Coordinated global action is starting to reverse the tide of the financial crisis, but governments also need to “deploy all instruments” to limit damage to the real economy, IMF Managing Director Dominique Strauss-Kahn told world financial leaders meeting in Washington.
“Until this weekend, the collapse in confidence in the markets has been almost matched by a collapse in confidence between countries. We saw a very bad trend toward unilateral measures taken with national interests in mind. Now things are beginning to turn around,” Strauss-Kahn said in a speech at the end of the October 10–13 IMF–World Bank Annual Meetings.
But he said there was still a long way to go to stabilize financial markets and revive the battered world economy. “Action in the financial markets is essential, but it is not sufficient. We also need to deploy all of the instruments of modern macroeconomic policy to limit the damage to the real economy,” he stated.
The IMF will take the lead to draw lessons from the crisis and recommend to member countries further action to restore confidence and stability.
World has learned from 1930s
In an address to the IMF’s Board of Governors, Strauss-Kahn said that the world was going through the most dangerous financial crisis since the Great Depression of the 1930s. But because of lessons learned, the world now had the economic tools to “emerge from this crisis with our economies and our societies intact.”
During the weekend, world financial and political leaders meeting in Washington and Paris put together a series of plans and statements to combat the financial crisis and restore confidence in the global financial system hit by a severe credit crunch triggered initially by the collapse in the United States.
Leaders of the Group of Seven (G-7) advanced economies, the 15 members of the euro area, the International Monetary and Financial Committee (IMFC) representing the IMF’s 185 member countries, and the Group of 20, which represents both advanced and developing economies, all agreed on the need for coordinated action around the world.
Strauss-Kahn said governments were willing to try new approaches to end the downward spiral in markets. “Increasingly, these approaches are comprehensive, attacking all aspects of financial market problems: liquidity, bad assets, shortage of capital, and, especially, confidence,” he said.
The centerpiece of the G-7 plan is a stronger than ever commitment to use all available tools to support systemically important financial institutions. The plan outlines specific mechanisms that countries can use to support the system, jump-start credit, and restore confidence.
Euro area countries announced that they would buy into banks to boost their finances and guarantee interbank lending until the end of next year. British Prime Minister Gordon Brown said after leaving the meeting, “I believe that in the next few days confidence in the banking system will be restored.”
Strauss-Kahn said that the worldwide response did not have to be uniform but should be coordinated. “We still have a very long way to go. We don’t all need to have the same policies, but we must all talk to each other about our policies and consider the effects of our actions on our partners. This weekend is just the beginning of a long effort.”
Spurring the real economy
Strauss-Kahn said action was needed to limit damage to the real economy. Growth in the world economy, according to the IMF’s latest World Economic Outlook, is set to slump to about 3 percent in 2009. The IMF Managing Director outlined how advanced economies, emerging markets, and developing countries should react.
•Advanced economies should use “fiscal policy when they can.” The most obvious use of fiscal policy is to ease pressures where they are greatest: in the financial and housing sectors. But governments that can afford it should also be ready to undertake a broader fiscal stimulus. Scope exists to use monetary policy to support growth, building on the collaborative easing of interest rates already implemented by central banks.
•Emerging economies have differing degrees of freedom to act. Some can afford to draw down reserves to finance a temporary and sudden shortfall in capital flows. Others will need to raise policy interest rates in line with rising risk premiums to stem outflows and bolster confidence in their currencies. Some may need very substantial help, including from the IMF. “We have plenty of liquidity,” Strauss-Kahn said.
•Developing countries face reduced export demand and reduced access to trade credit. And many are already suffering from the other crisis—the food and fuel crisis that has strained budgets and balances of payments, and raised inflation and living costs. Strauss-Kahn committed IMF help to countries in difficulty. He urged developed countries not to cut aid budgets because of the financial crisis.
Strauss-Kahn said the crisis in financial markets was the result of three failures: a regulatory and supervisory failure in advanced economies, a failure in risk management in the private financial institutions, and a failure in market discipline mechanisms.
“Preventing a recurrence of these failures will require an international effort, because borders do not confine financial institutions or keep out financial turmoil,” he said.
The IMFC has asked the Fund to take the lead in drawing the necessary policy lessons from the current crisis and recommending effective actions to restore confidence and stability. The Fund will work with the Financial Stability Forum, the G-20, and others, and is scheduled to report to the IMFC at the latest at its next meeting, which will be in April 2009.
The IMFC called for “further intensive Fund engagement across the membership to discuss and develop robust policy responses to the crisis.” Both new IMFC head Youssef Boutros-Ghali (see box, page 156) and Strauss-Kahn acknowledged that actions taken by individual governments would vary, depending on their situation and structure of their financial system.
In a speech on October 10, ahead of the G-7 announcement, Strauss-Kahn had proposed a four-point action plan to help stem the downward spiral in world markets and begin to rebuild confidence. The proposal included a temporary government guarantee of liabilities, government action to take out troubled assets and force the recognition of losses, government provision of capital to the financial system, and a high degree of international cooperation.
IMF ready to lend quickly
The former French Finance Minister, who took over as Managing Director of the IMF last year, has stressed that the Fund stands ready to lend quickly through its emergency financing mechanism to any member country in financial difficulty. “The IMF has the resources and we are ready,” he said. The IMF’s Emergency Financing Mechanism was set up in 1995 and has been used on six occasions—in 1997 during the Asian crisis for the Philippines, Thailand, Indonesia, and Korea; in 2001 for Turkey; and this year for Georgia.
The IMF has more than $200 billion of lendable funds and can draw on additional resources through two standing borrowing arrangements.
The difficult global financial environment, including elevated food and fuel prices, adds to the challenges for emerging market and developing countries to preserve macroeco-nomic stability, sustain growth, and make progress on poverty reduction. For these reasons, it is critically important that collaborative action be coordinated between advanced and emerging economies.
Wealth Funds Group Publishes Voluntary Principles
The International Working Group of Sovereign Wealth Funds (IWG) published October 11 a set of 24 voluntary principles designed to ensure an open international investment environment. The IWG also started examining the creation of a permanent international body to represent sovereign wealth funds. The IWG, representing 26 sovereign wealth funds, presented the Santiago Principles—agreed in the Chilean capital in September—to the IMF’s policy-setting body, the International Monetary and Financial Committee.
An IWG statement said the purpose of the Santiago Principles was to
• Establish a transparent and sound governance structure that provides for adequate operational controls, risk management, and accountability
• Ensure compliance with applicable regulatory and disclosure requirements in the countries in which SWFs invest
• Ensure SWFs invest on the basis of economic and financial risk and return-related considerations, and
• Help maintain a stable global financial system and free flow of capital and investment.
SWFs are open to being more transparent, IWG co-Chair Hamad Al Suwaidi told a news conference, noting that the Santiago Principles specifically commit wealth funds to make a series of public disclosures.
IWG co-Chair Jaime Caruana, Director of the IMF’s Monetary and Capital Markets Department, noted that investors with long-term horizons contributed to financial stability. “That’s exactly the role that SWFs can play, because they have this kind of long-term view.”