Rather than focusing on international action to address systemic instability, the process of reforming the international financial architecture has so far placed emphasis on what should be done at the national level. Even in this regard it has failed to adopt an "even-handed" approach between debtors and creditors, says UNCTAD´s Trade and Development Report 2001(1) released today. The Report sets forth alternative proposals for a more symmetrical treatment of debtors and creditors, less intrusive conditionality, more effective multilateral surveillance of macroeconomic policies of major industrial countries, and bolder moves to stabilize reserve currencies. It advocates payment standstills and limits on crisis lending as a means of involving the creditors in crisis resolution.
Governance matters in crisis prevention and management
Since the Asian financial crisis, all the serious talk on reform has been about how to discipline debtor developing countries and provide self-defence mechanisms against financial instability.
"Countries have been urged to better manage risk by adopting strict financial standards, improving transparency, adopting appropriate exchange rate regimes, carrying large amounts of reserves, and making voluntary arrangements with private creditors to involve them in crisis resolution", the Report says. While recognizing the merits of some of these reforms, it argues that "they presume that the cause of crises rests primarily with policy and institutional weaknesses in the debtor countries. By contrast, little attention is given to the role played by institutions and policies in creditor countries in triggering international financial crises", and many issues of concern to developing countries have not reached the discussion table.
These asymmetries and omissions reflect political rather than technical constraints. According to the Report, "the reform process has been driven by the interest of the major creditor countries". To be credible, the reform agenda must be reformulated and the reform process must provide for much greater collective influence from developing countries.
The Report also urges that developing countries reach a consensus among themselves on how they want the reform process to move forward. It notes that, while consensus among developing countries is lacking on several issues on the reform agenda, there are many commonly shared objectives.
Accounting for crises
The Report reviews recent initiatives to establish or strengthen codes and standards for the financial sector, and in respect of macroeconomic policy and policy regarding disclosure. While such initiatives have some value, it says, they will not eliminate the risk of financial crises.
The Report is critical of the "lopsided" approach adopted thus far, with the emphasis being on reforms in countries receiving capital flows while reforms in source countries are downplayed. It argues for an approach which recognizes diversity and the need for gradual reforms, and avoids placing excessive administrative burdens on developing countries and linking implementation of codes and standards to IMF conditionality.
Rethinking the exchange rate system
Better codes and standards offer limited protection to debtor countries in the absence of measures designed to tame supply-driven fluctuations in international capital flows. Almost all major crises in emerging markets have been connected with shifts in exchange rates and monetary policy in the major industrial countries. According to the Report, the root of the problem lies in the failure to establish a stable system of exchange rates after the breakdown of the Bretton Woods arrangements. Currency instability exerts much greater damage on debtor developing countries, which depend more heavily on trade and whose borrowing profile exposes them to greater currency risk. So far, advice has concentrated on the optimal regime for such countries, with opinion polarizing between a hard peg (dollarization) and floating.
The UNCTAD Report breaks with this consensus. Crises are as likely to occur under floating rates as under adjustable pegs. A currency board regime makes payments crises less likely only by making banking crises more likely, and costs incurred in defending a hard peg may exceed those incurred by countries experiencing a collapse of soft pegs.
"The key question is whether there exists a viable and appropriate exchange rate regime for developing economies when major reserve currencies are subject to frequent gyrations and misalignments, and international capital movements are extremely unstable", the Report states. While it advocates seeking a solution to the problem at the global level, it notes that the exchange rate system is not even on the agenda for the reform of the international financial architecture. The Report recommends that serious consideration be given to:
- introduction of adjustable target zones for the three major reserve currencies, together with a commitment by the countries to defend them through coordinated intervention and macroeconomic policy action;
- establishing effective multilateral surveillance over macroeconomic policies of major industrial countries, particularly with a view to their impact on poorer countries; and
- regional arrangements, which, in the absence of progress at the global level, could provide collective defence mechanisms for developing countries against systemic failures and instability but would probably require the participation of a large reserve currency country.
Crisis intervention: bailing-in the private creditors and limiting crisis lending
Without effective global mechanisms to prevent financial instability, appropriate intervention in crises takes on greater importance. With the benefit of hindsight, the international policy response to the Asian crisis left much to be desired. According to the Report, a good deal of the problem rests with rescue packages designed not so much to protect currencies from speculative attacks or to finance imports as to meet the demands of creditors and maintain open capital accounts.
Such bailout operations prevent private creditors from bearing the consequences of the risks they take, which weakens market disciplines, the Report contends. It is estimated that since the beginning of 1997 international banks collected more than $20 billion per annum as risk premium on loans to emerging markets, while total cumulative losses incurred by these banks in these markets are estimated at $60 billion during the whole period. The burden generally falls on taxpayers in debtor countries, since their governments are often forced to assume responsibility for the private debt.
With doubts about large bailout packages growing in creditor countries, relying on such packages to guarantee stability in the international financial system no longer seems tenable. Instead, the Report proposes a temporary standstill for countries under financial attack in order to stop asset-grabbing and pave the way for an orderly and equitable debt workout.
While recognizing the role of voluntary mechanisms, such as collective action clauses in bond contracts, in facilitating debt restructuring, the Report argues that "a credible strategy for involving the private sector in crisis resolution should combine temporary standstills with strict limits on access to Fund resources". Although domestic bankruptcy legislation provides a model for this approach, the Report concludes that full-fledged bankruptcy procedures are not necessary to ensure an orderly workout for international debts. It recommends :
- amending the IMF´s Articles of Agreement to provide a member who is imposing unilateral standstill with some protection against the risk of creditor litigation;
- establishing an independent panel to sanction such standstills because, as a creditor itself, the IMF cannot be expected to play this role;
- limiting access to Fund resources for crisis management, but improving access to countercyclical and emergency financing of the current account;
- reappraising the IMF´s overall resource position, which has lagged far behind the growth of the global economy; and
- focusing IMF conditionalities on core macroeconomic objectives, as recent experiences with bailouts in Turkey and Argentina suggest that the practice of attaching wide-ranging policy recommendations to official loan packages persists.
The Report contends that despite the emphasis on private-sector participation, large-scale bailouts have continued to be the preferred response to crises in countries considered to pose systemic risks. "Since the main objective of large-scale contingency or crisis financing would be to allow debtor countries to remain current on payments to their creditors, it is difficult to see how this could be reconciled with a meaningful private-sector involvement in crisis resolution and burden-sharing", the Report concludes.