DISTINCTION BETWEEN TRADE AND INVESTMENT STRESSED, CRISIS PREVENTION WEIGHED, AS PANEL REVIEWS REFORM OF WORLD FINANCIAL ARCHITECTURE

Press Release
GA/EF/2868

DISTINCTION BETWEEN TRADE AND INVESTMENT STRESSED, CRISIS PREVENTION WEIGHED, AS PANEL REVIEWS REFORM OF WORLD FINANCIAL ARCHITECTURE

Financial Experts, Bankers, Give Views And Field Questions As Second Committee Hosts Discussion

While there was a growing consensus on the need for reform of the international financial architecture, the exact nature of that change was not clear, Stephany Griffith-Jones, Senior Fellow, Institute of Development Studies, Sussex University, said this morning during a panel discussion conducted by the Second Committee (Economic and Financial) on the theme “taking stock of the reform of the international financial architecture”.

How radical should the change be? she asked. Should the current structure be reformed or a new one created altogether? It was important to have a vision of what the objectives of a new financial system should be in the context of the current global economy. Among the many prevalent views was that the current structures should be adapted to today’s needs, so as to enable them to avoid crisis nationally, provide official liquidity at times of crisis, and provide adequate mechanisms for debt work out.

While it was clear that the international financial system must be reformed, crises could not be avoided altogether, said Rodrigo Briones, Director, Deutsche Asset Management Americas, Deutsche Bank. Crises could happen again, although they might differ from region to region and in their degree of severity. There was a large pool of money waiting to be invested. What portfolio managers did was place that pool where it could receive the best return. The funds would not be invested in countries where restrictions operated. Hedge funds existed because they were unregulated, and they existed offshore because that was where there were fewer restrictions. What investors did, especially in developing countries, was to look at the rewards and the risks. What was more important than anything else to investors was liquidity, since they sought the highest and safest returns. Liquidity was vital for making markets more attractive.

Martin Mayer, Guest Scholar, Economic Studies, The Brookings Institution, said that “Mr. Briones could not get his desired liquidity”. That was a moral hazard. Losing on a trade was an inside

Second Committee - 1a - Press Release GA/EF/2868 AM Meeting 13 October 1999

risk. Investors did not trade, they invested. The international financial crisis had gone unnoticed in the United States outside the financial sector. Only those who traded pieces of paper learned about it. The question was whether one wanted to establish a world where all pieces of paper could be exchanged for other pieces of paper. The question was also whether those pieces of paper could be priced against each other.

During the recent international financial crises, data to enable appropriate policy responses to emerging problems had been unavailable, Jack Boorman, Director, Policy Development and Review Department, International Monetary Fund (IMF), said. Countries could claim reserves, while non-published liabilities against those reserves had been built up. When the market awoke to such a situation, the market would run, which was what had happened. Disclosure by governments and central banks was necessary, but that disclosure must be based on internationally accepted standards. At the moment, standards were being improved and codes of good fiscal and financial conduct were being developed. In adhering to those standards and codes, countries could be rewarded with lower spreads when borrowing in the market, and an increase in foreign direct investment (FDI).

Committee Chairman Roble Olhaye (Djibouti) was moderator of the panel, to which Under-Secretary-General for Economic and Social Affairs Nitin Desai also contributed.

The Committee will meet again at 10 a.m. on Friday, 15 October, to continue consideration of its agenda items.

Committee Work Programme

The Second Committee (Economic and Financial) this morning held a panel discussion on the theme “taking stock of the reform of the international financial architecture”. The panel was in support of the Committee’s consideration of two of its agenda items: high-level international intergovernmental consideration of financing for development; and financing of development, including net transfer of resources between developing and developed countries. The event was chaired by the Committee’s Chairman and moderated by the Under-Secretary-General for Economic and Social Affairs. The panelists were: Jack Boorman, Director, Policy Development and Review Department, International Monetary Fund (IMF); Rodrigo Briones, Director, Deutsche Asset Management Americas, Deutsche Bank; Stephany Griffith- Jones, Senior Fellow, Institute of Development Studies, Sussex University; and Martin Mayer, Guest Scholar, Economic Studies, The Brookings Institution.

Introductory Statements

Committee Chairman ROBLE OLHAYE (Djibouti), welcoming the panelists and participants to the discussion, said that the recent financial crisis was receding and recovery from it was showing progress. That sigh of relief however, had not provoked the necessary debate on the reform of the international economic structure. The following questions should be asked -- were we in the reform process and what more needed to be done? Reform of the international financial architecture was an integral part of the two items before the Committee today.

STEPHANY GRIFFITH-JONES, Senior Fellow, Institute of Development Studies, Sussex University, said that the deep integration of developing countries into the global economy had many positive effects. However, there had also been negative consequences. It was sometimes fashionable to criticize developing countries for their macroeconomic decisions during periods of surges in capital inflows. Those flows posed the risk of large reversals. The Asian financial crisis had showed that, even while temporary, those reversals had the effect of increasing poverty. The benefits of such inflows were therefore sometimes questioned. There was a clear contrast between foreign direct investment and trade. The latter brought undeniable economic benefits to countries.

There was a growing consensus on the need for reform, and there was a not so clear but growing consensus on the exact nature of what needed to be changed, she said. One issue open for discussion was how radical the change in architecture should be. Should the current structure be reformed or a new one created altogether? It was important to have a vision of what the objectives of a new financial system should be in the context of today’s global economy. One view was that it was important to realize what today’s needs were and to adapt the structures to them, in order to fulfil three main functions. Firstly, to avoid crisis nationally. Secondly, to provide official liquidity at times of crisis. Thirdly, to provide adequate mechanisms for debt work out.

Regarding the discussions on crisis prevention and better crisis management, it was right to put the emphasis on prevention, she said. In the context of prevention, one of the areas highlighted in the wake of the Asian crisis was the issue of transparency. There had been important progress, for example, on making more information available. There had also been progress on better implementation of standards, and other fiscal and monetary issues. With regard to the implementation of standards, there was a feeling among some developing countries that those standards were formed mostly in forums where developed countries had the strongest voice. Information was always prone to limitations; better information by itself would not avoid crisis, because it depended on how that information was processed. In addition, better information was needed on how the international financial system was operating.

Along with better information, she continued, stronger tools, such as better national and international regulation, were also necessary. Those countries that had not fully opened their capital accounts should do so slowly, especially to avoid the reversal of such large surges of capital flows. Also, tighter and stricter regulations were needed in times of boom to prevent the loosening of lending. More analytical work was required in pursuing counter-cyclical policies. Several tasks still remained, including regulation of high-leverage institutions such as hedge funds. It had to be discerned what role those institutions played, both in the good times and in the bad times. Many of the current regulatory proposals were criticized because institutions could avoid them by going offshore. Regarding crisis management, an important step was taken conceptually in the creation of the Contingent Credit Line Facility. Practically however, it might be too complex. What was needed was a facility that could be dispersed rapidly in times of crisis. Also, debt workout was an area in which much analysis had been done but little action taken.

Jack Boorman, Director, Policy Development and Review Department, International Monetary Fund (IMF), said that on the question of developing a new financial architecture he would not touch on the superstructure, solely on the substructure –- or the “plumbing” -– of the international financial system and how to improve it. Three areas had to be addressed, namely standards, transparency and private-sector involvement.

During the recent international financial crises, data to enable appropriate policy responses to emerging problems had been unavailable. Countries could claim reserves, while non-published liabilities against those reserves had been built up. When the market awoke to such a situation, the market would run, which is what had happened. Sometimes national authorities did not even know about foreign liabilities, for instance when the corporate sector accumulated them. Moreover, available information was not based on internationally accepted standards. Developments needed to be made public. If quality information was available, it should not be covered up: the authorities had to deal with it.

At the moment, standards were being improved and codes of good fiscal and financial conduct were being developed. The IMF was publishing transparency reports, but the problem was that the IMF was not a standard-setting body. The institution had reached out to the World Bank and other institutions for help on that issue. Adhering to standards had to have some payoff for countries as well. Rewards could consist of lower spreads when borrowing in the market, and an increase in Foreign Direct Investment (FDI).

On transparency, Mr. Boorman said that disclosure was necessary, but disclosure had to be standardized. The IMF was improving in that area in shaping its own policy (there was an enormous increase of information on its web sites), but also in relation to its standards of transparency when dealing with individual countries. The Fund could use soccer’s “yellow card” concept, but that could easily trigger a crisis -- and the Fund might be wrong in its assessments. Information, however, could be published on an ongoing, routine basis. Transparency also meant exposing oneself to outside scrutiny, something which the IMF was doing more and more. There were several aspects to the question of private-sector involvement, he said. One aspect was public-policy management by the borrowing country, the other was the way markets operated. Still another aspect was ensuring that private- sector actors adhered to conditions rather than running when a crisis occurred. Countries should not expose themselves to risks of market reversals. A short-term debt structure was easily reversible and therefore risky. In debt management, countries should not look at costs alone when borrowing, but also at the risks involved. Structured notes, which would allow debt service to be modified, linked to oil prices for instance, were helpful in risk management.

The question of crisis resolution was the most difficult one in the new financial architecture. In the past, the IMF could call together top bankers in time of crisis and pressure them into support. With the involvement of the private sector, that was impossible. The international community did not possess the instruments to ensure that the private sector would remain involved.

RODRIGO BRIONES, Director, Deutsche Asset Management Americas, Deutsche Bank, said that he wanted to present a different point of view -- that of the private sector -- and wanted to discuss only one subject -- capital flows. While he agreed that the international financial system had to be reformed, he disagreed with the view that crises could be avoided. Crises would happen again, although they might differ with regard to the regions affected and in their severity. The important challenge was the presence of a large pool of money waiting to be invested. What portfolio managers did was to place that pool where it could receive the best return. The funds would not be invested in countries where restrictions operated. It was important to distinguish the difference between portfolio investments, short and long-term investments and foreign direct investments. The distinction was important because since it was being said that a new international financial architecture should regulate portfolio investments. Hedge funds existed because they were unregulated, and they existed offshore because that was where there were fever restrictions.

What investors did, especially in developing countries, was to look at the rewards and the risks, he said. Some investors (and that was part of the problem) did not make adequate assessments of the rewards/risks ratio. What was more important than anything else to investors was liquidity. One year ago, no one wanted to buy debt instruments from Latin America and the emerging economies. Liquidity was crucial because one wanted funds managers to provide the highest and safest returns. It was a major component of the equation. Last year, liquidity had dried up in the emerging markets. A new financial system must address that issue in order to avoid panics. Investors had a very short memory and tended to believe that investment was something that was attached to intelligence. It was important to look at liquidity and to be conscious of the fact that it was something necessary in markets to make them more attractive.

The recent Asian crisis was the worst crisis seen since the 1930s, he said, and had raised an important point, namely that it was a systemic crisis. In Mexico, there had been a major peso crisis every six years for the past 30 years. On the one hand, there was a pool of capital, and on the other, the performance of emerging economies had been very poor. A solution was needed to ensure that crises would be less frequent. The question was how to build something better than what currently existed, especially in attracting new funds. If one looked at the financial systems in emerging economies, they all had common features –- their banking system and underdeveloped capital markets. Years ago, he said, Chile had created an interesting idea. It had come out with a concept in the mid-1980s and early 1990s, stipulating that every company in the private sector that wanted to issue stocks in the international market had to go through several requirements. One of those requirements was to receive an international shadow rating. Only when the company had received the sufficient rating could it issue its stocks in the international system.

MARTIN MAYER, Guest Scholar, Economic Studies, The Brookings Institution, said that Mr. Briones could not get his desired liquidity. That was a moral hazard. Losing on a trade was an inside risk. Investors did not trade, they invested. The international financial crisis had gone unnoticed in the United States outside the financial sector. Only those who traded of pieces of paper learned about it. The question was whether one wanted to establish a world where all pieces of paper could be exchanged for other pieces of paper. The question was also whether those pieces of papers could be priced against each other.

The question of opacity was much worse when dealing with short-term capital, he said. Central banks must have more reserves, more redundancy, to make leverage smaller. But when the central banks kept their reserves liquid those reserves would earn less, and borrowing by countries was carried out at much higher interest rates. Thus central banks became money losers. That was why central banks were trying to maximize returns, which mean more illiquidity, which led to higher risks. Central banks ought to publicize where they had invested their reserves.

The opacity of over-the-counter derivatives was a major problem. There would always be resistance from the private sector and banks to transparency, because those institutions thrived on the quality of their own information. Regulation assumed that government knew more than the markets knew.

One improvement that could be made, he said, was in the schooling of banking supervisors. Well-trained banking supervisors could increase financial stability. There were no cultural differences in the supervision of banks. Collateral valuations were important too. The value of collateral was a function of credit.

While foreign direct investment was desirable, bank lending was problematic. The bank’s risk weight was determined by rating institutions. The problem was that when lending officers were optimistic the rating agencies would be optimistic too, and vice versa. Honest men on both sides were needed in order to make FDI work.

Discussion

In response to questions posed by delegations, Ms. GRIFFITH-JONES said that people from developing countries felt, as the representative of Thailand noted, that it took two to tango where financial crises were concerned. The behaviour of international capital markets had played a role in the crises, and national economies were not to be solely blamed. Obviously there would be crises. They could not be avoided. However, many years ago, banking crises were quite frequent in countries like the United Kingdom. Better regulatory measures were therefore instituted. While they had not prevented crises, they had made them a little easier to manage. Rather than sit back and say that crises would not happen, they must be made less likely to occur and more manageable when they did. The objective of the private sector was precisely the search for liquidity and profit. At the same time, there must be someone who represented the common good -- and that was the Government. In response to a question on social aspects of reform of the international financial architecture, she said that the social aspect should be central to the discussion. The objective of the reform process should be to foster economic growth that would help reduce poverty. The question was how social safety nets could be funded, and particularly how Governments could fund such safety nets in the midst of crises. One answer was that Governments should accumulate resources during boom time and use them during times of crisis.

Mr. BOORMAN said that he did not seek to assign blame when he cited the examples of particular countries. He did so in order to give a sense of why it was crises that led to certain initiatives in certain countries. Many of the things that went wrong during times of crisis were preventable. It was incumbent on actors to bring those issues forward so that everyone could benefit from others’ experiences. It was true that the severity of crises could not be predicted, he said.

With regard to tightening of fiscal policy in times of crisis, he added that in July 1997, Thailand had been the only country in trouble. For a number of reasons, the fiscal situation in the country had been weakening. By November, when the situations of Indonesia and the Republic of Korea surfaced, it was realized that there should have been an easing of fiscal policy sooner.

Regarding social safety nets, he agreed that there was a rush, particularly after the Korean crisis, to put past-crisis safety nets in place. What was needed was counter-cyclical safety nets which would stand the strain in the midst of crises. As for earlier suggestions that developing countries following an unworkable economic model, he said that countries should take care not to “throw out the baby with the bath water” following crises.

In the context of voluntary cooperation and the private sector, he said that more effective steps were needed to recruit the private sector automatically in moments of crisis. Contingent credit lines could help in that regard. More and more, it was a matter of capturing the leverage that you had at the moment.

Mr. BRIONES said that today transactions that did not even require cash could take place. Furthermore, if you owed the bank $100 it was your problem -- but if you owed it $1 billion then it was the bank’s problem. Nowadays, if you owed $1 billion, it was not to the bank but to international investors. It was difficult to deal with investors as a whole today, and that was why information was so essential. The question that had to be addressed was the role of the commercial banks. The banking sector was crucial. The common denominator in the recent crises was that banking systems could not handle the crises. The crises had brought forward the notion of systemic risks. You could not run away from one country to invest in another because the waves of crisis traveled to other economies.

He said that voluntary cooperation of the private sector could take many forms. One way was to set clear rules before a crisis erupted. For example, an investor should not be slapped with a tax following the eruption of a crisis.

Mr. MAYER said that market economies existed within a legal order. The investors’ responsibility was to make a commitment of some length of time. The aim should be to get as many commitments as possible.

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