1

The Global Character of the Economic and Financial Crisis:

Toward a New Financial Architecture

by

Tonny LybekIMF’s Resident Representative in Romania and Bulgaria

tlybek@imf.org

at

Overcoming The CrisisRepresentation of The European Commission

& European Institute of Romania

BucharestNovember 19, 2009

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Agenda Character of Global Crisis: I: World Economic Outlook II: Regional Economic Outlook

– From excessive credit growth to a credit crunch

Changes in the Financial Architecture:

III: The role of the IMF IV: Romania as a case in point V: Conclusion

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I.1 Character of The Global Crisis Deepest global recession since the

1930’s: In 2009, world growth is expected to decline

(1.1 percent) for the first time in 60 years! International trade declining

The phases: Sub-prime in the USA

-> Financial fragility increases (from local to global)

Sep. 15, 2008: Lehman’s Bankruptcy -> Global downturn

March 2009: Downturn looses speed -> Uneven recovery

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I.2 How Long Will It Last?

Financial shocks: Global integration larger than most realized! Financial shocks typically lasts longer!

No obvious locomotive: Unemployment is lagging! Non-performing loans (NPLs) are lagging!

Positive signs, but no time for complacency! Principles for exit (G20 in November 6–7):

http://www.imf.org/external/np/g20/110709.htm

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I.3 World Economic Outlook

2007 2008Time of projection: April June Sep April June Sep

World output 5.2 3.0 -1.3 -1.4 -1.1 1.9 2.5 3.1

Advanced economies 2.7 0.6 -3.8 -3.8 -3.4 0.0 0.6 1.3 United States 2.1 0.4 -2.8 -2.6 -2.7 0.0 0.8 1.5 Euro area 2.7 0.7 -4.2 -4.8 -4.2 -0.4 -0.3 0.3 Germany 2.5 1.2 -5.6 -6.2 -5.3 -1.0 -0.6 0.3 France 2.3 0.3 -3.0 -3.0 -2.4 0.4 0.5 0.9 Italy 1.6 -1.0 -4.4 -5.1 -5.1 -0.4 -0.1 0.2 Spain 3.6 0.9 -3.0 -4.0 -3.8 -0.7 -0.8 -0.7 Japan 2.3 -0.7 -6.2 -6.0 -5.4 0.5 1.7 1.7 United Kingdom 2.6 0.7 -4.1 -3.8 -4.4 -0.4 0.1 0.9 European Union 3.1 1.0 -4.0 -4.6 -4.2 -0.3 -0.1 0.5

World trade volume 7.3 3.0 -11.0 -12.2 -11.9 0.6 1.0 2.5 Imports of advanced economies 4.7 0.5 -12.1 -13.5 -13.7 0.4 0.6 1.2 Imports of emerg. & dev. countries 13.8 9.4 -8.8 -9.6 -9.5 0.6 0.8 4.6 Exports of advanced economies 6.3 1.9 -13.5 -14.9 -13.6 0.5 1.3 2.0 Exports of emerg. & dev. countries 9.8 4.6 -6.4 -6.5 -7.2 1.2 1.4 3.6

Source: Table 1.1 in World Economic Outlook, April 2009; Table 1 in World Economic Outlook Update , July 2009,

IMF; and Table 1.1 in World Economic Outlook, October 2009 , IMF.

2009 2010

Real GDP and World Trade, Annual Change in Percent

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II.1 Character of The Regional Crisis

The Good Times 2003–07—Catching-up Vulnerabilities were building-up!

Crisis came late to the region: The five stages: Denial ->

Resentment -> Bargaining -> Depression ->

Acceptance!

Initial denial made it difficult to take early action!

Impact of the global crisis

Regional Economic Outlook

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II.2 The Good Times 2003–07: Catching-up

Central and Eastern Europe (CEE) real GDP growth averaged 6%: Strong global GDP growth boosted exports of CEE. Capital inflows boosted domestic demand:

Liberalized, integrated, preparing for EU accession. Western Banks expanded aggressively in Emerging Europe.

Fiscal deficits reduced and public debt ratios declined: Except in Hungary (public debt) and Romania (fiscal deficit)

Private sector imbalances growing rapidly! Public finances looked much better than they

were! Convergence process not fully appreciated!

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II.3 Vulnerabilities building-up:

Current account deficits widened to unsustainable levels!

Exposures to Western European banks increased! Credit growth was very rapid => asset price

booms! Much of the lending was in foreign currency

Private sector external debt increased quickly to very high levels!

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II.4 Current Account Deficits Increased

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II.5 Increasing Exposure to Western Banks

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II.6 Much of The Lending in FX

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II.7 Impact of The Global Crisis

Shock I: Lower external demand Shock II: Slowdown in capital inflows:

Foreign direct investment (FDI) Funding of—mainly foreign-owned—banks! Direct borrowing by non-financial companies

Slow-down in domestic demand: Delaying investments, particularly construction Uncertainty about employment Slower wage growth and lower remittances Wealth effects (asset prices)

Some already ripe for a home-grown crisis: Cushions differ among countries IMF has tried to stress differences in the region!

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II.8 Vulnerabilities and Severity of Recessions Have

Varied

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II.9 Regional Economic Outlook

2007 2008Time of projection April June Sep Nov April June Sep Nov

Baltics Estonia 7.2 -3.6 -10.0 … -14.0 … -1.0 … -2.6 … Latvia 10.0 -4.6 -12.0 … -18.0 … -2.0 … -4.0 … Lithuania 8.9 3.0 -10.0 … -18.5 … -3.0 … -4.0 …

Central Europe Hungary 1.2 0.6 -3.3 … -6.7 … -0.4 … -0.9 … Poland 6.8 4.9 -0.7 … 1.0 … 1.3 … 2.2 …

Southeastern Europe Bulgaria 6.2 6.0 -3.5 -7.0 -6.5 … -1.0 -2.5 -2.5 … Croatia 5.5 2.4 -3.5 … -5.2 … 0.3 … 0.4 … Romania 6.2 7.1 -4.1 -8.0 -8.5 -7.8 0.0 1.7 0.5 0.5

Source: Table 2.4 in World Economic Outlook, April 2009; Table 1 in World Economic Outlook Update ,

July 2009, IMF; and Table A4 in World Economic Outlook, October 2009, IMF.

2009 2010

Real GDP, Annual Change in Percent

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III.1 Coordinated Global Measures

Avoid the mistakes of the 1930s: Avoid a liquidity crisis becoming a solvency crisis Avoid trade restrictions and capital controls Avoid excessive competing depreciations

Coordinated policy actions (G20 statements): Central banks provide ample liquidity Governments allow stimulus subject to fiscal

space Global coordination:

The changing role of the IMF World Bank, EBRD, EIB, etc. The European Union (EU)

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III.2 The Role of The IMF Mitigating the impact of the global crisis:

Reform of IMF facilities: Adjust set of facilities:

– Introduced Flexible Credit Line (FCL) – Enhanced Stand-By Arrangement (SBA)– Facilitated exceptional access and frontloading

Streamlining conditionality:– Re-focus on macroeconomic stability– Reduce detailed structural conditionality

Increase access to funding ($250 ->$750 bill)

Increase SDR allocation Further encourage policy coordination:

Surveillance (macroeconomic policies) Financial sector regulation (role of FSAP)

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III.3 IMF Assistance Suddenly Needed

Access levels and growth declines in Fund arrangements

MNG

THA

IDN

KOR

ARG

PHL

IDN

UKR

BRA MEX

RUS

TUR

IDN

ARG

BRA

TUR

URY

BRA

COL

ARG ARG

TUR

IRQ

LVA

ISL ROM

HUN MEX

POL

COL

UKR

BIH

SRB

PAK

BLR

ARM

LKA

GEO

SLV CRI

GTM

SYC

-30

-25

-20

-15

-10

-5

0

5

10

1997 1999 2001 2003 2005 2007 2009

Perc

en

t ch

an

ge i

n r

eal

GD

P 1

/

Sources: WEO and staff calculations.1/ Maximum cumulative decline in three years from program inception; projected changes for current programs.

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III.4 IMF Lending Activities

Member Date of Expiration Total Amount Undrawn OutstandingArrangement

Belarus SBA 12-Jan-09 11-Apr-10 2.3 0.9 1.4Bosnia and Herzegovina SBA 8-Jul-09 30-Jun-10 1.0 0.8 0.2Hungary SBA 6-Nov-08 5-Apr-10 10.5 2.9 7.6Iceland SBA 19-Nov-08 31-May-11 1.4 0.7 0.7Latvia SBA 23-Dec-08 22-Mar-11 1.5 0.8 0.7Romania SBA 4-May-09 3-May-11 11.4 5.4 6.1Serbia SBA 16-Jan-09 15-Apr-11 2.6 1.9 0.7Ukraine SBA 5-Nov-08 4-Nov-10 11.0 4.0 7.0Poland FCL 6-May-09 5-May-10 13.7 13.7 0.0Total Europe 55.5 31.1 24.4Total 108.8 78.6 30.9 o/w Europe in percent 51.0 39.6 79.0

Source: International Monetary Fund.Note: 1 SDR = 1.08804 € on October 31, 2009.

In billions of SDR

IMF Lending Arrangements, October 31, 2009

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IV.1 Romania: A Case in Point

Global crisis made it increasingly difficult to secure external financing: Large short-term private debt

Large fiscal imbalances even in good years, make financing challenging during a recession

=> Emerging credibility problem!

=> In need of a “safety belt”!!

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IV.2 Romania’s Package

Joint package supporting Romania’s program!

Size of the “safety belt” (€20 billion over 2 years): IMF: May 4; 24-month Stand-By Arrangement with exceptional

access €12.95 billion (1110.77% of quota). Interest rate about 3½% and repayment over 3–5 years.

EU*: May 5; ECOFIN Council approved the framework for a €5 billion loan, a maximum of five installments over 24 months (on top of pre-and post-accession funds and the advance payment of structural funds in 2009). Interest rate is libor + spread and an “average maturity of maximum 7 years”.

World Bank*: 2009–10, 3 DPLs of total €1 billion. Interest rate will depend on the maturity, currency, and if fixed or floating rate.

EBRD and other multilateral IFIs (EIB): various projects, about €1 billion.

*Also budget support

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IV.2 Romania’s Economic Program

Foreign banks committed to maintain exposure: European Bank Coordination Initiative: exposure CAR of 10%

Government addresses fiscal imbalances: Fiscal consolidation: ensure sustainability! Improve fiscal governance: ensure predictability!

NBR continues to maintain sound banking system: Ensure prompt and early action

Price stability remains primary objective of monetary policy

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IV.3 Ensure Fiscal Sustainability Budget deficits: March adjustment 1.1% of

GDP August adjustment 0.8 % of

GDP March August 2009 -4.6% -7.3% 2010 -3⅔% -5.9% 2011 better than-3% -4.3%

Public salaries Vulnerable groups Arrears of general government Government guarantees

Balance following factors: Back on a sustainable path Realistic financing Avoid excessive cuts exacerbating the recession

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IV.4 Ensure Fiscal Predictability

Tax administration Restructuring of public sector *Public compensation reform (“unitary public

pay law”): Simplified pay scale, reduce reliance on bonuses More transparent Equity Save resources

Better monitoring and control of public enterprises *Fiscal responsibility act:

Multi-year budgets Independent fiscal council Local governments and self-financed units

*Pension reform: Pensions related to contributions Broaden coverage Index to inflation instead of wages Increase gradually the retirement age

* New legislation

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IV.5 Market ReactionsEURNM CDS Spreads 5-year(In basis points)

0

200

400

600

800

1000

1200

1400

Apr-08 Jul-08 Oct-08 Jan-09 Apr-09 Jul-09 Oct-09

Bulgaria

Czech Republic

Estonia

Latvia

Lithuania

Hungary

Poland

Romania

Slovak Republic

September 15, 2008Lehmann Brothers files for bankruptcy

April 2, 2009 G20 Statement

in London

March 25, 2009 Agreement at staff level on Romania's Economic Program

October 1, 2009 Romania's coalition government splits

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V.1 Conclusion: IMF Global financial crisis is deep!

Financial integration is significant!

The IMF is mitigating the crisis by: Intensified coordination:

member countries, other IFIs, EU, and banks Providing financing to smooth the

adjustment:– Should not be an excuse to delay structural reforms!

Functioning as an external anchor provided authorities are committed!

Further encourage global policy coordination

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V.2 Lessons: The Jury Is Still Out!

Unsustainable imbalances must be addressed: No alternative to sound macroeconomic policies:

Sustainable fiscal policies! Price stability with an eye on asset price inflation!

G20 (IMF, WB, etc.): Improve global surveillance!

Financial intermediation is a catalist: Legal and prudential framework must ensure:

Sound incentives, and Adequate capital buffers!

G20 (FSB & IMF), and EU: Revisit regulatory and supervisory framework!

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Thank you very much for your attention

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Principles for Policy Exits 1. The timing of exits should depend on the state of the economy and the

financial system, and should err on the side of further supporting demand and financial repair.

2. With some exceptions, fiscal consolidation should be a top policy priority. Monetary policy can adjust more flexibly when normalization is needed.

3. Fiscal exit strategies should be transparent, comprehensive, and communicated clearly now, with the goal of lowering public debt to prudent levels within a clearly-specified timeframe.

4. Stronger primary balances should be the key driving force of fiscal adjustment, beginning with actions to ensure that crisis-related fiscal stimulus measures remain temporary.

5. Unconventional monetary policy does not necessarily have to be unwound before conventional monetary policy is tightened.

6. Economic conditions, the stability of financial markets, and market-based mechanisms should determine when and how financial policy support is removed.

7. Making exit policies consistent will improve outcomes for all countries. Coordination does not necessarily imply synchronization, but lack of policy coordination could create adverse spillovers."

Source: http://www.imf.org/external/np/g20/110709.htm