Tuesday, November 18, 2008

The G20 Role In The Current Financial Crisis

The Finance Ministers and Central Bank Governors of the G-20, held
The tenth annual meeting in Sao Paulo, Brazil. They met at a time when the
global economy is facing its most serious financial crisis and economic
slowdown in decades. The key debate revolved around the causes of and policy responses to the global financial crisis. In what follows we provide a summary of the G20 conclusions.

In the G20 view, the current financial crisis is largely a result of excessive risk taking and faulty risk management practices in financial markets, inconsistent macroeconomic policies, which gave rise to domestic and external imbalances, as well as deficiencies in financial regulation and supervision in some advanced countries.

According to the communiqué released, the key challenge is to resolve the financial crisis in a durable manner and to mitigate the impact of the crisis on global economic activity through broad, coordinated and timely measures as appropriate. In their view, measures must be designed not only to restore growth and financial stability, but also to minimize the negative social impact particularly in emerging and low income countries. The G-20, with its broad representation of major systemically important economies, has a critical role to play in ensuring global financial and economic stability, and, with that purpose, is committed to enhancing collaboration.

The measures taken so far by a many emerging markets to stabilize its economy are driven to reduce the impacts on the commercial banking system. However, there remains considerable volatility in global financial markets. According to the G20 proceedings they agreed that all countries must address the risks associated with
excessive leverage and improve their regulatory and supervisory regimes
in order to deliver improved risk assessment and management by financial
institutions, to enhance transparency and accountability in financial
markets, as well as to strengthen international cooperation to identify and
respond preemptively to national and international systemic risks.

Furthermore, the G20 proceedings argues for the need to improve the supervision and
governance of financial institutions, at both national and international levels. In this regard, the g20 argues that we should consider ways of enhancing the
identification of systemically important institutions and ensure proper
oversight of these institutions, including credit rating agencies. Also, it is important to address the issue of pro-cyclicality in financial market regulations and
supervisory systems. Another related issue is the one on the role financial institutions and the fact that they should have common accounting standards and clear internal incentives to promote stability and that action needs to be taken, through voluntary effort or regulatory action, to avoid compensation schemes which reward excessive short-term returns or risk taking. Regulators and supervisors should
enhance their vigilance and cooperation with respect to cross-border flows.

The G20 also noted that fiscal policies have served as an important instrument to
address the current financial crisis, including through government support
to the financial sector and have performed an important stabilization role
and in mitigating further negative effects on markets and on economic
activity. The idea that countries like China are already taken fiscal policy measures to boost its economy suggest that the G20 members countries must use all their policy flexibility consistent with their circumstances, to support sustainable growth, while we recognize the importance of fiscal sustainability for macroeconomic stability and growth. Furthermore, in cases where severe market disruptions have limited access to the necessary financing for counter-cyclical fiscal policies, multilateral development banks must ensure arrangements are in place to support countries with a good track record and sound policies.

The G20 communique recognizes the relevance of adopting sound monetary policies. The recent slowdown in world growth and consequent reduction of commodity prices have decreased inflationary pressures especially in advanced economies and allowed central banks to decide on monetary easing. According to the G20: “In those economies facing currency depreciation and still suffering from second round effects, inflationary pressures may be more persistent. In this context, monetary authorities will need to continue to carefully monitor economic developments, including the consequences of financial deleveraging, in order to take appropriate action if needed.”

Fiscal Policy Actions
The fact that China has announced a comprehensive fiscal package to boost consumption in the amount of US$580 billion over two years raises the question was to whether other emerging markets like Brazil will follow a similar path. The announcement reflects the acknowledgement of China’s policymakers of the severe global economic downturn as well as their determination to limit the domestic economic slowdown caused by slumping demand in developed countries.

The massive spending package is equivalent to more than 6% of China’s 2-year GDP and involves an ambitious spending list. These include outlays on rural infrastructural development, transportation, health and education and improved waste management, as well as tax relief and increased direct financial support for low-income households. It should be noted that it remains unclear how much of the massive sums is net new money. Nevertheless, the administration will undoubtedly be judged by the effectiveness of these well-publicized measures in supporting job creation and income growth; as such, we expect that the net stimulus impact will be sufficient to keep overall economic growth at 8% in 2009.

The magnitude of the headline expenditure initiative can be viewed within the context of the November G-20 Finance Ministers’ gathering as a further step in Beijing’s assertion of China’s global economic leadership. Indeed, as we explained above the communiqué of the São Paulo meeting emphasized that the use of counter-cyclical fiscal policy to boost economic growth.

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