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At the meeting in Washington on April 14-15^th, G20 leaders agreed on the way forward for promoting external sustainability as part of the Mutual Assessment Process. The approach they agreed upon is a two-step procedure. In the first step, a number of indicators will be measured against a benchmark reference value. Countries that are then judged to be problematic will subject to an an in-depth assessment of the nature and root causes of these imbalances and of any impediments to adjustment. Based on an assessment by the IMF and the G20, the G20 plans to ascertain the set of corrective and preventive measures that will form the 2011 action plan to ensure “strong, sustainable, and balanced growth”, to be discussed by leaders at the Cannes Summit. The overall aim is to promote external sustainability and to ensure that G20 members pursue the full range of policies required to reduce excessive imbalances and maintain current account imbalances at sustainable levels. This framework calls for a number of observations:

1. To anyone following the European policy discussion, the framework is very familiar. The European Commission has recently come forward with a so-called “excessive imbalances procedure (EIP)”, which looks like the blueprint of the current G20 procedure. The Commission has played a key role in promoting the approach at the G20 level.
2. The list of indicators agreed upon by G20 leaders is very similar to the Commission’s scoreboard, including public debt and fiscal deficits, private savings rate and private debt, and the “external imbalance” composed of the trade balance and net investment income flows and transfers. However, there are a number of important differences. Most importantly, the G20 scoreboard does not include a measure of exchange rates or competitiveness, unlike the EU scoreboard, which does. Exchange rate issues are only “taken into account”. Moreover, the external imbalance is assessed not on the basis of the current account but on the basis of the trade balance and the net investment income flows and transfers. The current account is, essentially, the sum of the two. So why this break-up of the current account and the omission of the exchange rate?

   China was opposed to these indicators as it does not want the G20 exercise to touch upon exchange rate issues and current account issues. But excluding exchange rates and current accounts also has implications for the IMF. The 2007 surveillance decision of the IMF (IMF 2007) puts the concept of external stability as the organizing principle for bilateral surveillance. External stability is assed on the basis of exchange rate misalignments which would be judged based on an estimate of the current account deviation from the “equilibrium” current account. By excluding the exchange rate and the current account form the list of variables to be monitored in the first stage of the procedure, the G20 effectively also constrains the scope of assessment to be done by the IMF for the G20. The G20 therefore agreed that the organizing principle of external stability for bilateral surveillance (IMF 2007) would not be relevant for the G20 surveillance. Clearly, China scores a victory here. At the same time, all that China opposed is still indirectly part of the process.

   Leaving out the exchange rate is a major weakness for the G20 scoreboard. Large imbalances in the global economy are related to exchange rate misalignments and current accounts can also reflect fundamental imbalances. Of course, the current account should not be considered as a problem by itself but it may reflect fundamental policy failures for example related to inappropriate financial regulation or insufficient developments of capital markets. In turn, the exchange rate is used by some economies as a policy tool to promote stability and exports. Clearly, omitting the exchange rate from the scoreboard will render a discussion of this issue more difficult.

3. The G20 agreed on 4 different approaches for setting a reference value, against which to benchmark the indicators. This will mostly likely make the assessment exercise very complicated. Two of the approaches allow for significant discretion, namely the structural approach and the benchmarking of G20 countries against “a group of countries at similar stage of development”. It seems clear that G20 leaders could not agree on publishing precise numbers for the reference values. It will be all the more important, that the IMF comes forward with a thorough and convincing assessment.
4. Finally, it appears strange for the reference values for moving to the second stage of the G20 process to be different for “systemically” relevant countries, defined as countries representing more than 5% of G20 GDP. For non-systemic countries the threshold will be set at two standard deviations of the distribution, but for systemic countries the threshold will be at one standard deviation. Systemic countries would thus more easily move to the second stage. Economically, it is however difficult to argue that such a threshold of 5% makes any sense. A major crisis in any of the G20 countries would certainly have major implications for the world economy. An interesting case in point is France, which would fall below the 5 % threshold in the PPP-exchange rate based computation and could easily also fall below 5% in the market based exchange rates, depending on the data used. It is difficult to see that imbalances in France would be less consequential than imbalances in Germany for instance. For the UK, computations are similarly ambiguous – indeed a strange idea to count the UK as an economy without systemic relevance. Clearly, the systemic relevance of imbalances depends on the nature of the links across countries and the vulnerability of other countries to that economy. The simple GDP threshold definition is not adequate. Alternatively, all countries could be considered as systemically relevant. Accordingly, for all countries, the lower threshold would be applied. This would also help

Overall, the compromise reached in Washington is somewhat disappointing. While the agreement is a step in the right direct, it is still mostly technical. G20 leaders will need to move forward and agree on the really burning issues such as exchange rate misalignments, financial regulation etc.

Reference

IMF (2007), Review of the 1977 decision – proposal for a new decision and public information notice, Washington, IMF, June 21.