Reforming The Architecture of the International Monetary System: Managing The Impossible Trinity

Rakesh Mohan Michael Debabrata Patra Muneesh Kapur Conference of the The BRICS & Asia, Currency Internationalization, and International Monetary Reform Hong Kong 10-11 December 2012 1

Presentation Outline

      IMS – Performance Evaluation IMS Early Warning: Review and Reform Managing Capital Flows: Country-centric or Multilateral Issues in reserve management  Stylized facts  Dominant Reserve Currency – Risks to IMS; Demand-Supply Dynamics Currency Internationalization: the Way Forward?

 Costs and Benefits IMS and Central Banks  Central Bank Mandate(s) – Rethink?

 Key Takeaways 2

What is the IMS?

   

Set of official arrangements comprising:

◦ exchange arrangements and exchange rates ◦ international payments and transfers relating ◦ international capital movements; and ◦ international reserves

What it is not Mission creep Shifting channels of contagion- This time will be different

3

IMS Performance – Evaluation  Increasing incidence of crises Period Gold Standard (1870-1913) Inter-War Period (1925-1939) Bretton Woods (1948-1972) a.1948-1958 b.1959-1972 Post Bretton Woods (1973 2010) a.1973-1989 b.1990-2010 Banking Crisis Currency Crisis 1.3

0.6

2.1

1.7

0.1

0.0

0.1

1.7

1.4

1.9

2.6

2.2

3.0

3.7

5.4

2.4

External Default 0.9

1.5

0.7

0.3

1.1

1.3

1.8

0.8

Source: Bush, Farrant and Wright (2011) [Table A, p,7].

4

IMS Performance Evaluation: Higher Exchange Rate Volatility

Period

1970-79 1980-89 1990-99 2000-09

Variability in Major Exchange Rates (coefficient of variation in percent) Yen/ US Dollar

16.47

Pound / US Dollar

13.91

Swiss Franc/ US Dollar

30.62

Euro/ US Dollar

21.91

26.05

13.55

8.63

13.46

6.91

14.72

2000-12 12.96

24.49

Note: Data for Euro/US Dollar prior to 1999 pertain to Deutsche Mark/US Dollar.

Source: International Financial Statistics, IMF.

18.90

8.46

17.90

27.92

21.69

15.07

18.32

18.18

5

  IMS Performance Evaluation: Exchange and Payment Arrangements Intermediate Solutions – managed floats; soft pegs Current restrictions ebbing; capital restrictions well in evidence

Exchange Arrangements : Current and Capital Transactions

1970 1980 1990 2000 Article VIII Status (no restrictions on payments/transfers for current international transactions 37 No. of Countries 54 72 152 Article XIV Status (Transitional restrictions) Bilateral Payments Agreements Controls on Payments for Invisible Transactions and Current Transfers Repatriation/Surrender Requirements for Exports and/or Invisibles Controls on Capital Transactions Total number of countries covered Source: AREAER (various issues), IMF.

80 60 80 100 99 119 86 42 73 114 110 141 83 47 87 124 123 155 34 60 98 107 182 186 2010 171 19 67 95 89 186 190 6

IMS Performance : Evaluation High flux in Capital Flows 9 8 7 6 1 0 -1 5 4 3 2 Debt flows-Short term Debt flows-Long term Portfolio equity flows FDI flows Total capital Recycling petro dollars Debt crisis US easy monetary policy Asian crisis Greenspan put 2008 crisis 7

High Flux for AEs too

1 Total Assets (Outflows) (2+3+4)

2 International Organizations 3 AEs 4 EDEs (5 to 10) 5 Dev. Asia

Capital Inflows and Outflows: Advanced, Emerging and Developing Economies

6 Central and eastern Europe 7 CIS 8 Mid. East and north Africa 9 Sub-Saharan Africa 10 Western Hemisphere 2003

2881

62 2676 142 24 11 34 75 14 -16 2004

4838

31 4528 279 20 32 63 112 16 36 2005

6137

61 5634 442 137 20 77 113 17 78 2006

7461

-2 6667 796 234 72 102 236 35 117 2007

10293

97 9104 1093 250 119 164 358 39 162 2008

279

85 -623 817 173 88 286 154 23 94

(US $ billion)

2009

213

2010

3723

88 -196 321 145 2841 737 125 2 62 46 15 71 294 -36 125 149 32 174

11 Total Liabilities (Inflows) (12 to 14)

12 International Organizations 13 AEs 14 EDEs (15 to 21)

3458

55 3168 235

5299

29 4847 423

6703

60 5992 651

8160

29 7222 909

11231

103 9384 1744 15 Dev. Asia 16 Central and eastern Europe 17 CIS 18 Mid. East and north Africa 86 54 41 36 159 93 61 54 265 125 85 73 324 195 126 150 471 298 286 346 19 Sub-Saharan Africa 20 Western Hemisphere 9 8 15 41 17 86 7 106 65 278

21 Net (11-1) 577 462 566 699 938 Note:

Both inflows and outflows are exclusive of movements in foreign exchange reserves.

1061

74 4 984 256 264 167 90 42 164

782 1102

84 277 741 344 78 43 61 56 159

889 4555

134 3132 1289 640 75 101 89 58 325

832

8

Reserve Accumulation by EMEs and AEs

12,0

Stock of International Reserves

10,0 8,0 EDEs AEs 6,0 4,0 2,0 0,0 мар-2000 июн-2012 Other; 1,5

Composition in Percent (March 2000)

Euro; 17,5 Swiss Franc; 0,3 Yen; 6,3 Other; 5,3

Composition in Percent (June 2012)

Euro; 25,1 Swiss Franc; 0,1 Pound; 2,9 US Dollar; 71,5 Yen; 3,8 Pound; 3,8 US Dollar; 61,9 9

AEs share in global reserves are coming down End of World AEs EMDCs Sub-Saharan Africa Developing Asia Emerging Europe Middle East& North Africa Western Hemisphere

IMS: International Reserves@ (US $ billion)

1970 97.6

72.6

20.6

3.0

3.5

0.6 4.7

5.5

1980 461.2

273.6

162.2

14.8

27.7 5.4 74.0 40.3

1990 990.0

628.7

201.5

13.3

68.1

19.3

51.7

49.0

2000 2070.3

1325.8

739.4

36.1

324.5

104.1

117.5

157.2

2011 10705.1 3744.9

6954.6 178.1 4058.0 870.6

1108.1 740.1

Memo: World Reserves with Gold at Market Prices 100.1

1089.0

1373.5

2314.3

@: comprising foreign exchange, reserve position in the IMF, SDR holdings and gold valued at SDR 35 per ounce.

Source

: International Financial Statistics, IMF.

12186.3

10

IMF Surveillance –Review and Reform

   Gaps in Surveillance – Response ◦ Enhancing integration of multilateral macro-financial analysis: WEO & GFSR ◦ introduction of Early Warning Exercise, Fiscal Monitor, Spillover Report, Pilot External Sector Report, and the G-20 Mutual Assessment Process ◦ Improvements in bilateral surveillance – multi-country perspective: timeliness and readability ◦ The Financial Sector Stability Assessment (FSSA, a major component of FSAP) made mandatory for 25 key countries An Alternative approach: an India example ◦ Ensured compatibility with best practices and enhanced the skill-sets within the financial sector, leading to significant capacity building ◦ ◦ 4 independent advisory panels Reports peer reviewed ◦ ◦ ◦ Integrated Surveillance Decision ◦ Why not amend Articles?

More multilateral less bilateral Dealing with spillovers – dialogue; encouragement?

Flawed governance, flawed surveillance 11

Managing Capital Flows • • • • • • • Five challenges for collective action Empirical evidence on beneficial effects of CAL weak Danger of one-size-fits-all approach Capital account management does not mean less openness – fully open capital account may not be desirable Policies needed to counter externalities associated with cross-border flows Even-handed treatment?

◦ ◦ ◦ ◦ Advisory role for the IMF is the best option for now Analysis of push and pull factors Cross fertilisation of country experiences Improve mapping Capital controls legitimate part of policy toolkit 12

Issues in Reserve Management   Massive Reserve Accumulation Reserve Accumulation vis-à-vis Other Metrics Months of Imports Percent of GDP Percent of Gross capital Formation Percent of Short-term Debt Months of Imports Percent of GDP

Table : Reserves in Relation to Selected Metrics

1990 2000

Global

4.4

5.2 @ 5.2

6.9

23.4 @ n.a.

30.9

n.a.

Low and Middle Income Countries

5.6

6.2

6.6 @ 11.3

Percent of Gross capital Formation Percent of Short-term Debt 25.7 @ 107.5 @ 47.1

229.5

Months of Imports Percent of GDP Percent of Gross capital Formation Percent of Short-term Debt

Note:

@: Data pertain to 1992;

High Income Countries

4.2

4.8

5.0 @ 5.9

22.9 @ n.a.

n.a. = not available 26.9

n.a.

2010 13.5

17.1

75.2

n.a

16.3

28.7

89.1

556.5

10.2

11.6

62.8

n.a.

2011 13.2

17.0

n.a.

n.a

15.7

26.9

82.0

n.a.

10.6

12.0

n.a

n.a.

13

 Dominance of US Dollar in International Reserve Currency

US Dollar in International Finance

Foreign exchange transactions International reserves Debt securities Share of banknotes held overseas Cross-border bank deposits Cross-border bank loans

Source:

IMF (2010b).

0 86 64 46 52 59 65 50

Percent to World Total

100 14

Demand for Reserve Assets continues to rise…

Country Brazil Hong Kong China

India

Korea Russia Saudi Arabia Total

Net Foreign Assets: Requirements of Major EMEs

US $ billion 2011 Actual Scenario A 2017 Scenario B Scenario C 349 280 3776 883 479 9510 591 329 6483 470 305 5129

286

309 491 547 6036

665

500 1456 1393 14886

460

330 755 592 9540

373

319 623 569 7788 Source: Authors’ Calculations (see text for methodology) based on IFS, IMF data.



Demand likely to outstrip supply of reserve currencies

15

Underlying Risks



Threats to IMS Stability

◦ US debt sustainability and Triffin dilemma ◦ Underpricing all Risks ◦ Risks from policies towards domestic orientation in the US 

Ability of US Dollar to meet future reserve currency demand?

16

Trends and composition of GDP

Sectoral Contribution to GDP growth

2 0 -2 12 10 8 6 4  Agriculture Industry Services GDP Growth has moderated over last six quarters ◦ Sluggish industry growth ◦ Services has also shown moderation in last 3 quarters 17

Inflation Persistence

WPI YoY Inflation

12 11 10 9 8 0 -1 -2 7 6 5 4 3 2 1  February 2010 to November 2011 – Highly elevated inflation ◦ Average Inflation 9.6 per cent  February 2012 to October 2012 - Sticky Inflation ◦ Average Inflation around 7.6 per cent 18

Movement of Indian rupee vis-à-vis US dollar

30 20 10 0 60 50 40 

Market-determined-movements two ways

19

Financial openness of India increasing

40 30 20 10 0 90 80 70 60 50 Intenational Assets International Liabilities Source: Lane and Milessi-Feretti Database Total Assets + Liabilities 20

India’s Currency Invoicing

Currency Pound Sterling

Currency-wise Pattern of Invoicing of India’s Mercandise Trade

1990-91 Export 4.5

Import 3.1

1999-2000 Export 3.9

Import 1.7

2005-06 Export 2.9

Import 2.0

(Per cent) 2008-09 Export 2.8

Import 0.9

US Dollar Japenese Yen Euro Indian Rupee Others 57.2

0.1

27.7

10.5

59.7

4.4

7.7

25.1

87.0

0.3

3.0

0.3

5.5

85.8

3.8

3.3

0.0

5.4

87.4

0.5

7.7

1.6

78.2

4.2

12.5

3.2

84.1

0.5

10.9

1.8

86.3

2.3

9.5

1.0

 US Dollar is also the major currency for invoicing software exports with 76% share, followed by Pound Sterling (10%) and Euro (7%) in 2009-10.

21

2 0 6 4 16 14 12 10 8

Share in World GDP- PPP based

1980 1990 2000 2011  EMEs account for 49% of global GDP in 2011; India: 5.6 % 22

Currency Internationalization

Growing scope for EME Currency Internationalization…

Selected Macro and Financial indicators of Select Currencies with Internationalization Potential

Indicator

Macroeconomic Indicators

GDP share Economic growth 3.6

4.2

Inflation 4.9

Sovereign ratings BBB 10.9

9.5

2.6

AA 0.4

4.4

3.4

AAA 2.8

8.1

5.2

BBB 1.3

6.7

4.8

BB+ 3.2

4.2

3.3

A 1.7

3.6

3.1

BBB 1.7

4.3

7.2

BBB 0.4

4.4

2.5

AAA 0.6

4.2

5.0

BBB+ 1.2

4.2

5.2

BBB Capital account openness Total trade 0.4

1.3

Exchange rate flexibility

Financial Indicators

Financial depth Intl. debt securities FX market turnover FX bid-ask spreads Floating 1.6

0.1

0.3

8.6

-1.1

11.0

Crawl like 7.2

0.1

0.4

1.7

2.5

2.7

Currency board -1.1

2.3

1.1

0.9

0.4

3.1

1.1

1.8

Floating Floating Floating Floating 0.2

2.3

Other managed 2.5

-1.1

0.1

2.6

Other 0.5

1.0

managed Floating Floating 1.6

0.2

1.2

1.2

1.1

0.0

0.5

6.7

0.3

0.0

… … 1.2

… 0.8

11.6

0.5

0.1

0.6

7.2

0.8

0.1

0.5

7.9

0.5

0.1

0.7

6.7

0.5

0.1

0.4

31.2

0.4

0.1

0.4

23.6

23

EMEs’ share in global trade is rising but…

Country Euro area

Exports of Goods, Services and Financial Flows: Share of Top 20 Countries(%)

Exports of goods and Exports of goods and services and services 2001-2005 2006-2010 24.1

23.6

financial flows 2001-2005 25.3

2006-2010 24.6

US China UK Japan Canada Korea Singapore Russia Switzerland Mexico

India

Sweden Saudi Arabia Australia Malaysia UAE Norway Brazil Thailand Total

Source:

IMF (2011c). 18.5

8.8

9.1

8.3

4.7

3.2

2.9

2.3

2.8

2.5

1.3

2.0

1.5

1.4

1.6

1.0

1.4

1.2

1.3

100.0

16.8

12.0

7.7

6.9

3.7

3.4

3.2

3.2

2.7

2.0

2.0

2.0

1.9

1.7

1.5

1.5

1.5

1.4

1.4

100.0

22.4

7.5

12.7

7.2

3.8

2.5

2.3

1.9

2.4

2.0

1.1

1.7

1.1

1.6

1.2

n.a.

1.3

1.1

1.0

100.0

19.1

10.4

11.7

6.0

3.3

2.7

2.6

2.8

2.8

1.7

1.8

1.9

1.5

1.9

1.2

n.a.

1.5

1.5

1.1

100.0

24

…..Share of EME currencies in Fx turnover still negligible...

Currency US dollar Euro Japanese yen

Global Foreign Exchange Market Average Daily Turnover: Currency-wise

(Per cent)

2001 44.9

19 11.8

Share in Global Turnover 2004 2007 44 44.9

18.7

10.4

19 11.8

Pound sterling Australian dollar Swiss franc Canadian dollar Hong Kong dollar Swedish krona New Zealand dollar Korean won Singapore dollar

Indian rupee

6.5

2.2

3 2.2

1.1

1.2

0.3

0.4

0.5

0.1

8.2

3 3 2.1

0.9

1.1

0.5

0.6

0.5

0.2

6.5

2.2

3 2.2

1.1

1.2

0.3

0.4

0.5

0.1

Russain rouble Chinese renminbi South African rand Brazilian real Others

Memo:

Global turnover (all currencies, US$ bn)

Source: BIS

0.2

0 0.5

0.2

5.9

1239 0.3

0 0.4

0.1

6 1934 0.2

0 0.5

0.2

5.9

3324 2010 42.4

19.5

9.5

6.4

3.8

3.2

2.6

1.2

1.1

0.8

0.8

0.7

0.5

0.5

0.4

0.4

0.3

5.9

3981 25

…US Dollar and Euro continue to dominate in Global Fx Derivatives Market…

Global Forex Derivatives Market Turnover(Share in %)

US dollar Euro Japanese yen Pound sterling Australian dollar Swiss franc Canadian dollar Hong Kong dollar Swedish krona New Zealand dollar Korean won Singapore dollar Indian rupee Russain rouble Chinese renminbi South African rand Brazilian real Others 26

…Rising presence of some EMEs..

Currency

International Bond Issuance in Emerging Market Currencies

(Per cent)

Share in Total EM Issuance in 2010 Hong Kong dollar Brazilian real South African rand Singapore dollar Chinese renminbi Russian rouble Korean won

Indian rupee Total

18.0

10.9

10.8

10.2

5.8

4.5

0.5

0.4

61.1

Source

: IMF (2011e).

27

Prerequisites…



Acceptability is key, comprising

◦ Deep and liquid financial and foreign exchange markets ◦ Full currency convertibility and an open capital account ◦ Wide use in international transactions ◦ Macroeconomic and Political stability 28

Cost and Benefits of Currency Internationalization

   Reduces transaction costs Reduces exchange rate risks Access to international debt securities markets –domestic deepening      Complicates monetary management Can hurt export competitiveness Could make exchange rate more volatile Exorbitant privilege or exorbitant risk Systematic consequences

Rush into currency internationalisation – repent at length

29

     

Key Takeaways

Enlightened IMS Governance is key ◦ More representative legitimate and effective IMF ◦ Regional arrangement and national reserves integral part of global safety net Domestic stability, external stability and global stability – new impossible trinity ◦ Dealing with spillovers critical Managing Capital Flows – One size fits all or customised to country context?

Central banks mandate in reformed IMS – financial stability; self FSAP Future demand-supply mismatches in reserve currencies –recipe for future shocks?

Currency internationalisation ◦ EMEs in a still nascent continuum ◦ ◦ Managed internationalisation is flawed and dangerous Economic size, financial depth, openness, credibility, usability, - set a high bar Blending fundamentals with country experience will balance desirable with feasible 30

Thank You!

31