1. The Financial Crisis and The Future of Financial Globalization Gian Maria Milesi-Ferretti International Monetary Fund, Research Dept. and CEPR

2. Disclaimer Views are mine and do not necessarily reflect those of the IMF

3. Structure of Presentation Key features of international financial integration in the runup to the crisis The onset of the crisis The ‘sudden stop’ in capital flows The future of globalization

4. International financial integration (I) Two main aspects of cross-border capital flows:  Net flows: financing of global imbalances, accumulation of creditor and debtor positions  Gross flows: increase in cross-border holdings

5. Net capital flows, 1998-2009

6. International financial integration (II) Boom in cross-border capital flows… Particularly large among advanced economies Large inflows and outflows within the euro area… …but very high cross-border flows in Europe even netting out intra-euro-area flows Increase in flows also to and from emerging markets

7. Gross capital flows: World capital inflows by region

8. International Financial Integration (IFI) In advanced economies and emerging markets, large expansion in cross-border flows and holdings in the form of equity and FDI… Boom in cross-border debt holdings among advanced economies (key role of banks), but not in emerging markets Round-tripping / regulatory arbitrage: use of financial centers (mostly by advanced economies)

9. IFI -- Portfolio equity and FDI holdings

10. IFI – external debt holdings (assets+liabilities)

11. Net foreign assets (NFA) in EM Large improvement in NFA in emerging Asia, Middle East Some NFA improvement in Latin America Large NFA worsening in emerging Europe

12. Change in structure of portfolio in EM Large decline in debt liabilities Large increase in FDI and equity liabilities Some increase in FDI and equity assets Large increase in FX reserves Big decline in net FX exposure

13. Change in structure of portfolio in EM: Latin America

14. Change in structure of portfolio in EM: emerging Asia

15. Change in structure of portfolio in EM: emerging Europe

16. The onset of the crisis Exposure to US-issued non-agency MBS  High in some European countries  Low in Japan, Spain  Very low in emerging markets Large creditors (China, Japan, oil exporters) initially unaffected Transmission related to international financial integration, rather than global imbalances

17. Subsequent phases of the crisis First half of 2008:  Run-up in commodity prices  Collapse of Bear Stearns, USD concerns, big decline in banking flows in the 2 nd quarter Second half of 2008:  Crisis becomes global  Collapse in global demand and capital flows (particularly in the 4 th quarter)  Accelerated deleveraging (financial institutions, hedge funds)  Yen, USD and Sfr appreciate (safe-haven currencies)  euro, RMB stable  everybody else depreciates sharply

18. The sudden stop in advanced economies Large repatriation of capital in cross-border banking (UK, US, Switzerland) Net sales of foreign portfolio instruments Only FDI flows fairly resilient Net foreign purchases of domestic bonds remain (barely) positive (flight-to-safety)

19. The sudden stop: advanced economies, capital outflows

20. The sudden stop: advanced economies, capital inflows

21. Sudden stop in emerging markets Flows solid Q1-Q3 2008, but collapse in Q4 Big portfolio repatriation by foreigners Reduction in bank exposures to EM (particularly in Asia) Resilient FDI flows Decline in FX reserves to offset foreign sales of domestic assets

22. The sudden stop: emerging markets

24. The Sudden Stop: Latin America

26. How to understand financial developments in Q4 2008? Deleveraging process Sharp increase in home bias (likely influenced as well by measures implemented nationally to deal with banking sector problems) Flight from “risk”

27. Flight to ‘safety’: Net foreign purchases of US bonds

28. Are we out of the woods yet? Recovery in capital flows to emerging markets in 2009 (improved outlook, higher commodity prices, reduced risk aversion)  Increase in equity and bond issuance  Increase in flows to EM mutual funds  Appreciating currencies  Recovering stock markets

29. Are we out of the woods yet? …but external risks remain significant  Weakness in financial sector in advanced economies  Slow pace of recovery  Different vulnerability across regions

30. What future for financial globalization? Net flows  Global imbalances?  Scope remains for external financing of EM  But danger of very large CA deficits…  …and fear of crises  Key to ensure appropriate cross-border insurance mechanisms Swap lines Flexible credit line Role of IMF

31. What future for financial globalization? Gross flows  Retrenchment in cross-border banking positions  FDI flows resilient  Some recovery in portfolio flows  Very large government debt issuance, especially from advanced economies. How will it be absorbed?  What role for financial centers?

32. What future for financial globalization? Composition of flows (EM)  Dependence on development in advanced economies (financial system, regulation etc)  Further development of domestic-currency borrowing  Monitoring of sectoral FX exposures  Still scope for FDI, portfolio investment  More uncertainty on size of bank flows

33. Muchas gracias!