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Global Economic Crisis: What Can Small Open Economies Do?

Asad AlamThe World Bank

AIPRG Conference, YerevanJuly 7, 2009

What does history teach us?

Economic contractions that follow financial crises are longer and deeper than contractions that do not (Reinhart, Rogoff)

Such contractions tend to have significant adverse consequences on government finances (deficit and debt)

Unemployment consequences of such contractions are also usually larger than for downturns without major financial stress

Swift policy responses are critical – additional financing is helpful but adjustment is almost always needed.

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Recovery is likely to be slow and hesitant

Large fiscal stimulus of big economies, especially US and China, will help; but recovery will be slow

Return to pre-crisis status-quo is not a sustainable solution for global economy: the long-term solution is in addressing global imbalances, i.e. increase in US saving rates

The past drivers of growth in emerging markets will likely be

weaker as private capital will be scarcer and more discriminating, and export growth slower

A second wave of financial turbulence is possible if quality of

banking sector loans deteriorate substantially: this will further suppress global capital flows and delay their recovery

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Small open economies gained heavily from global growth and integration but are exposed to global shocks

Small open economies gained from key transmission channels:

Trade FDI Remittances Rising ToT Foreign credit

But the same channels are now transmitting global shocks to their shores

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All economies are hit but impact is differentiated according to fundamentals

External balance , role of external financing, rollover needs

Fiscal balance, whether sufficient fiscal space exists

Health of the financial sector (quality of loan books, open exchange rate positions)

How narrow is production and export base

Structural rigidities (in goods and factor markets)

Size of domestic market

Exposure to different transmission channels5

Policy responses

Fiscal stimulus through own resources (fiscal space permitting) and/or leveraging donors inflows

Protect the poor and the vulnerable through scaling up targeted SSN, within limits of affordability

External (exchange rate) adjustment as a response to changed external environment

Fiscal adjustments (lower expenditures or higher taxes) as revenues collapse and countercyclical expenditure needs rise

Enhanced financial sector support and regulatory strengthening

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7 lessons for small open economies

1. Initial conditions matter MAINTAIN STRONG MACRO FUNDAMENTALS 2. Global volatility is going to be normal in an integrated world DEVELOP

MACRO RISK MANAGEMENT SYSTEMS 3. Smart countercyclical policies can help create jobs in the short term and

strengthen competitiveness in the medium term BE PROACTIVE4. Recovery will be slow and more prolonged than in larger markets PLAN

FOR THE MEDIUM-TERM 5. Balance between financing and adjustment has to be found EXTERNAL

ADJUSTMENT AND MEDIUM-TERM FISCAL CONSOLIDATION IS INEVITABLE6. Even with properly manager public finances, the fight against poverty will

be set back SCALE UP EFFECTIVE ANTI-POVERTY PROGRAMS7. External resources will continue to be scarce specially in the post-crisis

world STRENGTHENING COMPETITIVENESS AND ECONOMIC DIVERSIFICATION IS KEY

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