SUNS  4315 Tuesday 3 November 1998


FINANCE: G-7 REFORM MOVES DEPEND TOO MUCH ON OTHERS

Geneva, 1 Nov (Chakravarthi Raghavan) -- The "reform measures" announced by the G-7, in their communique in London, appears to involve medium- to long-term actions by others, and in the
short-term, depends on how much pain and hardship Brazil can undergo, to impress the markets and stave off speculative attacks on the currency and continued loss of reserves.

Brazil's liberalization programmes have indexed its domestic debt (estimated at $250 billion) to the dollar, and with capital convertibility, has made it easy even for domestic holders of its paper to cash their debts, convert it into the dollar and export the capital.
And while Brazil has also external debt, and a sizeable portion as short-term, it is generally believed that foreigners holding such debt have already taken out their exposure over the last few weeks
and months.

This implies that to hold on to the real-dollar value, the Brazilian government has to maintain the high-interest rates and the sharp cuts in government expenditure, putting the economy into recession -- which would impact on the revenue side of the government even more -- when Brazil's solutions (both for its domestic and external debt) depend on reduced interest rates and recovery and growth.

And given Brazil's weight in the regional economy, and the stakes that the US has in the region, in terms of traditional orthodox neo-liberal economics, there is little room for manouevre by the
government, even a newly elected one, as that of President Henrique Cordoso.

It is possible, and most of its neighbours as well as well-wishers elsewhere would hope for this, the markets may be impressed by the size of the IMF rescue package and the willingness of the Brazilian government to put the economy and the public through a ringer, and currency speculators may desist.

But this depends on too many factors beyond Brazil's control.

And on top of it, the conditionalities that may come with the IMF package, may make the tasks of the government even more difficult.

In terms of the so called new financial architecture, the G-7 have in effect plumped for some tinkering here and there, actions by others (including actions by those formulating the Basle
guidelines, and the central banks and the supervisors, to restrain bank lendikng to hedge funds, by raising capital adequacy ratios).

But overall the reforms and the new financial architecture would only help preserve the status quo, increase the G-7 role vis-à-vis the US-sponsored G-22, and bring issues back to the interim
committee -- all at best procedural moves rather than tackling the substance.

On the one hand the G-7 are trying to expand the IMF resources in effect to make it an international lender of last resort, but using conditionalities that no national lender of resort can or does use
to prevent a run on banks.

In a purely domestic situation of a run on a bank, any central bank makes enough money available to the bank to stave off a run (and even the soundest bank cannot deal with it otherwise). Only then
the central bank may have a second look at the functioning of the bank it has helped rescue, and see whether it needs changes or has to be closed down, and its assets handed over to another.

A central bank does not argue in public with the bank it is purportedly rescuing or impose conditions for providing lender of last resort funds to the affected bank. If it does, it would soon find there is no bank left to save and the crisis has spread to other banks.

But on an international scale, without the ability to print currency, the IMF cannot have unlimited funds to throw and cannot provide funds without imposing conditions governing its rescue.

This among others was one of the reasons behind the proposal of UNCTAD in its Trade and Development Report, namely, for a government experiencing a run on its currency or reserves etc being able to unilaterally call a debt moratorium, impose controls on capital, and go before an international panel (other than the IMF which itself is a creditor) to be able to negotiate a restructuring under debtor-in-possession conditions.

Even more problematic for the success of an IMF package is the non-finance related conditions. And as former US Federal Reserve chair Fedelstein and many other mainstream economists have pointed out, the more conditions unrelated to saving the financial system are added on, the less likely will be its ability to prevent a meltdown -- as has been demonstrated in Asia and Russia.

And the various conditions attached to the IMF funding by the US Congress, as well as those dicatated by the neo-mercantalist trade policies of the US and other majors, who wish to stave off their own recessions by exporting to foreign markets, makes IMF non-finance related conditions more likely than ever before.

>From statements of the G-7 and more so of the US treasury and policy makers, it is apparent that US executive director and the Treasury through its points man at the IMF, is unlikely to advise
the country concerned to impose capital controls or put trade restrictions to safeguard the balance-of-payments.

Rather, the IMF would be pushing for more trade and financial services liberalisation, and freer imports of goods and services from abroad, and domestic conditions to attract capital inflows,
whose mixture of short- , medium- and long-term nature are used by the IMF to show adequacy of reserves and thus not justifying BOP-based WTO-legal trade restrictions.

This dilemma has not been resolved.

And in terms of the central banks and others taking actions that would restrict lending by banks under their supervision and control to lend to hedge-funds, this seems easier said than done.

Firstly, there are the problems of easily defining "hedge-funds" and restricting bank loans to them.

Secondly, as has been shown in the case of the US Long Term Capital Management Fund, much of bank lending to hedge-funds is as repos, loans against the collateral of government securities.

The fear that all the collateral securities held by the lending banks with exposure to the LTCM would be suddenly off-loaded and thus hit the market and thus the system was given by the US Federal
Reserve as the reason for orchestrating the rescue.

Under the Basle-guidelines, loans against such collaterals require much less capital set aside by the lending banks, than other loans. How to increase the capital adequacy of bank loans to hedge-funds against such government security collaterals, without raising the capital adequacy ratios for all loans against government security collaterals will not be easy of solution either.

A new international financial architecture and reform of the financial system may not be as easy as the original Bretton Woods architecture, cobbled in secrecy by the US and UK, and pushed
through the conference at Bretton Woods (during the war-time).

And while a series of steps and measures commanding consensus of developing and developed countries are needed, unless there is clearer perception of the objectives and goals, and every step
along the way is one moving in that direction, no new architecture can emerge or endure.