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Towards a new international financial architecture Peter Sanfey Lead Economist, EBRD 19 November 2009 The transition region is in deep crisis 2009 average output decline: 6.3 per cent Double-digit declines expected in 5 countries (Baltic countries; Ukraine, Armenia). Crisis is not over: rising non-performing loans and unemployment Slow recovery expected for 2010 Romania among the countries hardest hit (minus 8% in 2009, plus 1% in 2010) Output declines were deep, sudden, and heterogeneous… Quarter on quarter GDP growth, per cent (seasonally adjusted) 10 Q3 2008 Q4 2008 Q1 2009 Q2 2009 5 0 -5 -10 ga ria C ro at ia H un ga K az r ak y hs ta n La tv i Li th a ua ni a Po la nd R om an ia R us si a Se rb ia Sl ov ak ia Tu rk ey U kr ai ne B ul B el ar us -15 …but no full-fledged “twin crises”. Why? 1. Net capital outflows were less sharp than in previous crises (e.g. Asia) and other regions. 2. Financial systems were comparatively sound (high foreign bank presence, small non-bank financial sectors) 3. Forceful, coordinated and comprehensive crisis response In most transition countries, net capital outflows were comparatively modest Percentage changes in external assets of BIS-reporting banks Per cent 15 Avg 2008Q4/2009Q1 Avg 2007Q4/2008Q1 10 5 0 -5 -3.4 -4.4 -7.8 -10 -11.1 -11.9 -15 Emerging Europe (excl. UKR, RUS) Russia & Ukraine CA and Caucasus Latin America Emerging Asia Crisis response has been effective Domestic policies: Massive in western Europe and mature in central and eastern Europe Forceful & coordinated international support – IMF resources tripled from $250 to $750 bn – EBRD investments up more than 50% this year – EU BOP support quadrupled from €12.5 to €50 bn Parent banks maintained exposures New coordination platform – Vienna Initiative International support packages are much larger than in the Asian crisis External balance of payments support (Percent of GDP) 8.0 7.0 6.0 5.0 4.0 3.0 2.0 1.0 0.0 Q3 1997 Korea Q4 1997 Thailand Q1 1998 Q2 1998 Philippines Q3 1998 Indonesia Q4 2008 Hungary Q1 2009 Latvia Q2 2009 Romania Q3 2009 Ukraine The Vienna Initiative has helped maintain foreign bank funding Coordination among banks to maintain exposures Joint IFI (EBRD/EIB/WB) support to bank groups Home country authorities allow parent bank support of subsidiaries Host country authorities to provide liquidity equally to foreign and domestic owned banks The CEB and SEE growth model has three components 1. Political, legal-regulatory integration with EU 2. Trade integration (particularly with the EU) 3. Financial integration, led by EU banks External assets and liabilities, 1994-2008 Per cent of GDP 250 CEB SEE EEC Russia Turkey CA Foreign bank asset share, 1998-2008 Per cent SEE EEC Russia Turkey CA 100 200 80 150 60 100 40 50 20 0 CEB 0 1994 1996 1998 2000 2002 2004 2006 1998 2000 2002 2004 2006 2008 In transition countries, capital inflows are correlated with higher growth … in contrast with the experience in other emerging market regions. Transition sample 14 14 12 12 y = 0.1681x + 5.0106 R2 = 0.1201 10 10 8 8 6 6 4 4 2 2 0 0 -2 -2 -20 -10 0 10 CA/GDP, % (av. 1994-2008) Growth GDP per cap, PPP (av.1994-2008) Growth GDP per cap, PPP (av.1994-2008) Non-transition sample 20 18 16 14 12 10 8 6 4 2 0 20 18 16 14 12 10 8 6 4 2 0 y = -0.3442x + 5.2813 R2 = 0.2697 -15 -10 -5 0 5 CA/GDP, % (av. 1994-2008) 10 Financial integration is good for longterm growth in transition economies Financial integration associated with growth – 1 per cent of GDP in inflows raised annual growth by 0.15-0.4 percentage points per year – 10 percentage point higher foreign bank share raised growth 0.2-0.4 percentage points per year Financially dependent firms grew faster in financially integrated transition economies – 1.5 percentage points per year faster in high capital inflow countries than in low inflow countries Foreign banks are associated with better output performance in the crisis 5 Output growth over 2008 Q4 - 2009 Q1, q-o-q, sa, % 5 ALB BiH GEO MNE FYR SRB CZE HRV BUL ROM SVK POL 0 KAZ KGZ HUN BLR -5 AZE TAJ -10 TUR RUS MOL SLV 0 -5 -10 EST LIT ARM -15 -15 LAT -20 -20 UKR -25 0 20 40 60 80 100 Share of foreign bank assets in % of total assets, 2007 -25 120 But capital inflows fed credit booms and external (over-)indebtedness… Cross-border debt inflows and domestic credit growth, 2005-08 Median growth of BIS lending between mid2005 and mid-2007, % 90 90 UKR 80 AZE 70 ALB 60 EST 80 KAZ 70 ROM 60 LAT LIT 50 R2 = 0.2988 50 SER RUS 40 40 TAJ BUL FYR BiH SLV HRV CZE POL HUN 30 20 MOL 30 20 10 10 0 -20 30 80 130 180 Average credit growth between mid-2005 and mid-2007, % 0 230 … and contributed to FX lending in domestic financial systems Foreign bank asset share and share of FX lending in total lending Share of foreign currency lending in total domestic lending, % 100 100 90 90 LAT 80 EST 70 ALB SER 60 HUN AZE 50 FYR UKR MOL 40 KAZ HRV LIT ARM 30 20 RUS 10 10 SLV 0 0 20 60 40 POL 20 70 50 BUL TUR 30 80 40 60 80 Asset share of foreign-owned banks, % 100 0 120 Financial integration: policy implications Continue to integrate – Only region in the world where financial integration mostly worked the way it was supposed to Manage risks and unintended consequences – Take away the froth through tougher lending standards, and use of macro-prudential instruments – Reduce FX liabilities via better macro institutions, local currency market development, regulation.