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Rising fears of international financial instability and “financial protectionism

Updated On: Oct 23, 2007

A number of international financial governance issues were discussed this week at the Group of Seven (G7) meeting and also at the annual meeting of the International Monetary Fund (IMF). 

One of the top issues for G7 financial ministers and central bank governors was whether there should be a code of conduct for sovereign wealth funds (SWF) and whether the International Monetary Fund (IMF) should be the agency to monitor these SWF.

A recent Morgan Stanley study predicted that the world’s SWF could grow from the present US$2.5 trillion to nearly US$12 trillion by 2015.  The emergence of SWF is creating a political backlash in the form of “financial protectionism” and hence it is good that G7 has initiated the discussion to see that SWF operate by the same rules of transparency and disclosure as private funds.  The key is not to allow the sentiments against SWF and the unfound fear to be used as a cover for protectionism.

A number of these SWF are based in Asia e.g. ChinaSingaporeSouth Korea and Malaysia, and Russia and several Middle East countries are also in the game. Many of these countries have large and growing reserves. Japan is one notable exception. Despite having the second largest official reserves (after China), the Japanese government has distanced itself from any idea of the creation of a SWF. Globally, SWFs are estimated to manage more than $2 trillion and their rapid growth and lack of transparency have raised concerns in the United States and Western Europe.

Standard Chartered issued a report, State Capitalism: The Rise of Sovereign Wealth Funds cautioning that “there is a serious likelihood of Western governments and SWFs clashing over what they can buy and where… A protectionist backlash against strategic investments is real and threatens global trade.”

Another issue that has been discussed for a while is that of reforming the IMF to give the developing countries more say in the IMF. The G-24, a group of developing nations including the Philippines, reiterated their demand on Friday for bigger representation in the IMF. Brazilian Finance Minister Guido Mantega warned, “Developing countries, or many among them, would go their own way, were the perception to arise that reform will not happen or that we will be left with a purely cosmetic form.”

This request looks set to be satisfied. Italian Finance Minister Tommasso Padoa-Schioppa, who is also the newly-installed chairman of the IMF’s International Monetary and Financial Committee, announced that the IMF's board of governors had agreed on a new voting rights formula. The new voting rights would take into account both the size of the member’s economy and its purchasing power. Western Europeis likely to be the main casualty of the revamp. It currently accounts for more than 30% of the voting power but there have been calls for its share to be reduced with the introduction of the single currency- the euro.

The call for greater say in the international monetary order has been renewed in the wake of greater international financial instability due to the subprime mortgage sector in the United States. Mantega said, “The irony of this situation: countries that were references of good governance, of standards and codes for the financial system, these are the very countries that are facing serious problems of financial fragility putting at risk the prosperity of the world economy.”

The issue of financial fragility has been noted by the IMF’s Asia and Pacific Department Report- Fall 2007 Regional Economic Outlook. Although the report forecasted a modest slowdown of the Asian economies, it warned that the global financial turbulence might have significant spillovers to the region. The news that credit problems in the US are not confined to the high risk mortgage borrowers but may be spreading to other consumer loans may bring new risks to the American economy.  Given that the US is still a major consumer of Asian exports, any slowdown in the US economy will reduce growth in Asia.  (23 October 2007)

Sources:

Credit problems could spread to other types of loans (Straits Times, 23 October 2007)

Moving Ahead In Uncertain Global Economy (Bangkok Post, 22 October 2007)

GIC, Temasek Among Top State Funds (Straits Times, 22 October 2007)

Developing States To Get More Representation In IMF (BusinessWorld, 22 October 2007)

G24 Says Market Turmoil Shows Weaknesses Of Advanced Economies (Antara, 21 October 2007

Finance Chiefs Inch Towards IMF Vote Agreement (Straits Times, 21 October 2007)

IMF Official: Framework Exists For Sovereign Wealth Fund Code(Dow Jones, 20 October 2007)

IMF Says Asia Can Cope With Market Turmoil (Bernama, 20 October 2007)

FACTBOX-Sovereign Wealth Funds Brim With Money(Reuters, 20 October 2007)

UPDATE 1-Japan Distances Itself From Sovereign Fund Idea(Reuters, 20 October 2007)

U.S. Treasury Secretary Says Global Economy Remains Strong Despite Credit Crisis(Associated Press, 20 October 2007)