President Bush has invited the heads of state of the Group of 20 (G20) nations for a summit on November 15 in an effort to continue responding in a coordinated way to the unfolding financial and economic crisis, and also to discuss weighty issues such as regulatory reforms, improving banking and capital market supervision and reforming the international organizational structure to avoid the next crisis. The G20 group, which accounts for 90% of global GDP, includes 10 major emerging economies - including Brazil, China, India, Saudi Arabia and South Africa among others, along with members of the G8, Australia and the European Union. This meeting, which some have called a second Bretton Woods, follows a meeting of the G20 finance ministers and central bank governors on November 9 and meetings in DC at the beginning of October that somewhat opened the door to broaden the club of global economic leadership. Given the issues on their agenda, markets will be watching to see what reforms might be on the cards. However, while most governments have been advocating the need for more concerted global efforts, most policies must still be taken at the national level.
Reaching a consensus on international regulatory reform will likely be one of the key issues at the meeting. While the 27 EU leaders earlier failed to agree on a joint economic strategy to tackle the coming recession in Europe, the member countries worked out a joint five-point action plan for the G-20 with the following very specific proposals: 1) Submit rating agencies to registration and surveillance, especially with a view to credit ratings’ prominent role within the Basel II capital requirement framework. 2) Adopt principles to ensure the ‘convergence of accounting standards’. 3) Decide that no market segment, no territory and no financial institution should escape regulation or at least oversight. 4) Establish codes of conduct to avoid excessive risk-taking in the financial sector, including on the ‘remuneration’ of executives. 5) Give the IMF the ‘initial responsibility’ and ‘necessary resources’ for ‘recommending the measures to restore confidence and stability’ in the international financial system.
The Financial Stability Forum (FSF) released its implementation progress report in October. Its guiding principle is to recreate a financial system that operates with less leverage, that is immune to the set of misaligned incentives at the root of this crisis, where prudential and regulatory oversight is strengthened, and where transparency allows better identification and management of risks. According to observers, the strengthening of the Basel II framework calls for a reduction in the pro-cyclicality of risk-based capital requirements - Spain points to its stabilizing dynamic loan-loss provisions in this regard. The current framework also lacks a minimum liquidity requirement ratio. Equally important is the regulation of the off-balance sheet universe in order to put a dent on regulatory arbitrage. The FSF also urges to put in place a central counterparty clearing house for over-the-counter (OTC) credit derivatives and to achieve more robust operational processes.
There have also been calls by some countries for a global fiscal stimulus to offset the decline in private aggregate demand and cushion consumers and firms from the prolonged global slowdown. Coordinated action, especially one including the U.S. and the EU might be more effective than stimuli by individual countries, while also preventing leakages via trade and capital flows. However, global action is constrained by prevailing fiscal deficits in several countries, different economic structures and coordination issues. Notwithstanding these limitations, countries across Asia, the EU and as well as the U.S. are individually implementing fiscal stimuli via infrastructure spending, subsidized public services, housing, tax cuts, benefits for lower income groups and the unemployed. While surplus countries like China, Germany and the Gulf States have enough fiscal room for this, deficit-laden nations might face the risk of higher future sovereign debt and nominal yields.
Additionally, countries will face challenges to sustain the recent boom in trade. High oil prices have raised shipping costs, the credit crunch has crippled trade finance, and the global slowdown are severely affecting international trade. Ministers have also voiced concerns against any possible rise in protectionism in developed countries amidst the recession. Moreover, the financial crisis and the ongoing massive capital outflows from EMs would invite debate on the benefits of financial globalization, with implications on greater regulation in developed markets and a potential aversion to financial liberalization in developing countries.
Also, the financial crisis has reemphasized the role of the IMF, as it becomes the chosen vehicle for financial support to emerging market economies caught short by the reversal of capital flows and financial market disruptions. It is already set to approve loans to Iceland, Ukraine and Hungary and several other EM countries may be on the list. The IMF is providing funds via two channels: A less conditional borrowing facility (short-term liquidity facility or SLF) in which countries can borrow up to five times their quota with a three-month duration, and borrowing by countries in need of longer term programs which is likely subject to more specific conditions. The IMF has been heavily challenged by its potential ability to contribute to solve the current financial meltdown, after years of low demand for its assistance, as buoyant capital markets and rising commodity prices allowed many developing nations to raise funds on their own while the IMF’s own budget worsened. Some economists recently argued that the IMF's role in the current crisis should be sharpened as an interlocutor between lenders and developing country borrowers, rather than simply as a replacement for all other loan sources.
However, an expanded IMF agenda may mean the institution too will need a capital injection since its current available funds are just over $200bn. Japan has suggested it might channel funds from its forex reserves through the IMF if needed to support vulnerable EMs. U.S. and UK leaders have also been calling on surplus regions (China and the GCC) to contribute funds. With strong growth and forex reserve accumulation, Asia led by China may have a role to play in bailing out the global financial system, and cushioning from a global economic slump by lending reserves directly or via institution like IMF or even via swaps arrangements. This might be in their interest too in order to support their export markets. However, China argues that the best way it can support the global economy is by maintaining Chinese growth through a series of monetary and fiscal stimuli through 2010. Moreover, these plans come at a time when some surplus countries are witnessing slowing exports with massive capital outflows and oil prices approaching the break-even point. They are also beginning to need more capital at home given the realization that sovereign wealth funds may have suffered significant losses in the last few months.
This will, however, give new impetus to the ongoing debate on the reallocation of voting chairs and quota shares and give emerging economies greater weight in the IMF which so far remains dominated by the EU (32% of votes), U.S. (17%) and Japan. Leading emerging economies at the meeting will strengthen their calls for implementing changes in the international architecture to mark their growing clout in the international economic and financial system. This is especially true given that emerging markets are already participating in coordinated global interest rate cuts and swap agreements with the Fed, and will contribute to almost all of the global growth in 2009, as G10 growth stagnates. Thus, unless international institutions and groups include large economies like China, Brazil, India and perhaps Saudi Arabia, it will be very difficult to think of solving some of the most intractable global challenges ranging from international financial regulation and exchange rate alignments to energy supply and climate change responses. There are also additional ideas for floating new institutions - to create more robust regional institutions to pool capital and improve financial monitoring and regulatory enforcement; to create regional level FSFs supported by regional development banks; to expand the FSF to include the concerns of emerging markets.
Furthermore, the reallocation of country quotas in any significant manner could presumably address the large surpluses built up in countries like China and the Middle-East. At the end of the day, many say the solution to the global financial crisis must address the big elephant in the room, namely the current global imbalances which have stored-away vast sums of dollars on some sovereign balance sheets but not on others. Unless some of the surplus regions begin consuming more, the underlying dynamics would continue. But evidence shows that consumption in China might slow despite government capital injections and infrastructure financing, thus leaving some room for adjustment in the future. At least so far, the financial crisis seems to be contributing to an unwinding of some of these imbalances with the correction in oil and commodity prices and easing capital flows in surplus countries.
