Chapter 4 shows that financial stress is transmitted very rapidly, within one or two months, from advanced to emerging economies. Their financial stress from the current crisis became severe in the second half of 2008, manifested by exchange rate depreciations, reserve losses, stock market volatility and wider sovereign bond spreads across all major regions. But the transmission varies across individual emerging economies depending on the closeness of their financial linkages with advanced economies.
These linkages are in terms of capital flows that can take the form of bank lending, portfolio investment and foreign direct investment. Here are the major findings of the IMF research based on their econometric analysis of financial stress episodes during the period 1997-2008 in 18 emerging economies, including Turkey, distinguishing between common global effects and country-specific effects:
(1) The deeper and tighter the financial linkages, the faster and more strongly the stress is felt.
(2) Bank lending linkage is the main channel of stress transmission in the current crisis.
(3) Based on the fact that Western European banks have dominated bank lending to emerging economies since the mid-1990s and their lending has been concentrated in the emerging European region (Bulgaria, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Russia, the Slovak Republic, Slovenia and Turkey), the current crisis, centered on the banking sector, has hit that region, characterized by current account and budget deficits, the hardest.
(4) Based on what we learned from the financial crises of the 1980s and 1990s, the emerging economies -- especially the emerging European region with bank liabilities to advanced economies exceeding 50 percent of the gross domestic product (GDP), three times that of other regions -- are likely to suffer from a long and severe drought of capital inflows, mostly in bank lending from advanced economies.
(5) Although each emerging economy can lessen its country-specific vulnerability to shocks by strengthening its budget and current account balances and increasing its foreign reserves when the global financial seas are calm, it cannot insulate itself from the perfect storm of a global financial crisis.
(6) Fighting a global financial crisis requires globally coordinated efforts by both advanced and emerging economies.
(7) Such efforts can take the form of emerging economies' access to external official funding, support for advanced economies' banks with large exposures to emerging economies, international cooperation among financial supervisors and multilateral insurance systems that maximize the benefits and minimize the costs of global financial integration.
One econometric result in Chapter 4 intrigued me. In the chart below, the co-movement parameters ß measure how financial stress in emerging economy i responds to financial stress in advanced economies. ß implies no transmission; ß represents one-to-one transmission; and ß indicates magnified transmission. Mean (ß), the average of the 18 co-movement parameters, is large, but varies significantly across the 18 countries. On average, 70 percent of stress in advanced economies is transmitted to emerging economies (average ß). Turkey has the strongest systemic stress transmission, with ß, among the 18 emerging economies. The IMF researchers do not tell us why, leaving us to ponder, assuming their analysis is correct, the nature of Turkey's financial linkages with advanced economies.
