by Roberto Zahler, Former governor of the Banco Central de Chile
Conference on the Regional Challenges for Financing for Development: The Key Role of Regional Development Banks
February 19, 2002
© Peterson Institute for International Economics
The paper by Manuel Hinds is an important contribution to a very relevant topic in the current discussion on the "New International Financial Architecture (NIFA)". The paper is well and clearly organized in three chapters. The first one assesses the problems that are leading to a NIFA and proposes a role for the Regional Development Banks (RDBs) in their solution. The second chapter proposes the instruments and policies that the RDBs can use to play this role. The third chapter summarizes the proposal and raises some issues for discussion.
My comments relate to the issues I consider that could be improved or that require changes. When I have no comments, such as in sections C and D of Chapter II, it is because I agree with the bulk of the author's analysis and recommendations.
Comments to I. Assessment of the problem.
The author mentions two as the main problems of the functioning of the world financial markets in relation to developing countries. One is the instability of developing countries and the other their lack of access to the international financial markets. He also attempts to identify the roles that RDBs can play in the solution to these two problems.
General comments to A. Instability.
a) This section fails to mention some crucial problems related to the working of the international financial economy which directly impact emerging economies stability and/or their access to international financial markets, and where RDBs could, and probably should play an important role.
On the one hand, there is no mention to the supervision and regulation of financial markets at the international level, which presents a high degree of imperfection. In particular, the more favorable treatment of capital requirements for short-term inter-bank lending, present in the current Basle Capital Accord, adversely affects the stability of banking flows to LDCs by making their governments efforts to extend the maturity structure of foreign liabilities more difficult. And although it can be argued that the preferential treatment given to short-term inter-bank lending aims at strengthening banks in industrial countries, it nonetheless has clear adverse systemic consequences, by exacerbating emerging market fragility's caused by increasing their short-term indebtedness.
Secondly, although booms and busts are endemic to all financial markets, recent experience suggests that short-term financial international swings need to be brought under certain control. This is especially important if the main participants in the NIFA, which include the RDBs, are to concentrate their efforts more on crisis prevention than on crisis management. One of the main characteristics of many of the emerging market economies crisis, and later lack of access to the international financial markets during the nineties, in particular the Mexican, East Asian and Turkish crisis, and to a certain extent the actual Argentinean crisis, originated in excessive short term capital inflows from and to the private sector. And experience shows that by moderating these capital inflows booms that precede them, busts can to a certain extent be prevented. Here RDBs could play an important role by helping to value appropriately the social cost risk of short-term international lending to emerging market economies.
b) The paper fails to mention that in many cases emerging market economies instability is not related to inappropriate trade policy but to inadequate, either too sudden or wrongly sequenced opening of the capital account of the balance of payments. In other words, in many of the recent crisis the problems have been originated in the capital account of the balance of payments rather than in the trade account (excessive protectionism). The paper (points 3), 4) and 5)) concentrates only on the latter (trade account) as the unique source of LDCs instability.
And in other cases it has been the ill conceived domestic financial reform, i.e., interest rate liberalization without proper regulation/supervision, the main cause of instability, rather than issues related to trade liberalisation.
Specific comments to A. Instability
Point 4) says, "Since the industrial sectors of developing countries have developed behind high rates of protection…" In many LDCs this is not true any more.
In point 4) there is no mention to the fact that in many cases, in spite of LDCs having engaged in opening up, liberalization, privatization, etc., it has been the protectionism still quite prevalent in industrial countries what lies behind the "declining commodity export revenues", more than the terms of trade deterioration type of argument developed in this section.
Point 5) says, "In the 1990s, most developing countries, though still remaining heavily protectionist, liberalized their trade regime". A clarification would be useful regarding this apparent contradictory statement.
General comments to B. Lack of access to financial markets
Although I share the logic of the author in terms that if there is insufficient and/or fragile access to foreign saving, investment opportunities cannot be realized, I would suggest mentioning the need for implementing some policies oriented to increase domestic saving, and specially long term domestic saving. Latin America has interesting lessons from recent experiences that relate, on the one hand, to the catalytic role played by fiscal surpluses on private savings; and on the other hand, on the contribution of Social Security reform to the development of bond and equity markets, which constitute the domestic basis for long term sources of investment financing. RDBs are specially equipped to transfer knowledge and experience in these two areas to countries of their respective regions.
Specific comments to B. Lack of access to financial markets
Point 7) says, "Lack of access to the international markets is the other fundamental financial problem of developing countries". This is a very strong statement and, as mentioned, under certain and not so uncommon circumstances, it is the "excessive" access to international financial flows that creates, or at least facilitates crisis, even in those emerging economies which have sound macroeconomic policies .
Point 8) says, "These problems prevent not only the access to… but also…. retard the development of regional financial markets, which are practically inexistent in those countries". This is an area where it is difficult to find better-suited institutions than the RDBs to devote resources and efforts to create financial regional integration. (This topic is treated later, in point 15)).
In fact, there have been a number of interesting experiences involving regional and subregional institutions in the developing world. Examples include the agreement reached by the ASEAN countries, China, Republic of Korea and Japan to establish swap arrangements among their Central Banks; ASEAN pilot macroeconomic surveillance and monitoring schemes; the Arab Monetary Fund´s provision of liquidity for intraregional trade; the Latin American Reserve Fund (FLAR), which complements the IMF in providing liquidity financing during crises; the operations of subregional development banks such as the Andean Development Corporation (CAF); and the Arab Investment Guarantee Fund.
These experiences indicate that regional bodies can be effective in providing liquidity, sustaining trade links and facilitating access to international financial resources through risk pooling. They can also contribute to macroeconomic policy coordination and to the adaptation of regulatory systems to regional conditions. The sense of ownership surrounding them contributes to efforts aimed at adapting stringent rules, promoting full disclosure, and undertaking joint monitoring and surveillance of regional financial markets, as well as encouraging regional arrangements for monetary, financial and fiscal coordination to support sound macroeconomic policies. Regional and subregional institutions should actively be promoted and recognized as central players in the international financial architecture.
In particular, regional reserve funds and swap arrangements can contribute to crisis prevention and resolution thanks to their ability to provide international liquidity. And as mentioned in the paper, RDBs, as well as subregional development banks, can complement multilateral financing by providing and facilitating access to financial resources that support activities which yield high social returns and which the private sector is not prepared to finance. They can also play a countercyclical role in providing access to financial resources at times when international private capital becomes scarce. The experiences in this area are highly specific to each region but may serve as a basis for productive interregional exchanges of best practices.
Specific comments to C. The competitive advantage of RDBs.
In points 11) and 12) I suggest mentioning explicitly a very crucial "event rooted in the non financial parts of the economy" (first bullet of point 12)), which could be incorporated as a fourth bullet of point 11). It relates to the need for "second generation" reforms associated to improve the judiciary system, well defined property rights, bankruptcy laws, transparency, avoid conflicts of interest, appropriate corporate governance, minority shareholders rights, etc. These issues are becoming a major source of concern, not only to domestic savers but also to potential suppliers of foreign saving. Again, this is an area where RDBs could play a very significant role.
Point 18) mentions that "all multilateral institutions have tried many ideas…, most of which have proven useful. The instruments that they have used…have proven to be effective. The aim of the paper is putting these well-tried ideas…" But no example is given of how effective these instruments have been.
In fact, the IMF establishment of Contingency Credit Lines (CCLs) for coping with liquidity problems has not yielded the expected results. This is so probably because it takes a considerable amount of time to qualify for this facility and partly because of the possible loss of confidence or stigmatization that may be associated to its use. Furthermore only recently has the IMF stated an interest in dealing with private sector participation in crisis management by suggesting the implementation of an international equivalent to the US Chapter XI bankruptcy proceedings. This could help towards an orderly workout of emerging market economies debt crises, by mandating creditor co-ordination and a payments standstill.
Comments to II. Towards an improved international financial architecture: proposals for the RDBs
Although the author states that the main objective of the RDBs would be to "bring their member countries to the international financial markets in a sustainable fashion", no suggestion is made regarding the potential role of the RDBs to improve the working of the international financial markets in this regard. (For a recent view regarding international action required for stable and sustainable emerging market economies access to world financial markets, see "Rebuilding the International Financial Architecture" EMEEPG Seoul Report, October 2001).
Furthermore, point 19) states that "the RDBs…should work to reduce their own participation in the financing of the developing countries, bringing their members to a more plentiful and more sustainable source of financing for development needs, thus becoming able to concentrate on social projects with long maturity of benefits". But no mention is made here of the very well known fact of the procyclical behavior of private sources of finance and the need that multilateral banks play a countercyclical role when private financing is scarce. It is not clear, in my opinion, that overall RDBs financing should be reduced as a way to assure that LDCs integrate more aggressively and in a stable fashion to international financial markets.
B. Instruments and policies to integrate the public sector to the
1. Improving access to financial markets
Point 23) says, "Lending policies should be geared to the main objective of bringing the borrowing members to the markets, thus reducing their dependency on the development financial institutions. The design of the operations and their conditionality should be framed within this principle." For the reasons given in my comment to point 19) above, I consider that such a conclusion requires more grounding.
Point 24) relates mainly to trade liberalisation and, in my view, only in a very roundabout way to the access to international financial markets. Furthermore, I would reiterate that on this topic RDBs should work with WTO also on improving the openness of industrial counties markets to LDCs exports.
Point 25) relates to "improving the quality of macroeconomic management to make the debt of the country attractive in the financial markets and allow for the development of a solid local financial system". Regarding the reasons for which "true policy reform to ensure stability has not been attained", there is no mention to mistakes by IFIs in their approach to proper macroeconomic management in many countries, such as Mexico in 1994, Thailand in 1997, Turkey in 1999/2000 and more recently in Argentina. Some mention could be made to the need for a less ideological and narrow view from the IFIs and that, for example, "corner solution" exchange rate policies are not necessarily the best always; that the current account of the balance of payments matters, even when the fiscal sector is in equilibrium or in surplus; that capital account liberalisation does not need to be implemented in an abrupt way, etc. Many of these crucial components have not been appropriately assessed by IFIs when designing stabilisation and adjustment programs and have been important causes of major macro and banking crises in LDCs.
Furthermore, I have serious doubts regarding the proposed solution "to give more weight in the lending decisions to the credit ratings of the professional rating companies…. Such ratings provide a quantitative assessment of the well-informed perceptions of the market". On the one hand, the track record of most rating agencies has been quite mediocre. On the other hand, such a process of qualifying countries sovereign risk is likely to create a significant demand for new and frequent ratings by governments, because they will have a strong incentive to obtain a favourable rating in order to lower the interest rates and extend the maturity of international loans. This new demand for ratings will probably not be satisfactorily satisfied by existing rating agencies, and although good new agencies will enter the market with the intention to provide fair assessments and build up reputation, bad ones will enter with the purpose of maximising short-term profits through the provision of relatively favourable ratings. Under the abovementioned circumstances rating agencies, which best serve their purpose in the case of investor-driven ratings, and not when their services are demanded by borrowers (governments) seeking finance, will probably not contribute to market discipline in such a forceful way as suggested in the paper.
On points 27) and 28) I would reiterate my comment regarding the procyclical behaviour of most private sector lenders.
Point 29) is worth developing further, since this is an area where very little has been done. Increasing the regional and sub regional cooperation among supervisors and regulators would be very useful not only in relation to the stock exchange, but also in relation to banks and pension funds. The latter should become increasingly important as a way to promote labour mobility in the regions or sub regions.
2. Helping in the prevention and management of financial crisis
General comments on "Dealing with financial crises" (points 31) to 36))
a) I suggest putting the subtitle: "Preventing crises" (actual # 37)) before the title "Dealing with financial crises" (actual # 31))
b) From the text it is not clear to me why it is better that RDBs should use their resources to complement the IMF in dealing with "liquidity" issues rather than working more closely with the IMF in designing more effective crisis-prevention instruments. RDBs could play a more active role in monitoring developments in international financial markets, designing vulnerability indicators or early warning systems, monitoring domestic macroeconomic policies and, as mentioned in the paper, developing programs aimed at strengthening domestic financial sectors. Additionally, RDBs could help the IMF designing debt workouts. The latter should not be seen as a substitute for emergency financing, but as a complement that would play an essential rose in managing liquidity issues. Although such workouts do not eliminate the need for adequate provision of liquidity during crises, which has tended to increase, due to the severity of global financial instability, they could help substantially. Furthermore, before using RDBs resources, consideration could be given to the temporary issue of special drawing rights (SDRs), which could become the major source of funds for IMF emergency financing.
Point 31) mentions three issues and then refers to only two of them.
Point 34). I do not think it is convenient to say that funds being provided to recapitalize or liquidate financial institutions require that this should be done "without losses to depositors".
Comments on "Preventing crises" (points 37) and 38))
Trying to complement and improve the CCL (for the reasons given on my comments to point 18) in page 4) would require using RDBs resources for purposes not directly related to their specific task. As already mentioned, in my opinion it would be preferable if RDBs could devote efforts and research primarily to help to improve the working of the international financial system.
Additionally, it is my impression that what is stated in the paper would require a high and difficult degree of complementation between RDBs and the IMF. This co-ordination would become even more burdensome if, as it seems highly probable, there would be a need to incorporate the World Bank to these operations.
Op-ed: Who Should Lead the World Bank? February 17, 2012