Three years of G20 summits: an assessment
Montek S Ahluwalia, deputy chair, Planning Commission of India, and India’s sherpa for the G20 summit
Although G20 members can be proud of their recent achievements in rebalancing the global economy, an urgent and potentially greater set of challenges must be addressed as the group enters its fourth year of discussion and cooperation
From "The G20 Cannes Summit 2011: A New Way Forward," edited by John Kirton and Madeline Koch,
published by Newsdesk Media Group and the G20 Research Group, 2011
To download a low-resolution pdf, click here.
As the G20 leaders meet at Cannes, it will be three years since their first meeting in Washington, at the height of the 2008 crisis. They can claim significant achievements in this period, notably the containment of the worst global crisis since the Great
Depression, and also the start of some new initiatives, such as the coordination of macroeconomic policies and the evolution of an appropriate structure for financial regulation, although these remain works in progress. However, the eurozone crisis presents a new challenge that will again test its effectiveness in crisis management.
Most would agree that the G20 did well in orchestrating a simultaneous fiscal expansion by all countries with supportive gloabl monetary and financial policies to contain the 2008 crisis. There was a contraction in industrialised countries in 2009, but they returned to positive growth in 2010 and the emerging-market countries performed strongly in both years, indicating the emergence of a potential new source of dynamism in the world economy.
The turnaround was also supported by the G20’s decision to expand financial resources for the international financial institutions, strengthening the global safety net and stabilising market confidence. The voting share of dynamic emerging-market countries at the International Monetary Fund (IMF) was increased, less than might have been warranted, but clearly a move in the right direction. Significant progress was also made in outlining an action plan for reform of the architecture for financial regulation to deal with risk and instability. The Financial Stability Forum was expanded to include all G20 members and renamed the Financial Stability Board (FSB), as a permanent institution for overseeing the activities of international standard-setters and facilitating consultation with national supervisory authorities and the IMF.
The G20 also launched an ambitious multilateral effort – the Mutual Assessment Process (MAP) – to coordinate macroeconomic policies among the major countries. Coordination was viewed as critical for sustaining growth and reassuring markets. The crisis had led to a sharp increase in the sovereign debt position of industrialised countries, in large part due to the collapse in government revenues and the increase in expenditures on the social safety net.
While the resulting fiscal stimulus proved effective in supporting economic activity temporarily, it was obvious that it would have to be reversed. As such a reversal would have a contractionary effect on economic activity, it was felt that it should be phased to avoid an immediate contraction, while simultaneously seeking to reassure markets by taking credible steps to ensure fiscal viability over the longer term. This strategy needed to be supported by rebalancing global demand, with an expansion of demand in surplus countries accompanied by greater exchange-rate flexibility.
Coordinating macroeconomic policies on this scale among sovereign governments is not easy. Earlier IMF efforts had proved unsuccessful, but it was hoped that the MAP, being a country-led process, would do better. The Cannes Summit was to be the first opportunity to review, and hopefully agree upon, the outcome of the MAP in terms of a consistent set of policies for individual G20 countries capable of restoring growth.
All this has been overtaken by the explosion of the sovereign debt crisis in the eurozone. If not effectively controlled, it could have a major destabilising effect on Europe and, given the weight of Europe and its integration with the rest of the world, therefore also on the global economy. The crisis was triggered by the collapse of the rescue package for Greece, which put pressure on Ireland and Portugal, with contagion spreading to Spain and Italy. All these countries have serious debt problems, although none as serious as Greece. Unfortunately, the failure of the IMF package for Greece has eroded market confidence, making it difficult to prevent contagion.
Greece is now widely regarded as ‘insolvent’ in the sense that the maximum austerity that is socially and politically acceptable will not allow Greece to reduce its ratio of debt to gross domestic product (GDP) to acceptable levels, given the low-growth prospects facing the Greek economy. The low-growth potential in part reflects both weak underlying factors, such as low investment, and the fact that domestic austerity itself will reduce domestic demand and depress economic activity. There is little prospect for offsetting this contractionary effect by relying on external demand, given the absence of exchange-rate depreciation as a policy option and also the depressed state of the European and world economies.
For all these reasons, markets believe that Greece can be rescued only if there is a substantial debt reduction. The 21 July package agreed with European leaders did involve some reduction of Greek debt, via a restructuring package backed by the European Financial Stability Facility (EFSF), but it was much less than was needed. Current market sentiment suggests that a haircut of between 40 per cent and 50 per cent of bank debt would be needed. It remains to be seen whether such an outcome can be agreed upon and how the burden will be shared: should it be borne largely by the banks themselves that lent imprudently to begin with, or shared by the European Central Bank (ECB) and the EFSF? Of course, if the banks take a hit, it will be left to governments to recapitalise them, further eroding their weak positions.
The build-up of sovereign debt in Greece and other countries reflects a variety of factors, including weak growth, lax fiscal policies and imprudent bank lending, the last arising from a failure to recognise some inherent weaknesses in the eurozone. The adoption of a common currency removed the currency risk from lending to countries within the eurozone, which should have led to somewhat lower interest rates.
However, European banks behaved as if credit risk had also been eliminated. Fiscally weak sovereigns were able to borrow at interest rates only marginally higher than those of Germany. This would have been reasonable if the eurozone had mechanisms that enforced fiscal prudence, but there were none. Such mechanisms that existed had been breached earlier and made irrelevant. Despite this, the banks lent excessively, leading to a large build-up of sovereign debt in the countries that are now in trouble.
The Cannes Summit faces two major challenges in addition to the usual items on the agenda. First, and most immediately, it is necessary to reassure markets that credible steps have been taken to ensure stability in the eurozone. Second, having ensured stability, the G20 also needs to show some progress on the MAP. The two are obviously connected since progress on the MAP should allow higher levels of growth globally, and therefore also for the debt-stressed countries, which in turn will have a favourable impact on any assessment of debt sustainability.
Stabilisation of the eurozone urgently requires a package that ends the Greek crisis, which requires early agreement on the difficult issues listed above. This must be followed by an effective adjustment programme for each country under threat. Even if an objectively credible package is put in place for each country, it may not reassure markets immediately, posing serious liquidity problems, so these countries will need liquidity support.
This is reasonable: once solvency is taken care of, liquidity must be provided and in ample measure. If the resources to meet liquidity needs are to come from the eurozone itself (whether the ECB or the EFSF), the international community is not directly concerned, although it is vitally interested in the success of the measures. If the eurozone effort needs to be further backstopped by the IMF, the G20 is directly concerned. In that event it will be the IMF’s responsibility to determine whether the programme being supported is credible. In effect, the IMF will have to certify whether a haircut is necessary and, if so, whether it is adequately provided.
There is also the issue of what is the appropriate scale of the IMF’s contribution, relative to what should be done internally by the eurozone. More generally, these issues raise the question whether resources available within the eurozone are adequate, and likewise the resources available from the IMF. Markets will look for clear signals from the G20 on all these issues if normality can be restored.
Once the task of restoring stability in the eurozone is assured, the G20 will still need to make progress on the MAP, if only to persuade markets that the macroeconomic policies being followed by major countries are consistent with stimulating and sustaining robust growth in the medium term. As pointed out above, creating credibility about growth prospects is itself critical for reassuring markets that debt sustainability issues can be resolved.
All in all, the G20 members will have a lot on their plate in Cannes as they enter their fourth year. It illustrates the proposition that, in a globally integrated world, global coordination among major countries is needed. The G20 is the only mechanism we have to bring this about.
The views expressed in this article are those of the author and do not necessarily reflect the views of the Government of India.
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