Impact of Global Financial Crisis

on IDB Member Countries:

Regional Prospects and Challenges

Presentation to the Conference on

Global Financial Crisis and Capacities of the Islamic
Financial System, Islamic Republic of Iran
(17 January 2009)

Islamic Development Bank

Rapidly weakening global prospects

Growth
Prospects
Origin of Crisis

Chart 1: World Bank Economic Outlook

Projections, end-Nov. 2008
9

Core Faultlines

Comments by
Sage

MENA/GCC
Outlook

6
(percent)

Transmission
Channels

7
5
4
3
2
1
0

SSA Outlook
Asia Outlook
Global Recovery
by 2010

-1

2006
Global Output
Developing Countries

2007

2008

2009

2010

OECD Countries
Developing Countries (excl. China an

Slowdown of economic growth, so far !

Growth
Prospects

Chart 4: Growth Prospects of IDB Member Countries

9

Origin of Crisis

Comments by
Sage
Transmission
Channels
MENA/GCC
Outlook

(Percent)

Core Faultlines

7
6

5
4
2005

SSA Outlook
Asia Outlook
Global Recovery
by 2010

2006

2007

IDB-56 MCs

2008
LDMCs-28

2009
non-LDMCs-28

2010

Global Financial Crisis: How It All Started

Growth Prospects
Origin of Crisis
Core Faultlines
Comments by
Sage
Transmission
Channels
MENA/GCC
Outlook
SSA Outlook
Asia Outlook
Global Recovery
by 2010

De-regulation in the Name of Ideology

Major Wall Street investment banks, hedge & derivative funds,

unregulated credit default swaps market
In April 2004, net capital rule waived for US investment banks;
unleashed reserves held to cushion losses

Dark Heart of the US Financial System

$10 trillion in securitized toxic assets

$55 trillion in credit derivatives and credit default swaps
(mechanism to insure banks against losses)
CDS market size was more than twice the size of the combined GDP of
U.S.A. + Japan + the E.U.

From US Financial Crisis to Global Tsunami

AIG, operating in more than 100 countries, became insolvent (holding

$441 billion of CDS)
End of investment banks in US investment
Contagion effect on banks in Europe (UK, Switzerland, France,
Germany, Iceland, Netherlands)
Seizing-up of interbank lending market
Partial nationalization of banks and deposit guarantees
Cost of lending to businesses and households became prohibitive

Failure of De-regulation Ideology

Growth Prospects

Origin of Crisis
Core Faultlines

MENA/GCC
Outlook

Global Recovery
by 2010

Four Core Faultlines in the US Financial System

Poor market discipline

Slicing of risks and selling of debts to multiple investors; instead of risks being
diversified, it obscured risks creating systemic vulnerabilities

System incentivizes creation of speculative bubbles

Unsustainable rise in asset prices became possible because of co-mingling of

aggressive lending and truncating risk-taking

Lack of due diligence

Astronomical expansion in the size of the derivatives market created a false

sense of security

Moral hazard

Global financial institutions had grown to too big to fail size, leading to
imprudent lending practices

SSA Outlook
Asia Outlook

Growth in credit volume and paper profits generated by investing borrowed

funds

Comments by
Sage
Transmission
Channels

Excessive leverage model of financial intermediation

What Do The Sage Have To Say?

Growth Prospects
Origin of Crisis
Core Faultlines
Comments by
Sage

Alan Greenspan, Chairman of the US Federal Reserve

I made a mistake in presuming that self-interest of organizations, specifically banks and

others, were such that they were best capable of protecting their shareholders and their
equity in the firms.

Paul Krugman, Nobel Laureate, Prof. of Economics at MIT

Will the U.S. financial system collapse today, or maybe over the next few days? I dont think
so but Im nowhere near certain old world of banking,, has largely vanished, replaced
by what is widely called the shadow banking system. And as the unknown unknowns have
turned into known unknowns, the system has been experiencing postmodern bank runs.

Transmission
Channels

Joseph Stiglitz, Nobel Laureate, former Chief Economist, World Bank

MENA/GCC
Outlook

Will Hutton, Eminent British Financial Journalist

SSA Outlook
Asia Outlook

In a country where money is respected, Wall Streets leaders used to have our respect. They
had our trustTimes have changed. Gone is the respect and trust.
For 30 years, greedy, callow, ignorant financiers, supported by no less callow politicians
from all the political parties, have proclaimed the wonders of financial innovation and how
proud we all should be of the City of London. The pric etag for their behavious is an
economic calanity. We should never have bought such sname oil. The consolation in these
dark times is that we never will again.

Olivier Blanchard, Chief Economist, IMF

Global Recovery
by 2010

The coming months will be very bad. Halting this loss of confidence, providing stimulus and,
if necessary, replacing private demand are essential if we want to prevent the recession
from becoming a Great Depression.

What are the Major Transmission Channels?

Baseline Scenario
Growth Prospects
Origin of Crisis
Core Faultlines
Comments by
Sage
Transmission
Channels
MENA/GCC
Outlook
SSA Outlook
Asia Outlook
Global Recovery
by 2010

Sharp deceleration in investment growth

MICs: 13.2% in 2007 and projected: 3.5% in 2009
MENA: 16.8% in 2007 and projected: 7.0% in 2009
SSA: 20.3% in 2007 and projected: 7.7% in 2009

Tighter capital inflows to middle-income countries

Net private debt + equity flows: $1 trillion in 2007 to $530 billion in
2009 [7.7% to 3% of developing country GDP]
Sovereign and private-sector spreads have spiked sharply by 700 basis
points and 1,000 basis points

Weaker ODA and remittance flows to low-income countries

Sharp slowdown in global import-demand
Global export volume to fall by -2.1% in 2009; (1982)
OECD countries import-demand: -3.4% in 2009

Lower commodity prices in 2009

International price of crude oil is projected in the range of $68-75 per
barrel
Food prices to decline by 23% and metal prices to decline by 26%
Mixed BoP impact on developing countries

What are the Major Transmission Channels?

High Risk Scenario
Growth Prospects
Origin of Crisis
Core Faultlines

Deeper and longer recession in OECD Countries

Recovery delayed beyond mid-2010

Comments by
Sage
Transmission
Channels
MENA/GCC
Outlook
SSA Outlook
Asia Outlook
Global Recovery
by 2010

Impact on Developing (and IDB Member) Countries

Seizing up of borrowing and lending for investment and trade
financing
Banking failures of otherwise sound institutions
Vulnerable countries: high twin-deficits and high inflation could lead
to severe exchange rate crises
Impact on poverty
1 percent decline in growth leads to additional 20 million people
in poverty

MENA / GCC Region: Sharp U-type Growth Recovery !

Growth Prospects
Origin of Crisis

Chart 3: Growth Outlook for the MENA Region

Core Faultlines

Comments by
Sage

MENA/GCC
Outlook

(percent)

Transmission
Channels

SSA Outlook
Asia Outlook
Global Recovery
by 2010

3
2006

2007
2008
World Bank-MENA

2009
IDB-MENA-19

2010

MENA Region: Key Challenges

Growth Prospects
Origin of Crisis
Core Faultlines
Comments by
Sage
Transmission
Channels
MENA/GCC
Outlook
SSA Outlook
Asia Outlook
Global Recovery
by 2010

Steep fall in International Oil Prices

From $147 per barrel in May 2008 to less than $50 in December 2008
Fiscal balance of oil-exporting countries under threat

Troubled Banking Sector

Exposure of some SWFs and banks to US toxic debts

Over fivefold jump in riskiness of some GCC banks
Deposit guarantees and massive liquidity injections by GCC central banks

Troubled Corporates

Fourfold rise in borrowing costs during 2008

Cancellation of major infrastructure and commercial projects
Property bubble - significant drop in real estate prices

Wealth Destruction

October 2008: 25% drop in stock prices or $250 billion losses

Massive drop in GCC stock market indices by over 50% leading to potential
delinquencies by investors which adds to banks vulnerabilities

SSA Region: Smooth Recovery in 2010?

Growth Prospects
Origin of Crisis

Chart 4: Growth Outlook for Sub-Saharan African Countries

Comments by
Sage

Transmission
Channels
MENA/GCC
Outlook

(percent)

Core Faultlines

5
SSA Outlook
Asia Outlook
Global Recovery
by 2010

4
2006

2007
2008
2009
2010
World Bank-SSA excl. South Africa
IDB-SSA-22

SSA Region: Key Challenges

Growth Prospects
Origin of Crisis
Core Faultlines
Comments by
Sage
Transmission
Channels
MENA/GCC
Outlook
SSA Outlook
Asia Outlook
Global Recovery
by 2010

Steep fall in regional stock market

Composite index of WAEMU countries fell by 21%

Banking sector untroubled

Foreign-owned banks have continued their normal operations

Steep fall in prices of major non-oil exports

In October, prices of 12 commodities declined by 9 to 27 percent

ODA flows to slowdown

Official grants are projected to slowdown to 1.1% of SSA-GDP in 2009 from
1.5% in 2008

Risk of external debt distress to intensify (Oct. 2008)

Six MCs (Sudan, Comoros, Cote d Ivoire, Guinea, Guinea Bissau, and Togo) in
debt distress
Four MCs (Chad, Burkina Faso, Djibouti, and Gambia) are at high risk

Debilitating impact on poverty and progress to MDGs

Number of extreme poor gone up: 130 150 million
Cost of lifting extreme poor to poverty line: $38 billion or % of developing
country GDP

Asia Region: Protracted Recovery?

Growth Prospects
Origin of Crisis

Chart 5: Growth Outlook for the Asian Countries

Core Faultlines

14
12

Comments by
Sage
(percent)

Transmission
Channels

10
8
6
4

MENA/GCC
Outlook

2
0

SSA Outlook
Asia Outlook

2006

2008

2009

World Bank-East Asia

World Bank-South Asia

World Bank-Europe & Central Asia

IDB-Asia-8

IDB-CIS-7

Global Recovery
by 2010

2007

2010

Asian Region: Key Challenges

Growth Prospects

Global investment funds withdrew from broad range of risky assets and
converted into liquid holdings
Sovereign spreads rose: Malaysia 300 bp & Indonesia 570 bp

Origin of Crisis
Core Faultlines
Comments by
Sage
Transmission
Channels
MENA/GCC
Outlook

Risk aversion in middle-income countries

Reversal of private debt flows

Outflows in Turkey: $3.1 billion in 2008

Triggered large exchange rate depreciation

Turkey / Pakistan: 40% / 25% depreciation vs $

SSA Outlook
Asia Outlook

Global Recovery
by 2010

Weak export prospects

East Asian countries (excl. China) export growth projected to fall from 8.3% in
2008 to 2.6%in 2009
Turkeys precarious position: 2nd quarter growth deteriorated sharply to 1.9%
compared to 6.7% in previous quarter; troubled auto sector, foreign debt: $280
billion, of which one-sixth is short-term; and expected to adopt IMF program in
January 2009
CIS Countries: Kazakhstan has, globally, second riskiest banking system (based
on CDS prices); Vulnerable to slowdown in remittance flows
South Asian Countries: Falling prices of oil- and non-oil commodities will stabilize
BoP and alleviate exchange rate pressures; expected to recover quickiest in 2009

Targeting Global Recovery by 2010 !

Growth Prospects

Boosting Aggregate Demand

Origin of Crisis

Effectiveness of monetary policy is limited

Core Faultlines

Fiscal stimulus: 2% of combined global GDP

Comments by
Sage
Transmission
Channels
MENA/GCC
Outlook
SSA Outlook
Asia Outlook
Global Recovery
by 2010

Banks hoarding new liquidity

Regeneration of investments and stimulating consumer confidence

Reforming International Financial System

G-20 Declaration comprises of
Root causes of the current crisis, Actions taken and to be taken, Common
principles for reform of financial markets, Tasking of Ministers and experts,
Commitment to an open global economy, and Action Plan to implement
(i) priority actions by 31 March 2009, (ii) make progress on medium-term
actions, and (iii) prepare for next G-20 Summit on 30 April 2009

Relevance to IDB and Member Countries

Adequacy of MDBs resources
Strengthening transparency and accountability
Enhancing sound regulatory regimes

Growth Prospects
Origin of Crisis
Core Faultlines
Comments by
Sage
Transmission
Channels
MENA/GCC
Outlook
SSA Outlook
Asia Outlook
Global Recovery
by 2010

Thank You