FROM THE ECONOMIST INTELLIGENCE UNIT Wednesday, 25 February 2009
Jueves 7 de mayo de 2009, por Carlos San Juan
The Emergence of Financial Protectionism
The emergence of financial protectionism as the new catchphrase of the global crisis echoes growing fears that conventional trade protectionism might be superseded by restrictive rules on crossborder capital flows. Knowledge that retaliatory tariff hikes exacerbated the Great Depression of the 1930s, to which the current crisis is increasingly being compared, has heightened the desire of policymakers to avoid similar pitfalls this time. It has also alerted them to the possibility that the many bank rescues that have either taken place or are under consideration could have a similarly disruptive impact on international financial flows, setting off a round of competitive policymaking as efforts to promote domestic lending in some countries reduce the pool of capital available elsewhere.
Although financial protectionism remains a vague term, it conceivably refers to at least three main policy risks. The first is government direction of credit to ensure that banks that receive emergency aid, or that are nationalised, lend only to domestic borrowers. Public anger over the economy, and concern over the cost of proposed bail-outs, is increasing political pressure to ensure that taxpayer money is seen to be well spent. The second is that governments might discriminate in favour of domestic ownership when distributing bail-out funds—depriving foreign-owned bank subsidiaries of such facilities even when those firms have extensive operations in the countries concerned. The third risk is that governments might impose formal or informal controls on banks’ ability to transfer money to overseas branches, or to use deposits in one country to fund operations in another. This would magnify the impact of the second risk, as foreign-bank branches would find it harder to obtain financing at the very moment they most needed it.
In any event, external financing is set to remain extremely challenging in 2009. The Institute of International Finance, an organisation sponsored by major financial institutions, has predicted that net private capital flows to emerging markets will be 65% lower this year than in 2008. This translates into a fall of US$300bn compared with the estimated amount available last year. As it becomes harder to raise money overseas, competition for capital from domestic sources will increase. Moreover, as domestic capital in turn becomes relatively more scarce, the risk of severe losses on financial markets rises. Anxious investors are thus more likely to transfer their money to safe havens; for many emerging-market investors, this means developed-world bonds.
Dramatic as this sounds, assessing the likelihood of financial protectionism creating severe problems is complicated by the difficulty in separating the effects of policy from those of commercial pressures. Capital flows to emerging markets are naturally reversing as a result of risk aversion, solvency concerns and a re-focusing by many financial institutions on their core business (and consequently on their core geographical territory). Thus, even without government pressure to do so, financial institutions are likely to become less willing—and less able—to support non-core operations in other countries.
While these market forces are likely to play a bigger role than government intervention in restraining capital flows, there are growing concerns that nationalistic economic policies could make the situation worse. For one thing, greater government ownership of banks has increased the likelihood of political interference in commercial strategy—with a bias towards domestic markets. For another, governments could exercise moral suasion to influence commercial decisions. This seems likely to be the most widespread form of financial protectionism. Vastly less likely, but also more damaging, would be efforts to apply formal capital controls in major economies.
Restrictions in the movement of capital would have particularly severe consequences for Eastern Europe, where many countries have large current-account deficits and enormous external funding requirements. The high level of foreign ownership of the banking sector creates significant exposure to policy risk should Western European governments try to force banks in their countries to deny funds to subsidiaries in Eastern Europe. This could lead to legal disputes and tensions between governments, especially in cases where the Eastern European country in question was also an EU member. Although free movement of capital is one of the fundamental principles of the EU, in the present climate it seems unlikely that the European Commission would act forcefully to prevent national governments from using their increasing control of the banking sector (the result of rescue measures widely considered essential for avoiding economic collapse) to redirect bank capital to domestic markets.
Some observers have called for an increase in the IMF’s powers as a first step towards improving the stability of the global financial system. (Rightly, many experts argue that internationally consistent regulation is an essential reform.) However, it is clearly too late for such reform to contain the current threat. It is also unclear, in any event, whether the IMF would be able to act with more vigour than, say, the European Commission. Certainly, the IMF has the ability to impose strict policy conditions on emergency loans, and could deny money to would-be recipients unless they promised to allow unfettered capital flows. This could, at least, discourage cash-strapped emerging markets from imposing capital constraints. But it would be less effective the other way around: that is, in discouraging rich countries from choking off capital flows to emerging markets. Still, the desire of major developed countries to maintain the competitiveness of their financial sectors is likely to act as a deterrent against protectionist policies.