The Financial Crisis and the MDGs

1

Carlos A. Primo BragaDirector, PRMED

Commonwealth MinisterialOctober 2009

A Perfect Storm

Presentation outlineThe financial crisis in a nutshell

Implications for industrialized and developing economies

The MDGs and the crisisPerformance of Developing Commonwealth

Countries

Concluding remarks3

A Tale of Two DepressionsSource: Eichengreen & O’Rourke (2009)

94

The crisis in a nutshell

Antecedents of the crisis:Boom-bust credit boom, fueled by lax

monetary policy in developed countries

An asset price bubble and excess investment in real estate (poor assessment of risks)

Poor corporate governance

Macroeconomic imbalances5

Additional considerations

“Opaqueness” of new financial products -- Reckless use of collateralized debt obligations -- Growing reliance on the originate-to-distribute business model/poorer risk assignment

Financial integration-- Much larger capital flows /cross-border positions

Major regulatory and supervision changes-- The repeal of Glass Steagall (1999) to allow US conglomerates to

leverage their balance sheets like EU universal banks; transition from Basel I to Basel II; SEC ruling on net capital (2004)…

Developing Countries: Main Transmission Channels

• Financial sector effects impact on “domestic” financial sector and “sophisticated” firms

• Liquidity squeeze and lower risk appetite higher financial costs

• Lower commodity prices and trade volumes lower export proceeds and government revenues

• Reduction in capital flows and remittances tightened financial sources

7

Relative to past downturns the decline of capital flows has been even more dramatic

Percent

Net private capital flows / GDP in developing countries

Source: DECPG/GDF ; World Bank (2009a)

Percent

1980-83 1997-02

Projection2007-10

Percent of GDP (right axis)

Private capital flows are unlikely to recover to pre-crisis levels for some time

Net Private Capital Flows to Developing Countries percentUS$ billion

0

400

800

1200

1600

0

1

2

3

4

5

6

7

8

9

10

The current crisis, however, will not be a rerun of the Great Depression…

(Source: Brahmbhatt and Pereira da Silva, 2009)

Larger weight of developing countries in the world economy (24% in 2008 vs. 13% in 1929) plus “decoupling” of underlying trend rates of growth (growth gap = growth in Developing Countries – growth in ICs = 0.8 % in the 1990s/3.5% in 2000-08);

Larger share of services in global activity (employment in services less volatile);

Changes in the structure of world trade (greater elasticity of trade with respect to GDP);

Different policy responses: monetary, financial sector, trade and fiscal policies.

10

A recovery is underway, but is relatively weak, uneven, and subject to considerable risks (Source: DEC)

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

-4

-2

0

2

4

6

8

10World

High-income

Middle-income

Low-Income

Sub-Saharan Africa

Real GDP growth rates (%)

The crisis has hurt medium-term growth prospects―with high excess capacity and

unemployment continuing for several years (Source: DEC)

Output gap (% of potential GDP)

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

-8

-6

-4

-2

0

2

4

High-income Middle-income Low-income

2013

Poverty impact of the growth slowdown is large―and rising (Source: DEC)

Increase in number of poor (millions)

US$ 1.25/day US$ 2.00/day0

20

40

60

80

100

120

140

20092010

50

89

64

120

0

20

40

60

80

100

Achieved by 2007 Needed to be achieved by 2007 to be on track

% of goal

Growth collapses are costly for human development outcomes―the MDGs, already

in jeopardy, face further setbacks• Serious shortfalls on most human development MDGs; prospects are gravest in health.

• Sub-Saharan Africa is falling short on all MDGs.

• South Asia lags on all human development MDGs. Achievement of the poverty reduction MDG also is now threatened.

Tracking Progress on MDGs in 143 Developing Countries:

Most countries are falling short on most of the MDGs(# of countries)

15

MDG1.a: Extreme poverty

MDG 1.c: Hunger

MDG 2: Primary education

MDG 3: Gender Parity

MDG 4: Child Mortality

MDG 7.c: Access to safe water

MDG 7.c: Access to sanitation

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

20

16

46

81

7

47

17

23

12

7

13

25

18

11

12

25

15

8

70

19

23

28

30

37

18

39

49

75

60

60

38

23

2

10

17

Achieved target On-track Off-track Serioulsy off-track Insufficient data

Data Source: World Bank (2009b)

MDG shortfalls are more serious in low-income countries, especially in fragile

states• The challenge to achieve the MDGs will increasingly be

concentrated in these countries

Outlook for the MDGs in the Developing Commonwealth Countries

(# of countries)

17

MDG1: Poverty

MDG2: Pri-mary Educa-

tion

MDG3: Gender Par-

ity (Pri. & Sec.)

MDG4: Child Mortality

MDG5: Ma-ternal health

MDG7: 1-Water

MDG7: 2- Sanitation

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

3

13

24

1

1511

24

2

5

1

14

1

5

3

3

222 3

3

6

9

415

17 20

30

2617

8 59 6 8

Insufficient Data Seriously off-Track Off-Track On track Achieved Target

Data Source: World Bank (2009b)

Poverty Reduction Goal in Developing Commonwealth Countries

(# of countries)

18

Poverty Poverty (national line) Malnutrition0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

3 1 24

4 4

51

7

6

8

10

-26-30

-21

Insufficient data Serioulsy off-track Off-track On-track Achieved target

Data Source: World Bank (2009b)

Tracking Progress on MDG3 (Gender Parity) Developing Commonwealth Countries

(# of countries)

19

Gender (primary and secondary)

Gender (primary) Gender (secondary) Gender (tertiary)0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

24 22 21

13

5 7 7

3 41

46

8

-8 -5 -7

-31

Insufficient data Serioulsy off-track Off-track On-track Achieved target

Data Source: World Bank (2009b)

Child Mortality/Measles Immunization Developing Commonwealth Countries

(# of countries)

20

Child mortality Measles immunization0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1

12

1

622

4

1516

-5 -6

Insufficient data Serioulsy off-track Off-track On-track Achieved target

Source: World Bank (2009b)

Access to Safe Water and Sanitation in the Developing Commonwealth Countries

(# of countries)

21

Water Sanitation0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

11

2

4

1

3

3

20

30

-6 -8

Insufficient data Serioulsy off-track Off-track On-track Achieved target

Source: World Bank (2009b)

Responding to a development emergency: priorities for action

• Ensure an adequate fiscal response to support growth and protect the poor―consistent with maintenance of macroeconomic stability

• Improve the climate for recovery in private investment―including paying special attention to strengthening financial systems

• Redouble efforts toward the human development goals―including leveraging the private sector role

• Scale up aid to poor and vulnerable countries• Maintain an open trade and finance system―including action on

the Doha Round• Ensure that the multilateral system has the mandate, resources,

and instruments to support an effective global response to the global crisis

Avoiding a protracted recession calls for a globally coordinated fiscal stimulus―in both

developed and developing countries• Developing countries’ fiscal needs

are rising but fiscal space is narrowing―fiscal positions will weaken on average by more than 2% of GDP in 2009

• Expenditure priorities include social safety nets and infrastructure

• Enabling an adequate fiscal response in developing countries through appropriate financing will be a win-win for all

• Fiscal response needs to be tailored to country circumstances

Deterioration in developing countryfiscal balances, 2009

-6

-5

-4

-3

-2

-1

0

Middle East & North Africa

South Asia Latin America & Caribbean

East Asia & Pacific

Sub-Saharan

Africa

Europe & Central Asia

Percent of GDP

G20 countries – fiscal stimulus and financial sector support

24

1/ In percent of 2009 GDP. Excludes below-the-line operations that involve acquisition of assets.

2/ As of Apr. 15, 2009, in percent of 2008 GDP. Consists of capital injection, purchase of assets and lending by Treasury, and central bank support provided with Treasury backing.Source: IMF

Advanced economies: Average discretionary fiscal expansion in 2009: 1.5% of GDPAverage financial sector support: 5.4% of 2008 GDP

Emerging economies:Average discretionary fiscal expansion in 2009: 2.0% of GDP

Government Debt: Medium Term Prospects (Source: IMF, 2009)

Significant expansion of public debt in advanced economies

25

Debt/GDP 2007 2009 2014Advanced G20 77.6 100.6 119.7

Emerging G20 37.8 38.8 36.4

USA 63.1 88.8 112.0

Japan 187.7 217.4 239.2

UK 44.1 68.6 99.7

Korea 33.0 35.8 39.4Brazil 67.7 70.1 62.2

China 20.2 20.9 21.3

India 80.4 83.7 73.4

Indonesia 35.1 31.1 28.4

External financing from official sources will need to rise substantially

• Developing countries face large external financing gaps in 2009, as private flows will fall well short of financing needs

ECA=Europe & Central Asia; LAC=Latin America & Caribbean; SSA=Sub-Saharan Africa; SAS=South Asia; EAP=East Asia & Pacific; MNA=Middle East & North Africa.

-450

-350

-250

-150

-50

ECA LAC SSA SAS EAP MNA

US$ (billions)

Low case

Base case

-450

-350

-250

-150

-50

ECA LAC SSA SAS EAP MNA

US$ (billions)

Short-term debt due

Long-term debt due

Current account

External financing needs External financing gaps

Developing countries will face large financing gaps into the medium term(= current account balances – principal repayments on private debt vs. private sources of

external financing)

2009 2010 2011 2012 20130

200

400

600

800

1000

1200External Financing Needs

US$ billion

Note: Includes 59 countries with financing gap; Source: World Bank (2009a)

External

financing needs

Financing gap

Domestic resource mobilization must also be strengthened

• Even in Sub-Saharan Africa, with a relatively high dependence on official assistance in many countries, domestic revenue on average constitutes more than 70% of public resources for development

0

50

100

150

200

250

300

350

2002 2003 2004 2005 2006 2007

US$ (billions)

Domestic revenue Private flows ODA

Development finance in Sub-Saharan Africa

Looking Ahead: Globalization Revisited (adapted from Leipziger, 2009)

The crisis impacts economic thinking in a moment of transition: from the triumphalism of the “End of History” to the new emerging consensus around the messages of the Growth Commission

It is recognized that the global economy is unlikely to return to the boom conditions which prevailed shortly before the crisis Environment of large capital flows, low interest rates, and strong growth in trade will

not return for a while Changes in the roles and regulation of financial market participants will be profound Government will have a much larger role in the overall economy, with implications for

short-term and long-term growth Skepticism about globalization will be more pervasive, with increased perceptions of

risk across the spectrum of trade and investment activities The crisis will accelerate a significant rethinking – not necessarily of the overall merits

of globalization – but of how to better harness it for development ends Notably, there has not yet been a significant turning away from globalization by

developing countries, which is important The appetite for multilateral solutions, however, has increased

29

A protracted crisis?

31

Recessions

46 10

3

189

4

1

Credit Crunches

HousePrice Busts

EquityPrice Busts

31

Source: Claessens, Kose, Terrones (2008)

Recessions, Crunches, and Busts Output Trajectory During U.S. Recessions

• Current crisis is one of four of the past 122 recession to include a credit crunch, housing price bust, and equity price bust

• Average of past US recessions has shown that it has taken 5-6 quarters before pre-recession output levels were regained; current recovery will take longer

30

Source: JP Morgan

-2 -1 0 1 2 3 4 5 6 70.96

0.98

1.00

1.02

1.04

Output Trajectory During US Recessions (Pre-recession Output Peak = 1, at time = 0)

1973 Recession

1981 Recession

Average of 7 previous recessions2008:2

J.P Morgan fore-cast through 2010:1

Quarters before and after the peak ( 0 )

Slower world economic growth and higher cost of capital will mean a more difficult environment for developing countries seeking to accelerate growth and progress toward the MDGs.

In this environment, countries’ efforts to enhance efficiency of resource use and improve productivity will be even more important.

Financial crisis: scale of policy responses is country specific, but, given the procyclicality of the financial system, it is important to coordinate financial sector reform and to synchronize macroeconomic responses;

The severity of the downturn highlights the need for an increase in high-impact fiscal expenditures. But embedding stimulus packages in a credible medium-term strategy, that safeguards fiscal sustainability, is key;

Expansion of public debt will be massive. Countries need to design exit strategies to the ongoing fiscal interventions and to introduce growth-enhancing reforms to reassure markets of the public sector’s solvency. This is even more critical for those facing significant fiscal pressures associated with aging-related spending;

Debt sustainability implications for LICs: a function of the crisis duration. Implications of non-concessional borrowing need to be carefully evaluated;

Debt management: the crisis further underscores the importance of debt management practices and makes the Debt Management Facility even more relevant;

Concluding remarks

Beyond 2015: climate change; infrastructure needs; global vs. country targets; fragile states…

WBG response: increase in IBRD lending (mix of Development Policy Loans (budget financing/fast disbursing: financial sector restructuring; contingent source of liquidity...) and Investment Loans (preserving infrastructure spending; support for clean technology; social safety nets...)); fast-tracking IDA funds; Vulnerability Financing Facility; INFRA (support for infrastructure); guarantees via MIGA; new IFC facilities (support for trade; recapitalization of banks; refinancing of microcredit institutions); the Debt Management Facility.

World Bank Group Commitments fiscal years 2009 and 2008 (in U.S. billions)

World Bank Group FY09* FY08• IBRD 32.9 13.5• IDA 14.0 11.2• IFC 10.5+ 11.4+• MIGA 1.4 2.1

TOTAL 58.8 38.2

*Unaudited numbers as of July 1.+Own account only. Excludes $4.5 billion in FY09 and $4.8 billion in FY08 mobilized through syndications and

structured finance.

Concluding remarks (cont.)

References Brahmbhatt, M. and L. Pereira da Silva (2009) “The Global

Financial Crisis: Comparisons with the Great Depression and Scenarios for Recovery” PREM Note 141;

Claessens, S., M.A. Kose, and M.E. Terrones, (2008) “What Happens During Recessions, Crunches and Busts?” SSRN Working Paper Series, December;

Eichengreen, B. & O’Rourke, K. (2009) “A tale of two depressions”, VoxEu, (updated) 06/04/09;

Leipziger, D. (2009) Presentation on the findings of the Growth Commission;

World Bank (2009a) Global Development Finance: Charting a Global Recovery;

World Bank (2009b) Global Monitoring Report 2009: A Development Emergency. A report prepared jointly by staff of the World Bank and the International Monetary Fund.

33