Global economic imbalances raise risks of hard landing

Tuesday, September 26, 2006 Vincent Lingga, The Jakarta Post

The 2006 Global Meeting of the Emerging Markets Forum (EMF) here last week warned that the risks of a hard landing for the global economy had increased with the United States continuing its profligate spending amid steadily rising oil prices.

The EMF, an independent not-for-profit initiative of the Washington-based strategic advisory company, Centennial Group, sounded more pessimistic than the International Monetary Fund, which still foresaw a higher probability of a gradual, orderly adjustment of the American dollar.

Panelists and discussants at the EMF meeting, including several former senior executives of the International Monetary Fund and the World Bank, were worried that the U.S. current account imbalance is likely to worsen further. They said the adjustment process was being made even more difficult as a result of the combined impact of the steep hikes in oil prices and the decline in the propensity of net oil exporters to import from the U.S and to invest in dollar assets.

While oil exporters, notably in the Middle East, are together accumulating US$1 billion in a net current account surplus every day, it is estimated that the U.S. will book a $900 billion deficit this year, as against $800 billion last year.

The U.S. has often been warned that its excessive consumption is dangerous for both itself and the world economy, but so far Americans have ignored such doom-mongering, increasing the risks of a hard landing for the global financial market.

As long as American and foreign central banks, notably those in Asia, are locked in a codependent relationship, the U.S. will likely continue its spending spree. According to the latest estimates by the IMF, more than half of all publicly available U.S. Treasury bonds are now held abroad, notably by central banks in Asia. These banks are thus trapped in something of a vicious circle.

Even though the IMF also recognizes some downside risks, it asserts in its 2006 Global Financial Stability Report, which was issued in Singapore last week, that "the structural strength of the U.S. financial market has no doubt enhanced the scale and sustainability of the U.S. current account deficit. The continuing confidence of international investors in U.S. markets supports the prospects of orderly adjustment in current imbalances."

The World Bank estimates that roughly 70 percent of global foreign reserves are now in dollars, making them highly vulnerable to currency correction. An abrupt change in the dollar value could spell trouble, as central banks find themselves with black holes in their portfolios.

Obviously this is neither healthy nor sustainable in the long run. But will the political will emerge to correct the imbalances?

This is unlikely in the near future. It seems that it will be extremely difficult to reach a global consensus to address these global imbalances. There seems to be a mood of complacency given that the markets have thus far been prepared to absorb the imbalances.

The natural adjustment mechanism for America's rapidly growing foreign liabilities should theoretically be a declining dollar, which would lower demand for imports and make America's exports more attractive on foreign markets. But the Asian central banks have been stalling this process as they want to keep their currencies from appreciating against the dollar, and are thus buying sackloads of dollars.

The pressures on the U.S. to get is fiscal house in order by cutting its budget deficit and encouraging American consumers to save are not enough. Too steep a fall in American consumption could instead threaten the world economy with a deep recession. This is because it is the spending binge in the U.S. that has absorbed a steady stream of exports and capital inflows from Asia and other emerging markets.

Hence, reform policies should be implemented to foster the necessary adjustments in saving and investment imbalances, especially in countries that are the main counterparts to the global current account imbalances, notably the U.S., China, Japan, Germany.

There is another factor that has increased the risks of a hard landing for the global economy and made it more urgent and imperative to intensify multilateral consultations so as to achieve a global consensus on ways to correct the global imbalances.

Besides the declining propensity of sovereign Arab oil exporters to invest in U.S. assets and the diversification of their portfolio investments away from dollar assets, the increasing accumulation of petro-dollars by private oil exporters is posing another threat to global financial stability.

This development is shifting the institutional management of an increasing amount of money around the world from central banks in Asia, which hold huge foreign reserves in dollars, to private oil exporters. While central banks are more conservative and constrained in their investment choices (they usually prefer U.S. Treasuries), private oil exporters are entirely free to invest wherever they choose.

The change in the investment behavior of oil exporters, which have been accumulating huge surpluses, could change the pattern of global capital flows at the expense of an orderly adjustment of the global imbalances.

The IMF seems to be the most technically competent body to keep monitoring and analyzing the investment behavior of sovereign and private oil exporters, and to ring the alarm bell whenever necessary. But this institution needs to be given the instruments it requires to strengthen its multilateral surveillance.

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WB needs to wean itself off 'nanny' bank role

Thursday, September 21, 2006 Vincent Lingga, The Jakarta Post, Jakarta

The World Bank is an easy target for attacks from all sides given the conflicting demands of its 184 member countries. The bank is mostly active in developing countries, which make up the majority of its members, but its decision and policy-making is controlled by the few developed countries who make up the majority of shareholders.

The perception that the bank merely purveys the policies of developed countries, especially the United States, is therefore unavoidable. This notion is reinforced by the fact that it, together with the International Monetary Fund, is headquartered in Washington and that the U.S. has the privilege of appointing the bank's president.

The bank is under tremendous pressure. Most civil society organizations assail it for what they see as its failure to reduce poverty in the poor countries.

Developed countries criticize the bank for not using its leverage as a lender forcefully enough to obtain meaningful reform in the developing world.

The internal reforms the bank started making in the early 1990s by decentralizing, relocating its decision-making process to the country level, were apparently not fast enough to satisfy developing countries.
Indonesian Finance Minister Sri Mulyani Indrawati expressed the view of most other developing countries when she criticized the World Bank for often acting as a preacher, rather than a partner for developing countries.

Indeed, with annual lending resources of US$20 billion and the largest pool of development thinkers any single organization in the world has ever possessed, the bank's executives, many of whom are from developed countries, often face a strong temptation to act as arrogant advisers.

The bank, with over 10,000 well-paid professionals, commands a brain trust with a huge pool of broad-ranging knowledge and experience on the full range of technical and economic issues of development. Its experts possess the wealth of real-life development experience that the bank's lending operations have generated.

The bank started decentralizing its decision-making by appointing country directors who had the kind of power over budgets and projects that used to exist only at headquarters. But the results were seemingly far below expectations.

It was this slow-paced decentralization Sri Mulyani appeared to refer to when she noted at the World Bank-International Monetary Fund Meetings in Singapore on Tuesday that the World Bank should change the way it works on the front line.

The bank needs to strengthen its decentralization policy because it needs country-specific knowledge and expertise to help develop local institutions tailored to local political and social realities.

The country director in each member country therefore must have political savvy and be sensitive to a country's political constraints and to the opportunities of responsible leaders to push reform. That implies a premium on systematic analysis of local politics and institutions.

Under the rubric of country ownership, the bank has tried to tailor its lending policies so that clients have more say in their design.

The emphasis on local politics and institutions is crucial because institutional capacity, the quality of governance and the commitment to development differ widely from one country to another in the developing world. The bank's approach should take these differences into account.

The emphasis on local institutions and local ownership of policies, which was reasserted by the World Bank-IMF Development Committee (the highest policy-making body) in Singapore, was aimed at building respect for and partnership with local efforts by the bank staff.

As a Washington-based independent think tank, the Center for Global Development, suggested in a recent report, "the Bank should become less of a nanny bank, preoccupied with detailed conditionality and structural reforms. It should instead concentrate more on supporting healthy local economic and political institutions."

However, local political ownership is not necessarily conducive to equitable growth, as can clearly be seen in Indonesia under the authoritarian Soeharto administration. The World Bank, instead of forcing reform on Indonesia, fully supported the economic policies of the Soeharto government for more than 30 years and condoned its corrupt system.

The bank's effectiveness then depends on how it manages its lending operations in order to support policy reforms and development result.

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IMF reforming its decision-making mechanism

Wednesday, September 20, 2006 Vincent Lingga, The Jakarta Post, Jakarta

The International Monetary Fund took a major step Monday toward improving its acceptance and credibility among developing countries by adopting a package of reforms on quotas and voice in the IMF, with respect to its decision- and policy-making powers and the reshaping of its surveillance foundations.

These reforms are the first step in a long process that will increase the representation of many developing countries to reflect their rise in the global economy. Right away, the resolution of the IMF board of governors will increase the voting power of four countries -- China, Korea, Mexico, and Turkey -- that are most clearly underrepresented.

Equally important is that the board of governors has agreed the IMF must strengthen the voice and representation of poor countries that continue to borrow from the IMF but only have a limited share in IMF voting.

The reforms will improve legitimacy, in terms of how IMF governance is structured and how that is perceived among developing countries, which have long complained about what they see as the grossly unfair control of the IMF by developed countries.

Experience has shown it is not enough for the IMF, and its Bretton Woods sister -- the World Bank -- for that matter to prescribe the right policy advice. This advice is more likely to be accepted if it comes from an institution that is seen as representative of the interests of developing countries, which make up the majority of members and borrowers from the IMF.

The reforms just adopted by the highest policy -making body of the IMF will go along way toward improving IMF acceptance and credibility. The IMF's credibility will continue to be undermined if the monopolistic behavior of large countries with veto power is not checked.

Still encouraging is that more reforms are in the pipeline as the board of governors also has ordered the IMF executive board to reach an agreement on a new quota formula to guide the assessment of the adequacy of members' quotas in the IMF. Such a formula should provide a simpler and more transparent means of capturing members' relative positions in the world economy.

The present IMF quotas have been seen by most members as a distorted mirror of today's economy because they must do three things at once: They determine how many votes a member can cast on the board, how much money a country must put into the IMF coffers, and how many dollars a country can take out before attracting penalty interest rates. As a result, many countries are now underrepresented.

The reforms are implemented at a time when the IMF's popularity is at its nadir and its budget is shrinking because many of its best customers are now doing without it.

What then are the jobs of the IMF? Apart from generating mountains of analyses, the IMF's function is to inject foreign exchange in countries that have temporarily run short. But lately no one has been calling on its reserves. Brazil and Argentina have both repaid their debts. Even Indonesia has paid in advance half its $7.8 billion debts and plans to amortize the remainder later this year. Hence, now only Turkey still owes a significant amount of money to the IMF.

With no way of treating members in financial crisis with what "patients see as bitter pills", the IMF is left only with the power of surveillance, keeping an eye on the policies and frailties of its members. But even this surveillance role has increasingly been detested in many countries, especially in Asia.

But the fact is that, like it or not, the IMF's role as an emergency lender is still relevant, at least until regional financial cooperation can be expanded through reserve pooling. After all the IMF can immediately call on about $220 billion of hard currency if needed to help countries in financial distress.

True, South Korea, Japan, Singapore, Indonesia, China, Malaysia, the Philippines and Thailand, which together command international reserves worth 10 times the IMF total, have begun pooling a small fraction of their resources under an initiative launched in Chiang Mai in 2000. But this regional arrangement has yet to be tested.

If emerging economies want to insure themselves against financial crisis it would not be cost efficient to set up their own "safety net" to make emergency lending available. But how can the IMF, as an emergency lender to all countries, regain the confidence of its estranged members.

That is the main objective of the package of reforms adopted by the IMF board of governors at its annual meetings in Singapore.

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Regulations the biggest barrier to new investment

Monday, September 11, 2006 Vincent Lingga, The Jakarta Post,

Indonesia may find some consolation in the praise of the World Bank and its private-sector arm, the International Finance Corporation, over the improvements made in its business climate but this commendation means virtually nothing in the way of wooing investments because most other countries performed much better.

Indonesia predictably remains among the most difficult places in terms of the ease of doing business, ranked 135th of 175 countries surveyed for the 2007 Doing Business report, compared to 131st among 155 countries in the 2006 report, which tracks indicators of the time and cost of meeting government requirements in business startup, operation, trade, taxation and closure.

The fourth annual Doing Business survey measures quantitative indicators on business regulations and compares their enforcement across 175 economies based on data available as of last January.

The report, therefore, does not cover developments after the launch of the investment policy reform last March, which calls for expediting the time of business startup to 30 days.

But do not expect too much from the government's regulatory reform. Indonesia has been notorious as a laggard in reforms. Even President Susilo Bambang Yudhoyono, who came to office with a strong political mandate, failed to get the message from the Doing Business survey "take advantage of your new mandate and push through significant reforms at the start of your term.

The government did succeed in cutting down the time and cost of starting up business from 151 to 97 days and from the equivalent of $1,300, or 101.70 percent of the country's gross per capita income, to $1,111 last year, but scored poorly on most other key indicators.

The country would have scored much lower still if the ranking included such variables as macroeconomic stability, the quality of infrastructure, currency volatility, investor perception and law and order.

The comparative data in the report should give the government, notably chief economics minister Boediono, the ability to measure the government's regulatory performance compared to that of other countries, taking good lessons from global best practices to prioritize reforms.

It is disappointing to note that even among the ASEAN countries, Indonesia only scored better than Laos.

It took about 224 days in Indonesia to comply with all licensing and permit requirements, compared to the average of 147.4 days in the Asian region. The enforcement of commercial contracts took about 126.5 days, as against the Asian average of 52.7 days. Employment regulations were also among the most rigid.

Once incorporated, a company may want to buy land upon which to build a plant but the cost of registering property in Indonesia has reached as high as 10.5 percent of the property value, compared to the average of four percent in the region.

Overall, businesses in Indonesia often shoulder administrative costs that are twice as high and have to struggle through twice as many bureaucratic procedures as their counterparts in other Asian countries.

The March investment policy reform was designed to address all these business woes by expediting the procedures for business startup, speeding up customs, licensing, and court procedures, and made labor regulation more flexible.

As businesspeople here can easily testify, pointless regulations foster graft as the more irksome the rules, the greater the incentive to bribe officials not to enforce them. Because it is so difficult to obey all the rules, businesses tend to remain informal -- outside the law and the tax net. They cannot raise credit from the formal banking system.

However, it is not reasonable to expect a much faster pace of regulatory reform in the country. At best, improvements will be incremental, as found by the latest World Bank report.

The central government may be able to push harder with reforming and streamlining the first two sets of procedures for starting up business: First, by obtaining approval from the Investment Coordinating Board and second, through establishing a limited liability corporation through the Justice and Human Rights Ministry, which requires at least 10 different procedures involving notaries, banks and the tax department.

But the third set of procedures -- obtaining numerous licenses and registrations from ministries and local governments -- could be the hardest part because local administrations often follow their own rules, setting their own standards and criteria.

The government, therefore, took a shortcut by introducing last June the concept of a special-economic zone, which is being implemented on Batam, Bintan and Karimun islands in cooperation with the Singaporean government.

The regulatory environment and physical infrastructure in these SEZs will be developed to the standard of at least the world's 30 top performers in terms of the ease of doing business.

The government seems determined to turn the three SEZs into islands of competence, growth poles and catalysts for investment promotion in other parts of the country.

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