Speech by Mr Wellink to the 72nd Annual General Meeting
Speech delivered by Nout Wellink
President of the BIS and
Chairman of the Board of Directors
on the occasion of the Bank's Annual General Meeting
in Basel on 8 July 2002
On the occasion of the BIS Annual General Meeting, it is my privilege and pleasure to extend a warm welcome to all the delegates from our shareholding central banks, the representatives of non-member central banks and international institutions and our distinguished guests, including many from the international banking and financial community.
In the past, the President's speech was given at the Bank's AGM itself. This year, upon the Management's proposal, the Board agreed to some changes in the structure of the meetings. The formal resolutions were presented to the Bank's shareholding community earlier this morning at a new-format AGM. However, my remarks on the world economy will, I trust, be of interest not only to our shareholder institutions, but to the entire central banking community, and thus they provide the basis for this meeting, together with a report on the general situation of the BIS.
Before Andrew Crockett, the Bank's General Manager, presents that report, let me turn first to some of the salient aspects of recent developments in the world economy.
Equity market turbulence during the past weeks appears to have weakened confidence in the global recovery. Several emerging market countries now face a much more difficult financing environment. At moments like this, it is important to stand back and remember that the world economy has successfully come through much worse situations. Let me start by considering why the global economy proved last year to be much more resilient than many had expected. Next I would like to outline what I see as significant risks in the current conjuncture. I will conclude with a few words about the US current account deficit.
2001 was a very difficult year for the world economy. A sharp and deep decline in IT capital spending had a major impact on activity. The United States went into recession and global growth slowed sharply. Stock markets worldwide continued to weaken and much of the value of equity holdings in so-called "new economy" firms simply evaporated. Argentina and Turkey suffered major crises. The terrorist attacks of 11 September added to the gloom. One enduring legacy of these attacks has been a greater sense of political uncertainty, in particular with conflict in the Middle East and elsewhere. Many fear that this climate is exacerbating a wait-and-see attitude in the business community that could hold back investment.
Yet, despite these worries, recent macroeconomic indicators have been encouraging. There is evidence that a moderate recovery is already under way in most major economies. World trade appears to be reviving. Given the unprecedented sequence of shocks that have buffeted the world economy since the beginning of 2000, these early signs of recovery are very welcome.
When we have so often in the past had to ask: "What went wrong?", it is gratifying on this occasion to pose the question: "What went right?" The short answer is that macroeconomic, structural and financial factors all played a role. Let me consider each in turn. The general conclusion I draw is that policies of stabilisation and reform pursued over a number of years not only gave policymakers room to manoeuvre in a sharp downturn, but also contributed to more flexible economies.
The first factor was a surprisingly resilient macroeconomy. Recessionary forces were blunted by the strength of household spending even as business investment declined sharply. This was particularly evident in the United States and other English-speaking countries, but was also seen in parts of continental Europe and in several emerging Asian economies.
This resilience of household spending was supported by substantial monetary policy stimulus across the globe. Such significant and widespread easing of monetary policy was possible because inflation was low. Where a firm commitment to low inflation had earned credibility in financial markets, interest rates could be cut sharply without triggering expectations of higher inflation. The only major exception was Japan, where policy interest rates - already close to zero - could hardly be reduced further. Conventional monetary policy was clearly close to its limit.
In addition, fiscal policy in some countries provided an important support for demand. Countries with stronger fiscal positions were able to adopt more expansionary policies without damaging confidence. Earlier efforts to limit spending in the United States had, by 2000, produced a sizeable fiscal surplus. Although somewhat fortuitous, fiscal expansion in the United States turned out to be well timed, coming when the country was faced with a very sharp slowdown and the consequences of the terrorist attacks. Countries in the euro area were rather less well placed. Nevertheless, the steady reduction in deficits over a number of years meant that governments could allow at least the automatic stabilisers to work. In Japan, large deficits and high levels of debt have precluded additional fiscal stimulus. On the other hand, some Asian countries with comparatively healthy fiscal positions were also able to take expansionary measures.
It is clearly important to preserve the medium-term orientation of macroeconomic policies that has contributed so significantly to the resilience of the global economy in difficult conditions. Monetary policy cannot remain indefinitely as expansionary as it is at present. Equally, fiscal deficits need to be contained. It is often very hard to reimpose fiscal discipline once budgetary targets have been relaxed in exceptional circumstances. This is why commitments to medium-term limits on deficits are so important. In a number of developing countries, large budget deficits mean that the ratio of debt to GDP is on an unsustainable path. If not arrested, this could eventually crowd out private investment and undermine confidence.
The second factor was structural reform. Economic liberalisation and greater reliance on market forces have helped economies to take advantage of new opportunities and become more adaptable in the face of adversity. The United States in many ways exemplifies what a deregulated economy can achieve. But we can also draw some satisfaction from structural reform in Europe, while recognising that much remains to be done. European governments have in recent years taken some steps to liberalise several markets - telecommunications, electricity and so on. In addition, measures to make labour markets more flexible in the 1990s appear to have increased employment growth. That the unemployment rate in continental Europe no longer rises with each successive downturn is an indication that labour market reforms are beginning to bear fruit.
Particularly encouraging is the fact that several emerging market countries which suffered serious crises over the past decade responded by adopting ambitious programmes of structural reform. As a result, medium-term prospects in a number of countries in Asia, central Europe and Latin America have improved significantly. Similarly, those countries in sub-Saharan Africa that have pursued strong structural (and macroeconomic) policies have seen more rapid growth in per capita GDP than other countries in this region. Such policy successes should encourage policymakers in countries that are at present grappling with major crises to implement the measures needed to restore prosperity. It will not be easy. And it will take time. But experience clearly demonstrates that such policies can restore growth.
The global process of trade liberalisation has been a key element in structural reform, particularly in the developing world. The accession of China to the WTO is to be very much welcomed. This is not just because such a major power in international trade should be fully involved in multilateral trade processes. It is also because the disciplines of an open trading system can be particularly effective in fostering the development of a true market system in the domestic economy. At the same time, recent trade disputes remind us that advanced countries need to resist protectionist pressures at home. Giving in to such pressures impoverishes us all and encourages equally bad behaviour in less developed countries.
The third factor was the remarkable robustness of the global financial system. In the advanced economies, falling equity prices, a wave of corporate credit downgrades and several high-profile bankruptcies did not cause major financial strains. Banks and investors certainly suffered sizeable losses, but a generalised financing crunch was avoided. The quick recovery of the financial system after the destruction and the devastating loss of life at the heart of the financial world on 11 September was the most dramatic illustration of this resilience.
The financial system has, over recent years, doubtless become more flexible and capable of absorbing shocks. A key development has been the enhanced ability of the financial system to diversify and manage risks. Borrowers have become much less dependent on specific institutions. The most striking example is probably the limited scale of the damage caused by the bursting of the tech sector bubble. The fact that much of the IT-related investment in the late 1990s was financed through capital markets contributed to a wide dispersion of risks and, ultimately, losses. In addition, lenders have been able to redistribute credit risk through the credit derivatives markets. The exploration of new markets for credit risk transfer has probably also contributed to improvements in credit risk management techniques.
It is obviously crucial that supervisory practices evolve in line with developments in financial markets. The proposed New Basel Capital Accord stresses the responsibility of individual banks for managing comprehensively their risks. The wide dissemination of the extensive preparatory work undertaken by the Basel Committee has done much to spread awareness of modern risk management techniques. Recent losses - some of them heavy - have been painful reminders to all banks that they must remain alert to risks and monitor continuously how such risks evolve. The finalisation of Basel II and its subsequent implementation are of crucial importance if banks are to adapt to a new more risk-sensitive environment.
As innovation in the financial industry widens the scope of financial intermediation, we need to become more conscious of the risks. In that spirit, let me now turn to a few specific risks that could lead to a less satisfactory economic performance than appears likely at present.
The first risk is related to the interaction between asset prices and debt levels. Asset values depend on expectations about the future, which can change abruptly. All too often in the past, asset price increases have created the illusion of greater permanent wealth, leading to lower rates of saving. And all too often, higher asset prices have led to increased borrowing and still higher asset prices. Such effects can be dangerously procyclical, accentuating both booms and recessions. Many of us have seen this vicious circle at work in our own housing markets. When interest rates are low, the risks of increased debt are often underestimated. Debt ratios in some countries do indeed appear to be rather high for an early stage of a cyclical upswing; household debt is still rising sharply in some countries, and this needs to be watched.
Secondly, the quality of information which guides capital markets often leaves much to be desired. The collapse of Enron and the demise of WorldCom only last week demonstrate that effective corporate governance can be undermined by incomplete and misleading information. There is much to examine in this area: the need for proper accounting for employee share options; recourse to opaque mechanisms to hide debt exposures; fictitious transactions to overstate sales; and so on. Strong action may well be required.
A third cautionary note is that many financial instruments designed to mitigate credit risk are only recent innovations. Although such instruments have performed well in the recent downturn, they have yet to be tested by a prolonged recession. The high degree of concentration in the intermediation of credit risk could in some circumstances put financial stability at risk.
A fourth note of caution is that the full repercussions of the protracted crisis in Argentina have yet to be felt. The treatment of financial institutions there could well have consequences that extend beyond Argentina's borders. Several other countries in Latin America have problems of their own and have had to contend with periodic bouts of financial market nervousness over the past couple of years. Latin America is the only major region for which forecasts of growth in 2002 continue to be marked down. With sizeable external debts and continued current account deficits making many countries in the region vulnerable, rigorous fiscal and monetary policies are essential.
Let me conclude with a question that highlights the importance of the macroeconomic and structural issues I have touched upon this morning: "Should we worry about the US current account deficit?" This deficit, now running at around 4% of GDP, is a reflection of the fact that the rate of domestic saving in the United States falls well short of domestic investment rates, even at the present, rather depressed levels. From a global point of view, the benign aspect of this imbalance is the stimulus provided to world growth. A large and increasing deficit has to date been readily financed, in part because foreign capital was attracted by the flexibility and dynamism of the US economy. Underlying productivity growth increased significantly in the United States, but no such improvement was clearly discernible in either Japan or Europe. As a result, the dollar tended to appreciate.
Nonetheless, the United States cannot count indefinitely on foreign savings to cover such a large current account deficit. A reversal of the sharp decline in the US saving rate is both likely and desirable. The ideal international adjustment would be for more vigorous, sustainable growth in countries with strong current account positions to offset lower domestic demand growth in the United States. This applies particularly to Japan but also to Europe. Because the scope for further macroeconomic stimulus in both areas is limited, attention must focus on microeconomic reforms.