Stanley Fischer: Impact of the global financial crisis on Israel’s economy Address by Professor Stanley Fischer, Governor of the Bank of Israel, to the General Assembly of the Association of Publicly Traded Companies, Jerusalem, 8 December 2008. For more than a year the world has been confronting one of the worst financial crises in over seventy years. This crisis has two phases: the first, financial, and the second, real, in other words a significant slowdown, and possibly even a global recession. Both the financial and real effects of the global financial crisis on Israel's economy are clearly evident. I would like to stress, however, that Israel entered this period in a more favorable state than that in most other countries. On the financial side the crisis is reflected in Israel mainly by the fall in prices of shares and corporate bonds, unlike in the advanced and other economies. In addition, the rate of growth declined to 2.3 percent (annual rate) in the third quarter, and it is expected that the slowdown in Israel's growth rate will continue, i.e., growth will remain positive, but will slow further, (to 1.5 percent in 2009), as opposed to a more significant slowdown, or even a recession, in the advanced economies. Israel's relatively favorable situation is due to several factors: 1) The government's fiscal policy in the last few years was a responsible one. 2) The Bank of Israel’s interest rate policy supported financial stability and the ability of the economy to deal successfully with the effects of the slowdown in growth. This, without acting counter to the return of inflation to within the target range. 3) A surplus has been created in the current account of the balance of payments. 4) Israel's foreign exchange reserves are high and rising, as a result of the Bank of Israel's plan to increase them. 5) The levels of growth and employment were high at the onset of the crisis. 6) Israel's banking system is strong and stable compared with those of the advanced economies. 7) Israel's capital market did not develop advanced, complex financial instruments whose inherent risk levels are difficult to assess. 8) The average debt burden of companies and households is relatively low. The challenge at present is to preserve the economy's relatively favorable position, to take advantage of it to deal with the new situation, and to introduce the measures needed to escape from the period of slowdown without harming the economy's ability to return to the path of rapid and sustained growth. All this, despite the forthcoming elections and the fact that the 2009 budget has not been approved yet. At this stage the Bank of Israel, in the framework of its powers and the instruments available, is taking the following steps: 1) It is conducting an active interest rate policy intended to strengthen the economy's ability to handle the crisis. 2) The Bank Supervision Department has intensified its regular monitoring of developments in the banking system. In addition, the Bank announced that it was ready to help the banks with all the means at its disposal, as necessary, in order to support depositors. 3) The Bank's program to buy foreign currency will continue until the forex reserves reach the level considered appropriate under the current circumstances – between $40 billion and $44 billion. What do we still have to do? 1) A cautious fiscal policy should be pursued. Thus, assuming a growth rate of 1.5 percent in 2009, the budget deficit is expected to reach about 3 percent of GDP, based on the automatic stabilizers, i.e., the expected drop in tax revenues resulting from the slowdown in growth, on the one hand, and a certain rise in government expenditure arising, for example, from an increase in unemployment, on the other. It would not be advisable to allow the deficit to rise much beyond that; in other words, our ability to embark on an expansionary fiscal policy is limited. Nevertheless, the tax cuts planned for 2009 should proceed, in a manner consistent with the automatic stabilizers. 2) The measures formulated by the Ministry of Finance in cooperation with the Securities Authority and the Bank of Israel should be implemented. This program should help the economy weather the storm. 3) It is essential, and I would place the emphasis on this aspect, to introduce measures on the financial side, particularly steps intended to increase the sources of bank and nonbank credit for the business sector, including small and medium-sized businesses, and to stimulate foreign investment in Israel's capital market. Yesterday the Prime Minister decided to support the proposal put forward by the work teams of the Ministry of Finance, the Bank of Israel and the Prime Minister's Office, regarding a "safety net" for savers close to retirement age. The Bank is in favor of the proposal and its immediate implementation. However, we view the safety net as a temporary measure for this particular time. It is important to start thinking about changes to the structure of the pensions system in Israel, to ensure that those paying into funded pension schemes, as opposed to those covered by unfunded schemes, are not placed in a situation in which, close to retirement age, they are likely to lose a significant part of their savings. It is important that the pension system be structured such that when the time arrives savers can receive a reasonable pension for the rest of their lives. One possible pension scheme structure that could be adopted is the Sicilian model, in which the savings of those close to retirement age are transferred to relatively low-risk channels. To my great regret, the other steps formulated by the Ministry of Finance, although approved by the Prime Minister, are making little or no progress vis-à-vis the Knesset, and are not being implemented. Thus, valuable time that could be used to the benefit of the economy is being wasted, particularly regarding measures relating to the financial side. Further delay in applying these measures is likely to erode the economic achievements of the last few years and our ability successfully to meet the challenges facing us. This is not the time, therefore, to postpone decision making. The financial crisis is here, and is not waiting for us. The measures have been planned, and all that remains is to start with the none-too-simple task of making decisions and implementing them. It is essential that at this time, in the approach to the elections to the Knesset, we persist in being focused, and act with a view to the medium and long term. Failure to do so will cost us dear. The Impact of the Global Financial Crisis on Brazil Until quite recently I was among those who doubted whether we faced a major crisis in the real economy. When people said that we were in the middle of the greatest financial crisis since the great depression I did not contradict them, but I found one of the interesting aspects of this crisis to be the striking contrast between the gloom and doom prevalent in the financial sector and the buoyancy still in evidence elsewhere. This was especially evident among exporters in the US manufacturing sector, whose historic markets had been largely restored by the correction of the dollar overvaluation except versus some Asian countries, but it was a much more general characteristic. Through the first half of 2008, i.e. for about a year after the financial crisis broke, growth rates continued at historically high levels except among some of the advanced countries. To take an example close to the interests of many here this morning, Brazil reported year-on-year growth of 6.1 percent in the second quarter of 2008. There was much talk of reverse-coupling. Not only did it seem that the spillovers from financial markets to the real economy were proving blessedly limited, but one could reasonably argue that the emerging markets were unlikely to be severely affected. There were of course a few countries that had given precedence to policies of growth during the preceding boom years—many countries in Eastern Europe plus most conspicuously Turkey and Pakistan—but most countries seemed to have taken to heart the lessons that had been repeated ad nauseum after the crises of the 1990s. Such as: that countries needed to respond to capital inflows or current account surpluses by building up reserves, moving into fiscal surplus, paying off debt, eliminating the use of foreign currencies in denominating assets, cutting the debt/income ratio, and reducing inflation, rather than by splurging. Many of us were happy to emphasize that this was conspicuously true of Brazil. In the course of September 2008 this optimism, or maybe one should call it complacency, vanished. As the month wore on it became apparent that the financial crisis was deepening to a point where it would inescapably have major spillovers on the real economy. Housing values continued their decline, but meanwhile stock markets fell precipitously worldwide and credit markets virtually dried up, resulting in many who relied on borrowing suffering from acute illiquidity. Everyone had known from the start that a slowdown in the core of the world economy was bound to suppress demand everywhere, but until this point it seemed that the slowdown was to be welcomed rather than something that was going too far. Quite suddenly it seemed that the world was facing a real danger of a depression rather than a welcome alleviation of inflationary pressure. Moreover, the markets decided that while many of the emerging economies might no longer have any need for an inflow of loans, many (like Brazil) are still significant net debtors to the rest of the world and therefore still vulnerable to a sudden withdrawal of foreign credit. Compounding this is the fact that one may have a balanced overall position and still be vulnerable because debts are concentrated at short maturities. Hence one read, for example, of the Bovespa index falling by over 10 perce day (it has cumulatively halved in value since the peak in May). Likewise, the real has fallen by cumulative 32 percent in the past month. The markets clearly do not believe that Brazil has bee made invulnerable by the record cited above. These facts compel one to reassess the probabilities of Brazil suffering seriously in this crisis. Th in world demand is liable to impact the Brazilian economy primarily through the balance of payments. It will both diminish the prices of raw materials, which constitute roughly one half o Brazilian exports, and cut the quantity of sales of differentiated products, largely manufactures, constitute the other half of export sales. It is the past strength of raw material prices which prov the one logical basis for the very high value of the real in the past three years, and quite recently most reasonable forecast was that the price of materials, although likely to slip back from the ve high levels of recent months, would remain much stronger than in the 1990s and early years of decade. That no longer seems certain. A major worldwide recession would be consistent with a period reverting to weak commodity prices. The prospects for exports of manufactures are also gloomy, though perhaps somewhat less so. T value of world financial assets is estimated to have declined by about $20 trillion this year, and value of housing has likewise fallen very substantially, by about $6 trillion in the US over the la years and perhaps as much again in the rest of the world. Applying a conventional marginal propensity to spend out of wealth of 4 percent, this implies a fall in world demand of about $1. trillion, or 2 percent. To this must be added the still unknown effects of the current credit strin The net effect is bound to be a significant contraction in the demand for manufactures. The on bright spot is the decline in the value of the real on the exchange market, which can be expecte switch demand back toward Brazilian-made goods at the expense of goods made elsewhere. Th demand for Brazilian-made manufactures should therefore not be expected to decline as severel demand for such goods in general. (Of course, this assumes that the central bank will accept th decline in the value of the real on the exchange market, and not seek to push it back to an over level by selling dollars. See Figs 1 and 2 for two market estimates of the historical performance Brazilian real exchange rate: even on the basis of the Citibank estimate, it is clear that the real w overvalued prior to its recent decline.) There are other channels through which Brazil is likely to suffer besides the current account of balance of payments. First, it is well known that capital inflows to emerging markets like Brazil highly cyclical. One must therefore expect to see a diminution of the recent inflows. Two week the Institute of International Finance was forecasting an inflow to all emerging markets in 2008 $50 billion less than last year. Even if this figure is still realistic after the past two weeks, one w expect a further reduction next year. In part this will involve a fall in foreign direct investment therefore in investment, but most of the fall will probably be elsewhere. One expects a reductio portfolio equity, much (hopefully most) of which presumably has already happened and explai much of the fall in the Brazilian stock market. One also expects it to become more difficult for Brazilian enterprises to borrow in the international market: the strong financial position of the Brazilian public sector should enable the authorities to offset much of this with an expansion of domestic credit. In short, I would expect the main channel through which the likely fall in capital inflows will i Brazil to be via the stock market. Although maybe one-third of Brazilian shares are foreign-own the majority are domestically-held, and consequently there will be a wealth effect in diminishin consumption as well as some effect of the increased cost of capital in reducing investment. The effects from abroad will not simply come through the current account. One should not overlook the increased demand that will come from a more competitive real, but neither can one doubt that there will be costs as well as benefits of the decline in the real. In particular, it is likely to push the forecast of inflation back up above the value of 4.5 percent being targeted by the central bank, which was almost reached prior to the decline of the real (described in Brazil as a strengthening of the dollar). It seems to me that the central bank should ignore this overshoot. The aim should be to avoid any second-round effects of the depreciation, rather than to maintain the rate of inflation at the level previously being targeted. This should enable the central bank to avoid any further increase in interest rates, which would be highly counterproductive from a global standpoint. While a serious global recession appears inescapable at this point, there is still a great deal of uncertainty as to whether this is likely to be a short V-shaped recession similar to that experienced by Korea in 1997–98, or a protracted depression on the model of Indonesia after 1997, or Japan in the 1990s, or the world in the 1930s. The IMF has argued that the omens are bad because recessions accompanied by a collapse of the housing market have typically lasted longer than normal. However, this is not the only factor, and the collapse of the housing market is limited to certain countries rather than being a general phenomenon. In particular, I would argue that the United States (and Brazil) are likely to recover relatively rapidly due to the correction of a previously–overvalued currency, and China is likely to have a relatively brief recession as it has plenty of scope for fiscal expansion. I would expect recovery to be somewhat slower in many places elsewhere, but I do not anticipate a collapse similar to the 1930s. That was a result of ignorance from which we no longer suffer. There may well be proposals for concerted fiscal expansion to combat the world recession. The question would then arise as to whether Brazil should join other major countries in such an exercise, similar to (but broader than) the concerted interest rate cut of 0.5 percent by all the leading industrial countries on October 8. Such an expansion would threaten Brazil’s imminent move into overall fiscal surplus and reduce the rate of decline in the debt/GDP ratio. I would nevertheless favor Brazilian participation assuming (as I would hope) that it is invited, despite being much in favor of fiscal discipline. Of course I would wish the fiscal expansion to take a form that can easily be reversed and I would wish it to be strictly temporary, but the fact is that these are not normal times and we need to make some adjustments from customary behavior. The cost of not doing so would be to prolong the recession further. Effects Of Global Financial Crisis To Hit Russian Banks Later In 2008 - Gref MOSCOW. Feb 7 (Interfax) - The head of Russian bank Sberbank (RTS: SBER) German Gref predicted on Thursday that the majority of Russian banks would start feeling the effects of the current global financial crisis in the second quarter of 2008 and would respond by "somewhat" raising interest rates. As a result, "money supply for the real sector will shrink," the volume of investment will diminish and economic growth will slow down, Gref, who is a former economic development and trade minister, forecast in talking to reporters after a conference between the prime minister and the top brass of the Russian Banks Association. That the global crisis will hit Russia "is obvious already, the question is by how much the pace of lending and money supply will decrease," the Sberbank chief said. In 2007, the Russian banking sector's credit portfolio increased 52%, but in 2008 it would not grow by more than 40%, he said. "There's nothing critical about that, but we need the same pace of increase, and that won't happen," Gref said. Investment will not grow by more than 20% for 2008, he said. What will happen in 2009 depends on how much the global crisis affects the Russian financial markets, Gref said. As regards short-term liquidity, the ex-minister said first of all measures should be taken to deal with the effects of possible cash gaps. "Complete mutual understanding has been achieved there. I hope no problems will arise," he said. Such measures are the Central Bank's job, and the prime minister will order doing all the work in the current quarter, Gref said. Whether long-term liquidity will be sustained depends on the needs of the real sector and "is a matter of legislation," he said. Gref also said that the Finance Ministry had been ordered to consult banks on whether the resources of development institutions and the National Welfare Fund could be used to sustain the liquidity of the banking system. "Today the situation in the world financial system is very tense, and the Russian Banks Association has asked the prime minister to hold a conference on how the situation in world finances may affect the situation in Russia," Gref said. So far there are no indications that the global crisis has affected Russia, because there exists a stability reserve that enables Russian banks to function confidently and build up assets, Engr. Edemej Kesiena IMT, Enugu