core sector communique

EXPERTS WARN OF WEAK RECOVERY AND OVER REGULATION OF FINANCIAL SECTOR

• Policy-makers and regulators are focusing on peripheral problems in the financial sector rather than on the most important issues relating to transparency and risk management, experts warned
• Over regulation of the financial sector could choke growth, especially if steps taken by developed economies are emulated by emerging countries
• The recovery of the global economy is likely to be weak. China and other developing economies will be key contributors to the rebound

Davos-Klosters, Switzerland, 27 January 2010 − In the aftermath of the global economic crisis, policy-makers and regulators may respond to populist concerns and focus on peripheral problems in the financial sector such as compensation and bonuses rather than the more important issues relating to transparency and risk management, a panel of economists and industry leaders cautioned in a session on the first day of the 40th World Economic Forum Annual Meeting.

“We are in danger of attacking the most visible problems instead of doing what we need to do,” said Raghuram G. Rajan, Eric J. Gleacher Distinguished Service Professor of Finance at the University of Chicago School of Business. “We could over regulate and go too far and whittle away too much.” This could lead to higher costs in the financial system. The new financial sector reforms and regulations proposed by the Obama Administration in the US “are going in the right direction,” said Nouriel Roubini, Chairman of Roubini Global Economics Monitor, USA. “Financial institutions that are too big to fail should be broken up.” But just cutting banks down to size that are regarded as too big to fail may not be enough, Rajan added. “Too many to fail is also a problem” if so many small institutions take on the same risks. He warned that “the greatest danger” is that emerging economies follow the same reform and regulatory measures as developed economies and choke growth.

Earlier, panellists offered their outlook on the global economy. “It will be a U-shaped recovery,” said Roubini. “There is a risk of a double-dip recession. Emerging market economies will do better than advanced economies.” Roubini noted that labour market conditions remain very weak and credit markets are still “very crunched.” Over-saving countries are not increasing spending and lowering savings rates enough to compensate for the drop in growth in economies that had high consumption before the crisis. The model of export-led growth in emerging economies such as China is now challenged by the fact that countries like the US are importing less, Roubini explained. Yet, “China alone cannot be the locomotive of global growth.” He warned that increased Chinese fixed investment is leading to a glut of capacity that could result in deflationary pressures in China and around the world.

China’s GDP will exceed that of Japan in 2010, noted Heizo Takenaka, Director of the Global Security Research Institute at Keio University in Japan and a Member of the Foundation Board of the World Economic Forum. He predicted that the recovery of the global economy will be W-shaped, with China and the other BRIC economies key contributors to the rebound in growth. Reflecting on Japan’s experience of deflation over the past 15 years, Takenaka said that “monetary policy is very important and should be discussed.”

Multilateral coordination of financial reforms and the rebalancing of the global economy will be hard to achieve, panellists reckoned. “Getting national solutions is difficult enough; getting multinational solutions is almost impossible,” remarked David M. Rubenstein, Co-Founder and Managing Director of the Carlyle Group in the US. “We are sitting at a watershed moment,” argued Arif M. Naqvi, Founder and Group Chief Executive Officer of Abraaj Capital in the United Arab Emirates. “We do need multilateral solutions.” Dennis Nally, Chairman of PricewaterhouseCoopers International, concluded: “If we don’t strive for a global solution, we will go backward and not forward.”