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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

				
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