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Mainstream, Vol XLVII, No 18, April 18, 2009

Towards a New International Monetary and Financial Architecture

Saturday 18 April 2009, by Muchkund Dubey

For the last year-and-a-half, the world economy is in the throes of a global recession. It started with the collapse and bankruptcy of some of the most important multinational financial corporations of the United States and soon engulfed the financial sector of the countries of the European Union. Thereafter, it spread to the real economies of major developed countries. With the passage of time, the crisis has deepened and is now affecting the lives of people in every country of the world. In the beginning, it was expected that some of the developing countries like India and China, which had grown at a much faster rate than the rest of the world and had accumulated large foreign exchange reserves, would be able to avoid the contagion. But this did not turn out to be true and even these countries as well as other developing countries have seen sharp deteriorations in the major indicators of their economic health. The developing countries are facing tightening external financial conditions, declining commodity prices, contraction of export markets, sharp declines in ODA and in private capital inflows, and big reduction in remittances from abroad and the return of migrants to the home country. According to one estimate, between 2007 and 2009, the net capital inflow to Latin America would decline from $ 184 billion to $ 43 billion and that to developing countries in Asia, from $ 315 billion to $ 65 billion. The latest forecasts project a decline in the world GDP by approximately two per cent. According to the ILO data, 11 million persons lost jobs in 2008 and 15 million more are likely to be unemployed in 2009.

It is now widely recognised that since the current economic crisis is global, so should be its solution. And global solution has to pay attention to the needs of the developing countries to recover from the current recession. Since most of these countries do not have resources of their own to design and implement rescue packages, they should be assisted by the international community to do so. Looked at from this angle, the results of the G-20 Summit, held in London on April 2, 2009, can be regarded as a positive step forward. The Summit took a number of decisions to augment the resources of the international financial institutions to enable them to assist the developing countries in mitigating the impact of the worldwide recession and, in general, to play a pro-active role in the current economic and financial crisis. It was decided to bring about a three-fold increase in the liquidity at the disposal of the IMF, that is, to increase it from the current level of $ 250 billion to $ 750 billion. The G-20 decided to support a general allocation of Supplementary Drawning Rights (SDRs) which will inject $ 250 billion into the world economy. Since the SDR allocation is in proportion to the country quota, it is expected that developing countries will be allotted $ 80 billion dollars. The G-20 also agreed to support increased lending by the multilateral development banks (the World Bank and the regional development banks) to the tune of at least $ 100 billion. And finally they promised to ensure availability of at least $ 250 billion over the next two years to support financing of trade. These figures add up to $ 1.1 trillion. This is a substantial amount, though not adequate. Its impact will depend very much on the speed with which it is mobilised and disbursed.

The developing countries will gain substantially from the package announced at the London Summit. As already stated, their share of the allocation of additional SDRs will be $ 80 billion. The enhanced resources made available to the multilateral development banks will flow largely to the developing countries, as loans from these banks. A large proportion of the trade finance should also accrue to the developing countries. A good part of the additional liquidity to be made available to the IMF should be available for bailing out the developing countries in distress and adequately financing the various facilities under the Fund.

However, it is not clear from the London Communique as to the source from which these additional funds will come. There should not be much problem in issuing the SDRs because it is a kind of an international deficit financing for which all that is needed is the political decision of the IMF member countries, which can be deemed to have been taken. So far as the availability of the additional $ 500 billion of liquid resources to the IMF is concerned, only $ 250 billion out of it seem to be in sight, that is, pledges of $ 100 billion each by Japan and the EU and about $ 50 billion by China. It is not clear as to how the remaining $ 250 billion will be mobilised. The possible sources could be the United States, Gulf countries and India. There is also no mention in the London Communique as to where the amount of $ 100 billion to be made available to the multilateral development banks and the amount of $ 250 billion dollars for trade financing, would come from. Overall, there is justification for a measure of skepticism regarding the ability of the G-20 to put together the rescue package announced at the London Summit. Such packages for the developing countries have been announced several times by the developed countries in the past and each time the actual delivery has fallen short of the promises made.

Two other issues on which the London Summit took decisions were curbing protectionism and regulating the financial sector. On protectionism, the London Communique is long on rhetoric, but short on specific commitments. The Communique states that “we will not repeat the historic mistakes of the protectionism of the previous era” and that “we will not retreat into financial protectionism”. The Communique reiterates the Washington commitment to refrain from “raising new barriers to investments or to trade in goods and services, imposing new import restrictions, and implementing WTO-inconsistent measures to stimulate exports”. However, there was no mention of or discussion on the new protectionist measures built into the stimulus packages announced by some developed countries, like the Buy American provision in the US stimulus package or the banks receiving large amounts of government assistance as rescue measure, being pressurised to focus on lending domestically. The Director-General of the WTO, who has been assigned the role of monitoring protectionist measures and reporting on a quarterly basis, has tried to underplay the significance of the new protectionist measures already in place.

As regards regulatory measures, the G-20 have committed themselves to “take action to build a stronger and more globally consistent supervisory and regulatory framework for the future financial sector”. They have also put on notice Credit Rating Agencies and hedge funds which may come under surveillance. On tax havens, they announced that “the era of banking secrecy is over”. The tax havens will be dealt with mainly by naming and shaming. It is difficult to say how effective this is going to be, given the vested interest of major G-20 countries in some of the known tax havens.

It seems that the G-20 are going to rely principally on national regulatory arrangements. Effort at the global level will remain confined to pronouncement on the consistency of regulatory measures adopted at the national level and laying down norms and standards from time to time. A decision was taken to establish a new “Financial Stability Board (FSB)” as a successor to the Financial Stability Forum. The Board will include all G-20 members. This simply reflects the general shift of decision-making on international monetary and financial issues, from the G-7 to G-20.

There is no doubt that the decisions taken at the London Summit will infuse new life in the currently decadent IMF and World Bank. There will be a three-fold increase in the liquidity at the disposal of the IMF. It will be able to issue SDRs again on a sizeable scale, which can be seen as a move towards the creation of an international reserve currency. The IMF will have some role to play in implementing the G-20 decision on financial regulation. Moreover, the IMF has been assigned the task to monitor the implementation of the measures announced in London, assess their adequacy and suggest additional action needed at the global level. Even more important is the decision to revive the original mandate of the IMF for the surveillance of the economies of the member countries. The G-20 Communique declares:

We will support, now and in future, a candid, even-handed and independent IMF surveillance of our economies and financial sectors, of the impact of our policy on others, and of risks facing the global economy.

It is significant to recall that the developed countries had from the very early stage of the evolution of the IMF withdrawn their economies and economic policies from the IMF surveillance. This was mainly because the IMF lost its role of regulating the exchange rate policies of member countries after the collapse of the Gold Parity Standard System in 1971, following the unilateral withdrawal of the United States from the system. Since then both the IMF and World Bank have been used by the major developed countries principally for exercising surveillance on their behalf over the economies of the developing countries, and imposing on them development strategy and economic policies mainly designed to serve the interests of the developed countries and their multinational corporations.

The instrumentality used by the IMF for this purpose has been conditionality which acquired its quintessential form in the structural adjustment programmes prescribed for the developing countries since the early 1980s. Empirical evidence has shown that the imposition of this conditionality has converted a large number of developing countries, particularly in Africa, into a wasteland of development. The situation has come to a pass where several developing countries have decided not to avail themselves of the facilities of these two multilateral financial institutions instead of accepting their conditionality. That is the reason why some of the facilities under the IMF, like the compensatory financing facilities, Contingency Credit Line and Poverty Reduction and Growth Facility have been only scarcely utilised in recent years. A current anomaly arising out of the IMF and World Bank policies is that whereas the developed countries, under the grip of the global recession, are following counter-cyclical policies, the developing countries are still being advised by the IMF and World Bank to pursue pro-cyclical policies like controlling inflation, reducing government expenditure, devaluing their currencies and encouraging exports when the markets for them have shrunk drastically. The London Communique makes no recommendation on brining about reforms in, let alone jettisoning, the conditionality imposed by the multilateral financial institutions. The Communique simply refers to the new Flexibility Credit Line and reforms in lending and conditionalities. However, the fact is that these reforms fall far short of what is warranted in the current economic circumstances. In any case they do not, by any means, usher in a new regime for conditionality.

The IMF cannot be viewed as the solution when it is a part of the problem. The problem arises from its link to the financial market from where the current global recession has emanated and its adherence to the market theology, which has been mainly responsible for bringing about the global economic crisis. Finally, decision-making in the IMF and World Bank is proportional to the quotas held by the member countries in these institutions. The quotas are so distributed as to give a single country or a group of a few developed countries, the power to veto.

The vast majority of the developing countries have, therefore, taken the view that the IMF should not be strengthened before it is reformed. The G-20 have missed a historical opportunity to set in motion the process of drastically reforming the IMF. Some positive noises have been made in this regard in the London Communique. They have committed themselves to strengthening “the longer term relevance, effectiveness and legitimacy of the international financial institutions”. They have stated that they would “reform their mandate, scope and governance to reflect the changes in the world economy”. They have also conceded that the emerging and developing economies “must have a greater voice and representation” in the IMF. On one specific issue, that is, the appointment of the heads of these institutions, they have agreed that this will take place through “an open, transparent and merit-based selection process”.

There is legitimate concern whether any of these statements of objectives would ever be translated into concrete reforms. There have been similar expressions of good intentions in the past which have not been followed up. The reforms carried out so far have taken years and are peripheral. The Bretton Woods Institutions were born with original sins and there is no indication so far that the major developed countries would ever agree to relinquish their stranglehold over these institutions.

There is, therefore, a legitimate demand by the vast majority of the developing countries and independent experts that the United Nations is the unique forum to build agreement on a new international monetary and financial architecture. Anything that is agreed in the G-20 is unlikely to command credibility and inspire confidence among the vast majority of the countries of the world. As a universal forum only the United Nations has the political legitimacy to hammer out an agreement acceptable to all the countries of the world. It was in view of this that the current President of the UN General Assembly set up a Commission of Experts on the Reform of the International Monetary and Financial System under the chairmanship of Professor Joseph Stiglitz, a Nobel Laureate in Economics. This Commission is expected to submit its report in May 2009 and a summit-level meeting of the General Assembly has been convened in June to discuss this report and take decisions on its recommendations. In the meantime, Prof Stiglitz presented the recommendations of the Commission at the Thematic Dialogue on the Financial and Economic Crisis, held in the General Assembly on March 27, 2009. The very fact that the Commission’s recommendations have been prepared on behalf of the inclusive forum of the United Nations makes it different from the agreement reached and the package announced at the London Summit. On the specific issue of tiding over the present global crisis, the Stiglitz recommendations make a plea for coordinated stimulation packages for all countries, that are framed in ways in which the downstream multiple effects are large, the impact on the poor significant and global fall-out positive. On the general issue of the international monetary and financial architecture, the Commission’s recommendations are thorough-going and designed to deal with the fundamental problems of the system. As Prof Stiglitz has stated, “the stakes are too high for half-measures”. He says:

While individual countries must pick up the pieces, the international community has the responsibility and opportunity to identify long term measures beyond protecting banks, stabilising credit markets and re-assuring big investors.

The Stiglitz recommendations hark back, as any recommendation for a thorough-going restructuring must, to the Keynes Plan for a new international monetary and financial system, submitted at the Bretton Woods Conference. Keynes envisioned the IMF as a world Central Bank with sufficient resources at its disposal and with its own reserve currency called the “Bancor”. He proposed that in order to enable the IMF to discharge this responsibility, it should be enabled to acquire resources equal to one-half of world imports. A linked suggestion of far-reaching importance, made in the Keynes Plan, was to place the burden of adjustment on both the surplus and deficit countries, rather than on the deficit countries alone which is the case at present. The Keynes Plan envisaged a penal charge of one per cent a month on outstanding trade surpluses. This tax was to be utilised partly to finance the deficits of the countries facing balance-of-payments problems, partly to finance commodity buffer stocks and partly to be used as a leverage to impel the surplus countries to reduce their surpluses. There was an apparent expansionary bias in the Keynes Plan in that the deficit countries which created additional net employment were rewarded and the surplus countries which exported unemployment to the rest of the world were penalised. Though the Keynes Plan was not accepted at the Bretton Woods Conference and is not reflected in the operational guidelines and rules of the IMF, the preamble of the IMF statute retained the objective, widely shared in the immediate post-World-War period, of States acting both at the national and inter-governmental levels, playing a key role in maintaining global economic stability and employment. The objective of pushing capital and other financial market liberalisations and promoting contractionary fiscal policies, was evolved much later as a part of the Fund/Bank conditionality. This theology is reflected in the London Communique which states that the ”only sure foundation for sustainable globalisation and rising prosperity is an open world economy based on market principles”. This is in spite of the fact that the Summit was convened to deal with the biggest market failure in recent history.

The following are some of the important recommendations of the Stiglitz Commission:

A Balanced Response to Global Recession:

Since we need a global response to the current global crisis, every country must have a stimulus package. Since the developing countries do not have the resources for mounting such a package, they must have access to substantial additional funding, and whatever assistance is given to them should be without inappropriate conditionality.

A New Global Reserve System:

The Commission recommends the creation of a new global reserve system with the SDR as its anchor. Since the entire system will be based on the SDR, its issue on a once-for-all basis, as recommended by the G-20, will not suffice. The new system must be based on a greatly expanded SDR with regular or cyclically regulated emissions calibrated to the size of reserve accumulation. This is precisely what was recommended in the Keynes Plan.

A Global Reserve Currency:

The new multilateral reserve system should have its own reserve currency based on the SDR. This is the only way to overcome the inequities and instability inherent in a global reserve system based on a national currency, that is, the dollar. This concern was recently echoed by the chief of China’s Central Bank. The creation of a new international reserve currency has the support of both China and Russia.

Regional Monetary Arrangements:

Another important recommendation of the Stiglitz Commission is that the international reserve system should rely broadly on regional monetary arrangements and that the developing countries should actively cooperate to put such arrangements in place. This seems to be in direct line with the suggestion, made by the well-known economist Triffin in the late sixties, that the international monetary system should be based on regional monetary systems including regional reserve funds and reserve currencies. An obvious example that comes to mind in the present context is the Chiang Mai Initiative of the ASEAN Plus 3. The Chiang Mai Initiative has recently been given a new impetus, but it is still far short of building a regional reserve fund and issuing a regional reserve currency. Given the importance of countries like India, Australia and New Zealand in any regional monetary arrangements in Asia, it is doubtful whether the Chiang Mai Initiative would suffice. The optimum solution would be to have an Asian reserve system and an Asian reserve currency with the inclusion of all the countries participating in the East Asia Summit. This, however, very much depends upon China’s willingness to cooperate in building such a system. The only other region where there is a possibility of making a viable regional monetary arrangement, is the Gulf Cooperation Council (GCC) region suitably enlarged. The enlarged GCC has sufficient currency reserves to be able to build such a regional arrangment. Recently, there has been a depletion in these reserves owing to the decline in oil prices. However, oil prices are likely to increase and the reserves of these countries likely to be further augmented, with the commencement of the process of recovery from the global recession.

Strengthening the Lending Capability of Multilateral Development Banks:

It is well-known that the World Bank and Regional Development Banks do not have adequate resources for financing development in the developing countries at the desired level. They have not proved effective in raising resources from the commercial market for or lending them at concessional rates to the developing countries. The question of restructuring and reforming these multilateral development banks to enable them to adequately discharge their statutory functions has been long pending. It will be interesting to see what the Stiglitz Commission recommends on it. However, in the context of the current crisis, the Commission has recommended that a large scale programme for commercial lending to the developing countries should be launched and for this a new Credit Facility under the umbrella of the World Bank and Regional Development Banks should be created.

The Creation of a Global Financial Regulatory Authority and a Global Competition Authority:

The Stiglitz Commission is of the view that while the effective regulatory system must be national, there should also be a global regulatory framework to establish minimum standards and to govern the global operation of systemically relevant global institutions as well. According to the Commission, movements towards this global will be enhanced by taking steps to lay the groundwork for a Global Financial Authority and a Global Competition Authority. The purpose of the Global Competition Authority will be to prevent financial institutions from growing to sizes that generate systemic risks and make them too big to fail. The Commission suggests that these global institutions should be democratically constituted without indicating how this will be done and how they will be related to the UN system. Perhaps the fuller version of this recommendation will be given in the final report of the Commission. The Stiglitz Commission has also suggested that financial institutions and practices should be vetted by a “Financial Product Safety Commission in order to curb excessive risk accumulation”.

The idea of a financial regulatory mechanism and a mechanism to curb monopolistic practices of the multinational corporations is not new to the UN system. The IMF itself was created as a financial regulatory mechanism at the global level, whereas the Havana Charter had a whole chapter on restrictive business practices. Subsequently, after transnational corporations came to dominate the world economy and trade, the UN established a Commission on Transnational Corporations and also started negotiating a Code of Conduct for such corporations. However, in the beginning of the 1980s, under the influence of the neo-liberal economic policies pursued both at national and international levels, the TNC Commission was wound up and the attempt to negotiate the Code of Conduct for Transnational Corporations was given up. In a major non-governmental conference convened on the occasion of the 50th anniversary of the Bretton Woods Institutions, the idea of establishing an independent commission, to keep a surveillance on the activities of the transnational corporations with a view to curbing their non-competitive practices, was revived. However, it was not followed up at the inter-governmental level.

Coordination of Global Macro-Economic Policies:

Article 1(4) of the UN Charter provides that the United Nations will be a centre for harmonising the actions of nations in the attainment of the common ends mentioned in the Charter. Article 55 assigns to the UN the role to promote solutions of international economic and social problems. The Economic and Social Council is vested with the authority to carry out this function. Subsequently, the Charter functions of the United Nations, particularly of the Economic and Social Council, in the economic field were transferred to the IMF, World Bank and the WTO. Several committees, commissions and expert groups have made recommendations for restoring to the Economic and Social Council the Charter function of coordinating global macro-economic policies. The Stiglitz Commission has made a similar proposal. It has recommended the establishment of an elected and representative global Economic Coordination Council within the UN system, to meet annually at the summit level, to assess and coordinate development policies and lend leadership in socio-economic and environmental fields. In the preliminary reaction to this proposal in the discussion at the Thematic Dialogue conducted by the General Assembly on March 27, 2009, on the financial and economic crisis, the question was raised as to why it was necessary to create a new body for this purpose when the Economic and Social Council was vested with this authority under the Charter. This issue is likely to be debated in greater detail when the consideration of the full report of the Commission is taken up at the proposed summit conference of the General Assembly in June this year.

What is important to note at this stage is that the current economic and financial crisis has led to the acceptance of the need for an objective and independent surveillance of developments in the world economy and of the impact of the policies of some member governments on others. Whereas the G-20 would like this task to be entrusted to the IMF, the Stiglitz Commission has suggested the creation of a new special body within the United Nations for the purpose.

The author, a former Foreign Secretary of India who, as a serving diplomat, was deeply involved in multilateral economic negotiations, is currently the President of the Council for Social Development, New Delhi.

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