Financial Crisis Jeffrey Frankel Harpel Professor of Capital Formation & Growth Cutting Edge of Development Thinking Outline What characteristics have helped emerging markets resist financial contagion in the past
Arrillaga, Pauline, National Writer has reference to this Academic Journal, PHwiki organized this Journal Financial Crisis Jeffrey Frankel Harpel Professor of Capital Formation & Growth Cutting Edge of Development Thinking Harvard University, May 12, 2010 Outline Emerging Markets & Developing Countries in the Global Financial Crisis The 3rd capital inflow boom 2003-2008: Was it different Lessons of 1994-2002 on avoiding crises: Did they hold up in 2008 Big emerging markets come of age in 2009 Macroeconomics: decoupling Global governance: the G-20 replaces the G-7 The case of the RMB: sterilized intervention of inflows Addenda Global current account imbalances Countercyclical fiscal policy Cycle in capital flows to emerging markets 1st developing country lending boom (recycling petro dollars): 1975-1981 Ended in international debt crisis 1982 Lean years (Lost Decade): 1982-1989 2nd lending boom (emerging markets): 1990-96 Ended in East Asia crisis 1997 Lean years: 1997-2003 3rd boom (incl. China & India this time): 2003-2008 Global financial crisis of 2008-09
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This time, many countries used the inflows to build up as long as ex reserves, rather than to finance Current Account deficits 2003-07 boom 1991-97 boom Source: Benn Steil, Lessons of the Financial Crisis, CFR, March 2009 The financial crisis was abruptly transmitted to emerging markets in September 2008. What characteristics have helped emerging markets resist financial contagion in the past High FX reserves in addition to /or floating currency Low as long as eign-denominated debt (currency mismatch) Low short-term debt (maturity mis-match) High Foreign Direct Investment Strong initial budget, allowing room to ease. High export/GDP ratio, Sachs (1985); Eaton & Gersovitz (1981), Rose (2002); Calvo, Izquierdo & Talvi (2003); Edwards (AER, 2004); Cavallo & Frankel (JIMF, 2008).
Are big current account deficits dangerous Neoclassical theory if a country has a low capital/labor ratio or transitory negative shock, a large CAD can be optimal. In practice Developing countries with big CADs often get into trouble. Traditional rule of thumb: CAD > approx. 4% GDP is a danger signal. Lawson Fallacy CAD not dangerous if government budget is balanced, so borrowing goes to finance private sector, rather than BD. Amendment after 1994 Mexico crisis CAD not dangerous if BD=0 in addition to S is high, so the borrowing goes to finance private I, rather than BD or C. Amendment after 1997 East Asia crisis CAD not dangerous if BD=0, S is high, in addition to I is well-allocated, so the borrowing goes to finance high-return I, rather than BD or C or empty beach-front condos (Thail in addition to ) & unneeded steel companies (Korea). Amendment after 2008 financial crisis yes, all CADs are dangerous. Lessons of the 1994-2002 crises Many emerging markets after the 1990s learned to (1) float or hold large reserves or both (2) use capital inflows to finance reserve accumulation (self-insurance), rather than current account deficits (3) take capital inflows more in the as long as m of FDI or local-currency-denominated debt flows; avoiding the currency mismatch of $ liabilities in addition to avoiding short-term bank loans. The ratio of reserves to short-term debt is the most robust predictor of crisis likelihood & severity. e.g. the Guidotti Rule: Keep ratio >1 Early Warning Indicators: Some references on statistical predictors of crises among developing countries Jeffrey Sachs, Aaron Tornell & Andres Velasco, Financial Crises in Emerging Markets: The Lessons from 1995 (1996): Combination of weak fundamentals (changes RER or credit/GDP) in addition to low reserves (relative to M2) made countries vulnerable to tequila contagion. J. Frankel & Andrew Rose, “Currency Crashes in Emerging Markets” (1996): Composition of capital inflow matters (more than the total): short-term bank debt raises the probability of crash; FDI & reserves lower the probability. Graciela Kaminsky, Saul Lizondo & Carmen Reinhart, Leading Indicators of Currency Crises (1998). Best predictors: Real ex. rate, M2/Res, GDP, equity prices. A.Berg, E. Borensztein, G.M.Milesi-Ferretti, & C.Pattillo, Anticipating Balance of Payments Crises: The Role of Early Warning Systems, IMF (1999). The early warning indicators dont hold up as well out-of-sample.
Did those who obeyed the lessons of 1994-2002 done better in response to the 2008-09 shock Some who had large current account deficits & as long as eign-currency debts did have the most trouble, particularly in Central & E.Europe: Hungary, Ukraine, Latvia Despite views of some economists that emerging market countries had been holding too many reserves, they appear to have turned out the ultimate insurance. Aizenman (2009): The deleveraging triggered by the crisis implies that countries that hoarded reserves have been reaping the benefits. Systematic studies are only starting. Obstfeld, Shambaugh & Taylor (2009a, b): Finding: A particular measure of countries reserve holdings just be as long as e the current crisis, relative to requirements (M2), predicts 2008 depreciation. Current account balances & short-term debt levels are not statistically significant predictors, once reserve levels are taken into account. Rose & Spiegel (2009a, b) in addition to Blanchard (2009) found no role as long as reserves in predicting who got into trouble. Frankel & Saravelos (May 2010): We get stronger results, because we consider crisis period to have gone thru March 2009. Top 8 categories of Leading Indicators in pre-2008-crisis literature Frankel & Saravelos (2010)
Next 9 categories of Leading Indicators in pre-2008-crisis literature Frankel & Saravelos (2010) Equity prices suggest that the global financial crisis did not begin in earnest until Sept. 2008, nor end until March 2009 – whereas Rose & Spiegel, Obstfeld et al, look simply at 2008
Best in addition to Worst Per as long as ming Countries – F&S (2010), Appendix 4 Best in addition to Worst Per as long as ming Countries – F&S (2010), Appendix 4 Best in addition to Worst Per as long as ming Countries – F&S (2010), Appendix 4
Best in addition to Worst Per as long as ming Countries – F&S (2010), Appendix 4 F & Saravelos (2010): Bivariate F & Saravelos (2010): Multivariate
Actual versus Predicted Incidence of 2008-09 Crisis Frankel & Saravelos (2010) Conclusions from Frankel & Saravelos (May 2010) Early Warning Indicators were useful in predicting which countries were hit by the 2008-09 global financial shock, especially the most tried- in addition to -trued EWIs: Reserves (e.g., as a ratio to short-term debt), Preceding real exchange rate appreciation (relative to a long-run average RER). Among others that do the best: CA & Natl. Saving Big emerging markets
Big emerging markets came of age in 2009 Macroeconomics: decoupling Global governance: the G-20 replaces the G-7 The RMB issue De-coupling turned out to be real after all at least with respect to East Asia, which has rebounded very strongly over the last year, after a sharp loss of exports over the preceding year, from 2008 QI to 2009 Q I. Chinas growth has not only returned to its blistering pace of 10% but by now is a source of global growth because China is now a much larger share of the world economy than in the 1980s or 90s. India, Indonesia, & other Asian countries also weathered the global recession well, in addition to are growing strongly. Asian exports were especially hard-hit via RGE Monitor 2009 Global Outlook
Emerging & Devel- 6.1 2.4 6.3 6.5 5.2 6.3 7.3 oping Economies Central & E.Europe 3.0 3.7 2.8 3.4 1.9 1.3 4.1 Russia 5.6 7.9 4.0 3.3 3.8 1.7 4.2 Developing Asia 7.9 6.6 8.7 8.7 8.6 8.9 9.1 China 9.6 8.7 10.0 9.9 10.7 9.4 10.1 India 7.3 5.7 8.8 8.4 6.0 10.9 8.2 ASEAN-5 4.7 1.7 5.4 5.6 5.0 4.2 6.2 Middle East & N.Africa 5.1 2.4 4.5 4.8 Sub-Saharan Africa 5.5 2.1 4.7 5.9 Western Hemisphere 4.3 1.8 4.0 4.0 Brazil 5.1 0.2 5.5 4.1 4.3 4.2 4.2 Mexico 1.5 6.5 4.2 4.5 2.4 2.3 5.5 Year over Year Q4 over Q4 (2010-2011 are projections) 2008 2009 2010 2011 2009 2010 2011 WEO as long as ecasts, April 2010 The G-20 in 2010 Canada & Korea will host the summit meetings in June & November, respectively. The true significance of the G-20 in 2009 The G-20 accounts as long as 85% of world GDP The developing countries are the ones with strong fiscal positions! A turning point: The more inclusive group has suddenly become central to global governance, eclipsing the G-7, in addition to thereby at last giving major developing/emerging countries some representation, after decades of fruitless talk about raising emerging-market representation in IMF & World Bank.
A year later, they had the highest popularity rating of any ministers Why Developing countries in 2009, as long as the 1st time, were able to run countercyclical fiscal policies: On a global scale, Chinas fiscal expansion was the most important example. Chiles institutional re as long as m could be a model as long as all: Structural surplus of 1% of GDP (reduced to ½ %, then 0) if economy is at full employment & price of copper at its long-run level. Estimates of full employment & LR price of copper are made by commissions of experts, not politicians. those that had wisely saved during the boom Often in the as long as m of ForEx reserves or a SWF. Further thoughts on macro policy in mineral-exporting countries The Natural Resource Curse: A Survey, as long as thcoming in Export Perils, edited by B. Shaffer (U.Penn. Press). March 2010. A Comparison of Monetary Anchor Options as long as Commodity-Exporters in Latin America in addition to the Caribbean, Myths in addition to Realities of Commodity Dependence: Policy Challenges in addition to Opportunities as long as Latin America in addition to the Caribbean, World Bank, Sept. 2009. Peg the Export Price Index: A Proposed Monetary Regime as long as Small Countries, Journal of Policy Modeling, June 2005 .
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