The Ongoing Financial Crisis: Implications for Debt
Sustainability in Developing Countries and the Future of
the DSF
1
Carlos A. Primo BragaDirector, PRMED
April 25, 2009
Presentation outline
• The ongoing financial crisis in a nutshell
• Debt sustainability: a summary• Debt sustainability and the crisis• Debt management and the crisis• The ongoing crisis: a protracted
one?• Room for improving the DSF?
2
The crisis in a nutshell
• Antecedents of the crisis:– Boom-bust credit boom, fueled by lax
monetary policy in developed countries– Underestimation (poor assessment) of
risks– Poor corporate governance– Macroeconomic imbalances (low savings
in some developed countries,...) – An asset price bubble and excess
investment in real estate3
Additional considerations
• Financial innovation and increased opaqueness -- Reckless use of colaterized debt obligations relying on mortgages as collateral-- Growing reliance on the originate-to-distribute business model/poorer risk assignment
• Financial integration-- Much larger capital flows /cross-border positions
• Major regulatory and supervision changes-- The repeal of Glass Steagall (1999) to allow US
conglomerates to leverage their balance sheets like EU universal banks; transition to Basel II; SEC ruling on net capital (2004)…
Residential mortgage backed securities versus other securitized assets
Source: Blundell-Wignall and Atkinson (2008), Federal Reserve, Datasteam, OECD.
(% GDP USA)
The crisis in a nutshell
Three Contagion Channels• Liquidity squeeze and lower risk
appetite higher financial costs
• Lower commodity prices and trade volumes lower export proceeds and government revenues
• Reduction in capital flows and remittances tightened financial sources
6
The crisis in a nutshell
• Countries reactions to the crisis:– Loose monetary policy– Recapitalization of financial systems– Bail out of household and corporate
sectors– Fiscal stimulus packages – Financial systems regulatory overhaul
• And IFIs are intermediating more funds than ever
7
The crisis in a nutshellImpacts and responses
• Higher financial costs, although benchmark interest rates will remain low for a while;
• New intermediation channels, although financing gaps remain significant;
• Renewed focus on fiscal stimulus: fiscal space considerations.
Bottom line• Full impact depends on countries’ initial
conditions (fundamentals) and exposure to shocks;
• Final outcome depends on the depth and length of the crisis.
8
Presentation outline
• The ongoing financial crisis in a nutshell
• Debt sustainability: a summary• Debt sustainability and the crisis• Debt management and the crisis• The ongoing crisis: a protracted
one?• Room for improving the DSF?
9
List of Heavily Indebted Poor Countries (as of end March 2009)
24 Post Completion Point Countries
Benin Ethiopia Honduras Mauritania Rwanda Tanzania
Bolivia Ghana Madagascar MozambiqueSão Tomé and
Príncipe Uganda
Burkina Faso Guyana Malawi Nicaragua Senegal Zambia
Cameroon Gambia, The Mali Niger Sierra Leone Burundi
11 Interim Countries
AfghanistanCentral African
Republic
Congo, Dem. Rep. of the
Guinea Haiti Togo
Côte d’Ivoire Chad Congo, Rep. of Guinea-
BissauLiberia
7 Pre-Decision Point Countries
ComorosEritrea Somalia
Sudan Kyrgyz Republic
5
HIPC: Debt burdens have been reduced markedly….
In billions of U.S. dollars, in end-2008 NPV terms
87.373.6
35.6 30.36.8
50.6
40.7
21.421.4
17.1
0
20
40
60
80
100
120
140
160
Before traditionaldebt relief
After traditional debtrelief
After HIPC Initiativedebt relief
After additionalbilateral debt relief
After MDRI
24 Completion-Point Countries 11 Interim Countries
Progress to date (April 2009)• 35 out of 40 eligible countries have
passed the decision point and qualified for HIPC Initiative debt relief
• HIPC Initiative debt relief committed to the 35 post-decision-point HIPCs is US$57.3 bln
• Of the 40 HIPCs, 24 countries have reached the completion point and qualified for irrevocable debt relief under the HIPC Initiative and the MDRI, estimated at a total of US$61.6 bln
• Debt relief is expected to reduce external debt stock in post-CP HIPCs by about 80 percent in end-2008 NPV terms
Post-CP HIPCs are in a better debt situation than other HIPCs.
Debt Relief and Debt Sustainability
As of 2008
Debt sustainability: a summary
• Debt is sustainable as long as it can be serviced without resorting to exceptional financing and/or major corrections in the balance of income and expenditures.
• Analyses focuses on indicators such as:– PV of Debt in percent of: (i) Exports, (ii)
GDP, and (iii) Government Revenues;– Debt Service in percent of (i) Exports,
(ii) Government revenues.
13
IDA-only countries
Risk of Debt Distress
HIPCs
In the case of IDA, the graph reflects only countries for which a DSA is available. The graph for HIPCs includes: Bolivia and Honduras (both Blend countries) and Somalia (for which a DSA is not available)
Debt sustainability: a summary
• Debt sustainability indicators will deteriorate due to the fall in exports and government revenues, and the increase in debt service.
• For some countries rollover and accelerated repayment may be an issue.
• Debt sustainability indicators may deteriorate even further as governments implement fiscal stimulus packages.
15
Debt sustainability: a summary
• A critical issue is how long the crisis will last.
• A short lived crisis will have a small effect on debt sustainability as relevant indicators are of a long term nature (forward looking, 20 yrs).
• In contrast, a protracted crisis will have a more lasting effect on debt sustainability.
16
Presentation outline
• The ongoing financial crisis in a nutshell
• Debt sustainability: a summary• Debt sustainability and the crisis• Debt management and the crisis• The ongoing crisis: a protracted
one?• Room for improving the DSF?
17
Debt sustainability and the crisis
18
YEAR
1 2 3 4 5 6 7
(A) Exports: % deviation with respect to baseline
30 25 20 15 10 5 0
20 10 0 0 0 0 0
(B) Conditions of additional financing incurred to maintain consumption and expenditures constant
(i) IDA terms: 40 yrs; 10 yrs grace period; 0.75% interest
(ii) Commercial: 10 yrs.; no grace period; 5% interest
Two scenarios/shocks with different financing conditions
Debt sustainability and the crisis
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Debt sustainability and the crisis
20
Debt sustainability and the crisis
21
Debt sustainability and the crisis
22
Presentation outline
• The ongoing financial crisis in a nutshell
• Debt sustainability: a summary• Debt sustainability and the crisis• Debt management and the crisis• The ongoing crisis: a protracted
one?• Room for improving the DSF?
23
Debt management and the crisis
24
While a debt sustainability analysis focuses on the long-term sustainability of debt, which is influenced by both its level and composition, a debt management framework focuses on how the composition of debt is managed.
The crisis creates particular challenges for debt managers:
• How to close an increasing financing gap and finance a country’s development needs at low cost with a prudent degree of risk, especially at a time when conditions in financial markets are severely constrained?
• Given limited external financing options, how can potential benefits from developing domestic markets be exploited at a low cost and prudent degree of risk?
• Given the efforts by many governments to strengthen their balance sheets over the past decade, how can these sounder public debt structures be protected?
• Since the crisis implies substantial macroeconomic adjustments, how should debt management strategy reflect the new reality?
• Systematic application of the Debt Management Performance Assessment (DeMPA);
• Country-led design of medium-term debt management strategies (MTDS) jointly with the IMF;
• Design of reform programs;
• Training events;
• Research and development of knowledge products;
• Peer learning initiatives, such as a the Debt Management Practitioners’ Program and the Debt Managers Network.
The Debt Management Facility as part of the solution, leveraging existing TA providers
Presentation outline
• The ongoing financial crisis in a nutshell
• Debt sustainability: a summary• Debt sustainability and the crisis• Debt management and the crisis• The ongoing crisis: a protracted
one?• Room for improving the DSF?
26
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-4-202468
1012141618202224
The financial crisis will cause a sharp decline in global growth: the largest since the 1930s
World
Low-income
Source: DEC Prospects Group.
Growth of Real GDP, Percent
Middle-income
High Income
Economic shocks and the world trading system
• The food and fuel price surges led to disorderly and sometimes harmful trade policy responses
• Financial crisis has led to a trade credit crunch and sharp increases in credit spreads
0
50
100
150
200
250
2003 2004 2005 2006 2007 2008 est
Trade credit spreads (bp)
Brazil Indonesia
Korea China
India Russia
Turkey
Trade credit spreads (bp)
Source: Data collected by WB staff from private sources.
• Contraction in trade finance was also fostered by loss of critical market participants
• Secondary market drying up, reducing ability of banks to sell trade finance positions
• Concerns about protectionist measures rising
• World trade volume (goods and services) is likely to contract by 6% to 10% in 2009
All types of private capital flows to emerging economies plunging
U.S. dollars, billions, net 2006 2007 2008 2009
Private Flows 565 929 466 165
• Equity investment 222 296 174 195
• Direct 171 304 263 198
• Portfolio 52 -8 -89 -3
• Private Creditors 343 632 292 -30
• Commercial Banks 212 410 167 -61
• Nonbanks 131 222 125 31
Official Flows, net -58 11 41 29
• IFIs -30 3 17 31
• Bilateral -27 9 24 -2
Source: Institute for International Finance: “Capital Flows to Emerging Market Economies.” 01/27/09.
Potential declines inremittances and ODA
2005 2006 2007 2008 2009 2010
-10
-5
0
5
10
15
20
25
Baseline Low Case
Source: World Bank data and staff estimates.
Remittance Flows to Developing Countries
1977
1980
1983
1986
1989
1992
1995
1998
2001
2004
0
1
2
3
4
5
6
7
8
9
Low Income Middle Income
Official Development Assistance
(% of GDP)(USD, % Change)
Bottom line: outlook for LICs in 2009 has deteriorated sharply
31
Source: IMF Staff. Latest projections correspond to April 2009.
GDP Growth(In percent)
0
2
4
6
8
10
All LICs Sub-Saharan
Africa
Asia Middle Eastand Europe
LatinAmerica
WEO Spring 2008
Latest projections
Current Account Deficit(In percent of GDP)
0
2
4
6
8
10
12
14
16
18
20
All LICs Sub-Saharan
Africa
Asia Middle Eastand Europe
LatinAmerica
WEO Spring 2008
Latest projections
A protracted crisis?• Short-term responses/effects
– Fiscal stimulus packages substitute for the fall in aggregate demand
– Government’s and IFI’s lending replace banks and other financial intermediaries
– Recapitalization/lending to banks allow them to stay in business
32
G20 countries – discretionary fiscal stimulus in 2009 (% of GDP)
0.0 0.5 1.0 1.5 2.0 2.5 3.0 3.5
ArgentinaBrazilChinaIndia
IndonesiaKorea
MexicoRussia
Saudi ArabiaSouth Africa
Turkey
AustraliaCanadaFrance
GermanyItaly
JapanSpain
U.K.U.S.A
Advanced Economies - Simple average = 1.2% of GDP
Emerging Economies - Simple average = 1.3% of GDP
33Source: IMF Staff Note to G20 Deputies Jan. 31, 2009
A protracted crisis?• Long-term issues:
– Global imbalance: large deficits and accumulation of debt in some countries (and reserve accumulation in others) needs to be reversed, a costly and difficult adjustment.
– Further balance sheet effects may result from this adjustment as some currencies appreciate/depreciate.
– Allocation of losses among stake holders: a complex economic and political process.
34
Presentation outline
• The ongoing financial crisis in a nutshell
• Debt sustainability: a summary• Debt sustainability and the crisis• Debt management and the crisis• The ongoing crisis: a protracted
one?• Room for improving the DSF?
35
Room for improving the DSF?
• Broadly speaking the DSF comprises two aspects:– Country assessments: CPIA, DSA
(“medical check up”)– Policy on borrowing, including non
concessional (“treatment”)– Currently the treatment allows for
flexibility (the IMF is revising its own policy to make it more flexible and the Bank does a case by case analysis)
36
Room for improving the DSF?
• Bottom line:– Developing countries need growth and
trade to resume quickly (the sooner the better)
– Need cheap financing to muddle through (the more and cheaper the better)
• What relaxing the DSF and related policies would accomplish?– It would allow countries greater access to
borrowing, but that is not necessarily the remedy under the current conditions (non-concessional borrowing implications).
37
Room for improving DSF?• Is there room for improving the tests run
on the “patient”? YES, ongoing efforts• Is there room for more flexible
treatments? YES, but this needs to be integrated with broader reviews of concessionality policies
• Analysis of the “tests” and the “treatments” should not be confused
• LICs should be particularly careful about the implications of non-concessional borrowing…
38
• Financial crisis: scale of policy responses is country specific, but, given the procyclicality of the financial system, it is important to coordinate financial sector reform and to synchronize macroeconomic responses;
• The deepening of the downturn suggests the need for an increase in high-impact fiscal expenditures. But embedding stimulus packages in a credible medium-term strategy, that safeguards fiscal sustainability, is key;
• Debt sustainability implications for LICs: a function of the crisis duration. Implications of non-concessional borrowing need to be carefully evaluated;
• Debt management: the crisis underscores the importance of debt management practices and makes the Debt Management Facility even more relevant;
• WBG response: increase in IBRD lending (mix of Development Policy Loans (budget financing/fast disbursing: financial sector restructuring; contingent source of liquidity...) and Investment Loans (preserving infrastructure spending; support for clean technology; social safety nets...)); fast-tracking IDA funds; Vulnerability Financing Facility; INFRA (support for infrastructure); expansion of guarantees (MIGA); new IFC facilities (support for trade; recapitalization of banks; refinancing of microcredit institutions).
Concluding Remarks