The global financial crisis and the coming changes in global

economic power

Raghuram Rajan

Chicago Booth School of Business

Presentation to the XLIV Convención Bancaria de Colombia at Cartagena,

Colombia, July 10, 2009

Outline Main takeaways

Meta-causes for the crisis

Micro-causes

What needs to be changed in the global economic architecture?

What needs to be changed in the global financial architecture?

What are the emerging opportunities and risks for emerging markets?

Main takeaways This is not your father’s recession

nor even your grandfather’s recession.− Financial − Global− Policy response

The Great Recession will have more persistent effects than the average recession.

Meta causes: Insufficient global demand

Root cause of crisis is insufficient global demand

Meta causes: Excessive willingness of US to stimulate

US led the way in fiscal and monetary stimulus to boost economic growth in 2001-2004

Coupled with regulatory relaxation encouraging widespread homeownership

Why is US in forefront?− The U.S. as emerging market?

Meta causes: Emerging market focus on export led growth

Seared by past crisis, emerging markets focus on export led growth

Puts the burden of demand stimulus on industrial countries

Micro-causes: Unfettered financial sector in U.S.

Encouragement to expand credit

Fundamental problem in financial sector – get paid for taking on risk but some risks are observable only in the long run− Similar to writing earthquake insurance!

Aided and abetted by easy financial conditions

Where were− Risk Management?− Corporate Governance?− Regulators?

What needs to be done As government stimulus is

withdrawn in industrial countries, households will still be constrained

Emerging markets will need to step up demand− Allow exchange rates to appreciate− Open up to foreign investment− Remove impediments to domestic

consumption

Need for global economic dialogue

As slow growth persists, developed countries could become more protectionist− Towards trade− Towards inward investment

Emerging markets could resist exchange rate appreciation as well as capital inflows

Need to revitalize global dialogue via organizations like the G-20 and the IMF.− Governance reform− Liquidity facilities

Changes in global financial architecture

Governance in large financial firms broke down

Had large spillover effects throughout the world

But limited appetite for a global regulator

Instead− More cooperation in monitoring large

multinational banks − Some coordination on new capital and

liquidity regulations− Extremely limited movement on sharing

losses across borders if a large bank fails=> less cross-border branching, more room for domestic banks

Changes in domestic regulation

Focus on the system and regulatory gaps

Capital adequacy

Compensation and governance

Too big to fail

Opportunities for emerging markets

As demand shifts, opportunities for emerging market companies in domestic markets− Understand market better− Closer to customers: For example,

Tata Nano or Standard Bank− Especially important for services

associated with goods− Also for services – e.g., financial

And emerging-emerging trade (and corporate mergers)

However risks exist for emerging markets

Domestic demand-led growth harder to manage − Booms and bust in the past− Have to improve domestic institutions

But also have to create human capital capable of servicing the new exciting opportunities

Bottom line: This crisis will accelerate the shift in global economic power towards emerging markets. It is time for companies to position for that change.

THANK YOU