Developing world advised to retain national autonomy

Participants at a briefing session organised by the Third World Network at UNCTAD X were told that although the commitment to putting in place a new international financial architecture seems to have waned with the apparent recovery of the world economy, in the absence of fundamental changes at the global level, developing countries should, given the inherent instability of international financial flows, retain national policy autonomy over their financial systems and capital flows.

by Cecilia Oh

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 liberalisation, two international experts advised on 15 February.

Yilmaz Akyuz, UNCTAD's Chief Economist and leader of the team that produces its annual Trade and Development Reports, and Jose Antonio Ocampo, Executive Secretary of the UN Economic Commission for Latin America and the Caribbean (ECLAC), were speaking at a briefing session on 'What's Happened to the Financial Crisis and the 'New Architecture'?' The session was organised by the Third World Network for NGOs and delegations attending UNCTAD X.

Search called off?

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 the agenda of 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 former, Akyuz said.

The developing countries, as debtors, were being denied the most fundamental rights that are available nationally to debtors in industrialised 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 industrialised nations, with these resulting in the lowest-common-denominator approach of the G7. 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 with the international financial institutions like the IMF not having enough funds but having to depend on credit lines from the G7, could even result in more harm, Ocampo said.

Ocampo, a distinguished Latin American economist, agreed with Akyuz's views about the state of the search for a new international financial architecture and said that in the current situation, developing countries should retain the 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 were some ideas discussed and they then die out 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 themselves on what their common interests are 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.

Wrong emphasis

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) of 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. If it had to depend on the major industrialised 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 workout 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. Just as national authorities have to take actions to ensure credit flows to small enterprises, there was an imperative need on the international front to reverse the current declining trends in ODA and 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.

Referring to the various ideas and proposals for 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.

Of plumbing and power play

'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 to costly self-defence 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, and tight monetary and fiscal policies to secure market confidence, 'while maintaining open capital accounts 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; thus political power play would enter into the equation. 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 these problems 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 G7 regarding the direction of reforms. Proposals by some G7 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 the G7 has 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 the area of capital controls and management of financial crises, due to its leverage in international financial institutions. But it was not clear that such a system would even 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 (that) 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.

But despite a proliferation of meetings and communiques, and a multiplicity 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 internationally-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.'

Role of financial liberalisation

Martin Khor of the Third World Network said a central feature of the Asian crisis had been the role of financial liberalisation 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 liberalisation 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 misdiagnosing the cause and promoting further financial liberalisation as part of its conditionality, as well as a policy package (high interest rates, 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 near-collapse of Long-Term Capital Management (LTCM) fund 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 liberalisation. Khor proposed that:

* The IMF stop pursuing efforts to amend its Articles of Agreement to give it a mandate over capital account convertibility as this would enable the Fund to discipline developing countries to open up their capital accounts and markets;

* The Organisation for Economic Cooperation and Development (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 liberalisation;

* 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 latest round of financial crisis about the negative effects of financial liberalisation.

Khor said the second set of proposals relates 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 has broken 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 those 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 centres, the currency markets and the derivatives trade;

* An international system of stable currencies (including possibly a return to fixed exchange rates or 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 the policies and processes of institutions that have so much influence over 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 stabilising of their local currencies, which would allow them to have greater freedom in formulating macroeconomic policies that can counter recession (such as lower interest rates or budget expansion) whilst reducing the risks of volatility in the exchange rate and flow of funds.

Chakravarthi Raghavan, Chief Editor of the South-North Development Monitor, who chaired the session, said that 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 the house or fix the sewage plumbing to take the waste out into the public sewerage system, or whether they are undertaking a recycling process within the house.

Perhaps a major conclusion or message arising out of the views of the experts was that developing countries standing on the edge of the sandpit (by contemplating or talking about capital account liberalisation or financial liberalisation) 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.

Cecilia Oh is a researcher at Third World Network.