by TWN/Cecilia Oh

Bangkok, 15 Feb 2000 -- Developing countries would do well to push for and retain national policy autonomy over their financial systems and capital inflows and outflows rather than move towards any kind of capital or financial market liberalization, two international experts advised Tuesday.

Mr. Yilmaz Akyuz, UNCTAD's Chief Economist and leader of the team that produces its annual Trade and Development Reports, and Mr. Jose Antonio Ocampo, Executive Secretary of the UN Regional Economic Commission for Latin America and Caribbean (ECLAC), were speaking at a briefing session on "What's happened to the Financial Crisis and the 'New Architecture'?"

The session was organized by the Third World Network for NGOs and delegations attending UNCTAD-X.

Both Akyuz and Ocampo (who had chaired a UN group on the new financial architecture issues) were agreed that with the global economy apparently recovering from the effects of the Asian financial crisis, that spread to Brazil and Russia, the search for a new international financial architecture appears to have more or less disappeared from international discussions.

Perhaps, interest may reappear at the next crisis, and developing countries would do well to be prepared to formulate and put forward their views and proposals. But in the meanwhile, they would do well to retain their domestic and national autonomy of policy in being able to regulate and control capital inflows and outflows, exchange rate policies and to the extent possible, regulation of markets. National policy and solutions may be the second best, but in the absence of the first best, internationally agreed solutions and a new architecture, developing countries would have to adopt the second best, Akyuz said.

The developing countries, as debtors, were being denied the most fundamental rights that are available nationally to debtors in industrialized countries. Hence, while maintaining their national policy autonomy, the developing countries should continue to push for global arrangements for orderly debt workouts, Akyuz added.

Even any debt moratoriums by countries should remain a national autonomous decision (and not one suggested or pushed by international institutions), Ocampo said. He also saw some merit in such cases in distinguishing between creditors who extend credits during the crisis (like the IMF and the World Bank or even private creditors) and others who withdraw funds and contribute to the crisis.

Ocampo, who had led a UN task force on financial reform questions, said there were differences among developing countries, and among the developed countries too, particularly the Group of 7 leading industrialized nations, with these resulting in the lowest common denominator approach of the G-7. As a result, some of the suggested solutions being advocated about transparency of national policies for the markets, and about crisis prevention through contingency funds and lending, but on a case-by-case basis or for the international financial institutions like the FUND not having enough funds but having to depend on credit lines from the G-7, could result in more harm, Ocampo said.

Ocampo, a distinguished Latin American economist, agreed with Akyuz's views about the state of the search for new international financial architecture and said that in the current situation, developing countries should retain maximum degree of autonomy. Any international system in the present situation had to depend on national systems and institutions.

As to what developing countries could do, Ocampo said that with the return of normalcy to financial markets there was a sense of complacency among the major countries and the institutions. Past experience had shown that only when a crisis occurred some ideas were discussed and they then die until the next crisis. Hence the best policy for developing countries would be to maintain the discussion and try to build a certain consensus among developing countries on what their common interests were and fight for them.

Ocampo agreed that in the absence of coordination among the three major currencies so as to end fluctuations, it would be difficult for developing countries to maintain their currencies without being buffeted by fluctuations. Hence, macroeconomic coordination and avoidance of currency fluctuations among them was of importance to developing countries, Ocampo said.

On the issue of crisis prevention and resolution, Ocampo said the emphasis was on information and transparency and less on regulation. But even in the midst of a crisis, the existing emphasis on these was a totally wrong solution, and may in fact produce instability. The idea (of the IMF) for contingency financing in a crisis was an improvement on the old system, and was particularly important for developing countries where current account questions were most important. But for such a scheme, the IMF had to have large funds available. But if it had to depend on the major industrialized countries, and if there are doubts raised to the market about the availability or not of such funds, it would be a case of conveying wrong information to the market, and the mechanism could be destabilising.

An orderly debt work-out would be a good idea, but if it was going to be used on a case-by-case basis, it would be a total disaster, Ocampo said. And if such a scheme is sought to be imposed on a country, that too would worsen the situation, as had been shown in the case of Ecuador.

Developing countries, Ocampo said, should hence continue to strongly advocate total autonomy in the management of their capital accounts, so long as there were no clear and agreed rules in this area.

Ocampo also advocated a reversal of the trends in the flows of official development assistance, the only source of foreign capital and funds for many poor countries. And just as national authorities have to take actions to ensure credit flows to small enterprises, on the international front there was an imperative need to reverse the current declining trends in ODA and a need to strengthen the multilateral financial systems to provide such funds. There may also be some merit in ensuring both international and regional and sub-regional funding and all these institutions providing service to the developing countries both in competition and in complementary roles. It was also necessary that developing countries should fight for ownership of social and development policies, and not have externally oriented conditionalities by the multilateral institutions.

Martin Khor of the Third World Network, referring to the experience of various countries of the region during the Asian crisis and the solutions they adopted, said the developing countries should go slow, if not clawing back, on financial sector liberalization at the World Trade Organization (WTO), and resist any kind of investment agreements, whether at the OECD or the WTO.

Referring to the various ideas and proposals for the reform of the financial system that emerged after the outbreak of the Asian crisis, Akyuz quoted an IMF report as confirming that much of the proposals had concentrated on "marginal reforms and incremental changes" rather than big ideas.

"They have concentrated on plumbing the system rather than altering its architecture," Akyuz said. Attention has focused on standards and transparency (of national governments), and to a lesser extent, financial regulation and supervision. Efforts have been piecemeal or absent in the more important areas addressing systemic instability and its consequences. Emphasis has shifted on costly self-defense mechanisms in debtor countries... such as tight national prudential regulations to manage debt, large stocks of international reserves and contingent credit lines as a safeguard against speculative attacks, tight monetary and fiscal policies to secure market confidence, "while maintaining open capital account and convertibility."

There were certainly conceptual and technical difficulties in designing global mechanisms for prevention and management of financial instability, and such difficulties are also encountered in designing national financial safety nets. At the international level, there are problems of reconciling any system of control and intervention with national sovereignty and diversity and conflicting national interests and thus subject to political power play. It was thus not realistic to expect replication of national financial safety systems at international level involving global regulation, supervision and insurance mechanisms, an international lender of last resort and international bankruptcy procedures. But they also appeared to constrain even more modest global arrangements for prevention and management of financial crises.

And the political disagreements were not simply between industrial and developing countries, but also among the G-7 regarding the direction of reforms. Proposals by some G-7 countries for regulation, control and intervention in financial and currency markets had not enjoyed consensus, in large part because of the opposition of the United States, Akyuz noted. "By contrast, agreement among G-7 have been much easier to attain in areas aiming at disciplining debtor developing countries."

It seemed the US was opposed to a "rules-based global financial system" and preferred a case-by-case approach that gave the US considerable discretionary power, particularly in use of capital controls and management of financial crises, due to its leverage in international financial institutions. And it was not clear that such a system would be desirable from the point of view of smaller countries, particularly developing countries. "It is not realistic to envisage a rules-based global financial system could be established on the basis of a distribution of power markedly different from that of existing multilateral financial institutions."

Given the inherent instability of international capital flows, Akyuz said, any country closely integrated into the global financial system was susceptible to currency turmoil and financial crisis even when adopting the best standards for information disclosure, prudential regulations and supervision, regardless of the exchange rate regime it pursued. Developing countries were particularly vulnerable in view of their dependence on foreign capital and their net external indebtedness.

And despite a proliferation of meetings and communiques, and multiplication of groups and fora, "there remains a reluctance to accommodate the concerns of developing countries."

Thus, said Akyuz, "in the current political environment, the maximal feasible strategy for developing countries in their search for greater financial stability over the near term would seem to be to try to combine national control over capital flows with some international-agreed arrangements for debt standstills and lending into arrears, while strengthening their financial systems through better standards, and effective prudential regulations and supervision."

"It is also essential," Akyuz added, "that the autonomy of developing countries in managing capital flows and choosing whatever capital account regime they deem appropriate should not be constrained by international agreements on capital-account convertibility or trade in financial services."

Martin Khor of the Third World Network said a central feature of the Asian crisis had been the role of financial liberalization and deregulation that facilitated excessive short-term borrowing by local firms and that enabled international funds and players to manipulate and speculate on currencies and stock markets in the region. The prevailing mainstream view that liberalization was beneficial and had little dangers had been promoted by the IMF, World Bank and rich countries that wanted market access for their financial institutions to the emerging markets.

When the crisis struck, the IMF made it worse by mis-diagnosing the cause and promoting even further financial liberalization as part of conditionality, as well as a policy package (high interest, tight money and closure of local financial institutions) that converted a financial-debt problem into a structural economic recession. The IMF had also denied that hedge funds and other highly leveraged institutions had played a destabilising role, and it took the LTCM near collapse to expose the extremely high leverage and market power of these speculative funds.

Khor said that two sets of actions were urgently required at international level in the interests of developing countries.

The first set involves the need to avoid new policies or agreements that would "lock in" further financial liberalization. Khor proposed that:

* The IMF stop pursuing amending its articles of association to give it the mandate over capital account convertibility as this would enable the IMF to discipline developing countries to open up their capital account and markets;

* The OECD countries should stop altogether any attempt to revive their proposed multilateral agreement on investment, which would have given extreme freedom of mobility for all types of capital flows;

* There should not be an investment agreement in the WTO as this would put intense pressures on developing countries for compulsory financial liberalization;

* There should be a review of the financial services agreement in the WTO to take into account the new knowledge and lessons learned from the negative effects of financial liberalization resulting from the latest round of the financial crisis.

Khor said the second set of proposals relate to international policies and measures that need to be put in place, including:

* Measures and guidelines to help countries prevent debt and financial crises;

* Once a crisis broke out, measures to manage the crisis effectively, including debt standstill arrangements and a debt workout system that fairly shares the cost and burden between creditors and debtors. An international bankruptcy court along the lines of chapter 11 of the US bankruptcy law should be set up to implement this.

* A framework that allows and encourages countries (especially developing countries that are more vulnerable than rich countries) to establish systems of control over the inflow and outflow of funds, especially of the speculative variety;

* Governments of countries which are the sources of internationally mobile funds should be obliged to discipline and regulate their financial institutions and players to prevent them from causing volatility and speculation abroad;

* International regulation is needed for activities of hedge funds, investment banks and other highly leveraged institutions, offshore centers, the currency markets and the derivatives trade;

* A international system of stable currencies (including possibly a return to fixed exchange rates or of rates that move only within a narrow band) should be considered;

* A reform of the decision-making system in international institutions like the IMF so that developing countries can have a fair say in policies and processes of institutions that so much determine their economies and societies.

Khor said that in the absence of such international measures, developing counties have to institute domestic measures to protect themselves. In particular, they should have regulations that control the extent of public and private sector foreign loans (restricting them to projects that yield the capacity to repay in foreign currency); that prohibit manipulation of their currencies and stock markets; and that treat foreign direct investment in a selective way that avoids build-up of foreign debt.

The array of national policy instruments should include selective capital controls and the fixing or stabilizing of their local currencies, that would allow them to have greater freedom to have macroeconomic policies that can counter recession (such as lower interest rates or budget expansion) whilst reducing the risks of volatility in exchange rate and flow of funds.

Chakravarthi Raghavan, Chief Editor of the South-North Development Monitor, who chaired the session, said that the talk by the IMF and others about the international financial architecture, and the proposals that were being put forward now seemed like the definition of 'refacimento' by the English essayist. Refacimento, he wrote, "is yesterday's cake cut into two and prized twice as much."

And when these institutions tried to fix the 'plumbing' in the house, it was not clear whether they were trying to fix the plumbing that brings fresh and clean water into a house, or fix the sewage plumbing to take the waste out into the public sewerage or they are undertaking a recycling within a house.

Perhaps a major conclusion or message out of the views of the experts was that developing countries, standing on the edge of the sand-pit (by contemplating or talking about capital account liberalization or financial liberalization) should draw back from the edge rather than slide into the pit. And those who are already down in the pit, should stop digging themselves deeper, but pause and figure out a way, with help from outside, to get out of the pit and stay out. (SUNS4607)

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

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