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Accelerating Reforms to Establish a Risk Prevention System - A View from the IMF
March 20, 2016
As Prepared For Delivery
Introduction
Ladies and Gentlemen—Good afternoon, Xiàwǔ hǎo. [下午好]
Let me start by thanking Mr. Long Guoqiang, Vice Director of the Development Research Center, for the kind introduction. I would also like to thank Governor Zhou for giving me the opportunity to share this panel with him on such an important topic.
Establishing a stronger and safer international monetary system to prevent risks is of paramount importance for advanced and emerging economies alike. The moment could not be more fitting, given the conjuncture of risks and transitions in the global economy.
With China making a major contribution, over the past few years, we saw the center of global economic “gravity” shift toward emerging and developing economies. Together this group of countries is home to 85 percent of the world’s population and accounting for almost 60 percent of global GDP.1 Since the crisis, they have become the engine of global activity, contributing more than 80 percent of global growth.
Yet today, economic momentum in this group of countries is slowing. Structural shifts on the global landscape, including lower commodity prices and tighter and more volatile financial conditions, are denting their long run growth potential. China itself is in the midst of an historic transformation to deliver on the Chinese Dream of a “great rejuvenation of the Chinese nation”. We all agree that this transition is good for China, and good for the world—but that the road may at times be bumpy.
The global economy today is increasingly multipolar, complex, and interconnected. One needs to ask how the international monetary system can be strengthened so that China and other emerging countries can restore momentum and safely deepen economic and financial integration.
As one of the largest and most systemic economies in the world, China has a clear and central role to play in this system – as Governor Zhou has eloquently articulated. The decision to include China’s currency as part of the SDR basket starting October this year, along with the 2010 governance reforms which places it among the top 3 shareholders in the IMF, are a testament to its growing leadership role in the global arena. And we should anticipate an even greater role for China in the future.
1. Where is the IMS today?
Over the coming few months, the IMF, in consultation with our membership, will be exploring possible options to strengthen the resilience of the international monetary system. 2
So let me start with how we see that system today.
The 2008 financial crisis revealed considerable fault lines in the system. The impetus for reform was inevitable.
The priorities for the Fund were clear. We overhauled our own surveillance toolkit to take better account of economic and financial interconnections and spillovers, and revamped our institutional view on the management of capital flows. This is crucial to draw more attention to the risks and global implications of domestic policies. We are also enhancing our understanding of the impact of non-economic spillovers such as epidemics.
The Fund’s role in the overall global financial safety net was also strengthened. The recent approval of the 2010 governance reforms led to a doubling of our quota resources—to about US$660 billion. This increase will put the Fund on a stronger financial footing and boost its permanent lending capacity.
Recent steps also bode well for greater representation of dynamic emerging economies in the governance of the Fund. With the quota reforms, the BRIC countries are now among our top 10 shareholders.
There have also been improvements outside the Fund. Think of improvements to the global architecture, with the creation of the Financial Stability Board. Think of improvements in global cooperation, through the G20, of which China is currently the Chair. And think of improvements to the global financial safety net, with the creation of the Contingent Reserve Arrangement, the Chiang Mai Initiative, and the ESM in Europe. In many of these initiatives, China is a key founder and contributor.
Today there is also a network of bilateral swap lines that extends beyond the major advanced countries to include systemic emerging economies. Again, China is becoming increasingly important in this network, with more than 30 renminbi swap lines in place as of end-2015. These are equivalent to about US$500 billion and account for 85 percent of all global swap lines.
2. The need for further reform of the IMS
So, with all these important changes, a natural question is why the need for further reform of the international monetary system?
In my view, the answer is simple. These reforms were implemented in response to the crisis back in 2008.
The world today presents us with new realities that require a different response. Ongoing financial globalization and integration is creating challenges that we need to adapt to. I can think of three such new and interrelated realities.
New reality number 1: Post-crisis adjustments and increased financial integration have contributed to the build-up of financial vulnerabilities.
The good news here is that global current account imbalances have narrowed since the crisis. The not-so-good news is that the nature of the adjustment – combined with increased financial integration in many emerging and developing economies – may have increased domestic vulnerabilities.
Financial integration brings clear benefits in terms of better allocation of capital globally and greater risk sharing. But if not properly managed and regulated, it can bring financial stability risks, which the global financial safety net may not be adequate to handle.
As of end-2014, total cross border flows in emerging and developing economies stood at about US$20 trillion.3 It is no surprise that cross border borrowing, particularly for banks and corporates, has become an important source of funding for many emerging economies. Yet, this source of funding can contribute to balance sheet mismatches and possible liquidity pressures.
Let us also piece together the major elements of the financial safety net that can be called upon to alleviate such liquidity pressures. These would include four broad elements: individual countries’ foreign exchange reserves, bilateral swap lines, regional financing arrangements, and financing through multilateral institutions like the Fund.
Together these resources were “roughly” estimated at about US$16 trillion in 2014, of which the bulk—US$12 trillion—is individual countries’ foreign reserves. Yet, not all countries have equal access to the various elements of the safety net.
On one end of the spectrum, there are reserve currency-issuing advanced economies. These are best covered by all the elements of the existing framework. On the opposite end of the spectrum, there are the non-systemic emerging and developing economies, which face the most limited set of options in this safety net.
Clearly, we need a bigger – and more inclusive – net that captures all risks!
New reality number 2: Capital flow volatility is becoming a permanent feature of the global landscape.
Consider the exponential growth of cross-border flows over the past few years. These flows reflected both “push” factors, such as appropriately expansionary monetary policies in advanced economies, and “pull” factors, such as rapid growth in emerging economies.
Yet today, uncertainty about global economic prospects and asynchronicity in monetary policies of major advanced economies pose a challenge for the emerging world. We should expect that episodes like the “taper tantrum” of May 2013 could be recurring, rather than one-off.
The turning of the credit cycle in emerging economies – as capital inflows decelerate or even reverse – is adding a further layer of complexity. Last year, for example, emerging markets saw about $200 billion in net capital outflows, compared with $125 billion in net inflows in 2014.
For a sample of 45 emerging market economies, the cumulative slowdown in capital inflows between 2010 and 2015 is estimated at about US$1.1 trillion. Relative to economic activity, the aggregate decline in net capital inflows represents about 5 percent of the sample’s GDP.4
These magnitudes can test the resilience of even the most robust macroeconomic frameworks. Quick liquidity support during systemic events becomes of paramount importance to stem the risk of broader contagion.
New reality number 3: Increased financial globalization also means that financial spillovers are the norm, not the exception.
Financial integration also strengthens spillovers, or knock-on effects, across countries. Think of the turmoil earlier this year that – for a while – wiped out the equivalent of US$6 trillion – or 8.5 percent of global GDP – in equity market indices.
In the current international architecture, the central role of major reserve currencies means that policy and financial developments in reserve issuing currencies can have significant spillover effects on other countries. These knock-on effects can constrain domestic policy choices, especially when countries are at different stages of the business cycle.
Even so, major advanced economies are no longer the only source of financial spillovers.
Our forthcoming research in the Global Financial Stability Report shows that financial spillovers from emerging economies – to both advanced and to other emerging economies –have become stronger since the crisis.5 This is particularly the case for spillovers from equity markets in emerging economies, which increased by 28 percent since the crisis. Spillovers from some of the largest emerging economies, such as China and Brazil, were even bigger—at about 40 percent.
3. What should reforms focus on?
So these are some of the new realities to which the international monetary system needs to adapt. There are others, of course. Think of the turbo-charged speed of financial transactions; think of digital currency and blockchain technology; think of cyber-hacking—from which even central banks are not immune. So, speaking practically, where should the focus of the reforms be? In my view, it is along two key dimensions.
First dimension: ensure that the global financial safety net is large enough, coherent, and works for all.
Clearly, strong policies and effective Fund surveillance remain the cornerstone of crisis prevention.6 Still, a large enough and more coherent global safety net, with a well-resourced Fund, remains critical. Options should explore measures that would strengthen the reliability and reduce the stigma associated with accessing the safety net.
At the Fund, we will be looking into ways to make our resources and instruments more predictable for crisis prevention and resolution. This includes further improving coordination among the various layers of the safety net.
We will also be exploring options to strengthen the role of the SDR in the international monetary system. The merits of a general SDR allocation will be considered in mid-2016, as part of our regular five-year review of the SDR.
Second dimension: strengthen global cooperation on issues and policies affecting global stability.
Increased global integration brings with it greater potential for spillovers—through trade, finance or confidence effects. As integration continues, effective cooperation is critical to the functioning of the international monetary system. This requires collective action from all countries.
In practice, this involves large source countries – both advanced and emerging – to consider the impact of their policies on the rest of the world. We need to find a more systematic mechanism to discuss spillovers and how to mitigate them. There is also a need for greater cooperation on capital flows between source and recipient countries, and on global financial regulation.
For its part, the Fund will be taking stock of progress in the liberalization and management of capital flows, with a focus on capital flow measures and foreign exchange intervention. The role of macro- and micro-prudential policies in limiting vulnerabilities in the non-bank sector will also be explored, along with options to promote greater equity finance.
Conclusion
Let me conclude. Many options for reform of the international monetary system have been considered in the past. But changes have seldom been forthcoming until times of crisis.
The structural shifts unfolding on the global landscape pose challenges to the current architecture of the system. We should not wait for the next crisis to implement the reforms that we know could actually help to “prevent” it.
Reforms should be reconsidered in a holistic manner and with an open mind. This is critical to ensure that we have an architecture that can cope with the stresses that may come along in the next decade.
Clearly, China has a pivotal role in this process. The world will be watching closely to learn from China as it deftly manages the delicate balance between economic transformation and deeper global integration.
There is a Chinese proverb that says: “To set a good example / Set yourself as the standard.” [以身作则] [yǐ shēn zuò zé].
I am confident that with its wise leadership, China will set the right “standard” for itself – and the entire world
Thank you.
1 GDP measured at purchasing power parity.
2 IMF (2016). Strengthening the International Monetary System—A Stocktaking. [link to be provided]
3 Calculated as the sum of portfolio debt liabilities, FDI liabilities, and other investment liabilities. Based on the updated and extended version of the Lane and Milesi-Ferretti (2007) dataset: ”Philip R. Lane and Gian Maria Milesi-Ferretti, "The External Wealth of Nations Mark II: Revised and Extended Estimates of Foreign Assets and Liabilities, 1970-2004", Journal of International Economics 73, November 2007, pp. 223–250.
4 April 2016 World Economic Outlook, Chapter 2: Understanding the Slowdown of Capital Flows to Emerging Economies (forthcoming).
5 April 2016 Global Financial Stability Report, Chapter 2: The Growing Importance of Financial Spillovers from Emerging Market Economies (forthcoming).
6 Countries with good fundamentals and strong macroeconomic policies tend to recover much faster from external shock, such as volatile capital flows. See IMF Staff Discussion Note: Emerging Market Volatility: Lessons from the Taper Tantrum (SDN/14/09).
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