Turalay Kenç: Stocktaking of international financial architecture
Remarks by Mr Turalay Kenç, Deputy Governor of the Central Bank of the Republic of Turkey,
at the "Stocktaking of International Financial Architecture" Conference, organized by the
Reinventing Bretton Woods Committee (RBWC), Shanghai Development Research
Foundation (SDRF), Research Institute for Banking and Finance, China (PBOC) and Korea
Institute for International Economic Policy (KIEP), Shanghai, 26 February 2016.
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Over the last two decades the world has witnessed substantial increases in the trade volume
to global GDP ratio, sharply grown international investment positions and significantly
deepened production supply chains in the most part of the globe. As a result, monetary and
financial policies across countries have become much more correlated. The conference
organizers rightly asked the most crucial question whether the international monetary system
(IMS) is still sufficiently stable in this current environment with a growing interconnectedness.
In addition to this heightened interconnectedness, the global economy and financial markets
face the challenges of the unconventional and unusual monetary policies in the advanced
economies as well as diverging monetary policies of these countries, uncertainty in commodity
prices, the risk of China's economic hard-landing and the unintended market liquidity
consequences of the recent financial sector reforms across the world.
Large asset purchasing programs of the major central banks have depressed global bond
markets with decreasing long-term yields as well as short-term yields and their negative
nominal policy rates further destabilized bond markets and in general financial markets.
Heightened volatility in global financial markets can be associated with the presence of very
low and even negative rates rather than the underlying macroeconomic and external
imbalances. In these circumstances, any change in interest rate differential across countries
is likely to create greater impacts than otherwise. If this interest rate change takes place in the
largest and the most significant economy in the world, then the impact will expectedly be further
magnified.
The Fed's start of interest rate normalization has demonstrated that its impact on the global
economy and financial markets indeed has been large, giving rise to significant capital outflows
from emerging market (EM) economies, large adjustments and volatility in exchange rates as
well as widened EM spreads and interest rates. The adverse effects of the Fed's interest rate
normalization has been on average larger than those occurred in previous two financial turmoil
episodes, namely the Eurozone sovereign debt crisis and the US tapering tantrum. However,
the disparity between the effected countries has been large too. The plummeted commodity
prices as well as other factors led to this outcome as commodity exporters suffered from both
the lower commodity revenues and the tightening global financial conditions. Financial markets
also differentiated EM countries by policy frameworks and prudent policies. Those having rich
and better policy frameworks and prudent policies have withstood the recent global financial
turmoil better than the others.
With lessons learned from previous episodes and improvements over the years, emerging
market economies on average are better positioned to withstand financial turbulences, both
now and in the future, than in the past. They embarked on extensive structural reforms aimed
at overhauling financial regulatory and supervisory systems, strengthening public finances and
fiscal discipline, granting central banks independence and adopting flexible exchange rate
systems. These reforms enabled them to implement more prudent and countercyclical policies.
EM economies supported their post crisis reforms by accumulating adequate foreign exchange
reserves as an alternative to the IMF provided financing, which carries strong conditionality,
as well as by further deepening and broadening their domestic financial markets. As a result,
stock and flow balances, policy frameworks, and levels of economic confidence and market
development in EM economies have strengthened substantially and radically. Deepened and
broadened domestic financial markets have alleviated the so called original sin problem. It is
fair to say that they now look strong enough to render the adverse effects of external financial
shocks manageable. Given the current IMS what EM economies can most rely on are their
prudent policies, better policy frameworks, foreign exchange reserves and flexible exchange
rates.
As for the IMS related questions of the session namely
• "Do floating exchange rates along with largely unrestricted capital flows play their role
of shock absorber? Are we going to witness a return of currency crises of the
1990's?
• What does China economic slowdown and its current adjustment means for capital
markets and for the quest of renminbi internationalization?
• Should and can the systematically important countries "internalize" their spillovers
effects to mitigate negative external impacts?"
I organize my points around the three functions of an IMS - liquidity, confidence and
adjustment.
On liquidity function, there are two areas that we require significant improvement on the current
IMS. The first is related to excessive liquidity during normal times. What are the appropriate
policies to curb excessive capital flows? The IMF's approach advocates that recipient countries
should implement the capital flow management measures and use macro-prudential tools.
Hence, there is an asymmetric treatment of countries as source countries are not expected to
do much if not at all. There is of course room for a symmetric treatment. The Holy Grail may
exist in the IMF's articles of agreement as it states in Section 1 that "each member shall seek
to promote stability... by fostering a monetary system that does not tend to produce erratic
disruptions".
The second is about the existence of safety nets providing liquidity during financial stress
times.
Again, the optimal provision of liquidity is the main issue. To what extent it should be divided
among global, regional and local sources. It is a classic efficiency versus moral hazard
problem. Changes in governance structure of the global safety net providing IOs have a
potential to alleviate this problem. The 2010 IMF quota and governance reforms are a
significant development as they give greater voice to EM countries on governing the IMF
policies and procedures. This development together with increasing awareness of sufficient
global safety nets would strengthen IMF recourses and reduce their stigma effect. Again, there
is a symmetry issue in the provision of liquidity during financial stress times - whether there
should be internationally designed mechanisms enforcing countries that supplied excessive
liquidity in the first place also to provide liquidity to all recipient countries during financial stress
times such as through currency swap arrangements.
The confidence function of the IMS highlights the fact that all stakeholders including financial
markets have greatest confidence in the functioning, resources and governance of the system.
Strengthening its recourses, improving its governance and advancing its functions will crucially
bolster all stakeholders' confidence in the system. What have been done recently along the
lines of the 2010 IMF quota and governance reform, the inclusion of the renminbi in the SDR
system and the recent increases in the IMF resources greatly improved confidence in the IMS.
The adjustment mechanism of an IMS is mostly related to its sustainability but also affects its
confidence function. The IMS requires a symmetric and fair adjustment mechanism. The G20
plays a central role in the adjustment mechanism of the IMS through fostering international
policy coordination and cooperation. The IOs, especially the IMF, largely execute this G20
objective through bilateral surveillance and multilateral surveillance or oversight of the world
economy. Since the global financial crisis (GFC) giant steps have been taken at the G20 to
strengthen international policy coordination and cooperation. Overall there are two opposing
developments affecting the IMS. On the one hand, the significant reforms since the GFC have
strengthened the IMS. But on the other hand, growing interconnectedness especially through
increased international investment positions together with unconventional monetary policies
pose challenges to the IMS.
In these global circumstances, having faced the deterioration in inflation and its outlook
reflecting the pass-through from the TL depreciation and domestic factors and elevated
volatility in capital flows together with tightening global financial conditions the Central Bank of
Turkey has been following a tight monetary policy to fight inflation, taking liquidity stabilizing
measures for the foreign currency market and ensuring the stability of the financial system.
This policy framework was announced as a "road map" document back in August 2015
outlining monetary policy, foreign currency liquidity and financial stability related measures and
aimed at alleviating policy tradeoffs.
The key idea is to provide market making facilities to the local banks when they face financial
stresses in the global markets. They are then allowed to borrow in foreign currencies from the
central bank and use their all liquid assets irrespective of their denominations i.e., local
currency and foreign currency denominated assets as collateral when they borrow from the
central bank in any currency.