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Reforming the system needs even handed approach, says UNCTAD

by Chakravarthi Raghavan

Geneva, 25 Apr 2001 - - The reform of the international financial architecture needs to focus on international actions and issues of governance of the international system, and provide for more symmetrical treatment of debtors and creditors, less intrusive conditionality, more effective surveillance of macro-economic policies of major industries countries and bolder moves to stabilize the reserve currencies, the UN Conference on Trade and Development has said in its Trade and Development Report 2001.

In a foreword commending the report’s useful contribution to the issues to be discussed at next year’s UN High- Level event on financing for development, UN Secretary-General Kofi Annan, points to the in-depth discussions in the report on key areas of issue for reforming the system - like codes and standards, contribution of private institutions in managing crises and workings of the exchange rate system.

The idea of reforming the international financial architecture came high on the international agenda in the aftermath of the Asian crisis of 1997, and the initial fears (in the industrial centres) that it would affect their systems and institutions.

But with the easing of the crisis (by harsh adjustment measures forced on the countries of the region), the ‘benefits’ that came to the industrial countries (because of low commodity and product prices, and the fire-sale of assets in those countries), and the seeming rapid recovery of the crisis-hit countries, the crisis was blamed on ‘crony capitalism’ and financial excesses and wastefulness; and serious attention to reforming the international financial architecture has all but disappeared, though the jargon is still used to emphasise the national-level reforms needed in the developing world.

As UNCTAD Secretary-General, Mr. Rubens Ricupero, puts it in his overview to TDR-2001, “talk of far- reaching reform of the international financial architecture after the Asian crisis has proved to be no more than that. However if a strong wind (of economic downturn) picks from the North, the consequences for the world economy will be much more chilling than those of the wind that blew in from the South.

“It is to be hoped that this threat will suffice to breathe new life into the reform efforts,” he added.

The report assails the focus in the discussions so far on what should be done at the national level rather than on international actions to address systemic instability. And even in terms of national actions, there is a failure to adopt an “even handed” approach between debtors and creditors.

The TDR-2001 has presented some alternative proposals for a more symmetrical treatment of debtors and creditors, less intrusive conditionality, more effective multilateral surveillance of the macro-economic policies of the major industrial countries, and bolder moves to stabilise the reserve currencies, payment standards and limits on crisis lending as a means of involving creditors in crisis resolution.

Says the TDR: “The increased frequency and virulence of international currency and financial crises, involving countries with a record of good governance and macro-economic discipline, suggests that instability is global and systemic.  Although there is room to improve national policies and institutions, that alone would not be sufficient to deal with the problem, particularly in developing countries where the potential threat posed by inherently unstable capital flows is much greater. A strengthening of institutions and arrangements at the international level is essential, if the threat of the crises is to be reduced and better managed whenever they occur.”

Though the various ideas for reform have been discussed in several fora, not much progress has been made, and the failure to a considerable extent “is political in nature,” since the proposals have run into conflict with the interests of creditors. But governments of some developing countries too have opposed the reforms that could lower the volume of capital inflows and/or raise the costs, even if the measures could reduce instability and frequency of crises.

Referring to the proliferation of standards and codes, the TDR says these seem to reflect the view that the main flaws in the system for international capital movements are to be found in recipient countries which should bear the main burdens of the adjustments needed to prevent or contain the financial crisis.

When the postwar systems and institutions - the IMF, the World Bank and the GATT - were established, international capital movements did not fall within their purview, and no global regime for capital movements was contemplated since capital mobility was seen to be incompatible with currency stability and expansion of trade and employment. No such regime was established even after the breakdown of the Bretton Woods arrangements - despite growing importance of private capital movements. The only recent attempt for a global regime was the attempt to include capital convertibility among IMF objectives.

Referring to the functioning of the current institutions, including the BIS, the IMF, and the FSF (Financial Stability Forum), and the various suggestions and proposals for standards and codes to fill in lacunae in national regulatory regimes, the TDR points out that these seem intended not only for the financial sector itself but for macro-economic policy and policy regarding disclosure.

But from the point of view of reform, they contain many glaring omissions, and reflect asymmetries - and do not address for example the concerns of developing countries over the supply-side character of fluctuations in international capital flows - - strongly influenced by the monetary conditions in major industrialized nations, especially the USA, and the liquidity positions and her behaviour of lenders.

Says UNCTAD: “There are dangers in throwing at developing countries a Washington consensus view of economic policy, even if this consensus is now refurbished with new international codes and standards... the new set of external disciplines come hand-in-hand with a particular model of economic development of doubtful worth.”

Referring to the exchange rate system and the post-Jamaica floating exchange rate system, UNCTAD points out that given institutional hiatus and lack of policy coordination among major industrial countries, it should be no surprise that floating has failed to deliver what was originally expected of it.

UNCTAD challenges the idea that emerging market countries could attain exchange rate stability purely by adopting appropriate macro-economic policies and exchange rate regimes when the currencies of the major industrial countries are still so unstable. The exchange rate system as such, TDR complains, has hardly figured on the agenda for the reform of the international financial architecture..

The IMF itself has recognized the difficult choices facing developing countries - between truly flexible rates and hard pegs - and the large misalignments and volatility of exchange rates among major currencies as a major cause for concern for small, open commodity exporting economies. Nevertheless the IMF has not discussed any initiatives to deal with this, implying that the matter could only be sorted out between the US, the EU and Japan. The mainstream advice to developing countries is to choose between free floating or locking into a reserve currency through currency boards or dollarization.

But this is a false debate, charges UNCTAD. Whatever option is chosen it won’t be able to ensure appropriate alignment and stability of exchange rates in developing countries so long as major reserve currencies themselves are unstable and misaligned, and international capital flows are volatile and beyond the control of recipient countries.

“There is no satisfactory unilateral solution to exchange rate instability and misalignments in emerging, particularly under free capital movement,” says TDR-2001. Governance in macro-economic and financial policies lack the kind of multilateral disciplines that exist for international trade, the TDR says.

Yilmaz Akyuz, the chief author of the TDR, agrees that as evidenced by the range of problems and issues that have been raised at the WTO by the developing countries under the rubric of ‘Implementation issues”, the rules and their administration are asymmetric. But however well or ill, the negotiations leading to the rules, there are rules and the developing nations could assert their authority in terms of governance, but this is absent in the monetary and financial system, he points out.

Breaking with the ‘consensus view’, the TDR insists that crises are likely to occur whether with floating or adjustable pegs. A currency board regime may make payments crisis less likely, “but only by making banking crises more likely, and the costs incurred in defending a hard peg may exceed those incurred by countries experiencing a collapse of soft peg.”

The key question says UNCTAD, “is whether there exists a viable and appropriate exchange rate regime for developing economies when major reserve currencies are subject to frequent gyrations and misalignments, and international capital movements are extremely unstable.”

The TDR advocates seeking solutions at global level, but notes that reform of the exchange rate system is not even on the agenda for reform of the international financial architecture.

The report recommends that serious consideration be given to:

·        introduction of adjustable target zones for the major reserve currencies, together with a commitment by the countries to defend them through coordinated intervention and macro-economic policy actions;

·        establishing effective multilateral surveillance over macro-economic policies of major industrial countries, particularly with a view to their impact on poorer countries, and

·        regional arrangements, which, in the absence of progress at the global level, could provide collective defence mechanisms for developing countries against systemic failures and instability, but would probably require the participation of a large reserve currency country.

Dealing with the issues of orderly workout mechanisms for international debt, the TDR argues that without effective global mechanisms to prevent financial instability, appropriate intervention in crises takes on greater importance.  With the benefit of hindsight, it says, the international policy response to the Asian crisis left much to be desired. The report attributes a great deal of the problem to the rescue packages, “designed not so much to protect currencies from speculative attacks or to finance imports as to meet the demands of creditors and maintain open capital accounts.”

Such bailout operations, UNCTAD points out, prevent private creditors from bearing the consequences of the risks they take, thus weakening market disciplines.

The report estimates that since the beginning of 1997, international banks collected more than $20 billion a year as risk-premium on loans to emerging markets, while the cumulative losses incurred by these banks in these markets are estimated at $60 billion over the whole period.

The burden of all these fall generally on taxpayers in debtor countries, “since their governments are often forced to assume the responsibility for the private debt.”

However, doubts about such large bailout packages are growing in creditor countries. Hence relying on such packages to guarantee stability in the international financial system no longer seems tenable, says the TDR.

As an alternative, the report advocates a temporary stand-still for countries under financial attack, in order to stop asset-grabbing and pave the way for an orderly and equitable debt workout.

Voluntary mechanisms, such as collective action clauses in bond contracts, could have a role in facilitating debt restructuring, the TDR recognizes.

However, argues the TDR, “a credible strategy for involving the private sector in crisis resolution should combine temporary standstills with strict limits on access to Fund resources.”

Although domestic bankruptcy laws provide a model for this approach, TDR says that full fledged bankruptcy procedures are not necessary to ensure an orderly workout of international debts.

Instead, the TDR recommends:

·        amending the IMF’s Articles of Agreement to provide a member who is imposing unilateral standstill with some protection against the risk of creditor litigation;

·        establishing an independent panel to sanction such standstills because, as a creditor itself, the IMF cannot be expected to play this role;

·        limiting the access to the Fund resources for crisis management, but improving access to counter-cyclical and emergency financing of the current account;

·        reappraising the IMF’s overall resource position, which has lagged far behind the growth of the global economy; and

·        focussing IMF conditionalities on core macro-economic objectives, as recent experiences with bailouts in Turkey and Argentina suggest that the practice of attaching wide-ranging policy recommendations to official loan package persists.

Despite the emphasis on private sector participation, large-scale bailouts have continued to be the preferred response to crises in countries considered to pose systemic risks.

“Since the main objective of large-scale contingency or crisis financing would be to allow debtor countries to remain current on payments to their creditors, it is difficult to see how this could be reconciled with a meaningful private-sector involvement in crisis resolution and burden sharing,” the report says. –SUNS4883

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

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