BACK TO MAIN  |  ONLINE BOOKSTORE  |  HOW TO ORDER

New architecture on wrong diagnosis?

Recent pronouncements leading up to and at the IMF/World Bank meetings recently have not presented any fresh approaches towards dealing with the crisis-prone international financial system. Instead, they have only amplified the differences and contradictions within the orthodoxy on issues such as the desirability of unfettered financial liberalization and the failure of developed countries' financial supervisory regimes.

by Chakravarthi Raghavan


GENEVA: The semi-annual rituals of the world's finance ministers and officials, meeting in groups, mostly in concentric circles, and culminating in the IMF/World Bank Interim and Development Committees (whose communiques are drawn up in advance by the staff and often reflect only US and G-7 views), have concluded on 17 April.

The Fund and its Managing Director have emerged with a mandate to strengthen the architecture of the international monetary system for the "Prevention, Management and Resolution" of crises, with the usual incantations to achieve these: sound and stable macro-economic policies, strengthened fund surveillance and recommendations, greater availability and transparency of economic data from member-states, additional resources to the Fund through quota increases and new arrangements to borrow, continued mandate to work on amending the IMF Articles for Liberalization of Capital Movements, and so on.

Some of these and others were previewed in the pronouncements recently of US Treasury Secretary Robert Rubin, including his latest at the Brookings Institution (which asks the other G10 countries, for example, to disregard their WTO obligations and shut down banking branches of developing countries) and of the IMF Managing Director, Michel Camdessus.

But the communique does not reflect in any way the differing views about the crisis among many mainstream orthodox economists and institutions, nor the views of the Group of 24 developing countries. This is so even of their views voicing some caution over capital account issues and tying any amendment of the IMF Articles on the capital account to access to IMF resources to meet sudden capital outflows.

The G24 routinely meet, hear out the heads of the IMF and the World Bank (and UNCTAD and a few others), and issue their statements, but have never been able to get them reflected in the final outcomes of the Fund and the Bank meetings.

Over the last two decades, there has only been one instance (before the preparations for the Uruguay Round and its launch at Punta del Este) when the final outcome of the Fund/Bank meetings, drafted by the managements to be "accepted by consensus", had to be changed because one governor refused to be a party and insisted on his dissent being footnoted.

It was the Indian Finance Minister (who was also looking after trade at that time, and hence was aware of the issues) who had objected to the Development Committee being used to get endorsement for the GATT Director-General's eminent consultant's (Leitweiller) report for launching new negotiations. A "shocked" Development Committee chairman was forced to call a recess, and after extended discussions, a compromise was evolved.

It showed that developing countries, even with a minority of votes, not enough even to block a decision in the one-dollar- one-vote and informal consensus processes of the IMF and the World Bank, could influence decisions.

Movement away from original diagnosis

In the run-up to the meetings in mid-April, the statements of Rubin and Camdessus showed how far they have had to move away from their original diagnosis of the crisis in the international monetary system, conveniently dubbed as the "Asian crisis" and the "Asian flu" to suggest something endemic or peculiar to Asia and containable with vaccination, as is annually done for influenza (not often successfully) in Europe.

In his Brookings Institution speech of 14 April about strengthening the architecture of the international financial system, words that have been used in the Interim Committee communique too, Rubin went further to suggest wrong solutions on the basis of wrong diagnosis.

He indicated that the US (with other G10 countries) is ready to disregard its international obligations, including those under the 1995 financial services agreement at the WTO, which will remain in force until and unless the new agreement enters into force early in 1999.

The US' disregard of international law is not new, though it has become more assertive after it became the sole "superpower". But it wants other G10 countries to disregard their obligations in dealing with emerging economies.

Rubin's views

Rubin saw the crisis as having demonstrated how "badly flawed" financial sectors in "a few" developing countries, and inadequate risk assessment by international creditors and investors, can have significant impact in countries around the globe and how, unlike in the past, unsound policies in emerging economies can harm economies throughout the globe.

The former Wall Street banker then expounded his views on the challenges facing the global financial markets and how to meet them - through providing better information through improved disclosure and transparency, building strong national financial sectors, and creating mechanisms to ensure that the private sector bears more fully the consequences of its credit and investment decisions.

This last was ironic, considering how the IMF "agreements" with Seoul were held up, and constantly changed at the US Treasury's behest, to ensure that foreign banks do not pay for their bad decisions in lending to Korean enterprises in Korea and their subsidiaries in the G10 countries, and the opportunity used to shut down some excess capacity in competing industries (cars, semi-conductor chips and so on).

In virtually reversing the Washington Consensus dogma that government failures are worse than market failures, Rubin spoke of the lack of appropriate expertise and knowledge of international creditors and investors in weighing the risk in these economies, and the need for the IMF and the Bank for International Settlements (BIS) to take on some of these responsibilities!

Focusing on the second "diagnosis" of the "badly flawed domestic financial sector", which, in his view, was characteristic of all the countries affected by the crisis in Asia, Rubin called for a more systematic approach to strengthening national financial systems, involving a more intensive assessment of the vulnerability in national systems and promoting reforms.

Financial liberalization

The same US Teasury, in concert with the Trade Representative, just last December, when the "Asian" crisis was in full swing, was preaching full financial liberalization and safeguards through prudential regulations which, in private briefings, it was said, would not require more than 2-3 years to be put in place.

And the WTO head went around proclaiming that financial liberalization was the solution to the problems of the affected Asian countries, and not the problem, and that all the "worries" of developing countries could be taken care of through prudential regulations - a view that many mainstream economists and experts questioned.

Officials of the BIS, at that time, were privately cautioning, including at briefings for developing country negotiators, that even in the advanced countries like the UK which were first in liberalizing this sector and which had a long tradition of central bank supervision, it took ten years for head offices of banks and the central bank to evolve a viable prudential regulatory and supervisory system.

Ten months after the outbreak of the crisis in Thailand, there is now talk of a need to apply some brakes on short-term lending and even portfolio flows. Nevertheless, Rubin has claimed that allowing foreign financial service providers into their markets helps developing countries, and that the recent WTO financial services agreement was a step in that direction!

Rubin then outlined the need for "bankruptcy" regimes in the developing countries, international surveillance of the regulatory and supervisory systems, and using the leverage of access to developed country financial markets.

During the 1995 financial services negotiations at the WTO, and in the resumed negotiations in 1997, it became clear that US Treasury efforts to pry open developing country markets by using the leverage of expanding or denying access to its market would not work: by and large, no developing country was interested in expanding greatly its existing banking or other financial service operations in the US or Europe.

Now, Rubin wants to try the same tactic for a different aim.

He called in his Brookings speech for "incentives" to bring about strengthened financial systems (presumably in developing countries), and said: "For example, authorities in major financial centres could consider conditioning access to their markets by banks from other countries on a strong home country supervisory regime, as demonstrated by adherence to the Basle Core Principles, plus whatever relevant additional standards are developed."

Even in terms of better supervision to avoid future crises, this appears to be a case of misdiagnosis. Though there has been a wave of Western media writings about the crisis being due to "Asian values", lack of prudential regulations and so- called "crony capitalism", many economists are challenging this view.

In a column in the International Herald Tribune on 17 April, Dutch academic, Karel von Wolferen, was the latest to ridicule this theory, saying: "As a label for what is wrong with the Asian tigers, it displays a profound ignorance and is yet another manifestation of the conceptual poverty of post-Cold War political discourse."

Failure of supervisory regimes

But even apart from this, under the Basle Core Principles and the BIS regime, any bank headquartered in a country, with branches elsewhere, has to have a combined balance sheet and audit and so on, and it is the central bank of the country that has supervisory jurisdiction and that functions as the lender of last resort.

At least in the case of Korea, as Manuel Montes has pointed out in his recent book, a significant portion of the borrowings of the banks of the Korean chaebols were borrowings "by their offshore operations from international banks operating under regulatory rules of the foreign country."

This indicates the failure of the home country supervisory regimes of Japan, Europe and the US; however, under US (and Rubin's) prodding, it is the South Korean government which has been forced to take responsibility for these debts of Korean banks, which came about because of the liberalization forced on Korea by its accession to the OECD.

In Thailand, it was the foreign bank branches operating in its Bangkok offshore centre that lent to Thai banks without prudence and that encouraged the Thai banks to lend to the real-estate sector.

In Indonesia, the problem has arisen to a great extent due to the encouragement to Indonesian enterprises (a policy promoted by the World Bank and the IMF) to borrow abroad without any control or regulations of the Indonesian authorities. This led to the crisis when the rupiah's value collapsed under the floating regime promoted after the baht crisis by the IMF.

If the Rubin principles for the "architecture" are to be carried out, then developing countries should be encouraged, and enabled, to condition access to their markets for the US, European and Japanese banks, for the failure of their home countries and their central banks to exercise adequate supervision.

This issue apart, the US proposal would also involve a violation of its (and those of the EC and Japan) commitments under the financial services agreement of the WTO, entered into in 1995 and still in force.

Under that agreement, the US is committed to maintaining existing access, and can only close down the operations on its territory of a foreign bank subsidiary or branch on the grounds of the failure.

As a fundamental part of training, any medical student is taught the need for correct diagnosis before prescribing any medicine. Pleurisy and tuberculosis, as well as typhoid, produce in patients high temperatures in the mornings and evenings. But if pleurisy or Tb patients are treated as for typhoid (a common occurrence in the old days), their condition would worsen and they might even die.

But in the international monetary non-system, and its patchwork of periodic reforms (strengthening the powers of the IMF management over developing countries and some funding for the IMF) that has prevailed since the mid-1970s, misdiagnosis and wrong prescriptions still prevail. And as the Wall Street Journal editorially has reminded everyone, the belt-tightening and sufferings that the IMF prescribes for the developing world and its poor do not affect the emoluments of the IMF staff from the top to the bottom.

And the public will have to await the next crisis - which, according to some speeches of Camdessus and of Asian economists like Montes, can be before the end of this Christian millennium - or the continuance of the effects of the present, in the hope that some fresh thinking would at last prevail. (Third World Economics No. 183, 16-30 April 1998)

Chakravarthi Raghavan is the Chief Editor of the South-North Development Monitor (SUNS) from which the above article first appeared.

 


BACK TO MAIN  |  ONLINE BOOKSTORE  |  HOW TO ORDER