Bulletin 09 Sep 29

To: Organizations addressing Trade-Finance Linkages 1) Can the G20 have it both ways? Addressing global imbalances without reform of the world monetary system 2) Financial Crisis and Trade: Consultation with Asian government officials 3) Narrow export base keeps HIPC beneficiaries at risk 4) OWINFS call to action 5) Invitation: The IMF and Protectionist Trade Policies

1) Can the G20 have it both ways? Addressing global imbalances without reform of the world monetary system One of the main achievements touted by the G20 at their recently held Summit in Pittsburgh was agreement on a "Framework for Strong, Sustainable, and Balanced Growth." The declared intention of the framework is to lead to a correction, and prevent the future recreation, of imbalances between countries with high current account surpluses and those with high current account deficits. Unfortunately, the G20's attempt to do this without a substantial reform of the reserve and monetary system that has led to the current crisis will render the effort meaningless. Many observers, including this author, had brought to attention the conspicuous absence of global imbalances and a way to fix them in the London Summit agenda.[i] It is laudable that one summit later the G20 Leaders got this close, by making the issue a central one in their discussion. But the exercise of implementing the "Framework" agreed in Pittsburg looks dangerously similar to the 2006 "multilateral consultation on surveillance." which failed to stop the macroeconomic imbalances ultimately driving the world to the current financial and economic crisis.[ii] To make matters worse, just like in 2006, agreement is that the new "Framework" will also be policed by the IMF. The greatest reason for scepticism about the success of this proposal may not lie so much on its lack of teeth --though this is a significant factor-as on its neglect of what

is known in economic circles as the "Triffin Dilemma." This is the problem generated by the use of a national currency (in our current global economy the US dollar) as the currency of choice for the settlement of international trade transactions and the accumulation of reserves. Such situation eventually leads to overextended demand of such domestic currency which eventually fuels trade imbalances. The country issuing such currency tends to grow a deficit which fuels and is fuelled by ever- increasing amounts of holdings of such currency by surplus countries. This feature of the system is aggravated in a context of free capital mobility and flexible exchange rates. The trend is particularly troubling for countries that hope to take advantage of trade opportunities, as it disrupts the capacity of the system to support the exchange rate stability they would need to do so. Increased levels of exchange rate volatility have a strong impact on trade performance through channels such as the levels of domestic investment, the variations of relative prices of export products (which, in turn, affect competitiveness of the economies), the price of access to finance for production. The value of market access concessions and price-based trade liberalization measures that receive so much attention in trade negotiations are significantly affected by such variations. While the issue had been the subject of attention in UN reports for a long time, it failed to be taken politically serious until March of this year. Then, the Governor of the Chinese Central Bank issued a paper arguing in favor of an international reserve currency that is "disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies."[iii] Other high level statements brought further momentum to the debate. The report of the UN Commission of Experts (also known as "Stiglitz Commission") appointed by the President of the UN General Assembly to provide inputs into the World Conference on the Financial and Economic Crisis devoted a considerable attention to its examination. The consensual outcome of the conference recognized the insufficiencies of the current reserve system. Among the issues for further work in its follow up process is the "feasibility and advisability of a more efficient reserve system, including the possible function of SDRs in any such system..." Last June, at the first ever Summit of the BRIC countries, hosted by the Russian government, the US dollar's role in their foreign exchange reserves and cross-border trade was reportedly a subject on the agenda.[iv] In a statement previous to the G8 meeting held the following month in Italy, a Chinese State Councillor was quoted saying "We should have a better system for reserve currency issuance and regulation, so that we can maintain relative stability of major reserve currencies exchange rates ..."[v] The aspirations and the reality But in spite of the added momentum the G20 agenda has cautiously avoided any exploration of the SDR's potential as a key piece in a renewed system for multilateral exchange rate management. In London G20 Leaders agree to have the IMF issue USD 250 billion in SDRs. In

addition they agreed to implement the special one-time allocation of SDRs in the amount of USD 33 billion that had been pending US ratification since 1997. Both decisions, after approval was given by the US Congress, were implemented by the IMF over the summer. The decisions were, however, purely oriented to address liquidity considerations. A full analysis of the effect of such decision as an instrument of liquidity injection escapes to the purpose of this piece, but it is relevant to mention that the decision does little to address the overextended demand for US dollars that is at the heart of the growing global imbalances and the ensuing exchange rate volatility. The issuance of SDRs will no doubt play a positive role by by enabling countries to keep a greater portion of their reserves in SDRs thus taking some pressure off the demand for US dollars. But the amount and terms of the issuance will mean limited impact. The amount of SDRs issued may sound impressive but it is the equivalent of less than 5 percent of the estimated total reserve assets in the world. So it is too limited to have any meaningful effect in reducing demand for the US currency. Should countries choose not to use the SDRs as a reserve asset, but rather to purchase imports, they will have to swap them for a hard currency - most likely US dollars. To the extent that this is the case, the demand for USD will either remain unchanged, if such imports would have been purchased anyway, or grow-but certainly not decrease. On the other hand, making the SDR the basis for a new monetary system would require substantial reforms to make it a more suitable and attractive asset and means of payment, reforms that so far are nowhere to be found in the G20 plans. First, SDRs can hardly become a widespread reserve asset without becoming a means of payment of international trade transactions. But currently the SDR is an asset that can only be transferred between the allowed holders: the Fund, members and some limited non-member countries or institutions that the Fund may decide. Increasing the appeal of the SDR will also require more use of the SDR in invoicing international transactions. Otherwise, since there will be always a certain exchange rate risk between the value of the actual currency that a country uses in international transactions and the SDR, countries have an incentive to keep their reserves in the actual currency that needs to be used for the settlement. In addition, the fact that the SDR needs to be swapped by a hard currency in order to serve as a means of payment also may eventually entail some liquidity risks, this is, the prospect that there may not be enough US dollars available to exchange them. Liquidity risk of the SDRs is not great today, of course, but its importance could increase in a not too distant future. It is indicative that the IMF already found it necessary to address this liquidity issue in looking at the technical aspects of its most recent allocation.[vi] Second, because of the limited transferability of SDRs, they cannot be used in foreign exchange transactions. This also diminishes the SDR's effectiveness as a reserve asset. A reserve asset that cannot be directly used by a government holding it in order to intervene in its forex markets to influence the value of its currency, would be of limited use.

Third, the current composition of the SDR basket is not the most suitable to provide stability to exchange rates, and is even farther from optimal if one thinks of developing countries' trade needs. Being a basket of the four major currencies-USD, Euro, yen and Sterling-the SDR is, of course, less volatile than each of those currencies alone. On the other hand, these are not the least volatile currencies in the world. Modifications could include either changes or additions to the reference currencies or the criteria by which they are decided. Especially, the fact that only four currencies are allowed poses a limitation that could be overcome by expanding the number to eight, or more. Another G20 decision that touches upon the role of SDRs was the one to authorize the IMF to issue SDR-denominated bonds as a way to raise funding. So far several countries have purchased, or are in the process of purchasing, such assets. China has done so in the amount of USD 50 billion, and Brazil, India and Russia have made purchases in the amount of USD 10 billion each. Like the increased availability of SDR themselves, increased availability of SDRdenominated assets could contribute to reduced need for countries to accumulate USD holdings, giving them an opportunity to diversify. However, the usefulness of SDR-denominated assets for this purpose is also limited. For one, it is clear that countries that fear a US dollar depreciation could, in principle, diversify without the need to wait for the issuance of SDRs or SDR-denominated assets by having their currency holdings replicate the composition of the SDR basket. The problem they faced was how to engage in the necessary sales of USD dollar holdings without triggering a depreciation of the USD that would leave them worse off than at the beginning. In addition, this would have led to a relative appreciation of the domestic currency which some of these countries, China a clear case in point, had no interest in accepting. Against this backdrop, the IMF bonds denominated in SDRs provided a potential way for countries with large amounts of USD holdings to exchange them with the IMF without triggering undesirable consequences. As long as the IMF keeps the USD in their reserves, they can achieve the outcome of discretely diversifying their reserves without putting downward pressure on the US dollar value. There is only one problem with this strategy and it is its limited scope. The possibility of a depreciation of the USD is a continuing concern, regardless of large sales of US dollar reserves by emerging markets. To the extent that the dollar continues to face pressure towards a depreciation, the IMF has a mismatch between assets (in USD) and liabilities (in SDRs). The fact that the value of the USD represents an important percentage in the value of the SDR basket certainly reduces the impact of this mismatch (in other words, as the USD goes down, the SDR value will also, to a certain proportion, go down). But a mismatch will no doubt ensue. The question is to what extent will the IMF largest shareholders be willing to bear, and/or let the IMF bear, these risks. The IMF seems to take care of this problem when it says that "The SDR denomination would match the denomination of Fund credit, thereby ensuring that the Fund does not

incur exchange rate risk when it borrows."[vii] Indeed, there is no mismatch between assets and liabilities if they are both measured in SDRs, but this assumes that all currency holdings transferred to the IMF will be immediately lent through the other window. This is unlikely to be the case, and it's unlikely to be the case throughout the full life of the Notes. However, it is an open question whether this euphemistic approach will be considered enough by the main shareholders or eventually a certain tolerance limit to the exchange rate risk will become a ceiling to the use of this strategy. A complicating factor is that the terms of the agreements by which China and other countries bought these assets further limit the applicability of this strategy. According to such agreements the purchase price of the Notes will be paid "by transfer of the SDR equivalent amount of" the currency of the purchaser. In other words, a country purchasing the SDR-denominated bonds pays for them in its own domestic currency. Unless it issues it, it will still have to sell dollars in the market to get it. The chance to bypass a forex operation of USD sales would be, in this scenario, averted. By increasing the proportion of SDR-based assets towards the future it is, obviously, possible to gradually change the overall composition of the portfolio but the fact that a swift change of US dollars to SDR-denominated assets is ruled out, will slow down the process. Summing up, the G20 cannot have it both ways. Its attempt to face global imbalances without facing the features of the monetary system that give rise to them can be predicted to lead to only more of those imbalances. Developing countries whose trade potential fell victim to the flaws in the current exchange rate system may be better served, in the short term, by regional initiatives. Alongside the global discussion, the last few months have seen the initiation of bilateral initiatives between China and a number of countries within and outside Asia. Likewise, the use of a number of existing regional initiatives has seen a boost. At a recent seminar in Asia, representatives of 17 Ministries of Finance and Central Banks in the region restated the importance of a stable exchange rate and said that "domestic efforts towards a managed exchange rate will be much more efficient if supported by regional arrangements that lessen reliance on traditional reserve currencies, such as multilateral systems for payments of trade transactions with domestic currency, complemented by regional units of account and clearing unions." (see item 2 in this update) These initiatives should not be perceived as a hindrance to the pursuit of global ones. On the contrary, they are a natural stepping-stone to an eventually better design for them. [i] For an assessment of London Summit Declaration see London G-20 Summit: No 'Bretton Woods II' here, either, available at http://www.coc.org/node/6370 [ii] For more on these consultations see Caliari, Aldo. The IMF's ""multilateral consultations"": were the skeptics right? available at http://www.coc.org/node/4678 [iii] Xiaochuan, Zhou 2009. Reform the International Monetary System.

[iv] Xu, Wang 2009. BRIC summit may focus on reducing dollar dependence. In China Daily, June 16. [v] Parker, Dinmore et al 2009. China in New Dig at Dollar. In Financial Times, July 10. [vi] IMF 2009. Proposal for a General Allocation of SDRs. June 9. See Sections III C and E focusing on the "absorption Capacity" of existing voluntary arrangements and the possible need to resort to "designation," that is, the mechanism by which members with a sufficiently strong external position are required to purchase a determined amount of SDRs. [vii] IMF 2009. A Framework for the Fund's Issuance of Notes to the Official Sector. July 17.

2) Financial Crisis and Trade: Consultation with Asian government officials Last July, in Dhaka (Bangladesh) the Center of Concern, in cooperation with UNESCAP, held a regional consultation on the theme "Financial Crisis and Trade: Towards an Integrated Response." This is the second in a series of regional consultations that Center of Concern has been carrying out this year (for more information on the first one visit http://www.coc.org/node/6416). The consultation relied on the generous support of the Ford Foundation, the Swedish Ministry for Foreign Affairs and UN -ESCAP. It was carried as part of the regional seminar "Strengthening the Response to the Global Financial Crisis in Asia-Pacific: The Role of Monetary, Fiscal and External Debt Policies" and was attended by senior officials from Finance Ministries and Central Banks of 17 governments in the region, in addition to participants from intergovernmental organizations and civil society. In a statement at the end of the workshop participants said that Asia needs to develop new engines of growth as "Given the need to contain global imbalances, the United States and the European Union are unlikely to continue their pre-crisis role of engines for driving Asia's export led economic growth in the medium-term." For the full Outcome Document of the workshop visit http://www.unescap.org/pdd/calendar/strengthening_responses/papers/Dhaka_outco me_13Aug09.pdf (recommendations emerging from the trade portion of the workshop are captured in paras. 31-33) Two papers were produced and provided background for the consultation. The first paper, " The Financial Crisis in Asia: Assessing the Relevance of Trade and Trade-related Channels" is posted at http://www.unescap.org/pdd/calendar/strengthening_responses/papers/Special_sessi on_montes_choudhary.pdf (powerpoint presentation is at http://www.unescap.org/pdd/calendar/strengthening_responses/papers/Special_sessi on_montes_choudhary_ppt.pdf ) The second one, "The Financial Crisis and Trade in Asia: Towards an Integrated Response", is available at http://www.unescap.org/pdd/calendar/strengthening_responses/papers/Special_Sessi on_Aldo.pdf (powerpoint presentation available at http://www.unescap.org/pdd/calendar/strengthening_responses/papers/Special_Sessi on_Aldo_ppt.pdf )

For other materials produced at the conference, including background papers for sessions on debt, fiscal and monetary policy, visit http://www.unescap.org/pdd/calendar/strengthening_responses/strengthening_respon ses_July09.asp A press clip is available at http://www.unescap.org/pdd/calendar/strengthening_responses/dailystar_31Jul09.pdf

3) Narrow export base keeps HIPC beneficiaries at risk A new IMF Working Paper, "External Debt Sustainability in HIPC Completion Point Countries: An Update," by Jie Yang and Dan Nyberg, analyzes a number of structural factors affecting debt sustainability. The paper finds that in HIPC completion point countries the export base broadly remains narrow. They conclude that this is among the factors that will, if not addressed, lead countries back into a debt trap. According to the study, most HIPC completion point countries remain weak in their export diversification and vulnerable to terms of trade shocks. Their reliance on a few agriculture products or other commodities, such as gold and petroleum products, provides limited ability to cope with external shocks. Diversification of export remains a key challenge to HIPC completion point countries, though Ethiopia, Malawi, and Uganda are singled out as having made gains in this direction. The full paper is available at http://www.imf.org/external/pubs/ft/wp/2009/wp09128.pdf

4) OWINFS call to action Please find below link to a call to Action in preparation of the upcoming WTO Ministerial (scheduled for November 2009), that is being distributed at the request of of Our World Is Not for Sale. http://www.ourworldisnotforsale.org/en/signon/global-turn-around

5) Invitation: The IMF and Protectionist Trade Policies This invitation is circulated at the request of the Independent Evaluation Office of the IMF. The IMF and Protectionist Trade Policies: What does the record of the past 15 years tell us? The Independent Evaluation Office of the IMF

cordially invites you to a presentation of findings and recommendations from its recent evaluation of IMF involvement in international trade policy issues Friday October 2, 3:00-4:30 pm Room Elmadağ 2, Istanbul Congress Center Susan Schadler, head of the evaluation team, will present the main findings and recommendations. A panel of experts will lead the ensuing discussion Chair, Hector Torres, Counselor, WTO Vinod Thomas, Director General, Senior Vice President, Independent Evaluation Group, World Bank Jo Marie Greisgraber, Executive Director, New Rules for Global Finance Tam Bayoumi, Senior Advisor, IMF Tea and Coffee will be available

Aldo Caliari Director Rethinking Bretton Woods Project Center of Concern