2014 IMF Spillover Report

Emil Stavrev

Research Department

Warsaw, CASE

September 29, 2014

International Monetary Fund

1

1. Changing Growth Patterns are Leading Source of Spillovers at this Point.

2. Recovery and Normalization in Key AEs will Have Global Spillovers.

Nature of spillovers depends on underlying drivers of higher interest rates at source.

For recipients, spillover effects differentiate depending on their fundamentals.

3. EM Slowdown has Global Spillovers, Substantial Local Spillovers.

4. Spillover Risks Remain Relevant Going Forward and Can Interact.

Stronger Action at National Level Aligns with Better Global Outcomes.

Main Messages

EM Growth (percent change year-over-year; period averages)

AE Yield Projections 1/ (10-year; percent)

Sources: IMF, World Economic Outlook; and Consensus Economics.

1/ Rates for United States and United Kingdom. Range based on WEO forecasts from October 2009 used to measure +/-1 standard deviation.

Changing Tides and Global Spillovers

2

0

1

2

3

4

5

6

10 11 12 13 14 15 16 17 18

Forecast Range April 2014 WEO

3

4

5

6

7

8 2003-08 2010-13 2014-18

Pre-Crisis

Post-Crisis

Medium-term

40

60

80

100

120

5

6

7

8

9

10

11

12

13

Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14

EM foreign exchange volatility

U.S. interest rate volatility, Move index (basis points; RHS)

9/17

3 Sources: Bloomberg, L.P.; and IMF staff calculations.

Emerging Market Assets (index; January 1, 2013=100)

Implied Volatility (percent)

90

100

110

120

130

140

150

80

85

90

95

100

105

110

115

120

Jan-13 May-13 Sep-13 Jan-14 May-14 Sep-14

Equities - MSCI EMBI (RHS)

9/17

Taper talk Non-

Taper

Are Market Risks Rebuilding?

Taper talk Non-

Taper

Taper Taper

Spillovers from

Monetary Normalization

International Monetary Fund

5

EM Response in Purchasing Episode 1/ (percent change)

EM Response in Taper Episode 1/ (percent change)

Source: IMF staff calculations.

1/ Average responses during 2-day window around U.S. monetary events. Increase in exchange rate denotes EM currency appreciation.

-2

-1

0

1

2

3

Equity Bond yield Exchange rate

UMP Purchase UMP QE1

-2

-1

0

1

2

3

Equity Bond yield Exchange rate

UMP Taper UMP Taper Talk

Taper Shock Generated Large EM Spillovers

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1.1

1.2

5/22/13 6/21/13 7/21/13 8/20/13 9/19/13 10/19/13 11/18/13 12/18/13 1/17/14 2/16/14 3/18/14 4/17/14 5/17/14

Money Real

Real versus Money Shocks 1/ (percentage points; change in 10-year Treasury bond yield since May 21, 2013)

June 19

FOMC

Statement

Sources: Haver Analytics; and IMF staff calculations.

1/ Historical shock decomposition since May 21, 2013 based on a two-variable VAR estimated on daily data (2003-13). The variables are (log) S&P 500

and the 10-year Treasury bond yield. The VAR is identified with sign restrictions.

Sept. 18

FOMC Statement

“no taper surprise”

Dec. 18

FOMC Statement

“taper announcement”

Jan. 22, 2014

FOMC Statement

6

Drivers of U.S. Yields Evolved during Taper Episode

NEER

(percent change; + = appreciation)

Bond Yield

(basis points)

Source: IMF staff calculations.

1/ G-4 comprises of United States, United Kingdom, Euro area and Japan.

0

10

20

30

40

50

60

Money Real

-4

-2

0

2

4

6

Money Real -0.2

-0.1

0.0

0.1

0.2

Money Real

Industrial Production

(percent change)

Capital Flows

(percent)

7

EM Response to G-4 Shocks 1/ (scaled to a max. response of 100bps in U.S. 10 year yield)

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

Money Real

Different Drivers of Yields Have Different Spillovers

EM Bond Yields and Fundamentals 1/ (2-day change; percentage points)

-3

-2

-1

0

1

Reserves /GDP

Inflation Current account /GDP

Market capitalization /GDP

GDP growth 1-year ahead consensus

8

Sources: IMF staff calculations; and Mishra et al (forthcoming).

1/ Change in yields shown as differences from the mean for one standard deviation change in fundamentals from cross-section averages.

Spillover Effects Differentiate Depending on Fundamentals

International Monetary Fund

Reversal of Fortunes:

Spillovers from Emerging Market

0

10

20

30

40

50

60

70

80

90

100

90 92 94 96 98 00 02 04 06 08 10 12 14

10

Emerging Markets: Evolution of Growth (percent change year-over-year)

Sources: April 2014 World Economic Outlook; Consensus Economics; and staff calculations.

1/ Central and Eastern Europe; consisting of Czech Republic, Hungary, Poland, Russia, and Turkey.

2/ Red bars denote more than 70 percent of sample countries. For years 1990-2002, below the average of 1994-1996 real GDP growth, thereafter below the

2003-2007 average.

0

1

2

3

4

5

6

7

8

9

All Asia Latin America CEE 1/

2003-08 2010-13 2014-18 1993-2013

Synchronized EM Slowdown (percent of EM countries with growth slowdowns) 2/

Gradual and Synchronized Slowdown in EM Growth

11

Source: IMF staff estimates.

Note: Results are significant at 10 percent. The method of estimation is Global VAR using exports plus import value added weights. Generalized Impulse response are used for structural decomposition.

Cumulative Effect of a One-Percentage-Point

Decline in EM Growth (percentage points)

-0.4

-0.3

-0.2

-0.1

0.0

AE United States

Euro Area Japan United Kingdom

Cumulative Effect of a One-Percentage-Point

Decline in China Growth (percentage points)

-0.4

-0.3

-0.2

-0.1

0.0

AE United States

Euro Area

Japan United Kingdom

Other EM

Significant Spillovers Through Trade

-7

-6

-5

-4

-3

-2

-1

0

AE EM

12

Sources: IMF, Primary Commodity Price System; and IMF staff estimates.

Note: Results are significant at 10 percent. The method of estimation is VAR using Cholesky with AE entering first in the ordering. The IMF commodity price index includes energy, metal and food price inflation deflated by US CPI and weighted by their respective shares in global trade.

Cumulative Effect of a One-Percentage-Point GDP Growth Decline on Commodity Prices (percentage points)

Commodity Prices are Heavily Influenced by EM Growth

13 Sources: IMF staff calculations based on BIS; Central Banks; Bankscope; and IMF, International Financial Statistics.

Total AE Bank Capital Losses (percent of GDP)

0.0

0.5

1.0

1.5

Structural EM slowdown Cyclical EM slowdown Funding stress

EM Losses

AE Losses

Risk of Bank Losses through EM Exposures

14

Exposure to Brazil, 2010 – 2012 (exports to Brazil)

0

2

4

6

8

10

12

14

0

5

10

15

20

25

30

35

40 E

CU

VE

N

CO

L

PE

R

CH

L

UR

Y

AR

G

BO

L

PR

Y

percent of total exports

percent of GDP (RHS)

Sources: Country authorities; IMF, Direction of Trade Statistics; PDVSA; World Bank, Migration and Remittances database; and IMF staff calculations.

Local EM Spillovers Can Be Large

CEE + CIS: Regional Remittances (percent of total remittances to the

region; 2012)

0

5

10

15

20

25

30

35

40

45

By s

ou

rce

Tajik

ista

n

Kyrg

yz

Rep

ub

lic

Arm

en

ia

Ukra

ine

Azerb

aija

n

Other

CEE+CIS

Russia

Russia’s largest remittance

recipients

(percent of country’s GDP)

International Monetary Fund

Spillover Risks and Global Policies

16

2. Further slowdown in emerging economies

Unanticipated slowdown that is perceived to be cyclical, eventually seen as structural

(Autonomous) slowdown of ½ percentage point for growth per annum for 3 years

Elements of Global Downside Scenario

1. Sharper tightening in global financial conditions

Sooner-than-expected tightening in key advanced economies (money shock)

Long-term interests rates rise by 100 basis points in first year before easing gradually,

short-term interest rates rise briefly then ease within the year (up 25 bps)

3. Additional financial market stress

Higher risk premia in vulnerable emerging markets (50 basis points)—G20MOD

Calibrated asset price declines and exchange rate movements based on event studies

of past EM-led sell-offs—G40 Model

-1.2

-1.0

-0.8

-0.6

-0.4

-0.2

0.0

2013 2014 2015 2016 2017 2018 2019

Money Shock in U.S. and U.K EM structural slowdown Additional tightening in EM

Recipient AEs: Euro Area and Japan Source of AEs: U.S. and U.K.

Sources: IMF staff estimates; and G20MOD.

-4

-3

-2

-1

0

2013 2014 2015 2016 2017 2018 2019 -4

-3

-2

-1

0

2013 2014 2015 2016 2017 2018 2019

Vulnerable EMs Other EMs

Global Downside Scenario

-1.2

-1.0

-0.8

-0.6

-0.4

-0.2

0.0

2013 2014 2015 2016 2017 2018 2019

(percent; deviation from baseline)

17

Sources: IMF staff calculations; and G40 model.

Simulated Output Effect in 2015

(percent deviation from baseline)

18

Between 3.75 and 2.5

Between 2.5 and 1.5

Losses greater than 3.75

Between 1.5 and .75

Between .75 and .25

Losses less than 0.25

Global Downside Scenario Asynchronous Normalization

Between 3.75 and 2.5

Between 2.5 and 1.5

Losses greater than 3.75

Between 1.5 and .75

Between .75 and .25

Losses less than 0.25

19

Simulated Output Effect in 2015

(percent deviation from baseline)

Sources: IMF staff calculations; and G40 model.

Asynchronous Normalization + EM Slowdown

Global Downside Scenario

Asynchronous Normalization + EM Slowdown + Financial Turmoil

20

Global Downside Scenario

Simulated Output Effect in 2015

(percent deviation from baseline)

Sources: IMF staff calculations; and G40 model.

Between 3.75 and 2.5

Between 2.5 and 1.5

Losses greater than 3.75

Between 1.5 and .75

Between .75 and .25

Losses less than 0.25

Spillover Effects on Output (cumulative contribution to real GDP by 2016; percent deviation from baseline)

-9

-8

-7

-6

-5

-4

-3

-2

-1

0

Source Advanced (US, UK)

Recipient Advanced (EA, JP)

Recipient Advanced Other

Vulnerable Emerging Markets

Remaining Emerging Markets

Own Impact EM Spillovers ADV Spillovers

21 Source: IMF staff estimates.

Different Spillover Effects Across Countries

22

1. Central banks need well-calibrated communications and policy actions.

2. Advanced economies vulnerable to adverse spillovers may need

further monetary accommodation.

3. In EMs, priorities depend on country circumstances and vulnerabilities.

Strengthening fundamentals and policy frameworks where needed to reduce

vulnerabilities; Certain responses can help weather turbulence.

Renewed attention on structural reform priorities for medium-term growth.

4. Scope for cooperation reflects tradeoffs and possibly modest

“spillbacks.”

Policy Implications