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GENEVA, Dec 22 2009 (IPS) - In February of this year, the global economic downturn was peaking. The collapse of industrial output and exports was approaching a 40 percent year-on-year on average. Trade was shrinking dramatically. The outlook was indeed gloomy.

Now, at the end of 2009, progress has been made, but we are not yet out of the woods.

Actions taken by governments and central banks have restored some order in international financial markets. The financial crisis had been triggered by an excess of incentives to take ill-considered risks, as well as by the inability of supervisory authorities to properly regulate the financial system domestically and internationally.

Efforts to remodel the international financial system have been set in motion. A massive process of financial de-leveraging is underway, which is putting pressure on banks’ balance sheets and is likely to discourage fresh lending for some time to come. However, progress has been made in dealing with systemic failures. The International Monetary Fund estimates of future write-downs have now been reduced to some USD 3 trillion, meaning that the clean-up process has reached the half-way mark. But this progress is still too slow. Balance sheets are being hit by “second-round” effects of the downturn -that is, the direct effects of poor economic activity on loan repayments.

Efforts to deal with the solvency crisis come at a high cost for the world economy. International and domestic banks have to be recapitalised in line with the losses on their balance sheets, meaning that hundreds of billions of dollars of public or private money will still be necessary to restore sound and safe conditions in the financial sector. All this points to a continuing contraction of bank balance sheets rather than an expansion in lending. The credit crunch in industrialised countries will remain a delaying factor in the global recovery.

The restoration of public confidence in banks and other financial intermediaries is contingent on macro-prudential reforms involving the regulation and supervision of the financial sector. A business-as-usual approach is not an option. One of the first steps has been to strengthen the governance structure under which new standards can be set for banking regulation and supervision globally. The Basel Committee on Banking Supervision has broadened its membership and been placed under the authority of a newly-established Financial Stability Board, which reports to G-20 Leaders.

It is important that re-regulation be applied in a non-discriminatory manner, avoiding any form of a “re-nationalisation” of lending. Countries that have provided support to banks should be able to exit support as the de-leveraging process takes place in a manner that ensures a level playing field between national and foreign-owned institutions.

Of course, all this has come at a cost for public finances and should not be implemented for longer than necessary or sustainable. In Asia, where the recovery has been faster, stimulus should not be allowed to overheat the economy. Governments will have to confront the challenge of managing a substantial increase in public indebtedness.

Stricter monitoring of trade and investment policies has also been engaged, with the aim of preventing protectionist tendencies from frustrating the overall recovery efforts.

The existence of a solid, rules-based world trading system has contributed to containing protectionism. While some trade-restrictive measures have been adopted, the volume of global trade affected has remained below 1 per cent. For the second time in a little more than a decade -the first being the1997 Asian financial crisis- the multilateral trading system has passed the “stress-test” of a significant downturn without major reversals in trade policy.

But we are not in the clear yet. Pressures for protectionist actions, as cleverly as they may be devised, with their illusory gains for the domestic economy, will not necessarily diminish any time soon. On the contrary, with persisting unemployment, still on the rise, these pressures may intensify.

Furthermore, if global imbalances expand again with increased economic activity, as well they might, this will add an additional layer of protectionist pressures, as was the case in the 1980s: rising unemployment and increasing trade imbalances proved a potent combination in increasing demands for protection.

There is, in my view, an unfortunate irony in this, since the imbalances are manifested in trade terms but are not caused by trade. Rather, they reflect macroeconomic and sometimes macro-prudential realities.

These realities leave us with no room for complacency as far as trade is concerned. And this is part of the much larger systemic context for why rising to the challenge of completing the Doha Round of world trade negotiations is so vital. It is not only about reaping the potential future economic gains. Success would also send a powerful signal in terms of business and consumer confidence and government resolve to match words with action. Just as important, a successful Round would strengthen the hand of governments as they confront protectionist pressures. (END/COPYRIGHT IPS)

(*) Pascal Lamy is Director-General of the World Trade Organisation.

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