Crisis Talk - The World Bank Group

The Double-Edged Sword of Emerging Market Growth

The Economist has two interesting articles this week about capital flows in India. The Indian government is currently confronted with the a challenge of nurturing the growth of India's financial markets and multinationals, while mitigating the risks of excessive "hot money" flowing into the economy.

Proponents of capital controls point to India's success in avoiding the worst of the Asian financial crisis in the late 1990s and the current crisis, which was in part achieved by limiting the amount of money flowing in and out of the economy (for example, foreigners are limited in the amount of local bonds they can purchase).

Yet, India remains a sponge for foreign capital. The Economist notes that foreigners have invested $13.8 bn in India’s stockmarkets since April, having withdrawn $8.6 billion over the same period last year. The Sensex, India’s most widely watched stockmarket index, has surged by almost 100% since its March lows.

Advocates of a stricter capital controls are facing a strong resistance from the market...

The Case for Prudency: Latin America Edition

Bloggers at the IMF are looking at why Latin America fared better in this crisis than during previous episodes of financial duress. Their explanation: financial soundness mixed with enhanced credibility.

This improvement can be attributed to the fact that the region faced the crisis equipped with economic policy frameworks that were more solid and credible than in the past, and with smaller financial, external, and fiscal vulnerabilities. This allowed a number of countries of the region to implement countercyclical monetary and fiscal policies.

The estimates here suggest that these countries were able to “save” about 4 percentage points of GDP during the crisis, thanks to their better preparations for confronting external shocks.

A key element of this preparedness was credibility. Those countries which had responsibly managed their monetary and fiscal policies before the crisis were able to quickly lower interest rates, while increasing public expenditure and fiscal deficits. Countries such as Brazil, Chile and Peru managed to store away enough revenues from the commodity booms of the previous years in order to enact the necessary mix of countercyclical policies. Mexico, which is suffering from dwindling oil reserves, had less of a cushion, and has in turn struggled more than most of its neighbors.

Update: Vox has an interesting paper on the policy responses of Latin America Central Banks during the crisis, written by the former governor of the Central Bank of Ecuador.

Better Credit for Brazil

Yesterday, I analyzed the prospects for decoupling during the recovery. Will a robust emerging market rebound boost OECD growth? Or, are we due to see a multi-speed global recovery? The rise of emerging market IPOs, and its positive influence on IPO markets in developed economies, provides one data point in favor of the first theory. Today's news from Brazil may support the second. 

Moody's announced that it has elevated Brazil's credit rating to investment grade. The ratings agency described Brazil as a "winner", primarily because of its quick rebound from the recession, and strong growth potential for the future. This in an important step for Brazil, as it allows many institutional investors, who are forbidden from investing in "junk" debt, the opportunity to invest in Brazilian bonds.

Which country is next?

Emerging Market IPOs: Leading the way

Two years ago, as financial markets in the United States and Europe began to break down, there was much speculation over whether emerging markets would continue to grow in spite of the woes in the West. A year ago, this idea of decoupling was quickly dispelled.

As emerging markets rebound from the crisis, will there be a new decoupling, where they grow, and OECD economies struggle? It is probably too early to tell, but in one area, IPOs, developed economies are profiting from emerging market successes.

Economic Crises and Migration: Location, location, location

This morning's International Conference on Diaspora for Development featured an excellent discussion led by Hans Timmer, director of the World Bank's Development Prospects Group, and Dilip Ratha, lead economist and author of the Bank's migration blog. Messrs Timmer and Ratha discussed the impact of the crisis on migration patterns and remittance flows, providing several key insights.

First, to quote Ratha, "The more we learn about remittances, the more we realize how little we actually know." Overall remittance values are difficult to predict due to the size and informality of the sector.

That said, here is the 2008-9 outlook on remittance flows:

• Total estimated remittances for 2008 were $328bn
• Remittance flows in 2009 are expected to drop by 7-10 percent. This negative growth trend began in September 2008
• Paradoxically, remittances have become a more important source of external financing in many countries, as foreign direct investment has dropped by up to 50 percent

Bounce Back

Some are still holding out hope for a V-shaped recovery. And one chief economist is predicting that Latin America is where this kind of bounce back will start. 

Bankruptcy Reform: Better Late than Never

Recently, Simeon pointed out the need for a good bankruptcy regime as part of the crisis response: "No matter how successful fiscal stimulus packages and other crisis response measures might be, there will soon be a flow of corporate bankruptcies." Unfortunately, reforms of this magnitude take time to implement, so governments end up resorting to more interventionist measures (as Simeon points out in his post). New research suggests that it's not impossible to reform in the midst of crisis, though.

Writing in the Finance & PSD Impact newsletter, Xavier Gine and Inessa Love report that Colombia managed to carry out a successful reform of its bankruptcy code in late 1999:

Tax Stimulus Gathers Speed

As the crisis deepens, more and more governments resort to tax stimulus. On February 25th, China announced cuts in value-added taxes for metals exporters. This is in addition to the $17.5 billion in corporate income tax cuts announced last November. A week earlier, the Czech government announced cuts in social contributions (which are similar to payroll taxes), worth $1.3 billion. The goal is to save 70,000 jobs. The same week, Australia unveiled $3 billion in income tax cuts.

In January and February alone, 22 countries announced various tax stimulus measures: ranging from cuts in social contributions (Germany, Denmark, Finland, Norway, Vietnam, Latvia), cuts in value-added taxes (Israel, Singapore), tax rebates on payroll taxes (the United States), income tax reductions (Korea, Japan, Brazil, Chile, Mexico, India, Indonesia), and lower taxes for small businesses (Canada, the United States, Germany, Italy, Thailand).

The stimulus varies in relative size from country to country. In Finland, for example, 40% of the 2 billion euro package is slated for cuts in social contributions. In the US, 37% of the $787 billion package is tax stimulus. In Japan, it is 21% ($111 billion of $516 billion). In Brazil, tax stimulus represents about 7% of the $283 billion.

Remittances: Not as Bad as Predicted

Writing on the World Bank People Move blog, Dilip Ratha points out that not all the dire predictions about the crisis have come to pass. At least in the cases for which we have data, remittances have proven resilient. Mexico - one of the most important recipients of remittances and a country for which there is good data - is a case in point:

Remittance flows to Mexico dropped 10 percent year-on-year in December 2008, bringing the 2008 12-month total to $25 billion, a 3.6 percent decline compared to $26 billion registered in 2007. This decline is much smaller than the 8 percent decline projected by Mexico in August 2008.

As long as this is not a blip on the screen, remittances should help cushion the blow of the retreat of other forms of private capital flows. The Institute for International Finance warned late last month that "the outlook for private capital flows to emerging economies has deteriorated significantly in recent months." The fate of stimulus packages in rich countries consequently becomes all that more important for the rest of the world, as migrants will have a hard time keeping or finding jobs in the face of rising unemployment rates.