The Global Economic and Financial Outlook and Challenges for Emerging EconomiesKeynote Speech by Mr. Takatoshi Kato, Deputy Managing Director, IMF
At the 21st Meeting of the Central Bank Governors’ Club
of the Central Asia, Black Sea Region, and Balkan Countries
May 28–31, 2009
As prepared for delivery
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It is my pleasure to participate in the 21st Meeting of the Central Bank Governors’ Club of the Central Asia, Black Sea Region, and Balkan Countries. My presentation today is on the global economic and financial outlook, and challenges for emerging economies.
First, I will give a brief overview of the global economic outlook. Second, I will emphasize that the road to full recovery from the current crisis is likely to be protracted. Third, I will highlight key challenges for emerging markets. Fourth, the principal outcome of the recent G-20 summit will be summarized. And finally, I will say a few words about the role of the IMF in helping to solve the current global economic crisis.
The Global Economy and Outlook
My main message is that notwithstanding major policy efforts, the global economy is in the midst of the most serious recession since the Great Depression, although tentative signs are emerging that the rate of decline in economic activity is moderating.
• Global GDP is estimated to have fallen sharply by about 6 percent in the fourth quarter of 2008 (annualized). (Major advanced economies contracted by 7½ percent in 2008, while emerging economies shrank by 4 percent.) Preliminary estimates suggest that global activity contracted at a broadly similar pace in the first quarter of 2009.
World merchandise exports (in value terms) declined by over 15 percent in the quarter through February, reflecting falling trade in both advanced and emerging economies.
Countries reliant on manufacturing exports have been among the most heavily affected.
Inflation continues to ease across the globe, reflecting the sharp fall in economic activity and the collapse of commodity prices since mid-2008.
• Some encouraging, albeit tentative, signs are emerging that the contraction in economic activity is moderating. Recent data on retail sales and consumer and business confidence in some advanced and emerging economies suggest that the rate of decline of private consumption, exports, and industrial production may be easing. A turn in the inventory cycle after rapid drawdowns in stocks should also support production. Fiscal stimulus coming on stream and continuing monetary policy support should contribute to a moderation in the contraction of economic activity.
Global activity is expected to decline by 1¼ percent in 2009, before recovering gradually in the course of 2010.
• Growth in the advanced economies is projected to contract by 3¾ percent in 2009, and activity is projected to recover only gradually over the course of 2010. Growth would return to potential only at the end of 2010. With such a gradual recovery, unemployment in major industrialized countries is expected to continue to increase throughout much of 2010.
• Emerging and developing economies are projected to expand by a modest 1½ percent in 2009, rising to 4 percent in 2010. Growth will continue to be impeded by financing constraints, lower commodity prices, weak external demand, and associated spillovers to domestic demand.
The Road to Recovery Will be Protracted
The key message here is that with weak economic prospects and financial fragility feeding off each other, the world economy is being affected by two opposing forces.
• The first—which originated with the financial crisis—continues to pull the global economy down. The second—reflecting natural stabilizing mechanisms in inventories, housing and durable goods markets, but more importantly the impact of strong macroeconomic policies—is pulling the economy up.
• Currently, downward forces on the global economy continue to dominate, owing to the feedback loops from macro-financial linkages.
• Recessions associated with financial crises tend to be severe and recoveries from such recessions are typically slow. Recoveries from these recessions are often held back by weak private demand and credit. Globally synchronized recessions, as the present one, are typically longer and deeper than others and their recoveries are sluggish.
• In the current context, banks are still very much in the process of retrenching and tightening lending standards.
Inflation will continue to retreat, due to the combination of widening output gaps and lower commodity prices, with outright price declines expected in Canada, Germany, Japan, and the United States. Deflation risks, concentrated in the major advanced economies, could reinforce a deeper and longer downturn.
What are the Policy Challenges?
The immediate imperative is to decisively address financial strains. At the same time, macroeconomic policies—credibly anchored in medium-term frameworks—must continue to support demand to avoid a deeper and more prolonged recession.
Governments have taken significant policy steps aimed at addressing the crisis, but forceful implementation of policies is urgently required. Moreover, to the extent that financial market strains are global and interconnected, international policy cooperation is crucial for restoring market trust.
• Institutional arrangements for dealing with impaired assets are being put in place (notably in the US and the UK), but difficult operational issues relating to the valuation and disposal of these assets still need to be addressed.
• Following rigorous stress tests of balance sheets, viable banks should be quickly recapitalized, if necessary, with public money in the form of common equity. Insolvent institutions should be promptly intervened, and either closed or merged.
• Greater clarity and cross-border consistency of rules should be applied to the valuation of impaired assets, guarantees, and recapitalization to avoid regulatory arbitrage.
• Emerging economies should prepare, on a contingent basis, plans to address the growing risks of large-scale corporate failures and the likelihood that some of the loss in capital flows is likely to be permanent.
In the advanced economies, conventional monetary policy should remain accommodative until a sustained recovery takes hold.
• Policy rates are now at historic lows in all major advanced economies. Central banks should also clearly communicate their intent to keep policy rates low until a recovery firmly takes hold. This would be critical to guide expectations of future rates and inflation, and reduce deflation risks.
• Central banks in advanced economies should continue to explore unconventional measures to stimulate economic activity.
Fiscal stimulus has been critical in preventing the global economy from going into a tailspin, and should be sustained at least through 2010, while medium-term fiscal frameworks should be strengthened.
• Fiscal deficits in most G-7 and G-20 countries are expanding significantly in 2009 and 2010 (relative to pre-crisis levels of 2007).
• But given large output gaps, the stimulus will need to be sustained, if not increased, at least through 2010 to ensure that a durable recovery takes hold.
There may be some scope for allowing the exchange rate to depreciate in cases of floating exchange rates or adjustable peg regimes. Such adjustment may help exporters, and be especially appropriate where a country has relied on commodity exports and has seen large price declines. But not every currency can depreciate at once.
Furthermore, the prevalence of foreign currency-denominated contracts can cause significant negative balance sheet effects.
Challenges for Emerging Markets
The main message for emerging markets is that over the medium term, deleveraging is likely to weigh heavily on credit creation and capital flows.
Deleveraging, Capital Flows and Roll-Overs
The global credit crunch is expected to be deep and long lasting as a result of a protracted deleveraging and balance sheet adjustments in advanced economies.
• The deleveraging process will be driven by mounting bank write-downs in the financial sector and by the reversal of spending decisions of households who had accumulated record-levels of debt during the last decade. Large-scale official financing will be needed to offset the contraction in wholesale and cross-border funding markets that financed a large part of the previous buildup in credit.
• Emerging Europe has been hit particularly hard. Cross-border bank funding has been disrupted by the banking crisis in western Europe. Asset values have collapsed and currencies have come under pressure, especially in those countries with large domestic and external imbalances.
• Asia and Latin America have also felt the effects of the crisis. However, external funding risks are less acute as a result of stronger external balances, larger international reserves, lower refinancing needs, and deeper local funding markets.
Overall, net private flows to emerging markets, which peaked at 5 percent of GDP in 2007, will turn negative in 2009. Portfolio outflows will continue as investors face margin calls, high redemptions, and alternative government-guaranteed investment opportunities in mature markets. Foreign direct investments flows are expected to remain subdued in the present environment of scarce financing. However, remittances appear to be generally more resilient to external shocks than private capital flows or official aid. The rate of increase of remittances to developing countries has slowed from 23 percent in 2007 to 9 percent in 2008. According to latest projections by the World Bank, remittance flows to developing countries are projected to decline by 5–8 percent in 2009.
Sovereign debt issues
• In the last quarter of 2008, international debt markets were closed to emerging market sovereigns. However, access to markets has been partially restored, at least for those countries with a moderate debt stock. Since mid-December last year, several emerging market sovereigns, such as Turkey, have returned to international debt markets. Spreads have widened but borrowing costs have not necessarily increased as emerging market sovereigns have benefited from low U.S. Treasury yields.
• However, risks to gaining access to international debt markets abound. In particular, emerging market borrowers may be crowded out by increased competition from industrialized countries’ sovereign and sovereign guaranteed paper.
• Emerging market countries with debt sustainability problems, low credit ratings, and large external funding needs are the ones that could find their financing needs unmet.
• In these circumstances, careful public debt management is all the more important.
Trade Finance and the Protectionist Threat
As in past recessions, the decline in activity and the rise in unemployment are leading to protectionist pressures.
• For example, the number of anti-dumping investigations increased by 27 percent in 2008 from 2007. Potentially trade-distorting subsidies to support manufacturing industries, notably the steel and automobile industries, have also emerged in a number of countries. Trade-related concerns have also been raised regarding various programs to support financial services industries.
• A revival of trade will be needed to support the economic recovery, and it is therefore vital that governments resist protectionist pressure and keep their markets open for their own national interest as well as that of the global system.
The financial crisis has also brought about changes in the pricing and availability of trade finance. However, in spite of these tightened credit conditions for trade finance, the value of bank trade finance have declined by much less than the value of merchandise trade.
• Thus, while bank trade finance is not a major cause of the decline in trade, it is important that the recovery of global trade is not inhibited by difficulties in obtaining financing for imports and exports. In this context, it is particularly important that the G-20 leaders at the London Summit agreed on trade finance initiatives that ensure availability of at least US$250 billion over the next two years through export credit and investment agencies, and the Multilateral Development Banks.
Outcome of G-20 Summit
At the recent G-20 summit, there was appreciation of the serious state of the world economy and a genuine commitment to take all necessary actions, with the Fund given a pivotal role.
• Consensus was reached on the need for global coordinated fiscal and monetary responses.
- Leaders agreed to undertake an unprecedented and concerted fiscal expansion amounting to US$5 trillion by end-2010, raising output by 4 percent.
- G-20 central banks pledged to maintain expansionary monetary policies for as long as needed, consistent with price stability.
- The G-20 acknowledged the urgent need to restore domestic lending and international capital flows.
• There was agreement to dramatically strengthen the IMF’s lending capacity by tripling its resources to US$750 billion, and supporting the issuance of US$250 billion in special drawing rights (or SDRs).
• A strengthening of financial regulatory systems was called for. This could be achieved by: (i) promoting integrity and transparency; (ii) guarding against risk across the financial system; (iii) dampening rather than amplifying the financial and economic cycle; (iv) reducing reliance on inappropriately risky sources of financing; and (v) discouraging excessive risk-taking.
• G-20 leaders issued a Declaration on Strengthening the Financial System, which includes, among other things, the establishment of a new Financial Stability Board with a strengthened mandate, as a successor to the Financial Stability Forum (FSF).
Role of the IMF in Solving the Global Economic and Financial Crisis [Slide 18]
The G-20 summit shows that there is strong support for the IMF’s analysis, economic forecasts, policy advice, and reforms to better serve the global community.
• The IMF needs to continue efforts to adapt lending facilities, and to be ready to provide international liquidity support for its member countries in need.
• Already, since last October, the IMF has moved rapidly to provide about US$50 billion in balance of payments support to crisis countries. These new IMF programs have come with streamlined and more focused conditionality, and have paid due attention to the need for social protection measures.
• The new Flexible Credit Line (FCL) aims at providing effective contingent liquidity support for emerging economies with proven good macro-financial track records. The positive market reaction following decisions by Mexico, Poland, and Colombia to seek FCL support for a combined US$77 billion is encouraging.
• The IMF expects to triple its support to low-income countries over the next two years, and to double its medium-term concessional lending capacity.
• Candid, even-handed and independent surveillance, including the monitoring of fiscal and financial policy implementation of member countries and development of an early warning system are priorities for the IMF.
• Acceleration of reform of the IMF’s governance structure to better reflect global realities is now an urgent task.
• A top priority for the IMF’s legitimacy and effectiveness is the completion of outstanding governance reforms. The focus is now on promptly ratifying quota and voice reforms agreed in April 2008, and to complete the next stage, including further rebalancing, by January 2011. (Early consideration of the Trevor Manuel report proposals, particularly with regard to greater engagement of IMF Governors in enhancing its strategic direction and accountability, is also an important priority.)
• Finally, it is important to forge ahead with the implementation of the IMF’s new income model to safeguard its medium-term financial sustainability. Thank you.