While official ambitions are to refashion the global financial architecture, the IMF has yet to publish new thinking on capital flows, the G20 discussion on global imbalances is mired in dispute, and the debate on a new monetary system may go in the wrong direction.
The past year has re-opened thinking about the role of capital flows in economic development (see Update 74, 73, 72). In order to address the potential side effects of surges in financial flows, and with an eye on courting Asian nations that have been wary of the IMF’s embrace since the Asian financial crisis of the late 1990s, the IMF and the Bank of Indonesia co-organised a low-key conference in Bali in early March. While the conference had little of the fanfare the IMF devoted to its Washington get-together on post-crisis economic policy (see Update 75), the Bali conference “provided an opportunity for discussion of recent developments in capital flows and practices for effectively managing such inflows.” No one from the IMF management attended the conference, with head of the IMF’s Asia Department Anoop Singh sitting on only one afternoon panel.
The IMF staff’s analytical work on capital account management (see Update 74), including “draft guidelines” for using capital controls was discussed by the IMF board in late March. The board paper, written by the IMF policy department based on a number of case studies, re-asserted the IMF’s recent position that capital controls should only be used in limited circumstances. It specifies that only countries with sufficient reserves exchange rates that are not undervalued and an economy that is overheating should try to use capital controls.
a chaotic slippage into the emergence of a multi-currency system
A mid March research paper on Capital flows to developing countries in a historical perspective, published by intergovernmental think tank the South Centre, takes a different perspective when it asks whether “the current boom will end in a bust?” The paper argues that the IMF approach to capital controls may not protect against the risks from volatility in flows to developing countries. “Unlike the US, DDEs [developing and emerging economies] cannot adopt a policy of benign neglect of the exchange rate consequences of capital flows and they need to apply restrictions outside the banking system in order to limit financial imbalances and fragility. Moreover, controls over both inflows and outflows should be part of the arsenal of public policy, used as and when necessary and in areas and doses needed, rather than introduced as ad hoc, temporary measures.” The paper concludes, “Experience shows that when policies falter in managing capital flows, there is no limit to the damage that international finance can inflict on an economy.”
That perspective seemed to be shared by Brazil. According to the Wall Street Journal, in an end March meeting in China, Brazil “voiced wariness of rigid rules for using capital controls, wanting to maintain a freer hand.”
A working paper published by Boston University’s Kevin Gallagher contains a “preliminary analysis” of interest rates and exchange rates which “suggests that Brazil and Taiwan have been relatively successful in deploying controls, though South Korea’s success has been more modest.” In particular “the cases of Brazil, South Korea, and Taiwan all provide some evidence that interest rates between the US and each of these nations has become less correlated and that the interest rate differential widened. This indicates that the controls in each of these nations have to some extent met their objective of allowing a nation to have a more autonomous monetary policy.” Gallagher recommends global coordination on “policing capital controls”, “coordinated imposition of capital controls”, and “strip[ping] away the patchwork of legal barriers to capital controls that are found in trade and investment treaties”.
Many civil society organisations remain sceptical of the IMF board endorsing such a view. In an early March statement to the UN, Malaysia-based NGO Third World Network warned about the approach advocated by France in the G20 process (see Update 74): “The possibility of the IMF having jurisdiction over capital account regulations can be dangerous. Efforts to harmonise the complex array of policies included in capital controls is not appropriate in a world where countries are in very diverse stages of development and need national policy space.”
Filomeno St Ana III of Philippine NGO Action for Economic Reform agreed that “even as international rules are necessary to address supra-national development, international reforms need to be responsive to the specific country conditions. Which also suggests that international rules have to be thin. This must be the direction of international monetary and financial reforms, which we wish to hear from the IMF.”
Global imbalances remain
The capital flows debate is intricately linked with the problem of global imbalances – large and persistent trade and financial surpluses and deficits of some countries. The IMF has been trying, unsuccessfully, to resolve them for years (see Update 54, 53, 51). Just before the mid February meeting of G20 finance ministers, the Banque de France published a Financial Stability Review with essays on global imbalances by all G20 central bank governors. A reading of the different perspectives shows how big the gaps still are.
Zhou Xiaochuan of the People’s Bank of China argued global imbalances are driven by different national desires for savings and by the lessons learned from the Asian financial crisis when international organisations “failed to perform their regulatory responsibilities over abnormal capital flows. … Instead, excessive and stringent conditionalities were imposed. … The East Asian countries learned the lessons, and increased foreign reserves and domestic savings in order to beef up their defense against financial crisis.” Axel Weber of the German Bundesbank countered with “current account surpluses were also caused by the fact that some countries pursued exchange rate policies to artificially support their export sectors.” Mervyn King of the Bank of England also blamed the Chinese exchange rate: “those emerging market economies which have adopted floating currencies are now suffering from the attempts of other countries to hold down their exchange rates.”
While the G20 countries agree that global imbalances must be dealt with, so far they have only managed to select the indicators to judge whether there is an imbalance. These include: “(i) public debt and fiscal deficits; and private savings rate and private debt (ii) and the external imbalance composed of the trade balance and net investment income flows and transfers, taking due consideration of exchange rate, fiscal, monetary and other policies.” In future meetings they will formulate guidelines for assessing the indicators. Whatever the G20 agrees will likely come back to the IMF for surveillance. That makes this year’s IMF triennial surveillance review, planned to be completed by September, a potentially important process, especially as the Fund still is not trusted by many developing countries. The review will look at the comprehensiveness and consistency of the Fund’s work as well as “assess the candour and evenhandedness of Fund surveillance.”
It comes down to money
With much of the imbalances debate directed at the Chinese exchange rate, efforts towards international monetary reform (see Update 74, 72, 70) have yet to generate consensus at the IMF or outside.
In late March, at the behest of G20 chair France, China hosted a one-day ‘seminar’ on international monetary reform in Nanjing. While the Chinese foreign ministry called the meeting an unofficial academic discussion, French president Nicolas Sarkozy opened the event. Participants included IMF head Dominique Strauss-Kahn, former IMF heads Michel Camdessus and Rodrigo de Rato, as well as academics and almost all G20 finance ministers.
The French government launched a new global-currencies.org website for the G20, with the numerous background papers for the seminar as well as existing IMF and G20 papers. The G20 has commissioned the IMF to author a report for the next G20 finance ministers’ meeting in mid April, just in advance of the IMF spring meetings. It is unlikely the report will contain much new analysis beyond the IMF board papers discussed in December (see Update 74).
Not content with a single foray into monetary reform, World Bank president Robert Zoellick wrote another commentary (see Update 73) in the Financial Times in mid February, arguing that “over time the world economy will need to manage a system of multiple major currencies” based on “flexible exchange rates, without intervention”. He further argues that emerging markets should develop “domestic currency bond markets, which help [them] manage currency risks and capital flow volatility.”
This market-oriented arrangement runs counter to the calls by UN agencies for a more stable and coordinated exchange rate system (see Update 70). Even Zhou, in his essay, called for “advanc[ing] the international monetary system towards diversification over the long run” rather than explicitly advocating a single reserve currency system.
“Without substantial reform of the monetary system there are no chances that non-recessionary mechanisms to reduce global imbalances and the growing currency volatility can be achieved,” argued Aldo Caliari of US-based Center of Concern. “Unfortunately, without strong signs that countries are willing to engage in the constructive collective agreements that this calls for, a chaotic slippage into the emergence of a multi-currency system seems the more likely, default scenario.”