Wednesday, 15 October 2008

On the Banking Crisis and Developing Countries (1)

by Xavier Cirera
It is interesting to see how some commentators are drawing commonalities between the current banking crisis in OECD countries and previous financial crises in developing countries. Eventually, everything seems to be explained by excess liquidity from abroad, which is translated in reckless domestic lending.

Independently of existing commonalities, I would like to stress one main difference regarding the rescue packages being proposed and previous experiences in developing countries. This is, in my view, the concern for avoiding recession and the interest on the distributional impact of the current crisis.

As we know, financial crises can have long lasting impacts on households, and, therefore, I welcome any attempt to eliminate these negative impacts. However, one has to wonder why this approach was neglected in previous crises in Asia and Latin America, were recessions were seen as the natural outcome of the crises and the solution to reduce domestic absorption and cut excessive domestic borrowing. In addition, countries were left without any fiscal capacity to smooth the crises under very strict fiscal conditionality.

This partly could be explained by the threat of the current crisis on the whole world economy and the fact that the countries in crisis are the ones managing and financing their own rescue plans (the IMF's role in the current crisis seems irrelevant); probably due to the fact that they own hard currency. However, considering the large sums of current rescue plans, it seems that some of the previous crises could have been less severe with a different approach from the IMF and OECD countries, with more focus on helping countries to smooth the shocks in the real economy.

Two final questions. Will current rescue plans based on preserving the banking system, cross-country coordination and fiscal expansion, be the standard package for international institutions to tackle future crises in developing countries? What role for the IMF?