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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
Outline
I. Origin of the global crisis
II. Impact of crisis on Emerging Economies
III. Global crisis response
IV. Emerging Economies’ crisis policy response
V. Conclusions
I. Origin of the Global Crisis
Global warming (output)
2006
Heating economy—above trend growth
Cooling economy—below trend growth
Global cooling (output)
2009
Heating economy—above trend growth
Cooling economy—below trend growth
Root of crisis
The period of high growth and low interest rates
masked market as well as policy failures:
Financial regulation: perimeter, procyclicality
Macroeconomic policies: asset prices, capital inflows
Global architecture: coordination, warnings, insurance
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
Feedback loops:
Eastern Europe to Western banks
Losses from 20 percent loss on loan Reduction in claims of international banks
portfolio in CEE (in percent of GDP) (in percent of recipient country GDP)
First Round
Second Round
(from East to
(from Belgium
West)
and Austria)
High ( 5%-14%) High ( 5%-24%)
Medium (1% -5%) Medium (1% -5%)
Low (0-1%) Low (0-1%)
II. Impact of Crisis on
Emerging Economies
EMs hit by multiple shocks
1. Sudden stop in capital flows
2. External demand shock
3. Terms of trade shock for commodity exporters
4. Drop in remittances
1. Deleveraging in advanced countries…
Private Sector Credit Growth
20
(q/q, seas. adj. annualized, 4 quarter moving average,
percent)
United Kingdom
15
United States
10
5
Euro Area
0
-5
1989 1994 1999 2004 2009
…led to a sudden stop in capital flows to
EMs, notably Emerging Europe…
Private capital inflows
6
(percent of PPP GDP)
5 CEE
4
3
2
Middle
1 East
0
Asia
-1 Latin
America
-2
-3
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Source: IMF, World Economic Outlook
…where stronger financial linkages
amplified the shock transmission.
1800 1800
Europe, America, and Asia: Cross Border Claims
1600 on Emerging Economies, 2008:Q3 1600
(Billions of U.S. dollars)
1400 1400
1200 1200
1000 1000
Emerging Europe
800 Emerging Asia 800
Emerging America
600 600
400 400
200 200
0 0
Europe Asia America
Deleveraging
means not only
less availability
financing,
but also higher
borrowing
costs.
2. An external demand shock worse than
in past crises…
Volume of Imports by G3
160
G3 imports (2008 = 100)
140 G3 imports during past crises
(100 = start of crisis)
120
Index
100
80
60
40
1999 2001 2003 2005 2007 2009 2011 2013
…is leading to severe output contractions..
Industrial Production, monthly, 2006-2010
(weighted by PPP-GDP, 2006)
115
110
105
Index (Jun-08 = 100)
100
95
90
85 G3
80 EM non-crisis
EM crisis
75 Past crises
70
Jan-2006 Jan-2007 Jan-2008 Jan-2009 Jan-2010
…which tend to be amplified by
strong trade linkages…
30 30
Intraregional Trade, 1997–2007
(Percent of GDP)
25 25
20 20
Africa
15 Middle East 15
Western Hemisphere
Asia
Europe
10 EU 10
5 5
0 0
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
…as in Armenia’s case
Armenia: Exports by Recipient Country, 2008
(in percent of total exports)
Other, 19.7 Russia, 20.2
UK, 3.8
USA, 4.9
Germany, 17.2
Bulgaria, 5.7
Georgia, 7.7
Belgium, 8.5 Netherlands, 12.2
Source: DTS.
3. Fall in commodity prices hitting
commodity exporters very hard
Annual Percentage Changes in Exports and TOT, 2008-09
0
-5 Commodity Exporters
-10 Manufacturers
Change in Exports
-15
COL
-20
EGY DOM
-25 PER
CHL ECU ISL
-30
ARM JAM
-35
SER
KAZ
-40 ALG
VEN RUS
-45
-50 -40 -30 -20 -10 0 10 20 30
Change in Terms of Trade
4. Lower incomes in advanced countries also
means lower remittances to some EMs
Top 10: Projected decline in private current transfers
(in percent of GDP)
0
-1
-1.2 -1.2 -1.1
-1.5 -1.4
-1.6
-2
-2.2
-2.3
-3
-4 -3.8
-5
-6
-7
-7.0
-8
MDA LBN JOR VNM ELS GTM ARM MOR BIH EGY
Emerging Europe and CIS hit worst
Real GDP Growth Projections
15
Armenia
10
CIS
CEE Emerging Markets
5
Advanced Economies
0
-5
-10
2006 2007 2008 2009 2010
Source: IMF, World Economic Outlook
But, are EMs innocent by-standers?
Vulnerabilities explaining market spreads…
EM Credit Default Swaps
Increase in CDS (bps, 2007-2009, median)
1000
900 LVA
800 LIT
EST
700
ROM
600
EGY BGR
500 IDN
SER HUN
SAF VNM CRO
400
KOR
PER
300 PAM POL
COL PHL
BRA THA TUR
200
100
0
0 20 40 60 80 100 120 140
External debt (end-2007, % of GDP)
…and cross-country differentiation in recessions
GDP decline, 2009 proj. Real Effective Exchange Rate External and Public Debt
(Proj., percent) (Since Sep 2008, percent) (Percent of GDP, 2008)
LVA Peg
LIT Peg
EST Peg
UKR
Public Debt
ARM
External Debt
MDA
ROM
BGR Peg
HUN
RUS
CZE
BLR
BIH Peg
KAZ
GEO
POL
-20 -15 -10 -5 0 -30 -20 -10 0 10 0 50 100 150
II. Global crisis response
Global crisis requires global response
A. Coordinated G-20 policy response
B. IMF reforms: resources and lending framework
C. IMF lending
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)
A. G-20 Monetary policy easing
A. Liquidity injections/asset
purchases since January 2008
Liquidity Injections/Asset Purchases (percent of GDP)
0 to 5
5 to 10
10 to 15
> 15
No data
A. Banking recap since January 2008
Recapitalization (percent of GDP)
0 to 2
2 to 5
5 to 10
> 10
No data
B. IMF Reforms—Increase in resources
Size of war chest in relation to potential needs
Triple lending resources to $750 billion
$500 billion in bi-/multi-lateral agreements
Raise
Commitments so far over $400 billion
General SDR allocation of $250 billion
Boostscountry reserves by 75% of quota
Some $100 billion of liquidity to EMs and LICs
Later, quota increase
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)
C. Increase in IMF lending
160 152
US dollar billions
140
120
FCLs
100
86 88
80
60 Traditional
programs
40
14
20
0
1998 2002 2006 May 2009
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
IV. Emerging Economies’ Policy Response
(as seen through the lens of the recent
Fund-supported programs)
EMs policy response often constrained
Exchange rate regime
Degree of dollarization
Fiscal sustainability and credibility
Bank solvency
Institutional weaknesses
Social considerations
Political, electoral cycles
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)
Reflecting these constraints, fiscal deficits
were allowed to widen, but not fully…
Fiscal Adjustment in program cases
average fiscal balance, % of GDP
(excl.Latvia, Mongolia and Seychelles)
0
-1
latest program
-2
projections
-3
-4
fiscal adjustment in
-5 programs
implied overall fiscal
balance w /o adjustment
-6
-7
2003-07 2008 2009
…given the stock of public debt and
other initial conditions
Public Debt (2008) and Primary Balance (2009)
% of GDP
2
1 Belarus
Pakistan Hungary
0
Primary Balance (2009)
-1
Guatemala
Rica
Costa El Salvador
y = 0.07x - 4.17
-2 Serbia 2
R = 0.58
Armenia
Ukraine Georgia
-3 Romania
Latvia
-4
Mongolia
-5
0 10 20 30 40 50 60 70 80
Public Debt (2008)
Even so, fiscal programs are being flexibly
adapted to evolving macro conditions
2009 Overall Fiscal Balance (% GDP)
0.0
0.0
-1.0
-2.0 -1.8
-2.5
-3.0 -2.8
-3.0
-4.0 -3.8 -3.9 -4.0 -4.0
-4.2
-5.0
-5.6 Program
-6.0
Latest Rvw
-6.5
-7.0
ia
ry
e
n
ia
ia
in
sta
rb
rg
ga
en
ra
Se
eo
un
ki
m
Uk
Pa
Ar
G
H
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
Thank you
Back-Up Slides
Crises are costly, come in waves; and
require strong, comprehensive response
Fiscal and Output Costs of Banking Crises in Advanced and EM Countries
(Size of bubble represents gross fiscal cost as percent of GDP)
25
Debt crisis ERM Tequila Asian Current
Output cost: Minimum real GDP growth
20 crisis crisis crisis crisis
during crisis (percent of GDP)
15
Israel 1977 Norway 1991 US 2008
10
(fiscal cost: 30%) (fiscal cost: 3%) (fiscal cost:
Sweden 1991 51%)
5 Japan 1997
(fiscal cost: 4%)
(fiscal cost: 14%)
0
-5
US 1988
(fiscal
-10 cost: 4%)
Spain
-15 1977 Finland 1991 Korea 1997
(fiscal (fiscal cost: 13%) (fiscal cost: 31%)
-20
1975 1980 1985 1990 1995 2000 2005 2010
Starting date of crisis
Source: Laeven and Valencia (2008); FAD-MCM: Public Interventions in the Financial Systems.
When will markets normalize?
Expected duration of market pressures in EM universe
≤1 year, 5 countries
1-2 years, 28 countries
>2 years, 16 countries
Measured as number of quarters in which probability of exiting from the crisis reaches 0.5.
Duration model is estimated in Mecagni et al "Duration of Capital Crises-An Empirical Analysis,
" IMF Working Paper 07/258.
Recent IMF lending in context
Change in Output for Program Cases
15
10
ARG ARG
TUR
5 RUS TUR
COL
Percent change in real GDP 1/
IDN PAK
BRA BRA
0 PHL
BRA MEX COL
IRQ
UKR
BLR POL
ARG COL HUN
MEX
-5 ARM
KOR ROM
URY UKR
TUR
-10
THA ISL
IDN IDN
Size of bubble = access in
-15
ARG percent of quota
LVA
-20
-25
Dec-96 Dec-98 Dec -00 Dec-02 Dec-04 Dec-06 Dec-08
1/ Maximum cumulutive decline in three years from program inception
Large Access, Short Duration
Access in Percent of Quota (size of bubble) and Program Duration
50
Turkey
40
Korea
Uruguay
Latvia
Brazil Argentina
Brazil
Duration (in months)
Argentina Armenia
30
Serbia
Turkey
Pakistan
Iceland
20 Mongolia Guatemala
Belarus
Hungary El Salvador
Brazil Colombia
10 Mexico
Indonesia
Argentina Poland
0
Jan-93 Oct-95 Jul-98 Apr-01 Jan-04 Oct-06 Jul-09 Apr-12
Program approval
Access is large and front-loaded
Access, in percent of quota Access, in percent of 2009 GDP
1200 16
1000 14
12
800
10
600 8
400 6
4
200
2
0 0
Average Armenia Georgia Romania Ukraine Average Armenia Georgia Romania Ukraine
Access, in percent of 2009 short-term debt at First purchase in percent of total access
200 remaining maturity 45
Armenia, 1257 percent before 40
augmentation and 1823 percent 35
150 total
30
25
100
20
15
50 10
5
0 0
Average Armenia Georgia Romania Ukraine Average Armenia Georgia Romania Ukraine
Structural Conditionality
Number of structural conditions in initial
programs
20
Non-core
15
Core
10
5
0
Asian crisis Argentina, Brazil, Current programs
Turkey 2001-03
Core measures: financial/monetary, exchange rate and fiscal policy
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
Evolving circumstances:
downgrade in growth projections
GDP growth in 2009, percent
Sep 2008 WEO
8
projections
6
4
2
0
-2
-4
-6
-8
Jul 2009 WEO
-10 projections
-12
Bulgaria
Romania
Armenia
Georgia
Bosnia
Ukraine
AM average
EM average
Montenegro
Cyprus
Macedonia
Moldova
Israel
Croatia
Exchange rate policy
Should pegs be abandoned in crisis?
Keeping pegs can lead to severe loss of competitiveness with
respect to floaters
Regaining competitiveness (or correcting overvaluation)
under peg imposes harsh deflationary adjustment—plus it
seldom happens in crisis (only Hong Kong and Panama)
However, negative balance-sheet effects of depegging could
be large when liability dollarization pervasive (although
deflation in the context of peg also leads to insolvencies)
Regional contagion is another risk of depegging
Presence of a credible exit strategy from peg, including plans
to join monetary union, is another important consideration
Role of capital controls?
Exchange Rate Policy (continued)
To what extent should a country with flexible ER
intervene in the FX market?
Appropriate to offset disorderly conditions, counter currency
overshooting, and provide FX liquidity to banks
However, to be effective, needs to be accompanied by rate
hikes/active mopping up of domestic currency liquidity and
be part of credible policy response
Trade off use of reserves today with potential demand for
reserve use tomorrow
Exchange rate developments in programs
Pegs/tightly managed Step changes
10 10
0
5
-10
0
-20
-5
-30 ARM
BLR
-10 BIH
GEO
COS -40
SYC
ELS
approval dates
-15 GTM -50
LVA
approval dates -60
-20
Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09
Gradual depreciations
0
-10
-20
HUN
ISL
-30 PAK
ROM
SER
-40 UKR
approval dates
-50
Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09
Monetary Policy in Crisis
Considerations for appropriate monetary policy
stance (flexible exchange rate regimes):
Inflation pressures
Inflation-fighting credentials of monetary authority
Trade-off between (i) growth benefits from lower
interest rates and weaker currency and (ii) costs of
currency depreciation on unhedged balance sheets
Trade-off between (i) LOLR function in face of
deposit runs and (ii) avoidance of exchange rate
overshooting/loss of monetary control
Monetary Policy Instruments
Policy interest rates: The reduction in interest
rates in advanced markets has provided space
for reduction in nominal interest rates in EMs,
although country risk premiums have risen.
Quantitative measures: Especially useful when
the transmission mechanism from policy rates to
the rest of the economy may be impaired by
non-functioning credit markets.
Inflation pressures to persist,
especially for floating currencies
Inflation Projections vs Maastricht
16
14
Czech Republic
Hungary
12 Romania
Poland
10 Bulgaria
Estonia
Latvia
8 Lithuania
Imputed Maastricht Criterion
6
4
2
0
2005 2006 2007 2008 2009 2010 2011 2012
Source: IMF, World Economic Outlook
Fiscal policy: automatic stabilizers
operating in Western Europe…
1
Change in fiscal balance 2009 over 2008
0
-1
-2
-3
-4
-5 Advanced
Europe y = 0.8361x - 0.5989
-6
R2 = 0.7149
-7
-8
-12 -10 -8 -6 -4 -2 0 2
GDP growth in 2009
Source: IMF, World Economic Outlook
…but less evident in Emerging Europe…
1
Change in fiscal balance 2009 over 2008
0
Emerging
-1
Europe
-2
-3
-4
-5
-6 y = 0.0858x - 1.4215
R2 = 0.0497
-7
-8
-12 -10 -8 -6 -4 -2 0 2
GDP growth in 2009
Source: IMF, World Economic Outlook
-10
-8
-6
-4
-2
0
2
4
Ic
el
an
Se d
yc
he
ll e
Co s
st
a
Ri
ca
Co
lom
bia
M
ex
ico
G
ua
te
m
al
a
Ar
m
en
ia
Po
lan
d
La
tvi
a
Loosening
El
Sa
lva
do
r
% of GDP
Be
la
ru
s
Uk
ra
ine
M
on
go
lia
Change in Primary Balance from 2009 to 2008
Se
rb
ia
H
un
ga
ry
Ro
m
an
ia
G
eo
rg
ia
Pa
…despite fiscal easing in 2009...
kis
ta
Tightening
n
Further Fiscal Policy Considerations
Automatic stabilizers are preferable over discretionary
measures to achieve fiscal easing
More timely, better targeted (e.g. unemployment benefits),
and more credibly reversed than discretionary measures
Need to make room for stabilizing financial sector
Government support for recapitalization with safeguards
Investment expenditures and transfers targeting the
unemployed or poorer households (which have higher
propensity to spend) are effective stimulus measures
Subsidies to specific industries and hard-to-reverse
expenditures are not recommended
debt and deficit limits more respected
in emerging Europe, despite worse growth
Performance against Maastricht criteria
unweighted averages, percent of GDP
0
"Excessive" debt
-1
2008
-2 Emerging
2008 Europe
Fiscal balance
-3
-4 Advanced
2009 2010
Europe
-5 2009
"Excessive"
-6 deficit
2010
-7
20 30 40 50 60 70 80
Public debt
Source: IMF, World Economic Outlook
Financial sector policies in crisis
Preserving soundness of financial systems key for:
domestic financial stability and economic growth
stability of interconnected countries
effectiveness of monetary policy transmission
Financial sector policies in crisis—
lessons from previous crises
1. Avoid piecemeal approach
2. Secure confidence of creditors/depositors
3. Ensure upfront loss recognition
4. Facilitate recapitalization
5. Remove nonviable institutions
6. Do not delay debt restructuring
Coordination issues from diversified
financial links through parent banks
Concentration of Emerging Europe Exposure to Western
Europe, H1 2008
(Percent)
100%
80%
60%
40%
20%
0%
BA BY AL SK HR RO MD CZ UA HU BU RU PL MK LV LT EE
Austria Italy Germany France Sweden Switzerland Netherlands Other
Source: Bank for International Settlements, Quarterly Review, June 2008.
Note: Country names are abbreviated according to the ISO standard codes.
1/ Emerging Europe exposure to western European banks is defined as the share of the reporting banks in each western European country in the total
outstanding claims on a given emerging European country (both bank and nonbank sectors). For example, about 42 percent of Croatia's exposures to Western
European reporting banks is owed to Austrian banks, 38 percent to Italian banks, 13 percent to French banks, etc. For the Baltic countries, 85 percent or more of
exposures to the reporting banks is owed to Swedish banks.
Phase 1 – Contain Crisis
Establish credible macroeconomic policies
Provide needed liquidity
All countries have done this
Short maturity, collateral, penalty rates but need for flexibility
Open market operations successful in sterilizing injections
Protect depositors
Most countries have done this
Blanket guarantees successful but may be costly
Depends on size of financial hole and restructuring alternatives
Cover all liabilities except subordinated debt and equity
Announce medium-term restructuring program
Phase 2 – Restructure Banks
Diagnosis, focus on medium-term viability
Recognize losses upfront
Preserve viable, undercapitalized banks:
request time-bound recap/restructuring plans
close oversight and prompt corrective actions
Resolve insolvent, unviable banks:
not all institutions to be rescued
close/merge and liquidate assets
Use of Public Money for Recap
Rationale: To encourage private sector contributions (investor
of last resort)
Principles and safeguards:
All losses recognized/absorbed by existing shareholders
Match private injections with government funds
Government shares could have preferred status
Government representation in Board
Require operational restructuring/asset workouts
Sweeteners (option to buy back government shares)
Allow convertibility of state contribution to Tier 2 capital into Tier 1
capital if CAR falls below given ratio
Phase 3 – Manage Impaired Assets
Resolution of debt overhang needed to restart supply
and demand of credit
Corporate debt restructuring often neglected
Issues in institutional framework
speed versus value
centralized versus decentralized
legal reforms (bankruptcy/foreclosure)
out-of-court debt restructuring (London approach)
Phase 4 – Exit from Crisis Mode
Exit from blanket guarantee if applied
Exit from government ownership of banks
Sale of assets taken over
Overhaul of regulations to not repeat mistakes
Continue corporate restructuring to avoid “second-
wave crisis”
Flexible Credit Line (FCL)
Flexibility to draw or treat as precautionary
Qualification: Very strong fundamentals/policies
No conditions after approval
Access upfront, no cap
expected not to exceed 1000 percent of quota
Renewable arrangements, 6 months or 1 year (with
mid-term review), repurchases same as SBA
Safeguards: Board scrutiny, transparency, PPM
3 users so far: Colombia, Mexico, and Poland
FCL – Qualification Criteria
Very strong fundamentals, policies, and policy
track records
Positive assessment from recent Article IV
Qualification criteria (Annex 1 SM/09/69)
Strength of external position, market access, sound
fiscal position, low/stable inflation, absence of
systemic bank problems, effective bank supervision,
data transparency/integrity
Not all criteria need to be met, but offsetting reasons
needed
High Access Precautionary SBAs
HAPAs for members not eligible/do not request FCL
All BOP needs—credit tranche terms
No hard caps, but exceptional access policy applies
Phasing: can move to 2 instead of 4 purchases a year, in
relation to members’ strength/need
Review frequency: at least two a year
Length: flexible (up to 3 years)
Need to solve “blackout” problem
Access
Normal access limits doubled
200 percent annually, 600 percent cumulative
Exceptional access procedures modified
Both precautionary/nonprecautionary use
Same treatment in current/capital account crises
Eliminate ambiguities (debt sustainability criterion
Simplifying Surchages and Maturities
Figure A: Old Surcharge Schedule Figure B: New Surcharge Schedule
(in basis points) (in basis points)
600 600
500 500
400 400
SRF
300 300 > 300% of quota
SBA/SLF/EFF, > 300% of quota
200 200
SBA/SLF/EFF, 200-300% of quota
100 100
0 0
t t+12 t+24 t+36 t+48 t+60 t t+12 t+24 t+36 t+48 t+60
Time (in months) Time (in months)
Eliminate time-based repurchase expectations (effective immediately)
Remove 100 bps surcharge for credit of 200-300% of quota
Keep 200 bps surcharge for credit above 300% of quota
Introduce a 100 bps surcharge when outstanding credit is above 300% of quota for
more than 3 years
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
Exchange rate policy
Should pegs be abandoned in crisis?
Keeping pegs can lead to severe loss of competitiveness with
respect to floaters
Regaining competitiveness (or correcting overvaluation)
under peg imposes harsh deflationary adjustment—plus it
seldom happens in crisis (only Hong Kong and Panama)
However, negative balance-sheet effects of depegging could
be large when liability dollarization pervasive (although
deflation in the context of peg also leads to insolvencies)
Regional contagion is another risk of depegging
Presence of a credible exit strategy from peg, including plans
to join monetary union, is another important consideration
Role of capital controls?
Monetary Policy in Crisis
Considerations for appropriate monetary policy
stance (flexible exchange rate regimes):
Inflation pressures
Inflation-fighting credentials of monetary authority
Trade-off between (i) growth benefits from lower
interest rates and weaker currency and (ii) costs of
currency depreciation on unhedged balance sheets
Trade-off between (i) LOLR function in face of
deposit runs and (ii) avoidance of exchange rate
overshooting/loss of monetary control
Financial sector policies in crisis
Preserving soundness of financial systems key for:
domestic financial stability and economic growth
stability of interconnected countries
effectiveness of monetary policy transmission
Financial sector policies in crisis—
lessons from previous crises
1. Avoid piecemeal approach
2. Secure confidence of creditors/depositors
3. Ensure upfront loss recognition
4. Facilitate recapitalization
5. Remove nonviable institutions
6. Do not delay debt restructuring
