Column : Be strong as the dollar gets weaker

Fri, Oct 23 12:22 PM

The recent G-20 and IMF meetings have seen a long overdue increase in emerging markets (EM) representation in global institutions. The G-7 is to cease to exist. It will be replaced by the more representative G-20, set up in 1999 to bring together the most important advanced and emerging economies.

In addition, the IMF board is to give greater voice to emerging markets. Currently, countries outside the G-7 control only about half of the votes on the IMF board despite representing a greater share of the world economy. The BRICs (Brazil, Russia, India, China) control less than 10% of IMF votes. At the Pittsburgh summit last month, the G-20 has committed to implementing a shift in IMF quota and vote shares "of at least 5% from over-represented countries to under-represented countries" by the spring of 2011.

Perhaps more significant is a new, US-supported initiative to reduce global imbalances, i.e. reduce Asia's external surplus and the US external deficit. Under the plan proposed by the US Treasury and adopted by the G-20, the US would raise public and private sector savings; China and Japan would reduce their dependency on external demand, and Europe would implement structural reforms to spur business investment. G-20 members would meet periodically to review each other's progress while the IMF would offer technical support.

This sounds very much like a duplication of the multilateral surveillance currently carried out by the IMF. There is however a crucial difference between the US sponsored scheme and current IMF surveillance: the G-20 would be supervising the new initiative. By contrast supervision of the IMF surveillance is carried out by the IMF board where emerging markets are still under-represented. This long overdue adjustment in global governance reflects a long-term trend of fast emerging markets growth. Over the past 15 years countries outside the G-7 have increased their share of world GDP to 60% from 50% and their share of world exports by to 63% from 49%. They also own most of the world's 6.8 trillion dollars in foreign exchange reserves.

The rise of the BRICs has been even more impressive: over the past 15 years their share in global GDP has increased to one-fourth from one-sixth and their share of global exports to 13% from 3%. In addition, the BRICs now hold 45% of the world foreign exchange reserves.

The global financial crisis has acted as a catalyst in bringing about these much-needed changes in my view for three reasons. First, the crisis has originated in advanced economies and greatly reduced the legitimacy and credibility of their development model, especially when it comes to financial sector development.

Second, the need to fund the repairs of corporate and financial sector balance sheets in crisis countries has increased the bargaining power of cash rich countries. The former are mainly advanced economies while the latter typically are either oil exporting countries or Asian countries with large external surpluses.

Third, the crisis is likely to see faster growth in emerging markets than in advanced economies. Advanced economies will have to spend a substantial share of their income to fund household, financial and corporate balance sheet repairs over the next few years. This will reduce the funds available for productive investments. By contrast emerging markets that have largely avoided a crisis will be able to power on, perhaps with the exception of Eastern Europe. India is particularly well placed to outperform in view of its low dependency on external demand.

Greater EM representation in global institutions is good not just for EMs but for global institutions themselves. It will increase their legitimacy and efficacy. IMF advice is likely to carry more weight if the IMF is viewed as a true multi-lateral institution rather than as the agent of its most powerful members. For instance, China is more likely to accede to the demand of reducing its current account surplus if it is a fully empowered participant in a multi-lateral process than if it is under pressure from the US or the EU.

But, with greater voice comes more responsibility. Now that emerging markets have a bigger seat at the decision making table they are going to face stronger pressure to play their part in the rebalancing of the global economy. Dollar weakening, that is very much part of the needed rebalancing, is taking place at greater speed against advanced economies' and Latin American currencies than against emerging Asia's currencies.

Since end-February 09 the dollar has depreciated by 16% against a basket composed of the Euro, Yen, British pound, Canadian dollar, Swedish Krona and Swiss Franc and by 23% against a basket of Latin American currencies. By contrast the dollar has depreciated by 10% only against a basket of Asian currencies excluding the yen.

This limited appreciation of Asian currencies reflects that Asian countries so far have largely responded to the resumption of capital flows by engaging in large scale intervention in the foreign exchange markets. But this policy response only entrenches their dependency on external demand and prevents the reduction of global imbalances. Asia needs to play its part as an empowered global citizen and allow its currencies to appreciate against the dollar.

—The author is an economist with the Royal Bank of Scotland. These are her personal views

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