Events & Issues

New Delhi, 10 November 2008

Financial Crisis

Bretton Woods Revisited

Dr. P. K. Vasudeva

After World War II when the world economy was in recession it led to the Bretton Woods arrangement which entailed the establishment of the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (IBRD) – World Bank - in 1945 to overcome the financial crisis. However, these have turned out to be inadequate to meet the requirements of regulation of the present-day international financial system. Exposing a weakness that has today led to a crisis that is threatening the world with an unprecedented financial and economic squeeze.

The Hurricanes Ike and Gustav, the Category Five storm that hit Wall Street, in the form of the collapse of Lehman Brothers and the sell-out of Merrill Lynch, has spread panic across the global financial system. The shock waves from a collapse that was assumed would never be allowed, sent markets on a tailspin across the world.

Surprisingly, there is a chorus from many financial experts that the IMF should be replaced with a more effective international financial watchdog. A point which was also made by the Prime Minister Manmohan Singh, at the ASEAN Summit in Beijing recently.

Manmohan. Singh said, that the need of the hour was the creation of a “global monitoring authority to promote global supervision” of cross-border investment, trade and banking. He also called for a “collective international effort” to fight the present crisis which had to involve infrastructure investments in developing countries as a “counter-cyclical device”.

Plainly, the Prime Minister was obliquely hinting at the present-day relevance of the famous economist Keynes’s line adopted by Bretton Woods, which espoused a more active, development-oriented role for the IMF.

Indeed, it should not be too difficult for the Fund, or any new body that may come up in its place, to adopt a more active and regulatory role in international finance against the backdrop that, even in the US, the Government has been forced to intervene in the ownership structure of banks and financial institutions in an attempt to get things back on an even keel.

The British Prime Minister Gordon Brown is also rallying his counterparts to consider reforms of the international economic institutions. He has rightly advocated the importance of implementing an early warning system for meeting the financial crisis. Additionally, he has advocated rules for transparency in the banks and global supervision of the financial institutions. In other words, Brown has given a call for the establishment of “New Bretton Woods”.

Not only that. To overcome the present crisis the US President George Bush has invited the heads of the G-20 countries tomorrow (15 November) to develop a “common set of principles for the reform of the regulatory and institutional regimes for the world’s financial sectors.”

Further, the World Trade Organisation (WTO) Director-General Pascal Lamy, in his opening address to the Geneva Shipping and Trading Association’s Commodities Week last week stated, “Amidst the chaos that we are witnessing today, what we need is greater regulation. What we need is better global governance. While there is no doubt that global financial regulation must be crafted, there is no doubt either that global trade regulation must be reinforced. What is desperately needed at a time like this is to restore trust in markets by reassuring investors that they are still operating within a rules-based international trade and financial system,” he added for good measure.

Needless to say, all countries are busy taking action to overcome the crisis. While the British Prime Minister has advocated that the Gulf States must help solve the crisis. The German Chancellor Angela Merkel is busy urging banks to tap rescue fund. The Russians have placed 170 billion roubles for the rescue plan and J P Morgan Chase has announced a mortgage modification programme. The US Fed Chief Bernanke has advocated that the US Government’s backing for the debt issued by Fennie Mae and Freddie Mac must stay firm.

However, reforming the international financial system is one thing; getting the results to trickle down to the grassroots level is an entirely different ballgame, requiring a different set of delivery instruments. This has been effectively underscored by the International Labour Organisation (ILO) Chief Juan Somavia, who underscored that  world unemployment could increase by 20 million by the end of next year, surpassing in the process the 200-million-mark for the first time.

More important is his (expected) finding, he is of the view that those at the bottom of the heap would be affected much more severely than people better off. Thus, making it even more challenging for the international community to devise effective remedies.

In India too, the Reserve Bank of India (RBI) Governor D. Subbarao, has taken some measures, which are showing some positive signals with inflation steadying and industrial growth bouncing back. A few examples: The Repo rate (RBI’s lending rate) has been cut by 50 basic points to 7.5 per cent to make funds cheaper for banks.

The cash reserve ratio has been slashed by 100 basis points to 5.5 per cent, thus adding Rs 40,000 crore to the lendable resources of banks. The statutory liquidity ratio has been cut by 100 basis points to 24 per cent to make more funds available to the banks.

The RBI has agreed to buy back securities to sterilize the foreign exchange inflows. The liquidity support is to be extended to NBFCs as well. The refinance facility for banks for 90 days would be at 7.5 per cent. The Security Exchange Board of India (SEBI) has changed the securities lending and borrowing framework and extended the lending tenure. The IDBI has cut home, and educational loan rates by 0.5 per cent.

Clearly, there are no shortcuts to setting the house of world finance in order. Especially as there is a growing lack of investors confidence which is increasing the confusion. And yet there is no alternative to putting things in place in the shortest time possible and restricting the damage to the financial system. 

Let us hope that the Bretton Woods II comes out with some regulatory systems to avoid future financial crisis of this nature. ----- INFA

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