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Developing Countries Share Responsibility for Global Financial System

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May 21, 2008 — The growing wealth and influence of the developing world in the global economy means these countries share a “joint responsibility” for the stability of the global financial system, says the Growth Report.

Currently, no international institution allows developing countries to “discharge this responsibility properly,” the report observes. Given the increasing importance of new global players, it argues for a rebalancing of global responsibilities and representation.

“As the number of influential countries grows, it becomes all the more important to establish a mechanism for coordinating their policies,” says the report.

At $3.2 trillion, China’s economy is now about 20 percent the size of the United States economy. India’s economy is approaching $1 trillion. By mid-2007, reserves held by central banks were about $4.5 trillion, with China’s alone at $1.6 trillion and rising.

At the same time, US savings rates are low, while China’s reserve accumulations are continuing at the same pace, and its trade surplus is rising rapidly. Currencies that track the dollar (or the yuan) have largely accompanied the American currency on its descent, in defiance of their underlying fundamentals.

Global Economy Outrunning Capacity to Manage It

Several markets have become more opaque and difficult to regulate, as the current credit crisis in the US and Europe illustrates, says the report. The responsibilities of central banks “now extend well beyond inflation to credit crunches, growth slowdowns, asset bubbles, and, in some cases, exchange rates.”

“It is clear to most observers that the global economy has outrun our capacity to manage it,” the report says. “This creates risks for developing countries in particular, because they are most vulnerable to sudden stoppages of credit, and sudden switches of international demand or supply.”

Just as the credit crunch is affecting advanced economies, the report also stresses the importance of a strong financial system in developing and countries and argues for careful supervision of the banking sector to prevent banks expanding credit too far, and the removal of capital controls only in step with the financial market’s maturity.

An international institution that gave emerging economies their due would monitor the financial system for financial strains, imbalances, and fragilities, allowing it to act early to reduce the chances of abrupt adjustments, and to “muster a timely and co-ordinated response to those crises it failed to anticipate, such as rising food prices.”

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