According to this year’s TDR, the lack of dynamism of the aggregate demand at the international level and of reform of the international financial system impedes the global economy to grow at higher rates and regain its pre-crisis momentum.
“The current international financial architecture does not promote economic development,” said TDR team leader, UNCTAD’s Alfredo Calcagno.
“Speculative capital flows fuel financial asset bubbles, excessive credit, currency appreciation in countries receiving large capital inflows, and a current account deficit that in turn creates uncertainties eventually leading to capital outflows,” he added.
In the case of developing countries, and particularly in Latin America, worries of a sudden or substantial exit of inflows began with the economic slowdown and have become more pronounced with the increased volatility of recent months.
“The expectation of a very small adjustment in the interest rate of the Unites States Federal Reserve has triggered capital flow volatility and a financial meltdown,” Calcagno said.
Central banks in developing countries have a number of instruments in their policy toolkit to cope with market volatility, according to the report.
“They may use their considerable external reserve assets built up during the phase of capital inflows, which give them room of manoeuvre to administrate the exchanges rate. Countries can also turn to capital controls to cope with market volatility. Although this may not be enough to avoid crises as global solutions are needed to cope with a global problem,” Calcagno said.
The TDR 2015 highlights that managing the persistent volatility of financial flows requires an internationally coordinated policy response.
“The international monetary system should ensure the provision of stable international liquidity,” Calcagno added. “Currently, liquidity tends to be abundant in boom periods, but it rapidly evaporates in crises.”
The 2008 financial crisis triggered several initiatives aimed at strengthening regulation and banking supervision, as well as at facilitating access to official liquidity needed to address balance-of-payment problems. However, “reforms remain both too timid and narrow,” he said.
Ongoing efforts to strengthen prudential regulation -- by raising capital and liquidity requirements-- has focused on traditional banking. But “inadequate attention has been paid to the risks inherent in the shadow banking sector” Calcagno stated. Moreover, "current regulation discourages lending to SMEs and to innovation."
According to the report, reforms of the international financial architectureshould include ring-fencing of financial activities that require a strict separation of retail and investment banking and regulation of the activities now performed by the shadow banking system.
“Credit rating agencies should also be further regulated,” Calcagno added.