Presente y futuro del sistema financiero internacional

1. Presente y futuro del sistema financiero internacional SEGIB/ICEI/Fundación Carolina Madrid, 8 de junio 2009 Valpy FitzGerald University of Oxford

2. The global financial crisis

3. At the heart of the crisis: US household behaviour

4. ... but the reaction of financial markets is to increase risk aversion generally

5. Even though official interest rates have fallen to zero ...

6. Emerging market bond spreads reflect risk aversion and contagion

7. So capital flows slow down, and may even reverse in 2009:leading to major debt crises – now focussed on private sector

8. And commodity prices collapse

9. Global industrial activity and international trade hit hard by sudden lack of credit

10. World growth comes to a halt – though IMF optimistic about rapid recovery in 2011!

11. The world is a single market system

12. The Impact on Emerging Market Countries

13. Transmission effect now stronger through open capital markets

14. IMF Stress Index for emerging markets: still a single asset class.

15. Major devaluations mean major real wage cuts as well

16. Emerging Markets “self insured” by accumulating reserves after the experience of the mid-1990s

17. Policy response in Emerging Markets

18. Policy response - 1 • Rapid reaction to export decline (both volume and price) and capital outflow. Output, employment, consumption and investment all falling.  • Although macroeconomic strength (fiscal balance, low inflation, high reserves) greater than in previous crises. These ‘fundamentals’ do not make EMs ‘decoupled’. • But do give more policy space for counter-cyclical policies: initially monetary but increasingly fiscal. •  Retreat from fixed rules or autonomous policy bodies: governments become more active.

19. Policy response - 2 • Monetary policy to maintain bank liquidity to producers is crucial, and more rapid than fiscal measures; but private banks risk averse.  • Effectiveness of monetary policy depends on • depth and sophistication of financial markets • credibility of monetary authorities. So small/weak states have real problems.  • Fiscal expenditure increases impact more than tax cuts; public investment more than welfare – direct transfers quickest but hard to administer.

20. Policy response - 3 • Public investment has little employment impact (unless e.g. rural roads); decades of budget constraint minimized the project portfolio.   • Asia more proactive in countercyclical measures than Latin America; and LA more than Africa. Question of “policy space” • Limited support from IFIs for Developing Countries: most effort to bail out Eastern Europe

21. Medium term recovery prospects • “Delinking” an illusion: hard won gains since 1995 crisis (fiscal balance, reserves, low inflation, exchange stability, sound banking) may be lost. • Much depends on the speed of recovery of (a) the US economy; and (b) commodity prices. Five years at least for both. • Growing doubts about economic development model, changing de facto but still no alternative “doctrine” ...

22. ... although financial development model is already changing • Maintain gains on budget deficit control, reserves protection and competitive RERs • Reconsider open capital accounts; pro-cyclical “automatic” monetary policy; and dismantling of development banking => “market resegmentation”. • Reliance on domestic saving to fund: • public infrastructure/welfare (i.e. tax reform) • private investment for employment and growth

23. Finance and Macroeconomics Prospects: recovery or stagnation?

24. World growth slowing dramatically, and all in it together

25. Who will lead recovery?

26. IMF hopes pinned on China

27. And everyone else will follow?

28. Due to Asia’s growing contribution to total import and world growth 2008 Source: IMF

29. Particularly Chia’s and India’s growing demand for raw materials China and India´s contribution to the growth in world imports (2003-2006) : selected commodities Source: UN Comtrade Source: UN Comtrade

30. Financial recessions are longer and deeper than other shocks

31. And commodity markets will take a long time to recover

32. But the downside could be much worse due to trade linkages

33. Presente y futuro del sistema financiero THANK YOU Valpy FitzGerald University of Oxford

34. Appendix 1 The Impact on Latin America

35. IMF Stress Index for emerging markets: still a single asset class.

36. ... and LA components of IMF index indicate main shock was on securities markets

37. Major forced devaluations in the leading regional economies ...

38. ...lead to major real exchange rate depreciation, and thus real wage decline

39. Longer run issues • Investment: already half of Asian rate; with capital per worker static in the long run (NB EAP rising fast due to ageing plus feminisation); will fall again? • Exports: Shift from manufactures back to primary exports post-1982 amplified boom/bust; but no technological progress (TFPG) and vulnerable to world shift of industry to China and India. • Human capital investment (higher skilling, universities etc) still low; falling further behind Asia; social mobility and inequality deteriorating.

40. Capital formation (main growth driver in LA and new Asia) is low and set to fall

41. Capital stock per worker at the hear of problem of post-1982 strategy: future bleak?

42. APPENDIX 2: Potential Consequences of the Crisis on Latin American Economic International Relations Adapted from: Guillermo Perry ISAF/FCO Conference London, April 2009

43. A1. An Optimistic Medium Term Scenario G 20 agreements consolidate financial stability and facilitate OECD recovery in late 2009 or early 2010 China (and other Asian stimulus packages) succeed and deliver sound growth rates in 2009 (7% China, 6% India, 4% Asia). Commodity Prices bottom out and maintain acceptable historical levels

44. And in Latin America • Investment levels keep at reasonable levels in Peru, Colombia, Brazil and Chile, spurred by commodities long term outlook and sound policies. Growth return to 4-5% levels after a couple of years of 0-2% (Peru 3-4%). • Mexico follows the US recession and recovery. • Argentina, Venezuela feel the pain of previous mistakes, but avoid default. Ecuador? • Populism fades away slowly in Latin America

45. A2. A Pessimistic Medium Term Scenario Deflation and protracted recession in OECD countries. Mexico follows the US into deep recession China and India growth collapse to 2 to 3% . Commodity prices plunge to low historical levels

46. And in Latin America • Venezuela and Ecuador fall into deep macro crisis, recession and political instability: radicalization or change? • A new default and recession in Argentina: return to pro market policies? • The rest of Latin America muddle through a modest recession • Potential electoral success of further populist candidates (Mexico, Peru?)

47. B1. Potential consequences of theOptimistic Medium Term Scenario • National policies: • Some convergence towards pro market policies plus stronger (and more efficient) social policies • Hemispheric relations: • Rebuilding of relations with the US (less aggressive ALBA): • Limited revival of sub-regional integration • Strengthening of OAS with eventual inclusion of Cuba

48. And significantly strengthened links with Asia • Latin America recognizes shift of the global economic center towards the Pacific and Asia • Multiplication of LA-Asian bilateral trade agreements • Stronger LA participation in APEC • Growing importance of FDI flows in both directions (especially from Asia) • Partial integration of some LA manufacturing sectors with “factory Asia”

49. B2. Potential Consequences of the Pessimistic Medium Term Scenario • National Policies • Further polarization between pro market and populist policies • Hemispheric Relations: • Selective bilateral engagement with the US • Radicalization and divisions within ALBA • Agonizing subregional integration: • Except some strengthening of CAF/FLAR • Uneven and modest strengthening of links with Asia