The Financial Tsunami:The Financial Tsunami:Implications for South AsiaImplications for South Asia
ICRIER Conference, New Delhi, IndiaICRIER Conference, New Delhi, India
November 6November 6--7, 20087, 2008
Ernesto May, DirectorErnesto May, DirectorPoverty Reduction, Economic Management, Finance and Private SectPoverty Reduction, Economic Management, Finance and Private Sector or DevelopmentDevelopmentSouth Asia RegionSouth Asia RegionThe World BankThe World Bank
OutlineOutline
Sketch of the financial Sketch of the financial tsunamitsunami
How was South Asia positioned to How was South Asia positioned to receive the financial tsunami?receive the financial tsunami?
What are possible implications for What are possible implications for South AsiaSouth Asia’’s economic prospects?s economic prospects?
Immediate and medium term policy Immediate and medium term policy response, lessons being learnedresponse, lessons being learned
Sketch of the Financial Tsunami
Originated in the US, still has a long way to go and no country is really isolated from itMany factors contributed but two possibly dominate—the rapid growth in global liquidity and the permissive regulatory environmentWhen the credit crisis intensified, policy mistakes were made– Bail out packages never got ahead of the markets– Lehman’s collapse led to a breakdown in trust among
financial intermediariesFrom that point onwards, the challenge became how to prevent a collapse of the global financial system and deep recessionThe speed with which the crisis is affecting economic activity around the world is staggering.
OutlineOutline
Sketch of the financial Sketch of the financial tsunamitsunami
How was South Asia positioned to How was South Asia positioned to receive the financial tsunami?receive the financial tsunami?
What are possible implications for What are possible implications for South AsiaSouth Asia’’s economic prospects?s economic prospects?
Immediate and medium term policy Immediate and medium term policy response, lessons being learnedresponse, lessons being learned
Global Economic Growth: Before the TsunamiGlobal Economic Growth: Before the Tsunami
R eal G row th R ate
0
2
4
6
8
1 0
2003-06 1/ 2007 2008 2 009
Per
cent
ann
ual c
hang
e
W orld High Incomes Developing countries South Asia
Source : W orld B ank G loba l Developm ent F inanc e 2008.1/ Average o f 2003-2006
The Twin Shocks: Food and Fuel PricesThe Twin Shocks: Food and Fuel Prices
World Bank Weighted Index of Commodity Prices
0100
200300400
500600
2000
2001
2002
2003
2004
2005
2006
2007
2008
(May
)
FERTILIZER FOOD GRAINS ENERGY
Regional Impact of the Twin ShocksRegional Impact of the Twin Shocks
A ll c om m odit ies F ood E nergy
S outh A s ia -9.6 0.2 -9.1E as t A s ia and P ac ific -1.0 0.4 -0.4S ub-S aharan A fric a 25.5 -2.0 22.7Lat in A m eric a and Carribean 10.1 0.9 5.1E urope and Centra l A s ia 12.8 -0.6 10.5M iddle E as t and North A fric a 36.4 -2.7 44.9E A P O il Im porters -13.3 -1.4 -24.4
China -3.9 -0.1 -1.8S S A O il Im porters 2.5 -1.6 -4.6Sourc e: W or ld Bank s ta f f es timates .Notes : 1 . A s a s hare of 2002 GDP.
T e rm s o f T ra d e Im p a c tJan 2003 to M ay 20081
A ll c om m od it ie s F ood E ne rgy
B a n g lades h -7 .7 -3 .1 -2 .6Ind ia -9 .5 0 .5 -9 .5S ri Lank a -10 .2 -2 .4 -7 .7M a ld ive s -3 4 .1 -3 .9 -1 9 .6N epa l -21 .2 -3 .4 -11 .0P ak is tan -11 .3 1 .6 -11 .8S o u rc e : W o r ld B a n k s ta f f e s tima te s .No te s : 1 . A s a s h a re o f 2 0 0 2 G DP.
T e rm s o f T ra d e Im p a c t in S o u th A s ia R e g io nJan 2 0 0 3 to M ay 2 0 0 8 1
South Asia: Impact of the Twin ShocksSouth Asia: Impact of the Twin Shocks
-4.2-1.9-1.5-1.2-0.11.6South Asia ( SAS )
-8.9-5.8-5.4-3.3-0.84.3Pakistan ( PAK )
1.2-1.2-0.10.0-0.61.9Nepal ( NPL )
-7.8-3.9-5.3-3.2-3.4-0.6Sri Lanka ( LKA )
-3.8-1.6-1.0-1.00.11.5India ( IND )
0.81.22.0-0.3-0.50.3Bangladesh ( BGD )
200820072006200520042003
South Asia: Deteriorating Current AccountsSouth Asia: Deteriorating Current Accounts% share of GDP
-8.1-6.3-6.1-5.9-6.3-7.7South Asia ( SAS )
-7.4-4.2-4.2-0.4-2.1-1.0Pakistan ( PAK )
-2.8-1.4-1.6-0.8-0.9-1.8Nepal ( NPL )
-7.5-7.7-8.1-8.4-7.7-7.6Sri Lanka ( LKA )
-8.5-6.8-6.5-6.8-7.2-9.1India ( IND )
-4.7-3.7-3.3-3.4-2.9-3.4Bangladesh ( BGD )
200820072006200520042003
South Asia: High or rising fiscal deficitsSouth Asia: High or rising fiscal deficits% share of GDP
Figure 5: Trend in Inflation in South Asia
0.00
5.00
10.00
15.00
20.00
25.00
30.00
2000
2001
2002
2003
2004
2005
2006
2007
2008
Jan
2008
Feb
2008
Mar20
08Ap
r20
08May
2008
Jun
2008
Jul
Infla
tion
rate
(%)
India Nepal Pakistan Sri Lanka Bangladesh
South Asia: Inflationary PressuresSouth Asia: Inflationary PressuresAnnual % rates
OutlineOutline
Sketch of the financial Sketch of the financial tsunamitsunami
How was South Asia positioned to How was South Asia positioned to receive the financial receive the financial tsunamitsunami??
What are possible implications for What are possible implications for South AsiaSouth Asia’’s economic prospects?s economic prospects?
Immediate and medium term policy Immediate and medium term policy response, lessons being learnedresponse, lessons being learned
The financial tsunamiThe financial tsunami…… with massive bailouts with massive bailouts and liquidity injections with some impact so farand liquidity injections with some impact so far
Basis pointsBasis points
-50
0
50
100
150
200
250
300
350
Jan-0
7
Feb-07
Mar-07
Apr-07
May-07
Jun-0
7Ju
l-07
Aug-07
Sep-07
Oct-07
Nov-07
Dec-07
Jan-0
8
Feb-08
Mar-08
Apr-08
May-08
Jun-0
8Ju
l-08
Aug-08
Sep-08
Oct-08
USUS
Euro zoneEuro zone
Source: Source: DatastreamDatastream..
Spread between 3Spread between 3--month Libor and policy interest ratesmonth Libor and policy interest rates
14Source: MSCI & IFC.
70
80
90
100
110
120
130
140
150
Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08
MSCI equity price indexes(Jan. 2007 = 100)
Emerging markets
Mature markets
……global equity markets fallingglobal equity markets falling
15-70 -50 -30 -10 10
Composite index
JordanMorocco
ColombiaIsreal
Czech RepublicEgyptChile
ArgentinaMexico
MalaysiaHungary
BrazilThailand
PolandSouth Africa
IndonesiaTaiwan
PeruPhilippines
KoreaIndia
TurkeyPakistanRussian
China
Equity price change Exchange rate change
…… with emerging markets taking a big hitwith emerging markets taking a big hitPercent change in equity prices (in $US) since Oct, 2007
……corporate bond spreads have surgedcorporate bond spreads have surged
0
300
600
900
1200
1500
Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08
Emerging Europe
Latin America
Asia
Basis pointsBasis points
Emerging-market corporate bond (CEMBI) spreadsJan 2007 – Oct 20, 2008
Source: JPMorganSource: JPMorgan
EMBI bond spreads have surgedS&P rating outlook downgraded to “negative” for Pakistan and Sri Lanka
0
400
800
1200
1600
2000
Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08
Pakistan
Emerging markets
Sri LankaBasis pointsBasis points
Emerging-market bond index (EMBI) spreads over U.S. TreasuriesJan 2007 – Oct 23, 2008
Source: JPMorganSource: JPMorgan
Latin America
0
5
10
15
20
25
30
35
2004M1 2005M1 2006M1 2007M1 2008M1
$ billions (12-month moving average)
Bond issuanceBond issuance
……private debt and portfolio equity flows to private debt and portfolio equity flows to developing countries have been fallingdeveloping countries have been falling
Bank lending, bond and equity issuanceJan. 2004 – Sep. 2008
Bank Bank lendinglending
Equity issuance
August 2007
Source: World Bank.Source: World Bank.
$ billions$ billions
0
200
400
600
800
1000
1990 1993 1996 1999 2002 2005 2008P
0
2
4
6
8
Net private debt and equity flows to developing countries1990-2007, projected 2008-09
PercentPercent
Percent of GDP(right axis)
Private capital flows expected to decline furtherPrivate capital flows expected to decline further
Source: World Bank.Source: World Bank.
Momentum in industrial production Momentum in industrial production weakened in recent monthsweakened in recent months
-5
0
5
10
15
2006M1 2007M1 2008M1
Developing
Developing excl. China
High-income OECD
Percentage change(3m/3m)
Annualized growth of industrial production
……with South Asia following suitwith South Asia following suit
0
10
20
2005
M1
2005
M4
2005
M7
2005
M10
2006
M1
2006
M4
2006
M7
2006
M10
2007
M1
2007
M4
2007
M7
2007
M10
2008
M1
2008
M4
2008
M7
Bangladesh
Annual growth of industrial production
Percentage change(12m/12m)
Source: World Bank
India
Developing countries
Pakistan
High income countries
World trade expected to contract,for the first time since 1982
-3
0
3
6
9
12
15
1981 1984 1987 1990 1993 1996 1999 2002 2005 2008
Annual growth of global trade volumesPercentage change
Source: World Bank
……with a slowdown for South Asiawith a slowdown for South Asia
-3
0
3
6
9
12
15
18
21
24
1981 1984 1987 1990 1993 1996 1999 2002 2005 2008
Annual growth of global trade volumesPercentage change
Source: World Bank
South Asia
World
Investment loses force in developing Investment loses force in developing countriescountries……
-3
0
3
6
9
12
15
18
1992 1994 1996 1998 2000 2002 2004 2006 2008 2010
Annual fixed investment growth in developing countries1992 to 2007, projected 2008-2010
Percent
Source: DEC Prospects Group.
South Asia
A revised global economic growth baselineA revised global economic growth baseline……
0
2
4
6
8
2000 2002 2004 2006 2008 2010
High-income OECD
Developing countries
Real GDP growth2000 to 2007, projected 2008-10Percent
“New baseline”
Source: DEC Prospects Group.
…also in South Asia…
0
2
4
6
8
10
2000 2002 2004 2006 2008 2010
High-income OECD
Real GDP growth2000 to 2007, projected 2008-10Percent
“New baseline”
Source: DEC Prospects Group.
South Asia -original baseline
South Asia: Current versus original South Asia: Current versus original economic growth forecasteconomic growth forecast
Current Forecast Survey (" Old Base" )2006 2007 2008 2009 2010 2009 2010
Real GDP (% ch) 9.0 8.4 6.8 5.2 7.5 6.6 7.5 Contr. To GDP Growth
Prv. Cons 3.8 4.6 3.7 2.7 3.2 3.0 3.2Govt. Cons 1.1 0.5 0.9 1.0 0.8 1.0 0.8Fixed Inv. 4.2 3.7 2.3 1.1 3.2 2.5 3.3Stk. Bldg. 0.3 -0.2 0.0 0.0 0.0 0.0 0.0Exports 3.1 1.4 0.8 0.9 2.1 1.2 2.2Imports 3.9 1.4 1.3 0.5 1.8 1.1 1.9Discrepancy 0.5 -0.2 0.3 0.0 0.0 0.0 0.0
Difference = Current - SurveyReal GDP (% ch) -1.4 0.0 Contr. To GDP Growth
Prv. Cons -0.3 0.0Govt. Cons 0.0 0.0Fixed Inv. -1.4 -0.1Stk. Bldg. 0.0 0.0Exports -0.3 0.0Imports -0.5 -0.1Discrepancy 0.0 0.0
Oil Price ForecastOil Price Forecast
20
40
60
80
100
120
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
$/barrel
Source: DEC Prospects Group.
New baseline
Old baseline
Food price forecastFood price forecast
100
150
200
250
300
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Index (2000 = 100)
Source: DEC Prospects Group.
Old baseline
New baseline
Metals & minerals price forecastMetals & minerals price forecast
50
100
150
200
250
300
350
400
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Index (2000 = 100)
Source: DEC Prospects Group.
Old baseline
New baseline
South Asia:South Asia:Revised Macroeconomic ProspectsRevised Macroeconomic Prospects
-5.9-6.1-7.8-4.4-5.3-3.2-4.6Current Account Bal (% of GDP)5.54-4.56.36.87.76.05.2Real GDP Growth Rate (%)
Sri Lanka-2.8-3.9-8.9-5.8-5.4-3.3-3.7Current Account Bal (% of GDP)4.53-3.56.06.06.27.73.9Real GDP Growth Rate (%)
Pakistan0.40.51.2-1.2-0.10.0-6.3Current Account Bal (% of GDP)4.93.5-45.52.63.73.15.0Real GDP Growth Rate (%)
Nepal-2.0-1.8-3.7-1.6-1.0-1.0-1.2Current Account Bal (% of GDP)7.55.5-67.09.09.79.25.5Real GDP Growth Rate (%)
India0.60.50.81.22.0-0.3-0.4Current Account Bal (% of GDP)6.25.5-66.26.46.66.04.8Real GDP Growth Rate (%)
Bangladesh20102009200820072006200591-00
ForecastEst.South Asia Country Forecasts
OutlineOutline
Sketch of the Sketch of the financialfinancial tsunamitsunami
How was South Asia positioned to How was South Asia positioned to receive the financial receive the financial tsunamitsunami??
What are possible implications for What are possible implications for South AsiaSouth Asia’’s economic prospects?s economic prospects?
Immediate and medium term policy Immediate and medium term policy response, lessons being learnedresponse, lessons being learned
Immediate Policy ResponseImmediate Policy Response
Ensure adequate liquidity in both domestic and foreign currency, and reduce scope for currency mismatchesStrengthen crisis preparedness - Contingency planning, stress testing, development of protocols, legal powers of authorities, close monitoring of financial institutions and re-examine Deposit Insurance/Guarantees on bank debt as needed. Manage fiscal and monetary policies to regain and maintain macroeconomic balancesSupplement with international policy coordination
Medium Term Policy ChallengesMedium Term Policy Challenges
Accelerate ongoing efforts to deepen and develop domestic financial markets; fill missing marketsAddress weaknesses in institutional and regulatory infrastructure– bank restructuring and asset resolution
frameworks– credit bureaus and rating agencies– prudential regulations– payment and settlement systemsGovernments should consider whether controlling asset price inflation should be added to the mandate of monetary policy authorities
Lessons from the recent crisis
Realization that South Asia’s financial markets are much more integrated with global markets
Need for an ever greater emphasis on domestic market development
Financial supervision needs to keep up with financial innovation
Coordinated response from governments and regulators/ and among countries pays off
END
South Asia's growth paths in crisis:1997 (East Asia Crisis) and projected for 2008-10Real GDP growth in percent
Source: World Bank
6.8
3.8
5.6
6.8
5.2
7.0
0
2
4
6
8
t-1 t t+1
1997 Crisis 2008 Crisis
South Asia's growth paths in crisis:1997 (East Asia Crisis) and projected for 2008-10 General fiscal deficit as percent share of GDP
Source: World Bank
6.4
7.8
9.7
8.18.6
7.9
0
2
4
6
8
10
t-1 t t+11997 Crisis 2008 Crisis
-9
-6
-3
0
3
ECA MNA LAC SSA EAP SAR
South Asia: Least fiscal space among LMIC regionsprojected 2008
% share of GDP
0
2
4
6
8
10
12
14
EAP SSA LAC ECA SAR MNA
South Asia: Among highest inflation of LMIC regionsprojected 2008
Median GDP deflator (LCU)
Risks to outlook for South Asia
Deeper and more prolonged credit crunch: – contraction in investment and export growth
(instead of sharp slowdown)– FDI and remittances inflows could fall-off
markedly instead of moderation– Weaknesses in domestic banking sectors
could emerge
Quicker recovery:– Inflationary pressures would return to
forefront