## Financial Crises and Emerging Market Trade

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### Executive Summary
- Estimates indicate that the combination of zero net private capital flows to emerging markets and a domestic banking crisis could lower import volume growth by between 5 and 6 percent on impact.
- The effect on export volumes is slightly lower than on imports.
- Results support the view that general credit market conditions, including working capital, long-term investment financing, and trade finance, have an important impact on international trade over and above the concurrent impact on foreign and domestic output.
- Although significant, the estimated impact is less than anecdotal evidence suggests for the current global financial crisis.

### Introduction
- Question addressed: whether banking and financing crises have an additional impact on export and import volumes over and above the impact mediated by domestic and foreign output.
- Trade credits often collapse during banking crises despite being self-liquidating and typically backed by receivables; examples cited:
  - Trade credits declined by as much as 50 percent during the peak of recent crises in Argentina and Brazil, and fell by a comparable magnitude during the Korean crisis of 1997–98.
- Prior empirical work: Ronci (2004) finds changes in outstanding short-term trade credit significantly affect export and import volumes for 10 emerging market countries around crisis years.
- This paper expands Ronci by:
  - Using a larger set of countries and a longer time period (annual data 1980–2005).
  - Including a domestic banking crisis dummy and total net financial flows to emerging markets as proxy for external finance availability.
  - Sample: 36 emerging market economies (middle-income) plus two low-income countries (India and Pakistan); oil exports excluded.

### Econometric Analysis
- Baseline: standard trade equations relate import/export volumes to relative prices and domestic/foreign income.
  - Relative price for imports = import deflator / CPI (deflator uses CPI).
  - Income term for imports = domestic real GDP.
  - For manufacturing exporters: relative price = export deflator / unit labor cost of trading partners (demand-determined; expected negative).
  - For non-oil commodity exporters: relative price = world non-oil commodity price index / CPI (supply relationship; expected positive). For commodity exporters, relative price is a 3-year moving average.
- Estimation:
  - Annual data 1980–2005.
  - Regressions include lagged dependent variable, contemporaneous and first lags of income and relative prices.
  - Added contemporaneous and first lags of: (i) country-specific banking crisis dummy (0 = stable, 1 = experiencing a financial crisis), and (ii) total net private financial flows to emerging markets (in percent of EM GDP).
  - Instrumental variables implemented via generalized method of moments (GMM) with instruments = lags two to five of dependent variable and income and relative price terms.

Key empirical findings (short-run elasticities and coefficients):
- Imports (Table 1; short-run results emphasized in text):
  - Short-run relative price elasticity: –0.5.
  - Short-run income elasticity: 1.65.
  - Banking crisis dummy (contemporaneous coefficient): –0.021 (when a country experiences a banking crisis, import volume growth declines by over 2 percent immediately, all else equal).
  - EM private capital flows (contemporaneous coefficient): 0.95 *** (short-run coefficient around unity).
  - Private capital flows historically fluctuated between –0.2 and 3.1 percent of GDP.
  - Implication: at the trough of net private capital flows (slightly negative), import volumes were some 3 percent less than at its peak, with effect growing over time.
  - Robustness: including financing variables separately yields similar estimates; OLS yields larger magnitudes (banking crisis dummy rises to –0.032; private capital flows to 1.45).

- Exports — Manufacturing exporters (Table 2):
  - Short-run export price elasticity: –0.17.
  - Short-run income elasticity: 1.39.
  - Banking crisis dummy (contemporaneous coefficient): –0.013 * (implying export volumes for manufactures fall by about 1.3 percent when countries experience domestic banking crises; effect rises over time).
  - EM private capital flows: impact happens with a lag (first-lag coefficient significant and above unity: 1.48 *** in one specification).
  - Robustness: banking crisis coefficient significance can fall slightly below 90 percent in some robustness checks; OLS weakens manufacturing export crisis effect (banking crisis dummy much smaller at –0.007; private capital flows at 1.37).

- Exports — Non-oil commodity exporters (Table 2):
  - Relative price term positive but extremely small.
  - Foreign income term significant (short-run elasticity ~1.51).
  - Banking crisis dummy (short-run impact): –0.039 * (reported in Table 2; text highlights a short-run impact of –4 percent—roughly three times the size for manufactures).
  - Lagged private capital flows coefficient slightly above unity and significant.

- Comparison with Ronci (2004):
  - Ronci finds coefficients: 0.039 on change in short-term credits (exports) and about 0.1 (imports).
  - Ronci’s implied declines given large trade credit drops: about 2 percent in export volumes and 5 percent in import volumes.
  - Ronci’s estimates for domestic banking crises: insignificant effect on exports using GMM but large effects (5–7 percent) using GLS or IV; for imports Ronci finds very large coefficients (9–11 percent a year).
  - This paper’s estimates for exports are in the same order of magnitude as Ronci’s export result, but this paper finds smaller import effects than Ronci’s larger estimates.

- Diagnostics and estimation notes (selected figures from tables):
  - Import equation diagnostic statistics: # observations 895; # countries 38; R squared 0.8; A-B test for AR(1) -3.98 ***; A-B test for AR(2) -0.13.
  - Export equations (manufactures and non-oil commodities) diagnostics shown in Table 2: examples include # observations 523 and 279, # countries 22 and 12, R squared 0.98 and 0.97 respectively.

### Conclusion and Policy Implications
- Main quantitative implication:
  - The combination of zero net private capital flows to emerging markets and a domestic banking crisis could lower import volume growth by between 5 and 6 percent immediately, with a slightly lower effect on export volumes.
- Interpretation:
  - Financial conditions play a significant but not dominant role in stimulating trade volumes among emerging market countries.
  - The estimated effects are smaller than anecdotal reports during the current global financial crisis, likely because the initial withdrawal of financing tends to ease relatively quickly as alternative financing sources are discovered.
- Policy recommendation:
  - Because trade finance is not the only form of credit affecting trade (working capital and long-term investment finance also matter), policymakers should sensibly support credit flows in general rather than focus specifically on increasing trade finance alone.

*Prepared by the Strategy, Policy, and Review Department (Alun Thomas), March 11, 2009.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/spn/2009/_spn0904.pdf_