TWN Briefings for WSSD No.12
Proposals to Reform the International Financial System
By Martin Khor
The world financial system is now claiming a new set of victims: Argentina, Uruguay, Brazil. Also, Turkey is in financial crisis. This follows the East Asian crisis of 1997/8 with its damaging aftermath continuity.
It is obvious the financial system needs a complete overhaul. Yet the WSSD is not dealing adequately with this. The IMF and its major shareholder countries are not resolving the crises but have become the major cause. Failure to radically overhaul the system is a major threat to sustainable development.
A central feature of the Asian crisis was the role of financial liberalisation and deregulation that facilitated excessive short-term borrowing by local firms and that enabled international funds and players to manipulate and speculate on currencies and stock markets in the region. The prevailing mainstream view that liberalisation was beneficial and posed little danger had been promoted by the International Monetary Fund (IMF), World Bank and rich countries that wanted market access for their financial institutions to the emerging markets.
When the crisis struck, the IMF made it worse by misdiagnosing the cause and promoting even further financial liberalisation as part of its loan conditionality, as well as a policy package (high interest, tight money and closure of local financial institutions) that converted a financial-debt problem into a structural economic recession. The IMF also denied that hedge funds and other highly leveraged institutions had played a destabilising role, and it took the near-collapse of Long-Term Capital Management (LTCM) to expose the extremely high leverage and market power of these speculative funds.
Two sets of actions are urgently required at international level in the interests of developing countries.
The first set involves the need to avoid new policies or agreements that would ‘lock in’ further financial liberalisation. The following are proposed:
· The IMF should stop pursuing its goal of amending its Articles of Agreement to give it jurisdiction over capital account convertibility as this would enable the IMF to discipline developing countries to open up their capital account and markets;
· The OECD countries should stop altogether any attempt to revive their proposed Multilateral Agreement on Investment, which would give unfettered freedom of mobility to all types of capital flows;
· The proposal for an investment agreement under the aegis of the WTO should be abandoned as such an agreement would put intense pressures on developing countries for compulsory financial liberalisation;
· There should be a review of the financial services agreement in the WTO to take into account the understanding gained and lessons learned from the negative effects of financial liberalisation resulting from the latest round of financial crisis.
The second set of proposals relates to international policies and measures that need to be put in place, including:
· Measures and guidelines to help countries prevent debt and financial crises;
· Once a crisis has broken out, measures to manage the crisis effectively, including debt standstill arrangements and a debt workout system that fairly shares the cost and burden between creditors and debtors. For this purpose, an international bankruptcy court to apply an international version of Chapter 11 of the United States Bankruptcy Code should be set up.
· A framework that allows and freely permits countries (especially developing countries that are more vulnerable than rich countries), without fear of attracting penalties, to establish systems of control over the inflow and outflow of funds, especially of the speculative variety;
· Governments of countries which are the sources of internationally mobile funds should be obliged to discipline and regulate their financial institutions and players to prevent them from causing volatility and speculation abroad;
· International regulation is needed for activities of hedge funds, investment banks and other highly leveraged institutions, offshore centres, the currency markets and the derivatives trade;
· An international system of stable currencies (including, possibly, a return to fixed exchange rates or of rates that move only within a narrow band) should be considered;
· A reform of the decision-making system in international institutions like the IMF so that developing countries can have a fair say in the policies and processes of institutions that so much determine the course of their economies and societies;
· A change in the set of conditionalities (‘structural adjustment policies’) that accompany IMF-World Bank loans so that recipient countries can have options to choose among appropriate financial, monetary, fiscal, macroeconomic, trade, ownership and other economic and social policies, instead of being obliged to undertake financial liberalisation.
There should also be a review of the appropriateness of policies in other areas such as trade liberalisation. Inappropriate trade liberalisation can cause, contribute to or worsen a financial crisis. For example, when a country liberalises its imports when its local sectors are not yet prepared to compete whilst at the same time it is unable to earn more export revenue, the country’s trade and balance-of-payments (BOP) deficits may worsen significantly, adding to debt pressures.
In the absence of such international measures as outlined above, developing countries have no choice but to institute domestic measures to protect themselves. In particular, they should have regulations that control the extent of public and private sector foreign loans (restricting them to projects that yield the capacity to repay in foreign currency); that prohibit manipulation of their currencies and stock markets; and that treat foreign direct investment in a selective way that avoids build-up of foreign debt.
The array of national policy instruments should include selective capital controls and the fixing or stabilising of their local currencies, which would allow them greater freedom to adopt macroeconomic policies that can counter recession (such as lower interest rates or budget expansion) whilst reducing the risks of volatility in the exchange rate and flow of funds.
In this respect, it is essential to recognise and reiterate that the right of a nation to adopt capital controls (which is sanctioned by Article VI of the IMF’s Articles of Agreement) is an inalienable right. It is an integral part of a nation’s right to economic self-determination and no pressure must be brought to bear on any state that resorts to such controls, to abandon them. In particular, international financial institutions (IFIs) must desist from attempts to dissuade developing countries from having recourse to such controls by threats (overt or veiled) of the withdrawal of credits or other financial support.
In short, the crucial question of when or how a state wishes to liberalise its capital account, or whether it wishes to embark on such liberalisation at all, should be left to its sole determination, without outside pressure.