Global Economic Crisis: What Can Small Open Economies Do?

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• Global Economic Crisis What Can Small Open
  Economies Do?
• Asad Alam
• The World Bank
• AIPRG Conference, Yerevan
• July 7, 2009

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What does history teach us?

• Economic contractions that follow financial
  crises are longer and deeper than contractions
  that do not (Reinhart, Rogoff)
• Such contractions tend to have significant
  adverse consequences on government finances
  (deficit and debt)
• Unemployment consequences of such contractions
  are also usually larger than for downturns
  without major financial stress
• Swift policy responses are critical additional
  financing is helpful but adjustment is almost
  always needed.

3
Recovery is likely to be slow and hesitant

• Large fiscal stimulus of big economies,
  especially US and China, will help but recovery
  will be slow
• Return to pre-crisis status-quo is not a
  sustainable solution for global economy the
  long-term solution is in addressing global
  imbalances, i.e. increase in US saving rates
•  
• The past drivers of growth in emerging markets
  will likely be weaker as private capital will be
  scarcer and more discriminating, and export
  growth slower
•  
• A second wave of financial turbulence is possible
  if quality of banking sector loans deteriorate
  substantially this will further suppress global
  capital flows and delay their recovery

4
Small open economies gained heavily from global
growth and integration but are exposed to global
shocks

• Small open economies gained from key transmission
  channels
• Trade
• FDI
• Remittances
• Rising ToT
• Foreign credit
• But the same channels are now transmitting global
  shocks to their shores

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All economies are hit but impact is
differentiated according to fundamentals

• External balance , role of external financing,
  rollover needs
• Fiscal balance, whether sufficient fiscal space
  exists
• Health of the financial sector (quality of loan
  books, open exchange rate positions)
• How narrow is production and export base
• Structural rigidities (in goods and factor
  markets)
• Size of domestic market
• Exposure to different transmission channels

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Policy responses

• Fiscal stimulus through own resources (fiscal
  space permitting) and/or leveraging donors
  inflows
• Protect the poor and the vulnerable through
  scaling up targeted SSN, within limits of
  affordability
• External (exchange rate) adjustment as a response
  to changed external environment
• Fiscal adjustments (lower expenditures or higher
  taxes) as revenues collapse and countercyclical
  expenditure needs rise
• Enhanced financial sector support and regulatory
  strengthening

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7 lessons for small open economies

1. Initial conditions matter ? MAINTAIN STRONG MACRO
   FUNDAMENTALS
2. Global volatility is going to be normal in an
   integrated world ? DEVELOP MACRO RISK MANAGEMENT
   SYSTEMS
3. Smart countercyclical policies can help create
   jobs in the short term and strengthen
   competitiveness in the medium term ? BE PROACTIVE
4. Recovery will be slow and more prolonged than in
   larger markets ? PLAN FOR THE MEDIUM-TERM
5. Balance between financing and adjustment has to
   be found ? EXTERNAL ADJUSTMENT AND MEDIUM-TERM
   FISCAL CONSOLIDATION IS INEVITABLE
6. Even with properly manager public finances, the
   fight against poverty will be set back ? SCALE UP
   EFFECTIVE ANTI-POVERTY PROGRAMS
7. External resources will continue to be scarce
   specially in the post-crisis world ?
   STRENGTHENING COMPETITIVENESS AND ECONOMIC
   DIVERSIFICATION IS KEY