Friday, 17 October 2008

On the Banking Crisis and Developing Countries (2)

By Ricardo Gottschalk
The scale of the rescue packages in this financial crisis has been staggering. But developing countries that have faced banking crisis in the past have also bailed out their banking systems. The costs they have incurred in the process have been extremely high, sometimes equivalent to 10 or even 20 per cent of their total GDPs. Cirera correctly notes that the novelty this time has been the willingness on the part of governments from the crisis affected countries to generate large fiscal account deficits as a counter-cyclical fiscal policy to minimise the likely recessionary effects of the crisis. This willingness seems to be shared by the governments from all countries affected including those which already have large fiscal deficits. The IMF seems supportive of this. But would the Fund let other countries do the same? This time round a good number of developing countries – that in the past would be natural candidates to seek IMF’s support, have accumulated large amounts of international reserves. They therefore are able to 1) withstand a financial shock without the support of the Fund and 2) draw their own policy responses to minimise costs in terms of forgone output and to have in place social safety nets to protect the poor. Many Asian countries and a few in Latin America too are in this fortunate position.

What about the emerging economies from Eastern Europe? These countries are the likely next balls of the game. If they ask for the IMF’s financial support to deal with the crisis, it is likely the Fund will come up with the same sort of macroeconomic conditionality that it has imposed on countries in previous crisis episodes. Could things be different this time? Only if a new international financial system emerges and only if the new rising powers – China, India and Brazil – play an active role in shaping the new system to ensure the views and interests of developing countries are adequately represented in it.

In the absence of a new international system, a possible alternative is to go regional. That is, Asia gets together to help a neighbour in difficulty, and Western Europe to come to the rescue of Eastern Europe. But we still would have problems in Latin America – Brazil, for example, does not have the financial power to help its neighbours in a major way – and in Africa as well.