The current financial crisis: Eastern Europe and Russia Jörg Mayer UNCTAD Study Tour for Russian Member Universities of the Vi Network Geneva, 24 March 2009

Overview UNCTAD’s take on the crisis Main transmission channels The sharply increased external indebtedness of firms and households The limited usefulness of large foreign- exchange reserves as self-insurance Conclusions

1. UNCTAD’s take on the crisis Burst of US house price bubble trigger, not cause; Financial deregulation enhances the pro-cyclicality of financial markets; Absence of international monetary system facilitates exchange-rate speculation ; Faith in efficiency of deregulated financial markets created illusion of risk-free profits through speculative finance in many areas; Crisis in form of debt deflation: level of borrowing needs to be adjusted to diminished revenues;

2. Main transmission channels Trade (global economic slowdown): –Decline in global aggregate demand; –Sharp decline in primary commodity prices; Finance (global deleveraging): –Sharp reduction in working capital credit and in cross- border lending to banks and non-financial firms causes difficulty in rolling over external debt; –Hedge funds and institutional investors exit emerging markets; –Depreciation of financial (e.g. equities) and real (e.g. in extractive industries) assets forces a rouble depreciation;

Global output is contracting for the first time in 60 years and no region escapes from the crisis Real output growth, 2004–2009, per cent

Global trade volume is falling steeply Change in export volume, 2004–2009, year-on-year, per cent

Primary commodity prices declined steeply, but remain above long-term trends Primary commodity prices, 2000–2009, index numbers 2000=100

Rouble REER and oil prices are linked Rouble exchange rates and oil price, 2000–09, index numbers 2000=100

Emerging market bond spreads have risen sharply, but less than in 1997–1998 Emerging markets bond spreads, selected countries, basis points, 01/2003 – 12/2008

3. The sharply increased external indebtedness of firms and households Low international interest rates and ample liquidity made portfolio managers look for new markets; Improved risk rating of emerging markets following financial liberalization and sustained fast growth; Firms choose foreign borrowing to finance investment if useful for managing exchange-rate risk (e.g. their cash inflows are in foreign currency); Empirical evidence: mostly done by large firms in banking, infrastructure or extractive industry sectors.

Foreign borrowing by financial and non- financial firms strongly increased after 2001 Foreign borrowing by firms, selected regions, $ bn, 1999–2006

Risks of firms borrowing overseas Fairly stable exchange rates may lead firms with cash inflows in domestic currency to hold unhedged foreign positions – vulnerable to depreciation; Sudden decline in mineral and petroleum prices: –Reduced foreign-currency cash inflows; –Reduced value of collateralized assets in extractive industries –Reduced value of equity holdings in extractive industries Sudden change in external financial conditions can make (short-term) liability positions unsustainable; Balance sheets of banks borrowing overseas but lending to households for consumption, or in construction or other non-tradable sectors are subject to currency mismatch.

4. The limited usefulness of large holdings of reserves as self-insurance Lessons of Asian and Russian crises in include need to: –prevent vulnerability from currency and maturity mismatches in private balance sheets and external payments; –check financial and investment bubbles; –build adequate self-insurance against sudden stops and reversals of capital inflows through the accumulation of foreign exchange reserves at times of surges in capital inflows.

Russia’s foreign exchange reserves had strongly increased, but recently sharply declined Foreign exchange reserves, Russian Federation, January 1995 – December 2008

Large reserves cannot solve all problems Foreign-exchange reserves are subject to exchange- rate risk; Net amount of capital inflows can be reduced by allowing private capital outflows – but difficult to reverse when inflows stop; Official reserves cannot prevent: –Currency and maturity mismatches in balance sheets; –Vulnerability to shocks associated with greater presence of foreigners in domestic asset markets; Financial integration raises capital account volatility.

5. Conclusions The global economic slowdown requires strong, global and coordinated counter-cyclical measures; Need for global monetary and financial rules and re- assessment of benefits of national and international financial liberalisation; Need to strengthen prudential regulation and supervision particularly to avoid currency and maturity mismatches by firms; Need to complement the traditional microeconomic focus of prudential regulation and supervision with a macroeconomic perspective by introducing explicit counter-cyclical features.

Большое спасибо за внимание