Financial Crisis and Global Recession: At a Turning Point? Richard Newfarmer Special Representative to UN and WTO World Bank Cairo June 15, 2009
Main messages Recession in the US now appears to be bottoming out, but speed and strength of recovery is uncertain Even though recession will eventually end, several daunting challenges remain, particularly for the poorest countries and vulnerable social groups Domestic policy is critical, but generating a sustained recovery requires new forms of multilateral collaboration
Causes: Macroeconomic policy and changes in the financial system create conditions for the perfect financial storm Excessively easy money after 2001 Fiscal stimulus as US budget swung from surplus to large deficit Expansion of opaque financial innovation Subprime mortgages Home equity lending Consolidated Debt Obligations Credit Default Swaps Emergence of unregulated borrowing in the shadow banking system Mortgage companies Investment banks Hedge funds leading to excessive leverage of consumers, corporates, and public sectors financed by China and other countries accumulating large reserves
but the problem goes back to financial deregulation after 1980 and again after 2001
and the deteriorating global imbalances Current account balance, billions of dollars, 2002 and 2006, 2008 2008 2006 2002 Source: World Bank.
Crash of Lehman in September...precipitated financial panic that swept through global markets MSCI equity price indexes, January 2005=100 Emerging markets So 30% of household wealth wiped out $4 trillion of equity worldwide Pension funds obliterated Unprecidented contraction in consumption USA Euro Area Sept-2008 Source: World Bank, Global Economic Prospects, 2009
Contracting consumption in rich countries transmits recession to poor countries as world trade collapses Percentage change Annual growth of global trade volumes 15 12 9 6 3-1 -4 1981 1984 1987 1990 1993 1996 1999 2002 2005 2008-7 -10 Source: World Bank, Global Economic Prospects, 2009
Trade plummets in all regions Export Growth by Region 60 40 20 0 jan feb mar apr may jun jul aug sep oct nov dec jan feb -20-40 EAP ECA LAC MENA NOA SAS SSA Source: Datastream, U.S. Commerce Department and authors calculations. Simple average of growth rates across economies within regions for a balanced sample of 45 economies reporting data 8
Terms of trade shocks will compound difficulties in several countries
and diminished capital flows have deepened recession in the developing world Net private capital flows / GDP in developing countries Percent Projection 2007-10 1980-83 1997-02 Source: World Bank, DEC Prospects Group.
So now the world economy is contracting. for the first time in the last half-century Percent Growth of real GDP Developing World High Income Source: World Bank, DEC Prospects Group, Consensus Forecast, May 2009.
Developing countries stand to lose some 4 percentage points of GDP growth November 2008 Current Some 90 million additional workers are expected to be trapped in poverty with some 47 million in South Asia and 24 million in South-Saharan Africa. Source: World Bank, DEC prospect group, April 2009
Green shoots? Incipient signs of recovery.? Credit markets have stabilized secondary markets beginning to reappear Basis points 400 350 300 250 200 150 100 50 0 Spread between 3 month $ LIBOR and $ OIS Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 Source: World Bank, DEC Prospects Group.
Green shoots? Incipient signs of recovery. Credit markets have stabilized secondary markets beginning to reappear Equity markets appear to have established a floor Source: JP Morgan, World Financial Markets, June 2009
Green shoots? Incipient signs of recovery. Credit markets have stabilized secondary markets beginning to reappear Equity markets appear to have established a floor Personal income in US rose 0.4% in April household savings hit 5.7% of disposable income (highest since 1995) Some life in the real sectors Source: JP Morgan, World Financial Markets, June 2009
Green shoots? Incipient signs of recovery. and China s fiscal stimulus is beginning to take hold Source: JP Morgan, World Financial Markets, June 2009
Outlook? Recovery will probably begin later this year or early next year but strength is uncertain % change GDP annual growth rates (%) Forecast 7 5 Developing countries 3 1 High-income countries -1-3 1980 1985 1990 1995 2000 2005 2010 Shape of the coming recession depends on responding to several daunting challenges? Source: World Bank, Global Economic Prospects, 2009 and GEP Update, 2009
Daunting challenge: for rich countries, taking bad debt off the books of the banks Market Value as of January 20 th 2009, US$ b. Market Value as of Q2 2007, US$ b. Morgan Stanley RBS 120 Deutsche Bank 76 Credit Agricole 67 Societe Generale 80 Barclays 91 BNP Paribas 108 Unicredit 93 UBS 116 49 16 4.6 10.3 17 26 7.4 32.5 26 35 Citigroup 255 JP Morgan HSBC 215 165 Credit Suisse 75 Goldman Sachs 100 Santander 116 27 35 64 19 85 97 Source: Bloomberg, Jan 20 th 2009
Daunting challenges: Providing adequate financial support to maintain growth in developing countries Financing Figure gaps 1.e: range Credit from $200 crunch b to $700 b. means developing countries face significant funding gaps Estimated funding gap in 2009 by region 0-100 -200-300 -400-500 -600-700 -800 All developing countries East Asia and Pacific Europe and Central Asia Latin America and the Caribbean Middle East and North Africa South Asia Low estimate Base High estimate Source: World Bank, DEC Prospects Group. Sub- Saharan Africa
Daunting challenges: At-risk countries Those are at risk: export only a few commodities have large % in poverty have weak fiscal positions have low reserves/ high debt Source: IMF, 2009 Implications of slowdown Crises in Mexico, Argentina, and East Asia increased poverty dramatically 200 million likely to be trapped in poverty Infant mortality and child mortality rises 200,000-400,000 infants annually Cutbacks in health services
Daunting challenges: Providing support to workers and the poor Widening fiscal deficits will put pressures on social safety nets Figure 1.d: Weaker revenues will lead fiscal deficits to widen sharply in 2009 Fiscal deficits will widen sharply in 2009 0 projected deterioration (change) in fiscal balance, percentage points of GDP -2-4 -6 Middle-East & North Africa South Asia Latin America & Caribbean East Asia & Pacific Sub- Saharan Africa Source: World Bank, DEC Prospects Group. Europe & Central Asia
Daunting challenges: Providing support to workers and the poor Widening fiscal deficits will put pressures on social safety nets 25 Poor households suffer declines in remittances Remittance flows to developing countries (USD, % change) 20 15 Baseline 10 5 0-5 Low case 2005 2006 2007 2008 2009 2010-10
Daunting challenges: Providing support to workers and the poor Widening fiscal deficits will put pressures on social safety nets Poor households suffer declines in remittances and continued higher food and fuel prices Source: World Bank, Prospects Group
Source: JP Morgan, World Financial Markets, June 2009 Daunting challenges: Providing support to workers and the poor Widening fiscal deficits will put pressures on social safety nets Poor households suffer declines in remittances and continued higher food and fuel prices Firms will face tighter credit conditions and weaker demand, so they will be slow to create new jobs and unemployment will rise
Daunting challenges: Providing support to the unemployed 23 million more workers will be unemployed in 2009 than in 2007 Recessions with housing busts involve deepest employment cuts and longest period of recovery (Claessens, et al, 2008) Jobs are lost more quickly in contraction than are replaced during subsequent recovery (Rijkers, 2009) Employment usually takes twice as long to recover as output (Reinhard, et al 2002) Poor urban workers often move to agriculture if that is feasible (e.g., in East Asia crisis, 30-40% of displaced workers moved).
Policy options? For developing countries Counter-cyclical policies: But only open to countries with access to noninflationary sources of finance and a sound investment climate Since trade is a main channel of recession, policies to reduce trade costs can position countries to take advantage of recovery border and customs reforms port reforms improving logistics management Investment in labor-intensive and trade-related infrastructure, such as rural roads
Policy options? For developing countries Counter-cyclical policies: But only open to countries with access to noninflationary sources of finance and a sound investment climate Since trade is a main channel of recession, policies to reduce trade costs can position countries to take advantage of recovery Policies to support workers and the poor Increase in unemployment benefits Wage subsidies and lowering wage taxes Tariff reductions on food imports Public employment programs Conditional cash transfers programs (stay in school programs) Public investments in labor-intensive and trade-related infrastructure, such as rural roads
Multilateral collaboration is crucial and the G20 leaders have begun the process G20 Summit April 2 Agreed: Accelerated restructuring of banks and increased regulation Pledge to avoid protection Fiscal stimulus and expansive monetary policy Mobilization of more capital for developing countries IMF $700- b. New arrangement to borrow (NAB) World Bank MDBs Capital increase for ADB Reform of the IMF and World Bank Increased capital, new voting, merit selection of leaders
but improving the multilateral response requires Fulfilling pledges for development assistance Keeping global markets open and resisting pressures for trade protection and renewing a commitment to the Doha Development agenda Improving regulation of financial markets will require careful balancing of national regulatory authorities with international cooperation Developing multilateral governance mechanisms to be more inclusive
Conclusion Recovery is near, but its strength is in doubt and it will take many quarters to have full effect on incomes Meantime, assertive policy interventions are needed to protect core social spending and support households and invest in reforms that will revive growth The G20 process has helped but much remains to be done in keeping markets open, financial regulation, and providing adequate development assistance
Acknowledgements and Selected References This presentation was prepared with inputs from Mansoor Dailami of DECPG, Pierella Paci of PREM, and Margaret Grosh of HDN Claessens, S. M. Kose, and M. Terrones (2008) What Happens During Recessions, Crunches and Busts IMF Working Paper WP/08/274 December Consensus Forecast, June 2009 International Monetary Fund (2009) The Implications of the Global Financial Crisis for Low-Income Countries March JP Morgan, various reports in October, 2008 June 2009. Lin, Justin The Impact of the Financial Crisis on Developing Countries Paper presented at the Korean Development Institute, October 31. OECD, Economic Outlook Interim Report March, 2009 World Bank, 2008 Coping with New Strains in the Global Trading System: Doha Round, Food Prices, and Aid for Trade IMF - World Bank Staff Paper, September. World Bank 2008, Global Economic Prospects, 2009, and Up-date March 2009 and Global Development Finance, 2009 June 2009
Financial Crisis and Global Recession: At a Turning Point? Richard Newfarmer Special Representative to UN and WTO World Bank Cairo June 15, 2009