SAIIA/UNCTAD Financing development experiences of regional monetary - - PDF document

1 SAIIA/UNCTAD Financing development – experiences of regional monetary and financial South-South cooperation – the role of multilateralism in the current global economy” Johannesburg 10 May 2017 Opening statement, Diana Barrowclough, UNCTAD1 Good morning, dear colleagues and participants, I must begin by greeting warmly and thanking deeply the South Africa Institute of International Affairs, for having facilitated this significant event. We are grateful for your efforts organising and hosting what we anticipate will be a substantial and important exchange of research findings and practical experiences of South-South monetary and financial cooperation. UNCTAD appreciates the close ties we have been building with Government ministries, development institutions and academia in South Africa over the years and we look forward to continued collaboration and cooperation

• n these important topics for development.

I should make the point also that this week’s event is not a stand-alone for either SAIIA

• r UNCTAD, nor indeed for several of our speakers who have joined us from near and
• far. We will hear later today more about the work of SAIIA with respect to national

banking systems in Africa. From UNCTAD’s side, this seminar is one of a series of research activities and policy discussions on this theme that is specially authorised and financed by the General Assembly of the United Nations – for the reason of improving understanding about how regional financial and monetary mechanisms can help support development. The topic has become increasingly important for two reasons. One recognises the potential of south-south mechanisms in the light of failures and limitations in the global institutions and financial architecture. Ultimately we really need to reform those institutions and systems, but in the meantime regional mechanisms are proving to be an attractive and useful complement. Secondly, the topic is important because regional integration offers many positive benefits in other senses, including reducing vulnerability to external shocks, increasing resilience, and boosting growth because they also increase the potential for local production, consumption and regional trade –

1 Diana Barrowclough is Senior Economist, Division on Globalization and Development Strategies,

• UNCTAD. She is currently leading the multi-year, multi-country research project of which this

seminar is a part. Prior to joining UNCTAD, Dr Barrowclough was a lecturer in economics at the University of Cambridge and Fellow of St John’s College. She holds a PhD degree in Economics and a Masters of Philosophy in Economics from the University of Cambridge, UK. She was formerly educated in Auckland, New Zealand.

2 among others. So there are both push and pull factors supporting regional integration that we will be hearing about over the next two days. As part of this project, UNCTAD has been working closely with governments, academics and development institutions in Latin America, Asia and Africa. Several of those who have been directly involved are in the programme later today and tomorrow and we look forward to hearing from them later. In our research we have focused on four main policy areas of South-South financial and monetary cooperation, including: (i) mechanisms for short-term (foreign currency) liquidity provision to support the balance of payments, in particular the use of regional funds such as Latin America’s FLAR and Asian responses such as the Chiang Mai Initiative; (ii) the role of regional payment systems to mitigate exchange rate volatility and facilitate the expansion of intra-regional trade, including currency union such as West Africa’s CFA and the Eurozone, alongside very different mechanisms such as the “virtual” SUCRE and other innovative systems introduced in Latin America. (iii) A third tranche examined some of the new mechanisms emerging to provide long- term financing for development, such as the new regional and multi-regional development banks including New Development Bank, Banco del Sur and Asian Infrastructure funds alongside long-standing development banks at national and regional levels, many of which are adapting and changing to meet the new circumstances. (vi) Finally we examined the role of macroeconomic co-ordination and co-operation to stabilize and expand regional and domestic aggregate demand, promote the creation of dignified jobs and facilitate 'climbing up the technology ladder' to achieve higher value added productivity growth. During this process, we have learned that all four categories of macroeconomic function

• f governments are inter-dependent and inter-related. We should not confine

consideration of financial or monetary mechanisms for development without also considering other aspects of macroeconomics that can support or hinder their

• effectiveness. The need for reserve fund support in the first place may be related to

exchange rate volatility, trade-related payment systems, methods of production and trade, for example. Inter-regional infrastructure investment also needs supportive political institutions and policies. Industrial policy is needed to help create demand for the long-term development finance that is becoming available, to support new enterprise and structural transformation that cannot come from the private sector alone, despite the fact that finance may be readily available. Labour market policies are needed to promote employment and aggregate demand. Tax policies are needed to address base-shifting and tax ‘caves’ which divert finances away from domestic investment and future production and trade, as well as undermining government’s ability to finance

3 development banks, and so on. For obvious reasons, experts and practitioners usually focus on just one of those four categories but UNCTAD is striving to show that we need to consider all these integrated aspects of pro-growth macroeconomic policies together, and I look forward to learning more about these elements during our days together now. I will pick up these issues again in my own presentation tomorrow. For my remaining moments, I want to highlight four wider political economy issues that are important for the development potential of regional financial and monetary integration in the developing world, because they impact the “space” that exists for putting in place the policies needed. The first concerns the current global economic environment – which we in UNCTAD believe makes regional integration both more necessary and more difficult to achieve. It remains far from settled – gyrating between seeming good news and bad news; the world economy swings according to frequently changing market sentiment. Deep macroeconomic imbalances remain, reflecting the failure of the lead economies to

• rchestrate a durable recovery from the global financial crisis and subsequent
• recessions. The flipside of this is stagnation caused by a continued lack of demand in

the advanced economies. According to UNCTAD's latest estimates, global output decelerated to 2.2 per cent in 2016, down from 2.6 per cent experienced in both 2014 and 2015. A number of large emerging economies, in particular, suffered setbacks, registering weak or negative

• growth. Meanwhile, global trade continued to disappoint, growing at about 1.3 per cent
• ver the year in volume terms, but marked by a general decline during the first half of
• 2016. Some have found cause for cautious optimism in signs such as an uptick in

commodity prices and weak growth in manufacturing production; others gain comfort from a hint of tightening in labour markets in advanced economies. However UNCTAD’s view is that these are more reflections of short-term financial herding rather than any change in the underlying fundamentals; they are not evidence of economic recovery nor the start of a robust growth path. As my colleagues put it “quarterly capitalism with a happy face does not equal a break from the new normal”. In the USA for example, renewed optimism rests heavily on expectations of growth based on an expansionary fiscal policy and infrastructure support plus measures to protect employment – but there remains little in terms of concrete detail. Net fiscal injections may come from the lower corporate and high-income tax rates, but these are likely to produce only weak multiplier effects and not the significant boost to consumption, investment and aggregate demand needed. Turning to Africa, current macro data is scarce but it suggests a rebound from the very low growth rates of 1.7% last year, especially if commodity prices and global trade continues to rise. However, as most African countries have not diversified their economies, financing for the required pace of investment to sustain economic growth

4 will have to rely on commodity exports or capital inflows – which makes African economies particularly vulnerable to changes in sentiment in either of these two volatile markets. The problems with this second source of investment is my second point. It is a major concern that capital inflows in general to all developing countries remain extremely short-termist, volatile and prone to abrupt reversals. As shown in this graph below from the Trade and Development Report, net private capital flows to developing and transition countries increased dramatically since the moves to liberalize capital accounts in the early 2000s. Until the global financial crisis

• f 2007-8, these were positive and contributed to above average economic growth. But

net capital flows have been highly volatile, falling on the heels of the crisis, then initially rebounding, then with a massive inflow especially to some developing countries up until the second quarter of 2014. After this, flows turned sharply negative – mostly due to outflows from China but most other developing regions as well. The sharp reversal lead to a net negative flow of -$656 billion in 2015, and a further -$262 in the first two quarters of 2016 (-$185 in the first quarter of 2016). Importantly, these massive fluctuations in capital flows, which can also be seen as massive changes in the availability of cheap credit, are related more to the policies of quantitative easing in the USA and other developed economies, than with the prevailing conditions and needs in the recipient countries. Graph: Signs of an excessively financialised global economy Net capital inflows to selected countries. (See TDR 2016 pg 15).

5 Africa (shown in orange) appears something of an exception, because in this region capital flows are more related to FDI rather than global macroeconomic conditions but the levels are very low and not necessarily to be relied upon. Overall the trend to negative net capital flows is a core challenge for developing countries, especially given the expected return to “normal” monetary and interest rate policy in the USA. As I mentioned, they are more a reflection of the policies and interest rates in advanced economies – not the capital needs or investment opportunities of the developing ones. Those policies can be changed unexpectedly and without concern for the spillover effects onto other countries, and one obvious implication is that they cannot be relied upon for financing sustained long-term investment – for this, we need development banks or other publicly-supported funds of the kind that are being discussed here today and tomorrow. The fact that it is not just about finance however can be seen in UNCTAD evidence that even when capital is potentially available, at record-low interest rates, investment has not been forthcoming. In last year’s TDR, we showed that investment rates have been falling sharply even as profits and dividends rise (pg 143, 156.) In South Africa, the investment to profits ratio was around 83 for the years 1995-2002, but this fell to 66 for the years 2009-2014. Other developing countries show similar trends and there are many reasons for this, but the point is that investment is too low to promote growth. It reminds us that flanking policies are needed so that when development banks or investment funds do have capital to invest, they are able to look long-term and to the wider economic and social benefits that will be created, rather than giving too much attention to credit ratings or the vagaries of international capital markets Another implication of the large and abrupt reversals of capital flows shown in the graph concerns their effect on exchange rate volatility – which reminds us of the inter- related nature of the four macroeconomic categories we are discussing. Avoiding exposure to the costs of US dollar depreciation and volatility is one of the reasons some countries in Latin America have created bilateral currency swaps or the SUCRE, for

• example. In other countries, capital controls are once again in place – they have long

recommended by UNCTAD as one of the potentially useful tools in the macroeconomic toolbox and now even the IMF has come around to their use. This leads to my third point - the problem of debt, an area where UNCTAD has long been very active in terms of research, advocacy and in technical support to developing countries, and which has obvious implications for the topics we will discuss over the next few days. Against this background I have just sketched out – of slow global economic growth, dismal trade, negative capital flows, uncertain and low commodity prices, and potentially rising US interest rates and US Dollar, the growing stock of debt incurred by developing countries is bound to become a serious liability for their immediate

• future. At the global level, any global recovery appears still to be strongly debt-driven.

6 At the end of the third quarter of 2016, global debt levels had reached $217 trillion – surpassing the levels reached at the onset of the global financial crisis by a stunning $75 trillion. Thus a looming debt crisis is a major concern across the developing world. While external debt to GDP ratios remain relatively low by historical standards, debt service and payment burdens have risen sharply – to around 13% for all developing countries in 2015. This increase in debt service burdens has hit the most vulnerable developing countries the hardest. Of 67 low and middle income countries assessed recently by the IMF and World Bank,

• nly 12 were considered at low risk of debt default. This situation cannot be ignored,

especially since the main causes of this renewed high vulnerability to debt and financial distress in many countries remains outside of their control. As UNCTAD has argued for a long time, it reflects in part the continued austerity policies (or non-stimulatory at the least) from the north, but also the downside of a rushed integration into under-regulated financial markets; mis-matched debt compositions heavily tilted to high risk exposures, exchange rate fluctuations, maturity mismatches, and generally volatile and unpredictable investor sentiments. Short and cheap credit “bonanzas” do not lend themselves to the productive long-term investment that is needed – what is more likely is a new debt trap. And as we have seen in the past, even private sector and corporate debt can quickly lead to additional debt burdens on public balance sheets, including bail out payments. Harsh austerity responses are likely, further undermining growth prospects. Avoiding this kind of trap spreading across the developing world requires policy responses that go beyond business as usual. Graph 2 also taken from last year’s UNCTAD Trade and Development Report (pg 154) shows the rise in debt-service to income ratios for the private non-financial sector (corporations and households) for selected developing and developed economies since 2007. Graph: Debt service to income ratio, private non-financial sector (See TDR 2016: 154)

7 Debt service-to-income ratios (DSRs) are generally considered a reliable early warning indicator of banking crisis due to non-performing loans, with high DSRs also usually affecting consumption and investment negatively. In some East and South East Asian countries, this is a reflection of rising household debt, whereas the bulk of rising DSRs in other countries is attributable to rising corporate indebtedness. With the exception of South Africa and the advanced economies, the DSR not only is higher now in emerging economies than before the global financial crisis; the trend, within selected economies, is overwhelmingly rising. This reminds us of the need to take an inter-linking and inter- dependent view to the four categories of south-south monetary and financial mechanisms we are examining today and tomorrow. As we know from historical experiences – such as the developing country debt crises of the 1980s and 1990s - the pending spectre is one of private debt crises turning into sovereign ones, through the de facto ‘nationalisation’ of large chunks of toxic private debt. For smaller and poorer developing economies the picture is more complex. But, clearly, a global economic environment such as the current one, which is not conducive to stable and balanced economic expansion, places a very high burden on regional mechanisms for fast and effective macroeconomic policy co-ordination. However, this occurs at a time when deeper south-south integration, especially at financial and monetary terms, is only just emerging in many cases. This leads to my fourth and final point – the balance between regional responses and

• multilateralism. As I mentioned at the start of this address, while our discussions today

and tomorrow focus on South-South regional integration this is not to suggest this is a substitute or replacement for multilateral solutions and responses to global financial instability. Even the most powerful and effective of the current South-South financial and monetary institutions cannot deal with continuous (financial) exogenous shocks to their economies while also mobilising and maintaining long-term development finance. The Latin America’s reserve fund FLAR, for example, which has been used 38 times to support member countries over the last 35 years, explicitly aims to be a ‘lender of first resort’ for its members; it is too small to be a lender of last resort and sees itself as a complement to the IMF not a replacement. The greatest problem with such arrangements is their size, especially if all members are subject to shocks at the same

• time. There are various ways to deal with this but even then, regional mechanisms can
• nly go so far. Similarly with respect to the long-term investment needs set out in the

Sustainable Development Goals; these represent the most massive investment push in history and expectations are very high, and the new regional development banks and infrastructure funds are at best still emerging and finding their feet. Moreover, many development banks walk a fine line e between making truly developmental investment decisions, and protecting their credit ratings because of their reliance on being able to access international capital markets in order to finance loans.

8 The first best solution would still be a fully functional and development oriented multilateral system – one that can accommodate sustained financial and trade imbalances to finance structural transformation and allow developing countries to substantially increase export earnings and be able to cover debt payments. However this still remains out of reach, because it implies a comprehensive reform that would include a new agreement on rules for multilateral exchange-rate management, and a mechanism that shares the burden of adjusting to capital imbalances with surplus countries and not only deficit ones as at present, with its contractionary bias. It could also include a global central bank, even a new global currency. Much less ambitious changes include augmenting the resources of the IMF, and reforming its governance to better meet the voice and needs to developing countries. Other truly multilateral proposals include the establishment of a UN intergovernmental tax body, which remains stalled despite having strong support from developing

• countries. Also the Finance for Development process has seemingly morphed into a

means of implementing the Sustainable Development Goals, rather than being a true reform of the financial and monetary system. These are major disappointments especially given that other multi-regional initiatives relating to trade, investment, IPRs, and investor-state disputes among other things are emerging around the globe, but which threaten development interests. Given this context, regional South-South arrangements are the obvious alternative and many developing countries are using them to foster regional macroeconomic and financial stability, reduce the need for foreign reserve accumulation, and strengthen resilience and capabilities to deal with balance of payments crisis. At the same time however, such strong needs risk overloading them. Ideally we can combine strong national and regional initiatives with a supportive global environment that can be a stepping stone to a more comprehensive reform in the future. Sharing experiences on what is needed, as we are doing over the next few days, is a part of that process and the United Nations can play an important role in bringing the voices of all countries into the discussion and in helping to form and support new multilateral arrangements that will work better for development. UNCTAD is the part of the United Nations family mandated to work on issues relating to finance, investment, trade and development and we look forward to continued collaboration with our member states on the important issues that we are discussing now. ***