The need for better institutions and instruments for capital flows

In light of frequent financial market failures, there is a
need for setting up better institutions and instruments to
handle the problems associated with international capital
flows. This was stressed by the UNCTAD Secretary-General,
Rubens Ricupero in a speech at the G-24 Ministerial Meeting
in Caracas on 7-9 February 1998.

by Chakravarthi Raghavan

GENEVA: The need to avoid "ready-made and simplistic" remedies
and concentrate instead on setting up better institutions and
instruments to handle problems of international capital flows
has been stressed by the UN Conference on Trade and Development
(UNCTAD) Secretary-General, Rubens Ricupero.

Any global regime for capital transactions, the UNCTAD head
suggested, could not be limited to the issue of liberalization
but should also include a broader framework of governance for
economic agents in international financial markets.

Ricupero, addressing the Group of 24 Ministerial Meeting in
Caracas on 7-9 February, suggested that policy advice to
countries should be offered "with a certain degree of humility
and a healthy dose of pragmatism". In the light of the
recurring and frequent crises, "we should perhaps ask ourselves
if there is not something more systemic and global behind these
frequent manifestations of financial market shortcomings."

A copy of Ricupero's intervention was made available here by
the UNCTAD press office.

Reports from Caracas said that Ricupero's statement (which
sharply differed from the IMF's views), as well as other recent
papers from UNCTAD, including a question-and-answer brief on
the Asian crisis (please see page 14) and a detailed analysis
by the head of UNCTAD's Global Interdependence Division, Yilmaz
Akyuz, were circulated to the G-24, and influenced considerably
the G-24 discussions and the declaration issued there.

In his speech, Ricupero pointed out that the IMF head,
Michel Camdessus, had noted in November 1995 that the world had
experienced during the previous decade four major financial
crises, the last of them being the Mexican crisis. Camdessus
had then added that more destructive ones would come unless the
quality of the coordination of macro-economic, financial and
monetary policies was significantly improved. Since then, the
IMF has introduced new, more stringent transparency rules, in
the hope of setting up an early warning system that would help
prevent further crises.

Global effect of East Asian crisis

Despite these improvements, Ricupero said, Camdessus's words
have proved prophetic. "We are now facing another financial
crisis, this time originating in East Asia, which is perhaps
the most serious since the breakdown of the Bretton Woods
system. Not only are the financial markets more closely
integrated worldwide, but the very success of East Asian
countries over the past three decades has helped them gain a
significant share of world trade and production. Consequently,
the impact is being felt far more widely than during past
crises. Indeed, for the first time, a financial crisis starting
in the South has had a profound effect on capital markets in
highly industrialized countries."

"The duration and severity of the East Asian crisis will,
undoubtedly, be a major influence on the economic performance
of most countries, in both the developed and developing worlds,
over the coming months. On the one hand, we have been told that
in today's world, globalization has dramatically increased the
degree of market integration and the depth of interdependence
of economies. On the other hand, we hear that the impact of the
East Asian crisis on the global economy can be expected to be

But one should not forget that since 1990, these East Asian
countries have provided the strongest stimulus for growth in
the world economy and have, together with the US, become the
driving force of global demand, running trade deficits with
industrial countries financed in large part by private capital
flows. This is probably the reason behind the increasing
realism and sobriety that has lately started to dominate the
views of major international organizations (such as the OECD
and the IMF) which recognize that the impact of the crisis will
be considerable, amounting to a very significant loss of growth

There could be little doubt that the global ramifications of
the crisis will depend on how fast the East Asian countries
would be able to overcome their current difficulties, Ricupero

International organizations can and should act decisively to
contain and reduce the destructive effects of the crisis. The
priority should be to restore confidence and stability in
currency and financial markets, while avoiding a deep and
prolonged recession.

To this end, loans should be rolled over and rescheduled (as
in South Korea recently) to allow countries to service them
from future export earnings and not through increased external
borrowing at penalizing rates. This should be combined with the
provision of external liquidity to support the exchange rate
and a more accommodating monetary policy which avoids
unnecessary damage to the economy's real sector, while
restructuring of the financial sector is undertaken - the
approach pursued by the US Federal Reserve Board in the debt
deflation of the early nineties.

"Given the record so far," Ricupero declared, in a clear
reference to the international financial institutions and their
officials, "policy advice should be offered with a certain
degree of humility and a healthy dose of pragmatism."

Already some worrying, and largely unanticipated, trends
have appeared in East Asia, he noted. In particular, the credit
crunch seems to be so deep that, despite favourable exchange
rates, firms are unable to export, as their access to trade
credit has been curtailed. Thus, an important part of the
improvement in the current account balances of South Korea and
Thailand so far seems to have been due to import cuts rather
than to export expansion. Over the longer horizon, however,
increased exports should account for a major share of the
required external adjustment.

"The negative implications of the Asian crisis can already
be felt in other developing regions," the UNCTAD head stressed.

"In Latin America, for example, the largest economy, Brazil,
suffered a speculative attack which had to be fought off with
a severe adjustment programme of high interest rates, budget
cuts, economic contraction and sharp reduction in imports.
Chile, the best performing economy from the region for over 10
years, has seen its currency depreciate by 18% since October
and, on account of its dependence on Asian markets (which
account for 50% of Chilean copper sales), its current account
deficit can be expected to increase this year. Africa, whose
growth has picked up in the last three years, could be severely
hit if commodity prices continue to drop as a result of falls
in demand and deflationary pressures."

Stimulus to world growth needed

"There is no doubt, however, that the biggest threat ahead is
a protectionist backlash against trade liberalization. On the
eve of the crisis, there was already a major imbalance in the
world economy as virtually all major industrial countries
(except the US) were expecting faster growth on the basis of
increased exports. Before the Asian crisis, Europe was
projected to generate a current account surplus of nearly $100
billion this current year and Japan was not much behind."

"It is unlikely that in the year of the Euro, Europe will be
capable of stimulating domestic demand very much. Japan has
recently taken some steps to reflate its economy, while
reducing the drag on activity resulting from the weakness of
its banking sector. It is far from certain, though, that the
measures announced so far will be sufficient."

"This is worrying because a major boost to world trade and
growth can only come from the three largest economic areas -
the US, Japan and Europe. China can certainly help if it sticks
to its intention of avoiding currency devaluation and running
a trade deficit. But its contribution will probably prove
limited since many East Asian exports compete directly with

"This leaves the US in an unenviable position as the only
major locomotive in the world economy and the single most
important source of import demand, a sort of gigantic 'black
hole' that will have to swallow the rest of the world's surplus
goods. In 1997, the US trade deficit was $150 billion. It is
estimated that it could explode this year to $200 billion or
even as high as $300 billion in 1999. Of course, in relation to
the size of its economy, this would not be much higher than the
US trade deficit in the mid-eighties, on the eve of the Plaza

"Politically, however, it could become an extremely
difficult and sensitive problem to handle," the UNCTAD head

"Congress," he noted, "has already rejected the
administration's request for 'fast track' negotiating
authority, when conditions, both economic and political, were
much more auspicious. Now we have to allow for many more
unfavourable factors: the US economy will be slowing down;
corporate profits are being reduced; there are fears of a
severe correction in share values on Wall Street; and a mid-
term election is looming and political consensus may be harder
to obtain."

Managing international capital flows

"We have always maintained in UNCTAD that monetary and
financial instability is the principal enemy of free trade.
Perhaps the single positive contribution of the East Asian
crisis is that it has halted the tendency towards monetary
restriction and higher interest rates in the US and Europe, and
hence prevented the global deflationary gap from widening
further. Let us hope that it will now spur the surplus
economies to initiate domestic-demand-led growth and reduce
their external surplus, thus creating a favourable external
environment for the growth in trade not only for the East Asian
countries but developing countries everywhere."

The East Asian financial crisis, Ricupero said, has also
increased awareness of the need for greater management of
finance to prevent the recurrence of similar crises. There is
a lot that can be done at the national level, including, in
particular, improved prudential regulation and effective
supervision of the banking system.

"However, the limits of such actions need to be recognized.
Experience shows that when capital inflows lead to a rapid
liquidity expansion, it is not easy to prevent domestic credit
from being increasingly channelled from financing safe and
productive investment to risky and speculative assets. Here the
problem is the absence of instruments to restrict capital
inflows and contain their impact on macroeconomic and monetary
conditions. Moreover, prudential regulations cannot prevent
excessive non-bank private sector borrowing abroad, and in East
Asia, for example, an important part of private borrowing from
international banks has been by non-bank firms. Nor do
international financial markets impose the right kind of
discipline over private borrowers in developing countries. All
too often, they manifest herd-like, pro-cyclical behaviour in
both making and cutting back loans. This is why governments
need to be prepared to use a broad range of policy instruments,
including, but not restricted to, prudential regulations."

"Attention needs to be given to the global hiatus in
institutions and instruments for handling problems associated
with international capital flows. Even though financial markets
are highly integrated, there is no global governance for
financial transactions of the kind already in place for trade.
Moreover, the present international arrangements are
asymmetrical in that they aim at disciplining borrowers rather
than regulating lenders. They are designed to manage rather
than to prevent financial crises, and the measures used tend to
be at the expense of living standards, stability and
development in debtor developing countries. Furthermore, much
more has still to be done to make the IMF an effective and
adequately funded international lender of last resort for the
provision of liquidity. And in international debtor-creditor
relations, there are no rules for orderly work-outs analogous
to domestic bankruptcy procedures."

"These issues of system design should be considered
alongside of the current initiative to extend the IMF's
jurisdiction to capital transactions. Indeed, the question has
been raised whether a global regime for capital transactions
can be limited to the issue of their liberalization and should
not also include a broader framework of governance for economic
agents in international financial markets."

"Moreover, any amendment of the IMF's Articles of Agreement
needs to accommodate not only differing national conditions but
also exigencies dictated by the rapid and continuing changes
which characterize the financial sector but which cannot be
fully anticipated by policy-makers and regulators."

"Thus, the amendment should incorporate flexibility going
beyond that regarding the pace of liberalization. Commitments
or obligations undertaken under the amendment should not reduce
the options available to national governments to protect their
economies from the impact of developments in international
financial markets that threaten macroeconomic stability or
undermine national policy objectives."

"Mr. Camdessus has rightly stressed that we should have the
humility to recognize that no one can claim to perfectly
understand all the complex interplay of factors that caused the
East Asian crisis."

"Nor, I would add, could we pretend to know exactly what
should be done in order to avoid the recurrence of financial

"In effect," Ricupero concluded, "the lessons from the Latin
American crises of the eighties were not sufficient to help us
anticipate and prevent the Mexican crisis of 1995. Nor were the
lessons drawn from the latter and the measures taken by
multilateral financial institutions in its light, enough to
deal with the very different kind of storm that was slowly
gaining strength in Asia."

"This should suggest to us that besides specific measures
taken after each episode of crisis, we should perhaps ask
ourselves if there is not something more systemic and global
behind these frequent manifestations of financial market
shortcomings? To address this question we may need not so much
a major once-and-for-all conference, a sort of new Bretton
Woods, but rather a patient and ordained process that would
avoid ready-made and simplistic remedies and concentrate
instead on setting up better institutions and instruments to
handle problems of international capital flows." -(Third World
Economics No.179/180, 16 Feb-15 March 1998)

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