Credi: Omid Armin, Unsplash

By Yilmaz Akyüz
GENEVA, Oct 29 2020 (IPS)

The meltdown of the Turkish currency that began in 2018 has continued unabated with the decline reaching unprecedented proportions in recent days.  The causes of that turmoil including underlying financial fragilities and political shocks were discussed in a previous piece by this author.  Since then the economy has become even more vulnerable in these respects. 

Efforts to stabilize the currency resulted in large reserve losses and the lira has lost half of its value against the dollar in the past two years.  A matter of concern now is if this currency turmoil would eventually culminate in an external debt crisis and default.  

In previous crises in emerging economies currency and debt crises often came back to back.  Typically, an economy facing sudden stops in capital inflows and steep declines in its currency raised interest rates and deployed reserves in order to stabilize the currency, stay current on its external debt obligations and maintain an open capital account. 

Efforts to stabilize the currency resulted in large reserve losses and the lira has lost half of its value against the dollar in the past two years.  A matter of concern now is if this currency turmoil would eventually culminate in an external debt crisis and default

When reserves were exhausted, it ended up on the doorsteps of the IMF which provided some funding to enable the country to pay its debt to private creditors and avoid restrictions on capital outflows, and imposed austerity measures deemed to reduce external imbalances and generate confidence in international financial markets.  In most cases private external debt was socialised and the country’s external debt was rolled over at some penalty rates with the help of the IMF. 

So far, the Turkish case appears to depart significantly from this pattern.  Despite a steep and sustained drop in its currency and significant loss of reserves which are now well below the level of short-term debt, the country has avoided arrears on its debt payments and has in fact been able to continue borrowing in international markets, albeit at a relatively high cost.   What is going on?

There appear to be four factors that account for the sustained decline of the lira and loss of reserves. 

First, like most emerging economies that opened up its local markets to international investors in order to shift from debt to equity and from forex debt to local-currency debt in external financing, Turkey experienced a significant increase in foreign presence in its equity, debt and deposit markets, particularly during the rapid expansion of global liquidity and sharp drops in international interest rates brought about by quantitative easing and zero-bound policy rates in advanced economies in response to the global financial crisis in 2008. 

However, since 2018 there has been a rapid exit of foreign capital from local markets, notably from the debt market and this explains an important part of the decline in reserves and downward pressure on the currency.  Malaysia had experienced a similar exodus in 2015 which pushed the ringgit below the levels seen during the 1997 crisis. 

Second, the economy is highly dollarized both in credits and deposits.  A constant flight of the residents from the lira has been a major factor in its decline.  This seems to have taken place not so much as capital flight from the country as currency substitution within the Turkish banking system.   Forex deposits of residents as a proportion of total deposits have been on an upward trend since summer 2018, exceeding 50 per cent in recent months. 

A third factor is offshore speculation against the lira, notably in London, through derivative contracts very much like that against the Malaysian Ringgit in Singapore during the Asian crisis.  In Malaysia, the Mahathir government effectively shut down the offshore trading in Singapore.  

In Turkey in 2018 the authorities limited Turkish banks’ swap, spot and forward transactions with foreign investors to 50 percent of a bank’s equity, reducing it in several steps to 1 per cent in April 2020 before raising it to 10 per cent in September 2020. 

A fourth factor is payment of external debt by private corporations.  Alarmed by the sharp decline of the lira in 2018, many debtors in forex, notably financial institutions, started to deleverage, reducing their debt in an effort to avert losses due to sizeable exchange rate risks they were exposed to.  Between March 2018 and March 2020, private external debt fell by some $73 billion while the public sector continued to borrow, seeing its total external debt rise by $36 billion. 

Thus, the international financial markets have so far been willing to lend to Turkey in dollars but not in the lira even though the yields on lira bonds exceed those on sovereign (forex) bonds by a large margin.   There are two possible explanations for this. 

First, there is too much uncertainty about the future path of the lira, and the interest rate differentials between dollar and lira debt assets fail to cover the mounting exchange rate risk. 

Second, given the volatility of the present regime in Turkey, sovereign risk is much higher for lira bonds issued in domestic markets because they come under local jurisdiction.

The lira can fall much further in the period ahead if flight from it continues unabated, its decline fails to bring a sizeable improvement in the current account deficit, the private sector continues to deleverage and pay forex debt, the debt of insolvent companies hit by economic slowdown and the rise of the dollar is pushed onto the government and, finally, if the public sector cannot borrow abroad sufficiently to meet the foreign exchange needs created by all these factors.  

There is little scope for interest rate hikes to stabilize the lira not only because the government believes that high interest rates are the main cause of inflation and needs growth to restore credibility among its constituency, but also because under conditions of currency turmoil interest rate hikes may simply point to declining creditworthiness and greater default as shown by events in East Asia during the 1997 crisis. 

One counteracting factor could be a rush back of international capital, fire-sale FDI, to capture cheap Turkish assets resulting from hikes in the dollar and deflation in asset prices, as seen in several emerging market crises in the past.

If this currency turmoil will culminate in a debt crisis is difficult to tell.  Countries often default not because they are in debt but because they cannot borrow any more.  Whether or not Turkey will face a sovereign debt crisis will depend on the willingness of international financial markets to keep lending and this depends on their assessment of default risk. 

A high stock of debt and a continuous increase in foreign exchange needs make external borrowing more difficult and expensive, and this is also the case in Turkey.   However, it is quite difficult to predict at what point the country will be cut off from international financial markets.  These markets are often seen to pump in money for extended periods to countries widely seen to be on the verge of default.

There are a number of factors in Turkey’s favour in sustaining access to international finance.   First, it has a clean record in debt repayments ‒ the Republic never defaulted on its external obligations and even paid up the debt inherited from the Ottoman Empire.  Second, its debt is not seen as unsustainable, in need of reduction and relief, as in the case of Argentina.   Third, as noted by the World Bank in its Turkey Economic Monitor Report, its external debt profile remains favourable ‒ the average cost of the current debt stock is relatively low and the average maturity is long ‒ and its debt rollover rate is quite high.  Finally, although the risk margin and cost of new debt is very high, there is no obvious upward trend – today Turkey’s 5-year CDS rate is broadly the same as in September 2018. 

However, if the need for external financing does not diminish, this Ponzi-like process may well end up in a debt crisis.  On recent trends the external debt to GDP ratio can come to reach the 70-75 per cent range by 2023, well above that of Argentina on the eve of its recent restructuring initiative. 

Since the IMF option has been ruled out and the current government does not have many friends left among the major OECD countries that could come to help as in the past, in the event of a sudden stop in lending, debt moratorium and default cannot be avoided. 

This could come sooner as a result of political and geopolitical shocks triggering a reassessment of risks, especially since the economy is quite prone to such shocks under the current administration.  Of course, it is possible for the government to seek bilateral bailouts in return for economic and political concessions.  There is also the possibility of a change of government which would in all likelihood open the doors to the IMF and the West. 

There is no easy way out for Turkey after so many years of economic mismanagement and waste.  Until recently the economy enjoyed a debt-driven boom sucking in large amounts of imports financed by capital inflows. 

Investment has concentrated in areas with little foreign exchange earning prospects such as real estate and physical infrastructure ‒ roads, bridges, airports and hospitals.  Much of the latter capacity remains underutilised, entailing significant contingent liabilities for the government as a result of guarantees given to private constructers in dollars. 

The economy has been showing signs of premature de-industrialization that has pervaded many semi-industrialized economies in the past two decades.  Regrettably, while a genuine reform agenda should focus on how to reduce dependence on imports and foreign capital, the current debate in the country is largely concentrated on how to attract more capital.  

Yilmaz Akyüz is former Director, UNCTAD, and former Chief Economist, South Centre, Geneva

We are greatly saddened by the passing of Martin Khor, a long-time friend and colleague, an undaunted fighter for the poor and underprivileged, a passionate believer in a more balanced and inclusive multilateralism, a rare intellectual and eloquent orator, an icon of the Global South worthy of veneration, greatly respected for his struggle for justice and fairness against the dominance and double-standards of big economic powers.   

Martin was born in 1951 in colonial Malaysia, still under British rule, to a family of journalists. After his primary and secondary education in Malaysia, he left for the UK in 1971 to study at the University of Cambridge, where he obtained his B.A Hons and M.A. in economics, before completing his second Masters in Social Sciences at the University of Science, Malaysia in 1978. 

Martin Khor

In his Master’s thesis, he grappled with the changing nature of external dependence and surplus extraction in Malaysia as it moved from colonial to post-colonial status, with a view to its implications for the scope and limits of industrialization and development; a study which left an indelible mark on his subsequent engagement and activities in a world characterised by increasingly asymmetric power relations.  

He started his professional career as an Administrative Officer at the Ministry of Finance, Singapore before joining the University of Science, Malaysia as lecturer in Economics in 1975.   

He became the Research Director of The Consumers’ Association of Penang in 1978, an independent non-profit international research and advocacy organization on issues related to development.

The Third World Network (TWN) was created in 1984 at an international Conference on “The Third World: Development and Crisis” organized by the Consumers’ Association of Penang.   In 1990, Martin became the Director of the TWN, perhaps the most important NGO from the developing world with operations globally, both in the North and the South, through offices, secretariats and researchers, including in Penang, Kuala Lumpur, Geneva, Beijing, Delhi, Jakarta, Manila, New York, Montevideo and Accra.  

Martin’s approach to advancing progressive solutions on all these fronts was always one of quiet determination driven by a passionate commitment to strengthening the voice of developing countries.

He had an envious ability to synthesise and explain complex negotiating issues to a broad audience and in a way that could bring on board activists and policy makers alike

Martin held both positions at the Consumers’ Association of Penang and the TWN until 2009 when he became the Executive Director of the South Centre in Geneva, an intergovernmental organization of developing countries established in 1995 to undertake research in various national and international development policy areas and provide advice and support to developing countries in a variety of international negotiating fora. 

Under his leadership, the South Centre became an important voice in discussions on international trade and investment, intellectual property, health, global macroeconomics, finance, sustainable development, and climate change.

During his tenure, the Centre extended significantly the scope and quality of its policy research and advice, building an enhanced reputation and level of trust among developing countries in the struggles to protect and promote their interests.   After leaving the South Centre in 2018, Martin returned to Penang, already suffering from cancer, and acted as Chairman of the Board of TWN until his death on April 1, 2020.

Martin was a staunch multilateralist but not an advocate of globalization, at least in the neo-liberal guise it acquired from the early 1980s.   On the one hand, he was well aware that individually developing countries could not obtain fair deals with major (and minor) developed countries in the international economic system. 

On the other hand, he knew that multilateral rules and practices were unbalanced, designed to subject developing countries to the discipline of unfettered international markets shaped by transnational corporations and self-seeking policies of dominant powers in the North, denying them the kind of policy space they themselves had enjoyed in the course of their industrialization.  His efforts focussed on reshaping multilateral rules and practices as a way to bring about systemic changes in the service of development.     

Martin did this on three fronts.  From the mid-1980s he focussed mainly on international trade issues, particularly those raised by negotiations during the Uruguay Round, and subsequently in the WTO and the proliferating free trade agreements and bilateral investment treaties that accompanied the shift to a neo-liberal international economic order.

Martin was instrumental in bringing the attention of policy makers and activists to the implications of new trade rules for the industrialization and development of the Global South arising from more demanding obligations on tariff and non-tariff measures, industrial subsidies, investment and intellectual property rights. 

He made several proposals for reform in these areas to remove imbalances and constraints over industrialization, and economic diversification more generally, in the Global South. He opposed free trade agreements with developed countries on the grounds that, by simultaneously curtailing the policy space available to governments while expanding the space for abusive practices by the large international firms that dominate international trade, they posed an even greater threat to development than the earlier generation of trade rules under the GATT.

In the aftermath of the Marrakech agreement, Martin was a prominent figure blocking efforts by OECD countries to push for a multilateral investment agreement, to extend the neo-liberal agenda at the first WTO ministerial in Singapore and subsequently at the third meeting in Seattle and to water down the Doha Development Agenda at the Cancun Ministerial in 2003.

The second front concerned the issues around the operations of the Bretton Woods Institutions, notably debt and development finance.  Martin had been a long-time critic of the Washington Consensus, and in particular, the use of policy conditionalities attached to lending by the IFIs which sought to push a series of damaging measures on developing countries in the name of efficiency, competitiveness and attracting foreign investors.

But he started to pay greater attention to these after the 1997 Asian financial crisis, arguing against austerity, advocating capital controls, orderly debt work-out mechanisms, multilateral discipline over exchange rates and financial policies of major advanced economies and global regulation and supervision of systemically important international financial firms.

He was a particularly strong advocate of these positions in his role as a member of the Helsinki Group on Globalisation and Democracy.  Martin took the helm of the South Centre just before the 2009 Global Financial Crisis hit and was quick to provide substantive assistance to developing countries during the 2009 UN Conference on the World Financial and Economic Crisis and its Impact on Development, identifying the key issues for them and working to ensure their insertion in the Outcome Document.

He continued to push hard on these issues through the research output from the Centre while adding the related areas of illicit financial flows and international tax issues to its workload as developing countries sought support on these matters.

The third, and increasingly prominent, front was climate change and sustainable development which gained added importance in international discussions in the new millennium. Environmental issues had always been part of Martin’s work as head of TWN and as a member of the Commission on Developing Countries and Global Change. 

But this widened significantly after the UN Conference on the Environment and Development in 1992 in Rio de Janeiro. Subsequently, Martin became a member of the Consultative Group on Sustainable Development and a regular attendee at the UN Climate Change Conferences that began in 1995 playing a particularly important role in the Copenhagen COP in 2009 where the neglect of the development dimension by advanced economies, their reluctance to acknowledge common but differentiated responsibilities and their naïve belief in market-friendly solutions to the climate challenge led to acrimonious discussions and the eventual collapse of the conference.

While he clearly recognized the need to reduce the pace of emissions and protect the environment, Martin was wary that the measures promoted by industrial countries could become instruments to stem development in the Global South.  Under his leadership an important part of the work in the South Centre focussed on this issue.

During this time Martin was a strong critic of tighter intellectual property rights, particularly through trade agreements, that restricted the transfer of the technologies developing countries needed to help in the fight against rising global temperatures and to mitigate the climate damage they were already experiencing.

This work had a parallel in Martin’s fight to ease the burden of TRIPs on developing countries in dealing with public health emergencies which, thanks to a successful civil society coalition where Martin was a pivotal figure, eventually succeeded in a permanent amendment to the TRIPs agreement in 2017.

Martin’s support to developing countries in the climate change negotiations, carried out through the South Centre and TWN, fostered greater coordination among developing countries in protecting and promoting their development policy space in the climate negotiations, highlighting equity, and stressing the international obligation of advanced economies to provide support to developing countries.

Martin’s approach to advancing progressive solutions on all these fronts was always one of quiet determination driven by a passionate commitment to strengthening the voice of developing countries.

He had an envious ability to synthesise and explain complex negotiating issues to a broad audience and in a way that could bring on board activists and policy makers alike. He became a trusted advisor to policy makers and diplomats across the developing world.

But Martin was equally comfortable engaging in a productive debate with policy makers from advanced countries and in mainstream institutions.   His was a uniquely calming but authoritative voice for increasingly anxious times, one that has been silenced too soon and at a moment when his commitment to building a fairer and more resilient world was needed more than ever.

Yilmaz Akyüz, Former Director, Globalization and Development Strategies Division, UNCTAD; and Former Chief Economist, South Centre, Geneva.

Richard Kozul-Wright, Director, Globalization and Development Strategies Division, UNCTAD, Geneva. 

Inequality out in the open. Credit: A.D. McKenzie/IPS

By Yilmaz Akyüz
GENEVA, Jan 24 2020 (IPS)

The failure of large-scale bailout operations, historically low interest rates and rapid injection of liquidity to bring about a strong recovery from the 2008-2009 financial crisis and recession created a widespread concern that advanced economies suffered from a chronic demand gap and faced the spectre of stagnation.

The subsequent growth experience has reinforced these concerns.  Since the crisis the US has sustained the longest economic expansion in history, but it is also one of the slowest in terms of income, investment and job creation, lagging other post-war recoveries despite exceptionally favourable monetary policy.

Recovery has been slower and more erratic in Europe. Recently advanced economies have slowed further and global growth in 2019 was the lowest since the financial crisis, intensifying the fear of another recession.

Sluggish investment and growth, rising inequality, low inflation and interest rates, and rapid debt accumulation have become common features of major advanced economies and indeed much of the global economy at large.

These are all interrelated. At the centre of this state of affairs lies inequality ‒ wage suppression and concentration of wealth. It is the main reason for the chronic demand gap, exceptionally low inflation and interest rates, and rapid build-up of debt.

In sharp contrast with a long-standing belief that income shares stay relatively stable in the course of economic growth, there has been a secular downward trend in wage shares in all major advanced economies with real wages falling or lagging behind productivity growth.

In sharp contrast with a long-standing belief that income shares stay relatively stable in the course of economic growth, there has been a secular downward trend in wage shares in all major advanced economies with real wages falling or lagging behind productivity growth

In most countries this started in the 1980s, and continued unabated in the new millennium, both before and after the 2008-2009 crisis.  In China too the wage share started to decline in the 1990s.

Although this was reversed after 2010 as a result of efforts to establish a buoyant domestic consumer market, the wage share in China remains significantly lower than that in major advanced economies.  Wage suppression has been accompanied almost everywhere by growing concentration of wealth, resulting also in greater inequality in the distribution of incomes from assets.

Three factors have played an important role in growing inequality.

First, liberal policies have led to the erosion of labour market institutions, weakening labour while consolidating the power of large corporations.

Second the increased size, scope and influence of finance (financialization) has widened inequality and the demand gap as well as reducing growth potential by diverting resources to unproductive uses.

Finally, globalization has shifted the balance between labour and capital with the integration of China, India and the countries that constituted the Soviet Union into the global economy.

The erosion of labour market institutions and financialization have gone further in the Anglo-American world, and this explains why inequality is greater in the US and the UK than in other major economies.

The growing gap between labour productivity and wages means declines of the purchasing power of workers over the goods and services they produce.  This, together with the increasing concentration of wealth and asset incomes, results in underconsumption.

Although sustained declines in wages would reduce the cost of production and increase the surplus in the hands of the capitalist class, they would also limit the extent of the market since wages are the most important component of aggregate demand.

Wage suppression thus creates the classical-Marxian problem of monetary realization of the surplus ‒ a reason why Keynes also rejected declines in wages as a recipe for unemployment. It adversely affects demand and profits expectations and hinders investment regardless of how low the cost of borrowing is.

Exports can provide a way out.   Until the 2008-2009 crisis, China, Germany and Japan all relied on foreign markets in different degrees to fill the demand gap, using macroeconomic, labour market and exchange rate policies.

GDP grew faster than domestic demand in all three economies thanks to a strong growth in exports. After the crisis China’s exports plummeted and the country first moved to a debt-driven investment bubble and then sought to boost consumption to close the demand gap while moving to a significantly lower growth path.  Germany replaced China as a major surplus country and Japan also increased its reliance on exports to address the demand gap.

However, this solution is not feasible for major underconsumption economies taken together ‒ it faces fallacy of composition and breeds trade conflicts.  The Global South outside China is not big enough to provide an adequate market for the US, Europe, Japan and China.

They would need to run trade deficits in the order of several percentage points of their GDP for each percentage point trade surplus needed to avoid stagnation in the underconsumption economies.  They cannot rely on international capital flows to sustain such deficits.

The alternative is debt-driven expansion.  Sluggish wages reduce price pressures and allow and encourage central banks to create credit and asset bubbles to overcome stagnation without fear of inflation. 

There is indeed a remarkable correlation between the declining wage share and declining interest rates.  In the US over the past three cycles the Fed has been quite restrained in raising policy rates at times of expansion while cutting them drastically during contractions, creating a downward bias in interest rates.

This policy stance creates destabilizing interfaces between debt and interest rates.  Lower wages and subdued inflation lead to lower interest rates which, together with financial deregulation, encourage debt accumulation and asset bubbles.

This, in turn, makes it difficult for central banks to raise policy interest rates without causing disruptions in financial markets, thereby making low interest rates self-reinforcing.  Indeed, the downward bias in interest rates in G7 countries has been associated with a strong upward bias in debt since the mid-1980s, suggesting that ultra-easy monetary policies made possible by wage suppression and low inflation have led to a debt trap.

Financial boom-bust cycles generated by attempts to reignite growth by monetary easing and financial deregulation exacerbate the stagnation problem by creating waste and distortions on the supply side and reducing potential growth.

During booms, the financial sector crowds out real economic activity and cheap credit entails massive capital misallocation, diverting resources to low-productivity sectors such as construction and real estate.

Misallocations created by the booms are exposed during the ensuing crises when the economy would have to make a shift back to viable sectors and companies, but this is often impeded by credit crunch and deflation.

Second, boom-bust cycles also aggravate the demand gap by increasing inequality.  In the US, for instance, the crisis impoverished the poor, particularly those subject to foreclosures, while policy interventions benefitted the rich.  In the recovery, the top one per cent captured almost 60 per cent of total growth.

From 2008 onwards real hourly wages stayed behind hourly labour productivity and the share of wages fell both during the contraction and the subsequent recovery.  Two-thirds of households in 25 advanced economies were in income segments whose market incomes did not advance or were lower in 2014 than they had been in 2005.

These imply that when credit and asset bubbles burst and the economy contracts, even a bigger bubble may be needed for recovery and growth.  In the US the bursting of the Savings and Loans bubble of the 1980s was followed by a bigger technology (dot-com) bubble in the 1990s which ended at the turn of the century, followed by an even bigger subprime bubble and bust, leading to more aggressive interest rate cuts and liquidity expansion.

The past ten years have been relatively calm and stable.  Several instances of heightened market volatility including during the “taper tantrum” of May 2013 and on the eve of the first rise in US policy rates in December 2015 did not lead to a lasting turbulence.

However, this period of tranquillity has encouraged excessive risk taking and a rapid build-up of debt, thereby sowing the seeds of future instability, very much as during the so-called Great Moderation preceding the Great Recession.

Permanently low interest rates and massive injection of liquidity have led to a search for yield in high-risk, high-return assets globally.  Starting with the US, major stock markets have reached record highs and global debt has shot up to exceed $255 trillion or 320 per cent of world GDP in 2019.

Emerging economies, in particular, have seen a rapid build-up of private debt in reserve currencies and increased penetration of their markets by international capital and firms, heightening their external vulnerabilities and entailing large transfer of resources to advanced economies through financial channels.

As recognized by the World Bank, despite exceptionally low interest rates, this wave of debt accumulation could follow the historical pattern and eventually end in financial crises.

In the next global economic downturn, an important part of the debt accumulated in the past ten years could become unpayable, leading to debt deflation and asset price declines.  The central banks would no doubt try to respond in the same way as they did during the 2008-2009 crisis.

But the scope for cuts in interest rates are now limited because they are at very low levels and there is already plenty of cheap money in the system.  These may severely compromise their ability to stabilize the economy.

A countercyclical Keynesian fiscal reflation may save the day, but much more would be needed to address the structural demand gap and its underlying causes: a permanently bigger government financed by progressive income and wealth taxes and money printing; greater state ownership of productive assets and control over economic activity; income redistribution through the budget; a level playing field between labour and capital; a shift to wage-led growth; and taming financial capital.

Excerpt:

By Yilmaz Akyüz
GENEVA, Feb 6 2019 (IPS)

At a time when the world economy is seen poised for yet another financial turmoil, there is a widespread recognition that emerging economies (EMEs) are particularly vulnerable because of their deepened integration into the global financial system.   What is less appreciated is the implication of financial globalization and integration for external wealth distribution between emerging and advanced economies and resource transfers from the former to the latter.

This is the subject matter of a new study by this author on external balance sheets of emerging economies, focussing on nine G-20 EMEs (Argentina, Brazil, China, India, Indonesia, Mexico, Russia, South Africa and Turkey) and four major advanced economies, the US, Japan, Germany and the UK.

The new millennium has seen a rapid increase in gross external assets and liabilities of EMEs, both as a result of ultra-easy monetary policy in major advanced economies (AEs) and capital account liberalization in EMEs ‒ a process of deepened integration described as Playing with Fire.

Almost 90 per cent of outstanding external assets and liabilities of G-20 EMEs have been accumulated since the turn of the century.  Although debtor-creditor relations and foreign direct investment (FDI) within the Global South have been growing rapidly, a very large proportion of gross external assets and liabilities of EMEs are still with AEs.  This is true not only for financial assets and liabilities but also for FDI. Even in China less than 20 per cent of the stock of outward FDI are in other EMEs.

Yilmaz Akyüz

While foreign investment and lending in EMEs have reached unprecedented levels, even EMEs with current account deficits have been able to accumulate large amounts of gross external assets because inflows of capital have often exceeded what is needed to finance deficits.  In fact, with the exception of China and Russia, which have run current account surpluses since 2000, the entire foreign assets accumulation in G20 EMEs has relied on borrowed money, resulting in significant leverage in external balance sheets.

There are also significant changes in the structure of external balance sheets of EMEs.  The share of equities (FDI plus portfolio equity) in total external liabilities increased and the share of debt declined as governments sought to shift from debt to equities by opening up equity markets and liberalizing FDI regimes on grounds that equity financing is more stable and less risky than debt.

The share of equities in gross external assets also increased, but not as fast as in liabilities. Consequently, the net equity position (external equity assets minus liabilities) of G20 EMEs taken together, which was already negative at the beginning of the century, deteriorated further.

The share of international reserves in total external assets increased rapidly as countries sought to build self-insurance against speculative attacks, often with borrowed money.  The share of local currency in external sovereign debt increased as bond markets have been opened to foreigners to pass the currency risk. But the corporate sector has come to account for a growing part of external debt of EMEs by increasingly borrowing in international markets in dollars to benefit from lower rates.

These changes in the size and composition of external balance sheets of EMEs have not only generated new channels of transmission of external financial shocks (discussed in Playing with Fire), but also resulted in significant transfer of resources from EMEs to AEs.

Resource transfers from the South to the North through financial channels will continue unabated as long as capital flows remain unrestricted, the international reserves system favours a handful of rich countries which can also pursue self-seeking policies without regard to their global repercussions.

First, they have rendered the value of their existing stocks of external assets and liabilities more susceptible to changes in global financial conditions, notably asset prices and exchange rates, leading to capital gains and losses and altering their net foreign asset positions (NFAP or net external wealth, that is, the difference between gross external assets and liabilities).

Over the short term, these valuation changes can be much more important than current account balances in the movement of NFAP, particularly at times of severe instability as was seen during 2008-09. Since foreign assets and liabilities of EMEs are mainly with AEs, these gains and losses entail redistribution of external wealth between the Global South and the North.

Indeed, there is a strong negative correlation between year-to-year changes in net external wealth of nine G20 EMEs and four major AEs in the new millennium and a large proportion of such changes is accounted for by capital gains and losses rather than current account balances.

In the long-term current account remains a main determinant of net external wealth of nations, but capital gains and losses resulting from valuation changes can also be important.   Since the beginning of the century the NFAP of most G-20 EMEs deteriorated because of sustained current account deficits.

The NFAP of two surplus EMEs, China and Russia, improved, but not as much as their cumulative current account surpluses because they both suffered large amounts of capital losses on their outstanding external assets and liabilities.

For instance, China had a cumulative current account surplus of over $3 trillion during 2000-2016 but its net external wealth increased by only $1.6 trillion. By contrast the US had a cumulative current account deficit over $8 trillion during the same period but its net external debt deteriorated by less than $7 trillion because of capital gains. Even though some smaller G-20 EMEs also had capital gains, the nine EMEs taken together suffered capital losses in the order of $1.9 trillion during 2000-2016 while the four AEs enjoyed capitals gains over $1.6 trillion.

Second, with the expansion of gross foreign assets and liabilities, international investment income receipts and payments have gained added importance in the current account. Generally, EMEs are red in net international investment income not only because their external liabilities exceed assets, but also because the rate of return on their foreign assets falls short of the rate of return on their foreign liabilities.

Their liabilities are concentrated in high-yielding equities while a large proportion of their assets consists of low-yielding reserve assets. For this reason, even some EMEs with positive net external wealth positions such as China and Russia have deficits in net international investment income.

Furthermore, all EMEs including China earn lower return on their outward FDI than they pay on inward FDI. They also pay more on their external debt liabilities in risk premia than they receive on their external debt assets including reserves (US Treasuries), other bonds or deposits abroad.  The shift to domestic currency debt by governments of EMEs has widened the return gap between debt liabilities and assets because the exchange rate risk assumed by foreign investors needs to be compensated.

By contrast, the return differential between external assets and liabilities is positive for all four major AEs.  The US registers the highest positive return differential and runs a surplus on its international investment income balance despite having a negative net external wealth in the order of some 25 per cent of its GDP.

The return on its outward FDI is higher than in all other countries and exceeds by a large margin the return it pays on its inward FDI. As the country issuing the dominant reserve currency, the US also earns higher return on its external debt assets than it pays on its external debt liabilities (mainly Treasuries), thereby enjoying what is commonly known as “exorbitant privilege”.

The nine G-20 EMEs taken together have been transferring around 2.7 per cent of their combined GDP per year in the new millennium mainly to AEs as a result of the negative return gap between their foreign assets and liabilities and capital losses resulting from changes in asset prices and exchange rates.

These resource costs are incurred in large part because EMEs favour a particular structure of external balance sheets (highly liquid low-yielding assets, less liquid high-yielding liabilities) that is believed to be more resilient to external financial shocks.

This means that, in effect, EMEs are transferring large sums of resources to AEs in order to protect themselves against the shocks created mainly by policies of the very same countries. This is underpinned by an international reserves system that allows a handful of reserve-issuing countries, notably the US, to constantly extract resources from the rest of the world.

On the other hand, it is not clear if EMEs can adequately protect themselves against shocks when capital can move freely. Judicious use of capital account measures can secure reasonable protection while avoiding such costs.

For instance, one would not need to issue high-yielding liabilities to acquire large stocks of low-yielding reserves assets as self-insurance if inflows of fickle capital are effectively controlled.

Resource transfers from the South to the North through financial channels will continue unabated as long as capital flows remain unrestricted, the international reserves system favours a handful of rich countries which can also pursue self-seeking policies without regard to their global repercussions.

Excerpt:

By Yilmaz Akyüz
GENEVA, Aug 28 2018 (IPS)

The meltdown of the Turkish currency over a matter of a few days in August 2018 has elicited various reactions and interpretations both at home and abroad, and created widespread concern that it could mark the beginning of a series of crisis in emerging economies exposed to a reassessment of risks by international investors and lenders as well as a rapid normalization of monetary policy in the United States.

Some commentators have attributed the crisis to the sanctions imposed by the Trump administration discontent with the foreign policies pursued by Turkey on many fronts.  The Erdogan government has been too happy to put the blame on “the economic warfare launched by the United States”, rather than years of misguided policies that rendered the economy highly susceptible to political and economic shocks.  It has even enjoyed support from some western governments weary of Trump’s errant foreign policy. Others drew parallels with previous crises in emerging economies, notably the East Asian crisis, placing particular emphasis on the role of external debt in dollars, notably excessive short-term borrowing.

Yilmaz Akyüz

In reality Trump sanctions only acted as a trigger as the economy was sitting on a time bomb.  The currency was already under pressure before the sanctions came into force because of growing awareness of the fragility of the economy.  The lira had lost a quarter of its value against the dollar between January and July 2018.

On the other hand, there are some crucial differences between the underlying vulnerabilities culminating in Turkish and East Asian crises, particularly with respect to the size of current account deficits, the foreign presence in domestic securities, credit and deposit markets, the extent of dollarization and the scope for capital flight by residents.  In all these respects Turkey has been much more vulnerable to currency turmoil than were the East Asian economies in the 1990s.

In a book published by OUP last year, I identified Turkey as the most fragile emerging economy highly vulnerable to external financial crisis after examining, as of end 2013, various sources of potential pressure on its currency and drain on its international reserves in the event of a sharp turnaround in market sentiments and a sudden stop of capital inflows.  It was clear that in such an event, Turkey could not at the same time finance its current account deficit, remain current on its external debt payments in dollars and allow a rapid exit of non-resident portfolio investors from domestic financial markets even in the absence of capital flight by residents.  It was also remarked that capital flight for residents often constituted greater pressure on the currency and international reserves. This was a serious potential threat in Turkey as residents could freely buy and sell dollars, hold forex deposits in local banks and transfer their assets abroad.

The economy has become even more fragile since then.  The current account deficit has remained unchecked as the government sought consumption/construction-led, debt-driven economic expansion which has added very little to productive capacity and export potential.  Persistent deficits have been financed by massive sale of national assets and external borrowing, leading to a rapid deterioration of the net international investment position, from around ‒42 per cent of GDP in 2013 to over ‒54 per cent by 2018.

External debt as a proportion of GDP rose from 41 per cent in 2013 to 63 per cent on the eve of the crisis.  A large proportion of this debt, over 25 per cent of GDP, had a remaining maturity of up to one year. The sum total of short-term debt and current account deficits was more than twice as much as international reserves.  Furthermore, the presence of non-resident portfolio investors in domestic markets became more visible and capital flight by residents remained an even more serious source of pressure on the currency and reserves for political as well as economic reasons.

Turkey, as most other major emerging economies, is highly averse to recourse to the IMF for international liquidity because of its appalling record in interventions in past crises in emerging economies

Sovereign external debt now accounts for some 20 per cent of the total while the rest is equally divided between banks and non-financial corporations.  The latter have been allowed to borrow in dollars both at home and abroad irrespective of their potential to earn foreign currency to service it. Such debt poses greater threat to stability than sovereign debt since, at times of currency turmoil, private debtors attempt to close their open positions by purchasing foreign currency in order to avoid further losses and this in turn accelerates the decline of the currency.

Turkey has thus practised an extreme form of laissez faire in financial affairs and, in effect, become a highly dollarized, dual-currency economy.  Not only liabilities and assets are increasingly denominated in the dollar, but also an important part of property prices, incomes and rents, as well as government contracts in public private partnership projects are fixed in dollars.

In such an economy, a significant loss of confidence can exert intense pressure on the currency irrespective of volume and terms of external debt.  With Trump sanctions the lira started a free fall primarily because of flight of residents, both asset holders and dollar debtors, from the currency, sudden stop of capital inflows and the exit of non-residents from local markets.  Besides, the decline was accentuated by speculators, shorting liras in swap operations in anticipation of a significant drop in the currency. The short-term dollar debt to international creditors has not yet come into play. Still, the outcome has been steep falls in the lira and stocks and a hike in yields on local-currency sovereign debt.  The cost of insuring Turkish debt (Credit Default Swaps – CDS) has shot up, reaching 500 basis points compared to 240bp for Brazil and 315bp for Greece.

In view of stern opposition of the President, the Central Bank avoided a hike in lending rates, but closed its low-cost repo funding, forcing banks to borrow at its more expensive overnight rate ‒ something aptly described as “stealth” tactic to hike borrowing costs.  Further, it has limited currency swap transactions to curb speculation against the lira.

Turkey, as most other major emerging economies, is highly averse to recourse to the IMF for international liquidity because of its appalling record in interventions in past crises in emerging economies.  As anticipated in an earlier IPS article, it thus sought help from its close allies, securing a pledge of $15 billion from Qatar.

These measures, together with 9-days respite from Muslim Eid Al-Adha brought some calm to currency and financial markets.  But all is not over yet. The underlying structural fragilities remain unabated and cannot be remedied overnight because they involve severe balance sheet distortions and imbalances.

Even if the lira remains relatively stable from now on, the sharp decline it has so far undergone ‒ by some 40 per cent since the beginning of the year ‒ could impinge heavily on unhedged debtors, resulting in serious debt servicing difficulties and even defaults.  As Bloomberg reports the CDS curve is inverted ‒ as it was in Greece in the worst days of its debt crisis ‒ not only for sovereign debt but also for the debt of some of the biggest commercial banks; that is, it costs more to insure one-year default than to buy five-year protection.  This suggests that markets are expecting imminent debt-servicing difficulties.

As loans and bonds mature in coming months, the country may find it very difficult to persuade creditors to roll over debt or to replace maturing bonds with new ones even at significantly higher rates.  An important part of syndicated bank loans is due for renewal in September 2018. The dispute with the US involving the state-owned Halkbank over Iranian sanctions can make the renewal process complicated (I thank Hakan Ozyildiz for this point).  Thus, with short-term debt coming into play, the crisis could cease to be a currency crisis but a full-blown debt and banking crisis, leading to a deep and protracted economic contraction.

The crisis could also generate severe contagion to the rest of the world.  Defaults by Turkish debtors could squeeze some European creditors, mainly a number of banks in Spain, Italy and France who have relatively high exposure directly or through subsidiaries in Turkey.  This would also have a serious impact on global risk appetite. A sharp reassessment of risks, together with monetary tightening in the US and Trump follies in trade, could wreak havoc in several emerging economies who have gone out of bounds in the years of easy money since 2008.

When so many policy mistakes are committed and so much debt is accumulated and assets are lost, there is no easy way out.  But, it is always possible to ease the pain. It is not clear if the Turkish government will be able to move from populist rhetoric to effective economic measures to address the root causes of the crisis.  On the other hand, should the crisis spread globally, the international community is unlikely to be able to manage it in an orderly and equitable way, rather than muddling through it as in the past, because it is no more prepared to respond to such crises than it had been in previous episodes.

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A group of demonstrators protest in the Argentine city of Rosario against the wave of lay-offs of public employees since President Mauricio Macri took office. Credit: Courtesy of Indymedia.org

By Yilmaz Akyüz
GENEVA, Jun 5 2018 (IPS)

It is now more than a decade and a half since the last severe currency crisis in a major emerging economy ‒ that was in Argentina in 2001-2002 following a series of crises in Russia, Turkey and Brazil.  It is now common knowledge that such crises generally occur when countries fail to manage surges in capital inflows so as to prevent build-up of fragility including currency appreciations, large and persistent current account deficits, increased leverage and currency and maturity mismatches in balance sheets.  

The absence of a major crisis in the Global South since the early years of the new millennium owes not so much to judicious management of the surge in capital inflows that had begun in the early 2000s and continued with full force after the global financial crisis, as to persistently benign global financial conditions resulting from exceptional monetary policies in the US, Europe and elsewhere in advanced economies and favourable global risk appetite.

Even though there has been no fundamental reversal of these policies, the arrival of Minsky moment appears to be imminent with markets, in expectations of normalization of monetary policy in the US, getting nervous about the risks they have taken by investing heavily in emerging economies with poor economic fundamentals in search for yield in conditions of low global interest rates and ample supply of liquidity.

Yilmaz Akyüz, chief economist of the South Centre, Geneva.

The first serious signs have appeared in Argentina with the recently elected government of Macri knocking on the doors of the IMF. But Argentina is perhaps only the tip of an iceberg. Several other emerging economies are equally and even more susceptible to sudden stops and reversals of capital flows and currency and balance of payments crises.

In typical IMF interventions in previous crises, liquidity support was provided mainly to keep debtor countries current on their payments to international creditors and to maintain the capital account open.  As a result, obligations to private creditors were translated into debt to the IMF. Simultaneously, austerity was imposed on debtors by means of hikes in domestic interest rates, fiscal retrenchment, cuts in employment, wages and pensions in order to achieve a sharp turnaround in the current account, primarily through import compression, and to restore confidence among international creditors and investors.

This approach to crisis management was widely criticised on several grounds.  A strong case was made that the combination of debtor austerity and creditor bailout would lead to inequality between debtors and creditors in the incidence of the burden of the crisis, create moral hazard by allowing creditors to avoid the full consequences of the risks they have taken and are paid for, and endanger the financial integrity of the Fund.

Inequalities could also be created among creditors; in the event of a default and restructuring, those who exit first could escape without haircut, leaving the others to take the full brunt of debt write-offs. Profit opportunities are also created for vulture funds, at the expense of genuine creditors as well as the debtor, as seen in the case of Argentina.

Considerable scepticism was also expressed within the Fund about the wisdom of using public money to bail out private creditors and investors.  During the earlier episodes of crises, the IMF Board recognized the need for involving the private sector in forestalling and resolving financial crises, but insisted on voluntary mechanisms, notably collective action clauses (CACs) and automatic rollover clauses in debt contracts and informal negotiations between debtors and creditors.

However, as these proved ineffective and some advanced economies started to oppose bailouts, the IMF Board agreed that in extreme circumstances, if it is not possible to reach agreement on a voluntary standstill, members may find it necessary, as a last resort, to impose one unilaterally, and that since there could be a risk that this action would trigger capital outflows, a member would need to consider whether it might be necessary to resort to the introduction of more comprehensive exchange or capital controls.

No protection against litigation was offered, but it was suggested that the Fund could signal its acceptance of a standstill imposed by a member by lending into arrears to private creditors.  The Fund staff went further and proposed a formal Sovereign Debt Restructuring Mechanism (SDRM) to facilitate sovereign bond workouts.  However, this did not elicit adequate support and had to be abandoned. The issue was soon forgotten with a rapid recovery of capital inflows to emerging economies and bounce back of economic activity in crisis-hit countries.

However, private sector involvement in crisis resolution was back on the agenda again with the onset of the Eurozone crisis.  The Fund turned its attention to sovereign debt restructuring after misjudging the sustainability of the Greek debt, very much in the same way as it had done with Argentina about a decade earlier, pouring in money to bail out private creditors.

It restarted searching ways and means for involving the private sector in crisis resolution so as to “limit the risk that Fund resources will simply be used to bail out private creditors” and to ensure that private creditors made some concessions and took some losses on their holdings as a condition for Fund lending.

Subsequently it was suggested that the sovereign approaching the Fund for assistance were to be asked to find ways of rolling over all bonds and commercial loans falling due within the life of the Fund programme.  This would be necessary whether external payments difficulties are perceived to be as one of liquidity or solvency which is often difficult to identify with a reasonable degree of precision ex ante.

This so-called “reprofiling” was again to be market-based and voluntary.  However, no statutory mechanism was proposed for bailing in the private creditors in the event of failure of a voluntary agreement.  In such an event, as long as the IMF stood firm in refusing lending without private sector involvement, the debtor would have had no option but to impose unilateral standstills on its obligations to private creditors, but without any statutory protection against litigation.  Although various proposals were made outside the Fund to address the holdout problem and protect debtors against litigation, the matter was once again put aside without being resolved.

The stakes are now getting higher because of massive amounts of external liabilities that emerging economies built up in the past ten years.  These are not only in debt contracted in reserve currencies, notably by private corporations, but also unprecedented amounts of foreign holdings in local deposit, bond and equity markets.

Furthermore, most emerging economies have eliminated or significantly reduced restrictions over capital outflows by residents. Consequently, exit of nonresidents from local markets and capital flights by residents now constitute bigger sources of potential drain on reserves of emerging economies than external debt contracted in reserve currencies.

Emerging economies are widely commended for large amounts of international reserves they have accumulated in the new millennium.   However, in the large majority of cases these came from capital inflows rather than current account surpluses. Cumulatively, all G20 emerging economies except China and Russia have registered current account deficits since the beginning of the millennium, at a total amount of some $2 trillion while their external labilities have increased by over $4 trillion.

Reserves accumulated is less than a quarter of the increase in total liabilities while the rest of capital inflows (new liabilities) has been used for financing current account deficits or private acquisition of assets abroad – assets that would not necessarily return at times of interruption and reversal of non-resident capital inflows.

As of end 2016, on average, the reserves of deficit G20 emerging economies were less than one-third of their total non-FDI external liabilities including debt issued internationally and non-resident holdings in local deposits, bonds and equities.   In many cases these holdings plus short-term forex debt reach or exceed international reserves. In most cases reserves would be totally inadequate to provide a reliable buffer against a generalized exit of non-residents and a widespread capital flight by residents.

Given the dismal record of the IMF in crisis intervention and management, many emerging economies are loath to go back to the IMF in the event of a severe currency and liquidity crisis, except those such as Argentina whose neo-liberal policies are strongly supported by the IMF.  In any case at some $800 billion, the lending capacity of the IMF would be too small to take on the task. The level of liquidity that may be needed by many emerging economies in the event of capital reversals exceed by a large margin what the IMF could provide under exceptional financing.

Most emerging economies would also be highly reluctant to resort to unilateral debt standstills and exchange controls in view of their exposure to creditor litigation and chronic dependence on international lenders and investors.  On the other hand, not much relief could be expected from South–South multilateral arrangements for liquidity provision, notably the Chiang-Mai Initiative Multilateralization (CMIM) of East Asian countries and the Contingent Reserve Arrangement (CRA) of BRICS.

These are not only small in size but also have design problems. The CMIM has never been called upon, even during the global crisis. It does not include a common fund but a series of promises to provide liquidity, with each country reserving the right not to contribute to the specific request by a member.  Its size is $240 billion and access beyond 30 per cent of quotas is tied to an IMF program.

The CRA is also designed to complement rather than substitute the existing IMF facilities. Its size is even smaller, $100 billion, and access beyond 30 per cent is also tied to the conclusion of an IMF programme. Thus, these regional arrangements do not provide escape from IMF conditionality and surveillance.

That leaves bilateral swaps among central banks and bilateral lending by governments of reserve-currency countries, notably the US, and surplus emerging economies with ample international reserves such as China.  A very large part of bilateral swaps established by the US Federal Reserve is with other advanced economies.

Those with emerging economies (Brazil and Mexico) are too small to provide much relief.   In the words of the former chair of the US Federal Reserve, Janet Yellen, expanding the swap lines to serve as a safety net for countries encountering balance of payments pressures is not within the Fed’s mandate and therefore is a complete non-starter.  China has swaps with over 30 countries. But these are mostly with advanced economies and designed to support trade and investment and to promote the international use of renminbi rather than boost reserves.

To sum, as recognised by the IMF, the global financial safety net including international reserves, Fund resources, bilateral swap arrangements, regional financing arrangements is “fragmented with uneven coverage” and “too costly, unreliable and conducive to moral hazard”.

Given the aversion of emerging economies to the IMF and unilateral debt standstills and exchange controls, the next crisis is likely to be even messier than the previous ones. Some countries may seek and succeed in getting bilateral support from China or some reserve-currency countries according to their political stance and affiliation.

For instance, one of the most vulnerable emerging economies, Turkey, is likely to approach China, Russia or some Gulf states with strong reserve positions rather than the IMF if its currency goes into a free fall. In such cases, crisis intervention would become even more politicised than in the past and a lot less reliant on multilateral arrangements.

By failing to establish an orderly and equitable system of crisis resolution, the IMF may very well find its role significantly diminished in the management of the next bout of crises in emerging economies. In other words, multilateralism, however imperfect, could face another blow in the sphere of finance after trade.

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Asset and currency markets of all emerging economies with strong international reserves and investment positions, including China, have been hit on several occasions in the past ten years. Office buildings at night, Hong Kong - Credit: Bigstock

By Yilmaz Akyüz
GENEVA, Switzerland, Jul 27 2017 (IPS)

Debates are taking place on whether there will be another financial crisis, whether in some part of the world or that is global in scope.  Governments draw lessons from financial crises to adopt measures to prevent their recurrence.  However, such measures are often designed to address the root causes of the last crisis but not the next one.  More importantly, they can actually become the new sources of instability and crisis. 

Much of what has recently been written about the Asian crisis on the occasion of its 20^th anniversary praises the lessons drawn and the measures implemented thereupon.  But they often fail to appreciate that while these might have been effective in preventing the crisis in 1997, they may be inadequate and even counterproductive today because they entail deeper integration into global finance.

An immediate step taken in Asia was to abandon currency pegs and move to flexible exchange rates in order to facilitate external adjustment and prevent one-way bets for speculators.  This has a lot to commend it, but its effects depend on how capital flows are managed.

Under free capital mobility no regime can guarantee stable rates.  Currency crises can occur under flexible exchange rates as under fixed exchange rates.   Unlike fixed pegs, floating at times of strong inflows can cause nominal appreciations and encourage even more short-term inflows.  Indeed nominal appreciations have been quite widespread during the surges in capital inflows in the new millennium, including in some East Asian economies.

Second, most emerging economies, including those in Asia, have liberalized foreign direct investment regimes and opened up equity markets to foreigners on the grounds that equity liabilities are less risky and more stable than external debt.  As a result, non-resident holdings as a percent of market capitalization have reached unprecedented levels, ranging between 20 and 50 per cent compared to 15 per cent in the US.

This has made the emerging economies highly susceptible to conditions in mature markets.  Since emerging economies lack a strong local investor base, the entry and exit of even relatively small amounts of foreign investment now result in large price swings.

Yilmaz Akyüz, chief economist of the South Centre, Geneva.

Third, they have also sought to reduce currency mismatches in balance sheets and exposure to exchange rate risk by opening domestic bond markets to foreigners and borrowing in their own currencies.  As a result sovereign debt in many emerging economies is now internationalized to a greater extent than that in reserve-currency countries.

Whereas about one-third of US treasuries are held by non-residents, this proportion is much higher in many emerging economies, including in Asia.  Unlike US treasuries this debt is not in the hands of foreign central banks but in the portfolios of fickle investors.

Although opening bond markets has allowed the sovereign to pass the currency risk to lenders, it has led to loss of autonomy over domestic long-term rates and entailed a significant exposure to interest rate shocks from the US.  This could prove equally and even more damaging than currency exposure in the transition of the US Fed from low-interest to high-interest regime and normalization of its balance sheet.

Fourth, there has been extensive liberalization of the capital account for residents.  Corporations have been encouraged to become global players by borrowing and investing abroad, resulting in a massive accumulation of debt in low-interest reserve currencies since 2008.

They have also borrowed through foreign subsidiaries.  These are not always repatriated and registered as capital inflows and external debt, but they have a similar impact on corporate fragility.  Hence the reduction in currency mismatches is largely limited to the sovereign while private corporations carry significant exchange rate risks.

Fifth, limits on the acquisition of foreign securities, real estate assets and deposits by resident individuals and institutional investors have been raised or abolished.  A main motive was to relieve upward pressures on currencies from the surge in capital inflows.  Thus, liberalization of resident outflows was used as a substitute to restrictions over non-resident inflows.  Although this has led to accumulation of private assets abroad, these would not be readily available at times of capital flight.

Sixth, banking regulations and supervision have no doubt improved, restricting currency and maturity mismatches in bank balance sheets.  However, banks now play a much less prominent role in the intermediation of international capital flows than in the 1990s.  International bond issues by corporations have grown much faster than cross-border bank lending directly or through local banks and a very large part of capital inflows now goes directly into the securities market.

These measures have failed to prevent credit and asset market bubbles in most countries in the region.  Increases in non-financial corporate debt since 2007 in Korea and Malaysia are among the fastest, between 15 and 20 percentage points of GDP.  At around 90 per cent of GDP Malaysia has the highest household debt in the developing world.  In Korea the ratio of household debt to GDP is higher than the ratio in the US and the average of the OECD.

International Reserves

Asian economies, like many others, are commended for building self-insurance by accumulating large amounts of international reserves.  Moreover, an important part of these came from current account surpluses, not just capital inflows.  Indeed, all countries directly hit by the 1997 crisis made a significant progress in the management of their external balances in the new millennium, running surpluses or keeping deficits under control.

However, whether or not these reserves would be sufficient to provide adequate protection against massive and sustained exit of capital is highly contentious.  After the Asian crisis, external vulnerability came to be assessed in terms of adequacy of reserves to meet short-term external debt in foreign currencies.

However, there is not always a strong correlation between pressure on reserves and short-term external debt.  Often, in countries suffering large reserve losses, sources other than short-term foreign currency debt play a greater role.  Currencies can come under stress if there is a significant foreign presence in domestic deposit and securities markets and the capital account is open for residents.

A rapid and generalized exit could create significant turbulence with broader macroeconomic consequences, even though losses due to declines in asset prices and currencies fall on foreign investors and mitigate the drain of reserves.

In all four Asian countries directly hit by the 1997 crisis, international reserves now meet short-term external dollar debt.  But they do not always leave much room to accommodate a sizeable and sustained exit of foreign investors from domestic securities and deposit markets and capital flight by residents.

This is particularly the case in Malaysia where the margin of reserves over short-term dollar debt is quite small while foreign holdings in local securities markets are sizeable.  Indeed its currency has been under constant pressure since mid-2014.  As foreign holders of domestic securities started to unload ringgit denominated assets, markets fell sharply and foreign reserves declined from over $130 billion to $97 billion by June 2015.  In October 2015 the ringgit hit the lowest level since September 1998 when it was pegged to the dollar.  Currently it is below the lows seen during the turmoil in January 1998.

Deepening integration into the inherently unstable international financial system before attaining economic and financial maturity and without securing multilateral mechanisms for orderly and equitable resolution of external liquidity and debt crises could thus prove to be highly costly.
In Indonesia reserves exceed short-term dollar debt by a large margin, but foreign holdings in its local bond and equity markets are also substantial and the current account is in deficit.  The country was included among Fragile 5 in 2013 by Morgan Stanley economists for being too dependent on unreliable foreign investment to finance growth.

Capital account regimes of emerging economies are much more liberal today both for residents and non-residents than in the 1990s.  Asset and currency markets of all emerging economies with strong international reserves and investment positions, including China, have been hit on several occasions in the past ten years, starting with the collapse of Lehman Brothers in 2008.

The Lehman impact was strong but short-lived because of the ultra-easy monetary policy introduced by the US.  Subsequently these markets came under pressure again during the ‘taper tantrum’ in May 2013 when the US Fed revealed its intention to start reducing its bond purchases; in October 2014 due to growing fears over global growth and the impact of an eventual rise in US interest rates; in late 2015 on the eve of the increase in policy rates in the US for the first time in seven years.

These bouts of instability did not inflict severe damage because they were temporary, short-lived dislocations caused by shifts in market sentiments without any fundamental departure from the policy of easy money.  But they give strong warnings for the kind of turmoil emerging economies could face in the event of a fundamental reversal of US monetary policy.

Should self-insurance built-up prove inadequate, economies facing large and sustained capital flight would have two options.  First, seek assistance from the IMF and central banks of reserve-currency countries.  Or second, engineer an unorthodox response, even going beyond what Malaysia did during the 1997 crisis, bailing in international creditors and investors by introducing, inter alia, exchange restrictions and temporary debt standstills, and using selective controls in trade and finance to safeguard economic activity and employment.

The Asian countries, like most emerging economies, seem to be determined not to go to the IMF again.  But, serious obstacles may be encountered in implementing unilateral heterodox measures, including creditor litigation and sanctions by creditor countries.  Deepening integration into the inherently unstable international financial system before attaining economic and financial maturity and without securing multilateral mechanisms for orderly and equitable resolution of external liquidity and debt crises could thus prove to be highly costly.

This paper draws on a recent book by the author; Playing with Fire: Deepened Financial Integration and Changing Vulnerabilities of the Global South, Oxford University Press, 2017. 

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By Yilmaz Akyüz
GENEVA, Apr 26 2016 (IPS)

The US was the cause of the crisis but has come out better than anyone else in the advanced world and better than many developing countries. During the crisis there was a widespread perception that this was the end of US hegemony. It was end of the dollar as the major reserve currency.

Yilmaz Akyuz

The US economy is also fragile. Usually economic expansions are often followed by contractions. This is part of the capitalist system working in boom bust cycles. The US has had 24 quarters of expansion since the beginning of the crisis. And a lot of people think simply on this observation that after such expansion US recovery or growth is supposed to come to an end on historical evidence.

But apart from that? It is very difficult to get out of the policies that US introduced in response to the crisis. It does not know how to get out of the policy of easy money. It is very hesitant in raising interest rates. But on the other hand if there is a slowdown in the US and a contraction and renewed instability they do not have any ammunition to respond to it, because they used all their ammunition to respond to the last crisis and they are still using the same except in bond purchases

We have not had a serious debt crisis in an emerging economy in the past 10 – 12 years. However, the risks are very serious now. The world is caught in a debt trap today. Why? Because the resolution of the European and American crisis – which was a debt crisis – required cutting debt. But what we have seen is that the policies implemented to resolve that crisis have given rise to the accumulation of additional debt.

In the US, the ratio of public plus private debt to gross domestic product (GDP) increased from 200% to 280%. In Japan it increased to 500%; in the Eurozone and China it doubled. And in developing countries today it is close to 200% of GDP.

The current situation has an uncanny similarity to the 1970s and 1980s. Developing countries had a boom in commodity markets in the 70s which was accompanied by massive international lending by banks recycling petrodollars [oil surpluses]. And this twin-boom in commodities and capital flows to developing countries in the 70s ended up with a bust when the US raised interest rates in 1979 and 1980. And what we had was a debt crisis in Latin America. And the situation now is somewhat similar. We had a twin boom in commodity prices and capital flows and now we have come to the end of this boom even without the US changing its monetary policy in a big way. And the question is will the outcome be the same as in the 1970s?

We are highly vulnerable to the reversal of commodity prices and capital flows. The vulnerability to commodity prices nevertheless varies among developing countries because different types of commodities fell at different rates. Some developing countries benefit from commodity price declines but no developing country would benefit from tightening of the external financial situation. Now we cannot count on reserves. Traditionally we look at the reserve adequacy in terms of their volume relative to short-term external debt, but now there is a strong presence of foreigners in domestic bond, equity and deposit markets and their exit can cause significant turmoil.

Monetary policy now faces a major dilemma. In order to stimulate demand and growth we have to cut interest rates. A cut in interest rates can trigger capital outflows. So there is a dilemma between growth and stability. If we face a liquidity crisis we no longer have enough reserves to meet our imports and stay current on our debt payments and keep the capital account open – what do we do? Business as usual? Borrow from the IMF? Keep the capital account open? Continue allowing capital to run out, using reserves and the borrowing from the IMF and practicing austerity?

Now I think there is a strong misgiving vis-à-vis the IMF among the developing countries. And I am sure they will do their best to avoid going to the IMF in the event of a serious liquidity crisis. I am not referring to a solvency crisis, default – I am talking about simple liquidity crisis when you do not have enough foreign exchange to meet your current account needs and debt payments. Then what do you do?

Of course, the unorthodox response is to use reserves to support one’s economy, imports, not to support capital outflows. Are we prepared to impose controls over capital outflows? Are we prepared to impose temporary debt standstills? Or, are we prepared to impose austerity on creditors and investors rather than austerity on the people? These are the critical issues.

In conclusion, even if we avoid a fully-fledged financial crisis, the prospects are for sluggish, erratic growth and heightened instability in the global economy. Why? Because of financial excesses we have had in the past 8-9 years. And one cannot easily restructure balance sheets; that is the problem. We need to have a better policy mix than we have been using.

A few suggestions. First, stop relying on easy money which is not good except for speculation in advanced economies, abandon fiscal orthodoxy, invest in infrastructure and create jobs and create demand. Secondly, we need better control over international capital flows not only by recipient countries but also by source countries. Because they are most destabilizing. They are at the heart of the current difficulties that we face. Third, we need a mechanism for adequate provision of international liquidity and finally we need effective and equitable debt resolution mechanisms.

Now these issues should be studied and debated extensively, particularly at the current juncture. But unfortunately Bretton Woods institutions are not the best place to do that; neither to consider the fragilities, nor to resolve the problems. The IMF has missed one of the most serious crises in the world since the second world war, the subprime crisis. The IMF at the Secretariat level is not very efficient in providing early warnings to countries about the global economic situation. And this is not just a technical expertise issue; it is also a political issue. Because such an early warning – an effective projection of the difficulties in the world requires a critical examination of the policies of countries which exert significant impact on the world economy. It would require criticizing US and European economic policy. The IMF Secretariat cannot do that. In 20018 and 2009 when we were writing that the rise of the South was a myth, the IMF was promoting that the South was becoming a locomotive for the world economy. And they changed their mind only in 2013.

Secondly the IMF is not very bold in innovation. They are not bold in the reform of the international financial architecture. Why? Because the IMF is part of that architecture and that requires to reform that very same institution…So I believe that these matters should be discussed and debated among developing countries and in other fora such as the United Nations Conference on Trade and Development (UNCTAD), which has a much better record in anticipating these difficulties and providing proposals, which eventually became part of the mainstream.

(End)

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By Yilmaz Akyüz
GENEVA, Dec 29 2015 (IPS)

Foreign direct investment (FDI) is perhaps one of the most ambiguous and the least understood concepts in international economics. Common debate on FDI is confounded by several myths regarding its nature and impact on capital accumulation, technological progress, industrialization and growth in emerging and developing economies.

Yilmaz Akyüz, chief economist of the South Centre, Geneva.

It is often portrayed as a long term, stable, cross-border flow of capital that adds to productive capacity, helps meet balance-of-payments shortfalls, transfers technology and management skills, and links domestic firms with wider global markets.

However, none of these is an intrinsic quality of FDI. First, FDI is more about transfer and exercise of control than movement of capital. Contrary to widespread perception, it does not always involve flows of financial capital (movements of funds through foreign exchange markets) or real capital (imports of machinery and equipment for the installation of productive capacity). A large proportion of FDI does not entail cross-border capital flows but is financed from incomes generated on the existing stock of investment in host countries. Equity and loans from parent companies account for a relatively small part of recorded FDI and even a smaller part of total foreign assets controlled by transnational corporations.

Second, only the so-called greenfield investment makes a direct contribution to productive capacity and involves cross-border movement of capital goods. But it is not easy to identify from reported statistics what proportion of FDI consists of such investment as opposed to transfer of ownership of existing firms (mergers and acquisitions). Furthermore, even when FDI is in bricks and mortar, it may not add to aggregate gross fixed capital formation because it may crowd out domestic investors.

Third, what is commonly known and reported as FDI may contain speculative components and creates destabilizing impulses, including those due to the operation of transnational banks in host countries, which need to be controlled and managed as any other form of international capital flows.

Fourth, the immediate contribution of FDI to balance-of-payments may be positive, since it is only partly absorbed by imports of capital goods required to install production capacity. But its longer-term impact is often negative because of high import content of foreign firms and profit remittances. This is true even in countries highly successful in attracting export-oriented FDI.

Finally, superior technology and management skills of transnational corporations create an opportunity for the diffusion of technology and ideas. However, the competitive advantage these firms have over newcomers in developing countries can also drive them out of business. They can help integrate developing countries into global production networks, but participation in such networks also carries the risk of getting locked into low value-added activities.

These do not mean that FDI does not offer any benefits to developing and emerging countries. Rather, policy in host countries plays a key role in determining the impact of FDI in these areas. A laissez-faire approach could not yield much benefit. It may in fact do more harm than good.

Successful examples are found not necessarily among countries that attracted more FDI, but among those which used it in the context of national industrial policy designed to shape the evolution of specific industries through interventions. This means that developing countries need adequate policy space vis-à-vis FDI and transnational corporations if they are to benefit from it.

Still, the past two decades have seen a rapid liberalization of FDI regimes and erosion of policy space in emerging and developing countries vis-à-vis transnational corporations. This is partly due to the commitments undertaken in the World Trade Organization as part of the Agreement on Trade-Related Investment Measures .

However, many of the more serious constraints are in practice self-inflicted through unilateral liberalisation or bilateral investment treaties signed with more advanced economies – a process that appears to be going ahead with full force, with the universe of investment agreements reaching 3,262 at the end of 2014.

Unlike earlier bilateral treaties, recent agreements give significant leverage to international investors. They often include rights to establishment, the national treatment and the most favoured-nation clauses, broad definitions of investment and investors, fair and equitable treatment, protection from expropriation, free transfers of capital and prohibition of performance requirements.

Furthermore, the reach of bilateral investment treaties has extended rapidly thanks to the use of the so-called Special Purpose Entities which allow transnational corporations from countries without a bilateral treaty with the destination country to make the investment through an affiliate incorporated in a third-party state with a bilateral treaty with the destination country.

Many bilateral investment treaties include provisions that free foreign investors from the obligation of having to exhaust local legal remedies in disputes with host countries before seeking international arbitration. This, together with lack of clarity in treaty provisions, has resulted in the emergence of arbitral tribunals as lawmakers in international investment which tend to provide expansive interpretations of investment provisions in favour of investors, thereby constraining policy further and inflicting costs on host countries.

Only a few developing countries signing such bilateral treaties with advanced countries have significant outward FDI.

Therefore, in the large majority of cases there is no reciprocity in deriving benefits from the rights and protection granted to foreign investors. Rather, most developing countries sign them on expectations that they would attract more FDI by providing foreign investors guarantees and protection, thereby accelerating growth and development. However, there is no clear evidence that bilateral investment treaties have a strong impact on the direction of FDI inflows.

(End)

Excerpt:

By Yilmaz Akyüz
GENEVA, Mar 30 2015 (IPS)

Debt restructuring is a component of crisis management and resolution, and needs to be treated in the context of the current economic conjuncture and vulnerabilities.

International debt workout mechanisms are not just about debt reduction, but include interim arrangements to provide relief to debtors, including temporary hold on debt payments and financing.

They should address liquidity as well as solvency crises but the difference is not always clear. Most start as liquidity crises and can lead to insolvency if not resolved quickly.

Yilmaz Akyuz

Liquidity crises also inflict serious social and economic damages as seen in the past two decades even when they do not entail sovereign defaults.

International mechanisms should apply to crises caused by external private debt as well as sovereign debt. Private external borrowing is often the reason for liquidity crises. Governments end up socialising private debt. They need mechanisms that facilitate resolution of crises caused by private borrowing.

Only one of the last eight major crises in emerging and developing economies was due to internationally-issued sovereign debt (Argentina). Mexican and Russian crises were due to locally-issued public debt; in Asia (Thailand, Korea and Indonesia) external debt was private; in Brazilian and Turkish crises too, private (bank) debt played a key role alongside some problems in the domestic public debt market.

We have had no major new crisis in the South with systemic implications for over a decade thanks to highly favourable global liquidity conditions and risk appetite, both before and after the Lehman Brothers bank collapse in 2008, due to policies in major advanced economies, notably the United States.

But this period, notably the past six years, has also seen considerable build-up of fragility and vulnerability to liquidity and solvency crises in many developing countries."There are problems with standard crisis intervention: austerity can make debt even less payable; creditor bailouts create moral hazard and promote imprudent lending, and transform commercial debt into official debt, thereby making it more difficult to restructure”

Sovereign international debt problems may emerge in the so-called ‘frontier economies’ usually dependent on official lending. Many of them have gone into bond markets in recent years, taking advantage of exceptional global liquidity conditions and risk appetite. There are several first-time Eurobond issuers in sub-Saharan Africa and elsewhere.

In emerging economies, internationally-issued public debt as percentage of gross domestic product has declined significantly since the early 2000s. Much of the external debt of these economies is now under local law and in local currency.

However, there are numerous cases of build-up of private external debt in the foreign exchange markets issued under foreign law since 2008. Many of them may face contingent liabilities and are vulnerable to liquidity crises.

An external financial crisis often involves interruption of a country’s access to international financial markets, a sudden stop in capital inflows, exit of foreign investors from deposit, bond and equity markets and capital flight by residents. Reserves become depleted and currency and asset markets come under stress. Governments are often too late in recognising the gravity of the situation.

International Monetary Fund (IMF) lending is typically designed to bail out creditors to keep debtors current on their obligations to creditors, and to avoid exchange restrictions and maintain the capital account open.

The IMF imposes austerity on the debtor, expecting that it would make debt payable and sustainable and bring back private creditors. It has little leverage on creditors.

There are problems with standard crisis intervention: austerity can make debt even less payable; creditor bailouts create moral hazard and promote imprudent lending, and transform commercial debt into official debt, thereby making it more difficult to restructure; and risks are created for the financial integrity of the IMF.

Many of these problems were recognised after the Asian crisis of the 1990s, giving rise to the sovereign debt restructuring mechanism, originally designed very much along the lines advocated by the U.N. Conference on Trade and development (UNCTAD) throughout the 1980s and 1990s (though without due acknowledgement).

However, it was opposed by the United States and international financial markets and could not elicit strong support from debtor developing countries, notably in Latin America. It was first diluted and then abandoned.

The matter has come back to the attention of the international community with the Eurozone crisis and then with vulture-fund holdouts in Argentinian debt restructuring.

After pouring money into Argentina and Greece, whose debt turned out to be unpayable, the IMF has proposed a new framework to “limit the risk that Fund resources will simply be used to bail out private creditors” and to involve private creditors in crisis resolution. If debt sustainability looks uncertain, the IMF would require re-profiling (rollovers and maturity extension) before lending. This is left to negotiations between the debtor and the creditors.

However, there is no guarantee that this can bring a timely and orderly re-profiling. If no agreement is reached and the IMF does not lend without re-profiling, then it would effectively be telling the debtor to default. But it makes no proposal to protect the debtor against litigation and asset grab by creditors.

There is thus a need for statutory re-profiling involving temporary debt standstills and exchange controls. The decision should be taken by the country concerned and sanctioned by an internationally recognised independent body to impose stay on litigation.

Sanctioning standstills should automatically grant seniority to new loans, to be used for current account financing, not to pay creditors or finance capital outflows.

If financial meltdown is prevented through standstills and exchange controls, stay is imposed on litigation, adequate financing is provided and contractual provisions are improved, the likelihood of reaching a negotiated debt workout would be very high.

The role of the IMF in crisis management and resolution is incontrovertible. However, the IMF cannot be placed at the centre of international debt workout mechanisms. Even after a fundamental reform, the IMF board cannot act as a sanctioning body and arbitrator because of conflict of interest; its members represent debtors and creditors.

The United Nations successfully played an important role in crisis resolution in several instances in the past.

The Compensatory Financing Facility – introduced in the early 1960s to enable developing countries facing liquidity problems due to temporary shortfalls in primary export earnings to draw on the Fund beyond their normal drawing rights at concessional terms – resulted from a U.N. initiative.

A recent example concerns Iraq’s debt. After the occupation of Iraq and collapse of the Saddam Hussein regime, the U.N. Security Council adopted a resolution to implement stay on the enforcement of creditor rights to use litigation to collect unpaid sovereign debt.

This was engineered by the very same country, the United States, which now denies a role to the United Nations in debt and finance on the grounds that it lacks competence on such matters, which mainly belong to the IMF and the World Bank.

Edited by Phil Harris   

The views expressed in this article are those of the author and do not necessarily represent the views of, and should not be attributed to, IPS – Inter Press Service. 

* This article is partly based on South Centre Research Paper 60 by Yilmaz Akyüz titled Internationalisation of Finance and Changing Vulnerabilities in Emerging and Developing Economies.

Excerpt:

By Yilmaz Akyüz
GENEVA, Feb 16 2015 (IPS)

After a series of crises with severe economic and social consequences in the 1990s and early 2000s, emerging and developing economies have become even more closely integrated into what is widely recognised as an inherently unstable international financial system. 

Both policies in these countries and a highly accommodating global financial environment have played a role. Not only have their traditional cross-border linkages been deepened and external balance sheets expanded rapidly, but also foreign presence in their domestic credit, bond, equity and property markets has reached unprecedented levels.

Yilmaz Akyuz

New channels have thus emerged for the transmission of financial shocks from global boom-bust cycles.

Almost all developing countries are now vulnerable, irrespective of their balance-of-payments, external debt, net foreign assets and international reserve positions, although these play an important role in the way such shocks could affect them.

Stability of domestic banking and asset markets is susceptible even in countries with strong external positions.

Those heavily dependent on foreign capital are prone to liquidity and solvency crises as well as domestic financial turmoil.

The new practices adopted in recent years – including more flexible exchange rate regimes, accumulation of large stocks of international reserves or borrowing in local currency – would not provide much of a buffer against severe external shocks such as those that may result from the normalisation of monetary policy in the United States. “The surge in capital inflows that started in the early years of the new millennium, and continued with full force after a temporary blip due to the collapse in 2008 of the Lehman Brothers financial services firm, holds the key to the growing internationalisation of finance in developing countries”

And the multilateral system is still lacking adequate mechanisms for an orderly and equitable resolution of external financial instability and crises in developing economies.

This process of closer integration was greatly helped by highly favourable global financial conditions before 2008, thanks to the very same credit and spending bubbles that culminated in a severe crisis in the United States and Europe. The crisis did not slow this process despite initial fears that it could lead to a retreat from globalisation.  Integration has even accelerated since then because of ultra-easy monetary policies pursued in advanced economies, notably in the United States, in response to the crisis.

The surge in capital inflows that started in the early years of the new millennium, and continued with full force after a temporary blip due to the collapse in 2008 of the Lehman Brothers financial services firm, holds the key to the growing internationalisation of finance in developing countries.

It has resulted in a rapid expansion of gross external assets and liabilities of developing economies. More importantly, the structure of their external balance sheets has undergone important changes, particularly on the liabilities side, bringing new vulnerabilities.

The share of direct and portfolio equity in external liabilities has been increasing. An important part of the increase in equity liabilities is due to capital gains by foreign holders. In many developing countries presence in equity markets is greater than that in the United States and Japan.

While still remaining below the levels seen a decade ago as a percentage of gross domestic product (GDP), external debt build-up has accelerated since the crisis in 2008. This is mainly due to borrowing by the private sector, which now accounts for a higher proportion of external debt than the public sector in both international bank loans and security issues. A very large proportion of private external debt is in foreign currency. There is also a renewed tendency for dollarisation in domestic loan markets.

As a result of a shift of governments from international to domestic bond markets and opening them to foreigners, the participation of non-residents in these markets has been growing. The proportion of local-currency sovereign debt held abroad is greater in many developing countries than in reserve-issuers such as the United States, the United Kingdom and Japan. It is held by fickle investors rather than by foreign central banks as international reserves.

International banks have been shifting from cross-border lending to local lending by establishing commercial presence in developing countries. Their market share in these countries has reached 50 percent compared with 20 percent in developed countries.

These banks tend to act as conduits of expansionary and contractionary impulses from global financial cycles and increase the exposure of developing economies to financial shocks from advanced economies.

One of the key lessons of history of economic development is that successful policies are associated not with autarky or full integration into the global economy, but strategic integration seeking to use the opportunities that a broader economic space may offer while minimising the potential risks it may entail. This is more so in finance than in trade, investment and technology.

For one thing, the international financial system is inherently unstable in large part because multilateral arrangements fail to impose adequate discipline over financial markets and policies in systemically important countries which exert a disproportionately large impact on global conditions.

For another, the multilateral system also lacks effective mechanisms for orderly resolution of financial crises with international dimensions.

Thus, closer integration of several into the international financial system in the past ten years, after a series of crises with severe economic and social consequences, is a cause for concern.

In all likelihood, these countries will be facing strong destabilising pressures in the years ahead as monetary policy in the United States returns to normalcy after six years of flooding the world with dollars at exceptionally low interest rates.

In weathering a possible renewed instability, they cannot count on the more flexible currency regimes they came to adopt after the last bouts of crises or the reserves they have built from capital inflows or the reduced currency exposure of the sovereign.

It is important that they, as well as the international community, avoid going back to business-as-usual in responding to a new round of financial shocks, bailing out investors and creditors and maintaining an open capital account at the expense of incomes and jobs.

They need to include many unconventional policy instruments in their arsenals to help lower the price that may have to be paid for the financial excesses of the past several years

They should also take the occasion to rebalance the pendulum and to bring about genuine changes in the international financial architecture. (END/IPS COLUMNIST SERVICE)

Edited by Phil Harris   

The views expressed in this article are those of the author and do not necessarily represent the views of, and should not be attributed to, IPS – Inter Press Service. 

* This column is based on Internationalization of Finance and Changing Vulnerabilities in Emerging and Developing Economies, South Centre Research Paper 60, January 2015, which is available here.

Excerpt:

By Yilmaz Akyüz
GENEVA, Jul 16 2014 (IPS)

Since the onset of the crisis, the South Centre has argued that policy responses to the crisis by the European Union and the United States has suffered from serious shortcomings that would delay recovery and entail unnecessary losses of income and jobs, and also endanger future growth and stability. 

Despite cautious optimism from the International Monetary Fund (IMF), the world economy is not in good shape. Six years into the crisis, the United States has not fully recovered, the Euro zone has barely started recovering, and developing countries are losing steam. There is fear that the crisis is moving to developing countries.

Yilmaz Akyuz

There is concern in regard to the longer-term prospects for three main reasons.

First, the crisis and policy response aggravated systemic problems, whereby inequality has widened. Inequality is no longer only a social problem, but also presents a macroeconomic problem. Inequality is holding back growth and creating temptation to rely on financial bubbles once again in order to generate spending.

Second, global trade imbalances have been redistributed at the expense of developing countries, whereby the Euro zone especially Germany has become a deadweight on global expansion.

Third, systemic financial instability remains unaddressed, despite the initial enthusiasm in terms of reform of governance of international finance, and in addition new fragilities have been added due to the ultra-easy monetary policy.“The external financial vulnerability of the South is linked to developing countries’ integration in global financial markets and the significant liberalisation of external finance and capital accounts in these countries” – Yilmaz Akyuz

The policy response to the crisis has been an inconsistent policy mix, including fiscal austerity and an ultra-easy monetary policy. While the crisis was created by finance, the solution was still sought through finance. Countries focused on a search for a finance-driven boom in private spending via asset price bubbles and credit expansion. Fiscal policy has been invariably tight.

The ultra-easy monetary policy created over one trillion dollars in fiscal benefits in the United States – which was more than the initial fiscal stimulus; the entire initial fiscal stimulus was limited to 800 billion dollars.

There was reluctance to remove debt overhang through comprehensive restructuring (i.e. for mortgages in the United States and sovereign and bank debt in the European Union). Thus, the focus was on bailing out creditors.

There was also reluctance to remove mortgage overhang and no attempt to tax the rich and support the poor, particularly in the United Kingdom and the United States – where marginal tax rates are low compared with continental Europe. There has been resistance against permanent monetisation of public deficits and debt, which does not pose more dangers for prices and financial stability than the ultra-easy monetary policy.

The situation in the United States has been better than in other advanced economies. The United States dealt with the financial but not with the economic crisis, whereby recovery has been slow due to fiscal drag and debt overhang. And employment is not expected to return to pre-crisis levels before 2018.

As for the Euro zone, Japan and the United Kingdom, all have had second or third dips since 2008. None of them have restored pre-crisis incomes and jobs.

Meanwhile, trade imbalances have not been removed, but redistributed. East Asian surplus has dropped sharply and Latin America and sub-Saharan Africa have moved to large deficits. Developing countries’ surplus has fallen from 720 billion dollars to 260 billion dollars. On the contrary, advanced economies have moved from deficit to surplus, whereby U.S. deficits have fallen and the Euro zone has moved from a 100 billion dollars deficit to a 300 billion dollars surplus.

As tapering comes to an end and the U.S. Federal Reserve stops buying further assets, the attention will be turned to the question of exit, normalisation and the expectations of increased instability of financial markets for both the United States and the emerging economies.

This exit will also create fiscal problems for the United States because, as bonds held by the Federal Reserve mature and quantitative easing ends, long-term interest rates will rise and the fiscal benefits of the ultra-easy monetary policy would be reversed.

Developing countries lost steam as recovery in advanced economies remained weak or absent due to the fading effect of counter-cyclical policies and the narrowing of policy space. China could not keep on investing and doing the same thing. Another factor contributing to the change of context in developing countries has been the weakened capital inflows that became highly unstable with the deepening of the Euro zone crisis and then Federal Reserve tapering. Several emerging economies have been under stress as markets are pricing-in normalisation of monetary policy even before it has started.

The external financial vulnerability of the South is linked to developing countries’ integration in global financial markets and the significant liberalisation of external finance and capital accounts in these countries. These include opening up securities markets, private borrowing abroad, resident outflows, and opening up to foreign banks. While developing countries did not manage capital flows adequately, the IMF did not provide support in this area, tolerating capital controls only as a last resort and on a temporary basis.

Several deficit developing countries with asset, credit and spending bubbles are particularly vulnerable.  Countries with strong foreign reserves and current account positions would not be insulated from shocks, as seen after the Lehman crisis. When a country is integrated in the international financial system, it will feel the shock one way or another, although those countries with deficits remain more vulnerable.

In regard to policy responses in the case of a renewed turmoil, it is convenient to avoid business-as-usual, including using reserves and borrowing from the IMF or advanced economies to finance large outflows. The IMF lends, not to revive the economy but to keep stable the debt levels and avoid default. It is also inconvenient to adjust through retrenching and austerity.

Ways should be found to bail-in foreign investors and lenders, and use exchange controls and temporary debt standstills. In this sense, the IMF should support such approaches through lending into arrears.

More importantly, the U.S. Federal Reserve is responsible for the emergence of this situation and should take on its responsibility and act as a lender of last resort to emerging economies, through swaps or buying bonds as and when needed. These are not necessarily more toxic than the bonds issued at the time of subprime crisis. The United States has much at stake in the stability of emerging economies. (END/IPS COLUMNIST SERVICE)

*   A longer version of this column has been published in the South Centre Bulletin (No. 80, 30 June 2014).

Excerpt:

By Yilmaz Akyüz
GENEVA, Mar 24 2014 (IPS)

The United Nations’ Post-2015 Development Agenda should not simply extend the Millennium Development Goals (MDGs), or reformulate the goals, but focus instead on global systemic reforms and secure an accommodating international environment for sustainable development.

The MDGs are based on a donor-centric view of development with a focus on poverty and aid. They do not embrace a large segment of the population in the developing world, notably in middle-income countries, which fall outside the thresholds set in MDGs but still have their development aspirations unfulfilled.

It would be agreed that development is much more than the sum total of MDGs or any such arbitrary collection of a limited number of specific targets. But it is not possible to reach an international agreement on all important dimensions of economic and social development and environmental protection.

Any international agreement on such specific development targets would naturally be selective, leaving out many dimensions to which several countries may attach particular importance.There is no automatic trickle down from economic growth to human and social development.

Thus, instead of focusing on selective specific targets in the areas of economic and social development and environmental protection, we should aim at creating an enabling international environment to allow each and every country to pursue developmental objectives according to their own priorities with policies of their own choice.

Sustained economic growth is absolutely necessary for progress on the social front. No country has ever achieved constant improvements in living standards and human development indicators without sustaining a rapid pace of economic growth.

Without this, progress in human and social development would naturally depend on external and domestic transfer mechanisms – that is, aid and redistribution of public spending, respectively. Since there are limits to such transfers, social progress cannot go very far without an adequate pace of income and job generation.

Industrialisation is essential for reducing income, productivity, technology and skills gaps with more advanced economies since there are limits to growth and development in commodity-dependent and service economies.

We also know that there is no automatic trickle down from economic growth to human and social development. Policies and institutions are needed to translate economic growth to social development.

Job creation holds the key to improvements in living standards and to human development. But economic growth is not necessarily associated with the creation of jobs at a pace needed to fully absorb the growing work force. Thus, active policies are needed to provide secure and productive job opportunities.

Equity is an important ingredient of social cohesion and development. Prevention of widened inequality in income distribution calls for intervention in market forces, targeted policies and correctives.

Industrialisation and development cannot be left to market forces alone and least of all to global markets. Successful development is associated neither with autarky nor with full integration into world markets dominated by advanced economies, but strategic integration in trade, investment and finance designed to use foreign markets, technology and finance in pursuit of national industrial development.

To succeed, developing countries need to have adequate policy space. However, their policy space is considerably narrower than that enjoyed by today’s advanced economies in the course of their industrialisation because of the tendency of those who reach the top to “kick away the ladder” and deny the followers the kind of policies they had pursued in the course of their development.

It is necessary to reform multilateral and bilateral arrangements to allow developing countries as much economic policy space as those enjoyed by today’s advanced economies in the course of their industrialisation and development.

Developing countries also enjoy much less environmental space than that enjoyed by today’s advanced economies in the course of their industrialisation, and hence face greater constraints in attaining growth and development without compromising future generations’ well-being.

Thus, action is also needed at the international level in order to ease the environmental constraints over economic growth and development in developing countries and to compensate the costs inflicted on them by environmental deterioration resulting from years of industrialisation in advanced economies.

Finally, there is a need for a development-friendly global economic environment. We need mechanisms to prevent adverse spillovers and shocks to developing countries from policies in advanced economies or destabilising impulses from international financial markets.

Adequate policy space and a development-friendly global economic environment call for action at the international level on several fronts:

• Review multilateral rules and agreements with a view to improving the policy space in developing countries in pursuit of economic growth and social development.

• Attention to the international intellectual property regime with a view to facilitating technological catch-up and improving health and education standards and food security in developing countries.

• Industrial, macroeconomic and financial policies of developing countries are severely constrained by bilateral investment treaties and free trade agreements signed with advanced economies. These agreements are designed on the basis of a corporate perspective rather than a development perspective and they give considerable leverage to foreign investors and firms in developing countries. They need to be revised or dismantled.

• Remove terms unfavourable to commodity-dependent developing countries in contracts with transnational corporations to enable them to add more value to commodities and obtain more revenues from commodity-related activities.

• Introduce multilateral mechanisms to bring discipline policies in advanced economies to prevent adverse consequences for and spillovers to developing countries, including agricultural subsidies, restrictions over labour movements and transfer of technology and beggar-my-neighbour monetary and exchange rates policies.

• Establish mechanisms to bring greater stability to exchange rates of reserve currencies and prevent competitive devaluations and currency wars.

• Reduce global trade imbalances through faster growth of domestic demand, income and imports in countries with slow growth and large current account surpluses in order to allow greater space for expansionary policies in deficit developing countries.

• Reversal of the universal trend of growing income inequality should be a global goal. This calls for reversing the secular decline in the share of labour in income in most countries.

• Regulate systemically important financial institutions and markets, including international banks and rating agencies and markets for commodity derivatives with a view to reducing international financial instability and instability of commodity prices.

• Establish impartial and orderly workout procedures for international sovereign debt to prevent meltdown in developing countries facing balance-of-payments and debt crises.

• Secure a fair and equitable allocation of usable carbon space between advanced economies and developing countries, taking into account cumulative contributions of advanced economies to atmospheric pollution.

• Introduce international taxes in areas such as financial transactions or energy to generate funds for development assistance as well as for financing the costs of climate change mitigation and adaptation in developing countries.

• Reform international economic governance in ways commensurate with the increased participation and role of developing countries in the global economy. Re-examine the role, accountability and governance of specialised institutions such as the International Monetary Fund, the World Bank and the World Trade Organisation, and the role that the U.N. can play in global economic governance.

Excerpt:

By Yilmaz Akyüz
GENEVA, Mar 1 2014 (IPS)

Before the world economy has been able to fully recover from the crisis that began more than five years ago, there is a widespread fear that we may be poised for yet another crisis, this time in emerging economies.

The signs of external financial fragility in several emerging economies have been visible since the beginning of the financial crisis in the U.S. and Europe. The South Centre has constantly warned that the boom in capital flows that had started in the first half of the 2000s and continued even after the Lehman bank collapse is generating serious imbalances in the developing world along with the danger of a sudden stop and reversal.

Policy choices in advanced economies, notably in the U.S. as the issuer of the main reserve currency, in response to the crisis are key to understanding what is going on. Reluctance to remove the debt overhang caused by the financial crisis through timely, orderly and comprehensive restructuring, and an abrupt turn to fiscal austerity after an initial expansion, has meant an excessive reliance on monetary means to fight the Great Recession, with central banks entering uncharted policy waters, including zero-bound policy interest rates and the acquisition of long-term public and private bonds (quantitative easing).

This ultra-easy monetary policy has not been very effective in reducing the debt overhang or stimulating spending. It has, however, generated financial fragility, at home and abroad, notably in emerging economies.

In several emerging economies, policies pursued in recent years have no doubt made a significant contribution to the build-up of external vulnerability. Many commodity-dependent economies have failed to manage the twin booms in commodity prices and capital flows that started in the early years of the millennium and continued until recently, after a brief interruption in 2008-09.

These countries, and several others, have stood passively by as their industries have been undermined by the foreign exchange bonanza, choosing, instead, to ride a consumption boom driven by short-term financial inflows and foreign borrowing by their private sectors and allowing their currencies to appreciate and external deficits to mount. Hastily erected walls against destabilizing inflows have been too little and too late.

The International Monetary Fund (IMF), the organization responsible for safeguarding international monetary and financial stability, has also failed to promote judicious policies not only in major advanced economies, but also in the South. It has been unable to correctly identify the forces driving expansion in emerging economics and joined, until its recent U-turns, the hype about the “Rise of the South”, arguing that major emerging economies are largely decoupled from the economic vagaries of the North and have become new engines of growth, thereby underestimating their vulnerability to shifts in policies and conditions in the North, notably the U.S.

Even when it became clear that capital inflows posed a serious threat to macroeconomic and financial stability in these economies, its advice was to avoid capital controls to the extent possible and introduce them only as a last resort and on a temporary basis.

Policy response to a deepening of the financial turbulence in the South and tightened balance of payments should be similar in many respects to that recommended by the South Centre in the early days of the Great Recession. The principal objective should be to safeguard income and employment. Developing countries should not be denied the right to use legitimate trade measures to rationalize imports through selective restrictions in order to allocate scarce foreign exchange to areas most needed, particularly for the import of intermediate and investment goods and food.

Emerging economies should also avoid using their reserves to finance large and persistent capital outflows. Experience suggests that when global financial conditions are tightening, countries with large external debt and deficits find it extremely difficult to restore “confidence” and regain macroeconomic control simply by allowing their currencies to freely float and/or hiking interest rates. Nor should they rely on borrowing from official sources to maintain an open capital account and to remain current on their obligations to foreign creditors and investors.

They should, instead, seek to involve private lenders and investors in the resolution of balance-of-payments and debt crises and this may call for, inter alia, exchange restrictions and temporary debt standstills. These measures should be supported by the IMF, where necessary, through lending into arrears.

The IMF currently lacks the resources to effectively address any sharp contraction in international liquidity resulting from a shift to monetary tightening in the U.S. A very large special drawing rights (SDR) allocation, to be made available to countries according to needs rather than quotas, would help. (SDR is a weighted currency basket of major currencies defined by the IMF).

But a greater responsibility falls on central banks in advanced economies, notably the U.S. Federal Reserve, which can and should – as the originators of destabilizing impulses that now threaten the South – act as a quasi-international lender of last resort to emerging economies facing severe liquidity problems through swaps or outright purchase of their sovereign bonds.

The Federal Reserve could buy internationally issued bonds of these economies to shore up their prices and local bonds to provide liquidity; and there is no reason why other major central banks should not join this undertaking.

The extent to which these tools – exchange restrictions and temporary debt standstills, IMF lending into arrears, a sizeable SDR allocation and provision of market support and liquidity by major central banks – should be used would depend on the specific circumstances of individual emerging economies.

The world is facing bleak prospects largely because the systemic shortcomings in the global economic and financial architecture that gave rise to the most serious post-war crisis remain unabated.

The Outcome Document of the 2009 UN Conference on the “World Financial Crisis and Economic Crisis and Its Impact on Development” had clearly recognized that “longstanding systemic fragilities and imbalances” were among the principal causes of the crisis and proposed “to reform and strengthen international financial system and architecture” so as to reduce the likelihood of the occurrence of such crises.

It pointed to many areas where systemic reforms are needed including regulation of “major financial centres, international capital flows, and financial markets”, the international reserves system including the role of the SDR, the international approach to the debt problems of developing countries, and the mandates, policies and governance of international financial institutions. So far the international community has failed to address any of these issues in a significant way. They need to be put back on the agenda if recurrent financial crises with severe international repercussions are to be averted.

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By Yilmaz Akyüz
GENEVA, Oct 22 2013 (Columnist Service)

Five years into the crisis, growth in the U.S. is still below potential, Europe is struggling to pull out of recession and major emerging economies are slowing rapidly after an initial resilience during 2010-2011.

Longer-term prospects are not much brighter largely because the key problems that gave rise to the most serious post-war crisis – income inequalities, external imbalances and financial fragilities – remain unabated and have indeed been aggravated.

The world economy suffers from an under-consumption bias because of low and declining share of wages in the gross domestic product (GDP) in all major advanced economies including the U.S., Germany and Japan, as well as China.

Yilmaz Akyuz

Still, until 2008-2009 the threat of global deflation was avoided thanks to consumption binges and property booms driven by credit and asset bubbles, particularly in the U.S. and the European periphery.

The crisis has not removed but reallocated global trade imbalances.

Longer-term global prospects depend a lot on the U.S. due to its central position in the world economy and the international reserves system. It is highly unlikely that the U.S. can move to wage-led growth in the near future.

Nor can it shift to export-led growth. This would require, inter alia, exports to grow faster than domestic demand and the share of private consumption in GDP to fall. This is difficult to achieve since for several decades the U.S. has constantly lived beyond its means thanks to its “exorbitant privilege” as the issuer of the central reserve currency.

Thus, a key question is if the U.S. would be inclined to go back to “business as usual” and allow credit and asset bubbles in search of relatively rapid growth. This is closely connected to its exit from the ultra-expansive monetary policy.

Clearly, exit implies not just increased policy interest rates but also the normalisation of monetary policy – the federal funds rate to become again the main instrument of policy, a significant contraction in the size of the balance of the Federal Reserve (Fed) sheet and the volume of excess reserves that depository institutions hold at the Fed, and a large shift of the Fed’s asset composition back to short- and medium-term Treasuries.

A strategy that the Fed should gradually exit from the quantitative easing (QE) 3 but maintain low policy rates for several more years in order to support growth and use macro-prudential regulations to limit systemic risks appears to be enjoying considerable support.

However, it may not be easy to engineer such a process without jeopardising financial and macroeconomic stability. Uncertainty abounds because there are not many historical precedents for exit from extended periods of zero-bound interest rates and QE.

Even a gradual return of the Fed balance sheet to “normal” size and composition may result in a considerable hike in long-term rates even if policy rates are kept low for an extended period. The prospects for exit from the QE3 in the coming months have already pushed up the yield on the U.S. 10-year Treasury bond to almost 3 percent in August 2013 from around 1.60 percent in May.

If concerns about financial instability and the effectiveness of macro-prudential measures come to dominate, the Fed may be obliged to exit rapidly. This would result in a hike in short- and long-term interest rates and give a major shock to the financial system as in 1994.

It would result in slower growth and a stronger dollar. Too rapid an exit and re-pricing of substantially increased stock of debt could even cause a hard landing in the U.S. by leading to large losses for bondholders and depressing private spending.

These dilemmas arise in large part because of excessive reliance on monetary policy to combat recession and the reluctance to use fiscal expansion and debt restructuring to stimulate aggregate demand.

The normalisation of monetary policy in the U.S. will also cause problems for emerging economies. Despite occasional complaints about the “currency war” entailed by liquidity expansion in several major advanced economies simultaneously, the policy of ultra-easy money has generally been benign for emerging economies.

It has been a major factor in the sharp recovery of capital inflows after the sudden stop caused by the Lehman Bank collapse in September 2008.

Many major emerging economies such as India, Brazil, South Africa and Turkey have come to depend on such inflows as their current accounts started to deteriorate. They have invariably welcomed the asset bubbles that such inflows have helped generate and often ignored the financial fragilities caused by increased exposure to interest rate and exchange rate risks by private borrowers abroad.

Such exposures are on the rise since the beginning of 2012. As funds have started to be withdrawn from domestic securities markets, emerging economies have increasingly relied on international debt contracted in reserve currencies, which reached, in net amounts, 600 billion dollars between the beginning of 2012 and mid-2013.

As the Fed has got closer to ending the QE3 and the long-term U.S. rates have edged up, strong downward pressures have started to build up on the currencies, stocks and bonds of several emerging economies such as Brazil, India, South Africa and Turkey, which were widely seen as rising stars only a couple of years ago.

And the longer-term prospects of the eurozone are even less encouraging than the situation in the U.S. Deleveraging and recovery are likely to remain extremely slow in the periphery and many countries cannot expect to recuperate the output losses incurred after 2008 for several years to come.
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China has moved to investment-led growth, after its exports fell sharply in the aftermath of the global financial crisis. Credit: Bigstock

By Yilmaz Akyüz
GENEVA, Jun 10 2013 (IPS)

More than five years since the outbreak of the global financial crisis, the world economy has shown few signs of stabilising and moving towards strong and sustained growth.

While deleveraging continues to stifle private demand, economic activity is further restrained by a fiscal drag in the U.S. and Europe, as governments have turned to fiscal orthodoxy after an initial reflation. There has been excessive reliance on monetary policy, especially in the U.S., through provision of large amounts of liquidity to financial markets and institutions at close-to-zero interest rates, using unconventional means.

This has been largely ineffective in re-igniting bank lending and private spending, but has given rise to a search for yield in high-risk investments, increased leverage and boom in equity markets. It has also generated financial fragility and exchange rate instability in major developing countries.

The implications of an extended period of ultra-easy monetary policy in several reserve-currency issuers for future international financial stability remain highly uncertain since these are largely uncharted waters.

There have been strong spillovers from the crisis in advanced economies to developing countries.

Yilmaz Akyuz, chief economist of the Geneva-based South Centre.

Although conditions in international financial and commodity markets have generally remained favourable since 2009, the strong upward trends in capital flows and commodity prices that had started in the first half of the 2000s have come to an end and exports of developing countries to advanced economies have slowed considerably.

Furthermore, the one-off effects of countercyclical policies in developing countries have started fading and the policy space for further expansionary action has narrowed considerably.

Thus, growth in most major developing countries has now decelerated significantly. In Asia, the most dynamic developing region, growth in 2012 was some five percentage points below the rate achieved before the onset of the crisis; in Latin America it was reduced to almost half.

The world economy is facing under-consumption because of low and declining share of wages in national income in all major advanced economies, including the U.S., Germany and Japan, as well as China – countries that have a disproportionately large impact on global economic conditions.

There has also been an increased concentration of wealth and growing inequality in the distribution of income earned on real and financial assets. Financialisation, welfare state retrenchment and globalisation are the most important factors accounting for these trends.

In none of the major advanced economies and China is there a tendency for a significant reversal of the downward trend in the share of wages in national income and a more equitable allocation of wealth so as to allow rapid economic expansion based on income-supported, as opposed to debt-driven, household spending.

In the U.S. – where the downward trend in wage share started in the 1980s – in the past two decades consumption and property booms and economic expansions were driven primarily by asset and credit bubbles: first the dot-com bubble in the 1990s and then the subprime bubble in the 2000s.

The current crisis has led to a greater concentration of income and wealth. On current policies the U.S. cannot move to wage-led or export-led growth. Rather, it may succumb to the temptation of letting the current ultra-easy monetary policy degenerate into credit and asset bubbles in order to achieve a rapid expansion, very much in the same way as its policy response to the bursting of the dot-com bubble gave rise to the sub-prime boom, while exploiting the exorbitant privilege it enjoys as the issuer of the dominant reserve currency and running growing external deficits.

Whether or not it might help generate a strong expansion, such a return to business-as-usual could produce yet another boom-bust cycle. It could be more damaging than the present crisis, not only for the U.S. but the world economy at large.

If, on the other hand, asset and credit bubbles are not allowed to develop and boost aggregate spending, the outcome could be sluggish growth, sharply increased interest rates and a stronger dollar, a combination that often breeds problems for developing countries.

The eurozone appears to be mired in economic weakness for an indefinite period. Thus, the region cannot be expected to generate expansionary impulses for the rest of the world even if it manages to restore stability in the crisis-hit periphery.

China has moved to investment-led growth as its exports slowed sharply as a result of the crisis and contraction in advanced economies, and this has added to credit and property bubbles already under way. This pattern of growth cannot be sustained indefinitely. Despite the recognition of the need to raise the share of the household income in gross domestic product (GDP) and move to a consumption-led growth, the distributional rebalancing is progressing very slowly.

Whether or not China can avoid the bursting of the bubbles and a hard landing, over the medium term it is likely to settle on a lower growth path with a gradual rebalancing of external and domestic sources of demand and domestic investment and consumption.

All these imply that there will be no more Southern tail winds. Even if the crisis in the North is fully resolved, developing countries are likely to encounter a much less favourable global economic environment in the coming years than they did before the onset of the Great Recession.

Consequently, in order to repeat the spectacular growth they had enjoyed in the run-up to the crisis and catch up with the industrial world, developing countries need to improve their own growth fundamentals, rebalance domestic and external sources of growth and reduce dependence on foreign markets and capital. This requires, inter alia, abandoning neoliberal policies in practice, not just in rhetoric, and seeking strategic rather than full integration into the global economy.

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Excerpt:

There are numerous reasons to believe that the forces that have been driving growth in developing and emerging economies since 2009 cannot be sustained over the medium term. At the same time, it is impossible to return to the extremely favourable international economic conditions that prevailed before the eruption of the global crisis.

Yilmaz Akyuz

This means that unless there are fundamental changes in the way these countries are integrated into the world economy, the stunning recent ascent of the South may prove to be a passing phenomenon, and the speed of its convergence with the income levels of advanced economies may slow considerably in the coming years.

Developing countries face two interrelated challenges, which demand a rethinking of their strategies:

In the immediate future, they face the risk of a significant drop in their growth rates, which could be quite severe if the European recession deepens, bringing down the U.S.

Second, in the medium term they cannot go back to the kind of growth they enjoyed during the subprime expansion even if the advanced countries succeed in recovering fully and settling on a rigorous and stable growth path.

Developing countries now have a narrower policy space for a countercyclical response to deflationary and destabilising impulses than they had after the Lehman collapse in September 2008.

In the past few years, fiscal and external imbalances have widened significantly in many emerging economies. Despite this, they need to deploy all possible means to prevent a sharp slowdown of economic activity and a hike in unemployment.

There are numerous reasons to believe that the forces that have been driving growth in developing and emerging economies since 2009 cannot be sustained over the medium term. At the same time, it is impossible to return to the extremely favourable international economic conditions that prevailed before the eruption of the global crisis.

This means that unless there are fundamental changes in the way these countries are integrated into the world economy, the stunning recent ascent of the South may prove to be a passing phenomenon, and the speed of its convergence with the income levels of advanced economies may slow considerably in the coming years.

Developing countries face two interrelated challenges, which demand a rethinking of their strategies:

In the immediate future, they face the risk of a significant drop in their growth rates, which could be quite severe if the European recession deepens, bringing down the U.S.

Second, in the medium term they cannot go back to the kind of growth they enjoyed during the subprime expansion even if the advanced countries succeed in recovering fully and settling on a rigorous and stable growth path.

Developing countries now have a narrower policy space for a countercyclical response to deflationary and destabilising impulses than they had after the Lehman collapse in September 2008.

In the past few years, fiscal and external imbalances have widened significantly in many emerging economies. Despite this, they need to deploy all possible means to prevent a sharp slowdown of economic activity and a hike in unemployment.

Many developing and emerging economies, notably in Latin America, have some manoeuvring room in trade policy because their bound tariffs are above the applied tariffs, though the margins are generally quite narrow for the majority of them.

One way out would be to invoke, as a last resort, the General Agreement on Trade in Services balance-of-payments safeguard provisions, designed to address payment difficulties arising from a country’s efforts to expand its internal market or from instability in its terms of trade. If used judiciously, such measures would not necessarily restrict the overall volume of imports but rather their composition.

Selective restriction of non-essential, luxury imports as well as imports of goods and services for which domestic substitutes are available could ease payment constraints and facilitate expansionary macroeconomic policies by making it possible to increase imports of intermediate and capital goods needed for the expansion of domestic production and income.

The provision of adequate international liquidity by multilateral financial institutions could naturally alleviate the need for restrictive trade measures, even though it would not be wise for many developing economies, notably poor countries, to use such liquidity for importing non-essential goods and services.

In the event of large and continued outflows of capital, countries should be prepared to impose exchange restrictions and even temporary debt standstills, and these should be supported by the International Monetary Fund (IMF) through lending into arrears.

China cannot introduce another massive investment package to maintain an acceptable pace of growth without compromising its future stability. Any counter-cyclical policy response should be consistent with the longer-term adjustment needed to maintain rigorous growth and should address the underlying problem of underconsumption.

An immediate increase in private consumption could be achieved through large transfers from the public sector, especially to the poor in rural areas, and sharply increased public provision of health and education. The former would raise the purchasing power of households while the latter would help reduce precautionary savings.

China also needs to raise the share of wages in the gross domestic product (GDP) a lot faster than is promised by recent measures in order to shift to a consumption-led growth path.

Through its growing demand for commodities, China is already playing a key role in growth in commodity-dependent economies. However, it is not an important market for exporters of manufactured goods. At present, the size of its consumer market is less than 20 percent.

Therefore, to provide an important market for developing and emerging economies, China needs not only to raise the share of wages and household income in GDP, but also to increase the import content of consumption.

A shift to wage-cum-consumption-led growth would not mean that China would cease to be a major exporter of manufactured goods to finance its growing imports.

Even though an important part of the increased consumption demand might be met by domestic producers, such a shift would entail a significant increase in imported manufactured consumer goods.

China also needs to export manufactures in order to finance its growing commodity imports, which have now reached almost 10 percent of GDP, and imports of capital goods from more advanced economies. In other words, a shift to consumption-led growth by China may not significantly reduce the share of imports and exports in GDP.

For other developing and emerging economies policy challenges vary, but they are all linked, one way or another, to accumulation and productivity growth.

Commodity exporters in Latin America have little control over the two key determinants of their economic performance, namely capital flows and commodity prices, and their main policy challenge is how to break out of this dilemma and gain greater autonomy in growth.

They need to reduce dependence on foreign capital. Even though Latin America’s wealthy receive a greater proportion of the national income than Asia’s, they save and invest a much lower proportion of their income.

Low levels of investment and productivity growth are the main reasons for Latin American deindustrialisation, somewhat aggravated by recent booms in commodity markets and capital flows.

Low public and private investment and a high dependence on foreign capital is the very first problem that needs to be addressed, not only in Latin America but also in some exporters of manufactured goods, such as Turkey.

As seen in South East Asia, a high rate of savings does not always translate into an equally high level of investment and, as seen in India, a high level of aggregate investment does not necessarily translate into rapid industrial growth.

Overcoming all these difficulties requires targeted public interventions, including a judicious use of macroeconomic and industrial policy tools. (END/COPYRIGHT IPS)

* Yilmaz Akyuz, chief economist of the South Centre, Geneva. For further analysis see South Centre, Issue 66 and SC RP 44 (http://www.southcentre.org).

At a makeshift e-waste workshop in China's Guiyu town, a migrant worker cooks computer motherboards over solder to remove chips and valuable metals. Credit: Jeffrey Lau/IPS

By Yilmaz Akyüz
GENEVA, Aug 9 2012 (IPS)

Growth in developing economies (DEs) has accelerated significantly in the new millennium.

Whereas in the 1980s and 1990s their average growth was barely higher than that of advanced economies (AEs), from the early years of the 2000s until the global crisis, the difference shot up to five percentage points. It widened further during 2008-11 with the collapse in AEs.

Although there is diversity, the acceleration is broad-based with all developing regions enjoying faster growth than in the past. The notable exception is China, which has grown in the new millennium at broadly the same (albeit rapid) pace as in the 1990s.

This divergence has widely been interpreted as the South “decoupling” from the North. However, the evidence does not show the desynchronisation of cycles between developed and advanced economies, and deviations of economic activity from underlying trends continue to be highly correlated.

The more significant question is whether there has been a durable shift in the trend growth of the South relative to the North. Such a view is widely held, including among policy makers in DEs. However, a closer look suggests that the growth surge in the South owes as much, if not more, to exceptional and unsustainable global economic conditions as it does to improvements in their own fundamentals. There is, consequently, no room for complacency in policy circles in developing countries.

Until the financial crisis hit in 2008, the credit, consumption and property bubbles in the industrialised North, particularly the U.S., generated a highly favourable global environment for emerging countries in trade and investment, capital flows and commodity prices.

At least one-third of pre-crisis growth in China was due to exports, mostly to AEs, and the ratio is even higher for smaller Asian export-led economies.

There is a strikingly strong correlation between property booms and current account deficits both in the U.S. and other countries that have subsequently experienced financial turmoil. China’s accession to the WTO also provided a major impetus to outsourcing and exports to AEs by removing uncertainties surrounding its access to the U.S. market.

From the early years of the 2000s, historically low interest rates and rapid expansion of liquidity in the U.S., Europe and Japan triggered a search for yield and a boom in capital flows to DEs.

This was supplemented by a surge in workers’ remittances, which amounted to over 25 percent of gross domestic product (GDP) in some smaller countries but exceeded three percent of GDP even in India. Commodity prices also rose strongly, largely thanks to rapid growth in China driven by exports to advanced economies.

The boom was accentuated as financial investors started to diversify into commodity-linked assets and search for yield in commodity markets. On some estimates, Latin America would not have seen much growth over the last decade had terms-of-trade, dollar interest rates and capital flows remained at the levels of the late 1990s.

With the subprime crisis the international economic environment deteriorated in all areas that had previously supported expansion in DEs. Capital flows and commodity prices were reversed and AEs contracted.

However, emerging economies showed resilience and were able to rebound quickly, particularly where a strong countercyclical response was made possible by favourable payments, reserves and fiscal positions built-up during the preceding expansion.

As a result, the growth impulse in some leading Southern economies has shifted to domestic demand, including in countries that had previously been export-led.

China has played a key role, launching a massive stimulus package in infrastructure and property investment. Because of its high commodity intensity, this investment-led growth has given an even stronger boost to commodity prices than the pre-crisis export-led growth.

Capital flows also recovered briskly thanks to sharp cuts in interest rates and quantitative easing in AEs in response to the crisis. They have been more than sufficient to meet growing deficits in several major DEs including India, Brazil, Turkey and South Africa.

For several reasons the exceptional growth enjoyed by the South over the past ten years is unlikely to be sustained over the medium term. First, returning to the extremely favourable international economic conditions prevailing before the global crisis is precluded by the large adjustments now facing the AEs.

Indeed, efforts to move policy back to “business as usual”, with the U.S. acting as a locomotive and running growing deficits, would seriously destabilise the international trading and monetary systems.

But nor can the post-crisis domestic demand-driven growth be maintained for long. There are already strong signs of deceleration. China’s strategy of offsetting the slowdown in exports to AEs with accelerated investment cannot work indefinitely.

It needs to shift to consumption-led growth, lifting private consumption from its “wartime” level of some 35 percent of GDP. Doing so will entail overcoming political hurdles since it will require significant redistribution of wealth and income.

Even a moderate slowdown in China, towards seven percent, could bring an end to the commodity boom, threatening growth prospects in a number of Latin American and African countries.

Moreover, the risk-return configuration that has sustained the surge in capital flows to DEs, notably the historically low interest rates and rapid liquidity expansion in AEs, cannot last forever. The most vulnerable are those that have so far enjoyed the twin booms in commodity prices and capital flows.

Most DEs need to overhaul their development models in order to sustain the kind of growth they have enjoyed over the past ten years.

The export-led Asian economies need to reduce their dependence on consumers in AEs by expanding domestic and regional markets.

Commodity exporters need to reduce their reliance on capital flows and commodity earnings ­the two key determinants of their growth, which are largely beyond national control. These call for a genuine departure from market fundamentalism and neoliberalism both in macroeconomic and structural policies.

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* Yilmaz Akyuz, chief economist of the South Centre, Geneva. For further analysis see South Centre Research Paper 44 (http://www.southcentre.org)

This column is available for visitors to the IPS website only for reading. Reproduction in print or electronic media is prohibited. Media interested in republishing may contact romacol@ips.org

Global economic conditions continue to have a strong bearing on production, trade and investment in developing economies. In this respect the current landscape is not very encouraging. After three years of recovery the world economy still remains highly fragile. The short-term outlook predicts contraction in several advanced economies in Europe. Growth in others, including the U.S., is weak and erratic. But more importantly, medium term prospects are bleak almost everywhere.

There is considerable uncertainty in global financial markets. Asset and commodity prices, risk spreads, capital flows and exchange rates are highly susceptible to sudden swings with devastating consequences for growth and employment.

At a first glance, the recent record looks very promising for developing economies. The new millennium has witnessed a staggering rise of the South. During 2003-08, the average growth of developing economies exceeded that of advanced economies by some five percentage points, compared to around one point in the 1980s and 1990s. The difference widened during 2008-11 as most developing economies proved resilient to the crisis while advanced economies collapsed.

This growth divergence has widely been interpreted as the South decoupling from the North. However, the evidence does not show the desynchronisation of cycles between developing and advanced economies, and deviations of economic activity from underlying trends continue to be highly correlated. A closer look suggests that the growth surge in developing economies owes more to exceptionally favourable international economic conditions than improvements in their underlying fundamentals.

Until the financial crisis, the credit, consumption and property bubbles in advanced economies generated a highly favourable global economic environment for developing economies in trade and investment, capital flows and commodity prices. At least one-third of pre-crisis growth in China was due to exports, mostly to advanced economies, and the ratio is even higher for smaller Asian export-led economies.

From the early years of the 2000s, low interest rates and rapid expansion of liquidity in the U.S., Europe and Japan triggered a boom in capital flows to developing economies. This was supplemented by a surge in workers’ remittances, which exceeded three percent of gross domestic product in India and reached double-digit figures in some smaller developing economies. Commodity prices rose strongly, largely thanks to rapid growth in China. On some estimates, Latin America would not have seen much growth had terms-of-trade, dollar interest rates and capital flows remained at the levels of the late 1990s.

With the financial crisis the global economic environment deteriorated in all areas that had previously supported expansion in developing economies. However, developing economies showed resilience and were able to rebound quickly, particularly where a strong countercyclical response was made possible by favourable payments, reserves and fiscal positions built up during the preceding expansion. As a result, the growth impulse in some leading Southern economies has shifted to domestic demand, including in countries which had previously been export-led.

At the same time, short-term, speculative capital inflows surged with sharp cuts in interest rates and monetary expansion in advanced economies in response to the crisis. These have been more than sufficient to meet growing deficits in several major developing economies including India, Brazil, Turkey and South Africa. But they have also widened deficits by leading to currency appreciations.

This rapid domestic demand-led growth has now come to an end. China cannot maintain investment-led growth indefinitely. But it also faces hurdles in shifting rapidly to consumption-led growth. Even a moderate slowdown in China, towards seven percent, could bring an end to the boom in a broad range of commodities. This can be aggravated by a rapid exit of investors and traders in commodity derivatives as happened in 2008 after the collapse of the Lehman Brothers.

Developing countries are also susceptible to a sudden reversal of capital flows. These have shown a high degree of volatility since last summer and there are now signs of flight to safety. The immediate threat is not a hike in interest rates in the U.S.and Europe, but the deepening of the eurozone crisis, triggering a rapid exit, very much like the collapse of Lehman Brothers.

In conclusion, the world economy is no less fragile today than it was on the eve of the United Nations Conference on the World Financial and Economic Crisis and its Impact on Development that took place in June 2009 in New York. And developing economies are just as exposed to downside risks from advanced economies as they were then, but their policy space has narrowed in the interim.

There can be little doubt that there is a lot that developing economies could do to strengthen their own fundamentals and reduce dependence on foreign markets, capital and commodities to gain greater autonomy. But they cannot be expected to put their house in order when advanced economies falter and the global financial architecture continues to suffer from systemic shortcomings.

These difficulties continue unabated despite agreements reached at the June 2009 United Nations Conference on the crisis on decisive and coordinated action to address its causes, mitigate its impact, to avoid possible adverse impacts of stimulus measures on developing economies, and to reform and strengthen the international financial system and architecture.

The task remains unfinished. The United Nations is often said to have no competence in these matters. However, the international financial institutions and the groupings such as G7, G8 or G20 have proved to be totally ineffective in resolving these matters. Thus, they need to be pursued with greater determination and commitment in the United Nations and linked to a process of assessment and monitoring. (END/COPYRIGHT IPS)

* Yilmaz Akyuz is the chief economist of the South Centre. For further analysis see http://www.southcentre.org.

By IPS Correspondents, Yilmaz Akyüz, and - -
GENEVA, Oct 19 2011 (IPS)

It is growing increasingly likely that the world will face renewed risks of instability and slowdown before fully recovering from the so-called Great Recession. This is largely because the fragility and imbalances that have built up over recent years as a result of misguided policies in the US and Europe cannot be easily undone, regardless of the policy pursued today.

The strong growth in developing and emerging economies that we have seen since mid-2009 is not sustainable. First, it is the product of a strong policy response to the crisis whose effects are fading in several developing economies, particularly in China, which has been the locomotive for commodity-rich developing countries. At the same time, growth prospects in major advanced economies are worsening.

Second, the response to the crisis in advanced economies -excessive liquidity generation and sharp cuts in interest rates- is actually creating bubbles, not in Europe and US but in commodity markets and the developing world. This cheap money in search of yield is a major factor behind the rapid growth in several emerging economies, but it will not be there forever.

China introduced a massive stimulus programme in response to the crisis, reaching 15 percent of GDP, three times that of the US. But it focused on investments, pushing it to over 50 percent of GDP. Support to household incomes has remained moderate even though the country faces a problem of underconsumption, with private consumption hovering around 36 percent of GDP, half the level of the US. Chinese growth has also been pushed up because of large private foreign capital inflows.

China needs to reduce its dependence on exports and rely on domestic markets for growth. Its current account surplus fell from a peak of 11 percent of GDP in 2006 to around 5 percent in 2010, now lower than that of Germany. Chinese adjustment needs to be based on significantly faster-growing household income, that is, a rapid expansion of wages without a pass-through to prices, and employment. This would appreciate the currency while simultaneously creating domestic demand to offset the slowdown in exports.

China now recognises the need to shift to consumption-led growth. It has recently taken several measures related to minimum wages, wage growth, faster job creation, bolstering the service sector, improving social safety nets, etc.

What will happen if China slows down? A slide from double-digit growth to 7 percent could have a serious adverse impact on commodity exporters. On the other hand, over the longer term, a successful shift to consumption-led growth could also shift the Chinese demand from hard to soft commodities, particularly grains and meat, aggravating the global food shortage.

How will all of this end up? I can see four possible scenarios. First, these bubbles could end with an abrupt monetary tightening in the US. It could happen even before full recovery as a result of rising inflation and/or bond market pressures. No matter what, near-zero interest rates are not here forever; the question is whether they will return to normalcy gradually or abruptly.

Second, a significant slow-down of growth in China, possibly aggravated by the bursting of the credit and property bubble, could bring an end to the boom in commodity markets and capital flows. It could not only depress Chinese demand for commodities but also trigger a massive exit of speculative capital from commodity markets.

Third, a balance-of-payments crisis in a major developing economy could bring an end to the boom in capital flows by sparking contagion across emerging markets. For example, Turkey now has a current account deficit of close to 10 percent of GDP, and deficits are also high and growing in certain other emerging economies. A sudden change of mood in the markets, as we saw in East Asia in 1997, could trigger a currency and payments crisis in such countries.

But the Achilles heel of global finance is now Europe, where default is a very real possibility in the highly-indebted periphery. As long as the European Commission and the European Central Bank continue to pretend that this is mainly a liquidity crisis, the region will remain susceptible to extreme instability and messy defaults with the attendant consequences for capital flows and financial stability in emerging economies, similar to the aftermath of the Lehman collapse.

In any of these scenarios, it is highly likely that the downturn in capital flows will be associated with a reversal of commodity prices. As a result, the most vulnerable countries are those which have been enjoying the twin benefits of global liquidity expansion, that is, the surge in capital inflows and the commodity boom. (END/COPYRIGHT IPS)

(*) Ylmaz Akyuz is the Chief Economist of the South Centre. For further analysis see South Bulletin, issue 56 http://www.southcentre.org.

Excerpt:

By Yilmaz Akyüz and - -
GENEVA, Aug 2 2011 (IPS)

As in previous episodes, a key factor in the current boom in capital flows to developing and emerging economies (DEEs) is a sharp cut in interest rates and a rapid expansion of liquidity in the major advanced economies (AEs), notably the US. This first occurred in a coordinated way after an agreement at the April 2009 G20 summit in London as a countercyclical response to the crisis. In the US, recovery started in summer 2009 but the strong growth of nearly 4 percent in the first quarter of 2010 slowed to less than 2 percent in the second quarter. The response of the US Federal Reserve was to initiate another round of quantitative easing through purchases of long-term treasuries and other securities. Although the declared objective was to stimulate private spending by lowering long-term interest rates and raising asset values, this move has also been widely seen as an effort to weaken the dollar and stimulate exports.

But the rapid expansion of liquidity has not translated into a significant increase in private lending and spending in the US because of problems on both the supply and demand sides of the credit market. As uncertainty about recovery and stability has continued unabated, banks have not been willing to lend to the private sector but have simply cashed in on the differentials between short- and long-term rates and looked for profit opportunities abroad.

Similarly, consumers, overburdened with debt, have not been keen on borrowing and spending while, in the face of relatively stagnant consumer markets, firms have not had much incentive to continue the investing and stock-piling that they had started earlier. As a result, excess liquidity has spilled over globally in a search of yields in DEEs, many of which have been put on the defensive in response to what is widely seen as a competitive devaluation by the US.

A key factor in the surge in capital inflows to DEEs after the Lehman bankruptcy in September 2008 was their significantly higher growth performance and prospects than the AEs. Yet although interest rates in many major DEEs were initially brought down in response to fallout from the crisis, the arbitrage gap widened as they began to raise them in 2010, while rates in AEs remained at very low levels. As a result, carry-trade has been re-established and key emerging economies with high interest rates such as India and Brazil have become the main targets. Low interest rates in the US, together with the ongoing weakness of the dollar, made the dollar the new funding currency for carry-trade operations.

Furthermore, because of unprecedented difficulties encountered by large financial institutions in the US and Europe and increased public deficits and debt, the crisis has given rise to a lasting shift in investment to the DEEs from AEs, where risk is perceived as being greater. A natural outcome is that DEEs now constitute a larger portion in the equity and bond portfolios of investors in AEs.

This is largely because these markets have rapidly become more like financial markets, with several commodities being treated as a distinct asset class and attracting growing amounts of money in search of profits from price movements.

The parallel movements in capital flows, commodity prices, and the dollar are not due only to the overall market assessment of risks and return and global liquidity conditions; they are also directly linked to each other. A weaker dollar often leads to higher commodity prices because it raises global demand by lowering non-dollar prices of commodities. On the other hand, changes in commodity prices have a strong influence on capital inflows to commodity-rich DEEs.

These changes have important consequences for the vulnerability of DEEs to boom-bust cycles. Exposure to the risk of instability and crises generally results from macroeconomic imbalances and financial fragility that accumulated during the surge in capital inflows, mainly in three areas. First, surges in capital flows can produce or support unsustainable exchange rates and current account deficits. This is quite independent of the composition of capital flows. A surge in Foreign Direct Investment (FDI) would have the same effect on the exchange rate, exports, and imports as a surge in portfolio investment or external borrowing. If such imbalances are allowed to develop, sudden stops and reversals would produce sharp declines in the currency and economic contraction unless there are adequate reserves or unlimited access to international liquidity.

Second, financial fragility arises because of the extensive dollarisation of liabilities and currency and maturity mismatches on balance sheets. This would be the case when borrowing is in foreign currency and short-term. When capital flows dry up and the currency declines sharply, mismatches could result in increased debt servicing difficulties and defaults.

Finally, capital surges can produce credit and asset bubbles. Credit expansion can occur when banks borrow abroad to fund domestic lending, currency market interventions cannot be fully sterilised, or inflows lower long-term interest rates. The linkage between capital flows and asset markets strengthens with the greater presence of foreigners in domestic markets. Not only portfolio investments but also many types of capital inflows that are traditionally included in FDI, such as acquisition of existing firms and real estate investment, can create asset bubbles. Reversal of capital flows could then create credit crunch and asset deflation with severe macroeconomic consequences. (END/COPYRIGHT IPS)

(*) Ylmaz Akyuz is the Chief Economist of the South Centre. For further analysis see South Centre Research Paper 37 ( http://www.southcentre.org)

Excerpt:

By Yilmaz Akyüz and - -
GENEVA, Jun 15 2011 (IPS)

Much of the recent public discussion on the International Monetary Fund has been about the successor to Dominique Straus-Kahn and the flawed system of choosing its chief.

However, an even more significant issue is the reform needed on the mandate, agenda and policies of the IMF.

In its website under the rubric “About the IMF”, the Fund defines its main purpose as the provision of “the global public good of financial stability”.

The record of the IMF in preventing financial instability and crises leaves much to be desired. Recent decades have seen repeated gyrations in exchange rates of major currencies, persistent and growing trade imbalances, recurrent balance-of-payments, debt and financial crises in many countries.

The IMF has been unable to cope with misguided policies in countries with large influence on global financial conditions, or with instability caused by financial markets and international capital flows unleashed by widespread liberalization which it has been constantly espousing.

A reason for this is that the Fund has no teeth vis-à-vis its non-borrowing members. But, more importantly, the IMF has generally been unable to identify the build-up of financial fragilities, predict instability and crises and issue early warnings in large part because of its blind faith in markets.

In the sub-prime turmoil, it missed the biggest crisis of its lifetime. It has almost constantly failed to warn developing countries against destabilizing capital flows, unsustainable exchange rates, payments and debt positions.

Since the mid-1990s several countries working under IMF programs confronted severe instability and crises and in some cases, such as Russia and Argentina, sovereign default could not be avoided. The IMFÂ’s debt sustainability analyses and recommendations left many poor countries in disarray when they fell into debt distress.

The more the IMF has failed to prevent instability and crises, the more it has become involved in crisis management and lending which is now its primary activity.

IMF emergency lending is said to play multiple roles -provide breathing space to countries facing severe crises, prevents crises in countries with sound policies, and to diminish the need for self-insurance in international reserves.

However, the evidence shows that Fund lending rarely prevents economic downturn in countries facing payments instability and crises. By contrast, such lending is often associated with pro-cyclical policy conditionality which serves to deepen the impact of the financial crises on jobs and incomes. This is still the case with the IMF programs with European countries despite the improvements claimed.

But more importantly, emergency lending could create more problems than it solves. When the scale is large, it can endanger the financial integrity of the IMF. It is not always easy to determine if a crisis is one of liquidity rather than insolvency. Argentina and Russia ended up in default while receiving IMF support and there is no guarantee that Greece will now be able to avoid default.

Since the IMF crisis lending is effectively designed to keep countries current on debt payments to international creditors and to maintain an open capital account, it often leads to an unequal burden-sharing between creditors and debtors.

Commercial debt gets replaced by debt to the IMF which is often more difficult to renegotiate. Private debt gets dumped on the public sector –sovereign debt invariably rises after financial crises resulting from excessive build up of debt by the private sector. All these create moral hazard and prevent the operation of market discipline, because they allow investors and creditors to escape without bearing the full consequences of the risks they have undertaken.

Because of the problems posed by bailout operations, the primary task of the Fund should be crisis prevention rather than crisis lending. This calls for a significant improvement in the quality of the FundÂ’s financial and economic surveillance. It also calls for a reform of its membersÂ’ obligations so as to bring about a reasonable degree of multilateral discipline over macroeconomic, exchange rate and financial policies of its main shareholders.

There is a stronger case for multilateral discipline in money and finance than in other areas including trade since adverse external spillovers from monetary and financial policies in systemically important countries tend to be much more damaging.

But even with radical reforms in these areas, balance-of-payments and financial crises will continue to occur. Emergency lending is neither the only nor the best way of dealing with them. An alternative method is orderly debt work-out procedures based on widely recognized principles of insolvency designed to secure the involvement of private lenders and investors in crisis resolution.

This is more equitable between debtors and creditors and between private and official lenders, and more effective from the point of view of their impact on the behaviour of lenders and investors and, hence, on financial stability.

This is a vital component of the reforms needed to strengthen the IMFÂ’s role in crisis prevention. Otherwise, the IMF may increasingly become a quasi-international lender-of-last-resort without the requisite capacity and power of oversight and this will likely do more harm than good.

The international monetary system needs to be restored with the primary objective of preventing instability and crises and the missing components should now be evident.

However, some of the most important issues such as enforceable exchange rate and adjustment obligations, the international reserves system and orderly sovereign debt workout mechanisms are not squarely on the agenda of the IMF nor the G20.

Developing countries have a particular stake in this endeavour given their vulnerability and limited capacity to respond to shocks.

If major countries do not support the establishment of an orderly and equitable international monetary and financial system, developing countries should find ways and means of protecting themselves and looking after their interests through regional mechanisms. (END/COPYRIGHT IPS)

(*) Yilmaz Akyuz, Chief Economist, South Centre, Geneva ( www.southcentre.org) ============================================================ ============================================================

IMF PRIORITIES AND POLICIES NEED URGENT REFORM

By Yilmaz Akyuz (796 words)

// NOT FOR PUBLICATION IN CANADA, CZECH REPUBLIC, IRELAND, POLAND, AND THE UNITED STATES //

IPS COLUMNIST SERVICE, JUNE 2011

Editor’s note:

Much of the recent public discussion on the International Monetary Fund has been about the successor to Dominique Straus-Kahn and the flawed system of choosing its chief. However, an even more significant issue is the reform needed on the mandate, agenda and policies of the IMF, writes Yilmaz Akyuz, Chief Economist of the South Centre (Geneva).

The IMF has been unable to cope with misguided policies in countries with large influence on global financial conditions, or with instability caused by financial markets and international capital flows unleashed by widespread liberalization which it has been constantly espousing.

Because of the problems posed by bailout operations, the primary task of the Fund should be crisis prevention rather than crisis lending. This calls for a significant improvement in the quality of the FundÂ’s financial and economic surveillance. It also calls for a reform of its membersÂ’ obligations so as to bring about a reasonable degree of multilateral discipline over macroeconomic, exchange rate and financial policies of its main shareholders. ———————————————————————— IMF PRIORITIES AND POLICIES NEED URGENT REFORM

By Yilmaz Akyuz (*)

GENEVA, Jun (IPS/South Centre) Much of the recent public discussion on the International Monetary Fund has been about the successor to Dominique Straus-Kahn and the flawed system of choosing its chief.

However, an even more significant issue is the reform needed on the mandate, agenda and policies of the IMF.

In its website under the rubric “About the IMF”, the Fund defines its main purpose as the provision of “the global public good of financial stability”.

The record of the IMF in preventing financial instability and crises leaves much to be desired. Recent decades have seen repeated gyrations in exchange rates of major currencies, persistent and growing trade imbalances, recurrent balance-of-payments, debt and financial crises in many countries.

The IMF has been unable to cope with misguided policies in countries with large influence on global financial conditions, or with instability caused by financial markets and international capital flows unleashed by widespread liberalization which it has been constantly espousing.

A reason for this is that the Fund has no teeth vis-à-vis its non-borrowing members. But, more importantly, the IMF has generally been unable to identify the build-up of financial fragilities, predict instability and crises and issue early warnings in large part because of its blind faith in markets.

In the sub-prime turmoil, it missed the biggest crisis of its lifetime. It has almost constantly failed to warn developing countries against destabilizing capital flows, unsustainable exchange rates, payments and debt positions.

Since the mid-1990s several countries working under IMF programs confronted severe instability and crises and in some cases, such as Russia and Argentina, sovereign default could not be avoided. The IMFÂ’s debt sustainability analyses and recommendations left many poor countries in disarray when they fell into debt distress.

The more the IMF has failed to prevent instability and crises, the more it has become involved in crisis management and lending which is now its primary activity.

IMF emergency lending is said to play multiple roles — provide breathing space to countries facing severe crises, prevent crises in countries with sound policies, and to diminish the need for self-insurance in international reserves.

However, the evidence shows that Fund lending rarely prevents economic downturn in countries facing payments instability and crises. By contrast, such lending is often associated with pro-cyclical policy conditionality which serves to deepen the impact of the financial crises on jobs and incomes. This is still the case with the IMF programs with European countries despite the improvements claimed.

But more importantly, emergency lending could create more problems than it solves. Argentina and Russia ended up in default while receiving IMF support and there is no guarantee that Greece will now be able to avoid default.

Since the IMF crisis lending is effectively designed to keep countries current on debt payments to international creditors and to maintain an open capital account, it often leads to an unequal burden-sharing between creditors and debtors.

Commercial debt gets replaced by debt to the IMF which is often more difficult to renegotiate. Private debt gets dumped on the public sector –sovereign debt invariably rises after financial crises resulting from excessive build up of debt by the private sector. All these create moral hazard and prevent the operation of market discipline, because they allow investors and creditors to escape without bearing the full consequences of the risks they have undertaken.

Because of the problems posed by bailout operations, the primary task of the Fund should be crisis prevention rather than crisis lending. This calls for a significant improvement in the quality of the FundÂ’s financial and economic surveillance. It also calls for a reform of its membersÂ’ obligations so as to bring about a reasonable degree of multilateral discipline over macroeconomic, exchange rate and financial policies of its main shareholders.

There is a stronger case for multilateral discipline in money and finance than in other areas including trade since adverse external spillovers from monetary and financial policies in systemically important countries tend to be much more damaging.

But even with radical reforms in these areas, balance-of-payments and financial crises will continue to occur. Emergency lending is neither the only nor the best way of dealing with them. An alternative method is orderly debt work-out procedures based on widely recognized principles of insolvency designed to secure the involvement of private lenders and investors in crisis resolution.

This is more equitable between debtors and creditors and between private and official lenders, and more effective from the point of view of their impact on the behaviour of lenders and investors and, hence, on financial stability.

This is a vital component of the reforms needed to strengthen the IMFÂ’s role in crisis prevention. Otherwise, the IMF may increasingly become a quasi-international lender-of-last-resort without the requisite capacity and power of oversight and this will likely do more harm than good. (END/COPYRIGHT IPS)

(*) Yilmaz Akyuz, Chief Economist, South Centre, Geneva http://www.southcentre.org/

Excerpt:

An unusual feature of the global financial crisis is that for developing countries (DCs) the financial band seems to have picked up the pace of the music. While many advanced economies (AEs) continue to encounter debt deflation, financial stringency and risks of insolvency, the financial problem for most DCs is asset inflation, credit expansion and currency appreciations. Except for a brief interruption in 2008, DCs have continued to receive large capital inflows as major AEs have responded to the crisis caused by excessive liquidity and debt by creating still larger amounts of liquidity to bail out troubled banks and governments, lift asset prices and lower interest rates.  Quantitative easing and close-to-zero interest rates are now generating a surge in speculative capital flows to DCs with higher interest rates and better growth prospects, creating bubbles in foreign exchange, asset, credit and commodity markets.

By Yilmaz Akyüz and - -
GENEVA, Apr 6 2010 (IPS)

After a deep and widespread contraction in economic activity and a significant drop in output and employment, policy makers, financial analysts, and media pundits all appear to be heartened by the news from different parts of the world that the worst is over. The main concern now is about the strength and the shape of the recovery.

Over the medium term, the hope is that the global economy will resume the rapid and broad-based expansion enjoyed from the early years of the decade until 2008 -without, however, the accompanying financial fragility and the trade imbalances.

This optimistic scenario depends to a large extent on a measured rebalancing of the economies of the US, with the world largest deficit, and China, with the world’s largest surplus. In view of the central place occupied by the dollar in the international reserve system, it is recognised that international monetary and financial stability depends fundamentally on spending discipline by the US -in line with its income- which would allow for a fundamental and sustained balance-of-payments adjustment.

However, in order to maintain growth, the US should not simply cut domestic absorption but also shift to export-led growth. An orderly US adjustment would also require, inter alia, a shift by China from export-led to consumption-led growth and the realignment of the exchange rate of the renminbi against the dollar. In this way, prospects for global stability could be expected to improve without sacrificing growth.

Even if such a rebalancing proceeds smoothly, most developing and emerging economies (DEEs) are caught in a dilemma: they are damned if the US adjusts and damned if it does not. On the one hand, ‘business as usual’ would expose them to recurrent currency and financial instability. On the other hand, retrenchment and adjustment in the US could cause problems on several fronts. It is likely to lead to tightened global financial conditions with negative effects on several DEEs that have structural external deficits and are hence dependent on capital inflows to sustain acceptable growth.

More important, there is no other country that could act as a global locomotive. China could not replace the US even if it maintained Gross Domestic Product growth of 10 percent based on domestic consumption rather than exports. Its GDP is about one-third that of the US; the share of household consumption in GDP is much smaller; households save a much higher proportion of disposable income; and the import content of household consumption is much lower than in the US. We thus need more than US-China rebalancing to sustain global stability and growth.

While there has been an almost exclusive focus on US-China relations, a global restructuring of the pace and pattern of demand cannot exclude the two other major surplus countries, Japan and Germany, which have been siphoning off global demand without adding much to global growth and relying on exports to a much greater extent than China.

There is more, however, to global imbalances than macroeconomic geography. Income distribution has played an important role and should also be part of the solution. Market-driven globalisation has systematically tilted the balance of economic power against labour and in favour of capital, as indicated by the falling share of wage income almost everywhere. The outcome has been under-consumption in all major surplus countries, notably China, Germany, and Japan. However, the threat of global deflation has been avoided thanks to consumption and property surges financed by growing debt and capital gains brought about by rapid credit expansion and asset inflation, notably in the US but also a number of other advanced economies and DEEs, particularly in Europe.

This process has, in its turn, produced growing trade imbalances, large shifts in net asset positions of countries, and increased financial fragility, culminating in the most serious post-war economic crisis.

The world economy now faces a serious dilemma: financial consolidation and retrenchment in deficit countries would raise the spectre of economic stagnation, while a return to financial bubbles and debt-driven expansion could mean that the next crisis might be even worse and the state could be in a much weaker financial position to respond effectively. But in either case, the adjustments exist only in appearance since, without restoring the balance between labour and capital, neither stability nor growth may be sustained for long.

There is thus a need for adjustment in the four major economies -the US, China, Japan and Germany- with the aim of removing imbalances while ensuring adequate global demand without a return to financial bubbles and debt-driven spending.

The US needs to live within its means. China, Germany, and Japan all need to boost domestic consumption by reversing the downward trend in the share of wages in GDP. In the latter two countries, this is needed to accelerate growth, while in China it is needed to avoid a growth slowdown that may result from a deceleration of exports. Furthermore, China should not only accelerate domestic consumption but also increase its import content.

All these changes need to be complemented with a reform of the global financial architecture so as to ease the payments constraints of deficit and indebted developing countries.

However, there are no signs that the reorientation of policies needed for such a rebalancing is on the agenda of the major countries or the international community at large. Consequently, the world economy generally and DEEs particularly may face more serious challenges in coming years than they have seen during the recent global downturn. The outcome could be sluggish, with uneven and erratic growth, continued and even deepened instability in currency and asset markets, the rise of protectionism and economic nationalism, an escalation of conflicts in the international trading system, and a backlash against globalisation. (END/COPYRIGHT IPS)

(*) Yilmaz Akyüz is Special Economic Advisor of the South Centre (Geneva) and former director of the Division on Globalisation and Development Strategies, UNCTAD. This column is based on Research Paper No. 26 for the South Centre ( www.southcentre.org).

Excerpt: