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

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Presentation OutlinePresentation OutlineIMS – Performance EvaluationIMS Early Warning: Review and ReformManaging 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? 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 notMission creepShifting channels of contagion- This

time will be different3

IMS Performance – EvaluationIMS Performance – Evaluation

Increasing incidence of crises

Period Banking Crisis Currency Crisis External DefaultGold Standard (1870-1913) 1.3 0.6 0.9Inter-War Period (1925-1939) 2.1 1.7 1.5Bretton Woods (1948-1972) a.1948-1958 b.1959-1972

0.10.00.1

1.71.41.9

0.70.31.1

Post Bretton Woods (1973-2010) a.1973-1989 b.1990-2010

2.6

2.23.0

3.7

5.42.4

1.3

1.80.8

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

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IMS Performance Evaluation: IMS Performance Evaluation: Higher Exchange Rate Volatility Higher Exchange Rate Volatility

Variability in Major Exchange Rates (coefficient of variation in percent)

Period Yen/

US Dollar

Pound /

US Dollar

Swiss Franc/ US Dollar

Euro/

US Dollar1970-79 16.47 13.91 30.62 21.91

1980-89 26.05 13.46 18.90 21.69

1990-99 13.55 6.91 8.46 15.07

2000-09 8.63 14.72 17.90 18.32

2000-12 12.96 24.49 27.92 18.18Note: Data for Euro/US Dollar prior to 1999 pertain to Deutsche Mark/US Dollar.

Source: International Financial Statistics, IMF.

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IMS Performance Evaluation:IMS Performance Evaluation:Exchange and Payment ArrangementsExchange and Payment Arrangements

Intermediate Solutions – managed floats; soft pegs Current restrictions ebbing; capital restrictions well in

evidence

Exchange Arrangements : Current and Capital Transactions1970 1980 1990 2000 2010

No. of CountriesArticle VIII Status (no restrictions on payments/transfers for current international transactions

37 54 72 152 171

Article XIV Status (Transitional restrictions) 80 86 83 34 19Bilateral Payments Agreements 60 42 47 60 67Controls on Payments for Invisible Transactions and Current Transfers

80 73 87 98 95

Repatriation/Surrender Requirements for Exports and/or Invisibles

100 114 124 107 89

Controls on Capital Transactions 99 110 123 182 186Total number of countries covered 119 141 155 186 190Source: AREAER (various issues), IMF. 6

IMS Performance : EvaluationIMS Performance : EvaluationHigh flux in Capital FlowsHigh flux in Capital Flows

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High Flux for AEs tooHigh Flux for AEs tooCapital Inflows and Outflows: Advanced, Emerging and Developing Economies

(US $ billion)2003 2004 2005 2006 2007 2008 2009 2010

1 Total Assets (Outflows) (2+3+4) 2881 4838 6137 7461 10293 279 213 3723

2 International Organizations 62 31 61 -2 97 85 88 1453 AEs 2676 4528 5634 6667 9104 -623 -196 28414 EDEs (5 to 10) 142 279 442 796 1093 817 321 737

5 Dev. Asia 24 20 137 234 250 173 125 2946 Central and eastern Europe 11 32 20 72 119 88 2 -367 CIS 34 63 77 102 164 286 62 1258 Mid. East and north Africa 75 112 113 236 358 154 46 1499 Sub-Saharan Africa 14 16 17 35 39 23 15 32

10 Western Hemisphere -16 36 78 117 162 94 71 174

11 Total Liabilities (Inflows) (12 to 14) 3458 5299 6703 8160 11231 1061 1102 455512 International Organizations 55 29 60 29 103 74 84 13413 AEs 3168 4847 5992 7222 9384 4 277 313214 EDEs (15 to 21) 235 423 651 909 1744 984 741 128915 Dev. Asia 86 159 265 324 471 256 344 64016 Central and eastern Europe 54 93 125 195 298 264 78 7517 CIS 41 61 85 126 286 167 43 10118 Mid. East and north Africa 36 54 73 150 346 90 61 8919 Sub-Saharan Africa 9 15 17 7 65 42 56 5820 Western Hemisphere 8 41 86 106 278 164 159 32521 Net (11-1) 577 462 566 699 938 782 889 832

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

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Reserve Accumulation by EMEs and AEs

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AEs share in global reserves are coming AEs share in global reserves are coming downdown

IMS: International Reserves@ (US $ billion)

End of 1970 1980 1990 2000 2011

World AEs EMDCs Sub-Saharan Africa Developing Asia Emerging Europe Middle East& North Africa Western Hemisphere

97.672.620.6 3.0 3.5 0.6

4.7 5.5

461.2273.6162.2 14.8

27.7 5.4

74.0 40.3

990.0628.7201.5 13.3 68.1 19.3 51.7 49.0

2070.31325.8

739.436.1

324.5104.1117.5157.2

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 12186.3@: comprising foreign exchange, reserve position in the IMF, SDR holdings and gold valued at SDR 35 per ounce.Source: International Financial Statistics, IMF.

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IMF Surveillance –Review and ReformIMF Surveillance –Review and ReformGaps 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

• 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

Managing Capital FlowsManaging Capital Flows

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Issues in Reserve ManagementIssues in Reserve Management Massive Reserve Accumulation Reserve Accumulation vis-à-vis Other Metrics

Table : Reserves in Relation to Selected Metrics  1990 2000 2010 2011

GlobalMonths of Imports 4.4 5.2 13.5 13.2Percent of GDP 5.2 @ 6.9 17.1 17.0

Percent of Gross capital Formation 23.4 @ 30.9 75.2 n.a.Percent of Short-term Debt n.a. n.a. n.a n.a

Low and Middle Income CountriesMonths of Imports 5.6 6.2 16.3 15.7Percent of GDP 6.6 @ 11.3 28.7 26.9

Percent of Gross capital Formation 25.7 @ 47.1 89.1 82.0Percent of Short-term Debt 107.5 @ 229.5 556.5 n.a.

High Income CountriesMonths of Imports 4.2 4.8 10.2 10.6Percent of GDP 5.0 @ 5.9 11.6 12.0

Percent of Gross capital Formation 22.9 @ 26.9 62.8 n.aPercent of Short-term Debt n.a. n.a. n.a. n.a.Note: @: Data pertain to 1992; n.a. = not available 13

Dominance of US Dollar in International Reserve Currency

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Demand for Reserve Assets continues Demand for Reserve Assets continues to rise…to rise…

Net Foreign Assets: Requirements of Major EMEs US $ billion

  2011   2017Country Actual   Scenario A Scenario B Scenario CBrazil 349 883 591 470Hong Kong 280 479 329 305China 3776 9510 6483 5129India 286 665 460 373Korea 309 500 330 319Russia 491 1456 755 623Saudi Arabia 547 1393 592 569Total 6036   14886 9540 7788Source: Authors’ Calculations (see text for methodology) based on IFS, IMF data.

Demand likely to outstrip supply of reserve currencies15

Underlying RisksUnderlying RisksThreats 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?

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Trends and composition of GDPTrends and composition of GDP

Growth has moderated over last six quarters◦ Sluggish industry growth◦ Services has also shown moderation in last 3 quarters 1

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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

Inflation PersistenceInflation Persistence

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Movement of Indian rupee vis-à-vis Movement of Indian rupee vis-à-vis US dollarUS dollar

Market-determined-movements two ways

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Financial openness of India Financial openness of India increasingincreasing

Source: Lane and Milessi-Feretti Database 20

India’s Currency InvoicingIndia’s Currency Invoicing

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.

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

(Per cent)

Currency 1990-91 1999-2000 2005-06 2008-09

Export Import Export Import Export Import Export Import

Pound Sterling 4.5 3.1 3.9 1.7 2.9 2.0 2.8 0.9

US Dollar 57.2 59.7 87.0 85.8 87.4 78.2 84.1 86.3

Japenese Yen 0.1 4.4 0.3 3.8 0.5 4.2 0.5 2.3

Euro - - 3.0 3.3 7.7 12.5 10.9 9.5

Indian Rupee 27.7 7.7 0.3 0.0 - - - -

Others 10.5 25.1 5.5 5.4 1.6 3.2 1.8 1.0

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EMEs account for 49% of global GDP in 2011; India: 5.6 %

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Currency Currency InternationalizationInternationalizationGrowing scope for EME Currency Internationalization…

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EMEs’ share in global trade is rising EMEs’ share in global trade is rising but…but…

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

CountryExports of goods and

services  Exports of goods and services and

financial flows  2001-2005 2006-2010   2001-2005 2006-2010Euro area 24.1 23.6 25.3 24.6

US 18.5 16.8 22.4 19.1China 8.8 12.0 7.5 10.4UK 9.1 7.7 12.7 11.7Japan 8.3 6.9 7.2 6.0Canada 4.7 3.7 3.8 3.3Korea 3.2 3.4 2.5 2.7Singapore 2.9 3.2 2.3 2.6Russia 2.3 3.2 1.9 2.8Switzerland 2.8 2.7 2.4 2.8Mexico 2.5 2.0 2.0 1.7India 1.3 2.0 1.1 1.8Sweden 2.0 2.0 1.7 1.9Saudi Arabia 1.5 1.9 1.1 1.5Australia 1.4 1.7 1.6 1.9Malaysia 1.6 1.5 1.2 1.2UAE 1.0 1.5 n.a. n.a.Norway 1.4 1.5 1.3 1.5Brazil 1.2 1.4 1.1 1.5Thailand 1.3 1.4 1.0 1.1Total 100.0 100.0   100.0 100.0Source: IMF (2011c). 24

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

Global Foreign Exchange Market Average Daily Turnover: Currency-wise(Per cent)

Currency Share in Global Turnover  2001 2004 2007 2010US dollar 44.9 44 44.9 42.4Euro 19 18.7 19 19.5Japanese yen 11.8 10.4 11.8 9.5Pound sterling 6.5 8.2 6.5 6.4Australian dollar 2.2 3 2.2 3.8Swiss franc 3 3 3 3.2Canadian dollar 2.2 2.1 2.2 2.6Hong Kong dollar 1.1 0.9 1.1 1.2Swedish krona 1.2 1.1 1.2 1.1New Zealand dollar 0.3 0.5 0.3 0.8Korean won 0.4 0.6 0.4 0.8Singapore dollar 0.5 0.5 0.5 0.7Indian rupee 0.1 0.2 0.1 0.5Russain rouble 0.2 0.3 0.2 0.5Chinese renminbi 0 0 0 0.4South African rand 0.5 0.4 0.5 0.4Brazilian real 0.2 0.1 0.2 0.3Others 5.9 6 5.9 5.9Memo:        Global turnover (all currencies, US$ bn) 1239 1934 3324 3981Source: BIS 2

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

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……Rising presence of some Rising presence of some EMEs..EMEs..

International Bond Issuance in Emerging Market Currencies(Per cent)

Currency    Share in Total EM Issuance in 2010Hong Kong dollar 18.0Brazilian real 10.9South African rand 10.8Singapore dollar 10.2Chinese renminbi 5.8Russian rouble 4.5Korean won 0.5Indian rupee 0.4Total     61.1Source: IMF (2011e).

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Prerequisites…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

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Cost and Benefits of Currency Cost and Benefits of Currency InternationalizationInternationalizationReduces transaction costsReduces exchange rate risksAccess to international debt securities markets

–domestic deepeningComplicates monetary managementCan hurt export competitivenessCould make exchange rate more volatileExorbitant privilege or exorbitant riskSystematic consequencesRush into currency internationalisation – repent at length

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Key TakeawaysKey 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!Thank You!

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