Economic Growth and Financial Market Development: A Strengthening Integration, Speech by Rodrigo de Rato, Managing Director of the International Monetary Fund
IMF News, August 22, 2007
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- Economic Growth and Financial Market Development: A Strengthening Integration, Speech by Rodrigo de Rato, Managing Director of the International Monetary Fund
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- Published: August 22, 2007
Context and main messages
- Speech delivered at the 3rd International Derivatives and Financial Market Conference, Campos do Jordão, Brazil, August 22, 2007. As Prepared for Delivery.
- Three core observations on recent financial-market turbulence and implications:
- For the present, the global economy is still expected to continue performing well despite recent turbulence.
- Financial-innovation risks have been highlighted, but innovations are an important contribution to sustained growth in advanced and emerging markets.
- Financial markets foster growth and stability when they are transparent, well-regulated, and provide consumer and investor protection.
Global fundamentals and market outlook
- Global growth projection: sustained global growth of about 5 percent both in 2007, and 2008, with major emerging markets leading the way.
- Balance of risks: tilted to the downside relative to a few months earlier due to financial-market turbulence.
- Principal transmission channels of risk to the real economy:
- Declining asset prices.
- Tightening financial conditions with a repricing of risk.
- Weaker confidence leading to potential reductions in consumption, especially in the United States.
- Mitigating factors:
- Most corporations remain highly profitable.
- Household finances supported by solid employment growth.
- U.S. economy expected to grow at a moderate pace in the year of the speech.
- Regional growth notes:
- Euro area and Japan expected to continue at a solid pace of around 2½ percent.
- Major emerging markets like China and India will grow at close to or above double digit rates.
- China identified as one of the main engines of world growth this year.
- Nature of current market adjustments:
- Re-appraisal of risk following exuberant credit markets—viewed as ultimately beneficial for financial stability.
- Liquidity support by central banks viewed as appropriate to restore orderly market conditions.
- Expectation that liquidity conditions will return to normal as information problems diminish and transparency improves.
Financial market development and growth
- Enduring case: recent events do not undermine the need for developing strong, broad, and deep financial markets.
- Functions and benefits of sound financial markets:
- Mobilize savings and allocate them to productive investment.
- Provide stable financing sources for public and private sectors, reducing vulnerability to volatile global capital flows.
- Enable risk management and hedging that help economies manage volatility.
- Empirical observations and examples:
- Since the mid-1990s, productivity has grown by about 1 percent a year more in the United States than in the euro area; almost half of this difference is accounted for by differences in productivity in the financial sector.
- Pension and mutual funds in Chile have helped lengthen maturities and deepen financial markets.
- Brazil and Chile have developed foreign exchange derivatives markets described as among the most sophisticated and transparent in the world.
- IMF study finding (as summarized in the speech):
- Countries with more developed financial sectors, stronger institutions, sound macroeconomic policies, and more open trade systems are better placed to benefit from financial globalization and are considerably less likely to suffer instability from greater openness to global capital flows.
Building stronger financial markets — challenges and policy recommendations
- Macroeconomic precondition:
- Macroeconomic stability is fundamental for credit-market development; credit markets take off when uncertainties about inflation, interest rates, and the exchange rate are reduced to reasonable levels.
- Regulatory, supervisory, and legal framework priorities:
- Put in place clear and consistently applied regulatory frameworks.
- Maintain strong financial supervision and strengthen supervision as markets evolve and new instruments emerge.
- Reduce unnecessary legal and regulatory impediments to market functioning.
- Ensure a clear allocation of regulatory responsibilities.
- Supplement national regulation with codes of conduct where public law and enforcement are weak.
- Consumer and investor protection, transparency, and education:
- Implement adequate protections for investors and borrowers.
- Apply prudential regulation tools: risk-weighting, capital adequacy, loan classification, and provisioning.
- Encourage truth-in-lending rules, summary disclosures in plain language, and greater financial education.
- Provide financial advice via governments and regulatory agencies; use internet tools for financial education (example: Spain).
- Competition and market structure:
- Promote competition to narrow high interest margins in Latin American banks.
- Ease portability of credit and deposits and facilitate the sharing of client information to reduce banks' market power and enhance transparency (Brazil cited as moving in this direction).
- Legal and institutional reforms to support market development:
- Reform regulatory and legal frameworks for securitization, enforcement of collateral, provision and sharing of credit information, and promotion of rating agencies and credit bureaus.
- Strengthen accounting standards, encourage transparency, and clarify and improve creditor rights to deepen corporate bond and equity markets.
- Develop well-functioning public-debt markets to establish benchmark yields and infrastructure for other markets.
- Ease constraints on pension funds to increase demand for corporate bonds (Mexico cited as relaxing rules).
- Derivatives markets:
- Derivatives can contribute to risk management and diversification.
- Many Latin American countries lack derivatives markets; where present, limited depth and crowded positions can increase correction risks.
- Strengthening regulatory/legal frameworks, accounting rules, and disclosure requirements can boost confidence in using derivatives.
- Brazil’s experience highlighted: largest derivatives markets in Latin America; unique reporting requirements for over-the-counter derivatives providing broader information to supervisors and demonstrating feasibility of good data reporting and transparency.
Regional and household credit observations (selected statistics preserved exactly)
- Financial access:
- Only around one-third of the adult population in Latin America has an account in a financial institution, compared with more than three-quarters of the population in industrial countries.
- Household credit (end-2005 comparisons):
- Latin America: household credit averaged about 9 percent of GDP.
- Emerging Europe: 12 percent of GDP.
- Emerging Asia: 27 percent of GDP.
- More developed markets: 58 percent of GDP.
- Positive developments supporting household credit in Latin America:
- Household credit increasing rapidly in several countries, including Brazil, due to institutional changes lowering loan-recovery risks and widening credit vehicles.
- Brazil’s technology enabling banks to partner with retailers and point-of-sale locations expands access to new customers and less populated areas.
- Worker remittance flows present an opportunity to widen financial services for traditionally underserved populations as banks facilitate remittance transfers.
Specific cautionary points and policy balance
- Avoid directed credit and excessive product intervention:
- Governments should avoid directing commercial bank credit or excessively intervening in product design; while regulators should require adequate provisions for riskier credit forms, policies should not limit intermediaries’ ability to allocate credit productively.
- Prudential vigilance:
- Regulators must be alert to new instruments and potential problems as markets evolve; supervisory frameworks must be strengthened alongside measures to promote credit.
Conclusion
- Central message: financial markets are increasingly important for economic development; their quality critically determines countries' economic stability and success in financial globalization.
- Roles: governments, central banks, regulators, and the private sector all share responsibility for promoting strong, resilient, and innovative financial markets.
- Forums such as the conference provide opportunities to share ideas and build on best practices.
Speech by Rodrigo de Rato, Managing Director of the International Monetary Fund, August 22, 2007.