GATS may result in irreversible capital account liberalization

Financial services liberalization undertaken under the aegis of the WTO’s services agreement may achieve what the industrialized countries and the IMF have long been pushing for: the opening of developing countries’ doors to the free flow of cross-border capital.

by Chakravarthi Raghavan

GENEVA: Judged by the proposals of the advanced industrial nations in the WTO negotiations on trade in services, a major attempt seems likely to be made in the current talks to achieve, by the backdoor, the liberalization and convertibility of capital accounts of developing countries.

The management of the International Monetary Fund had in the mid-1990s mooted the idea of making the capital account convertible by changing the Fund’s Articles of Agreement. However, the financial crisis that erupted in 1997 in East and South-East Asia and then spread to Russia and Latin America (now further reinforced by the Argentine crisis) forced the IMF management to make a tactical retreat, though it has not abandoned the idea.

However, whether or not the IMF acts, the same objective would be achieved through the process of financial services liberalization under the General Agreement on Trade in Services (GATS) in the WTO.

Already under Article XI of GATS, no restrictions are to be applied by a Member country on international transfers and payments for current transactions relating to its specific commitments. During the Uruguay Round, before negotiations on GATS were concluded, in the relevant working groups for the GATS talks, the formulations and positions set by the US and the EC in terms of financial services liberalization left little doubt that their ultimate goal was to bring about capital convertibility and, through GATS, make it an irreversible process.

For, once a commitment is entered into and scheduled under GATS, changing course or reversing or modifying it would require renegotiating and compensating the country’s trading partners. This would be so costly that no country could easily contemplate it.

At best, then, the GATS route is one for progressively moving towards capital account convertibility, but with every step in that process becoming an irreversible one.

Also, though seemingly protecting the rights and obligations of members under the IMF’s Articles of Agreement, including on use of exchange actions, Art. XI of GATS also precludes WTO Members from imposing restrictions on capital transactions inconsistently with their specific commitments. The only exception to this prohibition is if the restriction is taken to safeguard the country’s balance of payments or at the request of the IMF.

In theory, or rather as envisaged at the founding of the Bretton Woods institutions, members are not to make use of the IMF’s general resources to meet a large or sustained outflow of capital. And the Fund may ask a member to exercise controls to prevent such use. However, in practice, the IMF and the World Bank have since at least the mid-1980s been encouraging and inducing developing countries to liberalize their financial markets, and the scheduling of commitments in GATS on the basis of the supposedly unilateral liberalization is promoted and encouraged.

Developing countries themselves often seek ‘credits’ for their unilateral liberalization - which implies that the unilateral liberalization measures are written into specific commitments under GATS (and thus effectively unchangeable) - and they are encouraged to do this in the trade literature of the WTO on the ground that such commitments will encourage the entry of investors. Economic theory - but not backed by empirical evidence - has it that liberalizing and ‘locking in’ the openness through WTO/GATS commitments  will encourage inflows of foreign direct investment.

According to a staff study by the World Bank (Policy Research Working Paper, WPS 2732), “The Unbalanced Uruguay Round Outcome,” by J. Michael Finger and Julio J. Nogues, following the liberalization of trade and the capital account by Argentina in 1991, FDI grew rapidly, a considerable part of it flowing into the services sector, with inflows trebling to $13 billion over 1992-98 - under the umbrella of bilateral treaties that impose no restrictions on sectors, percentage ownership, capital or profit remittances or employment conditions.

However, say Finger and Nogues, locking in such openness through commitments under GATS was not the key to attracting FDI. The growth of FDI was higher in service sectors where “commercial presence” was not bound at the Uruguay Round than in those in which it was.

Wishlists for financial liberalization

The recent Doha Ministerial Declaration of the WTO has reaffirmed the Guidelines and Procedures for the Negotiations on Services adopted by the Council for Trade in Services on 28 March 2001 as the basis for continuing the negotiations and achieving the objectives of GATS. The programme and timelines set by Doha require participants to submit initial requests for specific commitments by 30 June 2002 and initial offers by 31 March 2003.

Besides this issue of specific commitments under various sectors and sub-sectors, the current round of GATS talks also covers a range of rule-making areas, including issues relating to safeguards, subsidies, regulatory issues and balance-of-payments questions.

The proposals for negotiations tabled so far under the heading of Financial Services have come from the US, the EC, Japan, Canada, Norway, Australia, Switzerland, Korea, Colombia and Kenya. As a general objective, all want further liberalization, though Korea and Colombia have raised some cautionary signals on this and stressed the need for greater caution.

GATS envisages developing countries making specific commitments with appropriate flexibility: by opening fewer sectors, liberalizing fewer types of transactions, progressively extending market access in line with their development situation, and attaching conditions on market access. This ‘flexibility’ is often portrayed as “development-friendly”. However, this ignores the reality of such negotiations, namely the intense pressures that can be and are exercised bilaterally by the major industrialized nations on developing countries to open up as many sectors as their service suppliers want and remove the restrictions already in place.

The US proposal clearly sets out, as an objective in the current round, what it calls “benchmarks” for financial services liberalization:  common commitments constituting fundamental liberalization, and transparency and other principles for regulation of this fundamental liberalization. It further explains that this includes removal of restrictions on the form of commercial presence and at the level of equity participation preferred by the services supplier, and removing restrictions on the supply of certain financial services on a cross-border basis. All these are also specifically proposed as barriers to market access to be removed.

The EC too wants liberalization to promote trade in a sufficient range of financial instruments.

Among the others, Japan hopes that restrictions still maintained by a number of Members will be reduced. Canada seeks the expansion and strengthening of market-access and national-treatment commitments, and further reductions in barriers to trade in financial services. Switzerland too seeks relaxation of restrictions on commercial presence, and gives particular attention to insurance services and, in the banking sector, more commitments for brokerage, asset management, settlement and clearing services and transfer of information.

Regulatory capacity

While the seeming right of developing countries to open up fewer sectors or make less commitments is presented as a “development-friendly” aspect of GATS, it is made illusory in practice in the bilateral negotiations on specific commitments. There are also attempts to forge disciplines against the use of regulations, though the right to regulate is often presented as a safeguard.

The right to regulate under Art. VI of GATS is itself qualified by terms like use of “objective and transparent criteria”, “not more burdensome than necessary” or, in the case of licensing procedures, “not in themselves a restriction on the supply of the service.” All these terms in effect make the regulatory measures that a country might put in place subject to interpretation, when disputes are raised, by a dispute settlement panel and the Appellate Body - and at any time in the future. In the case of the financial sector, this is an invitation to inject the uncertainty principle into the sector.

Another element involves the extent to which the developing country can in fact institute prudential regulations and have the machinery as well as the qualified personnel to enforce such regulations. This aspect assumes particular importance if commitments are undertaken that may enable foreign financial institutions to engage in the use of a variety of complex instruments (such as derivatives, swaps, etc.) that even sophisticated counter-parties may find difficult to understand.

Such swaps and derivatives are often packaged and repackaged and sold to counter-parties. For example, cash flows could be ‘mimicked’ through some kind of a derivatives contract. In the Asian financial crisis, Korea, which had liberalized its financial services and market, found itself in great difficulty in dealings with Wall Street banker JP Morgan and the derivatives and currency swaps. Korea charged that the derivative had not been adequately explained and had been presented as something else.

In the current Enron case, some insurance companies have sued JP Morgan and other Wall Street banks on the ground that they had been asked to underwrite or insure a derivative (as commodity trade, energy trade and future price options) whereas the transaction was really a loan and thus not covered by the insurance policy.

Trade and financial experts have therefore been cautioning developing countries that they should not allow any financial instrument merely on the basis that they could institute safeguards through prudential regulations, but must also have the ability and capacity to supervise and enforce the regulations.

In the area of rule-making, the GATS talks have also been going on over the framing of rules and disciplines for invoking emergency safeguards, on subsidies and balance of payments.

However, developing countries invoking these escape clauses in GATS (or trying to quiet their domestic critics by pointing to the right to use the escape clause) will face an insurmountable problem of presenting objective data to back their assessments and justify the safeguard measures taken.

There are no data on services trade that can be used by them, and the manual for collection of such data that was recently approved by the UN General Assembly (see TWE #264) leaves little doubt that the manual is not tailored to meet the GATS definition of trade in services. In fact the statisticians who prepared the manual have declined to change the accounting systems to take care of the needs of GATS! (SUNS5071)                             

From TWE No. 275 (15-28 February 2002)