Volatility and Emerging Markets Financial Systems: Notes on a Conference

I just came back from an interesting conference – the International Derivatives and Financial Markets Conference – sponsored by the BM&F (Brazilian Mercantile & Future Exchange). I then thought it would be nice to summarize with RGE audience the discussions and main outcomes from the talks.

The talk by Edmund Phelps was very interesting. While it might look obvious, Phelps reminded the audience that the Brazilian economic future is on the hands of its own Brazilians. Nothing new! He just redirected the focus: “Brazil should not attach its forecast in what is going to happen to EUA”. According to him, a plausible long run economic growth depends on the ability of Brazil to promote a suitable environment for innovation and entrepreneurship: “Economy is essentially a system for generating new entrepreneurship and selecting among the best ideas; economy should be seen as an innovation machine”. He also suggested that Brazil should think with a longer time frame. It is only with such frame that we can foresee what will be the global market demands and how Brazil can deliver them.

Following Phelps´ speech, we had the round table with four Brazilian economists, Rogério Werneck, Gustavo Franco, Luiz Carlos Mendonça de Barros and Eduardo Loyo. Werneck´s warning regarding our fragile fiscal situation and perspectives for the future were the more important message of that round table. He presented two interesting charts: the first one showing the peculiarity of our fiscal adjustment where the increase in the primary surplus was almost always accompanied by expansion in the current expenditures, and the second one presenting the unsustainable path of the primary expenditures as a share of GDP.

Anne Krueger reminded us on the relevance of a modern financial system as support for a robust economic growth. Regarding Brazil we have a modern financial infrastructure in some aspects but we are far away from modernity in others (contract enforcement, excess of bureaucracy and so on).

Ricardo Caballero, with an instigating speech, challenged the efficiency of the emerging markets strategies for insurance against crises. According to him, EM should not claim that sudden stops episodes are events related to financial history. The shortage of store-of-value (financial) assets around the world is the main global macroeconomic phenomenon of our time: “Capital ability to produce output is only imperfectly linked to generate assets”. He then went on to talk about volatility: “volatility is intrinsic to a financial market with shortage of assets”. The key question is how emerging market economies can fight against the volatility and sudden stops? In his view, the current reserves management is inefficient and costly. For him, the best strategy to deal with sudden stops is to use contingent claims instruments, for example, US-GDP indexed bonds, commodity prices indexed bonds or even a volatility index security (VIX). The question is whether a sudden stop is forecasted in such a way that the country have enough time to use these so-called ‘contigent claims’ tools.

In brief, the main message from the conference is that emerging market economies should improve their risk management devices to deal with volatility and market crises. Indeed, in the long run there are no excuses or choices: only a modern and efficient economy can deliver economic and social welfare.

3 Responses to "Volatility and Emerging Markets Financial Systems: Notes on a Conference"

  1. Anonymous   August 30, 2007 at 10:57 am

    Very useful summary of this conference. thanks. Which Latin American emerging market is most at risk in your view?

  2. Guest   August 30, 2007 at 12:40 pm

    If Phelps said that “Brazil should not attach its forecast in what is going to happen to EUA”, then Brazil does not depend on the US financial system? Or what? The summary was useful. I was wondering why you stressed Rogerio Werneck whereas Gustavo Franco and even Eduardo Loyo are usually less conventional than Werneck. Thanks.

  3. Ricardo Meirelles   September 3, 2007 at 3:43 pm

    Thanks for the comments. Regarding Phelp´s talk, I would say he was just pointing out that the external environment has always marginal impacts over the economic growth. A robust growth would only come from the innovation locomotive built internally. The fiscal fragilities, one of the main potential problems in Brazil were very well described by Werneck´s intervention. Franco and Loyo have commented about other interesting points. Differently from other periods, the Latin America countries are less vulnerable regarding the current external environment. Mexico would suffer more directly from the impacts on the US economy. But in the domestic front there are plenty of important and dangerous problems to be solved in different Latam countries (Venezuela, Bolívia, Equador, Argentina, and even Brazil).