Download Capital Flows, Exchange Rates, and The Financial Crisis

The Financial Crisis and
The Future of Financial
Globalization
Gian Maria Milesi-Ferretti
International Monetary Fund, Research D
Disclaimer

Views are mine and do not necessarily
reflect those of the IMF
Structure of Presentation
Key features of international financial
integration in the runup to the crisis
 The onset of the crisis
 The ‘sudden stop’ in capital flows
 The future of globalization

International financial integration (I)

Two main aspects of cross-border capital
flows:
 Net
flows: financing of global imbalances,
accumulation of creditor and debtor positions
 Gross
flows: increase in cross-border
holdings
Net capital flows, 1998-2009
3
Global Imbalances
(percent of world GDP)
2
1
0
-1
-2
-3
1998
1999
2000
2001
2002
2003
2004
2005
2006
US
JPN
GER
CHN
EMA
OIL
ROW
PIGS
UK
2007
2008
2009
CEE
Discrepancy
International financial integration (II)





Boom in cross-border capital flows…
Particularly large among advanced economies
Large inflows and outflows within the euro
area…
…but very high cross-border flows in Europe
even netting out intra-euro-area flows
Increase in flows also to and from emerging
markets
Gross capital flows:
World capital inflows by region
20%
18%
Capital Outflows (ratio of world GDP)
16%
14%
12%
10%
8%
6%
4%
2%
0%
1998
1999
G-4 + Can-Swi
Middle East
World
2000
2001
2002
2003
Other advanced
Emerging Asia
2004
2005
2006
2007
2008
Latin America
Central and Eastern Europe
International Financial Integration (IFI)



In advanced economies and emerging markets,
large expansion in cross-border flows and
holdings in the form of equity and FDI…
Boom in cross-border debt holdings among
advanced economies (key role of banks), but not
in emerging markets
Round-tripping / regulatory arbitrage: use of
financial centers (mostly by advanced economies)
IFI -- Portfolio equity and FDI holdings
180%
160%
Sum of FDI and portfolio equity
assets and liabilities (ratio of country group's GDP)
140%
120%
Advanced
economies
100%
80%
60%
40%
20%
Emerging markets
and developing
countries
0%
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
IFI – external debt holdings (assets+liabilities)
300%
Sum of debt assets and liabilities (including reserves)
(ratio of country group's GDP)
250%
Advanced
economies
200%
150%
Emerging markets
and developing
countries
100%
50%
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Net foreign assets (NFA) in EM

Large improvement in NFA in emerging
Asia, Middle East

Some NFA improvement in Latin America

Large NFA worsening in emerging Europe
Change in structure of portfolio in EM
Large decline in debt liabilities
 Large increase in FDI and equity liabilities
 Some increase in FDI and equity assets
 Large increase in FX reserves
 Big decline in net FX exposure

Change in structure of portfolio in EM:
Latin America
10%
0%
Net debt
-10%
-20%
Latin
America
-30%
Net FDI
+equity
-40%
1990
1992
1994
1996
1998
2000
2002
2004
2006
Change in structure of portfolio in EM:
emerging Asia
50%
40%
Emerging
Asia
30%
20%
Net debt
10%
0%
Net FDI
+equity
-10%
-20%
-30%
1990
1992
1994
1996
1998
2000
2002
2004
2006
Change in structure of portfolio in EM:
emerging Europe
0%
-10%
Net debt
-20%
-30%
Emerging
Europe
-40%
Net FDI
+equity
-50%
1993
1995
1997
1999
2001
2003
2005
2007
The onset of the crisis

Exposure to US-issued non-agency MBS
 High
in some European countries
 Low in Japan, Spain
 Very low in emerging markets


Large creditors (China, Japan, oil exporters)
initially unaffected
Transmission related to international financial
integration, rather than global imbalances
Subsequent phases of the crisis


First half of 2008:
 Run-up in commodity prices
 Collapse of Bear Stearns, USD concerns, big decline
in banking flows in the 2nd quarter
Second half of 2008:
 Crisis becomes global
 Collapse in global demand and capital flows
(particularly in the 4th quarter)
 Accelerated deleveraging (financial institutions, hedge
funds)
 Yen, USD and Sfr appreciate (safe-haven currencies)
 euro, RMB stable
 everybody else depreciates sharply
The sudden stop in advanced economies




Large repatriation of capital in cross-border
banking (UK, US, Switzerland)
Net sales of foreign portfolio instruments
Only FDI flows fairly resilient
Net foreign purchases of domestic bonds remain
(barely) positive (flight-to-safety)
The sudden stop:
advanced economies, capital outflows
3000
2500
2000
1500
1000
500
0
-500
Capital outflows, main
advanced economies
-1000
-1500
-2000
2005Q1
2005Q3
FDI
2006Q1
Portfolio
2006Q3
2007Q1
Banks
2007Q3
Other
2008Q1
2008Q3
Total outflows
2009Q1
The sudden stop:
advanced economies, capital inflows
3000
2500
2000
1500
1000
500
0
-500
Capital inflows, main advanced
economies
-1000
-1500
-2000
2005Q1
2005Q3
FDI
2006Q1
2006Q3
Portfolio
2007Q1
Banks
2007Q3
Other
2008Q1
2008Q3
Total inflows
2009Q1
Sudden stop in emerging markets





Flows solid Q1-Q3 2008, but collapse in Q4
Big portfolio repatriation by foreigners
Reduction in bank exposures to EM (particularly
in Asia)
Resilient FDI flows
Decline in FX reserves to offset foreign sales of
domestic assets
The sudden stop: emerging markets
(Bil. US$)
Capital Flows into Emerging Markets
600
500
400
300
200
100
0
-100
-200
-300
Portfolio investment
Direct Investment
4
08
Q
3
20
08
Q
2
Net Derivatives
20
08
Q
1
20
20
08
Q
4
20
07
Q
3
07
Q
2
20
07
Q
1
20
07
Q
4
Other investment
20
06
Q
3
20
20
06
Q
2
20
06
Q
1
06
Q
4
20
05
Q
3
20
05
Q
2
20
Q
05
20
20
05
Q
1
-400
Total Inflow
The sudden stop: emerging markets
(Bil.
US$)
Capital Flows out of Emerging Markets
700
600
500
400
300
200
100
0
-100
Portfolio investment
Direct Investment
4
20
08
Q
3
08
Q
2
FX Reserves
20
20
08
Q
1
08
Q
4
20
20
07
Q
3
07
Q
2
20
20
07
Q
1
07
Q
4
Other investment
20
20
06
Q
3
06
Q
2
20
20
06
Q
1
06
Q
4
20
20
05
Q
3
05
Q
2
20
Q
05
20
20
05
Q
1
-200
Total Outflow
The Sudden Stop: Latin America
(Bil. US$)
Trend of Capital Flow out of Latin America
100
80
60
40
20
0
-20
-40
-60
2005Q1
2006Q1
Portfolio investment
Other investment
2007Q1
Direct Investment
2008Q1
FX Reserves
Total Outflow
The Sudden Stop: Latin America
(Bil. US$)
Trend of Capital Flow into Latin America
100
80
60
40
20
0
-20
-40
-60
2005Q1
2005Q3
2006Q1
Portfolio investment
Net Derivatives
2006Q3
2007Q1
Other investment
Total Inflow
2007Q3
2008Q1
2008Q3
Direct Investment
How to understand financial
developments in Q4 2008?

Deleveraging process

Sharp increase in home bias (likely influenced
as well by measures implemented nationally to
deal with banking sector problems)

Flight from “risk”
Flight to ‘safety’:
Net foreign purchases of US bonds
350
Crisis period
300
250
200
150
100
50
0
-50
-100
-150
2005:I
2005:III
2006:I
2006:III
Total Treasury securities
2007:I
2007:III
Agency bonds
2008:I
2008:III
Corporate bonds
2009 I
Are we out of the woods yet?

Recovery in capital flows to emerging markets in
2009 (improved outlook, higher commodity
prices, reduced risk aversion)
 Increase
in equity and bond issuance
 Increase in flows to EM mutual funds
 Appreciating currencies
 Recovering stock markets
Are we out of the woods yet?

…but external risks remain significant
 Weakness
in financial sector in advanced economies
 Slow pace of recovery
 Different vulnerability across regions
What future for financial globalization?

Net flows
 Global
imbalances?
 Scope remains for external financing of EM
 But danger of very large CA deficits…
 …and fear of crises
 Key to ensure appropriate cross-border insurance
mechanisms



Swap lines
Flexible credit line
Role of IMF
What future for financial globalization?

Gross flows
 Retrenchment
in cross-border banking positions
 FDI flows resilient
 Some recovery in portfolio flows
 Very large government debt issuance, especially from
advanced economies. How will it be absorbed?
 What role for financial centers?
What future for financial globalization?

Composition of flows (EM)
 Dependence
on development in advanced economies
(financial system, regulation etc)
 Further development of domestic-currency borrowing
 Monitoring of sectoral FX exposures
 Still scope for FDI, portfolio investment
 More uncertainty on size of bank flows
Muchas gracias!