The Multilateral Response to the Global Crisis for Emerging Economies:Rationale, Modalities, and Feasibility

The views expressed are those of the authors and not those of the IDB or its Executive Board.

Eduardo Fernandez-Arias, Andrew Powell, and Alessandro Rebucci

Inter American Development Bank

22 April 2009

Motivation

• EMs require significant multilateral assistance to respond successfully to the on-going global economic crisis

• Question is not whether multilaterals should intervene, but how?

• Our aim is to stimulate discussion among participants ….

Outline

• Why should multilaterals intervene?• How should multilaterals intervene? • What is the specific role of MDBs? • Is it feasible to gear up multilateral lending

substantially? • Looking ahead …

Why should multilaterals intervene? • Because the shock is exogenous and large, but

there remains reluctance to recognize it• he optimal policy response is the same as in

advanced economies• But being “emerging” means that it cannot be

implemented without multilateral support– Government paper is risky– Policy intervention must be conducted in advanced

countries’ currencies• This imposes tight constraints on active policy

response– Fiscal Policy: Higher rates and shorter maturities;

stimulus affects liquidity ratios– Monetary Policy: Risk de-anchoring expectations,

exchange rate instability– LOLR: liquidity provision may fuel capital flight and

monetary instability

Additional benefits of multilateral intervention

• Fiscal stimulus packages are more efficient the more countries partake– While EM’s are generally small, marginal

propensities to consume are higher and leakages larger helping IC’s

• Avoiding negative spillovers and protectionism in particular may have big pay off

• Reward past good policies and hedge against reform backslash

How should multilaterals intervene? Differently in different countries• We see four different modalities

– Countries with fiscal space and no liquidity problems

– Countries with fiscal space and potential liquidity problems

– Countries with no fiscal space and potential liquidity problems

– Countries with more serious “solvency” issues

Countries in the first group:Should they be reclassified as no longer EM’s?Have they over-saved?

Countries in the fourth group pose very difficult dilemmas

• Should they adjust or restructure their debt?• Should multilaterals hold off till a debt

restructuring is in the cards or try to help to fend off default?

• Should multilaterals lend without the IMF?• Still no framework for such restructurings

akin to corporate “insolvency” regimes, putting multilaterals in difficult position

Countries in the second group: red carpet treatment (unconditional liquidity)

• Multilaterals should support fiscal stimulus by providing liquidity (defined as reserves over liabilities coming due in a year)– IMF can help with reserves support and MDBs with

budget support (both allow safer and cheaper stimulus)

– Markets and IMF monitor budget envelope and MDBs help ensure its composition is development effective (see more below on MDBs)

– Insurance-type or precautionary arrangements, with very limited (e.g., no trade protectionist measure in fiscal stimulus) or no ex-post conditionality

Countries in the third group: the usual tough love (conditional liquidity)

• Multilaterals should support financially external adjustment and backstop liquidity as before– But countries may need to adjust to ensure a

sustainable fiscal stance– Ordinary multilateral stabilization programs with

traditional ex-post conditionality– Envelope is constrained but development

effectiveness is even more important: MDB’s can help on both liquidity (denominator) and protection of particular expenditures (social protection, supporting growth enhancing projects)

What is the specific role of IDB and other MDBs?

• Contribute to backstopping liquidity with medium and long-term lending

• Help countries to design development-effective expenditure composition policies within envelope:– Make sure transitory measure are credibly

transitory– Protect social programs thereby making

prudent policies more viable politically– Support infrastructure investment– …and help to reform fiscal institutions and

enact growth spurring policies that can expand sustainable envelope!

What is the specific role of IDB and other MDBs?

• Beyond central budget, support fiscal policy at sub-national levels of government and private sector investment in activities of public interest

• In non-systemic cases, IDB could also support the budget envelop and backstop liquidity by itself, but should not facilitate avoidance of IMF

• Partner with bilateral donors on specific areas of common interest, possibly channeling credit off balance sheet

Is it feasible to gear up multilateral lending substantially before recapitalization of the system?

• Historical average stabilization package is 5-10 percent of GDP– So it should be feasible to support fiscal stimulus (2

percent of GDP) and backstop liquidity (3-8) percent of GDP.

• But financing will likely remain endogenous to the severity of the crisis. – So it is useful to think about other ways to expand

demand and contain supply of resources for multilateral intervention regardless of the envelop size at any point in time

Ways to contain cost of multilateral intervention

• Expand financing supply:– Increase leverage of multilateral system– Extend SWAP network to G3 or G5 central

banks– Recycling mechanism for CA surpluses and

flight to quality funds

Ways to contain cost of multilateral intervention

• Contain financing demand:– Establish credible structural fiscal policy

frameworks– Approach multilaterals earlier rather than

later– Differentiate across countries (distinguish

systemic important cases from others)– Prioritize activities in any given country

Looking ahead

• Need to recapitalize the multilateral system as financial integration has deepened permanently, despite short term prospects for dileveraging to continue

• Its governance also appear inadequate (at least for the purpose of liquidity provision, i.e., IMF governance need reform)

• Crisis prevention: can multilaterals help private sector offer country insurance products?

• Crisis resolution: CACs vs SDRM. Unfortunately we may soon have to revisit this debate, set aside during the bonanza

Thank you