Financial crisis has moved ’strongly and rapidly’ to emerging economies: IMF

April 16th, 2009 - 10:48 pm ICT by IANS  

By Arun Kumar
Washington, April 16 (IANS) With the financial crises in advanced economies having passed “through strongly and rapidly” to emerging economies including India, the International Monetary Fund (IMF) Thursday called for a coordinated policy response.

A coordinated policy response is required, since “reducing individual country vulnerabilities alone cannot insulate emerging economies from a major financial shock in advanced economies”, warned the IMF’s latest World Economic Outlook (WEO) published ahead of next week’s World Bank-Fund Spring meeting.

Stronger current account and fiscal balances do little to mitigate the transmission of financial stress from advanced economies in periods of a financial crisis, the report noted.

However, they may help dampen the impact on the real sector of emerging economies and help re-establish financial stability and foreign capital inflows once financial stress subsides.

“Financial crises in advanced economies have passed through strongly and rapidly to emerging economies, with financial linkages a key channel of transmission,” the report said in a chapter on “How Linkages Fuel the Fire”.

“The decline in capital flows to emerging economies following a crisis may be protracted, given the solvency problems facing advanced economy banks who provide significant financing to emerging economies, it said.

In the fourth quarter, financial stress was elevated in all segments of financial systems in all emerging regions, and on average exceeded levels seen during the Asian crisis of 1993.

The reason for the relatively moderate response around the Asian crisis was that there were offsetting effects between countries afflicted by the crisis and other countries that experienced a reduction in stress, such as India and China, the report noted.

The extent of transmission of financial stress is related to the depth of financial linkages between advanced and emerging economies, notably through bank lending, it said. On average, stress in emerging economies moves almost one-for-one with stress in advanced economies, but there is significant cross-country variation.

During the most recent crisis, bank lending linkages appear to have been the main driver of stress transmission.

Close bank lending ties between emerging and western Europe are important factors behind ongoing financial turbulence in emerging Europe, the report said, noting, “Since the mid-1990s, Western European banks have dominated bank lending flows to emerging economies.”

Historical evidence suggests that the key role played by banks in the current crisis may presage a protracted decline in capital flows to emerging economies, the WEO said.

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