PREVIEW: Global Financial Governance Confronts the Rising Powers

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ISBN 978-1-928096-17-7

Global Financial G

overnance Confronts the R

ising Powers

Edited by C. Randall Henning and Andrew WalterForeword by Barry Eichengreen and Miles Kahler

Henning | WalterEMERGING PERSPECTIVES ON THE NEW G20

Global Financial Governance

Confronts the Rising

Powers

www.cigionline.org

EMERGING MARKET AND DEVELOPING COUNTRIES have doubled their share of worldeconomic output over the last 20 years, while the share of the major developed countries has fallen below 50 percent and continues to decline. The new powers are not simply emerging; they have already emerged. This will remain true despite financial turmoil in some of the rising powers. This historic shift in the structure of the world economy affects the governance of international economic and financial institutions, the coordination of policy among member states and the stability of global financial markets. How exactly global governance responds to the rising powers — whether it accommodates or constrains them — is a leading question, perhaps the leading question, in the policy discourse on governance innovation and the study of international political economy.

Global Financial Governance Confronts the Rising Powers addresses the challenge that the rising powers pose for global governance, substantively and institutionally, in the domain of financial and macroeconomic cooperation. It examines the issues that are before the G20 that are of particular concern to these newly influential countries and how international financial institutions and financial standard-setting bodies have responded. With authors who are mainly from the large emerging market countries, the book presents rising power perspectives on financial policies and governance that should be of keen interest to advanced countries, established and evolving institutions, and the G20.

C. RANDALL HENNING is professor of international economic relations in the School ofInternational Service at American University in Washington, DC. He specializes ininternational and comparative political economy, global governance and regionalintegration. He has focused recently on the International Monetary Fund, regionalfinancial arrangements, Europe’s monetary union, fiscal federalism and the G20,and has edited or authored several books and articles on these subjects. Currently,he is conducting projects on the fragmentation of global financial governance andthe political economy of the euro crisis.

ANDREW WALTER is professor of international relations in the School of Social and Political Sciences at the University of Melbourne and a senior fellow in the Melbourne School of Government. He has published widely on the political economy of monetary and financial issues, and is the author of East Asian Capitalism: Diversity, Continuity, and Change; China, the United States, and Global Order; Analyzing the Global Political Economy; Governing Finance: East Asia’s Adoption of International Standards; and World Power and World Money.

Published by the Centre for International Governance Innovation.



Powers


EMERGING PERSPECTIVES ON THE NEW G20



Powers


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v

CONTENTS

Foreword . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .vii Barry Eichengreen and Miles Kahler

Abbreviations and Acronyms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .xi

Introduction and Overview: Global Governance and the Changing Structure of International Finance . . . . . . . . . . . . . . . . . . . .1 C. Randall Henning and Andrew Walter

Part One: Financial Spillovers and Capital Flow Management1 Capital Flows and Capital Account Management in Selected Asian Countries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29 Rajeswari Sengupta and Abhijit Sen Gupta

2 Capital Flows and Spillovers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .67 Şebnem Kalemli-Özcan

3 Capital Controls and Implications for Surveillance and Coordination: Brazil and Latin America . . . . . . . . . . . . . . . . .83 Márcio Garcia

Part Two: Currencies and Liquidity4 The Global Liquidity Safety Net: Precautionary Facilities and Central Bank Swaps . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .119 C. Randall Henning

5 Internationalization of the Renminbi: Developments, Problems and Influences . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .151 Ming Zhang

vi

Part Three: International Financial Regulation6 Emerging Countries and Basel III: Why is Engagement Still Low? . . . . . . . . . . . . . . . . . . . . . . . . . . . .179 Andrew Walter

7 International Financial Standards and Emerging Economies Since the Global Financial Crisis . . . . . . . . . . . . . . . . . . . . . . . . . . .211 Hyoung-kyu Chey

8 Financial Structure, Regulation and Inclusion: An Empirical Study across Developing Economies . . . . . . . . . . . . . . . . . . . . . . . .237 Mariana Magaldi de Sousa

Part Four: Emerging Country Experience with Regulation9 International Cooperation on the Resolution of Financial Institutions: Where Does India Stand? . . . . . . . . . . . . . .263 Renuka Sane

10 Brazil’s Implementation of Basel’s Regulatory Consistency Assessment Program . . . . . . . . . . . . . . . . . . . . . . . . . .287 Fernanda Martins Bandeira

11 Shadow Banking in China and International Regulatory Cooperation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .307 Zheng Liansheng

Contributors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .331

vii

In 1944, 730 delegates from 44 nations met in Bretton Woods, New Hampshire, to agree on the structure of the international economic order, creating the International Monetary Fund (IMF) and the World Bank. Their negotiations were eased and streamlined by the fact that much of the preparatory work had been done by experts from two advanced countries, the United States and United Kingdom, reflecting the economic and financial power of America and the historical importance and intellectual influence of Britain.1 The monetary and financial order that emerged from Bretton Woods featured exchange rates that were pegged to the US dollar and a special role for the greenback as a source of safe and liquid assets for governments, central banks and markets.

Also notable was what the Bretton Woods system did not feature. It did not encourage freedom of international capital flows, given the perceived risks of capital mobility. It did not provide for the close coordination of national macroeconomic policies or establishment of a global financial safety net. Reflecting the segmentation of national financial markets, it did not focus on the need for international financial regulatory cooperation. It did not establish a smaller, more manageable subgroup of systemically significant economies to act as de facto steering committee for the world economy.

Seventy years later, the world economic order is very different. It is more multipolar, due to the rapid growth and increasing assertiveness of emerging

1 Eric Helleiner has reminded us that the developing economies were an active presence at this famous conference, but their participation does not change our essential point.

FOREWORD

Barry Eichengreen and Miles Kahler

viii Barry Eichengreen and Miles Kahler

markets such as China. Cross-border capital mobility has risen dramatically from the low levels of the immediate post-World War II era, as international markets and transactions recovered from earlier disruptions and policy makers responded by relaxing statutory controls. International monetary and financial spillovers have intensified, placing a premium on the international coordination of national economic policies, especially in global crises. Heightened cross-border financial spillovers have also highlighted the need for international cooperation on financial regulation given that what happens financially in one country no longer stays in that country, not just in crises but even during relatively placid times.

The Bretton Woods system of pegged but adjustable exchange rates may have fallen by the wayside, but the US dollar retains its special role as a source of international liquidity. At the same time, questions have arisen about the continuing ability of the United States to provide safe and liquid assets on the scale required by an expanding global economy. In turn, this has directed attention to the scope for other national units, such as China’s renminbi, to develop into supplementary sources of liquidity and, more generally, to play a greater international role.

Adapting policies and institutions to these new realities has not been easy. Start with the institutions. Reform of the IMF and the World Bank has been incremental at best. The Bretton Woods institutions continue to feature large executive boards, European overrepresentation, a US veto and a leadership selection process that privileges their American and European members.The US Congress has blocked the latest round of IMF reforms for five years.

Predictably, the slow progress of reform has encouraged the emerging economies to pursue alternatives. Some, like the New Development Bank (or BRICS Bank) established by Brazil, Russia, India, China and South Africa, are seen as alternatives to the Bretton Woods institutions.Others, such as the Group of Twenty (G20) and the Financial Stability Board (FSB), include both advanced and emerging-market countries.They differ from the IMF and the World Bank in their smaller memberships and, in some cases, their focus on issues like financial regulation that have traditionally been subsidiary concerns of the Bretton Woods institutions. Yet the utility and durability of this new architecture remain to be determined, as does the ability of these new groupings to work with the Bretton Woods institutions, which remain central to global economic governance. The G20 has emerged as a key steering committee for the world economy, but it was most effective during the 2008-2009 crisis. As the circumstances of different countries subsequently diverged, the G20 has arguably become a more troubled and less effective venue for international cooperation.

Controversy continues to swirl around such issues as the management of capital flows and cross-border spillovers. Many, but not all, emerging markets

Foreword ix

have long seen capital flows as a two-edged sword, displaying more sympathy than their advanced-country counterparts to the active use of capital controls and inflow and outflow taxes. But the efficacy of these measures continues to be debated, and efforts to promulgate a “code of conduct” for capital account regulation have not come to fruition. International standards for financial regulation, set by the FSB and other agencies, remain works in progress. There has been progress in developing a global financial safety net since the Asian crisis of 1997-1998 and the global financial crisis of 2008-2009, but that safety net is a patchwork of global, regional and bilateral arrangements whose effectiveness is untested. China’s progress in internationalizing the renminbi is impressive, but the currency will not soon become a significant supplement to the dollar as a source of global liquidity.

In order to promote cooperative outcomes on the issues of governance and policy that have divided industrialized and emerging economies, an intellectual basis for policy dialogue is required. This research project on New Thinking and the New G20 is intended to support such a dialogue. In designing the project we had two aims. The first was to contribute original research on reform proposals in two core areas: governance of international monetary and financial relations; and international collaboration in financial regulation. The second aim was to create a research network that would provide a continuing stream of new ideas, sustain international collaboration and integrate researchers from the emerging economies into global policy discussions. We hope that the efforts of the research teams engaged in the project will represent an important first stage in building such an emergent structure of collaboration. In recruiting the members of our research teams, we concentrated on “next generation” researchers who will contribute new thinking to policy debates for decades to come. They have demonstrated both their commitment to this multinational enterprise and the feasibility of a research network that spans North and South and multiple continents.

This project relied on financial support from the Centre for International Governance Innovation (CIGI) and the Institute for New Economic Thinking (INET) for which we are grateful. We also valued the intellectual contribution and support of Domenico Lombardi, Director of the Global Economy Program at CIGI. Alisha Clancy at CIGI aided the progress of the project through her skillful administration of the grant and her liaison with the organizers.

The organizers and leaders of the research teams, C. Randall Henning and Andrew Walter, provided essential guidance. The unflagging efforts of Randy and Andrew as both editors and authors have produced a volume that will impress both scholars and policy makers with its coherence and quality. And, of course, without the hard work and notable talents of the authors, drawn from

x Barry Eichengreen and Miles Kahler

six emerging economies, neither the research project nor the incipient network would have been a success.

At the inception of the project, participants in a planning meeting at the University of California, San Diego, in July 2013, contributed their invaluable counsel regarding the content and structure: Jennifer Corbett, José de Gregorio, He Fan, Eric Helleiner, Takatoshi Ito, Paul Jenkins, Ashoka Mody and Wing Thye Woo.Several members of this planning group have remained closely involved throughout the project. Two workshops in October 2014, one in Washington, DC, and one in Melbourne, Australia, brought together researchers and outside experts to discuss initial drafts of the papers. Experts who contributed their comments and suggestions at the workshops included James Boughton, Marcos Chamon, Kevin Davis, Andrew Godwin, Jikon Lai, Mark Lawrence, José Antonio Ocampo, Penelope Smith, Arvind Subramanian and Nofel Wahid. The Washington workshop also benefited from presentations by Martin Parkinson of the Treasury of Australia.

At the final conference in Washington, DC, on April 15, 2015, the authors presented their papers to an audience drawn from the academic and policy communities. A distinguished group of discussants added their recommendations at the event, among them Olivier Jeanne, Hung Tran and Nicolas Véron. The School of Government of the University of Melbourne and its Dean, Helen Sullivan, sponsored the conference luncheon. We were gratified to have two distinguished speakers at the conference: Adair Lord Turner and Turalay Kenç. We recognize the organizational assistance provided by Judy Jue to C. Randall Henning, the principal organizer of the conference.

We hope that readers will share our estimate of the accomplishment that this volume represents, not only for its editors and authors, but also for the international collaboration underlying the project and the promise that such collaboration holds for the future.

Barry Eichengreen and Miles KahlerCo-Directors of the project, New Thinking and the New G20

xi

ADB Asian Development Bank

ADR American depositary receipt

AFC Asian financial crisis

AFI Alliance for Financial Inclusion

ASEAN+3 Association of Southeast Asian Nations plus China, Japan and South Korea

BBVA Banco Bilbao Vizcaya Argentaria

BCB Brazilian Central Bank

BCBS Basel Committee for Banking Supervision

BCG Basel Consultative Group

BI Bank of Indonesia

BIS Bank for International Settlements

BoE Bank of England

BoJ Bank of Japan

BoK Bank of Korea

BoP balance of payments

BoT Bank of Thailand

BRIC Brazil, Russia, India and China

BRICS Brazil, Russia, India, China and South Africa

BRL Brazilian real

BRRD Bank Recovery and Resolution Directive

CASS Chinese Academy of Social Sciences

CBRC China Banking Regulatory Commission

CCB countercyclical capital buffer

CCF credit conversion factor

ABBREVIATIONS AND ACRONYMS

xii

CCP central counterparties

CFMs capital flow management measures

CIGI Centre for International Governance Innovation

CMG crisis management group

CMIM Chiang Mai Initiative Multilateralisation

CNH offshore RMB market

CNKI China National Knowledge Infrastructure

CNY onshore RMB market

CPMI Committee on Payments and Market Infrastructures

CPSS Committee on Payment and Settlement Systems

CRA credit rating agency

CRA Contingent Reserve Arrangement

CRAs credit rating agencies

CUNY City Univeristy of New York

D-SIB domestic systemically important bank

EAEs emerging Asian economies

EBA European Banking Authority

ECB European Central Bank

ECCL Enhanced Conditioned Credit Line

EMDE emerging market and developing economy

EMEs emerging market economies

EMP exchange market pressure

EMPI exchange market pressure index

ESM European Stability Mechanism

FATF Financial Action Task Force

FCL Flexible Credit Line

FDI foreign direct investment

FDIC Federal Deposit Insurance Corporation

FSAP Financial Sector Assessment Program (IMF)

FSB Financial Stability Board

FSDC Financial Stability and Development Council

Abbreviations and Acronyms xiii

FSF Financial Stability Forum

FSLRC Financial Sector Legislative Reforms Commission

FX foreign exchange

G7 Group of Seven

G20 Group of Twenty

GDF Global Development Finance (World Bank database)

GFC global financial crisis

GFCI Global Financial Centres Index

GFSN global financial safety net

Global Findex Global Financial Inclusion Database (World Bank)

GMM generalized method of moments

GPFI Global Partnership for Financial Inclusion

G-SIBs global systemically important banks

G-SIFI global systemically important financial institution

HM Her Majesty’s (Treasury)

ICC International Chamber of Commerce

ICICI Industrial Credit and Investment Corporation of India

IFC Indian Financial Code

IFS International Financial Statistics

IIF Institute for International Finance

IMF International Monetary Fund

INET Institute for New Economic Thinking

INR Indian rupee

IOSCO International Organization of Securities Commissions

ISDA International Swaps and Derivatives Association

L/C letter of credit

MMF money market fund

MSBs Monetary Stabilization Bonds

MSS Market Stabilization Scheme

NPA non-performing asset

NSFR net stable funding ratio

xiv

ODI outward direct investment

OECD Organisation for Economic Co-operation and Development

OTC over-the-counter

PBoC People’s Bank of China

PCCL Precautionary Conditioned Credit Line

PCL Precautionary Credit Line

PLL Precautionary and Liquidity Line

PPG public and publicly guaranteed

PRB Peer Review Board

QE quantitative easing

QEDS Quarterly External Debt Statistics

RBI Reserve Bank of India

RC resolution corporation

RCAP Regulatory Consistency Assessment Programme

REER real effective exchange rate

RFAs regional financial arrangements

RMB renminbi

ROSCs Reports on the Observance of Standards and Codes

RQFII RMB Qualified Foreign Institutional Investors

SBA standby arrangement

SBIs Bank Sentral Republik Indonesia certificates

SDDS Special Data Dissemination Standard

SDR Special Drawing Right

SIBs systemically important banks

SIFI systemically important financial institutions

SLF Short-Term Liquidity Facility

SOE state-owned enterprise

SRR special resolution regime

SSBs standard-setting bodies

TR trade repositories

UNSC United Nations Security Council

Abbreviations and Acronyms xv

UNSGSA United Nations Secretary-General’s Special Advocate for Inclusive Finance for Development

URR unremunerated reserve requirement

VIX Chicago Board Options Exchange Volatility Index

WEO World Economic Outlook

WS3 Workstream Three (FSB’s Standing Committee on Supervisory and Regulatory Cooperation)

WTO World Trade Organization

1

Emerging market and developing countries have doubled their share of world economic output over the last 20 years and the collective contribution of the countries that comprise the Group of Seven (G7) has, for several years, been a minority share even on the most favourable measure. The new powers are not simply emerging; they have emerged and continue to rise relative to the advanced countries. This historic shift in the structure of the world economy poses new challenges to the governance of international economic and financial institutions, the coordination of policy among member states and the stability of global financial markets. How exactly global governance responds to the rising powers — whether it accommodates or constrains them — is a leading question, perhaps the leading question, in the policy discourse on governance innovation and the study of international political economy.

It is not at all clear, however, what exactly the large emerging powers want with respect to economic policy or the institutional arrangements for global economic governance. We know that they do not seek to roll back trade and financial globalization, by and large, but do seek to maintain space for effective national autonomy to develop and stabilize their economies. They also seek the participation of advanced economies in mutual efforts to stabilize financial markets in crises. But it is not clear that, as creditors, the governments of rising powers would provide larger loans to crisis borrowers, ease or substantially modify policy conditionality, or lower prudential or regulatory standards for private global financial institutions, for example. Large emerging market countries seek larger shares in the quotas and voting arrangements in the formal international financial institutions to achieve autonomy and gain influence, but

INTRODUCTION AND OVERVIEW

Global Governance and the Changing Structure of

International FinanceC. Randall Henning and Andrew Walter

2 C. Randall Henning and Andrew Walter

what exactly they will do with this influence when and if they receive it remains to be seen.

Rising powers can create new institutions of their own, outside the set of governing arrangements that evolved under the leadership of the G7 in previous decades. To the extent that their preferences are not satisfied within the existing arrangements, they can be expected to do so. The exercise of such “outside options” raises the question of the fragmentation of global financial governance. Will further growth in the number of international institutions operating in the financial sphere degrade global economic cooperation, or can these organizations and initiatives be coordinated? If fragmentation is to be avoided, how will that coordination be achieved?

The Group of Twenty (G20) was created in the aftermath of crisis — first at the level of finance ministers in 1999 and then at the level of heads of government in 2008 — in order to involve emerging market and developing countries in the management of the solution. As an institution, it is an attempt to accommodate the rising powers in the management of the global economy. As an informal body, not founded on a charter defining rights and obligations of members, it is more flexible than the formal organizations such as the Bretton Woods institutions. The G20 guides the work of the formal bodies and serves as a forum for the coordination of the policies of the member states. While its decisions are consequential only through their impact on state policy and institutions’ decisions, therefore, the group is nonetheless deeply influential.

This book addresses the challenge that the rising powers pose for global governance, substantively and institutionally, in the domain of financial and macroeconomic cooperation. It examines the issues that are before the G20 that are of particular concern to these newly influential countries and considers how international financial institutions and financial standard-setting bodies (SSBs) have responded. Part One addresses financial spillover and the management of capital flows, while Part Two is devoted to the international role of currencies, specifically the Chinese renminbi (RMB), and the provision of liquidity in crises. Part Three presents analysis of the role of emerging countries in international financial regulatory arrangements, while Part Four examines the experience of India, Brazil and China with financial regulation. Gathering authors mainly from the large emerging market countries, the book presents rising power perspectives on financial policies and governance that should also be of keen interest to the advanced countries, established and evolving institutions, and the G20.

In this overview chapter, we set the stage for the chapters that follow in three ways. First we review the rise of the emerging powers and the development of the G20. We observe that, while the G20 was created to fill the gap that had opened between the rise of the large emerging markets on the one hand and

Global Governance and the Changing Structure of International Finance 3

their influence in global governance on the other, the gap remains fairly wide. Second, we present the key debates over macroeconomic policy, financial flows, regional financial arrangements (RFAs) and international financial regulation within the G20. We summarize the findings of the chapters as they relate to these debates. Finally, we present some of the key recommendations for policy and reform of the institutional arrangements, proposing them as the agenda for the G20 over the second half of this decade.

Ascendance of the Emerging Market Countries and Global Governance Dilemmas

Only in East Asia have “emerging” economies demonstrated sustained relative growth outperformance compared to the advanced economies of North America and Western Europe. This outperformance dates back to the 1950s for Japan, to the 1960s for Hong Kong, Singapore, South Korea and Taiwan, to the 1970s for some countries in Southeast Asia, and to the 1980s in the crucial case of China. The oil-producing countries of the Middle East experienced similarly rapid growth in the 1960s and 1970s, but this was not sustained in the decades that followed. Rapid growth in Latin America, Sub-Saharan Africa and South Asia is a relatively recent phenomenon, dating from the mid-to-late 1990s. However, as these latecomers joined the cohort of rapidly growing developing countries, the general idea of “emerging market economies” spread rapidly over the course of the 1990s and was firmly established by the turn of the century.1

Even more recently, this increasingly generalized growth outperformance has translated into a shift in the centre of gravity of the world economy. As recently as the early 2000s, the G7 countries collectively still dominated the world economy, making up about two-thirds of global output measured at market exchange rates (see Figure 1). From this time, however, growth outperformance in emerging economies rapidly eroded this share, a phenomenon that accelerated in the aftermath of the global financial crisis. Today, the G7 share of global output is less than half. If purchasing power parity exchange rates are used to compare GDP shares, the declining share of the G7 in global output can be made to look even starker. It is also clear that a rising global share for emerging East Asia has been the primary counterpart of the reduced share of the G7.

Until the unexpected collapse of the financial systems of the most advanced economies in 2008 and the unprecedented macroeconomic and microeconomic interventions that followed, many commentators saw a generalized pattern of convergence in policy and in state-market relations among developed and emerging countries. This convergence process was given considerable impetus

1 As indicated by the relative frequency of “emerging markets/economies” in published books in English in the Google Ngram Viewer database. See https:// books.google.com/ngrams/info.


by financial and economic crises in a number of countries and regions that had self-consciously pursued alternative models to the “neo-liberalism” advocated by the governments of Margaret Thatcher and Ronald Reagan in the United Kingdom and the United States. One by one, these alternative models suffered a series of reversals that neo-liberal triumphalists later interpreted as having been inevitable. The Latin American debt crisis of the 1980s, the economic decline and eventual political collapse of the Soviet system during the 1980s, the crises in Scandinavia in the late 1980s and early 1990s, and the difficulties faced by Japan and Germany after 1990, all fostered a growing sense that there was no viable alternative to the “Washington Consensus” (Naim 1999). When a number of emerging East Asian economies succumbed to financial crises over 1997-1998, the collapse of alternative models and the triumph of neo-liberalism seemed complete.

All of this had a significant impact on policy. A number of emerging country governments adopted policies that appeared to emulate those in the United Kingdom and the United States, including the Menem government in Argentina, the Salinas government in Mexico and the Kim Dae-Jung government in South Korea. The 1990s also witnessed the proliferation of international policy standards, from the “voluntary” bank regulatory standards set by the Basel Committee for Banking Supervision (BCBS) to the harder policy conditionalities set by key lending institutions such as the International Monetary Fund (IMF) and World Bank. Financial sector liberalization was

Figure 1: G7 and Region Shares of Global Economic Output 1980–2015, at Current Prices and Exchange Rates (Converted to US dollars)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1980

19

82

1984

19

86

1988

19

90

1992

19

94

1996

19

98

2000

20

02

2004

20

06

2008

20

10

2012

20

14

Other emerging and developing

Sub-Saharan Africa

Middle East and North Africa

Latin America and the Caribbean

Emerging and developing Europe

Emerging and developing Asia

Other advanced economies

Major advanced economies (G7)

Source: IMF (2015).


strongly encouraged. On macroeconomic policy, capital account liberalization was increasingly viewed as an appropriate policy objective for all countries, and inflation targeting by independent central banks as the optimal monetary policy regime. The reforms urged by the G7, the IMF and associated institutions on the crisis-hit East Asian economies in the late 1990s, represented the apotheosis of this reform and convergence agenda (Walter 2008). Even China, which had been relatively unaffected by the regional crisis, appeared to accept much of this neo-liberal policy consensus under Zhu Rongji’s premiership.

This partial convergence in terms of policy norms and economic models also served to bolster the leadership of the United States, the United Kingdom and associated countries in a number of international economic governance institutions. This was evident, for example, in the financial regulation agenda pursued in the BCBS and in the financial deregulation agenda pursued in the G7, the Organisation for Economic Co-operation and Development (OECD), the IMF and the World Bank. In a notable example, by 2005 China was under increasing pressure from the G7 and the IMF on its currency policy, with domestic financial and capital account liberalization among other things recommended as part of a package of reforms to accompany exchange rate liberalization.

The G20 finance ministers and central bank governors meeting, which was convened by the G7 in September 1999 and held its first meeting in Berlin in December of that year, was intended “to provide a new mechanism for informal dialogue in the framework of the Bretton Woods institutional system [and] to broaden the discussions on key economic and financial policy issues among systemically significant economies” (G20 Finance Ministers 1999, 1). This grouping was the first step in the direction of according greater influence to major emerging countries in the main processes of global economic governance. However, the G7 remained the primary informal governance body and chose a Canadian, Paul Martin, to chair the new grouping. Moreover, the agenda of this G20 finance group was shaped by the experiences of (predominantly) emerging country financial crises over the preceding two decades, and reflected the convergence agenda described above.

As has often been pointed out, the global financial crisis represented a major setback for this convergence agenda and for the legitimacy of US and UK leadership in important international bodies. The fact that the “global” crisis was centred in these and other major developed countries while growth in emerging countries remained relatively buoyant prompted the rethinking of a number of the policy standards advocated by the G7 countries. This was especially the case for those policy standards related to financial regulation, financial liberalization and capital account openness.


A number of emerging country governments became increasingly bold in demanding that their limited influence in global economic governance institutions be addressed. This governance gap was most visible at the level of the Group of Eight, in which Russia was the only emerging economy member. Even then, the narrower G7 club still dominated global economic policy discussions. The very limited inclusion of emerging countries in other important institutions such as the BCBS, the Financial Stability Forum and the OECD-based Financial Action Task Force (FATF), reflected a broad understanding among the major developed democracies that the narrow memberships of these key bodies were justified on grounds of expertise and relevance. The dissatisfaction of emerging and developing countries with this position reached new heights after 2007.

The crisis also reduced the ability of the G7 and IMF to insist on policy change in the major emerging countries, particularly China (Walter 2014). Both China and Russia were also re-associated with an old idea of “state capitalism,” which some claimed to be a more robust alternative to the neo-liberal economic model. Faith in the likelihood of continued convergence towards liberal market democracy suffered a sharp reversal. The “rise of the rest” was thus often seen as fostering both multipolarity and divergence in policy preferences and economic systems, although debate continues on how much their preferences diverge from those of the advanced countries.2

Economic Governance Since the Global Financial Crisis

The Post-crisis Governance Gap: Does the G20 Improve Legitimacy and Outcomes?

The impact of the crisis on the perceived legitimacy gap in global economic governance played an important role in the decision of the George W. Bush administration to convene a meeting in Washington, DC, of G20 leaders in November 2008. This subsequently led to the effective displacement of the G7 by the G20 as the steering committee for global economic governance. It expanded the formal involvement of major emerging countries in discussions on global financial governance, although the G20 was subject to criticisms of its legitimacy on the part of the great majority of countries that were excluded. In 2009, a variety of hitherto narrowly constituted bodies expanded to include G20 emerging countries as full members, including the BCBS and the Financial Stability Board (FSB). Chile, Estonia, Israel and Slovenia also joined the

2 Miles Kahler (2013), for example, argues that Brazil, China and India behaved as “moderate reformers,” before and after the global financial crisis, to maintain domestic policy space in the face of international rules. “It was most often their participation in the process of rule creation and institutional evolution that was the key issue, not the content of the rules themselves.”


OECD in 2010 and the FATF also became more inclusive — only Indonesia among G20 countries is not a member.

The April 2009 G20 London Summit also agreed to a series of reforms of the governance of the IMF and World Bank. This included the agreement to end the postwar convention that the leadership of these two institutions remained the exclusive reserve of the Europeans and the United States. G20 leaders agreed “that the heads and senior leadership of the international financial institutions should be appointed through an open, transparent, and merit-based selection process” (G20 2009, 6).

G20 leaders also agreed at the meeting in Pittsburgh in September 2009 to increase the voice and influence of emerging countries in the IMF beyond the modest increases already approved in 2008. G20 finance ministers and central bank governors then decided in Korea in October 2010 to increase the IMF executive board votes and quotas of emerging and developing countries (and of “under-represented” countries) by more than six percent, and to increase by two their number of board seats at the expense of advanced European countries.

This seemed to indicate a growing influence of the “BRIC” grouping (Brazil, Russia, India and China), which had met for the first time in September 2006 and had stepped up their advocacy of reform of international financial institutions after the global financial crisis.3 Both China and Russia also called for a reformed and less dollar-centric international monetary system. After the implementation of the votes and quota reform, the four BRIC countries would be among the top 10 IMF shareholders. The target deadline to achieve these governance reforms was the IMF annual meeting in October 2012.

The delay of more than three years in obtaining the agreement of the US Congress to these reform proposals focused attention on IMF governance reform as the most important unfinished task of the post-crisis period. The June 2011 appointment of Christine Lagarde, formerly France’s finance minister, as the new managing director of the IMF, and the April 2012 appointment of Jim Yong Kim, a Korean American academic, as the new president of the World Bank, also signalled that breaking with the norms of European and American leadership of these institutions would prove more difficult than many expected.4

Most accept that the high point of the G20 was in the year following its first meeting in November 2008.5 In their first two summits, G20 leaders agreed to a coordinated fiscal stimulus and a large increase in the IMF’s

3 See www.news.bbc.co.uk/2/hi/business/8102216.stm. In 2010, South Africa joined the BRICS, a signal that it sought greater legitimacy in the emerging debate over the reform of global economic governance.

4 However, Roberto Azevêdo, a Brazilian economist, was appointed World Trade Organization director-general in September 2013.

5 John J. Kirton (2013) provides a comprehensive review of the G20; see also Bradford and Lim (2010).


resources. According to some, “the system worked” and prevented a second Great Depression (Drezner 2014). Others argue that this view exaggerates the importance of G20 cooperation and underestimates the role of domestic political calculations in major capitals favouring fiscal stimulus, monetary easing and extensive financial interventions. Although the IMF has been substantially involved since 2010 in the European debt crisis, more important in the initial stages of the global financial crisis was the US Federal Reserve’s actions to lend hundreds of billions of dollars to 14 central banks via international swaps and to many private global banks through its various liquidity facilities (Helleiner 2014).6

Reform in Global Economic Governance: Innovations and FailuresEven if some of the kudos granted to the G20’s and IMF’s crisis

management was due rather to actions by the US Fed, the G20 has fostered progress in important areas since then. As noted above, the G20 effectively promoted the expansion of memberships of informal institutions of global financial governance. Some of these, such as the BCBS and FSB, have produced a series of revisions to global financial regulatory standards since 2009. There is a vigorous debate over whether these revised standards reflect successful post-crisis reform, or instead a failure to achieve the radical reforms necessary to ensure the effective stabilization and management of global finance (Admati and Hellwig 2013; Helleiner 2014). Yet there is no debating the volume of activity. For example, since 2009 the BCBS has issued 19 separate new documents providing new or revised financial regulatory and supervisory standards, and 18 new documents on regulatory and supervisory guidelines. It has also conducted Basel III implementation assessments for 15 separate countries and regions, and provided another 15 overviews of progress in implementation for the G20 or BCBS memberships.7

The stalemate over the reform of the IMF and World Bank should also not obscure some important informal changes in the governance of these institutions. China in particular has seen its representation among senior staff in these institutions improve. In 2008, Lin Yifu ( Justin Lin) was appointed chief economist and senior vice president of the World Bank, the first Chinese citizen to hold such a senior position. In July 2011, Zhu Min was appointed to a new (fourth) deputy managing director position in the IMF,8 and in March 2012, Lin Jianhai was appointed as the IMF’s secretary. Both of these IMF appointments were made by Christine Lagarde, whose candidacy for the

6 For details of the Fed’s program, see: www.federalreserve.gov/newsevents/reform_transaction.htm.

7 Authors’ calculations from www.bis.org/bcbs/publications.htm as of July 2015.8 Zhu Min had been appointed in 2010 as a special adviser to the then-Managing Director

Dominique Strauss-Kahn.


managing directorship China had initially opposed, but eventually supported (as did the other BRIC countries). It has also been evident that since the crisis, the Fund has adopted a more balanced and less confrontational position on its surveillance of China, and specifically on the question of its exchange rate policy and contribution to global rebalancing (Walter 2014). All of this suggests that, at least in the case of China, informal mechanisms of influence for some major emerging countries have increased since 2008, despite the continued setbacks to formal governance reform.

Nevertheless, the blockage in formal IMF governance reform has been crucial and points more generally to the limits of the G20 itself. In response, the BRICS have established new international financial institutions, including the New Development Bank and the China-sponsored Asian Infrastructure Investment Bank. As a hedge against stasis in IMF governance, the countries of the Association of Southeast Asian Nations plus China, Japan and South Korea (ASEAN+3) had created the Chiang Mai Initiative Multilateralization (CMIM) facility. To conduct surveillance among its members, the group also created the ASEAN+3 Macroeconomic Research Office. These developments show that institutional innovation is possible in the contemporary context, and indicate a willingness of major emerging countries to contribute to the provision of international public goods in areas in which they will be prime beneficiaries. However, they also indicate a new willingness to challenge the developed country dominance of institutions and of governance design in key areas, and point to the possible fragmentation of multilateralism.

Policy Debates in the G20

Macroeconomic and Financial CooperationThe global financial crisis of 2008-2009 and its aftermath required a rapid,

sustained and extreme (by historical standards) easing of monetary policy in most of the advanced countries. As interest rates were reduced to near zero, the US Federal Reserve resorted to unconventional measures and launched the first program of quantitative easing (QE) in 2008, followed by a second round two years later. These measures spawned capital outflow and placed downward pressure on the dollar, causing international criticism that reached an apex around the November 2010 G20 summit in Seoul. Brazilian Finance Minister Guido Mantega, who introduced a series of measures to stem capital inflows and the appreciation of the real, dubbed the conflict “currency wars.” The debate was repeated when the US Federal Reserve announced in 2013 that it would begin to taper its purchases under the (third) QE program, which provoked renewed volatility in financial flows and currency markets, particularly for emerging markets.


Meanwhile, the European sovereign debt crisis sent the euro area into recession in 2012 and a short period of falling prices at the end of 2014. In anticipation of further easing by the European Central Bank (ECB), the governor of the Reserve Bank of India, Raghuram G. Rajan (2014), advocated that advanced country central banks consider the impact on the rest of the world when making decisions on QE. The ECB launched its QE program in March 2015, with explicit acknowledgement that the exchange rate was an important channel through which easing would benefit the euro area economy. Along with the Bank of Japan and Bank of England, these central banks argued that reviving their domestic economies was paramount and the impact on emerging market countries would be positive on balance, notwithstanding volatility in currency and financial flows.

At the academic level, Hélène Rey (2013) launched a debate over financial spillover. She argues that spillover happens through gross financial flows and that the focus on net flows, and their counterpart the current account balance, is obsolete in a highly globalized environment insofar as national economic autonomy is concerned. Flexible exchange rates (driven by net flows) provide little or no insulation from volatility. If validated, this finding would overturn one of the implications of the dominant paradigm in international monetary economics. Since Marcus Fleming (1962) and Robert Mundell (1963) developed this model more than a half century ago, professors of economics have been teaching that fixed exchange rates, capital mobility and monetary autonomy are incompatible. This tradeoff has become known as the “international monetary trilemma.” Countries can choose any two of the three objectives, or they can choose partial satisfaction of each, but the three cannot be fully satisfied simultaneously according to the trilemma. In the presence of capital mobility, in particular, a flexible exchange rate would provide monetary autonomy. But Rey argues that monetary autonomy can be achieved only by restricting capital flows. “The global financial cycle transforms the trilemma into a ‘dilemma’ or an ‘irreconcilable duo’: independent monetary policies are possible if and only if the capital account is managed.”

At the same time, the G20 has grappled with the desirability of restrictions on capital account transactions, also known as capital flow management measures (CFMs). The movement for capital account liberalization reached its zenith before the Asian financial crisis of 1997-1998, but it took a combination of the global financial crisis and the rise of emerging market countries to secure acceptance of capital controls in principle under certain conditions. The G20 finance ministers and central bank governors adopted the “Coherent Conclusions” for the management of capital flows in October 2011 (G20 Finance Ministers 2011). They recognized CFMs as a legitimate part of the policy tool kit that could “be employed alongside, rather than substitute for,” appropriate


monetary and prudential policies. “Capital flow management measures should not be used to avoid or unduly delay necessary adjustments in the economy.” In a concession to the BRICS, the Conclusions did not relegate CFMs to a last resort option and recognized explicitly that the benefits of capital flows depend on other conditions being satisfied, such as a “robust regulatory and supervisory framework” being in place.9 The Conclusions also advocated putting in place “the conditions that allow members to reap the benefits from free capital movements, while preventing and managing risks that could undermine financial stability and sustainable growth, and avoiding financial protectionism.”

Similarly, the IMF developed guidelines for its members on the liberalization and management of capital flows.10 It developed an “Institutional View” on these matters that is applied, for example, in annual surveillance of members under Article IV (IMF 2012).11 These guidelines recognize that the benefits of capital liberalization depend on the stage of development, i.e., that the openness of the capital account should rise with greater sophistication of the economy and more robust regulatory capacity. Nonetheless, the circumstances under which capital flow measures are both effective and desirable remains normatively contested terrain — especially their relationship to domestic macroeconomic policy and macroprudential supervision.12 This is true within the Fund, among its membership, as well as among the members of the G20.

Emerging market countries wish to carve out space for the use of capital flow measures in regimes beyond the G20 and IMF as well. In deploying CFMs, they have often run afoul of liberalization provisions of bilateral investment treaties with the United States (see, for example, Gallagher 2015). The OECD Code of Capital Liberalization, established in 1961, also applied to its newer emerging market members and would apply to prospective members. For example, this Code called for South Korea to make an explicit reservation for measures it has taken to contain exchange rate risk in its banking system — a reservation the Korean government feared would have negative repercussions in the financial markets. Arguing that these were macroprudential measures with CFM characteristics, Korea appealed to the G20 in 2015 to nudge the OECD to revise its Code in the direction of the IMF’s Institutional View. Navigating the thicket of institutional rules on these measures will continue to challenge emerging markets and the potential for fragmentation could rise as these regimes become more elaborate.

These debates in the policy and academic realms animated the analyses conducted in the chapters in this volume. In chapter 1, “Capital Flows and

9 Kevin P. Gallagher (2015) provides an excellent review of the genesis of these agreements.10 A more permissive posture toward capital controls on the part of the IMF was signalled by

Ostry et al. (2010). See also Jeanne, Subramanian and Williamson (2012).11 See also IMF (2013).12 See Independent Evaluation Office (2015). See also Bruno, Shim and Shin (2015).


Capital Account Management in Selected Asian Countries,” Rajeswari Sengupta and Abhijit Sen Gupta analyze surge and stop episodes as well as changes in the composition of flows in India, Indonesia, South Korea, Malaysia and Thailand. After identifying these episodes, the paper evaluates the policy measures undertaken by these countries in response, including intervention in the foreign exchange market by the central bank and imposing capital controls. They find that the trilemma remains very much relevant to these countries — a shift in monetary independence is associated with an increase in exchange rate flexibility with relatively little change in the openness of the capital account. The success of capital controls has been limited, with temporary, selective controls found to be less effective than more permanent, systemic controls. This confirms a distinction between “gates” and “walls” introduced by Michael Klein (2012).

Greater flexibility in exchange rates coincides with an increase, not decrease, in international reserves — especially in Asia. As Olivier Jeanne (2015) points out, this is exactly the opposite of what the textbooks predict, although the pattern is consistent with the experience of advanced countries during their shift to floating rates in the 1970s. The pattern of foreign exchange intervention was asymmetrical — during the period covered, emerging market central banks in Asia tended to buy foreign currency during surges of capital inflows, but allowed them to depreciate rather than sell foreign exchange during sudden stops or outflows. On balance, they maintained competitively valued currencies and accumulated foreign exchange reserves.

In chapter 2, “Capital Flows and Spillovers,” Şebnem Kalemli-Özcan investigates the effect of different types of capital flows on output in emerging market countries. Focusing on business cycle frequencies and the effect of global risk appetite in driving capital flows into emerging markets, the chapter sheds light on the circumstances under which capital flows have expansionary effects or lead to a drop in growth. With respect to debt flows, her regression results suggest a positive initial impact followed by a negative impact two years later. The initial positive correlation between debt flows and output is driven by private debt flows, whereas the later negative correlation is due to public debt flows. Flows of foreign direct investment (FDI) boost output with a three-year lag, but reduce output in the third year in the presence of global financial volatility. This negative effect of uncertainty, measured by the Chicago Board Options Exchange Volatility Index (VIX), also holds for other types of private flows, suggesting that private investors leave emerging markets under these conditions, but local sovereign investors do not.

Márcio Garcia analyzes the effectiveness of capital controls in Latin America and its implications for IMF surveillance in chapter 3. He is critical of capital controls and finds them to be generally ineffective in stemming capital flows and currency movements. This is particularly true in the case


of Brazil during 2009–2011, perhaps the most important single example of recent experimentation with such measures. Chile, by contrast, decided against controlling the surge of capital inflows that was putting upward pressure on the peso at the same time as on the Brazilian real. Instead, Chile adopted a more restrictive fiscal stance, while Brazil maintained an expansionary one. Nor does the experience of Colombia and Peru, commodity exporters as well, support the use of capital controls, Garcia argues. He concludes that capital controls serve mainly to circumvent needed changes in macroeconomic policy, undercutting economic performance, and that, contrary to their guidelines, international institutions such as the IMF have not prevented the substitution of controls for adjustment. One implication is that there is a need to clarify how the Fund should respond in instances where capital flow measures do not conform to the caveats in the Guidelines.

Strengthening mechanisms of international support is another alternative for protecting vulnerable countries from financial volatility — the global financial safety net (GFSN). The GFSN is conventionally defined as a “network of country insurance and lending instruments — encompassing multilateral institutions like the IMF, RFAs, bilateral creditors, and individual countries’ own defenses — that countries could draw on to cope with financing shortfalls, volatility and contagion from a crisis” (Miyoshi et al. 2013, 4). The safety net was expanded after the global financial crisis by increasing the resources of the IMF, extending the network of central bank swaps and augmenting regional financial arrangements.

When South Korea assumed the chair of the G20 in 2010, its government proposed that the central bank swaps be multilateralized on a permanent basis.13 Specifically, during the preparations for the Seoul G20 Summit, South Korean officials proposed that the advanced-country central banks provide swaps to the IMF, which would conduct due diligence and provide liquidity to qualifying central banks. In this way, the global community could mobilize enough resources to address even a massive liquidity crunch and central banks would avoid credit risk. Owing to resistance from particular members, however, the G20 declined to endorse the proposal.

C. Randall Henning seeks to fill part of the gap in the GFSN. His chapter 4, “The Global Liquidity Safety Net,” is concerned with the patchwork of precautionary lending facilities and central bank swap agreements that help to shield high-performing countries from contagion. Gaps in coverage of the “liquidity net” leave an inconsistency between encouraging emerging market economies to maintain open capital regimes — which are still preferred, notwithstanding the more nuanced guidelines — and the reluctance to

13 Other proposals to strengthen the GFSN include Truman (2008; 2010); IMF (2010) Farhi, Gourinchas and Rey (2011); Prasad (2014); and Rajan (2014).


extend liquidity coverage. If emerging market countries are expected to avoid constraints on short-term flows, taxes on non-resident deposits and ring-fencing liquidity in crises, for example, and to avoid excessive reserve accumulation, then advanced countries will need to contribute more to collective insurance against the vulnerabilities associated with open capital regimes.

Henning then reviews the precautionary facilities that have been introduced over the last eight years by the IMF and several of the RFAs such as the CMIM, European Stability Mechanism and BRICS’ Contingent Reserve Arrangement. Precautionary facilities are distinguished by being made available in advance, before the need to draw, to countries with sound policies that might nonetheless be sideswiped by contagion. The chapter also reviews the central bank swap agreements that provided liquidity during the global financial crisis, a number of which have not been renewed. While the regional precautionary facilities are linked to the IMF — meaning they would be activated with an agreement between the country in question and the Fund — there is, nonetheless, a significant risk of fragmentation of the liquidity net. Reviewing countries for qualification, secondly, places a heavy burden on the surveillance and analytical capacity of financial facilities and central banks. By contrast, however, the IMF does have the capacity for ex ante qualification for precautionary financing. By reverse engineering the Flexible Credit Line (FCL) review process, the chapter identifies the countries that would likely qualify if they applied. This gives rise to a complementary division of labour and two recommendations to which we return in the policy conclusions section below.

International liquidity can also be bolstered by a greater international role for the Chinese RMB, among other currencies. Ming Zhang addresses this in chapter 5, “Internationalization of the Renminbi: Developments, Problems and Influences.” Since the Chinese government began to promote RMB internationalization after the 2008-2009 crisis, its currency has become more actively used in cross-border trade settlement and offshore RMB markets. Zhang notes, however, that rampant cross-border arbitrage and the lag of RMB invoicing compared to settlement are becoming increasingly problematic. Moreover, RMB internationalization complicates domestic monetary policy, exacerbates the currency mismatch on China’s international balance sheet and increases both the scale and volatility of short-term capital flows. For other emerging economies, on the other hand, it offers another alternative for pricing domestic currency and investing foreign exchange reserves. The overall impact of RMB internationalization on the stability of the international monetary system will depend on how the capital account is liberalized, and on the consistency and transparency of Chinese monetary policy.14 Zhang concludes

14 For more on sequencing RMB internationalization, capital account liberalization and domestic reforms, see also Eichengreen (2015).


with five recommendations for Chinese policy makers to promote RMB internationalization in a sustainable way that is conducive to international stability.

International Financial Regulatory CooperationAs noted above, the global financial crisis called the preceding policy

convergence agenda into question and weakened the position of the United States, the United Kingdom and other countries associated with neo-liberalism. This was especially so in the area of financial regulation. Prior to this crisis, the market dominance and perceived sophistication of large financial firms based in London and New York had helped to reinforce the positions of the United Kingdom and the United States as global regulatory leaders. The very visible fall from grace of leading global banks and the perceived failures of the trend toward encouraging these firms to manage their own risks and to allow them to hold historically low amounts of equity capital had the opposite effect. From 2009, G20 leaders directed the BCBS and the rebranded FSB to undertake a fundamental review of existing approaches to financial regulation and to propose revised international regulatory standards where appropriate.

The global financial crisis had another important effect. Prior to this crisis, the primary concern of emerging countries in this policy area was whether international standards issued by the BCBS, the International Organization of Securities Commissions and other bodies were appropriate to their national circumstances and those of their own banks and borrowers. This remained an important consideration after the crisis, but emerging countries were now also far more concerned about the effectiveness of international standards in fostering financial stability in the most advanced economies. Rising interdependence and the sharp drop in the demand for emerging country imports over 2008-2009 in North America, Europe and Japan underlined the importance for emerging and developing countries of financial stabilization in the developed world. This increased their stake in achieving greater influence in SSBs, and their interest in establishing mechanisms to ensure more effective implementation. These concerns were also due to the failure of the United States, prior to the crisis, to implement Basel II and its refusal to agree to a Financial Sector Assessment Program (FSAP) review by the IMF and World Bank. After the crisis, the vocal opposition of a number of major American and European financial firms to proposals for regulatory tightening indicated that implementation would remain a serious challenge.

In thinking about the factors shaping the influence of emerging countries in the institutions and processes of global economic governance, following Benjamin J. Cohen (2013) we can distinguish between two forms of state power in global economic governance. The first form is power as policy autonomy — the


ability of a country to make policy choices autonomously from the preferences and influence of other actors and institutions. The second form of power is the ability to shape outcomes and processes in global economic governance. This distinction can also be understood as internal versus external power.

In practice, it is difficult to separate these aspects of influence. The nature of international governance institutions is relevant to considerations of policy autonomy because it can shape how much compliance power these institutions, and actors within them, can exercise over other members and non-members. International institutions such as the World Trade Organization with binding rules and dispute settlement mechanisms will generally possess more compliance power than softer institutions such as the BCBS or FSB with voluntary international standards based on best efforts implementation. The IMF occupies an intermediate position, with some binding rules (for example, requiring currency convertibility for current account transactions) and lending-based conditionality, but with weaker compliance power regarding most policies of non-borrowing members. Formal equality in the softer institutions may thus be thought to be less important for countries seeking policy autonomy. Even here, however, G20 countries have supported more extensive monitoring and peer review of implementation than before the global crisis, “hardening” these voluntary standards. Perceived market pressure on countries to implement voluntary policy standards may also be an important factor in some areas.

Has the post-2008 expansion of the membership of international financial SSBs increased the influence of emerging countries in this area? In chapter 6, Andrew Walter argues that in the case of the BCBS and the revised Basel III standards, emerging country influence over outcomes has generally remained low despite their increased formal involvement. Emerging country members of the BCBS generally favoured tighter regulation of major banks after 2008, but the Basel III agreement was primarily a product of a compromise between developed countries: those favouring the relatively rapid introduction of much higher capital requirements and those who were opposed. In some areas where their interests were directly at stake, such as trade finance, emerging countries were able to exert influence. But they did so with the assistance of public and private international institutions and some developed countries. In many areas of Basel III negotiation, most emerging country members were not highly engaged. This reflected perceptions of limited relevance of the standards under negotiation for their banks, as well as lower levels of public and private sector expertise on, and experience with, the financial practices and issues in question.

Basel III reflected substantial continuity with Basel II in its continued heavy reliance on internal models for assessing portfolio risk and determining capital requirements. In this respect it failed to satisfy critics who argued that Basel III would not require sufficient levels of equity capital, particularly for the largest


and most interconnected banks. These critics argued for a reversion to a simpler model of bank regulation, in particular a much higher simple leverage ratio than the three percent minimum required by Basel III (Admati and Hellwig 2013). Since 2014, support for this position seems to have increased. In November 2014, the FSB proposed to increase substantially the amount of required total loss-absorbency capacity for global systemically important banks (G-SIBs) to at least double that of Basel III minima (FSB 2014). Many now refer to this and related proposals as “Basel IV.”

Have emerging countries played a role in this recent trend? Some emerging country regulators (for example China’s) have certainly argued in favour of regulatory simplification, which is more consistent with their current regulatory and financial systems. Many have also indicated an intention to go further than minimum Basel III capital requirements in their domestic regulation. In addition, most are less inclined than major developed countries to take into account the concerns of the G-SIBs who fear that they will be unfairly penalized by both Basel III and IV.

Nevertheless, it seems more likely that changing sentiment among major developed country regulators has been more important in explaining the turn toward greater regulatory stringency. Notably, regulators in the two most important developed countries in this area, the US Federal Reserve and the Bank of England, have argued for reduced reliance on risk-based capital and have taken steps in this direction in domestic regulation. The FSB is currently chaired by Mark Carney, governor of the Bank of England, and the US Federal Reserve Board is thought to support even more stringent requirements for US G-SIBs than those proposed by the FSB.

In chapter 7, Hyoung-kyu Chey takes a more optimistic view of the evolving role of emerging economies in international financial regulatory governance, particularly regarding its effects on their compliance with international standards. He argues that the inclusion of emerging countries in the BCBS and FSB has increased their exposure to external compliance pressures. For example, after the global financial crisis, the G20 agreed that all members should undertake FSAP reviews and the BCBS and the FSB now both undertake published peer reviews of implementation in a range of areas. Emerging country inclusion has also increased their ownership of international standards and, he suggests, their commitment to domestic implementation. BCBS and FSB reports to the G20 on implementation do suggest that, with some exceptions, emerging country members are not conspicuous laggards (see chapter 10). This may also reflect self-interest, given the renewed concern about the potential for financial instability in these countries (Bank for International Settlements [BIS] 2015).

In chapter 8, Mariana Magaldi de Sousa considers some of the potential implications of this increased emphasis on implementation among emerging


countries. She focuses on its impact on financial inclusion, an issue that has received increased attention since the crisis, and is of particular importance to developing and emerging countries. Utilizing two original indices of financial inclusion for 90 developing and emerging economies, she finds that international standards on banks’ information disclosure are positively related to financial inclusion, whereas adopting international standards on macroprudential regulation and capital adequacy are associated with lower financial inclusion. Especially if future studies replicate these results, more attention to the potential for uneven effects of international regulatory standards on domestic financial inclusion will be warranted. It raises further questions regarding the level of engagement of emerging countries with the process of international standard setting and the appropriateness of these standards for countries at very different levels of development, and with varying domestic challenges.

One of the important problems indicated by the recent crisis was the difficulty of resolving failing financial institutions with international operations. In chapter 9, Renuka Sane addresses the engagement of emerging countries with the principles of cross-border resolution that have been agreed since 2008, with a focus on the important case of India. As with many developing and emerging countries, India’s banks are less globalized than average. India is also hampered by the fact that its own domestic institutional capacity and experience in this area is limited, inhibiting the ability of its regulators to engage their international counterparts effectively. This policy area may seem less important than others, but as emerging country banks expand abroad and as these countries open their markets to global financial services firms, the limited progress that has been achieved in this area is likely to be of increasing consequence for them over time.

In chapter 10, Fernanda Martins Bandeira considers how major emerging country members of the BCBS have engaged with the new process of implementation monitoring embodied in Basel’s Regulatory Consistency Assessment Programme (RCAP). Brazil’s experience with the RCAP process was largely positive and it was judged to be in overall compliance with Basel standards; however, there were some areas of difference. For example, like the United States, Brazil has chosen to reduce reliance on credit rating agencies (CRAs) in standardized approaches to risk assessment. Although there was much discussion of the need to move in this direction after the crisis, Basel III retained reliance on CRAs. More generally, Martins Bandeira indicates that there may be a danger that implementation reviews take insufficient account of the difference between compliance with negotiated international standards and good regulatory practice in particular country cases. Nevertheless, as review bodies continue to learn from the experience of expanding the scope and depth of implementation review, Brazil’s experience suggests engagement on the part


of major emerging countries in this process and the scope for learning on all sides.

In the final chapter, Zheng Liansheng addresses the issue of shadow banking, which has received much attention since 2007 when the first critical ruptures in this market occurred in the United States. Initially thought to be relevant mainly to the most advanced economies, empirical studies have shown its growing importance in a number of emerging economies, albeit often in quite different forms. Zheng argues that, once again, emerging countries have been relatively passive in the major standard-setting organizations (the FSB is the most important locus of activity in this area). This is for a variety of reasons, including perceived lower current relevance for many emerging and developing countries, and knowledge and capacity limitations. Nevertheless, as he points out, the rapid growth of this sector in China has prompted growing interest among analysts, regulators and policy makers there, and over time a greater degree of engagement at the international level. China’s main goal has been defensive and pragmatic — to stabilize its domestic financial sector and economy. Indeed, this has been the primary driver of a general increase in levels of engagement by emerging countries in international financial stabilization efforts since 2008.

Key Messages for the G20We conclude that the G20 should focus on bolstering international

cooperation on surveillance of financial flows and spillover, best practices with respect to capital flow measures, financial regulation and crisis prevention, and crisis response. This agenda includes reforming the institutions of global governance and fostering cooperation among regional and multilateral financial facilities. While these matters concern all countries, they are of special interest to emerging markets and rising powers. We do not dispute here the broadening of the G20 agenda over time to issues such as infrastructure investment, growth potential, development and climate change. The macroeconomic and financial matters that we stress, however, are the original raisons d’être of the G20, arguably its comparative advantage, and areas in which its work is not by any means complete.

We present our conclusions with respect to the international monetary trilemma first, because these bear on the conceptualization of the policy problems. Then we turn to surveillance of capital flow measures and the provision of global liquidity, and finally to international financial regulation and its governing arrangements.


Coexistence of the Trilemma and DilemmaThe international monetary trilemma continues to configure the policy

choices that confront most countries, especially emerging market countries. On reflection, the notion that the trilemma might be obsolete because exchange rate flexibility does not provide insulation from financial volatility conflates two paradigms that are best kept separate: the macroeconomic paradigm and the financial paradigm. The trilemma applies to the macroeconomic paradigm now as much as in the past. But the recent debate illustrates the need for clarification of one of the points on the three-way trade-off: “capital mobility” should have always been and should now be understood as capital mobility in a net sense. This is the only meaning of the term that is logically consistent with its use in the trilemma, since the exchange rate was never understood in the standard macroeconomic model to be affected by gross capital flows. The current confusion of paradigms stems, in part, from the original ambiguity of that label.

To state this argument in another way, even well before the extensive globalization of financial markets, few would have suggested that a country’s exchange rate regime, whether fixed or flexible, would contain a bank run or a run in capital markets on sovereign bonds on the edge of default. These are best modelled in a financial paradigm where gross financial flows are indeed relevant. But the increasing globalization of financial markets and volatility of capital flows does not change the relationship between the exchange rate and net capital flows. Flexible exchange rates provide as much insulation for the domestic economy in the face of net flows as they did before gross flows became inflated. (This is true notwithstanding the fact that international monetary economists vigorously debate the value of exchange rate flexibility for monetary autonomy within the macroeconomic paradigm.)

Another source of paradigm confusion lies in the changing nature of monetary policy and the evolving purposes of central banking. Before the global financial crisis, central banking was thought to be safely narrow, focused on the rate of inflation or, as in the case of the Federal Reserve, for example, inflation in combination with growth and employment. Since the crisis, central banking has become broader, attending to financial market stability as well, and employing unconventional monetary policies. For broad central banking, monetary policy can sometimes be targeted toward financial market conditions and can, therefore, be affected by financial flows, market volatility and the global financial cycle. It does not follow, however, that adjusting the monetary stance in the face of financial conditions makes exchange rate flexibility any less effective in preserving monetary autonomy in the face of net flows. The two paradigms — one stressing net flows and the other gross flows — are simultaneously relevant.


Manage Institutional Guidance on Capital Flow MeasuresThere are benefits to altering the composition of capital flows to emerging

markets away from debt and toward equity and FDI, and to longer-term debt at the expense of short-term debt. Kalemli-Özcan emphasizes that shifting the composition away from debt flows involves strengthening the domestic institutional and regulatory environment. Sengupta and Sen Gupta stress the importance of domestic financial markets, banking institutions and the regulatory framework in managing flows in a stable fashion. Neither embrace capital flow measures without qualifications and Garcia is skeptical that such measures can avoid protecting inappropriate domestic policy. The G20 should continue to take a qualified position on the benefits of CFMs, emphasize the caveats attached to their use and support the institutions’ blowing the whistle on countries that use them to avoid adjusting domestic macroeconomic policies that are misaligned.

At the same time, however, when capital flows are the source of systemic financial instability within countries, macroprudential measures might well have to take the form of CFMs that distinguish between residents and non-residents. The use of such measures could well create conflict between emerging market countries and international institutions, and even among the rules of the institutions themselves. Navigating the thicket of rules, norms and obligations can be treacherous for governments in an environment of skittish financial markets. The G20 has coordinated and should continue to coordinate the work of the institutions on such matters, being attentive to resolving conflicting obligations on vulnerable members.

Reinforce the Global Liquidity Safety Net Henning recommends harnessing the surveillance and analytical capacity

of the IMF to the precautionary facilities of regional financial arrangements and the swap agreements of key-currency central banks. First, regional and plurilateral facilities should make the IMF’s qualification of a member for a FCL sufficient to grant access to one of their own precautionary facilities. The CMIM, which models its precautionary arm on the IMF’s Precautionary and Liquidity Line (PLL), can similarly accept the IMF’s qualification of a country for a PLL. Second, qualification for a FCL should create a presumption that key-currency central banks extend swap agreements to those countries’ central banks. Reaching across global and regional institutions and central banks, the G20 should advance these proposals and it is well placed to do so.

Henning’s second proposal would keep the ultimate decision on swaps in the hands of the central banks. But, it takes one step away from unconstrained discretion on their part by introducing a strong presumption that FCL qualifiers would receive a swap as well. Central banks that refuse should have to defend their decision in closed-door meetings at the Fund and BIS. To be clear, his


proposal would not make the IMF the gatekeeper for all central bank swaps. Central banks would be free to extend swaps to countries that are not FCL qualifiers — which indeed describes all of the countries in the permanent swap network of the “G6.”15

Establishing a link between FCL qualification and swap provision — and RFA precautionary facilities — would nonetheless have benefits for all parties. Swap recipients would get greater access to liquidity on terms more appropriate to liquidity contingencies. The IMF would enhance the attractiveness of the FCL, leverage its resources and assuage stigma. Providers of swaps and regional finance can outsource surveillance and receive at least partial protection from losses. For the system as a whole, these proposals exploit the comparative advantages of global and regional institutions while reducing the fragmentation of the global safety net by clarifying the nature of the “link” and avoiding conflicts among the criteria applied by different institutions.

These proposals would not address a system-wide liquidity crisis in which many countries would need to draw simultaneously; that would require concomitantly systemic reforms. As middle-range proposals, however, these could be introduced without amending the Articles of Agreement of the IMF, which is presently out of reach. The G20 adopted Principles for Cooperation between the IMF and Regional Financing Arrangements in 2011. It should endorse these proposals and review the adoption and implementation by the institutions — and thereby advance the inter-institutional cooperation envisioned in its Principles.16

Monitor Currency InternationalizationAlthough the Chinese government is actively campaigning for greater

use of the RMB internationally, such a role for the currency could well have costs that Beijing does not fully appreciate. Pursuing RMB internationalization could reinforce the advocates of capital market development and capital account liberalization in domestic policy making, but a prominent international role for the RMB could constrain monetary policy in the future, once external controls are reduced or eliminated. The United States has been criticized for targeting monetary policy toward domestic concerns, ignoring the stability of the system as a whole and the interests of foreign holders of the US dollar. China is likely to attract the same criticism if it is successful in internationalizing the currency, at a cost to its reputation. Ming Zhang has argued that China should re-sequence its reform measures by prioritizing domestic financial reforms, conceding greater

15 The G6 is the Bank of Canada, the Bank of England, the European Central Bank, the Bank of Japan, the Swiss National Bank and the US Federal Reserve. These central banks announced in October 2013 that their existing temporary liquidity swap arrangements would remain in place until further notice.

16 See G20 (2011), which were adopted by the G20 summit in Cannes, France.


flexibility in the exchange rate and then only cautiously liberalizing the capital account. The People’s Bank of China should clarify its monetary policy objectives and streamline its monetary policy tools as well. RMB internationalization can then follow at a pace that can be sustained by the breadth, depth and liquidity of its domestic financial markets — the G20 should take cognizance when it considers reform of the international monetary system.

Oversee Financial Regulatory GovernanceIntegrating emerging countries into global financial regulatory

governance more effectively requires the simultaneous pursuit of a number of reforms. Improvements in representation are still needed. As in the IMF, the overrepresentation of European countries and institutions in the major SSBs persists. As the European Union moves toward banking union, it is reasonable to expect EU countries to be represented collectively in the plenary committees of the SSBs — while still drawing on the expertise of many individuals from European countries in their specialized working committees. Given the persistent uncertainties regarding the policies and regulations needed to promote financial stabilization in countries at different levels of development, further investments in capacity in the FSB and BCBS are appropriate.

Efforts are also needed to promote the capacity of emerging country officials to engage more effectively in the work of these and related organizations. This can be done through more extensive staff exchanges and secondments among G20 regulatory institutions, elaborating and disseminating knowledge of the history and procedures of SSBs to new members, and increased investment in staff training by emerging country regulators. Regulators in emerging and developing countries should also invest in greater transparency to encourage their own financial institutions to engage more actively in financial policy making. External, independent expert reviews of the activities of the SSBs that assess their progress in achieving agreed goals reflecting the interests of all members would also be valuable, as the experience of the IMF’s Independent Evaluation Office has shown.

It is also important to reorient the agenda of the SSBs toward issues that are directly relevant to developing and emerging countries. This includes, for example, consumer protection, financial inclusion and development, and their relationship with the processes of regulatory innovation and implementation. More broadly, although the post-crisis focus on the activities and capital of the G-SIBs has been necessary, there is a need for greater attention to the kinds of regulatory measures and market frameworks relevant to countries at very different levels of development. To help facilitate this, officials with expertise in areas such as development finance and financial inclusion should be brought into the SSBs from the World Bank, regional development banks, and developing


and emerging countries. The surveillance of implementation also needs to focus more closely on the appropriateness of regulation to country circumstances, and to disseminate learning from the exercise of national discretion.

As we noted at the outset, it remains an open question how much contemporary global financial governance constrains or accommodates emerging countries. The chapters in this book suggest that improving the level of accommodation is a work in progress and that active measures are required to achieve this. There is a final consideration. Accommodating the most important rising powers is tempting, but poses its own dangers, since there is no guarantee that their interests are aligned with those of the more numerous small- and medium-sized emerging and developing countries, or consistent with the provision of global public goods. This is another reason to continue to improve levels of institutional transparency, conduct independent external reviews and to promote learning from the diversity of experiences contained within and beyond the G20.

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9 781928 096177

ISBN 978-1-928096-17-7

Global Financial G

overnance Confronts the R

ising Powers


Henning | Walter

EMERGING PERSPECTIVES ON THE NEW G20



Powers

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EMERGING MARKET AND DEVELOPING COUNTRIES have doubled their share of world economic output over the last 20 years, while the share of the major developed countries has fallen below 50 percent and continues to decline. The new powers are not simply emerging; they have already emerged. This will remain true despite financial turmoil in some of the rising powers. This historic shift in the structure of the world economy affects the governance of international economic and financial institutions, the coordination of policy among member states and the stability of global financial markets. How exactly global governance responds to the rising powers — whether it accommodates or constrains them — is a leading question, perhaps the leading question, in the policy discourse on governance innovation and the study of international political economy.

Global Financial Governance Confronts the Rising Powers addresses the challenge that the rising powers pose for global governance, substantively and institutionally, in the domain of financial and macroeconomic cooperation. It examines the issues that are before the G20 that are of particular concern to these newly influential countries and how international financial institutions and financial standard-setting bodies have responded. With authors who are mainly from the large emerging market countries, the book presents rising power perspectives on financial policies and governance that should be of keen interest to advanced countries, established and evolving institutions, and the G20.

C. RANDALL HENNING is professor of international economic relations in the School of International Service at American University in Washington, DC. He specializes in international and comparative political economy, global governance and regional integration. He has focused recently on the International Monetary Fund, regional financial arrangements, Europe’s monetary union, fiscal federalism and the G20, and has edited or authored several books and articles on these subjects. Currently, he is conducting projects on the fragmentation of global financial governance and the political economy of the euro crisis.

ANDREW WALTER is professor of international relations in the School of Social and Political Sciences at the University of Melbourne and a senior fellow in the Melbourne School of Government. He has published widely on the political economy of monetary and financial issues, and is the author of East Asian Capitalism: Diversity, Continuity, and Change; China, the United States, and Global Order; Analyzing the Global Political Economy; Governing Finance: East Asia’s Adoption of International Standards; and World Power and World Money.


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