FOR a while a number of leading financial luminaries like Goerge Soros, Bill Gates and pundits, have been predicting another financial crisis. Peter Dittus and Herve Hamoun, two former senior officials of the Bank of International Settlements, in their recent jointly-authored book, ‘Revolution Required: The Ticking Bombs of the G7 Model’, warned that the global financial system is waiting to explode because of the reckless and wrong policies of the major developed countries. Yilmaz Aykuz, former Director at the United Nations Conference on Trade and Development largely agrees in his, ‘Playing with Fire’ and analyses its implications for developing countries.
Events during the last few months seem to be vindicating the fear. The Indonesian rupiah has been under pressure in line with the overall trend of emerging market currencies, since early this year. India’s rupee struggles against the US dollar – now at its lowest point, as South Africa’s rand heads towards its weakest level. While Brazil’s real was in free fall in June, Argentina’s peso was unable to recover its lost values forcing Argentina to go to the IMF amidst national protests. Meanwhile, Turkey’s Lira has slipped into a dangerous territory. As Turkey struggles to stabilise its lira, the exposure of European banks and the threat of another global finance crisis heightens.
Why this vulnerability?
IN AN opinion piece (New Age, 30 July 2018), I have highlighted some of the fundamental weaknesses of the global economic governance architecture that are at the core of this vulnerability. These include the non-existence of any commonly agreed system of international finance since the collapse of the Bretton Woods System in August 1971 and the use of a national currency (the US dollar) as the reserve currency. This puts asymmetric burden on adjusting (deficit) countries vis-à-vis surplus countries and ensures spill-overs from the US monetary policy on other countries. Thus, countries are forced to accumulate dollars as a precautionary measure, sacrificing their option to invest in socially desirable projects.
Policy makers not only missed the opportunity to address these weaknesses in the wake of the 2008-2009 Great Recession, but also pursued misguided policies that have only compounded the problem. Having eschewed fiscal policy, they have left the entire burden of recovery to monetary policy. Thus, major central banks, led by the US Federal Reserve, embarked on unconventional expansionary monetary policy which pushed real interest rate to negative territory.
Emerging and developing economies witnessed large inflows of short-term capital as they offered higher returns than the US or other advanced economies following near zero interest rate policy. Thus, the external debt burden of emerging economies grew rapidly to an estimated amount of over $40 trillion during the decade of loose monetary policy in the developed world since the global financial crisis. The combined debts of a group of 26 large emerging markets rose from 148 per cent of gross domestic product (GDP) at the end of 2008 to 211 per cent in September 2017, according to the Institute of International Finance.
Now that the period of easy money is nearing its end, and as the US continues its ‘normalisation’ of monetary policy by raising the policy interest rate, emerging economies are witnessing capital flights back to the US, putting pressure on their currencies.
The availability of easy money meant rising household and corporate debt that fuelled housing and financial asset price bubbles. According to the International Monetary Fund (IMF, Fiscal Monitor, April 2018), global debt levels reached a historic peak of $164 trillion in 2016, amounting to 225 per cent compared to 125 per cent of global GDP pre-2008-2009 global financial crisis as global economic growth remains tepid. The IIF reported that debt held by Group of Seven (G7) industrialised nations and the majority of emerging market economies rose to a record $247 trillion in the first quarter of 2018, amounting to 318 per cent of their GDP.
Rising debt levels pose serious downside risks for the global economy. The problem is compounded by non-transparent cryptocurrencies and shadow banking. As the domino effect spreads through debt defaults with further rises in interest rates while income growth remains subdued, the world is likely to plunge into a catastrophic financial crisis for a number of factors.
Diminished response capability
BOTH developed and developing countries have less policy space than they had to respond to the 2008-2009 GFC. Most governments are saddled with debt as it reached an all time high due to bail out of ‘too big to fail’ financial institutions and failure to generate robust recovery. According to the IMF’s April 2018 Fiscal Monitor, average public debt for advanced economies stood at 105 per cent of GDP in 2017, constraining their ability to respond to any future crisis. Meanwhile their monetary policy has hit its limit after a decade of an extra-ordinary lax stance.
The IMF also reported that general government debt-to-GDP ratios in emerging market and middle-income economies reached almost 50 per cent in 2017 — a level seen only during the 1980s’ debt crisis. For low-income developing countries, it exceeded 40 per cent in 2017, climbing by more than 10 percentage points since 2012. Public debt-GDP ratios in EDEs are likely to trend upwards due to falling commodity prices and almost stagnant global trade, while they have almost no monetary policy independence due to their deepened global financial integration.
Weakened global economy
WHILE the corporate sector has been busy in mergers, acquisitions and share buybacks with cheap credits to boost executive pay-packages instead of investing in the real economy, the financial sector successfully promoted public debt as ‘enemy number one’. Being hostage to finance capital, governments around the world also wasted the opportunity to improve the productive capacity and social capital by investing in infrastructure and social goods when the real interest rate was at historic lows.
Thus, at around 24 per cent of global GDP, the global investment rate still remains below the pre-crisis level of around 27 per cent. Investment rates in EDEs have been either declining or stagnant since 2010. This means, the productive capacity of both developed and developing countries suffered significantly since the Great Recession. At the same time widening inequality continue to be a drag on aggregate demand which can only be maintained by ever rising unsustainable household debts.
Heightened social discontent
FAILURE to address falling wages share in GDP and rising executive salary as well as asset price bubbles due to extra-ordinary lax monetary policy continued to worsen growing income inequality and concentration of wealth. ‘Reverse Robin Hood’ policies – deep cuts in government spending and public services, while reducing top tax rates – are causing anger and resentment among voters. This is strengthening anti-establishment political figures and fuelling anti-trade sentiment.
THE world is less united now than it was in the wake of 2008-2009 GFC. Europe has lost its way with Germany at its back foot while anti-EU sentiment is on the rise around the continent. We are unlikely to see the leadership from the UK busy with Brexit. Neither will there be the leadership of the US when President Trump is bent on smashing all consensus with a sledge hammer. Meanwhile non-inclusive G20 has become a less coherent forum as G7 nations become suspicious of China and Russia and other members such as Brazil, Saudi Arabia and Argentina are overwhelmed with domestic issues.
Not good news for developing countries
TURBULENCE in the currency markets mirrors the lack of developing countries’ sovereignty over their economic policy and, their inability to manage the social needs of their population. Unfortunately, a decade after the GFC, developing countries still bear the scars in the form of lower growth and investment rates while they have become much more dependent upon growth in the advanced economies.
The financial sector of developing countries has now deeper and even more links with international financial markets as revealed by high percentage of the ownership of foreign funds and investors in the domestic stock markets and in government bonds. Large outflows of these foreign funds can cause a serious financial crisis for developing countries.
Recent collapse in commodity prices has caused a sharp build-up of debt by low-income countries. Twenty-four of them out of sixty (40 per cent) are now either already in a debt crisis or highly vulnerable to one—twice as many as only five years ago, according to the IMF. A few developing countries are already facing crisis and seeking IMF bail-outs.
The problem is compounded by the fact that majority of creditors are not part of the Paris Club dealing with sovereign debt issues. Access to concessional aid has also declined in recent years, adding to the difficulties in servicing external debt.
An all-out damaging trade and currency war will only add to the woes of developing countries.
Anis Chowdhury is an adjunct professor at the Western Sydney University and the University of New South Wales (Australia). He also held senior United Nations positions in New York and Bangkok
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