Resolving critical economic issues
Charles Dallara, Managing Director of the IIF, called for urgent action by a core group of the world’s major economies to broker agreements on critical macroeconomic and exchange rate issues.
He said: “Sustaining growth and restoring confidence will require not only astute domestic policymaking, but an unprecedented level of multilateral coordination. It will also require action that transcends purely domestic short-term concerns.”
Dallara stated in a letter on behalf of the IIF’s Board of Directors to the finance ministers and central bank governors in the forum of the IMF’s International Monetary and Finance Committee, “The challenge for global leaders is to recapture the political commitment to decisive, coordinated action that made the London Group of 20 Summit (April 2009) successful in restoring confidence battered by the crisis” and to use that commitment to take immediate and concerted policy measures within a multilateral framework. Market participants need to be convinced that the leaders of these major economies recognise their individual and collective responsibilities to work towards the goal of balanced and sustainable global growth.”
The IIF, representing over 420 member institutions headquartered in more than 70 countries, said the proposed core group of the world’s major economies need to take actions leading to the broader support and engagement of the G-20 at the Seoul Summit in November and the IIF today highlighted a proposed agenda of specific actions to be considered.
Dallara stressed, “Policymakers need to engage seriously in multilateral negotiation to deliver a set of consistent and mutually-reinforcing measures to address the problems—a communiqué of platitudes risks further undermining market confidence.”
The IIF drew attention today to critical issues on the financial regulatory reform front. Dallara stated, “We welcome the progress that has been made on regulatory reform. This can, properly framed with a measured pace of implementation, help increase the resilience of the financial system without a major negative impact on economic growth. However, the cumulative impact of all new regulatory and accounting measures needs to be fully understood, and reforms need to be introduced in a coordinated way which avoids fragmentation and the attendant risks of distortion and regulatory arbitrage. Indications of deviation from the recent Basel agreement are a source of growing concern.”
The IIF policy letter highlighted the lack of upward momentum in growth in the United States, the Euro Area and Japan (the G3 countries). In a separate report today, the Institute noted the continuing relatively strong performance of emerging market economies. It stated that policy conditions in the G3 are contributing to substantial capital flows into emerging markets and, in some cases, adding to exchange rate and domestic credit market pressures. The IIF stated that net private capital flows to emerging markets, which amounted to $ 581 billion in 2009, are likely to total $ 825 billion this year and then climb modestly to $ 834 billion in 2011.
Multilateral economic policy actions
The IIF said that even as countries race to boost growth via exports-”in many cases taking unilateral, uncoordinated policy actions-”domestic demand remains subpar in key “surplus” countries. It proposed that the core group make vigorous, politically-supported efforts to coordinate fiscal, monetary and exchange-rate policies, and structural reforms, to move key economies towards an appropriate balance of external and domestic sources of demand.
The IIF called for urgent progress in multilateral negotiations on major currency issues and noted that this would enable emerging market countries receiving strong capital inflows to be in a better position to adopt comprehensive policies to prevent risks to domestic financial stability, rather than resorting to uncoordinated measures such as capital controls.
The IIF called for a rebalancing of growth towards domestic demand in key surplus countries. It noted that as many economies that have traditionally relied on domestic demand now have consumer and financial sectors that still need to deleverage amid high unemployment and uncertain growth prospects, it falls broadly to surplus countries to find effective ways to stimulate their domestic demand.
At the same time, the IIF called on the governments of those major mature countries with worrying fiscal positions to develop specific and politically feasible plans for medium-term fiscal consolidation. With real and nominal growth slowing markedly in mature market economies such as the U.S., having credible fiscal consolidation plans in place would allow near-term support for faltering economic growth to be extended where necessary.
Financial sector regulatory reforms
Dallara noted that global financial regulatory reform has reached a critical stage, with the announcement by the Basel Committee on Banking Supervision (BCBS) of revised capital and liquidity proposals that are to be presented to the G-20 Summit. If implemented consistently as announced, and depending on how the open issues are addressed, these measures should contribute to building a more resilient global financial system.
However, he said: “Since the Basel announcement, some national authorities have indicated that they intend to place additional regulatory requirements on firms or to accelerate implementation. These steps are inimical to a balanced and coordinated approach to financial regulatory reform and will increase its economic impact and contribute to further fragmentation. It is also critical for regulators to understand and factor in potential market pressure for accelerated implementation, which itself is likely to be exacerbated by their announcements. Such market pressure will further magnify the economic impact of reforms.”
Dallara added: “The IIF has long warned of the damaging impact of regulatory fragmentation. Uncoordinated, inconsistent bank taxes and levies, for example, will create competitive distortions and encourage regulatory arbitrage. More generally, by committing to highly prescriptive measures domestically, national authorities may limit their ability to participate in international negotiations aimed at achieving coordinated approaches. Fragmentation both undermines the process and amplifies the costs of regulatory reform—the G-20 should reaffirm their determination to avoid it.”
Capital flows to emerging economies
The IIF said in its new report that the economic backdrop for private capital flows to emerging economies continues to be favorable in the current economic expansion. The mix of macroeconomic conditions reflects a mixture of “push” and “pull” factors, both of which have intensified in recent months.
Among the “push” factors, a key driver is the likelihood that the low nominal interest environment in the mature economies will be more extended than the IIF had earlier thought. The “pull” factors include high interest rates in some key emerging economies (e.g., Brazil and India), strong growth and, in some cases, improved terms of trade, which are especially powerful in attracting inflows into commodity exporting economies.
The IIF noted that persistent strength in private capital inflows is apt to lead to upward pressure on emerging market real exchange rates vis-à-vis most mature market currencies (especially the dollar, yen, euro and sterling). In recent weeks, this issue has come into focus, with a number of emerging market policymakers expressing concern that upward pressure on their currency could become unduly strong, especially as central banks in mature economies signal increasingly easy monetary conditions.
The near-term danger, stated the Institute, is that this upward pressure escalates and market adjustment becomes disorderly, causing renewed strains in global financial markets and between key economies.