Twenty parts to a rescue

Indian Express, 14 March 2009

The global nature of the present financial crisis has made it difficult for any single country's policies to get the country out of the crisis. In a situation in which a crisis hits a single country it only has to make sure that its own finance and banking is well regulated. It does not need to worry that poor regulation in another country is going to put its own financial system at risk. The complexity that has arisen out of the globalised financial system has made it difficult for a single country's policies to be effective.

First, there are issues that need to be addressed in the immediate future to prevent the world economy slipping into a deeper recession. These range from solving the problem of bad assets on the balance sheets of banks to providing a monetary and fiscal stimulus. Today, all large financial firms are global. When the US government works to put Citibank on its feet, the beneficiaries of this are all over the world, since Citibank operates everywhere. The assets and liabilities of big financial firms are spread all over the world, which complicates the task of understanding and resolving their problems. It also makes it politically difficult for a national government to put tax payer money into the firm if the beneficiaries are people from other countries. Thus, if it is perceived that putting French money is going to help an East European economy more than the French taxpayer, the French government is likely to end up putting conditions on the bank's operations to prevent that from happening. Similarly, while buying up bad US real estate loans from banks all over the world is a good idea, it is unlikely to be done by any single government and needs coordination across nations.

The need for international coordination is not restricted to the banking sector. Today with the contraction in output and demand being faced by there is a need for government intervention. Yet, when it comes to providing fiscal and monetary stimuli, there is a temptation for a small open economy to free ride on the heavy lifting being done by other countries. Each country could try to do a small fiscal stimulus, and hope to benefit from the efforts of its neighbours.

As mentioned above, when countries use tax payer money there is a danger of protectionism creeping into their policies. As is well understood now, when every country turns protectionist it becomes even more difficult to pull the world out of a recession. One important element of international coordination is to avoid protectionism. Though there is consensus on this issue, a number of countries, including India and the US, have tried to put in place protectionist measures in their stimulus packages.

Apart from the immediate difficulites there is the longer term issue of how to prevent such a crisis from occuring again. One element which generated the global financial crisis was excessive reserve accumulation by developing countries, owing to the fears they had after the Asian crisis about the possibility of IMF support in the event of a crisis, or the strings that came attached with IMF support. Preventing such crises requires modifying the ownership and governance of the IMF.

Equally importantly, preventing such crises requires modifying the mechanisms of financial regulation and supervision. However, since finance is international in nature, there is a need for coordination between the efforts of various countries in this regard.

The work of coordination has been placed on the G-20, which is the 20 biggest countries of the world. India is a member of this club, unlike many other clubs such as the G-7 or the UN Security Council, which exclude India. This gives India a ringside view of what is being done, and if there are areas where India has concerns, an opportunity to express these concerns. This seat on the table is the payoff which India has obtained by virtue of having high economic growth in the last decade, and will (in turn) help enhance Indian economic growth in the decades to come.

The next G-20 meeting is due to take place in London on 2nd April. There are four critical areas of debate which will take place.

First, some countries, notably on the European continent, have spent little money on a fiscal stimulus, even though they have the fiscal capacity to do more. They will be urged to do their fair share.

The G-20 countries will likely draft declarations on avoiding all forms of protectionism and exchange rate manipulation. However, the practical value of such statements is limited. Many countries, are known to announce new protectionist measures right after signing such declarations.

Third, the meeting will discuss IMF reforms. The involves the question of how to augment the resources of the IMF, and urge continental Europe to step aside in terms of influence over the IMF in favour of emerging Asia.

Finally, agreements will be made on the future of financial regulation. Everyone (including the Americans) agrees that the US system, of dozens of uncoordinated financial regulators, is dysfunctional and needs a massive overhaul. The European continent wants the ability to meddle in the regulation of London and New York, and the US and the UK want to have no such thing. There may be a long way to go on this front. At present there is little consensus on what the final destination is. India has a framework of bans on financial products and innovation because the government perceives to be risky. While some people may feel that this saved India from being affected very strongly by the global financial crisis, this is not a solution acceptable to anybody else in the G20. India, therefore, has little to contribute to this discussion.

In summary, the G-20 meetings in London are an important milestone in the process of getting the world economy back on track. India is flattered at having been invited into the high table. While today India has little experience to offer genuinetly useful suggestions on these questions, it can be hoped that being part of this process will give India the confidence to be a enthusiastic and active participant in the financial system that emerges from this process.

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