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Financial Crises
Access to foreign capital is key for private sector and government investment and thus for economic growth in developing countries lacking strong domestic financial systems. But openness brings risks as financial crises and shocks in recent decades have shown. CGD has provided practical advice to policymakers, including during the 2008 global financial crisis, to improve stability and safeguard vulnerable developing economies.
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Often overshadowed by the regional powerhouses that border it, Paraguay’s recent sovereign bond issuance of $530 million was five times oversubscribed, revealing that the landlocked country of 7.5 million people warrants more attention. With presidential and legislative elections approaching next month, the incoming government will surely hope to continue building upon the country’s recent economic growth, averaging 4.8 percent over the last decade. This growth has helped the country make massive poverty reductions in one of the lowest income per capita countries in Latin America—in 2016, Paraguay’s poverty rate was 26 percent, down from 57.7 percent in 2002.
This success has been largely thanks to sound macroeconomic management that has helped the country weather both political and economic uncertainty in two of Paraguay’s major trade partners, Brazil and Argentina. However, as protectionist forces gain strength in the United States, interest rate hikes by the Fed are certain, and renewed market volatility raises concerns, structural shortcomings threaten to diminish the country’s capacity to withstand external shocks. The persistent vulnerability to such shocks demands attention be paid to how structural variables undermine Paraguay’s resilience and reduce the effectiveness of its macroeconomic strengths.
Indicator of economic resilience to external shocksThe importance of structural variables is revealed in my latest CGD working paper, which constructs an indicator of economic resilience consisting of two dimensions: (i) the economy’s capacity to withstand the impact of the shock, and (ii) the authorities’ capacity to rapidly implement policies to counteract the effects of the shock on economic and financial stability. Each dimension consists of both macro and structural variables. While macro variables can fluctuate rapidly in the short run, structural variables take more time to change. Inadequate performance of the latter can limit the effectiveness of the former, downgrading resilience against shocks.
The figures below illustrate the dimensions of resilience with macro variables in black and structural variables marked in red.
In the event of an external shock, non-domestic sources of finance can become scarce and costly. Thus, the first dimension of Paraguay’s resilience depends on the strength of its external position and the availability of domestic sources of finance. The former is a testament to the country’s prudent macroeconomic management. In 2017, Paraguay boasted a current account surplus (as a percentage of GDP) and a total debt ratio of only 25 percent of GDP. Strong performances in these macro variables supported demand for Paraguay’s recent bond issuance, reflecting their importance as a safeguard against external shocks.
At the same time, Paraguay’s structural variables moderate such strengths and undermine its capacity to withstand shocks. First, trade shocks represent an important risk to Paraguay where soy and derivatives, cereal and beef account for about 75 percent of exports. In the event of a sharp decline in prices for these products, the lack of export diversity can expose Paraguay’s external position to current account balance deterioration and a weaker fiscal stance. Second, the national savings rate and indicator of financial depth are woefully low. Paraguay’s savings ratio is less than 20 percent. This helps explain Paraguay’s low level of financial depth that is hampered by a stubbornly low pension funds ratio. Together, these deficiencies signal a lack of domestic sources of finance needed to counteract a sudden scarcity and/or higher costs of external sources of finance.
With respect to the second dimension of economic resilience, the story is quite similar. Efforts to improve the country’s macroeconomic stance since 2003 have paid off and will continue to do so if a new adverse external shock hits the economy. During the global financial crisis, the authorities had the fiscal and monetary space to implement countercyclical policies, minimizing the overall effect of the shock. An analysis of Paraguay’s macro variables presented in my paper reveals that their relative strength has persisted, and in some cases, such as the behavior of inflation under an inflation targeting scheme, has even improved.
Again, the strength of these macro variables needs to be qualified by Paraguay’s structural deficiencies! Tax collection in the country is one of the lowest in Latin America. Despite a low fiscal deficit and debt, weak tax revenues can potentially undermine Paraguay’s ability to fund existing investment projects in the event of a shock that reduces or reverses external sources of funding. Additionally, Paraguay’s rate of financial dollarization, measured as financial institutions’ holding of assets and liabilities denominated in foreign currency, is nearly at 50 percent. The latter is contained because a significant part of borrowings in dollars corresponds to the agribusiness industry, whose revenues are denominated in dollars and, therefore, have a natural hedge. Notwithstanding, a high degree of dollarization remains a risk to financial sector stability and a constraint on the efficacy of the central bank to respond countercyclically to an adverse external shock.
Ranking Paraguay: the significance of structural variables in Paraguay’s performance relative to other emerging marketsTo evaluate Paraguay’s economic resilience and highlight the importance of structural variables, I put together two valuable exercises. First, similar to the exercise in my 2015 paper and using a similar methodology, I consider the macro variables discussed in this blog post to create a macroeconomic resilience indicator that is defined as the simple average of the seven variables in consideration. The two graphs below compare how this ranking has changed in the last decade, presenting the indicator’s values in 2007, pre-global financial crisis, and 2017. Countries are organized according to the value of the indicator. The larger the value, the greater the country’s macroeconomic resilience relative to the countries in the sample.
Paraguay only moves from second to fourth place in the ranking between 2007 and 2017, confirming the macroeconomic strengths discussed in this blog post. Yet, a second exercise that accounts for all variables considered in this blog post (macro and structural) paints a different picture.
Here we employ an indicator of economic resilience to external shocks that accounts for all the variables considered in this blog post (macro and structural).[i]
In this exercise, the effect of structural variables is clear. Paraguay’s position is not only lower than in the first exercise, but its position deteriorates considerably from position 11 to 19 out of the 22-country sample.[ii]
In Paraguay, the winners of next month’s elections will face the challenge of building upon Paraguay’s pragmatic macroeconomic management by bolstering its economic resilience through structural reforms. Considering that a more uncertain external environment looks increasingly likely, it truly is an opportunity that Paraguay can’t afford to waste.
[i] Four sub-indicators are considered represented in the two dimensions of resilience (external position, availability of external financing, fiscal position and monetary position). Each sub-category is formed by the corresponding variables discussed previously. These sub-categories are obtained by calculating the simple average of the standardized values of the variables that they’re comprised of. Finally, the indicator of economic resilience to external shocks is the simple average of the four sub-indicators.
[ii] This exercise considers tax revenue—an index without this variable is presented in the working paper where Paraguay falls from position 9 to 12 in the ranking.
This paper assesses the resilience of Paraguay’s economic and financial stability to external shocks and reaches two main conclusions.
On October 4, CGD convened a private roundtable on women and financial technology in development alongside Monica Brand Engel, co-founding partner of Quona Capital (which invests in financial technology solutions in the developing world), and Wendy Jagerson Teleki of the International Finance Corporation. An engaged set of participants from MDBs, government, civil society, and the private sector joined Engel and Teleki in exchanging ideas on how to increase women’s representation in financial technology (or “fintech” for short) leadership and improve access to financial services for women. Because the discussion was under Chatham House Rules, we won’t quote anyone, but a number of valuable points on and ideas for a better path forward emerged.
Globally, business remains depressingly gender-unbalanced. The World Bank’s enterprise surveys suggest that only about 20 percent of medium and large firm managers worldwide are women (and the figure isn’t much different in rich countries). Two particularly unequal sectors are finance and technology. The IMF suggests only 2 percent of bank CEOs are women, and a recent analysis of global patents suggests that only 15 percent of patents involve a woman inventor, with the share even lower in IT. So perhaps it is unsurprising that fintech companies are in a pretty grim place when it comes to employing women—especially in leadership. More than one discussant suggested that they frequently came across company boards in the sector without a single woman, and that they were the single woman on a number of boards. Why do so few women hold positions of power in fintech, and what can we do to change this bleak picture?
One participant suggested we know the macro case for greater women’s economic empowerment in terms of economic impact and development progress, and we know the micro case in terms of improved provision of services and outcomes for individual women and families in terms of earning, learning, and health outcomes; but company leaders need more, and more specifics, on the meso case—the business case for gender equity that includes better returns to shareholders, for example.
The discussion covered both better provision of financial services to women and better representation of women in firms that provide financial services—with the clear understanding that the topics are linked. Firms that recognized the benefits of a diverse client base were more likely to understand the value of having women in leadership—and vice-versa.
On the provision of financial services, a growing number of companies are recognizing the value of developing banking products with women customers in mind. And there were a lot of studies and examples to point to around the business case for those services. But it takes more than anecdotes, however convincing; banks frequently need engaged, long-term support to roll out new products for their markets (and there is a role for smart design of accompanying women’s empowerment projects including high quality business management and jobs skills training).
On greater women’s representation in fintech leadership, a recent Harvard Business Review survey based on US experience suggested limited or mixed impact of diversity training, hiring tests, and grievance systems, but better results from targeted recruitment. In the discussion, there was some skepticism towards enforcing board quotas, but on the other hand, there is evidence that the impact of quotas in discriminatory environments can often be to replace mediocre men with better women.
Mirroring the survey results, participants discussed the benefit of firms going the extra mile to find women for positions—leaving jobs open until a qualified woman applied, using ownership interest to place women on boards of directors, and targeted job searches using personal networks and contacts. And the discussion highlighted the importance of actively building pipelines—looking out for women to fill positions from intern on up. Again, while some participants felt mandating female board membership as a condition for investment was a step too far, positively judging companies with diverse boards as part of an investment decision could have both a financial and development impact.
And, especially given how few women there are in the sector today, men need to step up. Mentoring a pipeline of women employees shouldn’t be a burden that women in an organization carry alone. Men should be thinking about opportunities to better serve women clients. Men should be searching their networks for women candidates and recognizing and countering the role their own and others’ biases play in hiring and HR decisions.
On that note, it was a disappointment that there were so few men in the room for the discussion. At about 90 percent women, the roundtable saw even worse gender parity than at the average CGD event on gender. It was yet another indication of how far fintech—and the business community more generally—has to go towards equally involving and empowering women and men. And, in a sector known for its innovation and forward-thinking, a huge opportunity exists to transform the way we do business for profound social (and economic) impact.
For the US Development Policy Initiative’s inaugural Voices of Experience event, three former Treasury Under Secretaries for International Affairs took the stage: Tim Adams of the Institute of International Finance, Lael Brainard of the Federal Reserve, and Nathan Sheets of Peterson Institute for International Economics. The conversation, moderated by CGD Board Member Tony Fratto, revealed the “esprit de corps” of the International Affairs team, and covered everything from the central yet oft under-the-radar role the Office of International Affairs plays in the formulation and execution of international economic policy, to each Under Secretaries’ proudest moments. Interestingly, the event highlighted significant policy continuity across administrations and a nonpartisan approach to key decisions. See for yourself here, and take a peek at a few takeaways:
Global economic success equals success at homeBrainard kicked off the discussion noting that the primary but less understood role of Treasury is to negotiate the interface of US domestic and global economic policy. Panelists emphasized that continued engagement with the global economy serves domestic interests, but in the current political climate, the message must be communicated consistently and clearly. Brainard, who served during the recent US financial crisis, reflected on both sides of the isle coming forward in the wake of the crisis to support the recapitalization of every multilateral development bank. This remarkable feat represented a bipartisan recognition that economic recovery in the US happens only in concert with the rest of the world. Adams added that this engagement can be a difficult sell to the public particularly in times of domestic hardship, but that the case can rests strongly on three pieces: values, economics, and national security.
Strong, continued support of IFIs, but not without US leadership
The Office of International Affairs manages the United States’ engagement with international financial institutions and other financial international fora, such as the G-20 finance ministers and central bank governors process. All three urged that the US must continue to play a leadership role. Reflecting on his own experience, Sheets’ team time and time again turned to the IFIs to tackle some of the most challenging issues facing the international economic system. This meant taking advantage of the all-important leverage attached to every US dollar funneled through multilateral channels, and he asked: If the new administration is not willing to engage multilaterally with global challenges that affect the US, is the American taxpayer willing to foot the bill in its entirety?
Adams explained that not only should the US continue to have strong support for IFIs, but the US must lead in these institutions if they are to effectively confront global challenges and challenges at home. Reflecting on his (somewhat controversial) speech on shaking up the IMF, he noted that it is in US interests to push for more transparency and more accountability in these institutions. IFI’s are already international standard setting bodies, yet must constantly evolve in order to stay relevant for both domestic and global interests.
Policy continuity and collaboration across administrations is at the core of the office
The conversation revealed a remarkable level of mutual respect and policy agreement. This was no more striking than when each Under Secretary highlighted proudest moments on the job. Adams spoke of commencing the glide path from the G-7 to the G-20, and pushing the IMF to pursue its surveillance mandate more vigorously, including exchange rate policies, for which Brainard and Sheets kept the ball rolling. Sheets also spoke to the IMF’s now sound outlook for the next five years, and his office’s work to continue integrating China into the global financial system, which the panelists all agreed was important for global financial markets and growth. Brainard is proud of the US role in getting the world economy on track to recovery after the financial crisis, and seeing a convergence on exchange rate management in the G-20 with a commitment to avoid use as a trade competitiveness tool. After all, she said, Treasury has always been a mission driven organization, focused on putting the American economy first.
This panel was the first in CGD’s Development Policy Initiative (DPI) Voices of Experience series, which will feature discussion with senior officials from past administrations of both parties who shaped international development, economic, and financial policy.
Thanks to Nancy Lee for helpful comments on this post.
The new government in Buenos Aires has taken quick steps that send a strong message to the world: Argentina wants to open its markets. President Mauricio Macri’s moves to ease market distortions caused by currency controls, trade taxes, and a lack of international financing, have greatly improved local and international expectations about the country's future. However, history shows that the road to a more market-friendly economy can be rocky. Moreover, the challenges can be monumental under small fiscal space, as the recent experience in Brazil demonstrates.
The rise of digital technology has nurtured a growing industry in financial services that benefit the poor, from mobile payments and money transfers to micro-savings and mobile-based crop insurance. But as the financial landscape evolves to include these disruptive innovations, new players and new business models could bring fresh risks to individual users and to financial systems. So how should policymakers respond?
En español
The first thing we should be asking is why now in particular, since conditions have not really changed much in the past few months. For example, back in September, there were large uncertainties in the global economy. China’s economic slowdown was causing alarm. Volatility in international capital markets was high. The appreciation of the US dollar was hurting US exports, which could (yet) mean slower US economic growth. That was not the time for the US Federal Reserve to up interest rates. But now it is – and here’s why.
The Fed’s decision might be taken as an acknowledgment that the persistence of low interest rates since the global financial crisis has increased risk-taking by investors and could cause instability in the financial system. That, in addition to declining unemployment rates, calls for a less expansionary monetary policy. At the same time, this was a window of opportunity to respond to growing expectations that an increase was coming. In a way, by clarifying that future interest rate hikes will be gradual, the Fed has also bought more time to see how the global economy responds before making its next move. It’s a signal that the US economy is strong.
What does it mean for emerging economies? Increased cost of financing. Where emerging markets have been able to compete with the US for investors, they have had to compensate for their higher-risk status with higher rewards, or yields. A higher US interest rate only hurts their case by making “safer” US investments more appealing. US dollar appreciation. Funds migrating away from risky countries toward the US will result in further increased appreciation of the US dollar. Since many corporations from emerging economies actively issued dollar-denominated debt after the global financial crisis, important currency mismatches between their assets (denominated in local currency) and liabilities (debt denominated in US dollars) might ensue, risking corporations’ capacity to service external debts. As experience has shown, private sector liabilities can often become public sector liabilities. Debt problems in a number of emerging economies is not out of the cards. Increased differentiation between countries. Emerging markets will suffer unique consequences, but not all emerging economies will be hit as hard. Their resilience will be determined by the quality and reliability of domestic fiscal conditions and policies. For instance, Brazil’s large fiscal deficits and high inflation make it a poster-child for potential economic crisis. On the other hand, it’s hard to imagine a massive pull out from the Philippines because its financial house is in order. Basically, the market has seen this coming and identified some as problem economies—just this morning, Fitch Rating joined S&P in downgrading Brazil’s credit rating to junk status ahead of the hike. Not a coincidence. What should they do next?The answer to this depends on where you fall in the debate about what caused the US economic slowdown, whether it is the result of a process of deleveraging by banks, firms and households—and, therefore, lower consumption and investment following the US financial crisis—or a long-term productivity problem. If you see this as “secular stagnation” as Larry Summers has described, increasing rates will only make the US growth problem worse. I belong to the former camp. The US growth problem was one of debt-overhang that is largely resolved by now. If the Fed observes the response I have described above, then after the short-term volatility dissipates, it should proceed with gradual rate increases when the timing is right.
Lo primero que deberíamos preguntarnos (antes de responder la pregunta en el título de este blog) es por qué ahora, tomando en cuenta que las condiciones no han cambiado mucho en los últimos meses. Por ejemplo, en septiembre, se manifestaron incertidumbres en la economía mundial. La desaceleración de la economía china estaba generando preocupación. La volatilidad de los mercados internacionales de capitales era alta. La apreciación del dólar estadounidense estaba perjudicando las exportaciones de EE.UU, lo que implicaría una desaceleración de la economía americana. Ese no fue el momento adecuado para que la Reserva Federal de los EE.UU aumente las tasas de interés. Pero ahora sí el momento – a continuación explicaré por qué.
La decisión de la Fed podría interpretarse como un reconocimiento de que la persistencia de tasas de interés bajas desde la crisis financiera global ha aumentado el apetito por riesgo de los inversionistas y podría causar inestabilidad en el sistema financiero. Esto, en adición a la disminución de las tasas de desempleo, exige una política monetaria menos expansiva. Al mismo tiempo, esta fue una oportunidad para responder a las expectativas crecientes sobre un posible aumento de la tasa de interés. En cierto modo, al aclarar que los aumentos futuros serían graduales, la Fed habría comprado más tiempo para observar cómo evoluciona la economía mundial antes de su próximo movimiento. Esta es una señal de que la economía estadounidense se mantiene sólida.
¿Qué significa esto para las economías emergentes? Aumento del costo de financiamiento. En los ámbitos donde los mercados emergentes han sido capaces de competir con EE.UU. para atraer inversiones, estos han tenido que compensar su alto riesgo con rendimientos mayores. Una tasa de interés más alta los perjudica pues hace a las inversiones en EE.UU más atractivas. Apreciación del dólar. Los capitales que migran de países riesgosos hacia los EE.UU. generarán una apreciación del dólar estadounidense aún mayor. Dado que muchas empresas en las economías emergentes emitieron activamente deuda denominada en dólares después de la crisis financiera mundial, podrían generarse descalces de monedas entre sus activos (denominados en moneda local) y pasivos (deuda denominada en dólares), poniendo en riesgo la capacidad del sector corporativo para repagar su deuda externa. La evidencia muestra que los pasivos del sector privado a menudo pueden llegar a convertirse en pasivos del sector público. Los problemas de deuda en varias economías emergentes aún son una posibilidad. Mayor diferenciación entre países. Los mercados emergentes sufrirán consecuencias singulares, pero no todos serían afectados en magnitud similar. Su resiliencia será determinada por la calidad y la fiabilidad de las condiciones fiscales domésticas y sus políticas. Por ejemplo, debido a déficits fiscales mayores y una inflación alta en Brasil, el país se encuentra vulnerable a una crisis económica. Por otra parte, sería difícil imaginar una salida masiva de capitales en Filipinas, pues el país tiene “la casa en orden.” Básicamente, el mercado ha previsto esta situación e identificado a algunos países como problemáticos – esta mañana, Fitch Rating rebajó la calificación crediticia de Brasil al grado de “chatarra” antes de la subida de la tasa de interés. Esta no es una coincidencia. ¿Cuál deberían ser sus próximos pasos?La respuesta a esta pregunta depende de tu posición respecto a la causa de la desaceleración económica de EE.UU. Por un lado, la desaceleración habría sido resultado de un proceso de desapalancamiento de bancos, empresas y hogares - y, por tanto, un menor consumo e inversión. Por el otro, la desaceleración sería resultado de un problema de productividad a largo plazo. Bajo el enfoque de "estancamiento secular," descrito por Larry Summers, mayores tasas de interés empeorarían el problema del crecimiento de Estados Unidos. Creo que el problema de crecimiento de EE.UU. se ha basado en sobreacumulación de deuda y desapalancamiento, el cual se está resolviendo ahora en gran medida. Si la Fed observa la respuesta que he descrito anteriormente, entonces después de que la volatilidad de corto plazo se disipe, deberían proceder con aumentos graduales de tasas cuando el momento sea el adecuado.
This paper investigates the shifts in Latin American banks’ funding patterns in the post-global financial crisis period. To this end, we introduce a new measure of exposure of local banking systems to international debt markets that we term: International Debt Issuances by Locally Supervised Institutions. In contrast to well-known BIS measures, our new metric includes all entities that fall under the supervisory purview of the local authority.
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