Conference on International Cooperation in Times of Global Crisis: Views from G20 Countries – Delhi

The global financial crisis has set in motion a series of events, which have underlined the need for reform of the international economic system. The G20 has emerged as the premier forum for international economic cooperation since the crisis. Although cooordination exists on various economic aspects, including sustainable, balanced growth, financial sector reforms, and reform of international financial institutions, significant differences exist in the priorities of developed and developing economies within the G20 group. Nevertheless, the Seoul summit in the Republic of Korea has brought about long-awaited IMF reform by increasing the quota share of the emerging economies through the platform of G-20.

The positions taken by developed countries are relatively well established but, so far, developing countries have had fewer opportunities to express their views and to promote their own expertise at the international level. As the challenges facing the G20 have become more intense, it is hoped that the evolution of a broader agenda for the G20 and the articulation of developing countries’ position will become clearer.

In this context, on 16-17 September 2010, the Indian Council for Research on International Economic Relations (ICRIER), in collaboration with Bruegel-Brussels and the Centre d'Etudes Prospectives et d'Informations Internationales (CEPII-Paris), Konrad-Adenauer Foundation (KAS-Germany), the Asian Development Bank Institute (ADBI) and the International Monetary Fund (IMF) organized an international conference in New Delhi, bringing together a group of scholars and policy makers from the G20 countries to discuss the global economic and financial issues in the postcrisis period. The conference was held just ahead of the IMF and World Bank meetings and the G-20 Seoul summit on 11-12 November 2010.

The objectives of the conference were the following:

1. to provide a platform for sharing the perspectives of developed and developing countries on handling the post-financial-crisis situation;
2. to analyse global economic challenges and economic policies in a post-crisis scenario;
3. to support global economic cooperation and to ensure a convergence in the positions taken by developed and developing countries.

Developments in Global Macro Economy and Financial Sector Outlook

Two fundamental issues in the global macro economy need attention. The first is the need to generate an orderly transition in the direction and quantum of global demand. The contraction in demand in developed countries following the bursting of the asset price bubble, and the likelihood of further demand contraction need to be balanced by an enhancement in demand from other countries. One way this could be achieved is through the "mutual assessment process" initiated by the G20. However, the process could be rendered ineffective, just as the IMF’s region-specific proposals were, with countries insisting that the prescribed policies be implemented in the rest of the world as well at the Seoul summit. Since the IMF is expected to present country-specific recommendations, the G20 could appoint six or seven eminent nongovernment experts to comment on the IMF's recommendations. The second issue is the need to reform the global financial architecture. In the immediate aftermath of the crisis, several national governments had made regulatory changes even before the Financial Stability Board set up by the G20 came up with any findings.

Macroeconomic Policy Stimulus and Exit Strategies

The G20 was successful in its initial response to the world economic crisis, quickly reaching agreement on the need for stimulus policies and acting to strengthen international institutions by providing additional funding. The crisis has exposed the fragility of existing global financial and economic institutions as well as the limitations of existing macroeconomic policy tools. As expressed by the Honorable Finance Minister Pranab Mukherjee (India) at the conference, G20 intervention has prevented the current global crisis from escalating into another Great Depression. Thus, the need for coordinated policy action among G20 nations to ensure strong, sustainable and balanced growth was felt and acted upon through the G20. Both Changyong Rhee (sherpa for the Republic of Korea) and Montek Singh Ahluwalia (sherpa for India) expressed this view while speaking on the G20 agenda. The G20 platform provided for a coordinated policy response and a differentiated implementation for various countries at the forum. The 2009 Pittsburgh summit discussed and formulated a coordinated monetary policy and countries announced extraordinary fiscal stimulus packages to save their economies from recession and slow growth. The exit strategies of countries on the G20 forum have varied. Postcrisis scenarios were discussed during the Toronto summit and many countries have started to phase out their fiscal stimulus packages and to tighten monetary conditions.

Global Imbalances and Framework for Strong, Sustainable and Balanced Growth

Global imbalances are considered to have been one of the triggers of the recent financial crisis. A reduction in global current account imbalances is imperative for sustainable, robust global economic growth. Structural reforms would be the most reasonable solution for resolving these imbalances, which would mainly require that the countries with current account surpluses, such as China, raise their consumption levels and that countries with current account deficits, such as the US, raise their propensity to save.

Reshaping the Global Financial System: International Policy Development and Implementation

As far as the question of international coordination in financial regulation is concerned, the prevailing view is that there is a need to consider whether a retreat from such coordination will necessarily prove harmful. There are three reasons why such an assessment is required. First, while it is possible to see the need to make decisions at the national level, on the basis of an international dialogue, this encourages regulators of different countries to look for loopholes and exceptions in order to favour home institutions. Second, since taxpayers have to bear the burden of bailing out failing financial institutions, it would be politically reasonable that they would demand regulatory control. Third, macro prudential regulations contain some inherently national characteristics since macroeconomic shocks at the national level do not move in perfect consonance across nations, Countries differ in their capacity to bear systemic risk.

In response, policy makers put forth three broad principles for international regulatory coordination. First, it is necessary to ensure that national regulations do not become the basis for protectionism. Second, there is a need to promote free exchange of information between national regulators. Third, international coordination must aim to develop an overall framework while leaving enough free parameters within this framework to adjust for national specifics. Therefore, systems that integrate diversity will prove more resilient than those based on a ‘one-size-fits-all’ approach. While the recommended updates to the Basel Accord are an improvement, a number of important issues remain unaddressed. The present definition of ‘capital’ continues to allow the inclusion of many assets with limited loss-absorbing capacity. A long time horizon has been specified for transition to the new norms.

Financial Safety Nets

The main components of financial safety nets are: monetary and fiscal authorities (lenders of last resort), deposit insurance, prudential authorities, macro prudential regulation and supervision, and a failure resolution mechanism for monetary and fiscal authorities. The issue that arises is whether it is better to have a single global financial safety net (FSN) or regional FSNs. The advantage of regional FSN arrangements is that they promote better exchange rate management by maintaining fixed or monitored multilateral exchange rate mechanisms or monetary unions, they can draw on local expertise and governance, and they strengthen peer pressure and facilitate surveillance. Moreover, reserve pooling along with harmonized rules for capital controls and micro and macro prudential regulation are possible under such arrangements. There is a need to establish a clear responsibility for FSNs at all levels and well-defined links among them.

Mechanisms are also required for surveillance of the more advanced economies that are likely to affect the region indirectly. However, regional FSNs have a flip side in that the instruments likely to prevent the occurrence of a future crisis might have a trade-off in terms of increasing moral hazard at the national policy level. There is a need to establish the responsibility of FSNs at all levels clearly and to have well-defined links among them. Questions raised by the audience included whether an Asian Monetary Fund (AMF) would actually be able to impose tough terms and conditions and whether the absence of a fiscal union is also responsible for the contagion in the EU.

Role, Resources and Reforms of International Financial Institutions

A well-functioning international monetary system should provide an international framework for sound national economic policy making. Such a system will ensure exchange rate stability, facilitate current account adjustment, provide sufficient international liquidity for the world economy, and promote international trade and investment. Exchange rate volatility, the recurrence of currency and financial crises, persistent global imbalances, and the accumulation of US dollar debt abroad have been effects of the crisis and they undermine confidence in the US dollar and indicate that the current international system is not functioning well. The use of the US dollar as the dominant international currency creates tension between national and global monetary policy making. The euro is a potential rival to the US dollar, but lacks a solid sovereign backbone. Thus, there is a need for reform in the current international monetary system.

Since the breakdown of the Breton Woods system, attempts to construct an international monetary system appropriate for a global economy, in which the markets play a major role, have proven difficult. Nevertheless, recently the long-awaited IMF reform to increase the quota share of emerging economies through the platform of G-20 has become a reality. Under the new arrangements, the US has a 17.67% share of IMF quotas and retains a veto on the IMF’s decision-making. China is now the third biggest member of the IMF ahead of the UK, France, and Germany with 6.19% (up from 3.65%) whereas India has moved to eighth position ahead of Saudi Arabia, Russia and Canada with 2.75% (up from 2.44%). In addition, the BRIC (Brazil, Russia, India, and China) countries have together moved into the top ten shareholders of the IMF as they now represent 14.18%. The emerging countries bloc now has a 42.29 % share overall. However, constructing a new monetary system to meet the needs of the world economy is a daunting task, particularly because, under present political arrangements, international bodies cannot not impose national policies.

World Trade, Trade Finance and Protectionism

Since the crisis, the tendency to resort to protectionism by several countries, including G20 members, has been a key concern. Although an early conclusion of Doha Round is needed to avoid protectionism, the G20 has not been able to set a deadline. The nature and composition of protectionist measures are very different from the protectionist steps adopted during previous crises, as far back as the Great Depression. Non-tariff measures, including bailouts and state aid, export subsidies, export taxes and restrictions and trade defence measures are being used. Global Trade Alert data indicate that a large number of measures discriminate against foreign commercial interests and that the G20 countries are responsible for over 60% of these measures. Russia has introduced the largest number of protectionist measures; China has been the country that has been most harmed by these. While the magnitude and coverage of the new protectionist measures has been modest so far, this could change if unemployment remains high in the developed economies. Protectionism and competitive devaluations could trigger a vortex of ‘beggar-thy-neighbor’ policies. This is something world leaders need to continue to guard against.

Some steps that would be useful in this context include (i) develop a body of effective, non-discriminatory measures that governments can use to tackle pressing challenges during systemic crises; (ii) at the national level, find ways to empower the potential losers from discriminatory measures; (iii) evolve rules that would be capable of containing any negative impacts of bilateral or regional trade agreements; and (iv) encourage the unwinding of crisis-era protectionism.

Conclusions

Comprehensive global harmonization of financial regulations is not possible. The way forward is to attempt a sort of ‘internationalism’ with nations at the centre along with global convergence of regulatory principles with monitoring and consolidation of regulatory instruments. To improve efficiency, there should be complete information exchange between regulators. The Financial Stability Broad should facilitate proper peer reviews of country organizations to ensure regulation is not biased. The overall view at the meeting was that Basel III has unfortunately not been satisfactory. There was some scepticism about raising the capital requirements of banks. Some participants were of the view that raising capital requirements may be destabilising to growth in the present times and may not necessarily reduce risk in the financial sector.

A reduction in global current account imbalances is imperative for sustainable robust global economic growth. Structural reforms seem to be the most reasonable way of resolving these imbalances. Countries with current account surpluses, such as China, require structural reforms to raise their consumption levels, whereas countries running current account deficits need to raise their appetite for saving. To reduce volatile short-term capital flows, some sort of controls or taxes such as the Tobin Tax may be considered.

The role of fiscal imbalances has to be taken into consideration in reducing imbalances. There has to be reduction in exchange rate and capital flow volatility through the adoption of a common currency basket system. Exchange rate monitoring has to be strengthened. Improved macroeconomic and financial surveillance is needed, with the IMF playing an enabling role in this. Some participants expressed the opinion that an Asian currency basket is a better option than pegging currencies to the US dollar but for this to become operational, China, India, and Japan need to work together.