The Financial Crisis and The Future of Financial Globalization

1
The Financial Crisis and The Future of Financial
Globalization

• Gian Maria Milesi-Ferretti
• International Monetary Fund, Research Dept.
• and CEPR

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Disclaimer

• Views are mine and do not necessarily reflect
  those of the IMF

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Structure of Presentation

• Key features of international financial
  integration in the runup to the crisis
• The onset of the crisis
• The sudden stop in capital flows
• The future of globalization

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International financial integration (I)

• Two main aspects of cross-border capital flows
• Net flows financing of global imbalances,
  accumulation of creditor and debtor positions
• Gross flows increase in cross-border holdings

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Net capital flows, 1998-2009
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International financial integration (II)

• Boom in cross-border capital flows
• Particularly large among advanced economies
• Large inflows and outflows within the euro area
• but very high cross-border flows in Europe even
  netting out intra-euro-area flows
• Increase in flows also to and from emerging
  markets

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Gross capital flowsWorld capital inflows by
region
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International Financial Integration (IFI)

• In advanced economies and emerging markets, large
  expansion in cross-border flows and holdings in
  the form of equity and FDI
• Boom in cross-border debt holdings among advanced
  economies (key role of banks), but not in
  emerging markets
• Round-tripping / regulatory arbitrage use of
  financial centers (mostly by advanced economies)

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IFI -- Portfolio equity and FDI holdings
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IFI external debt holdings (assetsliabilities)
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Net foreign assets (NFA) in EM

• Large improvement in NFA in emerging Asia, Middle
  East
• Some NFA improvement in Latin America
• Large NFA worsening in emerging Europe

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Change in structure of portfolio in EM

• Large decline in debt liabilities
• Large increase in FDI and equity liabilities
• Some increase in FDI and equity assets
• Large increase in FX reserves
• Big decline in net FX exposure

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Change in structure of portfolio in EMLatin
America
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Change in structure of portfolio in EMemerging
Asia
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Change in structure of portfolio in EMemerging
Europe
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The onset of the crisis

• Exposure to US-issued non-agency MBS
• High in some European countries
• Low in Japan, Spain
• Very low in emerging markets
• Large creditors (China, Japan, oil exporters)
  initially unaffected
• Transmission related to international financial
  integration, rather than global imbalances

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Subsequent phases of the crisis

• First half of 2008
• Run-up in commodity prices
• Collapse of Bear Stearns, USD concerns, big
  decline in banking flows in the 2nd quarter
• Second half of 2008
• Crisis becomes global
• Collapse in global demand and capital flows
  (particularly in the 4th quarter)
• Accelerated deleveraging (financial institutions,
  hedge funds)
• Yen, USD and Sfr appreciate (safe-haven
  currencies)
• euro, RMB stable
• everybody else depreciates sharply

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The sudden stop in advanced economies

• Large repatriation of capital in cross-border
  banking (UK, US, Switzerland)
• Net sales of foreign portfolio instruments
• Only FDI flows fairly resilient
• Net foreign purchases of domestic bonds remain
  (barely) positive (flight-to-safety)

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The sudden stop advanced economies, capital
outflows
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The sudden stop advanced economies, capital
inflows
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Sudden stop in emerging markets

• Flows solid Q1-Q3 2008, but collapse in Q4
• Big portfolio repatriation by foreigners
• Reduction in bank exposures to EM (particularly
  in Asia)
• Resilient FDI flows
• Decline in FX reserves to offset foreign sales of
  domestic assets

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The sudden stop emerging markets
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The sudden stop emerging markets
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The Sudden Stop Latin America
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The Sudden Stop Latin America
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How to understand financial developments in Q4
2008?

• Deleveraging process
• Sharp increase in home bias (likely influenced as
  well by measures implemented nationally to deal
  with banking sector problems)
• Flight from risk

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Flight to safetyNet foreign purchases of US
bonds
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Are we out of the woods yet?

• Recovery in capital flows to emerging markets in
  2009 (improved outlook, higher commodity prices,
  reduced risk aversion)
• Increase in equity and bond issuance
• Increase in flows to EM mutual funds
• Appreciating currencies
• Recovering stock markets

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Are we out of the woods yet?

• but external risks remain significant
• Weakness in financial sector in advanced
  economies
• Slow pace of recovery
• Different vulnerability across regions

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What future for financial globalization?

• Net flows
• Global imbalances?
• Scope remains for external financing of EM
• But danger of very large CA deficits
• and fear of crises
• Key to ensure appropriate cross-border insurance
  mechanisms
• Swap lines
• Flexible credit line
• Role of IMF

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What future for financial globalization?

• Gross flows
• Retrenchment in cross-border banking positions
• FDI flows resilient
• Some recovery in portfolio flows
• Very large government debt issuance, especially
  from advanced economies. How will it be absorbed?
• What role for financial centers?

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What future for financial globalization?

• Composition of flows (EM)
• Dependence on development in advanced economies
  (financial system, regulation etc)
• Further development of domestic-currency
  borrowing
• Monitoring of sectoral FX exposures
• Still scope for FDI, portfolio investment
• More uncertainty on size of bank flows

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• Muchas gracias!