Professional Documents
Culture Documents
Debt and Financial Crises - Week 8
Debt and Financial Crises - Week 8
Debt and Financial Crises - Week 8
2
Introduction
Advantages and disadvantages of foreign borrowing
• Advantages
– Scarcity of capital in low income countries
– High returns in borrowing countries can make this sensible
– Easier and quicker than FDI
– Can provide buffer for shocks
• Downside
– Has to be repaid even if project goes bad
– Increases vulnerability to sudden capital withdrawals
– Problem of financing consumption through borrowing
3
• String of crises with huge impact on
growth, job creation and political dynamics
e.g.
– 1980s Latin America and in low income
countries extending into the 1990s
– 1997 Asian crisis
– 2008 Global financial crisis
– Recent Eurozone debt crisis
4
Explaining the Asian Economic
Crisis
• What happened
• Explanations
– IMF
– ‘Orthodox’ critics
• Problems with the IMF plan
– Unorthodox explanations
• Chang
• Wade
• Kaplinsky
6
Dimensions of the crisis
• Started Sept 1997 - collapse of Thai baht
– currency collapses
– capital outflows
– falling asset prices
– banking crises
• Impact on real annual GDP growth (year after
crisis)
– Indonesia (-13.1%)
– S Korea (- 6.7%)
– Thailand (- 10.5%)
– Compare to worst post war US recession in 2009 ( - 2.8%)
• Spread to Russia, Brazil, South Africa
8
Economics of Development, 7th Edition
Copyright © 2013, W.W. Norton & Company
10
Explanations
• IMF
• overheating
• overvalued pegged currencies encouraged
excessive (external) borrowing
• lack of supervision
The IMF response
• IMF mistakes
• encouraged cuts in government spending
• firms too leveraged to handle high interest rates
18
Causes of the Crisis
1.Destabilizing US regulatory framework
• Policy framework required/ rewarded banks and government sponsored
enterprises (GSEs - mortgage providers like Fannie Mae and Freddie Mac)
for funding selected classes of borrowers at a subsidized interest rate
• ‘Sub prime loans’ were only sustainable as long as house prices kept on
rising
• Deposit insurance at banks made them more willing to take on risk
• Regulatory agencies slow to understand new financial innovations
© The Author 2009. Published by Oxford University Press on behalf of the Cambridge Political
Economy Society. All rights reserved.
Income share of the top 1% in the USA, 1913–2006.
© The Author 2009. Published by Oxford University Press on behalf of the Cambridge Political
Economy Society. All rights reserved.
The result
Low interest loans + inadequate risk supervision +
slight market downturn led to:
• rising US sub-prime arrears
• losses on related securitized debt
• global loss of confidence
• liquidity is hoarded and money market tightens
• banks run into funding problems
• firms cannot get funding and bankruptcies rise
• unemployment increases and demand decreases
• spreads worldwide through financial channels (stock
markets) and real channels (export demand)
22
23
G20 Communique
• Commitment to increase country allotments to IMF by
$250 billion to a total of $750 billion
• commitment to refrain from competitive devaluations
• commitment to encourage WTO and resuscitate the
Doha round of trade talks
• increase funding to the Multilateral Development Banks
(MDBs) to help poorest countries (especially in sub-
Saharan Africa)
• agreement in principle to a combined fiscal stimulus
package of $5 trillion by the end of 2009
24
Impact on developing countries – main channels
• Banking failures and reductions in domestic lending
– Fear of financial contagion and declines in asset prices undermining stability of
banks and leading to reduced lending
• Reduction in export earnings
– Many developing countries had based growth on exports e.g. China, India, Korea
and Malaysia
– World trade slows sharply
• Declining commodity prices after reaching record levels in 2008 e.g. platinum in SA
Looking back – the impact of the 2008-
2009 crisis
• Developing countries weathered the 2008-
09 crisis quite well
– Epicentre was in developed countries
– Financial sectors not directly affected
– Decoupling of growth rates; largest emerging
markets continued to grow
– Resilience – had learned lessons
– Fiscal expansion cushioned the blow
Impact on SA
• Impact was larger than in many emerging
economies
– Falling commodity prices
– Macro policies countercyclical although not to a great
extent
• Slow fiscal response
• No large scale bailouts
– Exposure to developed economies, esp. Europe
– Employment fell sharply (0.75 - 1 million jobs lost)
• Recovery has been slow, especially of employment
Growth slowdown and output fall during the 2008-2009 crisis
Change in GDP growth rate from 2008 to 2009
Source: OECD
Real gross domestic product
Source SARB Annual Report , 2012
South Africa’s recovery lagged that of other emerging
markets…..
Source: IMF
And employment lagged the slow recovery….
(2008 Q4 = 100)
Source: IMF
SA vulnerabilities
• Low growth even in the good times
• Open economy
– Vulnerable to declining commodity prices
– Europe still very important as export market and source
of investment
– Current account deficit
• The social crisis
– Inequality and unemployment already exceptionally high
– Limits to further redistribution through social grants?
• More recently – political and policy uncertainty
Q: What is our biggest vulnerability?
35
GDP growth and unemployment: SA and Eurozone countries
10 30
8 24
6 18
4 12
2 6
0 0
Greece Spain Germany UK South Africa
-2 -6
-4 -12
-6 -18
-8 -24
-10 -30
37