the crisis.
8
Presentation outline
• The ongoing financial crisis in a
nutshell
• Debt sustainability: a summary
• Debt sustainability and the crisis
• Debt management and the crisis
• The ongoing crisis: a protracted
one?
• Room for improving the DSF?
9
List of Heavily Indebted Poor
Countries (as of end March 2009)
24 Post Completion Point Countries
Benin
Ethiopia
Honduras
Mauritania
Rwanda
Tanzania
Bolivia
Ghana
Madagascar
Mozambique
São Tomé and
Príncipe
Uganda
Burkina Faso
Guyana
Malawi
Nicaragua
Senegal
Zambia
Cameroon
Gambia, The
Mali
Niger
Sierra Leone
Burundi
Togo
11 Interim Countries
Afghanistan
Central African
Republic
Congo, Dem. Rep.
of the
Guinea
Haiti
Côte d’Ivoire
Chad
Congo, Rep. of
Guinea-Bissau
Liberia
57 Pre-Decision Point Countries
Comoros
Sudan
Eritrea
Kyrgyz
Republic
Somalia
HIPC: Debt burdens have been
reduced markedly….
In billions of U.S. dollars, in end-2008 NPV terms
160
140
120
50.6
100
40.7
80
60
40
87.3
21.4
73.6
21.4
17.1
20
35.6
30.3
6.8
0
Before traditional
debt relief
After traditional debt After HIPC Initiative
relief
debt relief
24 Completion-Point Countries
After additional
bilateral debt relief
11 Interim Countries
After MDRI
Debt Relief and Debt Sustainability
Progress to date (April 2009)
• 35 out of 40 eligible countries have
passed the decision point and qualified
for HIPC Initiative debt relief
• HIPC Initiative debt relief committed to
the 35 post-decision-point HIPCs is
US$57.3 bln
• Of the 40 HIPCs, 24 countries have
reached the completion point and
qualified for irrevocable debt relief under
the HIPC Initiative and the MDRI,
estimated at a total of US$61.6 bln
• Debt relief is expected to reduce external
debt stock in post-CP HIPCs by about 80
percent in end-2008 NPV terms
Post-CP HIPCs are in a better debt
situation than other HIPCs.
As of 2008
Debt sustainability: a summary
• Debt is sustainable as long as it can be
serviced without resorting to
exceptional financing and/or major
corrections in the balance of income
and expenditures.
• Analyses focuses on indicators such as:
– PV of Debt in percent of: (i) Exports,
(ii) GDP, and (iii) Government
Revenues;
– Debt Service in percent of (i)
Exports, (ii) Government revenues.
13
Risk of Debt Distress
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)
Debt sustainability: a summary
• 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.
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Debt sustainability: a summary
• A critical issue is how long the crisis
will last.
• A short lived crisis will have a small effect
on debt sustainability as relevant
indicators are of a long term nature
(forward looking, 20 yrs).
• In contrast, a protracted crisis will have a
more lasting effect on debt sustainability.
16
Presentation outline
• The ongoing financial crisis in a
nutshell
• Debt sustainability: a summary
• Debt sustainability and the crisis
• Debt management and the crisis
• The ongoing crisis: a protracted
one?
• Room for improving the DSF?
17
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
18
Debt sustainability and the crisis
19
Debt sustainability and the crisis
20
Debt sustainability and the crisis
21
Debt sustainability and the crisis
22
Presentation outline
• The ongoing financial crisis in a
nutshell
• Debt sustainability: a summary
• Debt sustainability and the crisis
• Debt management and the crisis
• The ongoing crisis: a protracted
one?
• Room for improving the DSF?
23
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?
24
The Debt Management Facility as part of the
solution, leveraging existing 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.
Presentation outline
• The ongoing financial crisis in a
nutshell
• Debt sustainability: a summary
• Debt sustainability and the crisis
• Debt management and the crisis
• The ongoing crisis: a protracted
one?
• Room for improving the DSF?
26
The financial crisis will cause a sharp decline in
global growth: the largest since the 1930s
Growth of Real GDP, Percent
24
22
20
Low-income
Middle-income
18
16
14
12
10
World
8
6
4
2
0
-2 1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009
-4
High Income
-6
Source: DEC Prospects Group.
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 6% to 10% in
2003
2004
2005
2006
2007
2008 est
Source: Data collected by WB staff from private sources.
2009
All types of private capital flows to
emerging economies 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.
Potential declines in
remittances and ODA
(USD, % Change)
(% of GDP)
Low Income
Baseline
Low Case
Middle Income
9
25
8
20
7
15
6
5
10
4
5
3
0
2005
2006
2007
2008
2009
2010
2
-5
1
-10
0
Remittance Flows to Developing Countries
Official Development Assistance
Source: World Bank data and staff estimates.
Bottom line: outlook for LICs in 2009
has deteriorated sharply
10
20
GDP Growth
(In percent)
18
WEO Spring 2008
8
Current Account Deficit
(In percent of GDP)
16
Latest projections
14
6
WEO Spring 2008
Latest projections
12
10
4
8
6
2
4
2
0
0
All LICs
SubSaharan
Af rica
Asia
Middle East
and Europe
Latin
America
All LICs
Source: IMF Staff. Latest projections correspond to April 2009.
31
SubSaharan
Af rica
Asia
Middle East
and Europe
Latin
America
A protracted crisis?
• Short-term responses/effects
– Fiscal stimulus packages substitute for the
fall in aggregate demand
– Government’s and IFI’s lending replace
banks and other financial intermediaries
– Recapitalization/lending to banks allow
them to stay in business
32
G20 countries – discretionary fiscal
stimulus in 2009 (% of GDP)
U.S.A
U.K.
Spain
Japan
Italy
Germany
France
Canada
Australia
Advanced Economies Simple average = 1.2%
of GDP
Turkey
South Africa
Saudi Arabia
Russia
Mexico
Korea
Indonesia
India
China
Brazil
Argentina
Emerging Economies Simple average = 1.3%
of GDP
0.0
0.5
1.0
1.5
2.0
2.5
Source: IMF Staff Note to G20 Deputies Jan. 31, 2009
33
3.0
3.5
A protracted crisis?
• Long-term issues:
– Global imbalance: large deficits and
accumulation of debt in some countries
(and reserve accumulation in others)
needs to be reversed, a costly and
difficult adjustment.
– Further balance sheet effects may result
from this adjustment as some
currencies appreciate/depreciate.
– Allocation of losses among stake
holders: a complex economic and
political process.
34
Presentation outline
• The ongoing financial crisis in a
nutshell
• Debt sustainability: a summary
• Debt sustainability and the crisis
• Debt management and the crisis
• The ongoing crisis: a protracted
one?
• Room for improving the DSF?
35
Room for improving the DSF?
• Broadly speaking the DSF
comprises two aspects:
– Country assessments: CPIA, DSA
(“medical check up”)
– Policy on borrowing, including non
concessional (“treatment”)
– Currently the treatment allows for
flexibility (the IMF is revising its own
policy to make it more flexible and the
Bank does a case by case analysis)
36
Room for improving the DSF?
• Bottom line:
– Developing countries need growth and trade
to resume quickly (the sooner the better)
– Need cheap financing to muddle through (the
more and cheaper the better)
• What relaxing the DSF and related
policies would accomplish?
– It would allow countries greater access to
borrowing, but that is not necessarily the
remedy under the current conditions (nonconcessional borrowing implications).
37
Room for improving DSF?
• Is there room for improving the tests
run on the “patient”? YES, ongoing
efforts
• Is there room for more flexible
treatments? YES, but this needs to be
integrated with broader reviews of
concessionality policies
• Analysis of the “tests” and the
“treatments” should not be confused
• LICs should be particularly careful
about the implications of nonconcessional borrowing…
38
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 deepening of the downturn suggests the need for an increase in highimpact fiscal expenditures. But embedding stimulus packages in a credible
medium-term strategy, that safeguards fiscal sustainability, is key;
Debt sustainability implications for LICs: a function of the crisis duration.
Implications of non-concessional borrowing need to be carefully
evaluated;
Debt management: the crisis underscores the importance of debt
management practices and makes the Debt Management Facility even
more relevant;
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); expansion of guarantees (MIGA); new IFC
facilities (support for trade; recapitalization of banks; refinancing of
microcredit institutions).