The Hindu Business Line : To set right global imbalances — BIS prescribes reforms for industrial economies

AT a time when international development institutions or management consultancies prescribe a credible medium-term plan for bringing about a modicum of fiscal consolidation in the emerging market economies or developing countries, any such suggestion of structural reforms for the industrial economies could never even be contemplated.

Yet, the Bank for International Settlements (BIS) did not refrain itself from prescribing this to the first world in its annual report released at its 74th annual general meeting held in Basle (Switzerland) on Monday, presumably to set right many global imbalances stemming from policy distortions of the rich world's economies.

Stating that debt is a charge on future taxpayers, who will have to service it, the report contends that pensioners constitute a further charge, since governments generally have pay-as-you-go pension schemes and health services.

"The danger is that the declining group of taxpayers will eventually find the tax burden too heavy, and an effective and perhaps disruptive repudiation of the Government's obligations will be the end result," the BIS aptly cautions.

It said this prospect is most serious in Japan and continental Europe but could affect the US and even some emerging market economies over time.

It is in this context that the BIS report argues that structural reforms in the industrial economies would also serve to attenuate the burden of debt, whether Government or private, by raising the productive potential of the economy and associated levels of income per head.

For the US, it recommends reform policies pertaining to energy, healthcare and the escalating burden of litigation.

In continental Europe, labour market reforms to raise employment, deregulation of services and the creation of truly pan-European markets are suggested. Pointing out that for governments that are already "fiscally challenged" finding the funds would be no easy way, the BIS called for a "ruthless pruning" of unproductive expenditures and wasteful subsidies which would be a good start.

Highlighting global trade imbalances, it said the fundamental issue is that Asia currently saves too much, relative to domestic opportunities for profitable investments and the western hemisphere (especially the US) saves too little.

However, it acknowledges the difficulties for creditors in Asia if they plump for lower saving rates through easier credit policies, designed to stoke consumer spending as the experience of Korea and Thailand proved that this could easily get out of hand. Investment in Asia (outside China) has also been very low and hence could be kindled.

"Again, the dangers inherent in such policies are starkly underlined by what we are currently seeing in China, and what we observed in Japan in the late 1980s".

Hence, the BIS argues that if creditors should make a contribution to unwinding global trade imbalances, so too should debtors, particularly the US which with its massive fiscal and trade deficits, needs to trim them down.

Being the world's central bank, the BIS is naturally concerned over the stability of the global financial system. Hence, it notes "raising productive potential and then keeping it fully employed requires marrying efficiency with stability in the financial system".

It deplored the less than optimal conditions in some countries, with reliance still being placed exclusively on loans from banks, and bankers often charging less for risk than they should.

Besides, certain banking systems are still operating under the burden of bad loans made in the past.

An even greater challenge than recapitalising commercial banks, would be to ensure they can operate profitably over time, the BIS said citing "continued political influence" as one of the pernicious forces.

"To be sure, directed loans to state-supported sectors seem increasingly to be out of favour, even in such countries as China and India", the BIS said adding "the damage that can be done to the private sector through competition from state-supported financial institutions is still not adequately recognised". While referring to the huge pile-up of foreign exchange reserves of Asian economies including India, the BIS notes that a continued process of large-scale intervention to keep the exchange rate from appreciating could still raise significant domestic policy challenges. First, reserve accumulation might at some point compromise the ability of the central banks to contain future monetary growth. Large reserve accumulation has already led to increasing technical difficulties, such as finding eligible instruments with which to mop up additional liquidity.

A second major policy challenge is that perceptions of an undervalued currency associated with foreign exchange market intervention and reserve accumulation can have marked expansionary effects on the economy even if sterilisation is effective.

In fine, this year's BIS annual report is replete with references to contemporary problems confronting both the developed and the developing countries in general and their central banks in particular and highlights one structural vulnerability evident almost everywhere.

This adverts to the shortage of information required to assess the health of corporations, that of the institutions which have lent to them and the resulting financial vulnerability of the economy as a whole.