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.

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?

Welcome to the Globalisation Team Blog

Welcome to the Globalisation Team Blog. The Globalisation Team, at the Institute of Development Studies, carries out research and policy work aimed at promoting sustainable economic growth to reduce poverty. Concretely, we focus on five main areas of research: Asian Drivers, Macro Finance, Trade, Value Chains and Climate Change. This blog is a tool for team members to express their views and opinions on issues on Globalisation and Developing Countries.