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World Economic Situation and Prospects 2009 - Executive Summary

Summary by DESA; UNCTAD; ECA; ECE; ECLAC; ESCAP; ESCWA, 2009

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World Economic Situation and Prospects (WESP) provides an overview of recent global economic performance and short-term prospects for the world economy and of some key global economic policy and development issues. One of its purposes is to serve as a point of reference for discussions on economic, social and related issues taking place in various United Nations entities during the year. The report of 2009 analyzes in detail the evolution of the global financial crisis during 2008 and the more fundamental factors that led to its build-up. It further assesses the impact on global economic activity, especially in developing countries. The report also reviews the policy actions so far taken worldwide in response to the global financial crisis. It recommends more forceful fiscal policy stimuli need to be taken in an internationally concerted manner in order to prevent the world economy from falling into a much deeper and more prolonged recession. The WESP further details a number of more fundamental reforms to the international financial system that are needed to reduce risks of a recurrence of such a devastating crisis in the future.

Executive Summary


Full Report can be downloaded at:
http://www.un.org/esa/policy/wess/wesp.html






1


Executive Summary


The global outlook


The world economy is entering into a recession


The world economy is mired in the worst financial crisis since the Great Depression. What
first appeared as a sub-prime mortgage crack in the United States housing market during
the summer of 2007 began widening during 2008 into deeper fissures across the global
financial landscape and ended with the collapse of major banking institutions, precipitous
falls on stock markets across the world and a credit freeze. These financial shockwaves
have now triggered a full-fledged economic crisis, with most advanced countries already
in recession and the outlook for emerging and other developing economies deteriorating
rapidly, including those with a recent history of strong economic performance.


In the baseline scenario of the United Nations forecast, world gross product
is expected to slow to a meagre 1.0 per cent in 2009, a sharp deceleration from the 2.5
per cent growth estimated for 2008 and well below the more robust growth of previous
years. At the projected rate of global growth, world income per capita will fall in 2009.
Output in developed countries is expected to decline by 0.5 per cent in 2009. Growth in
the economies in transition is expected to slow to 4.8 per cent in 2009, down 6.9 per cent
in 2008, while output growth in the developing countries would slow from 5.9 per cent in
2008 to 4.6 per cent in 2009.


The world economy could fall into recession in 2009


-1


0


1


2


3


4


5


2003 2004 2005 2006 2007 2008a 2009b


Baseline


Optimistic


Pessimistic


Percentage


Source: UN/DESA.
a Partly estimated.
b Projections, based on
Project LINK.


Indicates confidence
interval at two standard
deviations from
historical forecast
errors




2 World Economic Situation and Prospects 2009


Given the great uncertainty prevailing today, however, a more pessimistic sce-
nario is entirely possible. If the global credit squeeze is prolonged and confidence in the
financial sector is not restored quickly, the developed countries would enter into a deep
recession in 2009, with their combined gross domestic product (GDP) falling by 1.5 per
cent; economic growth in developing countries would slow to 2.7 per cent, dangerously
low in terms of their ability to sustain poverty reduction efforts and maintain social and
political stability. In this pessimistic scenario, the size of the global economy would actu-
ally decline in 2009—an occurrence not witnessed since the 1930s.


To stave off the risk of a deep and global recession, World Economic Situa-
tion and Prospects (WESP) 2009 recommends the implementation of massive, internation-
ally coordinated fiscal stimulus packages that are coherent and mutually reinforcing and
aligned with sustainable development goals. These should be effected in addition to the
liquidity and recapitalization measures already undertaken by countries in response to the
economic crisis. Under a more optimistic scenario—factoring in an effective fiscal stimulus
of between 1.5 and 2 per cent of GDP by the major economies, as well as further interest-
rate cuts—WESP forecasts that, in 2009, the developed economies could post a 0.2 per cent
rate of growth, and growth in the developing world would be slightly over 5 per cent.


Origins of the global financial crisis
The story of a crisis foretold


The intensification of the global financial turmoil in September-October 2008 revealed
the systemic nature of the crisis and heightened fears of a complete global financial melt-
down. Although the problems originated in the major developed countries, the mounting


Synchronized global slowdown, led by a recession in developed countries


Percentage


-2


0


2


4


6


8


10


2003 2004 2005 2006 2007 2008a 2009b


Economies in transition


Developing economies


Developed economies


Optimistic scenario


Pessimistic scenario


Source: UN/DESA.
a Partly estimated.


b Forecast.




3Executive Summary


financial fragility was closely tied to an unsustainable global growth pattern that had
been emerging as far back as the early 2000s, a risk forewarned early on in previous
issues of WESP. As part of this pattern, growth was driven to an important extent by
strong consumer demand in the United States of America, stimulated by easy credit and
underpinned by booming house prices as well as very high rates of investment demand
and strong export growth in some developing countries, notably China. Growing United
States deficits in this period were financed by increasing trade surpluses in China, Japan
and other countries that had accumulated large foreign-exchange reserves and were will-
ing to buy dollar-denominated assets.


At the same time, increasing financial deregulation, along with a flurry of
new financial instruments and risk-management techniques (mortgage-backed securities,
collateralized debt obligations, credit default swaps, and so forth), encouraged a massive
accumulation of financial assets supported by growing levels of debt in the household,
corporate and public sectors. In some countries, both developed and developing, domestic
financial debt has risen four- or fivefold as a share of national income since the early 1980s.
This rapid explosion in debt was made possible by the shift from a traditional “buy-and-
hold” banking model to a “dynamic-originate-to-sell” trading model (or “securitization”).
The leverage ratios of some institutions went up to as high as 30, well above the ceiling of
10 generally imposed on deposit banks. The deleveraging of this financial house of cards
now under way has brought down established financial institutions and has led to the
rapid evaporation of global liquidity, together threatening the normal operations of the
real economy.


Until recently, all parties seemed to benefit from the boom, particularly the
major financial players in the rich economies, while the risks were conveniently ignored,
despite repeated warnings, such as those highlighted in WESP, that mounting household,
public sector and financial sector indebtedness in the United States and elsewhere would
not be sustainable over time. As strains in the United States mortgage market were trans-
mitted to the wider financial sector, fears of a meltdown escalated and have now spread
around the world.


Policymakers worldwide have taken
unprecedented measures to deal with the crisis …


Policymakers initially responded in piecemeal fashion, failing to see the systemic risk or
to consider the global ramifications of the turmoil in their entirety. The approach in-
cluded massive liquidity injections into the financial system and the bailout of some ma-
jor financial institutions, while accepting the failure of others. As the crisis intensified
in September 2008, policymakers shifted to a more comprehensive and internationally
improved coordinated form of crisis management. The measures taken have reshaped the
previously deregulated financial landscape. Massive public funding has been made avail-
able to recapitalize banks, taking partial or full ownership of failed financial institutions
and providing blanket government guarantees on bank deposits and other financial assets.
Governments in both developed and developing countries have started to put together fis-
cal and monetary stimulus packages in attempts to prevent the global financial crisis from
turning into a worldwide human disaster.




4 World Economic Situation and Prospects 2009


… but it will take a long time for the
policies to take effect on the real economy


These policy measures are aimed at restoring confidence and unfreezing credit and money
markets by recapitalizing banks with public funds, guaranteeing bank lending and insur-
ing bank deposits. During the fourth quarter of 2008, interbank lending rates retreated
somewhat following the start of the large-scale bailout. However, by December 2008,
congestion and dysfunction remained in important segments of the credit markets. In any
event, it will take time for most of these policy measures to take effect; the restoring of
confidence among financial market agents and normalization of credit supplies will take
months, if not years, if past crises can be taken as a guide. Furthermore, it typically takes
some time before problems in financial markets are felt in the real economy. Consequently,
it seems inevitable that the major economies will see significant economic contraction in
the immediate outlook and that recovery may not materialize any time soon, even if the
bailout and stimulus packages were to succeed. Moreover, the immediate fiscal costs of the
emergency measures will be huge, and it is uncertain how much of these can eventually
be recovered from market agents or through economic recovery. This poses an additional
macroeconomic challenge.


Implications for world trade and finance
Commodity prices have become increasingly volatile …


The crisis has already had a severe impact on global commodity markets with far-reaching
implications for the prospects of the developing world at large. Commodity prices have
been highly volatile during 2008. Most prices surged in the first half of 2008, continu-
ing a trend that had begun in 2003. Trends in world market prices reversed sharply from
mid-2008, however. Oil prices have plummeted by more than 60 per cent from their peak
levels of July to November. The prices of other commodities, including basic grains, also
declined significantly. In the outlook, most of these prices are expected to even out further
along with the moderation in global demand.


… and prospects for world trade are bleak


Growth of world trade decelerated to 4.3 per cent in early 2008, down from 6.4 per cent
in 2007, owing mainly to a decline in imports by the United States. United States imports,
which account for about 15 per cent of the world total, have registered a decline in every
quarter since the fourth quarter of 2007 and dropped as steeply as 7 per cent in the second
quarter of 2008. Growth in the volume of world trade had dropped to about 3 per cent
by September 2008, to about one third of the rate of growth a year earlier. In the outlook,
global trade is expected to weaken further in 2009.


The risk of a pullback of lending to developing countries has heightened


Owing to their limited exposure to the mortgage market derivatives that brought down
major banks in the United States and Europe, financial systems in most developing coun-
tries initially seemed shielded from any direct impact from the international financial cri-
sis. Growing risks have emerged through other channels, however, as investors have started
to pull back resources from emerging market economies and other developing countries




5Executive Summary


as part of the deleveraging process of financial institutions in the developed countries. Ex-
ternal financing costs for emerging market economies surged along with the tightening of
the global credit market, as measured by the spreads of the Emerging Markets Bond Index.
Unlike in recent years when the spread varied significantly across regions and countries
to indicate investor discrimination among country-specific risks, the latest surge has been
uniform, suggesting that contagion and aversion to investing in emerging markets has
taken hold among investors. Spreads are expected to remain high in 2009, as the strains
in global credit markets linger and also as capital flows to emerging market economies are
projected to drop further.


Exchange-rate volatility has increased and the
risk of a hard landing of the dollar in 2009 remains


Volatility in foreign-exchange markets has also increased substantially with the deepening
of the global financial crisis. The United States dollar depreciated substantially vis-à-vis
other major currencies, particularly the euro, in the first half of 2008, but has since re-
versed direction even more sharply. For many currencies in developing countries, the ear-
lier trend of appreciation vis-à-vis the dollar has either reversed or slowed. Currencies in
a number of developing countries, particularly those that are commodity exporters, have
depreciated against the dollar substantially since mid-2008. The heightened risk aversion
among international investors has led to a “flight to safety”, as indicated by the lowering of
the yield of the short-term United States Treasury bill to almost zero.


However, it is expected that the recent strength of the dollar will be temporary
and the risk of a hard landing of the dollar in 2009 or beyond remains. Even though the
global imbalances have narrowed somewhat in 2008 and are expected to narrow further in


The rise and fall of commodity prices in 2007 and 2008


2000 = 100
Ja


n-
07


Ap
r-


07


Ju
l-0


7


O
ct


-0
7


Ja
n-


08


Ap
r-


08


Ju
l-0


8


O
ct


-0
8


Agricultural raw materials


Food commodities
Minerals, ores and metals


Crude petroleuma


100


150


200


250


300


350


400


450


500


Source: UNCTAD Commodity
Price Statistics database.
a Average of Brent/Dubai/
Texas, equally weighted
(dollars per barrel).




6 World Economic Situation and Prospects 2009


2009 with the recession in developed countries, the United States external deficit remains
significant and its net international liability position continues to increase. The large cur-
rent-account deficit and perceptions that the United States debt position is approaching
unsustainable levels are important factors underlying the trend depreciation of the United
States dollar since 2002. The flight to safety into the United States dollar in the wake of
the global financial crisis is pushing the external indebtedness of the United States to new
heights; this is likely to precipitate a renewed slide of the dollar once the process of delever-
aging has ended. Policymakers should recognize the risk of a possible hard landing of the
dollar as a potential source of renewed turmoil in financial markets in 2009.


Impact on developing countries
Developed economies are leading the global downturn, but the weakness has rapidly
spread to developing countries and the economies in transition, causing a synchronized
global downturn in the outlook for 2009.


Among the economies in transition, growth of the Commonwealth of Indepen-
dent States (CIS) region is on course for a marked slowdown in 2009, dragged largely by
the impact of a global recession and falling commodity prices on the largest economies,
such as Kazakhstan, the Russian Federation and Ukraine. A slowdown in business invest-
ment, and, to a lesser degree, in household consumption will be felt throughout the region.
In South-eastern Europe, a further moderation of economic growth is expected.


Among developing countries, growth in Africa is expected to decelerate in
2009, as the contagion effects of the global economic slowdown spread throughout the
region, leading to weakened export demand, lower commodity prices and a decline in in-


The global imbalances have narrowed, but still pose a risk for further financial trouble


Billions of dollars


-1 000


-800


-600


-400


-200


0


200


400


600


2003 2004 2005 2006 2007 2008a 2009b


Sources: IMF, World Economic
Outlook database, October


2008; UN/DESA.
a Partly estimated.


b Forecast.


United States


Japan


European Union


Developing countries
and economies in


transition, excluding
China


China




7Executive Summary


vestment flows to the region. Growth in East Asia is expected to decline notably in 2009,
as exports see significant deceleration. Some economies in the region will also experience
sizeable financial losses as a result of their relatively high exposure to global financial
markets. South Asia is experiencing an overall slowdown in economic growth from the
industrial sector to the service sector. Growth in Western Asia is anticipated to slow down
significantly in 2009 as export earnings from oil fall sharply, and investment spending
across the region is expected to decline. Growth in Latin America and the Caribbean is also
expected to slow markedly, dragged largely by the fall in commodity prices and global
credit constraints.


The crisis will present a setback for the fight against poverty


Coming on the heels of the food and energy security crises, the global financial crisis will
most likely substantially set back progress towards poverty reduction and the Millennium
Development Goals. The tightening of access to credit and weaker growth will cut into
public revenues and limit the ability of developing country Governments to make the
necessary investments to meet education, health and other human development goals.
Unless adequate social safety nets are in place, the poor will no doubt be hit the hardest.
An estimated 125 million people in developing countries were already driven into extreme
poverty because of the surge in global food prices since 2006. Lessons from earlier major
financial crises point to the importance of safeguarding (public) investment in infrastruc-
ture and social development so as to avoid major setbacks in human development and
allow a recovery towards high-quality economic growth in the medium term.


Immediate policy challenges
Policymakers initially underestimated the crisis


Policymakers worldwide initially underestimated the depth and breadth of the current fi-
nancial crisis. As a result, policy actions by and large fell behind the curve and, in the early
stages, policy stances were grossly inadequate for handling the scale and nature of the crisis.


Significant downturn in all developing regions in 2009


Annual percentage change


2003 2004 2005 2006 2007 2008a


2009b


Baseline
scenario


Pessimistic
scenario


Optimistic
scenario


Economies in transition 7.4 7.7 6.5 7.8 8.3 6.9 4.8 2.7 6.1


Developing economies 5.2 7.1 6.8 7.1 7.2 5.9 4.6 2.7 5.1


Africa 4.9 5.9 5.7 5.7 6.0 5.1 4.1 0.1 4.7
East Asia 6.9 8.0 7.7 8.6 9.0 6.9 5.9 4.6 6.4
South Asia 6.9 6.7 9.5 6.9 7.9 7.0 6.4 4.0 6.6
Western Asia 4.9 8.2 6.8 5.9 4.7 4.9 2.7 1.6 3.3
Latin America and the
Caribbean 1.8 5.9 4.6 5.5 5.5 4.3 2.3 -0.2 2.7


Source: UN/DESA.
a Partly estimated.
b Forecasts, based on Project LINK.




8 World Economic Situation and Prospects 2009


Only after the systemic risks for the global financial system became manifest
in September 2008 did six major central banks decide to move in a more coordinated
fashion by agreeing to cut their respective official target rates simultaneously and scale up
direct liquidity injections into financial markets.


Further monetary easing is expected in the world economy in the outlook for
2009. However, with consumer and business confidence seriously depressed and banks re-
luctant to lend, further lowering of interest rates by central banks will do little to stimulate
credit supplies to the non-financial sector or to encourage private spending. Indeed, it may
end up merely expanding the money base within the banking system.


Massive fiscal stimulus is needed


Restoring confidence in financial markets in order to normalize credit flows remains of
primary importance. However, as long as fears for a deep recession prevail, consumers and
investors will likely remain severely risk averse. Hence, counter-cyclical macroeconomic
policies are needed to complement the efforts to rescue the financial sector from wide-
spread systemic failure.


With limited space for monetary stimulus, fiscal policy options will need to be
examined as ways of reactivating the global economy. The severity of the financial crisis
calls for policy actions that are commensurate with the scale of the problem and that should
thus go well beyond any normal range of budgetary considerations. The United States ad-
opted a fiscal stimulus package in early 2008, totalling some $168 billion, or about 1.1 per
cent of annual GDP, mainly in the form of a tax rebate for households. While some analysts
believe the package had worked well to keep the economy buoyant for at least one quarter,
others doubted the permanency of its effects. It is now clear that the size of the fiscal pack-


Monetary easing moving to a liquidity trap?


Percentage


0


1


2


3


4


5


6


7


8


Ju
l-0


7


O
ct


-0
7


Ju
l-0


8


O
ct


-0
8


Ja
n-


08


Ap
r-0


8


Source: National central
bank websites.


China: One-year
loan rate


Japan: Discount rate


United States: Federal
funds rate (target)


Euro zone: Marginal
lending facility rate




9Executive Summary


age was too small in comparison with the seriousness of the situation and failed to sustain
the economy. At the end of 2008, a second, more substantial, fiscal stimulus package was
under discussion in the United States. Similarly, European countries were easing monetary
policies and preparing for significant fiscal expansion in 2009.


Counter-cyclical fiscal policies are also needed in developing countries


A large number of developing countries and the economies in transition have been reluc-
tant to ease monetary policy over concerns of inflationary pressures and currency depre-
ciation. Inflationary pressures should taper off during 2009, however, as world food and
energy prices are now retreating and global demand is weakening. This should provide
some space for monetary easing, as well as for fiscal stimulus, at least in those countries
that still possess ample foreign-exchange reserves.


The scope for counter-cyclical policies will vary greatly across developing coun-
tries, mainly for two reasons. First, many countries have a history of pro-cyclical macroeco-
nomic policy adjustment, partly driven by policy rules (such as inflation targeting). Providing
greater monetary and fiscal stimuli in such cases will thus require a departure from existing
policy practice and policy rules. Second, not all countries have equally sufficient foreign-
exchange reserves and some are likely to suffer stronger balance-of-payments shocks.


There are countries with ample policy space for acting more aggressively to
stave off a recession. The Chinese Government has already started to use its policy space,
for instance, and has designed a large-scale plan of fiscal stimulus amounting to 15 per
cent of its GDP to be spent during 2009 and 2010, which should contribute to reinvigorat-
ing global demand. The Republic of Korea has also announced a fiscal stimulus package
equivalent to 1 per cent of its GDP.


For many of the middle- and low-income countries, the scope for providing
such stimuli will be even more limited, as they may see their foreign-exchange reserves
evaporate quickly, with either continued capital reversals taking place or strong reductions
in the demand for their export products, or both. In order to enhance their scope for coun-
tercyclical responses in the short run, further enhancement of compensatory financing and
additional and reliable foreign aid flows will be needed to cope with the drops in export
earnings and reduced access to private capital flows caused by the global financial crisis.


As they fight fires today, policymakers worldwide must look to tomorrow


Looking to the long run, however, a broadening of the development policy framework
is needed to conduct active investment and technology policies so as to diversify these
countries’ economies and reduce their dependence on a few commodity exports, thereby
allowing them to meet key development goals, including reaching greater food security,
addressing climate change and meeting the Millennium Development Goals. This will
require massive resources for public investment in infrastructure, food production, educa-
tion and health, and renewable energy sources. The crisis also presents various opportuni-
ties to align fiscal stimulus packages with long-term goals for sustainable development.


The fiscal stimulus needs to be coordinated internationally


To ensure sufficient stimulus at the global level, it will be desirable to coordinate fiscal
stimulus packages internationally. In a strongly integrated world economy, fiscal stimulus
implemented by only one country tends to be less effective because of high import leakage




10 World Economic Situation and Prospects 2009


effects. By coordinating fiscal stimulus internationally, the positive multiplier effects can
be amplified through international economic linkages by 30 per cent or more, thereby
providing greater stimulus to both the global economy and the economies of individual
countries. As in the case of a coordinated monetary easing, internationally coordinated
fiscal stimuli can also limit unnecessary fluctuation in cross-country interest rate differen-
tials and in exchange rates among major currencies. Compared with coordinated interest
rate policies, fiscal policy coordination tends to be more difficult to attain, both techni-
cally and politically, and hence may be difficult to achieve through ad hoc agreements,
requiring instead a more institutionalized platform for coordination.


Without adequate coordination, global economic reactivation may be delayed,
and it may take longer before market confidence is restored. This may prolong the credit
crunch and keep borrowing costs high for developing country Governments and private
firms, thereby undermining their efforts to counteract the crisis.


Internationally coordinated policy action among deficit and surplus countries
is also critical for achieving a benign adjustment of the global imbalances and avoiding
a disruptive hard landing of the dollar. Now that the financial crisis has already turned
a disorderly adjustment into a synchronized global downturn, the need for international
policy coordination and cooperation is more pressing than ever.


Reform of the international financial system
Even in the most optimistic scenario, however, it will take time before confidence is re-
stored in financial markets and recovery can take place. As immediate solutions are being
worked out, it is important to address the systemic causes that led to the present crisis.


Global economic governance mechanisms are inadequate


The depression of the 1930s had been aggravated by “beggar-thy-neighbour” policies, dis-
integration of the global economy and resurgent protectionism. Under the promise “never
again”, it led to the design of the Bretton Woods institutions, including the creation of the
International Monetary Fund (IMF) and the World Bank, to safeguard the stability of the
global economy and promote growth and development. But over time, the ability of the
IMF to safeguard the stability of the global economy has been hampered by limited re-
sources, and it has been increasingly undermined by the vastly greater (and more volatile)
resources of private actors with global reach. More exclusive and ad hoc country groups,
such as the Group of Seven (G7) or the Group of Eight (G8), have become the platforms
where international policy coordination has taken place in practice.


The apparent irrelevance of the Bretton Woods institutions in today’s crisis
also stems from their skewed voting structures and governance, which do not adequately
reflect the importance of developing countries in today’s world economy. The lack of a
credible mechanism with broad representation for international policy coordination is an
urgently felt lacuna which is limiting swift and effective responses to the present crisis.


Regulatory frameworks are deficient


The financial crisis has revealed major deficiencies in the regulatory and supervisory frame-
works of financial markets. First, the new approach to the regulation of finance, including
that under the New Basel Accord (Basel II) rules, places the burden of regulation on the




11Executive Summary


financial institutions themselves. Second, the more complex the trade in securities and
other financial instruments has become, the greater the reliance on rating agencies who
proved inadequate to the task at hand, in part because of conflicts of interest over their
own sources of earnings, which are proportional to the trade volume of the instruments
they rate. Consequently, risk assessments by rating agencies tend to be highly pro-cyclical
as they react to the materialization of risks rather than to their build-up. Third, existing
approaches to financial regulation tend to act pro-cyclically, hence exacerbating a credit
crunch during a crisis. At times of boom, when asset prices and collateral values are ris-
ing, loan delinquency falls and results in inadequate provisioning and overexpansion of
credit. When the downturn comes, loan delinquency rises rapidly and standard rules on
provisions can lead to a credit crunch. Fourth, the spread of financial networks across the
world, and the character of securitization itself, has made practically all financial opera-
tions hinge on the “confidence” that each institution in isolation is capable of backing up
its operations. But as insolvencies emerge, such confidence is weakened and may quickly
vanish, generating a generalized credit freeze. The risk models applied by regulatory agen-
cies typically disregard such “contagion” effects and fail to account for the vulnerabilities
of the financial system as a whole, at home and abroad.


The basic objectives of the reform of prudential regulation and supervision of
financial sectors should thus be to introduce strong, internationally concerted counter-
cyclical rules supported by counter-cyclical macroeconomic policies.


The risk of a hard landing of the dollar is intrinsic
to the nature of the international reserve system


The risk of a hard landing of the United States dollar is intrinsic to the very nature of the
global reserve system, which uses the national currency of the United States as the main
reserve currency and instrument for international payments. Under this system, the only
way for the rest of the world to accumulate dollar assets and reserves is for the United
States to run an external deficit. However, as the net liability position of the United States
continues to increase, investors will start anticipating a readjustment and confidence in
the dollar will erode.


The world lacks an international lender of last resort


Over the past decade, many developing countries have accumulated vast amounts of for-
eign-currency reserves, providing some “self-insurance” against external shocks. However,
both the carry cost of holding such reserves and the opportunity costs of not using them
for long-term investment purposes are high. The tendency to accumulate a large amount
of reserves in developing countries has its roots in more fundamental deficiencies of the
international monetary and reserve system. Improved macroprudential capital-account
regulation can help reduce the need for the cost of self-insurance via reserve accumulation.
The need for self-insurance can be reduced further with more effective mechanisms for
liquidity provisioning and reserve management at the international level, both regionally
and multilaterally.


More generally, all IMF facilities should be significantly simplified and in-
clude more automatic and quicker disbursements proportionate to the scale of the external
shock. Recent action has been undertaken in this direction with the reform of the IMF
Exogenous Shocks Facility. But total resources remain limited and much more is needed
to provide collective safeguards for large-scale crises.




12 World Economic Situation and Prospects 2009


The way forward


Given the existing systemic flaws, it seems paramount that deliberations on a new interna-
tional financial architectures should address at least four core areas of reform:


(a) The establishment of a credible and effective mechanism for international policy
coordination. To guide a more inclusive process, the participation not only
of major developing countries but also of more representative institutions of
global governance is required; hence, a fundamental revision of the governance
structure and functions of the IMF and the World Bank is needed.


(b) Fundamental reforms of existing systems of financial regulation and supervi-
sion to prevent the re-emergence of excesses.


(c) Reform of the present international reserve system, away from the almost ex-
clusive reliance on the United States dollar and towards a multilaterally backed
multi-currency system which, perhaps, over time could evolve into a single,
world currency-backed system.


(d) Reforms of liquidity provisioning and compensatory financing mechanisms
backed through, among other things, better multilateral and regional pooling
of national foreign-exchange reserves and avoiding the onerous policy condi-
tionality attached to existing mechanisms.


The crisis is global; hence, global solutions are needed


World leaders have acknowledged these needs for reform. At the Follow-up International
Conference on Financing for Development to Review the Implementation of the Monterrey
Consensus, held in Doha, Qatar, from 29 November to 2 December 2008, Governments
agreed to address systemic problems and fundamentally reform the global financial
system.


At the Conference, donors also promised to honour all commitments to bridge
existing deficiencies in official development assistance to developing countries and empha-
sized that the financial crisis should not stand in the way of achieving this.


The global financial crisis could motivate countries to recur to greater trade
protection. At the Doha conference on financing for development, Governments pledged
to resist such temptation, but also stressed the need to break the impasse in the negotia-
tions to complete the Doha Round of multilateral trade negotiations and safeguard its de-
velopment dimensions, in particular the principle of special and differential treatment.


It will not be easy to find consensus among all stakeholders on the precise shape
of a new system of global economic governance, but the risk of endangering global peace
and prosperity by failing to address the systemic problems underlying the present crisis
are simply too high. This awareness should be the common ground for seeking common
solutions.






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