1 The Global Financial Crisis and the Debt Ssiteresources.worldbank.org/INTDEBTDEPT/Resources/468980...The Global Financial Crisis, Debt Management and the Debt Management Soup 1 Leonardo

The Global Financial Crisis,Debt Management and theDebt Management and the

Debt Management Soup

1

Leonardo HernándezPRMED

The World BankJVI, December 14-18, 2009

The financial crisis is causing (caused?) asharp decline in global growth: the largest

since the 1930s

7.5

10

12.5

Real GDP in 2000 USD,(% annual growth)

Middle IncomeCountries

Low IncomeCountries

Source: DEC Prospects Group.

-5

-2.5

0

2.5

5

7.5

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

2010

High IncomeCountries

World: Total

Unprecedented crisis

The crisis spread from the United Statesto virtually every region

Region Growth in 2009 (%)

Africa 2.0

Central and Eastern -3.7Central and EasternEurope

-3.7

CIS (plus Mongolia) -5.1

Developing Asia 4.8

Middle East 2.5

Western Hemisphere -1.5

Source: IMF World Economic Outlook, April 2009

A Perfect Storm?

Is there a solution?

5

Presentation outline

The financial crisis in a nutshell

Policy reactions to the crisis

Implications for industrialized andemerging economies: challenges inemerging economies: challenges indebt management

Debt sustainability and the crisis:implications for LICs

The importance of debt management

The menu: the Debt Soup6

The crisis in a nutshell

Antecedents of the crisis:

Boom-bust credit boom, fueled bylax monetary policy in developedcountriescountries

An asset price bubble and excessinvestment in real estate (poor risksassessment)

Poor corporate governance

Macroeconomic imbalances

7

Additional considerations

Financial innovation and increasedopaqueness Reckless use of collateralized debt obligations

Growing reliance on the originate-to-distribute businessmodel/poorer risk assignment

Financial integration Financial integration Much larger capital flows /cross-border positions

Major regulatory and supervisionchanges The repeal of Glass-Steagall (1999) to allow US financial

conglomerates to leverage their balance sheets, like EUuniversal banks; transition from Basel I to Basel II; SECruling on net capital (2004) ...

Residential mortgage backed securitiesversus other securitized assets

(% GDP USA)

Source: Blundell-Wignall and Atkinson (2008), Federal Reserve, Datasteam, OECD.

The crisis in a nutshell

Developing Countries: MainTransmission Channels

• Financial sector effects limited impact on“domestic” financial sectors and “sophisticated” firms(except countries in ECA Region)(except countries in ECA Region)

• Liquidity squeeze and lower risk appetite higherfinancial costs (temporary phenomenon)

• Lower commodity prices and trade volumes lower export proceeds and government revenues

• Reduction in capital flows and remittances tightened financial sources

10

Economic shocks and the worldtrading system

• The food and fuel price surges led to disorderly and sometimesharmful trade policy responses

200

250

Trade credit spreads (bp)

Brazil Indonesia

Korea China

India Russia

Turkey

Trade credit spreads (bp)

• The crisis led to a trade credit crunchand sharp increases in credit spreads

• Contraction in trade finance was alsofostered by loss of critical market

0

50

100

150

2003 2004 2005 2006 2007 2008 est

Turkey

Source: Data collected by WB staff from private sources.

fostered by loss of critical marketparticipants

• Secondary market drying up,reducing ability of banks to sell tradefinance positions

• Concerns about protectionistmeasures rising

• World trade volume (goods andservices) is likely to contract by morethan 6% in 2009

Impact on developing countries

The fall in global trade led to a sharp decline in theprice of commodities…

300

350

GrainsFats & Oils

(2000=100)

100

150

200

250

Jan-06 Jan-07 Jan-08 Jan-09

Grains(2000=100)

Source: DECPG Commodities Group.

Impact on developing countries

… which for many developing countries is animportant source of financing.

ChadCongo, Republic of

Commodity Revenues to Total Revenue, 2008

(Ratio, in percent of total revenue)

0 20 40 60 80 100

VietnamGuinea

MongoliaMauritania

Papua New GuineaSudan

AzerbaijanYemen, Republic

AngolaNigeria

Chad

Source: IMF staff estimates.

Some good news: pace of decline intrade is easing … sustainable?

20

40

60

High Income Countries

Developing Countries

-80

-60

-40

-20

0

Jan-07 May-07 Sep-07 Jan-08 May-08 Sep-08 Jan-09

Goods exports, nominal, Qtr/Qtr %Ch, SAARSource: Thomson/Data-stream

900

1100

1300

1500

5

7

9$ billions

Debt

Changing composition of private capitalflows to developing countries

(Source: DECPG/GDF 2009)

Percent of GDP (right axis)Percent of GDP (right axis)

percent

-100

100

300

500

700

2000 2002 2004 2006 2008e

-1

1

3

5

Port Equity

FDI inflows

Relative to past downturns, the decline ofcapital flows has been more dramatic

6

8Percent

1980-83 1997-02

Projection2007-10

Net private capital flows / GDP in developingcountries

0

2

4

1970 1975 1980 1985 1990 1995 2000 2005 2010P

Source: DECPG/GDF 2009

External Debt Refinancing Needs ($ billions)

600

700

800

900

1000

15%

20%

25%

Sovereign and

Corporate

Corporate

As a percentof U.S. dollar GDP

(right scale)

Corporate rollover needs are massive

0

100

200

300

400

500

600

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012 0%

5%

10%

15%Corporate

Sovereign

Asia Emerging Europe Latin America

Source: IMF

Over $1.5 trillion in rollover needs for 2009, with the private sector holding the lion’s share

17

Policy reactions to the crisis

• At country level: Monetary easing by CBs

Recapitalization of financial systems

Bailout of household and corporate Bailout of household and corporatesectors

Fiscal stimulus packages

Financial systems regulatory overhaul

• And IFIs are intermediatingmore funds than ever

18

G20 countries – fiscal stimulus andfinancial sector support

Advanced economies:Average discretionary fiscal expansion in 2009: 1.5% of GDPAverage financial sector support: 5.4% of 2008 GDP

19

1/ In percent of 2009 GDP. Excludes below-the-line operations that involve acquisition of assets.2/ As of Apr. 15, 2009, in percent of 2008 GDP. Consists of capital injection, purchase of assets and lending byTreasury, and central bank support provided with Treasury backing.Source: IMF

Emerging economies:Average discretionary fiscal expansion in 2009: 2.0% of GDP

Central Bank balance sheets in advancedeconomies have been rapidly expanding

Central Banks’ Total Assets (Index, 12/29/06 = 100)

200

250

300

350

UK

US

Euro Area

20

50

100

150

200

12/2

9/0

6

1/2

9/0

7

3/1

/07

4/1

/07

5/1

/07

6/1

/07

7/1

/07

8/1

/07

9/1

/07

10/1

/07

11/1

/07

12/1

/07

1/1

/08

2/1

/08

3/1

/08

4/1

/08

5/1

/08

6/1

/08

7/1

/08

8/1

/08

9/1

/08

10/1

/08

11/1

/08

12/1

/08

1/1

/09

2/1

/09

3/1

/09

4/1

/09

Collapse of Lehman Brothers

Euro Area

Japan

Source: IMF WEO (2009)

Government Debt: medium termprospects

Significant expansion of public debt in advanced economies

Debt/GDP Ratios (Source: WEO, 2009)

2007 2009 2014

AdvancedG20

77.6 97.7 114.1

EmergingG20

37.8 38.7 35.0

21

G20

USA 63.1 87.0 106.7

Japan 187.7 217.2 234.2

UK 44.1 62.7 87.8

Korea 33.0 40.0 51.8

Brazil 67.7 65.4 54.1

China 20.2 19.8 17.9

India 80.4 86.8 76.8

MDBs have stepped up lendingsubstantially as a response to the crisis …

WBG response: increase in IBRD lending; fast-tracking IDAfunds; Vulnerability Financing Facility; INFRA (support forinfrastructure); guarantees via MIGA; new IFC facilities (supportfor trade; recapitalization of banks; refinancing of microcreditinstitutions).

World Bank Group Commitments

Fiscal years 2009 and 2008 (in US billions)

… including the World Bank.

Fiscal years 2009 and 2008 (in US billions)

World Bank Group FY09* FY08

• IBRD 32.9 13.5

• IDA 14.0 11.2

• IFC 10.5** 11.4**

• MIGA 1.4 2.1

TOTAL 58.8 38.2*Unaudited numbers as of July 1. ** Own account only. Excludes $4.5 billion inFY09 and $4.8 billion in FY08 mobilized through syndications and structuredfinance.

Government Debt: medium andlong term challenges

Macro considerations: evolution of thedollar and interest rates, as well as thefuture of export-led models ofdevelopment;

The importance of preserving long-termThe importance of preserving long-termgrowth potential (the composition ofcurrent fiscal packages)

24

Debt sustainability prospects in LICs

Debt sustainability indicators willdeteriorate due to the fall in exports andgovernment revenues, and the increase indebt service;

For some countries rollover and acceleratedrepayment may be an issue;

Debt sustainability indicators maydeteriorate even further as governmentsimplement fiscal stimulus packages.

25

IDA-only countries

Risk of debt distress(as of early 2009)

HIPCs

In the case of IDA, the graph reflects only countries for which a DSA is available. The graph forHIPCs includes: Bolivia and Honduras (both Blend countries) and Somalia (for which a DSA is notavailable)

Debt sustainability prospects

A critical issue is how long the crisiswill last.

A short lived crisis will have a small effecton debt sustainability as relevant analysison debt sustainability as relevant analysisis of a long term nature (e.g., the DebtSustainability Analysis is forward looking,20 yrs horizon);

In contrast, a protracted crisis will have amore lasting effect on debt sustainability.

27

Debt sustainability and the crisis

YEAR

1 2 3 4 5 6 7

(1) Exports: % deviation with30 25 20 15 10 5 --

Two scenarios under different financing conditions

28

(1) Exports: % deviation withrespect to baseline

20 10 -- -- -- -- --

(2) Conditions of additionalfinancing incurred to maintainlevels of consumption andexpenditures constant

(a) IDA terms: 50% grant; 50% at 40yrs; 10 yrs grace period; 0.75% interest

(b) IDA terms: 40 yrs; 10 yrs graceperiod; 0.75% interest

(c) Commercial: 5 yrs.; no graceperiod; 8% interest


29


30


31


32

A protracted crisis?

Recessions

46 10

3 1

CreditCrunches

Recessions, Crunches, and Busts Output Trajectory During U.S. Recessions

1.00

1.02

1.04

Output Trajectory During US Recessions(Pre-recession Output Peak = 1, at time = 0)

1973 Recession

1981 Recession

Average of 7 previousrecessions2008:2

31

18

9

4

HousePrice Busts

EquityPrice Busts

31

Source: Claessens, Kose, Terrones (2008)

• Current crisis is one of four of the past 122 recessions to include a credit crunch, housing price bust, andequity price bust

• Average of past US recessions has shown that it has taken 5-6 quarters before pre-recessionoutput levels were regained; current recovery will take longer.

33

Source: JP Morgan

0.96

0.98

1.00

-2 -1 0 1 2 3 4 5 6 7

J.P Morganforecast through2010:1

Quarters before and after the peak

• Short-term responses/effects– Fiscal stimulus packages substitute for the

fall in aggregate demand

– Government’s and IFI’s lending replacebanks and other financial intermediaries


banks and other financial intermediaries

– Recapitalization/lending to banks allowthem to stay in business

– But, for how long can countries(governments) live spendingborrowed money?

34

• 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


needs to be reversed, a costly and difficultadjustment.

– Further balance sheet effects may resultfrom this adjustment as some currencieswill appreciate/depreciate.

– Allocation of losses among stake holders: acomplex economic and political process.

35

What will provide the next locomotivefor global growth?

8.0

12.0

United States: Personal Savings Rate and Current

Account Balance 1950 - 2008

36

-8.0

-4.0

0.0

4.0

1950

1955

1960

1965

1970

1975

1980

1985

1990

1995

2000

2005

Current Account Balance - % of GDP

Personal Saving Rate

The importance of DebtManagement

• Why assessing debt sustainability in LICs?

– LICs face significant challenges that are difficult toreconcile:

• Meet development objectives, including the MDGs ( invest borrow debt accumulation)

• Maintain debt at sustainable levels (avoid crisis recurrence)

– Those challenges may be exacerbated for the LICs thathave experienced a relief of their debt burdens:

• Significant debt reduction Ease of borrowing (and moral hazard)

• Economic circumstances remain highly volatile with new creditors(not necessarily under concessional terms) appearing (new kids inthe block)

37

48.5120

140

160


Debt burdens have been reduced by80% compared to DP levels (in US$

Since 1996, there has been substantial progressin both the HIPC initiative and the MDRI: debtrelief has opened space for contracting new debt.

89.275.6

36.8 31.5

7.0

38.8

20.220.2

16.9

0

20

40

60

80

100

Before traditionaldebt relief

After traditional debtrelief

After HIPC Initiativedebt relief

After additionalbilateral debt relief

After MDRI

9 Interim Countries 26 Completion-Point Countries

80% compared to DP levels (in US$billions, in end-2008 NPV terms)

• A new landscape (i.e., new lenders)

• Potential mounting of fiscal deficits(due to fiscal stimulus packages)

• Countries face a more volatile anduncertain financial environment


uncertain financial environment

Proper institutional framework isnecessary to manage public debtprudently and avoid a recurrence ofdebt distress (default) episodes, whileadequately financing future growth.

The Debt Management Soup

Debt sustainability

Long termDebt management

DeMPA

(process)

MTDS (debtcomposition)

Long termdebt

sustainability

DSF (debtlevel)

• Why a special menu? or What makes LICsdifferent to other countries?

– Higher vulnerability to exogenous shocks

• Narrow (less diversified) production and export structures

• Structures concentrated on primary commodities with highly volatile prices

• Response capacity to shocks is weaker

The Debt Management Soup

• Response capacity to shocks is weaker

– Greater reliance on official external creditors withgreater dependence on concessional debt

– Greater political instability and weaker policies andinstitutions

• Domestic conflicts, frequent government changes, and weak politicalinstitutions

• Complicate the implementation of sustainable macroeconomic policies

• Tend to increase the risk of mismanagement and thus debt problems

41

What makes LICs different to othercountries

Export Structure

2005 MIC

Manufacturing

42

0% 20% 40% 60% 80% 100%

2005 LIC

Non Manufacturing

Source: WDI, World Bank.

AngolaNigeria

ChadCongo, Republic of

Commodity Revenues to Total Revenue, 2008

(Ratio, in percent of total revenue)


0 20 40 60 80 100

VietnamGuinea

MongoliaMauritania

Papua New GuineaSudan

AzerbaijanYemen, Republic

Angola

Source: IMF staff estimates.

– Greater reliance on officialexternal creditors

– Debt is more concessional

– Governments account forthe largest share of LIC’s

External

DebtComposit ion

(2000-06)

60%

80%

100%

Non


the largest share of LIC’sexternal debt

44

0%

20%

40%

LICs MICs

Concessional

Non

Concessional

Source: GDF, World Bank.


-0.3

-0.2

-0.1

0.0

LICs

MIC

45

Kaufman Index

on Governance

(avg 2000-06)-0.7

-0.6

-0.5

-0.4

Political Stability* Aggregated index*

MIC

s

*Index take va lues be tween -2.5 and 2.5. Higher number

indica tes be tte r pe rfo rmance

Source: World bank.

• The DSF was introduced in 2005 andreviewed in 2006 and 2009.

• It is an analytical tool used to assess acountry’s debt burden (i.e., its probability ofdebt distress): the thermometer

The Debt Sustainability Framework

debt distress): the thermometer

• Its aim is to inform Bank-Fund analyses ondebt vulnerabilities and allow betterinformed decision making by lenders,borrowers and donors.

• Over the past four years its use hasincreased significantly.

• From this tool recommendations ariseregarding the maximum advisableborrowing that countries should incur, fora given probability (≈ 20%) of debt distress.


distress.

• Consequently, policies set by the Bank andthe Fund on non-concessional borrowing,as well as grant allocation decisions byIDA and others, use the analytical tool asan input: the treatment.

For external debt, the DSF uses the followingset of institutional and policy-dependentcountry specific indicative debt thresholds.

Table: Debt Sustainability Framework Thresholds


PV of debt in percent of Debt service in percent of

Exports GDP Revenue Exports Revenue

Weak Policy (CPIA < 3.25) 100 30 200 15 25

Medium Policy (3.25 < CPIA < 3.75) 150 40 250 20 30

Strong Policy (CPIA > 3.75) 200 50 300 25 25

What is DeMPA ?

Objective

• Assess public debtmanagement

Methodology

• 15 PerformanceIndicators (PI)

Implementation

• Assessment missions

Analytical tool with following attributes:

managementperformance capacity

• Monitor performance

• Design reformprogram

• Donor Harmonization

Indicators (PI)

• 35 Dimensions

• Covers six core DMfunctions

• It’s a snapshot(static)

• Performance Report

• No conditionality

• Report release at theauthorities’ discretion

• Demand driven

The Performance Indicators

Governance and Strategy Development

DPI-1 Legal Framework

DPI-2 Managerial Structure

DPI-3 Debt Management Strategy

DPI-4 Evaluation of Debt Management Operations

DPI-5 Audit

Coordination with Macroeconomic Policies

DPI-6 Coordination with Fiscal Policy

DPI-7 Coordination with Monetary PolicyDPI-7 Coordination with Monetary Policy

Borrowing and Related Financing Activities

DPI-8 Domestic Borrowing

DPI-9 External Borrowing

DPI-10 Loan Guarantees, On-lending and Derivatives

Cash Flow Forecasting and Cash Balance Management

DPI-11 Cash Flow Forecasting and Cash Balance Management

Operational Risk Management

DPI-12 Debt Administration and Data Security

DPI-13 Segregation of Duties, Staff Capacity and Business Continuity

Debt Records and Reporting

DPI-14 Debt Records

DPI-15 Debt Reporting

What is the MTDS?

Objective

• Provides guidance onthe process fordeveloping a planthat the government

Methodology(developed in partnership

with the IMF)

• Guidance Note (GN)provides practicalguidance on theprocess of

Implementation

• Implementationmission plus trainingfollow-up missions

• It is implementedthat the governmentintends to implementover the medium-term to achieve adesiredcomposition of thegovernment debtportfolio

• Evaluates the cost-risk tradeoffsassociated withdifferent strategies.

process ofdeveloping an MTDS.

• The Analytical Tool(AT) allows toundertake a cost-riskanalysis to guide theMTDS decision-making process.

• A Handbook explainsthe use of the AT.

• It is implementedjointly with the IMF

• Report release atauthorities’ discretion

• Demand driven.

The Eight Steps of an MTDS

I. Identify objectives for public debtmanagement and scope of the strategy

II. Analyze the cost and risk of the existing debt

III. Identify and analyze potential funding sources

IV. Identify baseline projections and risks in keyIV. Identify baseline projections and risks in keypolicy areas

V. Review key longer-term structural factors

VI. Assess and rank alternative strategies on thebasis of the cost-risk trade-off

VII. Review candidate strategies with fiscal andmonetary policy authorities

VIII.Submit and secure agreement on the MTDS

Thank you

53

Documents

1 The Global Financial Crisis and the Debt Ssiteresources.worldbank.org/INTDEBTDEPT/Resources/468980...The Global Financial Crisis, Debt Management and the Debt Management Soup 1 Leonardo