IMF managing director shares his views on the financial crisis

Saturday February 14, 2009
IMF managing director shares his views on the financial crisis
By JAGDEV SINGH SIDHU


THE International Monetary Fund (IMF) is no stranger to financial and economic crises. Thus, when it recently admitted that this is indeed a grave time for the global economy, those hanging on to the final threads of optimism must have felt shivers down their spine.

The steep declines in consumer confidence, global trade, consumption and a number of other economic indicators, paint a bleak picture for the world. And there may be more bad news ahead.

That was bluntly conveyed by IMF managing director Dominique Strauss-Kahn when he was in town last week. He used the D-word, saying the advanced economies are already in a ‘’depression’’ and that the financial crisis may deepen unless the banking system is fixed.


Dominique Strauss-Kahn
“The worst cannot be ruled out. There’s a lot of downside risks,” he was quoted as saying.

That prognosis is scary considering the IMF has witnessed 122 banking crises. Saying most of the world was already in a depression was a surprise, but Strauss-Kahn was clearly not in the mood for mincing words when he met the press at the end on his two-day trip to Kuala Lumpur.

The reason for this dire warning can be traced back to the litany of literature on how the world today is suffering from a number of angles. But one facet that could have a telling implication, Strauss-Kahn believes, is the psychology of consumers and investors.

In his speech at the 44th South East Asian Central Banks (SEACEN) Governors’ Conference, he says investors have lost confidence in many companies, especially banks, because they fear that there are further losses to be realised.

“Consumers are holding back from buying cars and from other big discretionary purchases, because they fear for their jobs,’’ he points out.

The IMF has slashed its forecasts dramatically over the past few months and is expecting the world to eke out a small growth this year.

To help restore growth, Strauss-Kahn says the main objective is to revive confidence. “At a global level, this means that governments and central banks need to act decisively so that investors once again feel confident about the solvency of financial institutions,” he says.

“And they should credibly commit to measures sufficient to eliminate the risk of a repeat of the Great Depression.’’

Strauss-Kahn adds that the world needs a coordinated global response to contain the crisis. Piecemeal responses are not enough and he argues that the one-size-fits-all approach will not work either.

“But policy responses have to take into account the interconnectedness of national economies, and the fact that decisions taken in one country can have profound effects on others,’’ he says, warning that protectionism is not a way out of the economic crisis.

To get the financial sector moving again, Strauss-Kahn stresses that financial stability is essential. He notes that governments have acted to address threats to systemic stability through massive liquidity support and have supported confidence in the banking system by extending guarantees.

He urges governments to examine the balance sheets of banks and restructure those in need of help. Furthermore, if needed, capital can be provided and bad assets carved out of the bank. He also suggests that governments sell or wind up insolvent banks quickly, depending on whether any franchise value remains. He advocates the establishment of a public resolution agency to manage bad assets to maturity or sale.

“Even with these measures, it will take time to restore credit growth. They will also be expensive for governments,’’ he cautions.

Fixing the financial sector is only one step. The damage from the weaker growth has to be addressed as well. “To restore aggregate demand, we also need supporting monetary and especially fiscal policies,’’ says Strauss-Kahn.

Fiscal policies have been promoted by governments across the world as a further fillip to deep interest rate cuts to stimulate growth, but those measures are only as good as their implementation.

Piling hope on a government-funded boost has its own hazards. Countries that take on huge debts to finance the pump-priming do so at the risk of affecting their credit ratings.

Strauss-Kahn says the pile-up of government debt may also present a future problem but stresses that the risk of not acting now far outweighs the danger of higher fiscal deficits.

He adds that China offers a great way for fiscal stimulus to work where pump-priming can lead to a rebalanced demand in favour of private consumption through improvements in the social safety net.

Social insurance will give the Chinese consumers the confidence to start spending instead of maintaining high precautionary savings. “Allowing greater flexibility for its currency to appreciate over time would also help,’’ he says.

“In doing so, China could support both domestic demand and intra-regional trade, because more domestic demand from China would mean more exports for other Asian countries.’’

Strauss-Kahn shares the view of many people – that Asia will be the first to rebound from the global mess. Its banking system is healthier than those in most parts of the world, and that is a strength the Asian economies can rely on when the world finally emerges from this slump.