Resilience of emerging economies in 2007 crisis

World Bank economists in this paper look at EME economies in the 2007 crisis.

They say against common perception, emerging economies suffered as badly as the developed economies during crisis (no decoupling please). However, their recovery was faster on account of better policies and measures taken before the crisis. These policies in turn were taken after some severe emerging market crisis broke in the past.

Reasons for better EME performance in recovery:

The first and most obvious one is that the root of the problem was in the financial markets of advanced countries and that developing countries had a low exposure to these markets relative to other developed countries. At the same time, the financial collapse hit highly leveraged consumers in some developed countries, while consumption was posed to continue growing at a high rate in emerging countries.

The second reason is that one of the main crisis transmission channels seems to have been international trade. As the U.S. economy came to a standstill in the fourth quarter of 2008, firms stopped their international orders anticipating an accumulation of inventories (due to the orders already being processed and shipped). This generated an immediate collapse in production in several emerging economies focused on supplying manufactures to advanced countries and the world economy in general, many of them located in Asia. As inventories started to decrease and it became more likely that global demand would stabilize and the crisis would not be transmitted full blown to emerging economies, firms reignited the production process and overall economic activity in emerging markets picked up.Thus, emerging economies were able to generate a faster recovery than developed countries (for which manufacturing accounts for a smaller share of total activity).

The third reason is that, to the extent that emerging economies grow at a higher pace in their path to become richer nations, a recovery of their growth trajectory would make their output converge sooner to the pre-crisis level.

The fourth reason for the better post-crisis performance of emerging economies, at least relative to their previous history, is a fundamental change in the way emerging countries have conducted their policies in the recent past. In effect, the behavior of emerging countries around the global crisis might come as a surprise given previous experiences during turmoil periods when foreign shocks tended to end up as full blown domestic crises. ………….In this paper, we document new developments that seem to indicate a structural break in the way emerging countries conduct their policies, with more countercyclical policies pursued before and during the global crisis. Furthermore, as opposed to previous crisis episodes, the resilience of countries to the 2008-2009 crisis might be partly attributed to a combination of sounder macroeconomic and financial policy frameworks and a shift towards safer domestic and international financial stances.

 

What did EME do differently this time?

 

First, the global crisis found many emerging countries with more fiscal space, better domestic balance sheets, and the required credibility to conduct expansionary fiscal and monetary policies.

Regarding the financial stance, emerging countries have, on average, made a conscious effort to try to reduce both the credit risk embedded in debt contracts and, within debt, currency and maturity mismatches.

On the external front, emerging economies became net creditors to the rest of the world as regards debt contracts while increasing significantly their net debtor position as regards equity contracts (particularly via FDI).

On the domestic front, several emerging economies (in particular their public sectors) have extended during the 2000s the maturity profile of their debt and the degree of domestic currency debt. This migration of emerging countries from a net debtor to a net creditor position vis-à-vis the rest of the world in terms of debt contracts and the reduction of foreign currency and short-term debt might have played a key contributing role in avoiding the downside risks of financial globalization.

Nice paper. Good overview of EME policies….