Below is the opening speech of H.E. Benjamin Mkapa, Chairman of the Board of the South Centre, at the Workshop on Global Economy, Climate Change and Sustainable Development, Geneva, 26 January 2011.

It gives me great pleasure to welcome you to this workshop which the South Centre is organising, in conjunction with our Board meeting and with the meeting of the Council of Representatives later today.

The themes of the workshop are the state of the global economy, and the situation regarding the global climate change negotiations.

I am sure you agree with me that these are two of the most important topics presently.

The world economic situation is worrying for the developing countries.  The recovery that was being proclaimed a few years ago seems to have become stuck because of new problems and even new crises that have emerged. 

In particular, it is now the turn of Europe to be hit by a severe financial crisis caused by unrepayable debts in an increasing number of European countries.  It is difficult to assess whether Europe will get out of this mess, or whether the present problems are a prelude to something worse to come.

The fiscal stimulus packages in many countries have been converted to budget austerity policies, which may also block the recovery process.

Some developing countries especially China and India seem to be doing well in terms of economic growth.  However many other developing countries are affected by a range of problems including uncertain exports, volatile commodity prices, and unstable large capital flows.

The crisis of high and rising food prices has come back, causing frustration and unrest in an increasing number of countries.   Inflation is often worse than debt. We need to curb speculation in commodities and food items.  This has not been addressed by the G-20 leaders. 

We need to guarantee food security in developing countries.  African countries once had an agriculture sector that was good enough to enable them to be net exporters of food.  But due to the wrong policy advice provided by the IMF and World Bank and taken by these countries, many governments were wrongly told to give up on subsidies and assistance to the agriculture sector.  Tariffs were asked to be as low as possible.  This resulted in a big increase in imports coming into the African countries and it caused immense damage to African agriculture.

The trade rules must allow developing countries to have tariff rates high enough to protect their small farmers and food supplies.  This is especially urgent because the United States and Europe continue to provide hundreds of billions of dollars of subsidies to their farms.  Therefore it is important for the WTO to establish an effective  special safeguard mechanism in agriculture for developing countries.

I understand that the Doha Round talks are intensifying this year.  I hope developing countries are prepared for this new round of talks.  The latest drafts overall are still imbalanced against the developing countries. 

Developing countries have to do more in agriculture in tariff reduction than they did under the Uruguay Round, and they also have to cut their tariffs drastically for industrial products. 

In return, the developed countries are not doing much.  It looks as if they will retain their total agricultural domestic subsidies, although they may change the type of subsidies from one box to another.  And they are asked to cut their industrial tariffs by a lower rate than developing countries.  

The developing countries would thus be wise to continue fighting for a better deal, which will give them real development benefits.

My biggest concern on the economic front is with the economic partnership agreements that ACP countries are negotiating with the European Union.  In Africa, this has become a big economic, social and political issue.    Analysis by the South Centre concludes that the obligations being imposed on African countries are simply too heavy to bear. And they are unquestionably anti-developmental. 

Besides cutting tariffs to zero for 80 per cent of products, African countries are also asked to abolish their export taxes.  The combination of these measures means a great loss of trade revenue at a time when Africa needs increased revenue to fight the economic slowdown.

African agriculture and industry would also be damaged by the tariff cuts while the abolition of export taxes means the loss of a policy tool for diversifying the economy.  Africa will thus become again the mere exporter of raw materials.

Moreover, opening up of all kinds of services under the EPA would deprive Africa from developing its own banking, insurance, retail trade, telecommunications, power and other sectors. Stripped of these attributes, national sovereignty and identity will be severely eroded.

The liberalisation of investments and government procurement under the EPAs would further destroy the basis of domestic development.  What was rejected by our countries in the WTO is now coming in through the back door of the EPAs.

Finally the regional integration of Africa would be damaged beyond repair by the EPAs.

Last year as Chairman of the Board of South Centre I wrote a letter to the political leaders of African countries warning them against signing the EPAs, and proposing alternative ways of reaching a trade agreement with Europe.  This year the problem remains, and I hope that African countries will pursue alternatives to the type of EPAs that are being proposed. But the challenge is more than Africa’s.

The problem of free trade agreements between developed and developing countries goes beyond Africa and the ACP countries as these agreements are being negotiated in many other regions and countries as well.  I urge all developing countries to carefully consider the costs and benefits before agreeing to conclude such agreements.

On the issue of climate change, the world has witnessed massive damage caused by extreme weather events, such as the floods in Pakistan, in other parts of Asia and Latin America. 

The climate talks are complex.  After the failure of Copenhagen, there is an agreement of sorts arising from Cancun.  However, reaching an agreement that is fair for developing countries and that is also sufficient to contain climate change has still not been achieved.

In some ways this task has become even more difficult.  It appears that many of the developed countries want to lower the obligations on them, while they want to increase the obligations of the developing countries.

Mr. Y?lmaz Akyüz,  Special Economic Adviser of the South Centre, made the following presentation at the South Centre Workshop on Global Economy, Climate Change and Sustainable Development, Geneva, 26 January 2011.

I will talk about something that is bothering many developing countries today. It is basically the surge in capital flows that has started earlier in the decade and continued after a brief interruption from 2009 onward.

The policy response to the crisis in the US and in Europe has no doubt been useful in containing instability and contraction. Nevertheless, continued monetary expansion in these countries, the quantitative easing where central banks buy government and other securities, is not really helping to increase domestic spending in these countries but is spilling over to developing and emerging economies and having adverse effects on exports by pushing their exchange rates up and creating fragility by generating bubbles.

And the capital flows are the main conduits of that. These flows are reversible, we know from history. And their proper management is essential. But except a few countries, developing countries are not properly managing these flows. It is ironic that surplus countries like China and some South East Asian countries are managing these capital flows better than deficit countries such as Brazil, India, South Africa and Turkey.

Going to the post-war boom-bust cycles in capital flows, there were basically three cycles until the middle of this decade. The first started in the late 70s with the recycling of the oil surplus and ended with a debt crisis in Latin America. The second cycle started in the early 1990s and ended with a number of crises starting with Mexico and then East Asia and elsewhere. The third cycle started in the beginning of this decade, 2000s, and  ended actually with the subprime crisis in September 2008 with the collapse of the Lehman Brothers. But the bust lasted a very short period and we have seen a new surge, a fourth post-war boom in capital flows to developing countries which has started around mid-2009 and is now going with full force.

Some common features of these capital cycles are that booms are almost always associated with liquidity expansion and low interest rate in reserve-issuing countries, mainly the United States. That was the case in the 70s, that was the case in the 90s and it is still the case today. The busts occur under conditions of tightened money, rising interest rates in the United States, stronger dollar and often deterioration in the macroeconomic conditions of recipient countries. It is usually relatively easy to predict and identify the build up of imbalances and fragilities in countries receiving capital flows. But it is not easy to predict the trigger— what triggers the outflows, and the timing of it.

If we look at the recent boom in capital flows we have several features which are quite different from the past. First, in the past, capital flows were concentrated in certain regions. Now it is more synchronized across all regions and most developing countries. Secondly, capital flows now are not needed in the sense that developing economies collectively generate a surplus in the current account. In the past capitals inflows were used mainly to finance deficits. Now they mainly go into reserves. Thirdly, they are also much larger today than in the past, both in absolute terms and in terms of GDP of the recipient countries.

 A fourth interesting feature of the current flows is that large inflows by non- residents are associated with large outflows by residents. So there is a two-way traffic, we have large money coming in and large money is going out.

A fifth feature of the recent boom is that we see increased capital flows among developing countries. These are mostly FDI and mostly intra-regional.

A sixth feature of the current boom is that external liabilities, the liabilities to foreigners, of developing countries are increasingly in their own currencies for two reasons. Equity flows have increased, both FDI and portfolio equity – they are going in stock markets and buying equities in developing countries. And increasingly, domestic bond markets are open to foreigners and therefore foreigners are acquiring a large proportion of domestically-issued government bonds in local currencies in developing countries.

Another feature of the current boom is the so-called carry trade. Carry trade is trade which is designed to benefit from interest rate differentials and/or currency appreciations. This has been growing rapidly since the beginning of the decade.

And finally as a result of all these, we have a massive presence of non-residents in domestic financial markets today. We did not have that in the 80s or even in the 90s. We have actually in some countries non-residents accounting for more than 50 per cent of actively traded shares in stock markets. All these imply that developing countries’ vulnerability to balance-of-payments crisis has declined but their exposure to asset boom-bust cycles and risk of financial instability has increased.

Now the current boom in capital flows started in mid-2009 and there are a number of reasons for that. I think these reasons are important because they also give us some hints as to how long this current boom can continue. One reason is that the monetary expansion in US and Europe is not being translated into domestic lending and spending. Banks are not willing to lend, consumers are not willing to borrow so money is looking elsewhere for yield.

Secondly, interest rates have moved in favour of developing countries. With interest rates being close to zero in Europe, Japan and the United States, while going up in the developing world, interest rate differentials are widening in favour of developing countries.

The third reason is that, there has been a once and for all durable shift in perceptions of riskiness of investment in advanced economies. Advanced economies until recently have always been considered less risky than the developing world. But the subprime crisis has made an important change in relative risk perception. They are still perhaps seen as less risky but the gap has narrowed.

And all these elements are likely to continue in the near future and this is why developing countries need to manage these flows properly in order to prevent fragility in mainly three areas.

One area is to make sure that the capital flows do not lead to unsustainable currencies and current account deficits.

Ironically, deficit countries are appreciating - India, Brazil, Turkey, South Africa - much more than surplus countries – China and South East Asian countries. Therefore, there are some vulnerabilities building up in deficit developing economies.

A second area of fragility is private sector borrowing in foreign currency, because domestic borrowing is more expensive. It is the private sector that has been borrowing and accumulating liabilities in foreign currencies. That means that they are becoming vulnerable to sudden exits and currency collapses. And therefore, in the case of capital exiting rapidly, countries with large private borrowing abroad can see widespread corporate default.

Finally, are credit and asset bubbles, particularly in the equity and property markets. Domestic financial cycles are closely linked today to cycles in international capital flows.

The moral of the story is we need to manage these capital flows better. Well, how do we manage it, how do we make sure that these capital flows do not lead to unsustainable deficits, unsustainable exchange rates, excessive corporate debt and bubbles in credit and asset markets. There are basically three ways of dealing with the surges of capital inflows. One is currency market intervention, the other is to liberalize and encourage residents to take money out and third, capital controls.

These three main measures are not equally effective in dealing with the three areas of fragility that I just mentioned. In the first measure, currency market intervention, the money is allowed in and the Central Bank buys and puts it in reserves and then tries to sterilise its impact on domestic liquidity by issuing interest bearing public debt. But full sterilization is difficult. And there can still be liquidity expansion and asset and credit bubbles in the economy. Also, this is costly, because the reserves do not bring much interest while the funds coming in earn higher returns. And finally, these interventions do not prevent excessive private indebtedness, but provide public insurance against private risks. 

Second, liberalize resident outflows. What you do is, you encourage, allow your funds, corporations to make investment abroad, to buy foreign assets. If there is too much money coming in, they can actually take that out and that will relieve, ease the pressure on the currency. And also ease the pressure on equity and property markets. This was done extensively in Asia, I discussed it in a previous paper, during the pre-Lehman boom until 2008, including China. Now, many countries encourage foreign direct investment by corporations. China did that, others did that but there was a difference. Some countries were investing abroad their own money. The others were investing abroad their borrowed money. The most important problem with this proposition is that it can be a one-way traffic. In good times you allow the residents to take the money out and build up asset positions abroad. But there is no guarantee that in bad times when foreigners are exiting they will bring the money back.

And finally, capital controls. Developing countries need to control excessive inflows. This is legitimate under current multilateral rules but some countries tied their hands in bilaterals or free trade agreements particularly with US and Europe. But nevertheless, we see many countries trying to control for the first time these inflows.

What kind of control? During the Asian crisis, there emerged a view that if there are prudential regulations, liberalization is OK. This is a myth. Most inflows today are not intermediated by the banking system where prudential regulations apply. In terms of net inflows only about one-third is intermediated by the banking system. So any banking regulation should be welcome, no doubt about it; prudential regulations to prevent maturity and currency mismatches in bank balance sheet. Banks should not be allowed to lend to people who have no foreign exchange earning opportunities.  In fact many developing countries now have prudential regulations restricting currency and maturity mismatches in bank balance sheets.

But that is not enough. You need other measures. Now the popular measure is a tax on incoming money. They do not work. Because the kind of taxes that people are talking about is too small. Interest differentials are far too large. You are talking about 2 per cent taxation with an interest differential of 12 per cent. It would not deter the investors. And secondly, money is coming not just for interest. It is coming for capital gains on currency holdings. It is coming on capital gains on equity holdings in developing countries. And therefore for all these reasons, such low taxes do not work.

So what you need is direct restrictions over private borrowing abroad, particularly those corporations which are not engaged in international trade, international investment, having no chance of earning foreign exchange to match their liabilities. You restrict entry of non-residents to domestic securities markets. Some countries do it. But these restrictions are being eased up. In fact, in some countries like India if it was not for the subprime crisis, we would have had much more open capital accounts today. One of the good things about these crises is that occasionally when they come, countries are deterred from liberalizing their capital accounts.

My conclusion is basically, that the worst seems to be over but developing countries are today quite worried because they are receiving deflationary and destabilizing influences. Bubbles have started forming, currencies are appreciating in deficit countries and that is worrisome. Developing countries are facing two challenges in the coming years. As a group they do not longer depend on capital flows from advanced economies. There are deficit and surplus developing countries but surplus developing countries could recycle these surpluses to deficit developing countries without going through Wall Street or the City. That is a matter for South-South cooperation. That is the first challenge. 

The second challenge is that developing countries have not reduced their dependence on markets in industrial countries. They have reduced their dependence on capital flows from advanced economies but they have not reduced in a significant way their dependence on markets in advanced economies. And these economies are unlikely to grow at a rapid pace to provide them expanding export opportunities in coming years. And therefore, for increasing self-reliance in growth, developing countries need to build up more dynamic domestic and regional markets.