Financial Crisis and Global Recession:
At a Turning Point?
Richard Newfarmer
Special Representative to UN and WTO
World Bank
Cairo
June 15, 2009
Main messages
Recession in the US now appears to be bottoming out,
but speed and strength of recovery is uncertain
Even though recession will eventually end, several
daunting challenges remain, particularly for the
poorest countries and vulnerable social groups
Domestic policy is critical, but generating a sustained
recovery requires new forms of multilateral
collaboration
Excessively easy money after 2001
Fiscal stimulus as US budget swung from surplus to large deficit
Expansion of opaque financial innovation
– Subprime mortgages
– Home equity lending
– Consolidated Debt Obligations
– Credit Default Swaps
Emergence of unregulated borrowing in the shadow banking system
– Mortgage companies
– Investment banks
– Hedge funds
…leading to excessive leverage of consumers, corporates, and public sectors
…financed by China and other countries accumulating large reserves
Causes: Macroeconomic policy and changes in the
financial system create conditions for the perfect financial
storm
…and the deteriorating global imbalances
Current account balance, billions of dollars, 2002 and 2006, 2008
Source: World Bank.
2002
2006
2008
Emerging markets
USA
Euro Area
Sept-2008
MSCI equity price indexes, January 2005=100
Crash of Lehman in September...precipitated financial
panic that swept through global markets
Source: World Bank, Global Economic Prospects, 2009
So…
• 30% of household wealth wiped out
• $4 trillion of equity worldwide
• Pension funds obliterated
• Unprecidented contraction in consumption
Contracting consumption in rich countries transmits recession to poor countries – as world trade collapses
-10
-7
-4
-1
3
6
9
12
15
1981 1984 1987 1990 1993 1996 1999 2002 2005 2008
Percentage changeAnnual growth of global trade volumes
Source: World Bank, Global Economic Prospects, 2009
8
Trade plummets in all regions
Source: Datastream, U.S. Commerce Department and authors’ calculations. Simple average of growth rates across economies within
regions for a balanced sample of 45 economies reporting data
-40
-20
0
20
40
60
jan feb mar apr may jun jul aug sep oct nov dec jan feb
EAP ECA LAC MENA NOA SAS SSA
Export Growth by Region
Percent
1980-83 1997-02
Projection2007-10
Net private capital flows / GDP in developing countries
Source: World Bank, DEC Prospects Group.
…and diminished capital flows have deepened
recession in the developing world
So now the world economy is contracting…. for the
first time in the last half-century
World High Income
Developing
Growth of real GDPPercent
Source: World Bank, DEC Prospects Group, Consensus Forecast,
May 2009.
Developing countries stand to lose some 4 percentage
points of GDP growth
November 2008
Current
Source: World Bank, DEC prospect group, April 2009
Some 90 million additional workers are expected to
be trapped in poverty – with some 47 million in
South Asia and 24 million in South-Saharan Africa.
Credit markets have stabilized…secondary markets beginning
to reappear
Green shoots? Incipient signs of recovery….?
0
50
100
150
200
250
300
350
400
Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09
Spread between 3 month $ LIBOR and $ OIS
Source: World Bank, DEC Prospects Group.
Basis points
Credit markets have stabilized…secondary markets beginning
to reappear
Equity markets appear to have established a floor
Green shoots? Incipient signs of recovery….
Source: JP Morgan, World Financial Markets, June 2009
Credit markets have stabilized…secondary markets beginning
to reappear
Equity markets appear to have established a floor
Personal income in US rose 0.4% in April…household savings
hit 5.7% of disposable income (highest since 1995)
Some life in the real sectors…
Green shoots? Incipient signs of recovery….
Source: JP Morgan, World Financial Markets, June 2009
Green shoots? Incipient signs of recovery….
…and China’s fiscal stimulus is beginning to take hold
Source: JP Morgan, World Financial Markets, June 2009
-3
-1
1
3
5
7
1980 1985 1990 1995 2000 2005 2010
Developing countries
High-income countries
GDP annual growth rates (%)Forecast
Shape of the coming recession depends on
responding to several daunting challenges…
Outlook? Recovery will probably begin later this year or
early next year … but strength is uncertain
% change
?
Source: World Bank, Global Economic Prospects, 2009 and GEP Update, 2009
Daunting challenge: for rich countries, taking bad
debt off the books of the banks
Morgan
Stanley
RBS
Deutsche
BankCredit
Agricole
Societe
Generale
Barclays
BNP
ParibasUnicredit
UBS
Goldman SachsSantander
Citigroup
JP Morgan
HSBC
Market Value as of Q2 2007, US$ b.
Market Value as of January 20th 2009, US$ b.
Source: Bloomberg, Jan 20th 2009
Credit Suisse
49
120
7667
8091
108
93
116
75
100
116
255
165
215
16 4.6 10.3 17 26 7.4 32.5 26 35
27 35 64 19 85 97
Daunting challenges: Providing adequate financial
support to maintain growth in developing countries
Figure 1.e: Credit crunch means developing
countries face significant funding gapsEstimated funding gap in 2009 by region
-800
-700
-600
-500
-400
-300
-200
-100
0
All
developing
countries
East Asia
and Pacific
Europe
and Central
Asia
Latin
America and
the
Caribbean
Middle
East and
North Africa South Asia
Sub-
Saharan
Africa
Low estimate Base High estimate
Source: World Bank, DEC Prospects Group.
Financing gaps range from $200 b to $700 b.
Daunting challenges: At-risk countries…
Those are at risk:
•export only a few commodities
• have large % in poverty
• have weak fiscal positions
• have low reserves/ high debt
Source: IMF, 2009
Implications of slowdown…
• Crises in Mexico, Argentina, and East Asia increased
poverty dramatically
• 200 million likely to be trapped in poverty
• Infant mortality and child mortality rises –
200,000- 400,000 infants annually
• Cutbacks in health services
Daunting challenges: Providing support to workers and
the poorWidening fiscal deficits will put pressures on social safety nets
Figure 1.d: Weaker revenues will lead
fiscal deficits to widen sharply in 2009
-6
-4
-2
0
Middle-East
& North
Africa
South Asia Latin
America &
Caribbean
East Asia &
Pacific
Sub-
Saharan
Africa
Europe &
Central Asia
Source: World Bank, DEC Prospects Group.
projected deterioration (change) in fiscal balance, percentage points of GDP
Fiscal deficits will widen sharply in 2009
Daunting challenges: Providing support to workers and
the poorWidening fiscal deficits will put pressures on social safety nets
Poor households suffer declines in remittances
-10
-5
0
5
10
15
20
25
2005 2006 2007 2008 2009 2010
Baseline
Low case
Remittance flows to developing countries (USD, % change)
Daunting challenges: Providing support to workers and
the poorWidening fiscal deficits will put pressures on social safety nets
Poor households suffer declines in remittances
…and continued higher food and fuel prices
Source: World Bank, Prospects Group
Daunting challenges: Providing support to workers and
the poorWidening fiscal deficits will put pressures on social safety nets
Poor households suffer declines in remittances
…and continued higher food and fuel prices
Firms will face tighter credit conditions and weaker demand, so they will be slow to create new jobs… and unemployment will rise
Source: JP Morgan, World Financial Markets, June 2009
Daunting challenges: Providing support to the
unemployed 23 million more workers will be unemployed in 2009 than in 2007
Recessions with housing busts involve deepest employment cuts and longest period of recovery (Claessens, et al, 2008)
Jobs are lost more quickly in contraction than are replaced during subsequent recovery (Rijkers, 2009)
Employment usually takes twice as long to recover as output (Reinhard, et al 2002)
Poor urban workers often move to agriculture if that is feasible (e.g., in East Asia crisis, 30-40% of displaced workers moved).
Policy options? For developing countries…
Counter-cyclical policies: But only open to countries with access to noninflationary sources of finance and a sound investment climate
Since trade is a main channel of recession, policies to reduce trade costs can position countries to take advantage of recovery
– border and customs reforms
– port reforms
– improving logistics management
– Investment in labor-intensive and trade-related infrastructure, such as rural roads
Policy options? For developing countries…
Counter-cyclical policies: But only open to countries with access to noninflationary sources of finance and a sound investment climate
Since trade is a main channel of recession, policies to reduce trade costs can position countries to take advantage of recovery
Policies to support workers and the poor
– Increase in unemployment benefits
– Wage subsidies and lowering wage taxes
– Tariff reductions on food imports
– Public employment programs
– Conditional cash transfers programs (stay in school programs)
– Public investments in labor-intensive and trade-related infrastructure, such as rural roads
• Accelerated restructuring of banks and increased regulation
• Pledge to avoid protection
• Fiscal stimulus and expansive monetary policy
• Mobilization of more capital for developing countries
• IMF – $700- b. New arrangement to borrow (NAB)
• World Bank MDBs – Capital increase for ADB
• Reform of the IMF and World Bank – Increased capital , new voting, merit selection of leaders
Multilateral collaboration is crucial… and the G20 leaders
have begun the process…
G20 Summit
April 2
Agreed:
… but improving the multilateral response requires…
Fulfilling pledges for development assistance
Keeping global markets open and resisting pressures
for trade protection – and renewing a commitment to
the Doha Development agenda
Improving regulation of financial markets will require
careful balancing of national regulatory authorities
with international cooperation
Developing multilateral governance mechanisms to be
more inclusive
Conclusion…
Recovery is near, but its strength is in doubt and it will
take many quarters to have full effect on incomes
Meantime, assertive policy interventions are needed to
protect core social spending and support households
– and invest in reforms that will revive growth
The G20 process has helped but much remains to be
done – in keeping markets open, financial regulation,
and providing adequate development assistance
This presentation was prepared with inputs from Mansoor Dailami of DECPG , Pierella Paci of
PREM, and Margaret Grosh of HDN
Claessens, S. M. Kose, and M. Terrones (2008) “What Happens During Recessions,
Crunches and Busts” IMF Working Paper WP/08/274 December
Consensus Forecast, June 2009
International Monetary Fund (2009) “The Implications of the Global Financial Crisis
for Low-Income Countries” March
JP Morgan, various reports in October, 2008 – June 2009.
Lin, Justin “The Impact of the Financial Crisis on Developing Countries” Paper
presented at the Korean Development Institute, October 31.
OECD, Economic Outlook Interim Report March, 2009
World Bank, 2008 “Coping with New Strains in the Global Trading System: Doha Round,
Food Prices, and Aid for Trade” IMF - World Bank Staff Paper, September.
World Bank 2008, Global Economic Prospects, 2009, and Up-date March 2009 and
Global Development Finance, 2009 June 2009
Acknowledgements and Selected References
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