Info Service on Finance and Development (June12/03)
The South Centre's Chief Economist, Dr. Yilmaz Akyüz, was a speaker at one of the four roundtables at the conference, which was on the theme of “limiting commodity price fluctuations, increasing production, trade and investment.” We reproduce his statement below.
statement illustrates how the Achilles Heel of the current international
economy is the eurozone, and describes the significant impacts developing
economies face from advanced economies, such as dampened export prospects
and unstable capital flows.
TO THE UN HIGH LEVEL THEMATIC DEBATE ON THE STATE OF THE WORLD ECONOMY
Economist, South Centre, Geneva
economic conditions continue to have a strong bearing on production,
trade and investment in developing economies (DEs). In this respect
the current landscape is not very encouraging. After three years of
recovery the world economy still remains highly fragile. The short-term
outlook is for contraction in several advanced economies (AEs) in
Europe. Growth in others, including the US, is weak and erratic. But
more importantly, medium term prospects are bleak almost everywhere.
the financial crisis, the credit, consumption and property bubbles
in AEs generated a highly favourable global economic environment for
DEs in trade and investment, capital flows and commodity prices. At
least one-third of pre-crisis growth in China was due to exports,
mostly to AEs, and the ratio is even higher for smaller Asian export-led
economies. China’s accession to the WTO also gave a major impetus
to outsourcing and exports to AEs by removing uncertainties surrounding
its access to the US market.
*** 1. BOP; 2. Reserves; 3. Fiscal positions = enabled CC response in DEs.
8. China has played a key role in the recovery of the South. It launched a massive stimulus package in infrastructure and property investment. Because of its high commodity intensity, this investment-led growth has given an even stronger boost to commodity prices than the pre-crisis export-led growth.
9. At the same time, short-term, speculative capital inflows surged with sharp cuts in interest rates and quantitative easing in AEs in response to the crisis. These have been more than sufficient to meet growing deficits in several major DEs including India, Brazil, Turkey and South Africa. But they have also widened deficits by leading to currency appreciations.
*** INFLOWS both reduce & widen deficits simultaneously: fills in money gap but also leads to currency appreciations which impacts current account deficit, debt sust, etc.
10. This rapid domestic demand-led growth has now come to an end. China cannot maintain investment-led growth indefinitely. But it also faces hurdles in shifting rapidly to consumption-led growth. Even a moderate slowdown in China, towards 7% per cent, could bring an end to the boom in a broad range of commodities. This can be aggravated by a rapid exit of investors and traders in commodity derivatives as happened in 2008 after the collapse of the Lehman Brothers.
11. DEs also face significant downside risks from AEs, including dampened export prospects and unstable capital flows. As noted by the IMF “even absent another European crisis, most advanced economies still face major breaks on growth. And the risk of another crisis is still very much present and could well affect both advanced and emerging economies.”
12. There can be little doubt that the crisis has posed difficult policy challenges for AEs. But there have also been shortcomings in the policy response. First, there is a failure to maintain adequate demand by reconciling the need for short-term fiscal stimulus with a credible programme for long-term consolidation, leading to a return to self-defeating fiscal orthodoxy and austerity in the Eurozone (EZ), the UK and even the US.
Third, deep cuts in interest rates and quantitative
easing have not been very effective in addressing over-indebtedness
and reversing spending cuts, but have led to “currency tsunami”
and problems for DEs in macroeconomic and exchange rate management.
The surge in short-term capital flows have shifted exchange rates
and trade not only between the North and the South but also among
DEs, creating tensions in the trading system. The matter has been
taken to the WTO by one of the most affected DEs for discussion in
a seminar held at the end of March. Questions have been raised on
the coherence between international trading and financial systems,
the impact of exchange rates on trade concessions and the rationale
and scope to deploy WTO disciplines, reaffirming once again the urgent
need to reform the international monetary system in order to avoid
beggar-my-neighbour policies and protectionism.
16. The risk-return configuration that has sustained short-term capital flows to DEs cannot last indefinitely. They are subject to sudden stops and reversals and they have already shown a high degree of volatility since last summer. The immediate threat is not a hike in interest rates in AEs, but the deepening of the EZ crisis, triggering a flight to safety, very much like the collapse of Lehman Brothers.
17. Default by Greece has been averted for the moment, but now Italy and Spain are facing similar pressures. Bailouts for these would require much larger funds and their austerity would create a much bigger impact. Spain is the epicentre. Its problems have little to do with fiscal irresponsibility, but excessive private debt built during the housing bubble, financed by core banks. Wrong diagnosis and recipes by the EC and ECB are now worrying even the IMF. With unemployment at 25%, foreclosures rising and economy shrinking, Spain is not expected to succeed in meeting deficit targets and financial obligations.
18. This is the main reason for the recent initiative to double IMF resources. This makes the Fund highly leveraged, particularly because of the failure to review quotas in time. The 2009 UN Conference on the World Financial and Economic Crisis and its Impact on Development agreed that the next quota review should “be completed no later than January 2011”. An agreement was reached in the IMF in 2010 to shift votes and two seats to DEs and double the quotas, to become effective by October 2012. Less than half of G20 members have ratified it so far. The US, Germany and its current chair, Mexico, are not among them. The package is unlikely to be ratified on time by the required percentage of votes and members.
19. In any case there is no justification for the EZ to draw on the IMF. Unlike DEs the EZ can issue unlimited international liquidity. The moral hazard argument used against intra-EZ bailouts also applies to IMF bailouts. More importantly, the financial integrity of the IMF may be put at risk by large scale lending.
In the event of a default by its borrowers, the IMF has no de jure preferential creditor status.
By the EZ core lending to the IMF to lend to the EZ periphery rather than lending to the periphery directly, the EZ is effectively shifting the default risk to IMF shareholders, including its poor members.
Thus, the IMF should lend to the EZ periphery subject to significantly increased efforts by the EZ to bail in private creditors and to supplement and use its own rescue fund.
20. Finally, despite recurrent sovereign debt difficulties, the international community has not been able to introduce orderly debt workout mechanisms. The attempt made at the IMF in the early years of the 2000s to establish a Sovereign Debt Restructuring Mechanism was blocked by some major AEs. The UN Conference agreed “to explore the need and feasibility of a more structured framework” for debt workouts. It has since then gained further importance with the EZ crisis. The Financial Stability Board has included bail-in as one of the key attributes of effective resolution regimes and the EC has formulated a bail-in proposal, but the issue is not placed squarely on the IMF agenda.
In conclusion, the world economy is no less fragile today than
it was on the eve of the 2009 Conference. And DEs are just as exposed
to downside risks from AEs as they were then, but their policy space
has narrowed in the interim. There can be little doubt
that there is a lot DEs could do to strengthen their own fundamentals
and reduce dependence on foreign markets, capital and commodities
to gain greater autonomy. But they cannot be expected to put their
house in order when AEs falter and the global financial architecture
continues to suffer from systemic shortcomings.