Commodity and Financial Market Linkages in Transmission of the Global Financial Crisis to the Developing World
Machiko Nissanke Department of Economics School of Oriental and African Studies University of London Presented: July 10, 2009 *The paper on which this presentation is available upon request to
[email protected]
Background
Repeated debt and financial crises in developing countries and EM economies in the 80s and 90s under the current wave of globalisation; Yet, the real causes for the crises were left unattended; In the absence of reforms to the governance over international monetary system, EMs have become a net creditor to the world by accumulating international reserves for self-insurance purposes against currency attacks “Global Savings Glut” and “Global Macroeconomic Imbalances”: Current Account Balances (% of World GDP)
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Background (cont’d)
The US – the largest debtor with massive fiscal and current account deficits Together with easy monetary condition, leading to the asset bubbles (the housing and credit booms) under lax regulatory regimes – bubble burst in asset markets The sub-prime debacle could not be contained within the US system under financial globalisation – through multi- layer securitisations, and other reckless risk management – irrational markets with systemic risks; Cracks facing the world economic system on the three fronts: a) the world food crisis and fuel crisis (commodity issues); b) the global financial system (financial regulations); c) the environmental crisis; Initially, developing countries and EMs spared from the effects of the financial crisis and credit crunch in the US and Europe, thanks to the commodity price booms and the Southern Growth Engine in BRICs – “Decoupling Hypothesis”; After the September events in the Wall Street, the Global Financial Crisis turning into the Globally Synchronised Slowdown, Global Recession and Economic Crisis
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Financial Market Linkages – transmission to EMs
Initial decoupling of EMs and DCs from the Financial Turmoil in the US and Europe for a year (Summer 2007-Summer 2008); But, sea-changes in investors appetite for EM funds began to appear– in a gradual increase in sovereign bonds spreads before September 2008; Credit crunches leading to difficulty in accessing to trade finance for DCs in 2008 (After September, escalating costs and little availability of trade finance)
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Financial Market Linkages (Stock Markets)
After massive deleveraging with the advent of the September events, financial Markets collapsed in both EMs and LDCs Low-income countries (e.g. in SSA) have not been immune to the contagion effects (in equity, bond and currency markets)
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Financial Market Linkages (Bond spreads)
Emerging Market Bond Spreads: Corporate bonds and Sovereign bonds (Source: World \Bank 2009, UN,2008)
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Financial Market Linkages (Debt and Equity Flows) Private Debt and Equity Flows to Emerging Market Economies dried up (Source World Bank 2009 and IIF 2009)
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Financial Market Linkages (International Issuance) Foreign Currency Denominated International Issuance by Emerging Market Economies by Regions (source IMF 2009)
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Financial Market Linkages Private Capital Flows to EMs in a historical perspectives(1980-2008): Source IIF (2009)
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Financial Market Linkages Currencies of Emerging and Developing Countries (Index, 2000=100, three month moving average) –Source (IMF 2009)
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Changes in International Reserves in EMs (source: IIF 2009)
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Spillovers to Commodity Markets Commodity Price Collapses
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Oil Prices
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Spillovers to Commodity Markets Grain Prices
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IMF estimates of commodity prices
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Commodity Market Linkages Monthly average world primary commodity prices, 2002-2007, 2008 (Percentage change over previous year monthly average)
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Commodity Market Linkages
Commodity price swings – creating a new configuration of winners and losers Resource poor countries – potential winners after experiencing acute BOP and fiscal deficits due to the surge in commodity prices up to the summer, 2008; yet, the rapid depreciation of national currencies against the US dollar have not produced so much a relief: For many the food and fuel crisis is not over and in some cases deepening; Resource Rich countries- potential losers with the commodity price collapse- yet, those middle-income countries with stabilisation funds from resource windfalls could ride through the short-term price cycles; but many fragile LICs, external shocks of this magnitude increase their fragility The precipitous fall in commodity prices
a) in part a reflection of the actual and expected shift of demand-supply fundamentals due to the anticipated weakened demand ; b) resulting from the massive liquidation of long positions in commodity futures markets and other OTC deals resulting from deleveraging on the part of portfolio investors the unprecedented magnitude of swings in commodity prices over medium term as well as the excessive volatility are likely to be a reflection of the increasing linkages between activities in commodity markets and financial markets.
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The Recessionary Effects of the Global Financial Crisis GDP Growth – the recessional effects were deep and swift- the growth prospect has been constantly adjusted downward until very recently IMF estimates as April 2009
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The Recessionary Effects of the Global Financial Crisis
GDP Growth
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The Recessionary Effects of the Global Financial Crisis GDP Growth
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The Recessionary Effects of the Global Financial Crisis Industrial Production and World Trade (Percentage Change from a year earlier –IMF, 2009)
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The Recessionary Effects of the Global Financial Crisis
A sharp reduction of private capital flows to EMs and DCs FDI have been severely affected
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The Effects on Employment and the Poor
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Previously, the costs of financial crises have been borne overwhelmingly by the developing world, and disproportionately so by the poor. This time, the poor in LICs are again most vulnerable; those in “vulnerable employment”, “ extreme working poverty “ and “working poverty” would increase globally and esp. in DCs (ILO 2009) Over 100 millions would be additionally pushed into poverty (50 millions into extreme poverty: WB estimates) 21
Implications of the Financial Market Linkages for Macroeconomic Management (Policy and Research Agenda)
Large misalignment in macroeconomic balances in Ems and DCs due to contagion effects through financial market linkages The need for reappraisal of policy configurations within Macroeconomic Trilemma with all three elements: exchange rate management, monetary policy framework and capital flow management Exchange Rate management: Reappraisal of the “two corner solution” for EMs recommended after the Asian Crisis on account of the credibility issue; “Fear of floating” prevails under financial globalisation; Asian EMs opted for managing exchange rates with accumulating international reserves, contributing to the “Global Macroeconomic Imbalances Q:How to make intermediate regimes (combining stability and flexibility) work?- e,g, BBC regime or a moving target regime- an active exchange rates management as policy instrument and development tool;
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Implications of the Financial Market Linkages for Macroeconomic Management (Policy and Research Agenda)
Monetary Policy Framework ( a reappraisal is required): Is the IT regime with a free floating really an universally best option? The IT regime was put to a severe test by the escalating costs of basic goods such as foods and fuels in 2007-8 The IT with a single policy instrument of fine-tuning of interest rates is ill-equipped to deal with a sudden hike of imported commodity prices, involving structural shifts in relative prices. The IT regime- focusing on good price inflation with little due attention to asset price inflation Capital Flow management Is financial globalisation without adequate regulation and management growth- and welfare-enhancing& income- and consumption smoothing? Many forms of Capital Flow Paradox (Global capital- more for asset shuffling and risk shedding rather than development finance for EMs and DCs How to manage capital flows, including an effective use of capital controls- more innovative management
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Understanding Structural Factors and the Links between Commodity and Financial Markets (Policy and Research Agenda)
The synchronised commodity boom-bust cycle of 2002-8- must be driven by common factors Has it be driven solely by structural shifts in fundamental demand-supply relationships affecting simultaneously many commodities ? On the supply side; constraints because of subdued investment and productive gains for a long time in minerals and energy and agricultural commodities due to low prices in the 1980s and 1990s and policies towards these sectors high price correlations between energy prices and other commodities due to factors such as climate changes, crop substitutions, higher transportation costs and input costs in production and marketing etc. On the demand side; Asian driver factors across commodities Poor inventory-stock management across commodities the high price volatility could result from the intensifying two-way interactions between the commodity and financial markets “instability in the commodity markets and in the financial markets feed on each other, and constitute an inbuilt mechanism of short-term destabilization and uncertainty in the world economy” (Maizels 1994)
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the Links between Commodity and Financial Markets
The heightened price volatility since the collapse of the International Commodity Agreements has led to a rapid expansion of derivative markets The growing interlinked activities between commodity and financial markets by portfolio investors could manifest itself in important changes in commodity price dynamics The fast expansion of commodity- derivatives markets after the severe downturn in equity markets of 2000-2002 with entry of global institutional and private investors-the accelerated link as a flight from equities and bond markets as well as from volatile currency markets; New actors - investment, pension and hedge funds and sovereign wealth funds (managed funds) and commodity index trading Structures in commodity markets have undergone fundamental changes close links between commodity and financial markets hold important policy implications in managing the global economy as we well as macroeconomic management of both commodity producing and consuming countries New thinking is required for commodity price stabilisation schemes
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Concluding Remarks
Globalisation at a cross road Huge Collateral Damage of the present financial crisis to the developing world and a larger damage due to the ensued global recession The poor functioning of the international financial system in performing a vital role of financial intermediation for global development Both Market Failure and Governance Failure Reforms should not be confined just to narrowly defined issues of bank supervision or regulation The need for fundamental reforms over the globalisation process and to the post-Bretton Woods International Monetary and Financial Systems new thinking over macroeconomic management under financial globalisation (exchange rate management, capital flow management, monetary policy framework) and addressing commodity-related issues should be a part of creating a new system of governance over globalisation process Resolution of commodity related issues is fundamental to dealing with the “Commodity-Dependence Trap” of many LICs.
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