The Financial Crisis and the MDGs

1. The Financial Crisis and the MDGs Carlos A. Primo Braga Director, PRMED Commonwealth Ministerial October 2009

2. A Perfect Storm

3. Presentation outline • The financial crisis in a nutshell • Implications for industrialized and developing economies • The MDGs and the crisis • Performance of Developing Commonwealth Countries • Concluding remarks

4. A Tale of Two DepressionsSource: Eichengreen & O’Rourke (2009) 9

5. 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 imbalances

6. 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)…

7. 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

8. Relative to past downturns the decline of capital flows has been even more dramatic Net private capital flows / GDP in developing countries Projection2007-10 Percent Percent 1997-02 1980-83 Source: DECPG/GDF ; World Bank (2009a)

9. Private capital flows are unlikely to recover to pre-crisis levels for some time US$ billion percent Net Private Capital Flows to Developing Countries Percent of GDP (right axis)

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.

11. A recovery is underway, but is relatively weak, uneven, and subject to considerable risks (Source: DEC) Real GDP growth rates (%)

12. 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) 2013

13. Poverty impact of the growth slowdown is large―and rising (Source: DEC) Increase in number of poor (millions)

14. 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. % of goal

15. Tracking Progress on MDGs in 143 Developing Countries: Most countries are falling short on most of the MDGs(# of countries) Data Source: World Bank (2009b)

16. 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

17. Outlook for the MDGs in the Developing Commonwealth Countries(# of countries) Data Source: World Bank (2009b)

18. Poverty Reduction Goal in Developing Commonwealth Countries(# of countries) Data Source: World Bank (2009b)

19. Tracking Progress on MDG3 (Gender Parity) Developing Commonwealth Countries(# of countries) Data Source: World Bank (2009b)

20. Child Mortality/Measles Immunization Developing Commonwealth Countries(# of countries) Source: World Bank (2009b)

21. Access to Safe Water and Sanitation in the Developing Commonwealth Countries(# of countries) Source: World Bank (2009b)

22. 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

23. 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 country fiscal balances, 2009

24. G20 countries – fiscal stimulus and financial sector support Advanced economies: Average discretionary fiscal expansion in 2009: 1.5% of GDP Average financial sector support: 5.4% of 2008 GDP Emerging economies: Average discretionary fiscal expansion in 2009: 2.0% of GDP 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

25. Government Debt: Medium Term Prospects (Source: IMF, 2009) • Significant expansion of public debt in advanced economies

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

27. 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) US$ billion External financing needs Financing gap Note: Includes 59 countries with financing gap; Source: World Bank (2009a)

28. 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 Development finance in Sub-Saharan Africa

29. 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

30. Recessions Credit Crunches 46 10 1 3 4 18 31 9 HousePrice Busts EquityPrice Busts A protracted crisis? 31 Source: Claessens, Kose, Terrones (2008) Source: JP Morgan • 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

31. Concluding remarks • 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;

32. Concluding remarks (cont.) • 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.

33. 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.