Fatih Özatay, TOBB-ETÜ and TEPAV Sarajevo, 20 October 2009 tepav Economic Policies in the...

Fatih Özatay, TOBB-ETÜ and TEPAV Sarajevo, 20 October 2009

tepavEconomic Policies in the Aftermath of Financial Crises in Emerging Economies

Why? EM are less fragile now, compared to past

crises. EM as a whole have given less response

to contractory forces than developed countries.

Within the EM, considerable differences in the implementation of countercyclical policies have been observed.

What are the potential underlying reasons?

Aftermath of financial crises Slide 2

Fiscal stimulus and macroeconomic indicators


Fiscal st./GDP Debt/GDP Fiscal bal. / GDP CAB / GDP FX Reserves Output gap2009+2010 2007 2007 2007 end2007 (bil$) 2009

Argentina 1.5% 67.9% -2.2 1.6 46.2 -3.5%Brasil 1.2% 67.7% -2.5 0.1 180.3 -3.6%China 5.8% 20.2% 0.9 11.0 1528.2 -2.1%India 1.2% 80.5% -5.2 -1.0 275.3 -0.5%Indonesia 2.0% 35.1% -1.2 2.4 56.9 -1.1%Korea 8.3% 29.6% 3.5 0.6 262.2 -9.4%Mexico 2.5% 38.2% -1.4 -0.8 78.0 -9.8%Russia 5.4% 7.4% 6.8 5.9 477.9 -8.1%Saudi Arabia 6.8% 18.5% 15.7 25.1 423.0 -2.5%South Africa 5.1% 28.5% 1.2 -7.3 33.0 -3.7%Turkey 1.1% 39.4% -2.1 -5.8 76.4 -9.5%Czec Rep.* 1.9% 25.3% -0.6 -3.2 34.9 -5.7%Hungary* 4.0% 65.8% -4.9 -6.4 24.1 -5.0%Poland* 5.5% 42.7% -1.4 -5.8 65.7 -3.0%

Fiscal stimulus vs public debt (EM in G-20 + 3)


.0

.1

.2

.3

.4

.5

.6

.7

.8

.9

.01 .02 .03 .04 .05 .06 .07 .08 .09

STIMULUS (2009+2010)

PUBLIC

DEBT / GDP (2

007)

Fiscal stimulus vs fiscal balance (EM in G-20+3)


-8

-4

0

4

8

12

16

.01 .02 .03 .04 .05 .06 .07 .08 .09


FIS

CAL B

ALANCE/G

DP (2

007)

Fiscal stimulus vs current account balance (EM in G-20+3)


-8

-4

0

4

8

12

16

20

24

28

.01 .02 .03 .04 .05 .06 .07 .08 .09


CA B

ALANCE / GDP (2

007)

In previous crises…

Countercyclical policies were generally not an option for most of the EM countries in previous crises.

Asian crisis, The contagious Russian crisis, 2001 Turkey, Argentina…


Vulnerability dominance… Capital flows (CF): Portfolio choice CF = f[Rrf-εeR*/ε-kΘ*p] A positive relationship between the

real exchange rate and probability of default.


Vulnerability dominance: Risk and credit supply

CR = L. [CR0+PB.B0-(D0d+ ε.D0

fx)]As p and θ* increases;

PB decreases,Real depreciation (ε increases).Credit supply can decrease.


Aggregate demand As default probability increases, AD

decreases (if the usual NX channel does not offset).

Vicious spiral:As p increases Rr and ε increases,As Rr and ε increases, vulnerabilities

increase, Hence, p increases.

Aftermath of financial crisesSlide 10

Countercyclical policies??? Basic principle: Your policy response should

decrease default probability and risk aversion.

So the main task of the policymakers is to identify the source(s) of existing and potential vulnerabilities that increase p and θ* and address these problems.

This is the basic logic behind expansionary fiscal consolidations, for instance.


A Case: Turkey 2001


Fiscal policy indicators (Turkey, % of GDP, old series)Fiscal Fiscal Public Growth

impulse1 impulse2 debt (%)

2001 -3.0 -5.6 104.3 -5.7

2002 -0.5 1.3 90.7 6.2

2003 0.6 3.1 80.6 5.3

2004 1.9 2.9 74.9 9.4

2005 5.0 5.1 68.9 8.4

2006 0.8 0.2 63.0 6.9

Countercyclical policies??? However, as a response to a contractory

crisis, in order a tightening cycle (monetary+fiscal) to work, there should be significant vulnerabilities prevailing.

Of course, the appropriate policy response should not only depend on monetary and fiscal mesures. For example, the financial sector can be problematic.


Countercyclical polices??? This is no longer the case for many EM

countries: These countries are more resiliant to shocks:Healthier financial sectors,Improved fiscal balances,Reduction in government debt,Low inflation,More flexible exchange rate regimes,Insurance: More reserves.


EMBI spreads (1998.1 – 2009.9)


0

400

800

1200

1600

2000

500 1000 1500 2000 2500 3000

Russian crisis End 2007

LAC7: Government debt/GDP (%)


32

36

40

44

48

52

56

60

1994 1996 1998 2000 2002 2004 2006 2008

LAC7: FX Reserves/GDP (%)


2

3

4

5

6

7

8

9

90 92 94 96 98 00 02 04 06 08

Turkey: Government debt /GDP and FX reserves /GDP (%)


20

30

40

50

60

70

80

0

2

4

6

8

10

90 92 94 96 98 00 02 04 06 08

TUR:B/GDP TUR:FX/GDP

Response to the global crisis: EM vs developed economies


Response of G-20 to the crisis (% GDP)Advanced Other G-20

2009 2010 Total 2009 2010 TotalFiscal 1.9 1.6 3.5 2.2 1.6 3.8Financial* 8.7 8.7 0.5 0.5 (Financial used) (2.5) (2.5) (0.3) (0.3)Automatic stab. 2.4 2.5 4.9 1.1 1.2 2.3Total 13 4.1 17.1 3.8 2.8 6.6

Fiscal indicators of G-20 (%)Advanced Other G-20

2007 2009 ∆ 2007 2009 ∆Public debt / GDP 78.8 100.6 21.8 37.5 38.8 1.3Fiscal Bal. / GDP -1.9 -10.2 -8.3 0.2 -4.9 -5.1*: Announced capital injection and purchase of assets

Response to the global crisis: EM vs developed economies

In developed countries automatic stabilizers are at work.

Nonetheless, their policy responses (fiscal + financial) have been much sharper than EM. Moreover, some ‘extraordinary’ mesures have been taken.

This is striking; excluding countries like China and Korea, it is even more so.


Then: Why are some of EM shying off countercyclical polices?


Fiscal st./GDP Debt/GDP Fiscal bal. / GDP CAB / GDP FX Reserves Output gap St. Spread2009+2010 2007 2007 2007 end2007 (bil$) 2009 2007 av.**

Argentina 1.5% 67.9% -2.2 1.6 46.2 -3.5% -0.72Brasil 1.2% 67.7% -2.5 0.1 180.3 -3.6% -1.26China 5.8% 20.2% 0.9 11.0 1528.2 -2.1% -0.71India 1.2% 80.5% -5.2 -1.0 275.3 -0.5%Indonesia 2.0% 35.1% -1.2 2.4 56.9 -1.1% -0.67Korea 8.3% 29.6% 3.5 0.6 262.2 -9.4% -0.87Mexico 2.5% 38.2% -1.4 -0.8 78.0 -9.8% -1.00Russia 5.4% 7.4% 6.8 5.9 477.9 -8.1% -0.62Saudi Arabia 6.8% 18.5% 15.7 25.1 423.0 -2.5%South Africa 5.1% 28.5% 1.2 -7.3 33.0 -3.7% -0.94Turkey 1.1% 39.4% -2.1 -5.8 76.4 -9.5% -1.02Czec Rep.* 1.9% 25.3% -0.6 -3.2 34.9 -5.7% -0.43Hungary* 4.0% 65.8% -4.9 -6.4 24.1 -5.0% -0.27Poland* 5.5% 42.7% -1.4 -5.8 65.7 -3.0% -0.90*UN; ** A negative sign indicates below the mean spread.

Why shying off? Relative to past, less fragile; but still

fragile?There are still some country specific problems

(dollarization, current account deficits, etc.),But most of the indicators are in the positive

side, Powerful memories?

“They are again implementing unsound polices.”

Fear of “punishment”?


Why shying off? Less fiscal room?

Yes, debt to GDP ratios have declined considerably,

But, financial systems of these countries are much shallower than those of developed countries,

However, correcting for this fact, for most of these countries still there is room for maneuver.


Why shying off? Great uncertainties leading to a ‘wait

and see’ mode?Accumulated FX reserves: “however let us

do not use them, liquidity situation can get worse”?

No expertise?Addicted to Washington institutions for

designing a policy package?Know how to tighten, but lack of expertise

in countercyclical policies?


Turkey: What could have been the policy response?

Turkey is one of the main victims of this crisis (%6.5 contraction, %15 unemployment).

However, did not give a significant policy response.

What has been done was put in place too late (March and June 2009) and weak.



Extraordinary times need extraordinary measures,

When most of the countries are taking such measures, risk of punishment decreases,

Main problems are drying-up of international liquidity and lack of foreign demand,



Show that as a policymaker you are doing your best without jeopardizing the future stability,

Do not expect too much, but try to mitigate contractionary forces as much as you can.

Use your limited fiscal room to get maximum multiplier effect



To increase demand for domestically produced goods:Target unemployed and poor: Increase

unemployment coverage and benefits,Temporary increase in pensions and

transfers to poor.



To trigger credit supply, try to decrease risk perception of banks,Credit guarantee systems (Budget),FX credit guarantee systems: (Budget and

CB), Commitment to medium term stability,

Fiscal rule?How to widen the tax base?How to increase human capital? Especially

for unemployed?


Short-run response of the economy to alternative policies (calculated in January 2009)

Growth rate (%) Unemployment rate (%)


Full response of the economy to alternative policies (calculated in January 2009)

Growth rate (%) Unemployment rate (%)


Thank you…


Fatih Özatay, TOBB-ETÜ and TEPAV Sarajevo, 20 October 2009 tepav Economic Policies in the...

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