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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
"AIPRG equity credit line"