1. Global Economic Crisis: What Can Small Open Economies Do?
Asad Alam
Regional Director
South Caucasus
Europe and Central Asia Region
The World Bank
July 7, 2009

2. 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

5. 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

6. 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 Social Safety Networks, 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

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