Impact of Global Financial Crisis on IDB Member Countries: Regional Prospects and Challenges

Presentation to the Conference on Global Financial Crisis and Capacities of the Islamic Financial System, Islamic Republic of Iran
(17 January 2009)

Islamic Development Bank

Rapidly weakening global prospects

Growth Prospects Origin of Crisis Core Faultlines Comments by Sage Transmission Channels MENA/GCC Outlook SSA Outlook Asia Outlook Global Recovery by 2010
(percent)

Chart 1: World Bank Economic Outlook Projections, end-Nov. 2008

9 8 7 6 5 4 3 2 1 0 -1 2006
Global Output Developing Countries

2007

2008

2009

2010

OECD Countries Developing Countries (excl. China an

Slowdown of economic growth, so far !

Growth Prospects

Chart 4: Growth Prospects of IDB Member Countries

9

Origin of Crisis

8
Core Faultlines Comments by Sage Transmission Channels MENA/GCC Outlook SSA Outlook Asia Outlook Global Recovery by 2010

(Percent)

7 6

5
4 2005 2006 2007 2008 LDMCs-28 2009 non-LDMCs-28 2010 IDB-56 MCs

Global Financial Crisis: How It All Started

Growth Prospects Origin of Crisis Core Faultlines Comments by Sage Transmission Channels MENA/GCC Outlook SSA Outlook Asia Outlook Global Recovery by 2010

De-regulation in the Name of Ideology

Major Wall Street investment banks, hedge & derivative funds, unregulated credit default swaps market In April 2004, net capital rule waived for US investment banks; unleashed reserves held to cushion losses

Dark Heart of the US Financial System

$10 trillion in securitized toxic assets $55 trillion in credit derivatives and credit default swaps (mechanism to insure banks against losses) CDS market size was more than twice the size of the combined GDP of U.S.A. + Japan + the E.U.

From US Financial Crisis to Global Tsunami

AIG, operating in more than 100 countries, became insolvent (holding $441 billion of CDS) End of investment banks in US investment Contagion effect on banks in Europe (UK, Switzerland, France, Germany, Iceland, Netherlands) Seizing-up of interbank lending market Partial nationalization of banks and deposit guarantees Cost of lending to businesses and households became prohibitive

Failure of De-regulation Ideology

Growth Prospects Origin of Crisis Core Faultlines Comments by Sage Transmission Channels MENA/GCC Outlook SSA Outlook Asia Outlook Global Recovery by 2010

Excessive leverage model of financial intermediation

Growth in credit volume and paper profits generated by investing borrowed funds

Poor market discipline Slicing of risks and selling of debts to multiple investors; instead of risks being diversified, it obscured risks creating systemic vulnerabilities

Four Core Faultlines in the US Financial System

System incentivizes creation of speculative bubbles Unsustainable rise in asset prices became possible because of co-mingling of aggressive lending and truncating risk-taking
Lack of due diligence Astronomical expansion in the size of the derivatives market created a false sense of security Moral hazard Global financial institutions had grown to too big to fail size, leading to imprudent lending practices

What Do The Sage Have To Say?

Growth Prospects Origin of Crisis Core Faultlines Comments by Sage Transmission Channels MENA/GCC Outlook SSA Outlook Asia Outlook Global Recovery by 2010

Alan Greenspan, Chairman of the US Federal Reserve

I made a mistake in presuming that self-interest of organizations, specifically banks and others, were such that they were best capable of protecting their shareholders and their equity in the firms.

Paul Krugman, Nobel Laureate, Prof. of Economics at MIT

Will the U.S. financial system collapse today, or maybe over the next few days? I dont think so but Im nowhere near certain old world of banking,, has largely vanished, replaced by what is widely called the shadow banking system. And as the unknown unknowns have turned into known unknowns, the system has been experiencing postmodern bank runs.

Joseph Stiglitz, Nobel Laureate, former Chief Economist, World Bank

In a country where money is respected, Wall Streets leaders used to have our respect. They had our trustTimes have changed. Gone is the respect and trust. For 30 years, greedy, callow, ignorant financiers, supported by no less callow politicians from all the political parties, have proclaimed the wonders of financial innovation and how proud we all should be of the City of London. The pric etag for their behavious is an economic calanity. We should never have bought such sname oil. The consolation in these dark times is that we never will again. The coming months will be very bad. Halting this loss of confidence, providing stimulus and, if necessary, replacing private demand are essential if we want to prevent the recession from becoming a Great Depression.

Will Hutton, Eminent British Financial Journalist

Olivier Blanchard, Chief Economist, IMF

What are the Major Transmission Channels? Baseline Scenario

Growth Prospects Origin of Crisis Core Faultlines Comments by Sage Transmission Channels MENA/GCC Outlook SSA Outlook Asia Outlook Global Recovery by 2010

Sharp deceleration in investment growth

MICs: 13.2% in 2007 and projected: 3.5% in 2009 MENA: 16.8% in 2007 and projected: 7.0% in 2009 SSA: 20.3% in 2007 and projected: 7.7% in 2009

Tighter capital inflows to middle-income countries

Net private debt + equity flows: $1 trillion in 2007 to $530 billion in 2009 [7.7% to 3% of developing country GDP] Sovereign and private-sector spreads have spiked sharply by 700 basis points and 1,000 basis points

Weaker ODA and remittance flows to low-income countries Sharp slowdown in global import-demand
Global export volume to fall by -2.1% in 2009; (1982) OECD countries import-demand: -3.4% in 2009

Lower commodity prices in 2009

International price of crude oil is projected in the range of $68-75 per barrel Food prices to decline by 23% and metal prices to decline by 26% Mixed BoP impact on developing countries

What are the Major Transmission Channels? High Risk Scenario

Growth Prospects Origin of Crisis Core Faultlines Comments by Sage Transmission Channels MENA/GCC Outlook SSA Outlook Asia Outlook Global Recovery by 2010

Deeper and longer recession in OECD Countries

Recovery delayed beyond mid-2010

Impact on Developing (and IDB Member) Countries

Seizing up of borrowing and lending for investment and trade financing Banking failures of otherwise sound institutions Vulnerable countries: high twin-deficits and high inflation could lead to severe exchange rate crises Impact on poverty 1 percent decline in growth leads to additional 20 million people in poverty

MENA / GCC Region: Sharp U-type Growth Recovery !

Growth Prospects Origin of Crisis

Chart 3: Growth Outlook for the MENA Region

Core Faultlines Comments by Sage Transmission Channels MENA/GCC Outlook SSA Outlook Asia Outlook Global Recovery by 2010

5
(percent)

3 2006 2007 2008 World Bank-MENA 2009 IDB-MENA-19 2010

MENA Region: Key Challenges

Growth Prospects Origin of Crisis Core Faultlines Comments by Sage Transmission Channels MENA/GCC Outlook SSA Outlook Asia Outlook Global Recovery by 2010

Steep fall in International Oil Prices

From $147 per barrel in May 2008 to less than $50 in December 2008 Fiscal balance of oil-exporting countries under threat

Troubled Banking Sector

Exposure of some SWFs and banks to US toxic debts Over fivefold jump in riskiness of some GCC banks Deposit guarantees and massive liquidity injections by GCC central banks

Troubled Corporates

Fourfold rise in borrowing costs during 2008 Cancellation of major infrastructure and commercial projects Property bubble - significant drop in real estate prices

Wealth Destruction

October 2008: 25% drop in stock prices or $250 billion losses Massive drop in GCC stock market indices by over 50% leading to potential delinquencies by investors which adds to banks vulnerabilities

SSA Region: Smooth Recovery in 2010?

Growth Prospects Origin of Crisis Core Faultlines Comments by Sage Transmission Channels MENA/GCC Outlook SSA Outlook Asia Outlook Global Recovery by 2010

Chart 4: Growth Outlook for Sub-Saharan African Countries

7
(percent)

4 2006 2007 2008 2009 2010 World Bank-SSA excl. South Africa IDB-SSA-22

SSA Region: Key Challenges

Growth Prospects Origin of Crisis Core Faultlines Comments by Sage Transmission Channels MENA/GCC Outlook SSA Outlook Asia Outlook Global Recovery by 2010

Steep fall in regional stock market

Composite index of WAEMU countries fell by 21%

Banking sector untroubled

Foreign-owned banks have continued their normal operations

Steep fall in prices of major non-oil exports

In October, prices of 12 commodities declined by 9 to 27 percent

ODA flows to slowdown

Official grants are projected to slowdown to 1.1% of SSA-GDP in 2009 from 1.5% in 2008

Risk of external debt distress to intensify (Oct. 2008)

Six MCs (Sudan, Comoros, Cote d Ivoire, Guinea, Guinea Bissau, and Togo) in debt distress Four MCs (Chad, Burkina Faso, Djibouti, and Gambia) are at high risk

Debilitating impact on poverty and progress to MDGs

Number of extreme poor gone up: 130 150 million Cost of lifting extreme poor to poverty line: $38 billion or % of developing country GDP

Asia Region: Protracted Recovery?

Growth Prospects Origin of Crisis Core Faultlines Comments by Sage Transmission Channels MENA/GCC Outlook SSA Outlook Asia Outlook Global Recovery by 2010
(percent)

Chart 5: Growth Outlook for the Asian Countries 14 12 10 8 6 4 2 0 2006 2007 2008 2009
World Bank-South Asia IDB-Asia-8

2010

World Bank-East Asia World Bank-Europe & Central Asia IDB-CIS-7

Asian Region: Key Challenges

Growth Prospects Origin of Crisis Core Faultlines Comments by Sage Transmission Channels MENA/GCC Outlook SSA Outlook Asia Outlook Global Recovery by 2010

Risk aversion in middle-income countries

Global investment funds withdrew from broad range of risky assets and converted into liquid holdings Sovereign spreads rose: Malaysia 300 bp & Indonesia 570 bp

Reversal of private debt flows

Outflows in Turkey: $3.1 billion in 2008

Triggered large exchange rate depreciation

Turkey / Pakistan: 40% / 25% depreciation vs $

Weak export prospects

East Asian countries (excl. China) export growth projected to fall from 8.3% in 2008 to 2.6%in 2009 Turkeys precarious position: 2nd quarter growth deteriorated sharply to 1.9% compared to 6.7% in previous quarter; troubled auto sector, foreign debt: $280 billion, of which one-sixth is short-term; and expected to adopt IMF program in January 2009 CIS Countries: Kazakhstan has, globally, second riskiest banking system (based on CDS prices); Vulnerable to slowdown in remittance flows South Asian Countries: Falling prices of oil- and non-oil commodities will stabilize BoP and alleviate exchange rate pressures; expected to recover quickiest in 2009

Targeting Global Recovery by 2010 !

Growth Prospects Origin of Crisis Core Faultlines Comments by Sage Transmission Channels MENA/GCC Outlook SSA Outlook Asia Outlook Global Recovery by 2010

Boosting Aggregate Demand

Effectiveness of monetary policy is limited
Banks hoarding new liquidity

Fiscal stimulus: 2% of combined global GDP

Regeneration of investments and stimulating consumer confidence

Reforming International Financial System

G-20 Declaration comprises of
Root causes of the current crisis, Actions taken and to be taken, Common principles for reform of financial markets, Tasking of Ministers and experts, Commitment to an open global economy, and Action Plan to implement (i) priority actions by 31 March 2009, (ii) make progress on medium-term actions, and (iii) prepare for next G-20 Summit on 30 April 2009

Relevance to IDB and Member Countries

Adequacy of MDBs resources Strengthening transparency and accountability Enhancing sound regulatory regimes

Growth Prospects Origin of Crisis Core Faultlines Comments by Sage Transmission Channels MENA/GCC Outlook SSA Outlook Asia Outlook Global Recovery by 2010

Thank You