As the international community anticipates the biggest investment push in history to attain the new global development goals set by world leaders at the United Nations Sustainable Development Summit in New York last month, the international monetary and financial system will need to undergo its own makeover to ensure more stable and predictable conditions for real investment, the UNCTAD Trade and Development Report, 20151 argues. Making the ambitious post-2015 development agenda feasible requires transforming rather than just fine-tuning existing financial rules and monetary arrangements.
“The report emphasizes the disruptive impact on productive investment of short-term and speculative financial flows,” UNCTAD Secretary-General Mukhisa Kituyi said. “It outlines reforms and policies which, in the context of the new developmental agenda, can help mitigate recessions and extinguish local financial fires before they threaten to engulf the global economy.”
The 2008 financial crisis triggered several initiatives aimed at strengthening regulation and supervision, as well as at facilitating access to official liquidity needed to address balance-of-payment problems. The report argues, though, that many reforms remain both too timid and narrow. Moreover, insufficient account has been taken of the specific needs of developing countries.
Higher capital adequacy ratios and new provisions for systemically important banks are welcome, but still allow excessive leveraging, while discouraging lending to small and medium-sized enterprises.
In addition, a focus on traditional banking has meant inadequate attention to shadow banking whose importance has continued to grow, including in several developing countries. Innovative forms of credit provision and a new breed of asset managers (such as hedge funds) and broker-dealers (often in financial conglomerates) have kept leveraging at high levels, impairing financial stability. Despite the poor record of credit-rating agencies, their assessments still rule asset allocation and borrowing interest rates, as well as risk weights for capital requirements.
Raising capital and liquidity requirements is necessary but not enough. The report calls for a bolder agenda, beginning with a strict separation of retail and investment banking, including at the international level, as well as monitoring and regulating shadow banking. Dealing with conflicts of interest around credit rating can be addressed by shifting from an “issuer pays” to a “subscriber pays” model, backed up by public sector involvement to avoid freerider issues. Also, banks could assess for themselves the creditworthiness of borrowers and/or pay fees to a public entity that assigns raters to grade securities.
The report also raises concerns about the growing dominance of private liquidity since the breakdown of the Bretton Woods system in the early-1970s, far superseding official sources. Yet, while private international liquidity tends to be abundant in boom periods, it rapidly evaporates in crises.
In response to this procyclical pattern, many developing countries have accumulated large amounts of official liquidity in the form of foreign-exchange reserves as a form of self-insurance. However, UNCTAD is concerned, however, that where reserve accumulation results from foreign borrowing countries will still remain exposed to the vagaries of global financial markets. Furthermore, if many countries attempt to accumulate reserves through trade surpluses, there is a serious risk of a currency war and a further holding back of already weak global demand and economic recovery.
New multilateral arrangements, such as multilateral exchange-rate management or a greater role for special drawing rights, are still the best options. Their adoption, though, requires institutional changes that appear out of reach in the immediate future. Foreign currency swap arrangements can offer a way forward, but these have mainly catered to the needs of developed countries. Such swaps involving developing countries are still relatively limited. Expanded International Monetary Fund-loan facilities could also help but, so far, new arrangements have largely remained unused. Meeting the needs of developing countries will require prior reform of the International Monetary Fund’s governance, policy orientation and surveillance mechanism.
“A preferred option for developing countries may be to proactively build on a series of regional and interregional initiatives with the aims of fostering regional macroeconomic and financial stability, reducing the need for foreign exchange accumulation, and strengthening resilience and capabilities to deal with balance-of-payment crises,” Dr. Kituyi remarks.
To address the limited size of existing regional arrangements, interregional swap arrangements would be particularly useful. Another possibility might be the creation of a common fund with a periodic increase of paid-in capital, which could be used by a regional clearing union or reserve pool to increase its liquidity provision capabilities by borrowing on its own.
In a diverse international community, strong regional initiatives could combine with other global, regional and national institutions to create a better governance system. Such a combination of initiatives at various levels, UNCTAD concludes, could at least partially provide an alternative to reserve accumulation, thereby serving as a stepping stone to more comprehensive international monetary reform in the future.
Report: http://unctad.org/en/PublicationsLibrary/tdr2015_en.pdf
Overview: http://unctad.org/en/PublicationsLibrary/tdr2015overview_en.pdf
