Context of the meeting
The Summit of G-20 Leaders in London will take place in a context of deterioration of the international economic and financial crisis. It now concerns not only the developed countries where it was engendered, but it also affects emerging and developing countries, particularly through trade and external financing channels. The crisis has reached the real economy and plunged some countries into deep recession. In others, it leads to growth deceleration. For the most vulnerable countries, it represents a concrete possibility of problems related to balance of payments, alongside serious threats of setback in the economic and social spheres.
The G-20 Leaders must produce a bold and effective political response to the challenges of the present, that is, strong and coordinated measures to accelerate the overcoming of the current scenario and, at the same time, point towards the future, by outlining the bases of a new global financial governance, both in the regulation and supervision of the financial markets and in the reform of international financial institutions.
Position of Brazil
For Brazil, the G-20 is the appropriate international forum to take this reform agenda forward. Its omposition, ringing toghether developed and developing countries, accounts or approximately two-thirds of the world's population, 80% of worl trade and 90% of global GDP. The forum allows the participation of developing countries that are active stakeholders in the international trade and capital flows and in the global economic growth, which even today do not have adequate representation, given their weight and importance, in inernational decision mechanisms. The G-20 is a basic and crucial step to include economies with dynamic growth in these decision-making circles.
In this sense, Brazil advocates the consolidation of the G-20 as a forum of Leaders. In the subsequent G-20 Summit – for which it is necessary to define a venue and a date at the London Summit on the 2nd April - the Group of Leaders should be formalized as a permanent institution of Heads of State and Government. Thus, the G-20 would be in charge, in the short term, of taking the necessary measures to face the current economic crisis and drive the governance reform of the international financial institutions forward, without loss to other bodies such as the regional forums and the United Nations. In the medium term, the Group should develop an agenda focused on addressing all relevant international economic themes.
Macroeconomic context of the meeting
The impact of the economic crisis on the productive sectors of national economies is one of the main points of the agenda of the forthcoming G-20 Summit. It is expected that the Leaders will be able to offer concrete proposals, in compliance with the goals outlined during the G-20 Summit in Washington. It is crucial not to frustrate expectations for results in the London Summit.
In London, policies aimed at rekindling production and trade will also be discussed. The effects of the crisis on the level of employment should not be left aside either, since, in some countries, unemployment rates have reached alarming levels, with no sign of deceleration until now. In this respect, it is encouraging that the title of the G-20 Summit of the 2nd of April includes the theme of employment, in line with the importance conferred to it by Brazil.
The times require bold responses, both in the fiscal area and in the monetary and financial spheres, as well as in the governance of the international financial institutions.
The international community should prioritize the application of resources, at this moment of deep distrust and uncertainty in the financial system, to guarantee the solidity and stability of the markets, with a view to reactivating the economy and preventing insolvency of banks that can generate a contagion effect over the rest of the financial system and in the productive sector. In this sense, Brazil has adopted, among other decisions, a series of measures to strengthen the liquidity of local financial institutions, which, in spite of having quite solid financial positions and good quality credit portfolios, are not immune to the sudden problems of liquidity that hit world markets as a reflection of the crisis in the credit system.
The urgency of tackling credit and toxic assets
One of the central aspects of this crisis is the high rate of insolvency of the credit portfolios, a problem that is heightened in the high risk credits (subprime) that were negotiated and passed on countless times in the market by means of complex security structures, which were unable to adequately mitigate the inherent risks of these assets. Keeping such toxic assets in their portfolios hinders the performance of the main financial institutions of the world to the extent that they are unable to contract new operations.
The countries where these toxic assets are concentrated – especially those that issue reserve currencies (a circumstance that increases potential transmission effects) – need to make more intense and broader efforts to absorb such assets in the shortest possible time. Unless such assets are removed from the economy (from the balances of companies and financial institutions), all other measures, both of an emergency nature and structural ones, will have their effectiveness reduced in driving credit resumption and in the fight against the consequences of the international crisis.
All options must be considered, without ideological biases. In face of the scale of the problem, extraordinary measures may be required, including the possibility of temporary nationalization of the banks. Public management of banks can be as efficient asprivate management. At this time of crisis, the public banks can play a market stabilizing role, as the Brazilian experience demonstrates. The greater the delay in adopting the necessary measures, the greater will be the deterioration of the real economy and of the financial institutions, making it even more difficult for them to recover.
Resistance to protectionism
In face of the shrinking of international trade, protectionist reactions by certain political, economic and social segments may occur. However, it is clear that if all countries yield to the temptation of protectionism, international trade will contract brutally and all will lose. Moreover, protectionism usually goes hand in hand with xenophobia, which also leads to discrimination against foreign emigrants and workers, who in fact contribute significantly to the development of countries. Therefore, an unmistakable message against protectionism must be put out.
Brazil understands that all countries, in particular those where the financial crisis emerged originally, need to adopt measures aimed at mitigating its recessive effects, as yet not fully known, and that threaten the world’s economic growth in the next years. However, Brazil advocates avoidance of measures that can represent a setback in the liberalization of international trade, such as increase of subsidies that distort trade or that may lead to forms of financial protectionism. To this end, a fast conclusion of an agreement for the Doha Round of the WTO, based on the general guidelines agreed last July, would help increase market confidence and be an eloquent incentive to the markets for the resumption of economic growth.
For Brazil, the G-20 countries, especially those that issue reserve currencies, could examine the possibility of extending credit facilities, with minimum conditionality, to be transferred by the IFIs to the least developed countries and middle income countries, in a targeted manner, in order to:
- Help maintain trade flows (World Bank);
- Help maintain international liquidity (IMF).
Internally, Brazil followed a similar path to increase funds for the National Economic and Social Development Bank (BNDES), with a view to supporting credit for investment. Instead of simply capitalizing the bank, it created targeted credit lines to be managed by the institution.
The reestablishment of international trade financing, especially for South-South trade, is a crucial part of the effort to overcome the international financial crisis. An interesting measure might be the establishment of payment mechanisms using local currencies, especially between countries that do not issue a reserve currency, as Brazil and Argentina have been doing in South America.
Interruption of capital flow to emerging countries
A worrying by-product of the financial crisis is the surge of capital flight from emerging countries. A reduction in the flow of external capitals into portfolio investments has been observed across these countries, as well as a reduction of direct investments and greater imbalance in their current accounts. On the one hand, developed countries receive excessive capital flows, which lead to the valuation of their currencies and loss of trade competitiveness; on the other hand, the emerging countries run out of capital to fund their foreign trade and domestic investments. In this manner, international trade retracts even further and the world’s activity continues to decline.
It is only through the coordinated efforts of governments that a balanced flow of capitals in the world can be reestablished. To this end, international financial institutions (IFIs), such as the IMF and the World Bank, must increase the volume of available funds and facilitate access, with more flexibility and less conditionality. The G-20 must coordinate a transfer of capitals to the IMF, in sufficient amounts to cover needs, to be allocated to the emerging and developing countries that need them. Developed countries, especially those with larger reserves, should proceed to the capital replenishment of the international financial institutions, following the recent example of Japan. These measures are urgent and should be adopted soon, while an equally crucial agreement on quota and capital increase and realignment is discussed, on a more permanent basis.
Improvement of the regulation and transparency of the financial system
In recent years, financial markets have enjoyed extraordinary vitality. The combination of new products with greater leverage capacity allowed for the acceleration of financial intermediation and the provision of credit conditions that to a large extent allowed mature economies to grow at rates well above the historical average. The global economy as a whole also benefited from this trend and grew at particularly robust rates in the past decade.
However, such processes occurred mostly in the advanced countries, in a context of severe regulation gaps and weak supervision. On the one hand, the financial market experienced an acceleration of financial innovation and liquidity expansion, while on the other, the excesses, lack of controls and dysfunctions of this same process demonstrate that the potential for wealth destruction and recessive impacts on the real economy constitute the perverse side of the coin.
This recent experience, of the biggest financial crisis since 1929, has demonstrated the importance of the presence of the State as market regulator and supervisor of the financial markets. However, it is necessary to find a point of balance where regulation is enough to ensure stability without incurring into excesses that restrict the development of these markets. There is no doubt that regulation needs to be improved, and we should take advantage of this moment to make tough decisions that would find little support in times of economic growth. The decisions need to be taken now, to reestablish credibility in the financial systems and to prevent future crises, albeit they could be gradually implemented, as the crisis abates.
For Brazil, the lessons of the crisis indicate the need to create adequate mechanisms to predict and address financial crises, update and strengthen the regulation and supervision of the banking system, as well as to put in place similar mechanisms for the non-banking financial sector and propose additional cooperative ways to supervise the performance of the financial players that have global presence and systemic importance. Therefore, we must move forward on the issue of regulation and supervision, an area where Brazil has experience and robust results.
As regards the integrity of global financial markets, Brazil supports the decision that IMF and the expanded FSF should develop an Early Warning Exercise. There should be, at the multilateral level, a mechanism to keep track of the evolution of the systemic risks connected to financial activities with global impacts.
For Brazil, the international standards of prudential regulation and accounting should reinforce the need for financial institutions to measure their risks taking into consideration more appropriate crisis scenarios and time frames.
The financial institutions should prepare complete financial statements, including detailed information on the risk exposure of off-balance sheet operations. The real value of the assets and liabilities must be demonstrated appropriately. Brazil also defends the strengthening of transparency requirements for institutions that are currently not regulated in many countries, such as mutual funds and hedge funds.
Regarding supervision, the strengthening of supervisory colleges to oversee the activities of systemically relevant financial institutions that operate at the international level is considered highly positive. However, attention should be drawn to the fact that supervisory colleges should include supervisors from countries where the subsidiary of the financial institution is systemically important, even though they might not be relevant, in terms of risk, for the financial group to which it belongs or for the supervisor of the headquarters.
There is also need to supervise and obtain information on the financial operations of non-financial institutions whose activities may have a major impact on the markets and, consequently, on financial stability. Brazil has been advocating the development of mechanisms for information exchange on complex financial operations (including exotic derivatives, which have caused heavy losses for national companies) that are contracted by non-financial companies in other jurisdictions, but can affect the liquidity and financial stability of the local market. Greater transparency and control are also necessary for securitization operations and over-the-counter operations.
As regards the non-banking financial system, Brazil considers it crucial to identify and eliminate national and international gaps in financial market regulation and supervision. All financial activities and agents must be subject to regulation and supervision, including hedge funds and other pools of capital. A sound international financial system entails the elimination of the shadow banking system Furthermore, Brazil defends a multilateral and coordinated fight against tax havens. The existence of non-cooperative jurisdictions and practices undermines regulation efforts and reduces the effectiveness and progressiveness of the tax and fiscal policies, as well as hindering or even making it impossible to supervise financial institutions and financial and capital markets.
Lastly, Brazil welcomes the announcement of the expansion of the Financial Stability Forum (FSF) of the Basel Committee on Banking Supervision (BCBS), and of the International Organization of Securities Commission (IOSCO). We see the recent decision as a necessary step in the right direction. Other forums, such as the International Accounting Standards Board (IASB) should also become more representative in their composition and governance by including significant representation from emerging and developing countries.
The role of international financial institutions and the reform of the international financial architecture
International financial institutions should promote a thorough review of their governance, resources and instruments for action. A crucial step is an ambitious review of the distribution of quotas, voice and representation. An external observer should be able to see a correspondence between the relative economic weight of members in the real world and their voice, whether in the IMF or in the World Bank.
To this end, the G-20 countries should demonstrate strong political support to: review the resources and instruments of the international financial institutions, in view of the needs of their members and the pressures resulting from the impact of global economic deceleration; compliance with the Declaration of the G-20 Leaders, dated 15th of November, 2008, with a view to a substantial realignment of quotas to more propriately reflect the changes in the relative positions of the emerging and developing countries in the world economy. More ambitious quota and voting power reforms are key elements to increase the participation and engagement of member countries and, therefore, to ensure greater legitimacy and effectiveness in the fulfillment of the mandates of those organizations.
Moreover, a clear and unequivocal demonstration of the decision to reform the Bretton Woods Institutions would be the G-20’s pledge to support processes for selection of the heads of the IMF and the World Bank in an open and merit-based manner, regardless of geographic or nationality preferences, thus abandoning the non-written rule of reserving the presidency of the World Bank to US citizens and the office of Managing Director of the IMF to citizens of European countries.
International Monetary Fund
Brazil considers the reform of the IMF an essential element of response to the financial crisis. We expect a firm and clear commitment towards a new and more ambitious reform of quotas and voting power of the IMF, in compliance with the Action Plan agreed by the G-20 Leaders in Washington, in November 2008. From Brazil’s view, this new reform, which should result in a significant transfer of voting powers to emerging and developing economies, is independent from the entrance into force of the initial package of changes approved in April 2008. The worsening of the financial crisis justifies that the two processes, national ratification of the previous reform and beginning of a new reform, take place in parallel, rather than excluding one another.
To this end, the G-20 countries should pledge to employ all possible efforts to speed up the legislative approval of the reform of quotas and voting power concluded in April 2008. Additionally, Brazil understands that the Fourteenth General Review of IMF Quotas, to be completed by no later than January 2011, must necessarily result in a new and significant realignment of quotas in favor of developing countries.
Still on the topic of governance, Brazil advocates the strengthening of the IMFC, which is a consensus mechanism currently headed, for the first time in history, by a minister from a developing country. Brazil does not support the replacement of the IMFC by a ministerial-level Council, with a weighted voting structure identical to that of the IMF Executive Board. The composition of both the IMFC and the Executive Board should be changed in order to increase their representativeness and ensure a balanced representation of the different regions of the world. Both institutions should be the most representative of the multilateral nature of the institution and should continue to be at the center of the decision-making process.
Brazil advocates a significant increase of the IMF resources. The greater the expansion of global liquidity, the more severe the effects of a contraction will be. In this context, a more robust IMF is a key element in reversing or mitigating the decline of the world economy and in preventing future crises.
However, in Brazil’s view, in the short term, it is the responsibility of the countries that issue reserve currencies and that have large surpluses to replenish the IMF capital, according to flexible mechanisms that include bilateral loans and other modalities to be explored.
Valid options may include an expansion of the New Arrangements to Borrow (NAB), or the temporary bilateral borrowing arrangements to meet the most immediate demand for financing, or even the issuance of IMF bonus to the official sector. However, for emerging and developing countries such as Brazil, the subscription of resources to the Fund on a permanent basis entails the reform of quotas and voting power.
Therefore, G-20 members should reaffirm their political support to the immediate launching of the second phase of the World Bank voice and representation reform, on the basis of a defined roadmap, in the next Spring Meeting, to be concluded no later than April 2010. Such reform should promote a significant change in voting power and take into consideration the unique character of the Bank’s institutional mission as a development bank and the participation of countries as donors, clients and partners of these institutions. Its ultimate goal should be to achieve voice and representation parity between developed and developing countries.
As to the reform of the Inter-American Development Bank Group (IDB), Brazil believes that it is necessary to review its capital adequacy. The region’s needs are increasing and urgent. In this context, financial resources for investments, financing instruments and management practices need to be reviewed.
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