Little progress in global financial reform
In the aftermath of the Asian financial crisis, there was widespread concern about the international financial system and the need to prevent and manage the cataclysmic crises to which it is prone. Speaking at a recent UN regional meeting on Financing for Development, experts lamented the slow pace of global financial reform and the lack of attention accorded to developing-country concerns in the debate on the ‘new international financial architecture’.
by Martin Khor
THE reform of the global financial system is proceeding slowly, especially on issues of concern to developing countries, and there are many imbalances and asymmetries in how debtor and creditor countries, as well as developing and developed countries, are being treated in the reform process.
This was a major theme that emerged from a panel of experts speaking at a regional consultation meeting on Financing for Development. The experts included Yilmaz Akyuz, the United Nations Conference on Trade and Development’s (UNCTAD) chief economist, Ariel Buira, former Deputy Governor of Bank Mexico (Mexico’s central bank), and Aziz Ali Mohammed, Advisor to the Group of 24 (a grouping of developing-country members of the World Bank and IMF).
They pointed out that despite the discussions and fora on the ‘new international financial architecture’, little or no progress had been made since the recent round of financial crises, either to prevent or to better manage future crises.
The regional consultation meeting, sponsored by Indonesia and co-organised by the United Nations Economic and Social Commission for Asia and the Pacific (ESCAP) and UNCTAD, was the first of the regional preparatory meetings towards a UN high-level ‘event’ on Financing for Development in 2001. It was attended by 152 delegates from 37 countries, NGOs, financial institutions and UN agencies.
In the plenary session on 3 August, on the theme of ‘recent developments in the reform of the international financial architecture’, UNCTAD Secretary-General Rubens Ricupero (who chaired the session) posed some critical questions for discussion. Among them: What is the state of debate on IMF reform? Is there a need for global financial standards and should it be on the basis of one-size-fits-all? Can financial regulation and supervision be organised under current financial arrangements or will an extension be needed and would it just add more conditionality? Also, what is the scope of prudential regulations and how effective are they? Why are (countries) keeping open capital accounts and capital convertibility so important to the Washington institutions?
Ricupero concluded that there are difficulties in having measures to prevent financial crises but also difficulties in instituting national financial safety nets. Another problem is that any global system of controls must be able to accommodate diverse national conditions and also be compatible with regional arrangements.
State of play
A wide-ranging review and analysis of current developments in the debate on managing and preventing crises was presented by Akyuz, Officer-in-Charge of UNCTAD’s Division on Globalisation and Development Strategies.
Dealing first with prevention issues, Akyuz said that since the crisis, the reform discussion had placed more emphasis on greater information provision. However, having more information is not enough to prevent crises. Moreover, although much has been done on getting more information from governments, there has been less work done on getting information on markets. Little has been done on highly leveraged institutions and offshore markets, although there has been discussion at the Financial Stability Forum.
Akyuz pointed out the uneven nature of the use of information. IMF surveillance had focused mainly on developing countries. So far the IMF consultations with countries had been unable to prevent major financial turmoil. Traditionally, attention is paid to macroeconomic variables but not exchange rates and capital flows. The IMF has been reluctant to advise countries to control short-term inflows before a crisis strikes.
On the other hand, said Akyuz, too little attention is being paid to policies of developed countries as they affect developing countries’ exchange rates. Every emerging-market crisis of the 1980s and 1990s was associated with major swings in exchange rates and the liquidity position of major industrial countries.
A major issue is whether developing countries are capable of maintaining exchange rate stability when major currencies undergo sharp fluctuations. Akyuz said currency coordination among the G3 countries (US, Europe, Japan) is needed for stability of the dollar, euro and yen. But there has been no resolution of this. As a result, there are gyrations of up to 20% in the span of a week or 10 days. Although there are such very large swings, their effects on developing countries have simply been ignored and developing countries are expected to adjust to such changes.
On the issue of prudential regulation, Akyuz said the international approach is to formulate global standards and countries are expected to implement them individually. The standards are set in the Bank for International Settlements (BIS).
Akyuz said there were three problems with this procedure. Firstly, such standards do not account for risks in international lending. Although new proposals have been put forward to respond to this, they actually create new problems. For instance, the standards rely on external rating agencies, but they have a poor record, being pro-cyclical.
Secondly, the standards are designed to protect creditors, not the debtor countries. The same level of exposure may mean different risks to creditors and debtors.
Thirdly, there is a danger of a one-size-fits-all approach to standards. The IMF has now extended its survey of countries to include this issue. Although there is agreement that the IMF should not set standards, there is now a concern that it would police the implementation of such standards.
On the issue of capital account regime and management, Akyuz said that after the latest crises, there appears to be agreement that short-term capital flows need to be regulated. Developing countries are not stopped from controlling their short-term capital flows. But international approval of such measures would help countries planning to introduce these moves. So far, such an approval has not been forthcoming.
On exchange rate regimes, Akyuz said the present advice to developing countries seems to be to either fix (through a currency board system or even dollarisation) or freely float their currency, and not to support it through an intermediate regime. However, UNCTAD studies had shown that a float system is associated with the same degree of volatility as a fixed system. The difference between the two is in how the shocks work themselves out.
Akyuz added that the issue is that the choice of exchange rate regime should not be part of IMF conditionality and countries should choose their own system.
On the management of crises, Akyuz highlighted two issues: provision of international liquidity and orderly debt workout.
Countries facing crisis have three problems relating to international liquidity provision.
Firstly, multilateral institutions (the IMF) do not have the funds. Facilities may be introduced but they lack funds. Thus, the IMF draws on its major shareholders, opening the road to undue political influence. Secondly, the conditionality associated with such provision of liquidity is excessively intrusive and even mainstream economists (such as Feldstein) have said the conditions interfere with the sovereignty of recipient countries.
Thirdly, the funds go not to the countries but to bail out creditors. The funds should ideally be used to support the country’s currency level against speculation, but typically, the currency is instead allowed to collapse and the funds go to bail out the creditors.
On the issue of orderly debt workout, Akyuz said UNCTAD had raised the issue that many debtor counties were treated as de facto bankrupt but were not afforded the protection of bankruptcy courts. He said in such a system, a debtor’s rights included a temporary standstill on payments, continued financing, and debt restructuring.
Akyuz pointed out that Article 8 of the IMF’s Articles of Agreement allows for this temporary standstill. But in practice, as in the Korea case, the creditors are brought together and an agreement takes place. In such cases of restructuring, three problems arise: governments are asked to assume private debt; creditors get better terms in restructuring whilst in a bankruptcy court (modelled after Chapter 11 of the US Bankruptcy Code) debtors get better terms; and the new finance goes to creditors, instead of supporting the debtor.
Akyuz said Canada had proposed a six-point plan to introduce an IMF standstill mechanism for countries facing attack, and several IMF members now support such a mechanism but some oppose it.
He added that some of the concerns expressed earlier, before the Asian crisis, should be reviewed in light of the Malaysian experience. Part of Malaysia’s capital controls was a temporary standstill, and this is now widely accepted as a success. ‘We should examine that experience and see what lessons can be drawn from it for the temporary standstill mechanism.’
Ariel Buira, Mexico’s Ambassador to Greece and former Deputy Governor of Bank Mexico, said it is recognised today that all is not well with the global financial system, and both the role of the international financial institutions and the conventional wisdom of the Washington Consensus are being questioned.
‘We have an international monetary system that is crisis-prone,’ he said, pointing to the currency crises in Europe (the ERM crisis of the early 1990s in Italy, Spain, the UK, France), Mexico (1994-5), Asia (1997-8), Russia and Brazil.
‘Private capital flows can destabilise any economy by being too big or too little. We have failed to put reforms in place. We are not sure there won’t be a crisis in the coming months or years.’
Buira said there had been some changes in a somewhat reluctant fashion. Capital controls to avoid excessive inflows, which some countries have instituted, have become increasingly acceptable, with the IMF becoming a little more tolerant. A report of the US Council of Foreign Relations had favoured this measure, and even US Treasury Secretary Larry Summers had said it may be useful in some cases.
Buira recounted how the IMF and US policy-makers had pushed for capital liberalisation. He said a New York Times article revealed how the then US Treasury Secretary Robert Rubin prevailed on President Clinton to press the IMF to promote capital account liberalisation. The NYT article suggested there were strong interests in Wall Street pushing for capital account liberalisation. This had precipitated such liberalisation when the conditions to absorb it were not present.
On the issue of debt ‘bail-out’ and ‘bail-in’ of the private sector, Buira said that people who lend to or invest in developing countries earn high premiums because of the high risk. He said in Mexico and other countries, the rescue packages had been aimed at rescuing creditors who took no loss. They had obtained the benefit of high premia but did not face any loss (when the countries went into crisis). He added this was the real issue of ‘moral hazard’. Buira suggested that in the reform process, the question then is how to move from bailing out the private sector to bailing it in.
He added that since the crisis had to do with capital flows, there were two choices in coping. The first is to provide unlimited support or huge amounts of funds to the affected country which then would not run out of reserves (in supporting its currency), and this would thus discourage further speculation as the speculators would not be able to gain.
The second is for the country to stop or temporarily suspend payments to creditors in order to enable debt restructuring. To do this, the private sector had to be ‘bailed in’. In the exercise, no one must run out in the next few weeks, payments for trade would continue but not debt service payments, and there would be restructuring where everyone shares some of the costs. Thus, for example, instead of collecting in the next three years, creditors may be asked to collect in five or six years.
Buira pointed out there were some crucial issues where very little is being said in the reform discussion. There is no progress on IMF reform. There is also no progress on crisis prevention. He said although there may be discussions on an early warning system and the need to bail in creditors, there is no development of rules. For instance, there is reluctance on the part of some governments to determine when a debt standstill should be done, there are no rules for debt workouts, and so far the IMF has not developed a facility to deal with preventing a crisis.
Buira added that other basic issues of interest to developing countries are not even on the table, for example, the asymmetry in the adjustment process. By focusing on issues related to the Washington Consensus, the issues of developing countries are being neglected.
Among these neglected issues are: How can developing countries obtain the benefits of globalisation whilst minimising the costs? What can be done to deal with reversal of capital flows, lender-of-last-resort facility, debt restructuring?
He said the Fund only comes in after a crisis has occurred, and this is inconsistent with an IMF article stating that an objective of the IMF is to prevent crisis. The legitimacy of international financial institutions has come into question. There is awareness of a heavy concentration of power in a few countries and the need to have wider participation.
South’s concerns ignored
Aziz Ali Mohammed, Advisor to the G24, gave a review of the state of the debate on the new international financial architecture. He highlighted the imbalance in the process: the issues that have an impact on the developing countries are not on the table whilst those issues affecting the developed countries are.
He discussed four of the issues that should be on the table but were not:
* the global implications of exchange rate movements of major currencies, on which the IMF surveillance system had little to say despite the fact that they are sources of financial and economic disturbance to other countries.
* the unequal distribution of voting power in the global financial system, which derives from a totally arbitrary formula designed to perpetuate the dominance of developed countries.
* the internal governance of the IMF, in which a very few countries, particularly the US Treasury, have an undue influence over the Executive Board and staff.
* the reluctance to apply the obligations of transparency, accountability and equity on the capital markets and institutions of developed countries.
Aziz stressed that the equity issue must be put forward by the South in preparing for its negotiations with the North in the context of the UN event on Financing for Development.
Aziz said the global financial system was ‘full of asymmetries’. There was asymmetry between borrowers on the one hand and creditors and investors on the other in the way they were treated; asymmetry in the governance of the international financial institutions; in the debt resolution process; and in the surveillance process in relation to major currencies as contrasted to developing countries’ currencies.
Aziz said that in taking up these concerns, developing countries must try to agree among themselves first, and highlighted some areas in which they need to develop positions.
First is the need to strike the correct balance between rules and discretion. On the one hand, we want to have rules (for example, in the debt workout process) but on the other hand, rules also create risks for developing countries. A rule that enables temporary debt standstill can also increase risks of contagion. Would ‘constructive ambiguity’ be a better route on debt workouts?
Second is the question of who represents developing countries. Should their interests be promoted through treaty-based institutions like the Bretton Woods institutions, or should developing countries take part in ad hoc groupings? Aziz said it was a strange situation when the United States decided to invite 11 developing countries to enter a Group of 20 and those 11 jumped at the chance to take part, considering it a great privilege that they were chosen. [The G-20, an international forum of finance ministers and central bank governors, is mandated to promote discussion, and study and review policy issues among industrialised countries and emerging markets with a view to promoting international financial stability.] They lend themselves to a procedure that takes oxygen away from their own institution. Aziz posed the question whether developing countries should play this game or whether they should stay on with representative institutions.
Third, how far do developing countries want to push for the use of special drawing rights (SDRs)? He said most developing countries are themselves not prepared to hold SDRs. ÔHow are we to push the concept of lender of last resort using SDRs if we prefer not to hold SDRs ourselves?Õ he asked. [The SDR is a reserve currency introduced by the IMF that was intended to be used in settling international transactions. The IMF uses SDRs, whose value is based on a basket of currencies, for bookkeeping purposes and issues them to member countries.]
Fourth, on the development of regionalism, what importance do developing countries want to give to accepting peer pressure within regional arrangements? Should our neighbours be enabled to engage in surveillance, or should the task be given to an institution located in Washington?
Martin Khor is the director of Third World Network.