Financial Services Liberalisation Forum SADC - Johannesburg

1. Financial Services Liberalisation Forum SADC - Johannesburg David Bicchetti EconomicAffairsOfficer July 2013

2. Financial sectorlikeanyothersector? • The financialsector has the capacity to hamper/support all the sectors of the economy • During expansion phases support the economy by providingcredit & financialintermediation • During a crisis, focus on their "core" market and leave the "periphery" (Developed vs developing countries, North Europe vs South Europe, etc.)

5. Capital flows to developing countries

6. Rational for liberalisation (1) • Rational isbased on the Efficient MarketHypothesis (EMH) • Specifically for financialmarkets: • Provide a medium of exchange and unit of account • Allocatecredit to itsmost productive uses • Efficient intermediarybetweensavers and investors • Efficient means to save for the future ("smoothingconsumptionstream over time")

7. Rational for liberalisation (2) • Practicallyat the international level: • Higherlevel of output and investment • More rapidproductivitygrowth and economicgrowthoverall • Allocation of financialresourcesfrom K-surplus towards K-deficit countries • Lessrisk(betterrisk management) • Smoothconsumptionovertime

8. Rational against full liberalisation • All the rationalsearlier have a domestic and microeconomiclogic • Might not fullyapplyat the international levelbecause of macroeconomic issues likeunemployment and financialinstability

9. Objectives of Capital Management Techniques • Promotefinancialstability • Encourage desirableinvestment and financing arrangements; e.g. support a key industry • Enhancepolicyautonomy, including the maintenance of stable and competitive exchange rates

10. Academicliterature onfinancialliberalisation & growth • A number of studies have attempted to examine the linkbetween free capital mobility and growth • Kose et al (2006): "taken as a whole, the vastempiricalliteratureprovideslittlerobustevidence of a causal relationshipbetweenfinancialintegration and growth"

11. Whathistory tells us?

12. Trilemma • Difficult to maintain all of themat the same time: • Free capital mobility • Autonomousmonetarypolicydirected to domesticconcerns • Managed exchange rates • Need to find a balance between full liberalization and full control

13. Risksthat affect financialstability • Currencyrisk (appreciation/depreciation on a very short period of time, in particularwith "carry trade" strategies) • Maturityrisk (most of the liabilities mature at the same time) • Investor flight risk (massive sell off) • Lender flight risk (terminatelending programmes or extend in prohibitive terms) • Fragilityrisk (vulnerability of the domesticeconomy to internal/externalshocks) • Contagion risk (financial and macroeconomicinstabilityoriginatingelsewhere)

14. Someconcreteexamples • borrowers might employ financing strategies that involve maturity or locational mismatch; • agents might finance private investment with capital that is prone to flight risk; • or investors (domestic and foreign) might over-invest in certain sectors, thereby creating overcapacity and fuelling unsustainable speculative bubbles (real estate)

15. Rep. Koreaapproach to volatile capital flows • Rep. Koreafaced important inflows of capital thataffected the exchange rate and consequentlyitstrade balance • Introduced K control, although a member of OECD and subject to the Code of Liberalization of Capital Movements • Marketfriendlymeasuresinclude: ceiling on forexforward positions of banks, a levy on non-depositliabilities and a withholdingtax on interestincomefromforeign holdings of treasuries and monetarystabilization bonds

16. Other countries alsofollowedwithmarketfriendlymeasures • Brazil: taxes and unremuneratedreserverequirements • Peru: tax on foreignpurchases of CB papers • Indonesia: specialreserverequirements • Thailand: withholding taxes • Switzerland: fixed exchange rate to the EUR

17. Commoditypricesvolatility Bicchetti & Maystre, 2012

18. Financial marketsbecomealsoprone to herding Filimonov et al. (2013)

19. Financial innovation may hide risks • Many private (rating agencies but also banks, e.g. Lehman Brothers, etc.) and public entities (regulators, IMF) failed to understand fully financial innovation • CDOs, CDS, MBA, NINJA, etc. • Resulted in important bail out and recent bail in (Cyprus)

21. IMF new view of 2012 (1) • The IMF now recognises that capital flows carry risks, and that the liberalisation of capital flows before nations reach a certain threshold of financial and institutional development can accentuate those risks. • • It also acknowledges that under certain circumstances, cross-border capital flows should be regulated to avoid the worst effects of capital flow surges and sudden stops.

22. IMF new view of 2012 (2) • It rightly says that nations that are the source of excessive capital flows should pay more attention to the potentially negative spillover effects of their macroeconomic policies. • Finally, the IMF boldly notes that its new view on capital flow management may be at odds with other international commitments, such as in trade and investment treaties that restrict the ability to regulate cross-border finance. Source: Gallagher and Ocampo, 2013

23. Conclusion • Anyliberalizationprocessshouldtakeaccount of countries/regionsspecific (weightcost/benefitanalysis in a dynamicfashion) • It shouldallow for somedegree of policyautonomy • From the currentexperiences, a dynamic management of the capital accountseem to work best • Provision for marketfailures issues (financialstability, toobig to fail, etc.) • Capacity-building of the regulatorsis key to ensure the financialstability • Balance between full liberalization and total control

24. Thankyou • Questions? david.bicchetti@unctad.org

25. A currentexample

26. Source: BIS