The Road to Post-Crisis Growth

MILAN – It is about 18 months since the financial crisis hit, and 12 months since the panic started to recede, with asset prices stabilizing and beginning to turn up. Although recovery in advanced countries remains fragile, developing countries appear to have weathered the storm. Growth in China and India is bouncing back toward pre-crisis levels, Brazil’s growth is rising after a sharp dip, and developing-country trade is rebounding from depressed levels.

Reasons for this remarkable resilience abound, and they offer guidance for advanced and developing countries alike. As the crisis struck, capital flowed out of developing countries to shore up damaged balance sheets in advanced countries. Credit tightened sharply. But rapid responses by developing-country central banks, in collaboration with relatively healthy domestic banks, prevented a severe credit freeze.

Moreover, the reserves built up over the preceding decade were, in many cases, used to offset some of the capital outflows. Bank balance sheets had been strengthened after the 1997-1998 financial crisis, and were unencumbered by the overvalued securitized assets and complex derivative securities that caused much of the damage to advanced-country financial institutions.

Leverage was lower in several sectors. Financial institutions – and, more importantly, households – held less debt relative to assets and income. In advanced economies, the main mechanisms for transmitting balance-sheet damage to the real economy were credit rationing and reduced consumption due to loss of net worth in households. Both factors were more muted in developing economies.