## _061510

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---

### Impact of the crisis on emerging markets
- Growth of the global economy fell 6 percentage points from its pre-crisis peak to its trough in 2009, the largest straight fall in global growth in the post-war era.  
- On average, real output in EMs fell about 4 percent between the third quarter of 2008 and the first quarter of 2009.  
- Real output contracted 11 percent during this period in the worst affected quartile of EMs; output rose 1 percent in the least affected quartile.  
- Sovereign spreads rose by more than 1,000 basis points for some EMs through the crisis but by only around 100 basis points for some others.  
- During the crisis the IMF put in place 24 arrangements, many with exceptional access, and including the recently introduced Flexible Credit Line.

### Role of pre-crisis fundamentals and vulnerabilities
- Primary message: countries that had improved policy fundamentals and reduced vulnerabilities in the pre-crisis period fared better during the crisis.  
- Higher international reserves holdings reduced external vulnerability and helped buffer the impact of the crisis, but reserves had diminishing returns: at very high levels of reserves there is little discernable evidence of their moderating impact on output collapse.  
- Countries more open to trade and financial linkages were more affected.  
- Pre-crisis credit booms were associated with sharper output falls during the crisis, though less so than in past crises; such credit booms were typically foreign-financed and more pronounced for countries with fixed exchange rate regimes.  
- The external vulnerability index from the Spring 2007 VEE is used as the primary indicator of pre-crisis vulnerability; the terms “low,” “medium,” and “high” vulnerability refer to ratings on this index in the Spring 2007 round of the VEE.  
- Of the “high” vulnerability group, about half the countries were in Emerging Europe.

### Patterns in financial transmission and market phases
- Three phases of transmission in stock markets (August 9, 2007 start):  
  - Decoupling: between the start of the crisis and collapse of Lehman, stock markets in low and medium pre-crisis vulnerability EMs were 15 percent below August 2007 levels, while those in AEs and high vulnerability EMs had already fallen around 30 percent.  
  - Re-coupling: Lehman’s collapse triggered panic and all EMs fell almost uniformly.  
  - Re-decoupling: with return of stability, a striking gap opened between high vulnerability countries and others; since August 2007, stock markets in low and medium vulnerability countries have broadly recovered to pre-crisis levels, while those in high vulnerability countries remain depressed.

### Measurements of impact and key statistics
- Impact on real economy: preferred measure is percent change in seasonally adjusted quarterly GDP from each country’s peak to its respective trough during the crisis.  
- Impact on financial markets and banking sector measured by:  
  - change in average monthly stock market index during the crisis;  
  - collapse in real private sector credit growth from peak to trough and the difference between pre- and post-crisis average monthly credit flows in percent of GDP;  
  - rise in average monthly EMBI sovereign spread from trough to peak (in basis points).  
- Table excerpted indicators and summary statistics (as reported):  
  - Output collapse 1/ Median-4.9-4.5  
  - 25th percentile-8.4-6.6  
  - 75th percentile-2.0-2.9  
  - Stock market collapse 1/ Median-57.1-55.4  
  - 25th percentile-72.0-64.1  
  - 75th percentile-45.2-49.0  
  - Rise in sovereign spreads 2/ Median462465  
  - 25th percentile287...  
  - 75th percentile772...

### Econometric methodology and primary specification
- Primary regression explains fall in real output as a function of: pre-crisis vulnerabilities; trade connectedness with the rest of the world; international financial integration.  
- Three measures that best explained cross-country variation: external vulnerability index (Spring 2007 VEE); percent change in domestic demand of AE trading partners weighted by trade shares; consolidated stock of claims of BIS reporting banks (immediate borrower basis) on EMs in percent of the EM’s GDP in December 2007.  
- Other indicators, including regional dummies, were tried but did not affect the central findings.

### Key empirical findings on output collapse (selected coefficients and magnitudes)
- Magnitude: The least vulnerable EMs, on average, contracted 6½ percentage points less than the most vulnerable EMs (Table 2).  
- Selected regression coefficients (robust standard errors in parentheses):  
  - External section vulnerability index (ranged 0 - 1): -6.40 ** (3.04)  
  - Domestic demand growth in AE trading partners (percent): 1.44 ** (0.68); alternative specifications include 1.47 ** (0.63); 1.68 *** (0.53); 1.63 *** (0.59); 1.53 ** (0.65); 0.91 (1.34); 1.60 * (0.87)  
  - Foreign bank claims (percent of GDP, expressed in logs): -1.7 * (0.92); -1.90 ** (0.81); -1.85 ** (0.83); -0.86 (1.08); -1.90 * (1.00); -2.50 * (1.37); -1.07 (1.25)  
  - GIR in percent of (short-term debt at residual maturity plus current account deficit, expressed in logs): 2.84 *** (0.86); 8.00 *** (2.56); 2.63 * (1.31)  
  - Current account balance (percent of GDP): 0.17 * (0.08)  
  - External debt (percent of GDP): -0.09 ** (0.04)  
  - External debt (percent of exports): -2.40 (1.59)  
- Regression samples and fit: Observations across specifications: 40, 41, 45, 42, 42, 22, 19; R-squared values reported: 0.44, 0.49, 0.40, 0.44, 0.40, 0.55, 0.25.  
- Notes: Robust standard errors in parentheses. *** p<0.01, ** p<0.05, * p<0.1. Source data: VEE Spring 2007; GEE; IFS; WEO. Fund staff calculations.

### Reserves, nonlinear effects, and reserve-coverage regressions
- Pre-crisis reserve holdings associated with positive but diminishing returns in cushioning output collapse.  
- Reserves defined as ratio of reserves to external financing requirements (sum of short-term debt at residual maturity and the current account deficit).  
- Empirical pattern: higher reserves helped reduce external vulnerabilities and support rollover of external debt and market confidence, but when sample split at 100 percent of reserve coverage (and at 150 percent or median reserves-to-GDP), reserves had a significant payoff at low levels of reserve coverage but much less so at high levels.  
- Supporting specification: peak-to-trough percent change in output regressed on reserves, short-term debt, and current account balance (each expressed in percent of GDP).  
- Reserve-coverage scatter regression (full sample): y = 3.37ln(x) - 21.254, R² = 0.25; After excluding outliers: y = 3.66ln(x) - 22.399, R² = 0.2199.  
- Cross-study note: Blanchard and others (2010) do not find a significant role for international reserves once controlling for short-term debt, but they do not explore potential non-linearities.

### Trade linkages, credit booms, and cross-border funding
- Trade linkages matter substantially: coefficients indicate EMs experienced an additional 1½ percentage point reduction in real output for every percentage point fall in domestic demand in their advanced-economy trading partners.  
- Large EMs with exports a smaller component of aggregate demand (e.g., Indonesia and India) experienced smaller real shocks.  
- Trade fell more in this crisis than in past global recessions. Trade finance problems were not identified as the principal cause of the sharp collapse in trade.  
- Pre-crisis credit booms, often funded from abroad, generally ended in credit and output busts. Cross-border claims of BIS reporting banks on EMs in December 2007 ranged up to around 37 percent of GDP.  
- Empirical effect: a country that had double the average level of claims of about 7 percent of GDP experienced an additional 1¼ percentage points in output reduction.  
- Credit busts associated with sharp increases in money market rates, suggestive of a credit crunch. Impact particularly pronounced in Emerging Europe. EMs funded primarily by domestic deposits were better able to sustain credit growth.

### Sovereign spreads and banking sector risk
- Pre-crisis external vulnerabilities help explain the rise in sovereign spreads during the crisis: the country considered most externally vulnerable in March 2007 experienced 220 basis points more in rising spreads than the least vulnerable (Table 4, column 1).  
- Reserve coverage: ratio of reserves to short-term external financing needs influenced market perceptions; greater reserves coverage associated with smaller increase in spreads (Table 4, column 2).  
- Other factors: cumulative inflation in 2003–2007 showed coefficients 0.13 *** (0.02) and 0.11 *** (0.02) in alternative specifications; inflation-targeting regimes showed coefficients -1.24 (0.75) and -1.80 *** (0.63) in alternative specifications.  
- Selected Table 4 coefficients: External vulnerability, Spring 2007: 2.20 ** (1.05); Reserve cover of ST debt at RM and CA deficit: -0.93 ** (0.40); Observations: 38, 38; R-squared: 0.63, 0.65.

- Banking sector risk and liquidity: Moody’s expected default frequency (EDF) used to measure banking risk — increase from pre-crisis trough to peak.  
  - Public sector vulnerability index (2007) regression: y = 6.2721x + 0.7041, R² = 0.3683.  
  - Average money market rate (2008Q3–2009Q2) regression: y = 0.3162x - 0.1857, R² = 0.3705.  
  - Interpretation: higher pre-crisis public sector vulnerability and tighter interbank liquidity associated with higher banking default probabilities.

### Policy response, fiscal and monetary accommodation
- Fiscal accommodation in 2009 (change in primary balance) averaged close to 2½ percent of GDP for EMs.  
  - Advanced Economies (AEs) provided larger accommodation: 4¾ percent of GDP on average, partly reflecting financial sector restructuring costs.  
- Monetary stimulus: monetary policy rates in EMs were lowered by 300 bps on average; AEs reduced rates by about 320 bps on average.  
- Countries with better pre-crisis fundamentals were able to enact more counter-cyclical easing. Higher pre-crisis primary balances and lower public debt levels allowed greater fiscal accommodation; these factors accounted for most of the explained variation across countries.  
- Distribution: change in primary deficit varied from around 1 percent for the quartile with the least fiscal response to around 4 percent for the quartile with the highest response.

### Determinants and constraints on fiscal accommodation (selected Table 5 coefficients)
- Primary balance (lagged): 0.24 ** (0.12); 0.26 ** (0.12)  
- Overall balance (lagged): 0.38 ** (0.15)  
- Public debt (lagged): -3.54 *** (0.94); -2.96 *** (1.07); -0.40 (1.51)  
- Growth: -4.63 (6.21); -8.18 (6.44)  
- Constant terms: 4.30 *** (0.54); 3.98 *** (0.58); 3.57 *** (0.57)  
- Observations: 48, 48, 48; R-squared: 0.30, 0.31, 0.36

### “Extra” accommodation in 2009 and financing constraints (Table 6)
- Out-of-sample prediction shows an “extra” accommodation in 2009 for the average EM of around 2 percentage points of GDP.  
- The amount of “extra” stimulus was more limited in countries with: higher pre-crisis foreign claims of BIS-reporting banks and higher pre-crisis EMBI spreads.  
- Table 6 coefficients: Pre-crisis exposure of BIS-reporting banks (% of GDP): -0.12 *** (0.04); EMBI in August 2008: -0.49 * (0.28); Constant: 3.95 *** (0.87); Observations: 34; R-squared: 0.11.  
- Monetary stimulus (Reduction in Policy Rates, Aug. 2008–Oct. 2009, mean in percentage points): All advanced economies: 3.2; All emerging markets (EMs): 3.0. EMs by exchange rate regime: Fixers: 2.1; Floaters: 3.4. EMs by region: Asia: 3.1; Europe: 3.1; Middle East, Cent. Asia, and S. Africa: 1.4; Western hemisphere: 3.6.

### Monetary policy determinants, transmission, and exchange rates (selected coefficients)
- Determinants of policy rate reductions (Table 7): Change in inflation 2009: -0.31 *** (0.06); Policy rate Aug. 2008: 0.60 *** (0.10); Inflation 2008: -0.32 *** (0.07); Interaction terms with peg: Change in inflation 2009 * peg: 0.61 ** (0.25); Inflation 2008 * peg: 0.58 *** (0.16). Observations: 36; R-squared: 0.58 (col 1), 0.64 (col 2).  
- Panel regression (Table 8) explaining policy rate and money market rate levels (30 countries, quarterly): EMBI: 0.19 *** (0.04) for policy rate level; 0.79 *** (0.07) for money market rate level. EMBI * peg: -0.39 *** (0.14) col 1; -0.24 (0.16) col 2. Output gap (t-1): 0.41 *** (0.05) col 1; 0.69 *** (0.09) col 2. Observations: 206 (col 1), 200 (col 2); R-squared: 0.48 (col 1), 0.57 (col 2).  
- Exchange rate and reserves (Table 9): Reserve/(ST debt + CA), 2007: -0.02 (col 1) and -0.02 *** (col 2). Policy rate, Aug. 2008: 2.13 *** (0.74) col 1; -0.51 * (0.26) col 2. Observations: 29 (both columns); R-squared: 0.36 (col 1), 0.30 (col 2). Figure: Initial Reserves and Reserve Use regression y = -1.83x + 12.41, R² = 0.40 (fall in reserves (peak to trough, percent of 2008 GDP) vs Reserves/GDP (2008 December)).

### Recovery: timing, cross-country differences, and determinants
- By late 2009 recovery was underway in most EMs; on average, real GDP in EMs expanded 3 percent during the last three quarters of 2009.  
- Non-peggers recovered faster than peggers. Regional averages (Recovery from the Crisis, averages, percent): All EMs: GDP growth 3.1; Industrial production growth 10.8. Fixed exchange rate regimes: GDP 0.2; IP -1.6. Flexible exchange rate regimes: GDP 3.9; IP 14.0. Asia: GDP 6.4; IP 26.7. Europe: GDP 1.2; IP 4.3. MCD: GDP 4.8; IP 10.9. Western hemisphere: GDP 3.1; IP 9.7. (IP growth measured from each country's trough to Dec. 2009.)  
- Determinants of recovery (Table 10 and Table 11): better pre-crisis vulnerability indicators and reserve coverage, and sustaining stronger public spending during 2009, associated with faster recovery. Flexible exchange rate regimes associated with faster recovery. “Bounce-back” effect: deeper contractions associated with faster recoveries.

- Selected Table 10 coefficients (growth rate over last three quarters of 2009): GDP growth during contraction: -0.21 ** (0.08) col 1; External vulnerability in 2007: -6.02 *** (2.02) col 1; Peg dummy: -2.54 * (1.27) col 1; Reserves (percent of short-term debt + current account deficit): 0.01 *** (0.0) col 1; Growth in public demand: 0.16 * (0.08) col 1. Observations: 39 (col 1); R-squared: 0.44.

- Table 11 (industrial production growth recovery): IP growth during contraction: -0.62 ** (0.25) col 1; Trading partners’ import recovery: 2.59 *** (0.86) col 1; Growth in public demand: 0.69 *** (0.22) col 2; Peg dummy: -9.79 * (5.00) col 1. Observations: 36 (col 1); R-squared: 0.40.

### Country cases: Philippines, Russia, Indonesia (illustrative)
- Philippines: fiscal stimulus around 2¼ percent of GDP in 2009; public debt fell by some 35 percentage points of GDP from 2004 to 2008; remittances around 11 percent of GDP in 2009; output would have fallen 4 percent under 2005 external vulnerabilities but actual fall was 2¼ percent. Banks enjoyed credit and deposit growth through the crisis; temporary regulatory relief on mark-to-market requirements and a dollar repo facility were used.  
- Russia: output fell by about 11 percentage points of GDP from peak to trough; reserve use exceeded $200 billion (representing 13 percent of 2008 GDP); real private sector credit growth in Russia was -6½ percent (y/y) in December 2009 compared to about one percent (y/y) for EMs on average; fiscal loosening: primary balance loosened by 10½ percent of GDP between 2008 and 2009, and after accounting for oil revenue collapse the accommodation magnitude was 6½ percent of GDP.  
- Indonesia: domestic demand around 90 percent of real GDP in 2007; trading partners’ domestic demand decline 3¼ percent vs average EM decline around 2¾ percent; contingent financing secured included $5½ billion in budget support from multilateral and bilateral partners plus additional external swap and credit lines; output grew 4½ percent from 2009Q1 to 2009Q4 vs EM average 3 percent.

### Exit issues, medium-term losses, and policy priorities
- Bifurcated policy agenda: high pre-crisis vulnerability EMs need fiscal tightening and structural reforms; low vulnerability EMs face capital inflows, closing output gaps, and rising inflation risks.  
- Projected medium-term output loss (difference between IMF WEO projections for 2013 in April 2010 and April 2008): 16 percentage points for EMs with low and medium pre-crisis vulnerabilities and 21 percent for those with high pre-crisis vulnerabilities.  
- External and fiscal adjustment implications: past crises often produced abrupt current account adjustments and temporary increases in external debt-to-GDP, with debt-to-GDP typically falling by 5−10 percentage points within five years; in the current crisis high vulnerability EMs have higher external indebtedness and are likely to see a 10–15 percentage point increase in debt-to-GDP that is unlikely to be reversed in the next five years without consolidation.  
- Policy priorities by vulnerability group: High vulnerability countries: fiscal tightening and structural reforms; Low vulnerability countries: manage capital inflows, consider policy mix changes, and guard against overheating while maintaining credible frameworks.

### Fast-recovering EMs and cautious withdrawal of stimulus
- Taylor-rule evidence: predicted interest rates in many fast-recovering countries are significantly higher than their actual rates at present—by over 100 bps on average across all low- and medium-vulnerability EMs.  
- Constraints from capital inflows and exchange rates: countries may keep rates below predicted levels due to uncertainty, fear of triggering excessive capital inflows, and concerns about exchange rate appreciation damping recovery.  
- Drivers of capital inflows: push factor—accommodative AEs; pull factor—EMs’ stronger recoveries and better fiscal sustainability. Currently inflows are returning to pre-crisis levels.  
- Coping options for inflows: allow exchange rate appreciation; build reserves; ease monetary policy; tighten fiscal policy; improve prudential framework. Practical limitations: fiscal tightening political and slow; prudential improvements take time; monetary and exchange rate tools may be relied upon but have limits.  
- When price-based capital controls and prudential measures may be helpful: when exchange rate is not undervalued, reserves are adequate, and the economy is at risk of overheating. Caveat: assessing exchange rate overvaluation is uncertain; some appreciation may be necessary.

### Lessons from the Crisis (summary)
- Heterogeneous EM experience underscores the importance of fundamentals and global linkages. EMs with smaller initial imbalances suffered smaller declines and had more space for stimulus and faster recoveries. The pay-off from better fundamentals implies about five percentage points less of a reduction in permanent output compared with economies with weaker fundamentals.  
- External linkages, foreign bank claims, and reserve coverage mattered for severity of the crisis and market perceptions. Diminishing returns to reserves beyond short-term debt plus current account deficit. Flexible exchange rates and credible monetary frameworks (inflation targeting) provided greater room for loosening. Low public debt allowed greater fiscal loosening. Safeguarding improved frameworks remains important as the crisis recedes.

### Fiscal policy response: 2009 versus past crises (panel evidence)
- Fiscal procyclicality in past crises: higher lagged primary balance associated with contractionary fiscal policy during past crises; crisis dummy effect: 2.98 ***. 2009 year dummy effect: 3.26 *** and 3.25 *** in alternative specifications.  
- Regression excerpts (Determinants of Change in Primary Deficit — "+" Means Higher Accommodation):  
  - Specification (1): Primary balance (lagged): 0.41 ***; Public debt (lagged): -1.53; Growth: -12.14 **; Crisis dummy: 2.98 ***; Constant: 1.45 *; Observations: 435; R-squared: 0.24; Number of countries: 49.  
  - Specification (2): Primary balance (lagged): 0.46 ***; Public debt (lagged): -2.31 *; Growth: -12.88 **; Primary balance (lagged) * 2009: 0.18; Public debt (lagged) * 2009: -3.06 **; Growth in 2009: 5.43; 2009 Year dummy: 3.26 ***; Constant: 2.06 ***; Observations: 515; R-squared: 0.39; Number of countries: 48.  
  - Specification (3): Primary balance (lagged): 0.47 ***; Public debt (lagged): -2.34 *; Growth: -12.95 **; Primary balance (lagged) * 2009: 0.18; Public debt (lagged) * 2009: -3.07 **; Growth in 2009: 5.43; Primary balance (lagged) * past crises: -0.89 **; Public debt (lagged) * past crises: -14.00 ***; Growth in past crises: 24.30 *; 2009 Year dummy: 3.25 ***; Constant: 2.09 ***; Observations: 515; R-squared: 0.40; Number of countries: 48.  
- Implication: 2009 fiscal behavior systematically different from past crisis episodes with a positive 2009 year dummy indicating stronger-than-usual accommodation.

### Annex: sample and data sources
- Sample coverage: 57 economies are considered; country samples differ across regressions depending on data availability.  
- Data sources: Spring 2010 World Economic Outlook; internal staff assessment of vulnerabilities; public sources including BIS, CEIC, Haver, IFS, Moody's, and others.  
- Country lists by region (as presented):  
  - Asia (11): China, India, Indonesia, Korea, Malaysia, Mongolia, Pakistan, Philippines, Sri Lanka, Thailand, Vietnam  
  - Emerging Europe and CIS (22): Albania, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, Georgia, Hungary, Kazakhstan, Latvia, Lithuania, Macedonia, Montenegro, Poland, Romania, Russia, Serbia, Slovak Republic, Slovenia, Turkey, Ukraine  
  - Western Hemisphere (17): Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, El Salvador, Guatemala, Jamaica, Mexico, Panama, Paraguay, Peru, Uruguay, Venezuela  
  - Middle East and Africa (7): Egypt, Israel, Jordan, Lebanon, Morocco, South Africa, Tunisia

*Source: Excerpts from the IMF paper (sections I–II) and associated figures and tables in the supplied content.*

### 4. Determinants of the Change in Spreads from Trough to Peak ....................................15

### 4. Determinants of the Change in Spreads from Trough to Peak ....................................15

### Impact of the crisis on emerging markets
- Growth of the global economy fell 6 percentage points from its pre-crisis peak to its trough in 2009, the largest straight fall in global growth in the post-war era.  
- On average, real output in EMs fell about 4 percent between the third quarter of 2008 and the first quarter of 2009.  
- Real output contracted 11 percent during this period in the worst affected quartile of EMs; output rose 1 percent in the least affected quartile.  
- Sovereign spreads rose by more than 1,000 basis points for some EMs through the crisis but by only around 100 basis points for some others.  
- During the crisis the IMF put in place 24 arrangements, many with exceptional access, and including the recently introduced Flexible Credit Line.

### Role of pre-crisis fundamentals and vulnerabilities
- Primary message: countries that had improved policy fundamentals and reduced vulnerabilities in the pre-crisis period fared better during the crisis.  
- Higher international reserves holdings reduced external vulnerability and helped buffer the impact of the crisis, but reserves had diminishing returns: at very high levels of reserves there is little discernable evidence of their moderating impact on output collapse.  
- Countries more open to trade and financial linkages were more affected.  
- Pre-crisis credit booms were associated with sharper output falls during the crisis, though less so than in past crises; such credit booms were typically foreign-financed and more pronounced for countries with fixed exchange rate regimes.  
- The external vulnerability index from the Spring 2007 VEE is used as the primary indicator of pre-crisis vulnerability; the terms “low,” “medium,” and “high” vulnerability refer to ratings on this index in the Spring 2007 round of the VEE.  
- Of the “high” vulnerability group, about half the countries were in Emerging Europe.

### Patterns in financial transmission
- Three phases of transmission in stock markets (August 9, 2007 start):  
  - Decoupling: between the start of the crisis and collapse of Lehman, stock markets in low and medium pre-crisis vulnerability EMs were 15 percent below August 2007 levels, while those in AEs and high vulnerability EMs had already fallen around 30 percent.  
  - Re-coupling: Lehman’s collapse triggered panic and all EMs fell almost uniformly.  
  - Re-decoupling: with return of stability, a striking gap opened between high vulnerability countries and others; since August 2007, stock markets in low and medium vulnerability countries have broadly recovered to pre-crisis levels, while those in high vulnerability countries remain depressed.

### Measurements of impact and vulnerability
- Impact on real economy: preferred measure is percent change in seasonally adjusted quarterly GDP from each country’s peak to its respective trough during the crisis.  
- Impact on financial markets and banking sector measured by:  
  - change in average monthly stock market index during the crisis;  
  - collapse in real private sector credit growth from peak to trough and the difference between pre- and post-crisis average monthly credit flows in percent of GDP;  
  - rise in average monthly EMBI sovereign spread from trough to peak (in basis points).  
- Table excerpted indicators and summary statistics (as reported):  
  - Output collapse 1/ Median-4.9-4.5  
  - 25th percentile-8.4-6.6  
  - 75th percentile-2.0-2.9  
  - Stock market collapse 1/ Median-57.1-55.4  
  - 25th percentile-72.0-64.1  
  - 75th percentile-45.2-49.0  
  - Rise in sovereign spreads 2/ Median462465  
  - 25th percentile287...  
  - 75th percentile772...  
  - (Sources: Haver; Bloomberg; Fund staff calculations.)

### Policy response, recovery, and exit implications
- Policy response: countries with more policy space and less binding financing constraints entered the crisis able to implement more aggressive fiscal and monetary stimuli; fiscal policy in particular responded more strongly than implied by historical behavior.  
- Recovery: countries with better pre-crisis fundamentals and those able to sustain public spending growth are recovering more quickly.  
- Exit issues and outlook:  
  - EMs that entered the crisis with high vulnerabilities smoothed adjustment due to quick access to financing, including from the IMF, but need to sustain adjustment in coming years to improve vulnerability indicators.  
  - EMs with low pre-crisis vulnerabilities are further ahead in the recovery cycle than AEs; some may be constrained from withdrawing stimulus because monetary tightening in AEs could fuel capital inflows.  
  - To cope with surges in capital inflows, these countries may need to adjust policy mix and/or consider price-based capital controls and prudential measures, where appropriate.

### Implications for IMF surveillance and related work
- The finding that markets discriminated across EMs and rewarded prior progress underscores the relevance of vulnerability indicators for IMF surveillance and policy advice.  
- This paper complements IMF work on the Fund’s future financing role, exit issues from crisis intervention policies, the state of public finances, and strategies for fiscal consolidation in the post-crisis world.

*Source: Excerpts from the IMF paper (sections I–II) and associated figures and tables in the supplied content.*

### 15. Econometric analysis was used to assess the impact of pre-crisis external

### 15. Econometric analysis was used to assess the impact of pre-crisis external vulnerabilities on output collapse, controlling for global linkages

### Methodology and primary specification
- Primary regression explains fall in real output as a function of:
  - pre-crisis vulnerabilities;
  - trade connectedness with the rest of the world;
  - international financial integration.
- The three measures that best explained cross-country variation:
  - external vulnerability index in the Spring 2007 round of the VEE;
  - percent change in domestic demand of AE trading partners weighted by trade shares and computed over a similar period to the peak-to-trough change in each EM’s output;
  - consolidated stock of claims of BIS reporting banks (immediate borrower basis) on EMs in percent of the EM’s GDP in December 2007.
- Other indicators, including regional dummies, were tried but did not affect the central findings.

### Key empirical findings on output collapse
- Magnitude:
  - The least vulnerable EMs, on average, contracted 6½ percentage points less than the most vulnerable EMs (Table 2).
- Main regression coefficients (selected results reported in the chapter):
  - External section vulnerability index (ranged 0 - 1): -6.40 ** (3.04)
  - Domestic demand growth in AE trading partners (percent): 1.44 ** (0.68); alternative specifications: 1.47 ** (0.63); 1.68 *** (0.53); 1.63 *** (0.59); 1.53 ** (0.65); 0.91 (1.34); 1.60 * (0.87)
  - Foreign bank claims (percent of GDP, expressed in logs): -1.7 * (0.92); -1.90 ** (0.81); -1.85 ** (0.83); -0.86 (1.08); -1.90 * (1.00); -2.50 * (1.37); -1.07 (1.25)
  - GIR in percent of (short-term debt at residual maturity plus current account deficit, expressed in logs): 2.84 *** (0.86); 8.00 *** (2.56); 2.63 * (1.31)
  - Current account balance (percent of GDP): 0.17 * (0.08)
  - External debt (percent of GDP): -0.09 ** (0.04)
  - External debt (percent of exports): -2.40 (1.59)
- Regression fit and samples:
  - Observations across specifications: 40, 41, 45, 42, 42, 22, 19
  - R-squared values reported: 0.44, 0.49, 0.40, 0.44, 0.40, 0.55, 0.25
- Notes: Robust standard errors in parentheses. *** p<0.01, ** p<0.05, * p<0.1. Source data: VEE Spring 2007; GEE; IFS; WEO. Fund staff calculations.

### Reserves and nonlinear effects
- Pre-crisis reserve holdings associated with positive but diminishing returns in cushioning output collapse.
- Reserves defined as ratio of reserves to external financing requirements (sum of short-term debt at residual maturity and the current account deficit).
- Empirical pattern:
  - Higher reserves helped reduce external vulnerabilities and support rollover of external debt and market confidence (Table 2, column 2).
  - When sample split at 100 percent of reserve coverage of short-term debt (and at 150 percent or median reserves-to-GDP), reserves had a significant payoff at low levels of reserve coverage but much less so at high levels.
- Supporting specification:
  - Peak-to-trough percent change in output regressed on reserves, short-term debt, and current account balance (each expressed in percent of GDP).
- Reserve-coverage scatter regression (full sample):
  - y = 3.37ln(x) - 21.254, R² = 0.25
  - After excluding outliers: y = 3.66ln(x) - 22.399, R² = 0.2199
- Cross-study note:
  - Blanchard and others (2010) do not find a significant role for international reserves once controlling for short-term debt, but they do not explore potential non-linearities.

### Trade linkages
- Trade linkages matter substantially:
  - Coefficients indicate EMs experienced an additional 1½ percentage point reduction in real output for every percentage point fall in domestic demand in their advanced-economy trading partners.
- Large EMs with exports a smaller component of aggregate demand (e.g., Indonesia and India) experienced smaller real shocks.
- Trade fell more in this crisis than in past global recessions, reflecting increasing interconnectedness and responsiveness of global supply chains (Freund, 2009).
- Trade finance problems were not identified as the principal cause of the sharp collapse in trade.
- Although trade dispute filings intensified, a wholesale rise in protectionism did not materialize.

### Credit booms, cross-border funding, and credit busts
- Pre-crisis credit booms, often funded from abroad, generally ended in credit and output busts.
- Cross-border claims of BIS reporting banks on EMs in December 2007 ranged from close to zero to around 37 percent of GDP across countries.
- Empirical effect:
  - A country that had double the average level of claims of about 7 percent of GDP experienced an additional 1¼ percentage points in output reduction (Table 2).
- Credit busts associated with sharp increases in money market rates, suggestive of a credit crunch.
- Regional and structural observations:
  - Impact of global deleveraging was particularly pronounced in Emerging Europe where cross-border lending had been growing sharply.
  - EMs whose banking systems were primarily funded by domestic deposits were better able to sustain credit growth (consistent with Kamil and Rai, 2010).
- Determinants of peak-to-trough real credit growth (selected):
  - 2007 credit to GDP in percent of 2003 ratio: -0.21 *** (-0.03) and -0.004 *** (-0.001) in alternative specifications.
  - Change in money market rate from August 2008 to peak: -0.59 *** (-0.18) and 0.004 (-0.009) in alternative specifications.
  - Constant reported: 6.39 and 0.06 (standard errors -3.84 and -0.20).
  - Observations: 37 and 40; R-Squared: 0.76 and 0.22.

### Credit bust severity relative to past crises
- Through 2009Q4, credit busts in EMs were less damaging than during past crises, despite pronounced pre-crisis credit booms.
- The change in growth rate of private credit was more pronounced for countries with high pre-crisis vulnerabilities.
- Possible explanations:
  - Lack of currency and banking crises in many EMs;
  - Support provided by the international community;
  - Some EMs may not yet have reached their credit growth trough.

### Sovereign spreads and market perceptions
- Pre-crisis external vulnerabilities help explain the rise in sovereign spreads during the crisis (Table 4).
  - The country considered most externally vulnerable in March 2007 experienced 220 basis points more in rising spreads than the least vulnerable (Table 4, column 1).
- Reserves coverage:
  - Ratio of reserves to short-term external financing needs influenced market perceptions; greater reserves coverage associated with smaller increase in spreads (Table 4, column 2).
- Other significant factors for spreads:
  - Cumulative inflation in 2003–2007: 0.13 *** (0.02) and 0.11 *** (0.02) in alternative specifications.
  - Inflation-targeting regimes: coefficient -1.24 (0.75) and -1.80 *** (0.63) in alternative specifications.
- Selected Table 4 coefficients:
  - External vulnerability, Spring 2007: 2.20 ** (1.05)
  - Reserve cover of ST debt at RM and CA deficit: -0.93 ** (0.40)
  - Constant: 1.22 and 6.87 *** (0.97) (1.81)
  - Observations: 38, 38; R-squared: 0.63, 0.65.

### Banking sector risk and liquidity
- Countries with greater initial fiscal vulnerabilities and where interbank liquidity dried up experienced higher banking sector risks during the crisis.
- Measure used: Moody’s expected default frequency (EDF) — increase from pre-crisis trough to peak.
- Relationships:
  - Public sector vulnerability index (2007) positively associated with change in EDF: regression y = 6.2721x + 0.7041, R² = 0.3683.
  - Average money market rate (2008Q3–2009Q2) positively associated with change in EDF: regression y = 0.3162x - 0.1857, R² = 0.3705.
- Interpretation:
  - Higher pre-crisis public sector vulnerability likely raised market concerns about capacity to address bank solvency problems.
  - Tighter interbank liquidity (higher money market rates) associated with higher default probabilities, reflecting counterparty and other banking risks.

### Policy response and recovery: overall stance
- EMs mounted significant fiscal and monetary measures to stem decline in aggregate demand (Figure 7).
- Fiscal accommodation in 2009 (change in primary balance) averaged close to 2½ percent of GDP for EMs.
  - Advanced Economies (AEs) provided larger accommodation: 4¾ percent of GDP on average, partly reflecting financial sector restructuring costs.
- Monetary stimulus:
  - Monetary policy rates in EMs were lowered by 300 bps on average; AEs reduced rates by about 320 bps on average.
  - The response varied across EMs, in part due to higher pre-crisis rates.

### Determinants and constraints on fiscal accommodation
- Countries with better pre-crisis fundamentals were able to enact more counter-cyclical easing.
- Cross-country analysis of EM responses in 2009:
  - Higher pre-crisis primary balances and lower public debt levels allowed greater fiscal accommodation (Table 5).
  - These two factors accounted for most of the explained variation in accommodation across countries.
  - Evidence that fiscal accommodation was greater where growth collapsed the most (though growth was not statistically significant in regressions due to endogeneity concerns).
- Selected Table 5 coefficients (determinants of change in primary deficit; "+" means higher accommodation):
  - Primary balance (lagged): 0.24 ** (0.12); 0.26 ** (0.12)
  - Overall balance (lagged): 0.38 ** (0.15)
  - Public debt (lagged): -3.54 *** (0.94); -2.96 *** (1.07); -0.40 (1.51)
  - Growth: -4.63 (6.21); -8.18 (6.44)
  - Constant: 4.30 *** (0.54); 3.98 *** (0.58); 3.57 *** (0.57)
  - Observations: 48, 48, 48; R-squared: 0.30, 0.31, 0.36
- Distribution of accommodation:
  - Change in primary deficit varied from around 1 percent for the quartile with the least fiscal response to around 4 percent for the quartile with the highest response.
- Empirical robustness:
  - Inclusion of overall—rather than primary—balance (to capture interest-payment constraints) did not change the results.
  - Changes in fiscal balance can be decomposed into cyclical (automatic stabilizers) and discretionary components; main results hold when cyclically adjusted measures used.

*Source: VEE Spring 2007; GEE; IFS; WEO; Haver; Bloomberg; Moody’s KMV; Fund staff calculations.*

### 27. While the empirical framework works well to explain the fiscal response on

### 27. While the empirical framework works well to explain the fiscal response on 

### Fiscal response: cross-country variation
- The empirical framework explains the fiscal response on average, but important country-specific differences exist.
- Largest differences between actual accommodation and model-predicted accommodation arise among commodity exporters like Russia and Chile, where the fall in commodity revenues to the budget account for the differences (text figure).
- Financing constraints forced several countries to accommodate less than predicted by the model; absence of fiscal space implies some countries were even more constrained than average regression estimates suggest.
- Footnote context:
  - Inclusion of a dummy for countries heavily dependent on commodity-related revenues and regressions excluding such countries show the main results generally hold.
  - In Estonia, constraints may also have reflected the policy goal to meet the Maastricht criteria in 2009 itself.

### Role of financing constraints
- Bivariate correlations indicate available financing played a role in limiting fiscal accommodation.
- Simple measure: level of public debt — countries with higher pre-crisis public debt levels were more constrained in accommodation in 2009 (text figure).

### “Extra” accommodation in 2009 (fiscal stimulus beyond predictions)
- Two approaches indicate a stronger-than-predicted fiscal response in 2009 for EMs (See Box 5 referenced in source):
  - Out-of-sample prediction from pre-crisis behavior calculated an “extra” accommodation in 2009 for the average EM of around 2 percentage points of GDP, with all regions showing higher-than-predicted fiscal accommodation.
  - Direct examination of differential behavior in 2009 found a similar result.
- The amount of “extra” stimulus was more limited in countries with:
  - Higher pre-crisis foreign claims of BIS-reporting banks, and
  - Higher pre-crisis EMBI spreads,
  - Likely reflecting further constraints on external financing including from a sudden stop of capital inflows (Table 6).
- Table 6 (summary statistics shown in source):
  - Coefficients (Table 6 regressions excerpt):
    - Pre-crisis exposure of BIS-reporting banks (% of GDP): -0.12 *** (0.04)
    - EMBI in August 2008: -0.49 * (0.28)
    - Constant: 3.95 *** (0.87)
    - Observations: 34
    - R-squared: 0.11
  - Country group means (Monetary Stimulus: Reduction in Policy Rates, Aug. 2008-Oct. 2009, mean in percentage points):
    - All advanced economies: 3.2
    - All emerging markets (EMs): 3.0
    - EMs by exchange rate regime:
      - Fixers: 2.1
      - Floaters: 3.4
    - EMs by region:
      - Asia: 3.1
      - Europe: 3.1
      - Middle East, Cent. Asia, and S. Africa: 1.4
      - Western hemisphere: 3.6

### Monetary response: overall patterns
- Monetary responses varied widely across EMs, reflecting exchange rate regimes, external funding costs, and pre-crisis policy rates.
- Measured by reduction in policy rates, on average EMs provided a similar-sized monetary response as AEs (Figure 7 referenced).
- Regional and regime patterns:
  - Western Hemisphere EMs provided the largest average stimulus.
  - Middle East EMs (higher inflation and many pegs) had less space for monetary easing.
- Timing: bulk of monetary stimulus was provided in the first half of 2009 (Figure 8 referenced).
- Unconventional measures:
  - Ishi and others (2009) note EM use of unconventional central bank measures was constrained compared to AEs, though credit policy played an important role in some EMs (examples: China’s directed credit policies and Korea’s expansion of SME credit guarantees).

### Determinants of monetary stimulus and policy rate reductions (Table 7)
- Factors explaining drop in policy rate across EMs (Aug 2008–Oct 2009):
  - Policy rate and inflation on eve of output collapse, and inflation dynamics during the crisis.
  - These factors accounted for around 60 percent of the observed reduction in policy rates across EMs.
- Quantitative effects (Table 7 coefficients shown in source):
  - Change in inflation 2009: -0.31 *** (0.06) in column (1); -0.36 *** (0.06) in column (2)
  - Policy rate Aug. 2008: 0.60 *** (0.10); 0.66 *** (0.11)
  - Inflation 2008: -0.32 *** (0.07); -0.36 *** (0.08)
  - Interaction terms with peg dummy (column (2)):
    - Change in inflation 2009 * peg: 0.61 ** (0.25)
    - Inflation 2008 * peg: 0.58 *** (0.16)
  - Observations: 36
  - R-squared: 0.58 (col 1), 0.64 (col 2)
- Interpretation:
  - Countries with credible monetary frameworks (low or falling inflation) provided more monetary stimulus.
  - Countries with one percentage point higher inflation in August 2008 lowered policy rates 32 bps less than other EMs.
  - Higher initial policy rates provided greater room for easing (distance from zero lower bound).
  - Policy rates showed less sensitivity to these factors in fixed exchange rate regimes (interaction terms).

### Interest rate transmission and exchange rates (Table 8 and Table 9)
- Countries with pegged exchange rates or higher EMBI spreads were constrained in ability to lower policy rates.
- Panel regression of policy rate levels (2008Q1–2009Q3) explains policy rates by lagged inflation, output gap (Taylor-rule variables), and EMBI spreads (Table 8, first column).
- Table 8 key coefficients (panel, 30 countries, quarterly data):
  - EMBI: 0.19 *** (0.04) for policy rate level (col 1); 0.79 *** (0.07) for money market rate level (col 2)
  - EMBI * peg: -0.39 *** (0.14) col 1; -0.24 (0.16) col 2
  - Output gap (t-1): 0.41 *** (0.05) col 1; 0.69 *** (0.09) col 2
  - Output gap (t-1) * peg: -0.27 *** (0.10) col 1; -0.70 *** (0.16) col 2
  - Inflation (t-1): 0.12 *** (0.02) col 1; 0.10 *** (0.03) col 2
  - Inflation (t-1) * peg: -0.10 * (0.05) col 1; 0.11 (0.08) col 2
  - Constant: 5.40 *** (0.24) col 1; 2.77 *** (0.46) col 2
  - Observations: 206 (col 1), 200 (col 2)
  - R-squared: 0.48 (col 1), 0.57 (col 2)
  - Number of countries: 30
- Findings:
  - Countries with higher EMBI sovereign spreads kept policy rates higher; EMBI effects are larger for money market rates than for policy rates.
  - Transmission of policy rate changes to bank lending rates was less than one-for-one (text figure), with considerable cross-country variation. Regression shown: Change in bank lending rate vs Change in policy rate between Oct. 09 & Aug. 08 (R-squared = 0.1943).
- Exchange rate behavior and reserves (Table 9):
  - Countries with more reserves were able to intervene more to stem exchange rate declines.
  - Exchange rates depreciated more where countries had more space to cut policy rates (lower initial inflation or higher initial policy rate).
  - Table 9 coefficients (summary from source):
    - Reserve/(ST debt + CA), 2007: -0.02 (col 1) and -0.02 *** (col 2) (standard errors: (0.02) and (0.01))
    - Policy rate, Aug. 2008: 2.13 *** (0.74) col 1; -0.51 * (0.26) col 2
    - Inflation in 2008: -1.44 *** (0.51) col 1; -0.03 (0.18) col 2
    - Constant: 17.60 ** (8.04) col 1; 6.40 ** (2.77) col 2
    - Observations: 29 (both columns)
    - R-squared: 0.36 (col 1), 0.30 (col 2)
  - Figure: Initial Reserves and Reserve Use — regression y = -1.83x + 12.41, R² = 0.40 (fall in reserves (peak to trough, percent of 2008 GDP) vs Reserves/GDP (2008 December)).

### Recovery from the crisis: timing and cross-country differences
- By late 2009 recovery was underway in most EMs but with considerable variation.
- On average, real GDP in EMs expanded 3 percent during the last three quarters of 2009.
- Non-peggers recovered faster than peggers.
- Regional averages (Recovery from the Crisis, averages, percent; from source Table):
  - All EMs: GDP growth 3.1; Industrial production growth 10.8
  - By exchange rate regime:
    - Fixed exchange rate regimes: GDP 0.2; IP -1.6
    - Flexible exchange rate regimes: GDP 3.9; IP 14.0
  - By region:
    - Asia: GDP 6.4; IP 26.7
    - Europe: GDP 1.2; IP 4.3
    - MCD: GDP 4.8; IP 10.9
    - Western hemisphere: GDP 3.1; IP 9.7
  - Note: IP growth measured from each country's trough to Dec. 2009.

### Determinants of recovery (Table 10 and Table 11)
- Two key takeaways from regression analysis of determinants of strength of recovery (Table 10):
  - Countries with better pre-crisis vulnerability indicators, including reserve coverage of short external financing requirements, recovered faster.
  - Countries that sustained stronger public spending during 2009 recovered faster (real public consumption and investment growth in 2009 used to capture fiscal contribution).
- Additional determinants highlighted:
  - “Bounce-back” effect: countries that contracted the most during the crisis experienced faster recoveries (suggestive of overshooting).
  - Recovery helped by growth in trading partners; a double-dip in AEs could jeopardize EM recovery.
  - Flexible exchange rate regimes associated with faster recovery than pegs, even after controlling for vulnerabilities and initial output fall.
- Table 10 selected coefficients (dependent variable: growth rate over last three quarters of 2009):
  - GDP growth during contraction: -0.21 ** (0.08) col 1; -0.22 *** (0.07) col 2; -0.33 *** (0.11) col 3; -0.30 ** (0.11) col 4
  - External vulnerability in 2007: -6.02 *** (2.02) col 1; -3.70 (2.16) col 2 (not significant)
  - Trading partners' import recovery: 0.21 (0.27) col 1; 0.57 ** (0.24) col 2; 0.30 (0.31) col 3; 0.49 * (0.28) col 4
  - Peg dummy: -2.54 * (1.27) col 1; -3.23 * (1.60) col 2; -1.72 (1.31) col 3; -2.26 (1.42) col 4
  - Reserves (percent of short-term debt + current account deficit): 0.01 *** (0.0) col 1
  - Growth in public demand: 0.16 * (0.08) col 1; 0.19 ** (0.08) col 2
  - Constant terms and model fit:
    - Observations: 39 (col 1), 38 (col 2), 31 (col 3), 32 (col 4)
    - R-squared: 0.44, 0.42, 0.49, 0.44 respectively
- Table 11 (industrial production growth recovery, trough to Dec. 2009):
  - IP growth during contraction: -0.62 ** (0.25) col 1; -0.96 *** (0.21) col 2
  - Trading partners’ import recovery: 2.59 *** (0.86) col 1; 1.23 (1.22) col 2
  - Growth in public demand: 0.69 *** (0.22) col 2
  - Peg dummy: -9.79 * (5.00) col 1; -12.56 * (6.60) col 2
  - Constants, observations, and fit:
    - Constant: 10.74 *** (3.18) col 1; 0.89 (4.29) col 2
    - Observations: 36 (col 1), 28 (col 2)
    - R-squared: 0.40 (col 1), 0.57 (col 2)

### Country cases: variability and illustrative examples
- Empirical framework explains about a quarter to three-quarters of observed EM experiences depending on specification; with ~50 EMs in main sample, too few degrees of freedom to include many explanatory factors.
- Three country cases examined to illustrate diverse experiences: Philippines, Russian Federation, Indonesia.
  - Philippines:
    - Fits model predictions well and benefited from stronger-than-expected remittances during the crisis.
    - Entered crisis with improved external vulnerabilities and reserve buffers while allowing exchange rate flexibility.
    - Based on empirical estimation in Section II, output would have fallen 4 percent had the Philippines entered the crisis with its external vulnerabilities as in 2005; actual fall from peak to trough was 2¼ percent.
  - Russia:
    - Output fell sharply and more than can be explained by Section II analysis.
    - Russia made greater use of reserves than nearly all EMs and gave a large fiscal stimulus.
  - Indonesia:
    - One of few countries to sustain growth through the crisis despite sharp financial market volatility, outperforming regressions’ predictions.

*Source: IMF staff calculations and analysis as presented in the provided chapter excerpt.*

### 41. Improved fiscal fundamentals allowed for considerable fiscal stimulus during

### 41. Improved fiscal fundamentals allowed for considerable fiscal stimulus during

### Philippines: fiscal space, remittances, and financial sector resilience
- Fiscal stimulus and space
  - Fiscal stimulus during the crisis was around 2¼ percent of GDP in 2009.
  - Due to VAT and other reforms, the government balance improved significantly and public debt fell by some 35 percentage points of GDP from 2004 to 2008, providing substantial fiscal space.
  - The 2009 fiscal package was calibrated to match the projected fall in the contribution to growth from external demand and focused on infrastructure and social spending to support growth and protect the poor.
  - Better fiscal fundamentals allowed the Philippines to secure necessary financing during the crisis despite disruption to international debt markets.
- External and domestic demand buffers
  - Remittances were around 11 percent of GDP in 2009 and are a key driver of domestic demand; remittances held up during the crisis.
  - The Philippines did not experience pre-crisis overheating, implying fewer pre-crisis excesses and a smaller economic bust.
- Financial sector strengthening and policy measures
  - Since 2004, significant progress in financial sector reforms included strengthening supervision of market, liquidity, and credit concentration risk.
  - Banks’ asset quality and capitalization levels noticeably improved preceding the crisis.
  - Philippine banks had limited direct exposure to subprime assets; larger risks stemmed from mark-to-market losses on government bond holdings.
  - Authorities provided temporary regulatory relief on mark-to-market requirements (later reversed) and the central bank created a dollar repo facility to support dollar liquidity and address counter-party risk in the interbank market.
  - Philippine banks enjoyed credit and deposit growth through the crisis.

*Source: IMF staff analysis in the referenced chapter.*

### Russia: large output collapse, reserve use, and fiscal response
- Output contraction and explanatory factors
  - Output fell sharply by about 11 percentage points of GDP from peak to trough, one of the largest output collapses in EMs.
  - The model in Section II explains only about half of Russia’s actual fall in output.
- Role of oil prices and terms-of-trade shock
  - Collapsing oil prices revised outlooks for the economy and the ruble, causing domestic demand to plunge due to both immediate terms of trade shock and anticipation of a bleaker outlook.
  - Capital outflows, banks’ increased risk aversion, and a credit crunch exacerbated the collapse.
  - High oil prices prior to the crisis may have masked inefficiencies in un-restructured sectors.
- Pre-crisis credit boom and exchange rate policy
  - Through 2007, Russia grew at 7 percent per year on average, driven by high oil prices, domestic demand, and a credit boom.
  - A rigid exchange rate policy and balance of payments surpluses led to reserve accumulation and a large monetary and credit expansion, increasing reliance by some corporates and banks on short-term capital flows.
- Reserve use and consequences
  - Russia spent more than $200 billion of its reserves (representing 13 percent of 2008 GDP) to temper pressure on the ruble, one of the largest declines among EMs.
  - Reserves provided space for corporates and banks to adjust to lower oil prices, but the strategy entailed costs: some market participants profited from speculating on devaluation and problem banks remained to be addressed.
  - Real private sector credit growth in Russia was -6½ percent (y/y) in December 2009 compared to about one percent (y/y) for EMs on average.
- Fiscal accommodation
  - Russia loosened the primary balance by 10½ percent of GDP between 2008 and 2009, one of the largest fiscal accommodations among EMs.
  - After accounting for the oil revenue collapse, the accommodation magnitude was 6½ percent of GDP, still among the largest in the sample.

*Source: IMF staff analysis in the referenced chapter.*

### Indonesia: domestic demand-led resilience, market concerns, and stimulus timing
- Resilience drivers
  - Domestic demand constituted around 90 percent of real GDP in 2007, making Indonesia less reliant on international trade and allowing it to grow through the crisis.
  - Advanced-economy trading partners experienced a decline in domestic demand of 3¼ percent compared to the average EM decline of around 2¾ percent, but Indonesia’s large domestic market mitigated the impact.
  - Increased spending related to national elections in 2009 also supported demand.
- Market volatility and contingent financing
  - Sovereign spreads rose substantially amid market nervousness driven by a large conglomerate’s debt problems and doubts about external exposures.
  - Indonesia tempered market volatility via reserve buffers, absence of systemic financial stress due to prior reforms and strong capital and liquidity positions, and by securing contingent financing.
  - Contingent financing secured included $5½ billion in budget support from the World Bank, AsDB, Australia, and Japan, plus additional external swap and credit lines from China and the Chiang Mai Initiative.
- Recovery and policy timing
  - From 2009Q1 to 2009Q4, output grew 4½ percent, above the EM average of 3 percent for the same period.
  - Pre-planned tax cuts going into 2009 meant fiscal stimulus was one step ahead of the curve; authorities topped up fiscal loosening with cash transfers and social spending as the crisis struck.
  - Monetary policy response and liquidity management by Bank Indonesia supported the recovery.

*Source: IMF staff analysis in the referenced chapter.*

### V. Exit issues and lessons — heterogeneous policy challenges for EMs
- Bifurcated policy agenda as EMs emerge from the crisis
  - EMs with high pre-crisis vulnerabilities generally still have substantial imbalances and need to sustain adjustment despite suffering larger output losses.
  - EMs with better pre-crisis fundamentals face immediate cyclical concerns: tightening to counter rising output and inflation risks inducing capital inflows if advanced economies remain accommodative, yet failure to tighten risks overheating and asset price bubbles unless exchange rates are highly flexible.
- Medium-term output losses and implications
  - Projected medium-term output loss (difference between IMF WEO projections for 2013 in April 2010 and April 2008) was 16 percentage points for EMs with low and medium pre-crisis vulnerabilities and 21 percent for those with high pre-crisis vulnerabilities.
  - Weaker pre-crisis fundamentals are associated with larger projected output losses; faster pre-crisis credit growth also predicts bigger medium-term output loss.
  - The effects of IMF-supported programs on medium-term output loss are difficult to detect empirically in this framework.
- External and fiscal adjustment implications
  - Past crises often produced abrupt adjustments in the current account and temporary increases in external debt-to-GDP, with debt-to-GDP typically falling by 5−10 percentage points within five years of the crisis.
  - EMs that entered the current crisis with high vulnerabilities have higher levels of external indebtedness than past crisis cases and are likely to remain vulnerable; persistent current account deficits and permanent output loss plus low inflation will depress the denominator and imply a 10–15 percentage point increase in debt-to-GDP, little of which is projected to be reversed in the next five years.
  - An increasing number of countries with high external vulnerabilities have recently accumulated fiscal vulnerabilities; fiscal consolidation will help address both fiscal and external vulnerabilities by stemming public debt rise and facilitating external adjustment.
- Policy priorities by vulnerability group
  - High vulnerability countries: need fiscal tightening to accelerate external adjustment and address fiscal sustainability, complicated by weak post-crisis recoveries; also require structural reforms to improve medium-term growth (e.g., competitiveness and financial sector reforms).
  - Low vulnerability countries: face rising capital inflows, closing output gaps, and rising inflation; inflation has picked up relatively quickly and is close to its average since 2005 in these countries, partly reflecting energy price effects and headline inflation influences on expectations.
  - Capital inflows turned positive in the second half of 2009 for low vulnerability countries, remaining more subdued for high vulnerability EMs.

*Source: IMF staff analysis in the referenced chapter.*

*Document: IMF chapter section titled "41. Improved fiscal fundamentals allowed for considerable fiscal stimulus during".*

### 59. Fast recovering EMs appear to be taking a cautious approach to the withdrawal

### 59. Fast recovering EMs appear to be taking a cautious approach to the withdrawal

### Monetary policy stance and Taylor-rule evidence
- Standard Taylor-rule regressions were run for a sample of EMs based on 2000−07 data for output gaps, inflation, and lagged interest rates.
- Predicted interest rates in many fast-recovering countries are significantly higher than their actual rates at present—by over 100 bps on average across all low- and medium-vulnerability EMs.
- Conclusion from the evidence: these countries are presently maintaining lower interest rates than they would have based on past responses to output and inflation developments.

### Constraints from capital inflows and exchange rates
- Some fast-growing EMs may be constrained in their monetary policy decisions by possible spillovers from accommodative policies in AEs.
- Reasons why rates may be kept below predicted levels:
  - Lingering uncertainty over the domestic and global recoveries.
  - Concern that raising interest rates when policy rates in major advanced economies remain near historic lows could prompt excessive and unwanted capital inflows, potentially fueling asset price bubbles.
  - Concern that associated appreciation in exchange rates could dampen recoveries in many export-oriented economies.
- Possible behavioral response: some countries may alter their fiscal/monetary policy mix and withdraw more fiscal stimulus than they would in the absence of monetary policy constraints.

### Capital inflows: drivers and near-term implications
- Capital inflows have resumed in EMs that came out relatively unscathed from the crisis.
- Drivers of inflows:
  - Push factor: historically, accommodative monetary policies in AEs have been associated with rising capital flows to EMs.
  - Pull factor: EMs recovering briskly with better fiscal sustainability indicators than AEs may pull capital by offering promising investment opportunities in a high growth macroeconomic environment.
- Current assessment: overall, such inflows are just returning to pre-crisis levels.
- Policy concern: surges in such flows going forward may complicate policy challenges for EMs recovering quickly from the crisis.

### Coping options for capital inflows (macro and prudential)
- Conventional responses to coping with inflows include:
  - Allowing the exchange rate to appreciate.
  - Building reserves.
  - Easing monetary policy.
  - Tightening fiscal policy.
  - Improving the prudential framework (financial regulation and supervision).
- Practical considerations and limitations:
  - Tightening fiscal policy may be particularly relevant in countries that have recently implemented a fiscal stimulus, but may entail political challenges and take time to implement.
  - Improving regulation and supervision frameworks generally takes time to implement while fast-moving surges in capital inflows could present an immediate problem to monetary authorities.
  - Consequently, countries may be forced to rely on monetary and exchange rate tools which may also have limitations.

### When price-based capital controls and prudential measures may be helpful
- Three economic factors are relevant in deciding when such measures may be helpful: exchange rate valuation, reserve adequacy, and the risk of overheating.
- Price-based capital controls and prudential measures have a clearer case where:
  - The exchange rate is not undervalued,
  - Reserve build-up is not needed (reserves adequate),
  - The economy is at risk of overheating (inflation outlook not benign, incipient credit or asset price boom, or fiscal tightening not desirable or feasible).
- Practical caveats:
  - Assessing the degree of exchange rate overvaluation is subject to significant uncertainty.
  - The mere presence of large inflows may signal market expectation that the currency is undervalued.
  - Therefore, some currency appreciation might need to be tolerated as part of the adjustment process even for countries where the exchange rate is not judged to be significantly undervalued.

### Lessons from the Crisis (relevant implications)
- Heterogeneous EM experience underscores the importance of economic fundamentals and global linkages.
  - EMs with smaller initial imbalances went into recession later and suffered considerably smaller declines in output during the first stage of the crisis.
  - These EMs had greater space to loosen fiscal and monetary policy and experienced earlier and faster post-crisis recoveries.
  - The pay-off from better fundamentals is likely to be long-lasting: they are expected to experience about five percentage points less of a reduction in permanent output compared with economies with weaker fundamentals.
- External linkages mattered:
  - Countries with stronger external linkages—higher dependence on demand from AEs or larger exposure to foreign bank claims—experienced sharper falls in output during the crisis.
  - Recovery in trading partners is helping EMs come out of the crisis.
- Reserves:
  - Higher levels of pre-crisis reserve cover were associated with less deterioration in both sovereign spreads and output during the crisis.
  - Diminishing returns: EMs enjoyed little additional benefit for having reserves in excess of the sum of short-term debt and the current account deficit.
  - For countries with flexible exchange rate regimes, building appropriate reserve buffers should not jeopardize the commitment to maintaining currency flexibility.
- Policy frameworks:
  - Countries with flexible exchange rates (especially inflation targeters) were less constrained in their ability to loosen monetary policy than other EMs.
  - Those with lower levels of public debt had greater space for fiscal loosening.
  - As the crisis draws to a close, the benefits of improved frameworks need to be safeguarded with prudent policies.
  - In low vulnerability EMs (a number of which are also inflation targeters), central banks need to carefully consider their responses to rising inflation to ensure that inflationary expectations remain well anchored.

*Source: _061510 - 59. Fast recovering EMs appear to be taking a cautious approach to the withdrawal*

### Section II)—to explore whether past crises have behaved differently—also yielded

### _061510 - Section II)—to explore whether past crises have behaved differently—also yielded

### Fiscal policy response: 2009 versus past crises — key findings
- Countries with higher lagged primary balance ran contractionary fiscal policy during past crises.
- The procyclicality of fiscal policy in past crises is underscored by the large positive coefficient on growth.
- Even after refining the specification, the coefficients for 2009 remain broadly the same.
- Crisis dummy effect: 2.98 ***
- 2009 Year dummy effect: 3.26 *** and 3.25 *** (in alternative specifications)

### Regression coefficients (Determinants of Change in Primary Deficit — "+" Means Higher Accommodation)
- Specification (1)
  - Primary balance (lagged): 0.41 ***
  - Public debt (lagged): -1.53
  - Growth: -12.14 **
  - Crisis dummy: 2.98 ***
  - Constant: 1.45 *
  - Observations: 435
  - R-squared: 0.24
  - Number of countries: 49
- Specification (2)
  - Primary balance (lagged): 0.46 ***
  - Public debt (lagged): -2.31 *
  - Growth: -12.88 **
  - Primary balance (lagged) * 2009: 0.18
  - Public debt (lagged) * 2009: -3.06 **
  - Growth in 2009: 5.43
  - 2009 Year dummy: 3.26 ***
  - Constant: 2.06 ***
  - Observations: 515
  - R-squared: 0.39
  - Number of countries: 48
- Specification (3)
  - Primary balance (lagged): 0.47 ***
  - Public debt (lagged): -2.34 *
  - Growth: -12.95 **
  - Primary balance (lagged) * 2009: 0.18
  - Public debt (lagged) * 2009: -3.07 **
  - Growth in 2009: 5.43
  - Primary balance (lagged) * past crises: -0.89 **
  - Public debt (lagged) * past crises: -14.00 ***
  - Growth in past crises: 24.30 *
  - 2009 Year dummy: 3.25 ***
  - Constant: 2.09 ***
  - Observations: 515
  - R-squared: 0.40
  - Number of countries: 48

- Notes: Robust standard errors in parentheses. *** p<0.01, ** p<0.05, * p<0.1
- Source for regressions: WEO; Fund staff calculations.

### Annex: Country sample and data sources
- Sample coverage: 57 economies are considered; country samples differ across regressions depending on data availability.
- Data sources: Spring 2010 World Economic Outlook; internal staff assessment of vulnerabilities; public sources including BIS, CEIC, Haver, IFS, Moody's, and others.

- Country lists by region (as presented)
  - Asia (11): China, India, Indonesia, Korea, Malaysia, Mongolia, Pakistan, Philippines, Sri Lanka, Thailand, Vietnam
  - Emerging Europe and CIS (22): Albania, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, Georgia, Hungary, Kazakhstan, Latvia, Lithuania, Macedonia, Montenegro, Poland, Romania, Russia, Serbia, Slovak Republic, Slovenia, Turkey, Ukraine
  - Western Hemisphere (17): Argentina, Bolivia, Brazil, Chile, Colombia, Costa Rica, Dominican Republic, Ecuador, El Salvador, Guatemala, Jamaica, Mexico, Panama, Paraguay, Peru, Uruguay, Venezuela
  - Middle East and Africa (7): Egypt, Israel, Jordan, Lebanon, Morocco, South Africa, Tunisia

### Implications implied by the findings
- Past crises show fiscal procyclicality: higher lagged primary balances were associated with contractionary responses in crises (interaction terms for past crises negative for primary balance and public debt).
- The 2009 response exhibits a distinct positive year dummy (3.25–3.26 ***) suggesting a systematically different fiscal stance in 2009 relative to baseline.
- Growth coefficients differ across contexts: negative and significant in baseline specifications, positive in past-crisis interactions (24.30 *), indicating heterogeneous roles of growth across episodes.

*Source: WEO; Fund staff calculations.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/np/pp/eng/2010/_061510.pdf_