Phulbari Day in Photos: Remembering the August 26 Martyrs

 

 

 

 

 

 

 

 

 

 

Open letter to financial institutions investing in GCM Resources Plc regarding the Phulbari Coal Project, Bangladesh

August 2008 

110 organizations from 31 countries have endorsed an open letter to the private investors of GCM Resources Plc declaring solidarity with community representatives in Bangladesh regarding investment in the Phulbari Coal Project. The letter was sent to UBS, Credit Suisse, Morgan Stanley and Fidelity Investments. 

Dear Investor: 

We are writing to you in solidarity with community representatives in Bangladesh regarding your institutionís involvement in the Phulbari coal mine, otherwise known as the Phulbari Coal Project. Community representatives opposing the project cannot be identified due to fear of recrimination under the current military backed government in Bangladesh. 

We understand that your institution has obtained or is managing over a 3 percent shareholding in Global Coal Management Resources plc. (GCM) which, through a wholly-owned subsidiary, is primarily focused and committed to the development of the Phulbari Coal Project in Bangladesh (GCM 2007 annual report).   

With this letter, we formally bring to your attention the fact that the project, and therefore your financial institution through its shareholding in GCM, is associated with numerous human rights violations and risks future abuses if project development continues.  

Such abuses violate or risk violation of the Universal Declaration on Human Rights (UDHR), the UN Declaration on the Rights of Indigenous Peoples (UNDRIP), the International Covenant on Economic, Social and Cultural Rights (CESCR), and in many cases do not meet standards under the Equator Principles, which are widely considered best practice for mitigating social and environmental impacts in project finance.  

Although the Equator Principles do not technically apply to equity financing for parent companies, several Equator banks apply the Principles to non-project finance transactions where use of proceeds is known.  In the case of GCM, it is very likely that new capital (through share issues, for example) will be deployed towards the mine; for example, from June-December 2007, GCM spent £940,000 exploring and developing the Phulbari project (Interim Report for the six months ended 31 December 2007). Especially given GCMís difficulties in obtaining project loans for the mine, equity financiers such as your institution take on a greater role and responsibility in financing this project, and the environmental and human rights abuses that are occurring. 

Following is a list of some of the human rights abuses associated with the Phulbari coal project, including reference to selected applicable international standards that have been or have the potential of being violated:  

1) On 26 August 2006, the Bangladesh Rifles, paramilitary force, indiscriminately discharged firearms into a crowd of over 50,000 residents who were demonstrating in opposition to the mine project. This shooting resulted in the deaths of three people, including a fourteen year old boy, and left over 100 people injured.  

• Right to life, liberty and security of person, Article 3, UDHR 
• Right to freedom of opinion and expression, Article 19, UDHR 
• Right to freedom of peaceful assembly and association, Article 20, UDHR 

2) In February 2007, Mr. S.M. Nuruzzaman, one of the leaders of the social movement in opposition to the project, was falsely arrested and subsequently tortured. The Bangladeshi ëjoint forcesí were reportedly directed by officials of Asia Energy, a wholly-owned subsidiary of Global Coal Management, to arrest Mr. Nuruzzaman.  

• Right to the freedom from torture, and cruel, inhuman or degrading treatment or punishment, Article 5, UDHR 
• Right to equality before the law, Article 7, UDHR 

3) Since January 2007, Bangladesh has been under a state of ìEmergency Rule.î Through its project dealings with the Bangladeshi military regime, GCM is providing implicit support to a military- backed interim government which has suspended civil rights, including public gatherings. Though the government is currently under a process of relaxing some of these rules that violate civil liberties, it continues to be difficult for communities in the Phulbari region to express themselves freely regarding the project. 

• Right to participate in government, and requirement of democratic elections, Article 21, UDHR  
• Right to freedom of opinion and expression, Article 19, UDHR 
• Right to freedom of peaceful assembly and association, Article 20, UDHR 

4) As demonstrated by the magnitude of community opposition to the project, GCM has not met the principle of free, prior and informed consultation and has not incorporated concerns of the community into project planning. GCM has not disseminated a draft Environmental Impact Assessment, Resettlement Plan, and Indigenous Peoples Development Plan to community members in an accessible form, for non-literate community memebes, or in the Bangla language.   

• Consultation and Disclosure, Principle 5, Equator Principles 

5) With regards to the economic and physical displacement of an estimated 2,200 indigenous persons, GCM has not made any significant efforts towards obtaining their free, prior and informed consent to the project activities or to displacement, in direct violation of the right of all peoples to self-determination by virtue of which they can freely determine political status, and pursue economic, social and cultural development. Failure to consult adequately and to seek and obtain consent from indigenous peoples is in contravention of the spirit and letter of the UN Declaration on the Rights of Indigenous Peoples.  

• Self-determination, Shared Article 1, ICCPR and ICESCR and Article 3, UNDRIP 
• Free, prior and informed consent for any relocation, Article 10, UNDRIP 
• Collective rights to lands and territories, Article 26, UNDRIP 
• Control over development priorities, Article 32, UNDRIP 

6) Expected environmental damage due to the open-caste mine will result in a massive reduction of ground water, threatening the availability of potable water and irrigation for agriculture much beyond the mine life of 30 plus years.  Furthermore, without proper study, field tests, and appropriate mitigation, acid-mine-drainage is likely to contaminate both soil and water in the project area. Experts contend that adequate precautions against acid-mine drainage in Northwest Bangladesh for a mine the size of Phulbari will detrimentally affect the economic viability of the project. These issues have not been adequately addressed in project documents, despite concern raised by the community in this regard.  

• Right to an adequate standard of living, right to health and well-being, Article 25, UDHR 

7) The Phulbari Coal Project is expected to relocate at least 50,000 people, although some studies indicate that the physical displacement impacts will include well over 100,000 people.  Additional displacement impacts will be felt by those who are economically displaced by the project and by host communities which will be expected to absorb the tens of thousands of displaced peoples. There is currently no plan to replace agricultural land and there is no available information on how livelihoods of the displaced will be restored. Loss of livelihood will inevitably result in impoverishment of displaced people, which could lead to the risk of death and poor health, in addition to the lost economic base. Concerns expressed by community members regarding the inadequacy of information about and deficiencies of plans for resettlement, compensation, rehabilitation and employment opportunities have not been satisfied.  

•  Action Plan and Management System, Principle 4, Equator Principles 
•  Right to an adequate standard of living, right to health and well-being, Article 25, UDHR 
• Right to adequate housing, Article 11(1), CESCR 

Over 80 percent of the land expected to be taken for this project is currently used for farming and Phulbari is considered the agricultural breadbasket for the country.  Moreover, the Phulbari region remains one of the few areas in Bangladesh that does not face annual flooding.  There is no information or study on whether or how food supplies will be replaced and the subsequent impacts on food security within Bangladesh. 

• Right to an adequate standard of living, right to health and well-being, Article 25, UDHR 
• Right to be free from hunger, Article 11(2), CESCR 

GCM and the government of Bangladesh have made numerous public statements that, despite the human rights abuses associated with this project, show they are committed to moving forward with the mine. 

Through its investments in GCM, either on its own account or on behalf of clients, and since the company has established a special purpose entity to develop the Phulbari Coal Mine project, your institution is giving consent and support for the continued development of this flawed project. To take no action, is an indication in support of GCM and the Phulbari Coal Mine project. 

Due to the gravity, range and proportions of human rights abuses associated with the project and dealings in Bangladesh under the current political structure, and taking into account the interests of those human rights which are at risk, we respectfully request your financial institution and any other group members which may be involved in this venture, to commence an exit strategy to cease provision of all financial services to the company and divest all GCM shares over which you have control. 

We are pleased to provide you with more information upon request. For comments or questions, please contact the International Accountability Project at iap@accountabilityproject.org.  

This letter is endorsed by the following organizations: 

1. Association “For Sustainable Human Development”, NGO in Special Consultative Status with UN ECOSOC, Armenia 

2. AID/WATCH, Australia 

3. Blue Mountains Conservation Society Inc, NSW, Australia 

4. Courthouse Climate Action Group, Australia 

5. Friends of the Earth, Australia 

6. Jubilee, Australia 

7. Locals Into Victoriaís Environment, Australia 

8. Nature Conservation Council of NSW, Australia 

9. Oxfam Australia Queensland Committee and the University of Queensland Environment 

Collective, Australia 

10. Resistance, Australia 

11. Rising Tide Newcastle, Australia 

12. Sutherland Climate Action Network, Australia 

13. FIAN, Austria 

14. Oil Workers Rights Protection Organization Public Union, Azerbaijan 

15. ActionAid, Bangladesh 

16. BanglaPraxis, Bangladesh 

17. Coastal Development Partnership (CDP), Bangladesh 

18. Solidarity Workshop, Bangladesh 

19. VOICE, Bangladesh 

20. N ̇cleo Amigos da Terra, Brasil 

21. Green Policy Institute, Bulgaria 

22. FOCARFE, Cameroon 

23. Friends of the Earth, Cyprus 

24. Friends of the Earth, Finland 

25. Les Amis de la Terre, France  

26. Asienhaus, Germany 

27. FIAN International, Germany 

28. Urgewald, Germany 

29. Forum for Indigenous Perspectives and Action, India 

30. Indian Social Action Forum -INSAF, India 

31. Nadi Ghati Morcha, India 

32. National Forum of Forest People and Forest Workers, India 

33. North East Peoples Alliance on Trade Finance and Development, India 

34. Public Interest Research Centre, India 

35. Urban Research Centre, India 

36. Debtwatch, Indonesia 

37. Institute for Essential Services Reform (IESR), Indonesia 

38. Campagna per la Riforma della Banca Mondiale, Italy 

39. Japan Center for a Sustainable Environment and Society, Japan 

40. NGO Globus, Kazakhstan 

41. Community Environmental Promotion and Cultural Association (CEPCA), Lao PDR 

42. Center for Human Rights and Humanitarian Law, Nepal 

43. National Concerned Society, Nepal 

44. Nepal Policy Institute, Nepal 

45. Water and Energy Federation Nepal (WAFED), Nepal 

46. BankTrack, Netherlands 

47. Both ENDS, Netherlands 

48. Milieudefensie / Friends of the Earth, Netherlands 

49. Participatory Development Initiatives, Pakistan 

50. Umeedenao Citizen Community Board, Pakistan 

51. 11.11.11, Philippines 

52. Center for Environmental Concerns (CEC), Philippines 

53. EmPOWER Consumers, Philippines 

54. Freedom from Debt Coalition, Secretary General, Philippines 

55. NGO Forum on the ADB, Philippines 

56. ODA Watch, Philippines 

57. Philippines Rural Reconstruction Movement, Philippines 

58. Public Services International Research Unit, Philippines 

59. NGO Environmental Law Center “Armon”, Republic of Uzbekistan 

60. Friends of the Earth, Scotland 

61. Wave, Scotland 

62. Centre for Environmental Justice, Sri Lanka 

63. Aktion Finanzplatz Schweiz, Switzerland 

64. arbeitskreis tourismus & entwicklung, Switzerland 

65. Basler Appell gegen Gentechnologie, Switzerland 

66. Berne Declaration, Switzerland 

67. berwegerconsulting, Switzerland 

68. BeTrieb, Switzerland 

69. fair-fish association, Switzerland 

70. Greenpeace, Switzerland 

71. Gr ̧ne Partei der Schweiz, Parti Ècologiste suisse, Switzerland 

72. HEKS, Swiss Interchurch Aid, Switzerland 

73. medico international schweiz, Switzerland 

74. Responsible for Projects of medico international schweiz, Switzerland 

75. Schweizerisches Rotes Kreuz Kanton Zurich, Switzerland 

76. SOLIFONDS, Switzerland 

77. Swiss Red Cross Canton Zurich, Switzerland 

78. World Without Mines, Switzerland 

79. Youth Ecological Centre, Tajikistan 

80. Forest Peoples Programme, U.K. 

81. Platform, U.K. 

82. The Corner House, U.K. 

83. War on Want, U.K. 

84. World Development Movement, U.K. 

85. Adrian Dominican Sisters, U.S.A. 

86. Congregation of St. Joseph, U.S.A. 

87. Congregation of the Sisters of St. Agnes, U.S.A. 

88. Crude Accountability, U.S.A. 

89. Environmental Defense Fund, U.S.A. 

90. Friends of the Earth, U.S.A. 

91. Forest Ethics, U.S.A. 

92. Gender Action, U.S.A. 

93. Global Response, U.S.A. 

94. International Accountability Project, U.S.A. 

95. International Rivers, U.S.A. 

96. Maryknoll Sisters, U.S.A. 

97. Midwest Coalition for Responsible Investments, U.S.A. 

98. Mission Hospital, U.S.A. 

99. National Association of Muslim American Women (NAMAW), U.S.A. 

100. Oil Change International, U.S.A. 

101. Pacific Environment, U.S.A. 

102. Rainforest Action Network, U.S.A. 

103. Region VI Coalition for Responsible Investment, U.S.A. 

104. School Sisters of Notre Dame Cooperative Investment Fund, U.S.A. 

105. Sisters of Charity of Cincinnati, U.S.A. 

106. Sisters of Charity of New York, U.S.A. 

107. Sisters of the Blessed Sacrament, U.S.A. 

108. Sustainable Energy and Environment Network, U.S.A. 

109. Instituto del Tercer Mundo (ITEM), Uruguay 

110. Rural Development Services Centre, Vietnam 

 

 

The Current Global Financial Turmoil and Asian Developing Countries

Yilmaz Akyüz*, Third World Network, April 2008

This is a summary of a paper presented on 29 April 2008 at the ministerial segment of the 64^th session of the UN Economic and Social Commission for Asia and the Pacific (ESCAP) in Bangkok.

Download the full text as PDF. 

After about six years of exceptional growth, the world economy has now entered a period of instability and uncertainty due to a global financial turmoil triggered by the subprime crisis in the United States. Current difficulties, however, are not unrelated to forces driving the preceding expansion. From the early years of the decade the world economy went through a period of easy money as interest rates in major industrial countries were brought down to historically low levels and international liquidity expanded rapidly. In the United States ample liquidity and low interest rates, together with regulatory shortcomings, resulted in a rapid growth of speculative lending, sowing the seeds of current problems. Global liquidity and an increase in the risk appetite, rather than improvements in fundamentals, have also been the main reason for a generalized and sustained surge in capital flows to emerging markets. They have given a boost to growth in the recipient countries, but also generated fragility and imbalances, including unsustainable currency appreciations and current account deficits, and credit, asset and investment bubbles, which now render them vulnerable, in different ways and degrees, to shocks from the subprime crisis.

The crisis is comprehensive and global, encompassing the banking sector, securities and currency markets, and institutional and individual investors in most parts of the world. The bursting of the bubble has left the United States with excessive housing investment which cannot be put into full use without significant declines in prices. The household sector has ended up with debt in excess of equity represented by such investment. An important part of portfolios of banks and their affiliates is not performing. Bond insurers face massive obligations they cannot meet. And many investors across the world have found themselves holding worthless mortgage-based securities and commercial paper.

The evolution of the world economy now depends crucially on the impact of the crisis on growth in the United States and its global spillovers through trade and finance. Whether growth in Asia would be decoupled depends not only on the nature and extent of contagion and shocks from the crisis, but also on the strengths and vulnerabilities of the economies in the region and their policy response. Adverse spillovers from this crisis will certainly surpass those from the crises in emerging markets in the 1990s. However, for the first time in modern history hopes seem to be pinned on developing countries for sustaining stability and growth in the world economy. On the one hand, the sovereign wealth funds (SWFs) from emerging markets are increasingly looked at as stabilizing forces in financial markets by providing capital to support troubled banks in the United States and Europe while taking large risks. On the other hand, economic prospects in the world economy seem to hinge on the ability of developing countries to continue surging ahead despite adverse spillovers from the crisis.

Crisis, growth and external adjustment in the United States

There is great uncertainty as to whether the United States economy will succumb to this crisis brought on by years of profligate lending and spending or be able to restore growth after a brief interruption. Policy makers have responded to mitigate the difficulties in the financial system by cuts in interest rates and liquidity expansion, and to support spending by a fiscal package. But it is agreed that monetary easing cannot fully resolve the difficulties since this is, in essence, a solvency crisis. Again, the fiscal package may not be enough to make up for cuts in private spending. It now appears that the United States is unlikely to avoid an economic contraction and, on some accounts, may even face the worst recession since the Great Depression.

The crisis could well produce a sizeable retrenchment in private consumption, reduction in the savings gap and correction of external deficits in the United States. Not only could consumption be cut sharply with declines in employment, income and wealth, but any subsequent recovery is unlikely to be associated with the kind of consumption spree that has produced mounting external deficits. This adjustment could be a protracted process, resulting in erratic and slow growth, as in Japan during the 1990s. In any case, the rest of the world would need to rely less on the United States’ market for growth. Briefly, the crisis is likely to bring a fundamental adjustment to global imbalances, but the main question is how orderly and rapid that would be.

Recent capital flows and vulnerability in Asia

A key question in Asia is in what way and to what extent the crisis will affect the economies in the region. This depends, inter alia, on present vulnerabilities which are greatly shaped by the manner in which the recent surge in capital flows has been managed. In this respect it is possible to draw on the lessons from the Asian crisis, focussing on four areas of vulnerability associated with surges in capital inflows: (i) currency and maturity mismatches in private balance sheets; (ii) credit and asset bubbles and excessive investment in property and other sectors; (iii) unsustainable currency appreciations and external deficits; and (iv) lack of self-insurance against a sudden reversal of capital flows, and excessive reliance on outside help and policy advice.

The recent record in Asia in these respects is mixed. Most Asian countries have avoided unsustainable currency appreciations and payments positions, and accumulated more than adequate international reserves to counter any potential current and capital account shocks without recourse to external support. But they have not always been able to prevent capital inflows from generating credit, asset and investment bubbles or maturity and currency mismatches in private balance sheets.

Interventions designed to absorb excess foreign currency due to the surge in capital inflows and/or current account surpluses have been broadly successful in stabilizing exchange rates in the region. But their effect on domestic liquidity could not always be fully sterilized, and this has resulted in rapid domestic credit expansion. Outside China, reserves are largely “borrowed”, coming from capital inflows rather than earned from current account surpluses. In the region as a whole the cost of borrowed reserves is estimated to be around $50 billion per annum. The option to invest excess reserves in more lucrative, less risky assets abroad through SWFs seems to be constrained because of resistance towards such investment in certain advanced countries. An alternative would be to recycle them in the region for infrastructure projects in low-income countries in need of development finance.

Asian countries have received, in different degrees, relatively large inflows of speculative capital. Foreign presence in equity markets and the banking sector has increased rapidly, raising volatility and the risk of contagion. Capital inflows, together with expansionary monetary policy, have created bubbles in stock and property markets in several countries, notably in China and India, where prices have gone beyond levels that could be justified by fundamentals. Low interest rates and equity costs have also given rise to a boom in investment which may cease to be viable with the return of normal financial conditions.

Many Asian countries have been facing macroeconomic policy dilemmas mainly because they have chosen to keep their economies open to financial inflows, rather than imposing tighter countercyclical measures of control. Capital accounts in the region are more open today than they were during the Asian crisis. The main response to large capital inflows has been to liberalize outward investment by residents. This is partly motivated by a desire to allow national firms to become important players in world markets through investment abroad, but there has also been considerable liberalization of portfolio outflows. The rationale of such a policy as a strategy for closer integration with global financial markets is highly contentious. As a short-term measure, it could be even more problematic since, once introduced for cyclical reasons, it may not be easily rolled back when conditions change.

Financial contagion and shocks

Growth projections have been constantly revised downward since summer 2007 as financial difficulties became more visible. Still, none of the most recent baseline projections by the International Monetary Fund (IMF), World Bank, United Nations, the Asian Development Bank and the Institute of International Finance envisage a sharp drop in income in the United States in 2008. They also seem to assume that for emerging markets these difficulties are just a hiccup, not expected to cause a large deviation from the recent trend of rapid and broad-based growth. However, the downside risks they all mention may become a reality in the coming months with growth falling much more than predicted.

Asian economies do not appear to have large direct exposure to securitized assets linked to high-risk lending, and the financial impact of the crisis is likely to be transmitted through changes in the risk appetite and capital flows. These would be coming on top of domestic fragilities associated with credit and asset bubbles in some of the key countries in the region. The question of sustainability of these bubbles had been raised even before the subprime turmoil, and they have now become even more fragile, susceptible to a sharp correction. By itself this may not lower growth by more than a couple of percentage points in China and India. However, if combined with a sudden reversal of capital flows and/or contraction of export markets, the impact on growth can be much more serious.

According to the most recent projections, the crisis would not have much impact on private capital flows to emerging markets in the current year; there would be some decline in bank lending, largely compensated by increases in equity flows. It is also argued that capital flows may even accelerate if Europe joins the United States in easy monetary policy. This would imply persistence of asset bubbles in China and India, necessitating an even sharper correction in the future.

It is quite likely that international investors will now start differentiating among countries to a much greater extent than has been the case in recent years. Those with large external deficits, high levels of debt and inadequate reserves may face a sudden stop and even reversal of capital flows and sharp increases in spreads. Given massive amounts of reserves, even a generalized exit of capital from emerging markets would not create serious payments difficulties for most Asian countries, and the impact would be felt primarily in domestic financial markets. Such an exit could be triggered by a widespread flight toward quality, with investors taking refuge in the safety of government bonds in advanced countries, or a need to liquidate holdings in emerging markets in order to cover mounting losses and margin calls.

Trade linkages and growth in Asia

In general, trade shocks from the subprime crisis are not expected to result in a sharp decline of growth in Asia. Exports to the United States amount to some 8 per cent of GDP in China and 6 per cent in other Asian countries. In value-added terms these ratios are lower because of high import contents of exports. Consequently, even if exports to the United States stop growing or start declining in absolute terms, the Asian countries can still sustain rapid, albeit somewhat reduced, growth provided that other components of aggregate demand continue growing.

This line of thinking clearly focuses on the impact of exports on aggregate demand, rather than on the foreign exchange constraint. It is implicitly assumed that the countries affected can continue to maintain import growth despite reduced export earnings. This would pose no major problem for those running large current account surpluses. Others with deficits, however, would need to rely increasingly on capital inflows and/or draw on their reserves in order to finance the widening gap between imports and exports.

This simple arithmetic is further complicated by a number of factors. First, the trade impact of the crisis depends on how other Asian export markets are affected. A sharp slowdown in Europe can hurt growth in Asia since exports to that region account for 7 per cent of GDP in China and even more in other Asian emerging markets. Second, for some countries indirect exposure to a decline in growth of exports to the United States and Europe can be just as important because of relatively strong intra-industry trade linkages. Those supplying intermediate goods to China would be affected by cuts in not only their direct exports to the United States and Europe, but also their indirect exports through China. Finally, a slowdown in exports can trigger a sharp drop in investment designed to supply foreign markets and this can, in turn, contract aggregate demand further.

Policy challenges

Whatever the nature and extent of contagion and shocks from the crisis, it is important to avoid destabilizing feedbacks between real and financial sectors. A sharp drop in exports together with a rapid correction in asset prices could bring down growth considerably, which can, in turn, threaten the solvency of the banking system given the high degree of leverage of firms in some countries. The appropriate policy response would be to expand domestic demand through fiscal stimulus. If difficulties emerge in the financial sector, it would also be necessary to provide lender-of-last-resort financing. Nevertheless, policy interventions should smooth, rather than prevent, correction in asset prices and facilitate restructuring in over-expanded sectors.

China would need not just countercyclical macroeconomic expansion, but a durable shift in the composition of aggregate demand from exports towards domestic consumption because, inter alia, the crisis is likely to bring a sizeable external adjustment in the United States. Current conditions including the twin balance-of-payments surpluses, growing reserves, an undervalued currency, and an unprecedented growth of production capacity heavily dependent on external markets cannot be defended on grounds of efficiency. As the experience of late industrializers in Asia shows, a development strategy emphasizing exports does not require generation of large and persistent current account surpluses with undervalued exchange rates. Cheap currency often leads to terms-of-trade losses and impedes technological upgrading.

If capital inflows continue at their recent pace or accelerate, a policy of controlled appreciation of the yuan combined with tighter control over inflows and a long-term strategy of expansion of Chinese direct investment abroad, including in developing countries, would appear to be a desirable response. But perhaps the greatest challenge would be to secure expansion of the internal market based on a more rapid growth of consumption than has hitherto been the case. Since the early years of the decade, consumption has constantly lagged behind income and investment, and its share fell below 40 per cent of GDP − almost half of the figure in the United States, and less than the share of investment in China. The imbalance between the two key components of domestic demand has meant increasing dependence of industry on foreign markets. This is largely a reflection of the imbalance between profits and wages. Despite registering impressive increases, wages have lagged behind productivity growth and their share in value-added has declined in recent years. There are also relatively large precautionary savings from wage incomes because of absence of adequate public health care, education and social security services.

All these imbalances are presumably among the problems that Premier Wen Jiabao was referring to when he pointed out at the National People’s Congress in March 2007 that “the biggest problem with China’s economy is that the growth is unstable, unbalanced, uncoordinated and unsustainable”. They need to be addressed independent of the shocks from the subprime crisis if China is to avoid the kind of difficulties that Japan faced during much of the 1990s. Expansion of public spending in areas such as health care, education and social security, as well as transfers to poorer households financed, at least partly, by dividend payments by state-owned enterprises, can play an important role in lifting consumption.

In other Asian economies closely linked through production networks, domestic stimulus would be needed to offset a reduction in exports to China as well as the United States and Europe. Given many burdens already placed on monetary policy, including control over inflation and management of capital flows and exchange rates, the task falls again on fiscal policy. Most countries in the region have considerable scope to respond by fiscal expansion, in very much the same way as they were able to do during the weakness of global demand at the turn of the millennium. The scope is somewhat limited in countries with fiscal deficits. In such cases it is particularly important to design fiscal stimuli in such a way that they do not add to structural deficits.

On the external side, Asian emerging markets appear to have sustainable current account positions as well as relatively large stocks of reserves to weather any potential worsening of their trade balances as a result of a slowdown in exports. Countries with current account deficits could see them rise further as exports slow down and growth of income and imports is sustained. Given their relatively high levels of reserves, this should cause no serious problem. However, if slowdown in markets abroad is accompanied by a sudden stop or reversal of capital flows, these countries could be restricted in their ability to respond positively to external shocks. In some of these cases twin structural deficits in fiscal and external accounts would thus need greater attention for reducing vulnerability to such shocks.

Low-income countries dependent on official flows are highly vulnerable to a sharp deterioration in global economic conditions and in many of them, including small island economies, current account deficits could rise rapidly as a result of a slowdown in trade in goods and services. These countries should thus be able to have access to additional IMF financing through augmentation of resources made available under Poverty Reduction and Growth Facility arrangements and the Exogenous Shocks Facility.

Regional and international cooperation

A reasonable degree of consistency would be needed among policy responses of individual countries in Asia to shocks from the subprime crisis. A coordinated macroeconomic expansion would certainly be desirable, but it would be even more important to secure consistency in exchange rate policies. Despite a clear division of labour and complementarity of trade based on vertical integration, trade patterns in East and South East Asia are becoming increasingly competitive. Divergent movements in exchange rates in the region can thus be highly disruptive and conflictual. Experience shows that such movements can become particularly intensive at times of severe external shocks and instability of trade and capital flows. Some countries may even be tempted to respond by beggar-my-neighbour exchange rate policies.

It is, therefore, important to engage in intra-regional consultations in exchange rate policies and explore more durable regional currency arrangements. The experience of Europe in exchange rate cooperation culminating in the European Monetary Union holds valuable lessons, even though it may not be fully replicated since the region is not yet ready to float collectively vis-à-vis the G3 currencies (viz., the dollar, euro and yen). There are other, more flexible options available. Complementary arrangements could also be considered, including a common set of measures to curb excessive capital inflows, formal arrangements for macroeconomic policy coordination, surveillance of regional financial markets and capital flows, and extended intra-regional short-term credit facilities based on the Chiang Mai initiative already under way.

Current conditions demonstrate once again that when policies falter in regulating financial institutions and markets, there is no limit to the damage that they can inflict on an economy and that in a world of closely integrated markets, every major financial crisis has global repercussions. This means that shortcomings in national systems of financial rules and regulations are of international concern – particularly those in major advanced economies because of their significant global repercussions. So far piecemeal initiatives in international fora such as the Bank for International Settlements, the IMF and the Financial Stability Forum have not been very effective in preventing recurrence of virulent global financial crises. A fundamental collective rethinking with full participation of developing countries is thus needed for harnessing financial markets and reducing systemic and global instability.

 

___________________________________________

* Former Director of the Globalization and Development Strategies Division at the United Nations Conference on Trade and Development (UNCTAD). This is a summary of a paper presented on 29 April 2008 at the ministerial segment of the 64^th session of the UN Economic and Social Commission for Asia and the Pacific (ESCAP) in Bangkok.

 

Phulbari Coal Project and Barclays Bank

World Development Movement, April 24, 2008

Activists from the World Development Movement attended Barclays’ AGM to question the bank’s involvement in the controversial Phulbari Mine project in Bangladesh.

Risk Concentrations in Financial Conglomerates

By Andrew Cornford∗, SUNS # 6480, 23 May 2008

Unforeseen shifts in concentrations of banking risks have been at the centre of the current credit crisis. Such concentrations are now a major item on the regulatory agenda and the subject of a recent paper (‘Cross-sectoral review of group-wide identification and management of risk concentrations’) issued in April by the Basel-based Joint Forum on Financial Conglomerates.

The Joint Forum paper draws on two surveys, one of the views of 15 supervisory bodies from 10 countries and the other of approaches to identifying and managing risk concentrations in 18 financial conglomerates. Its publication coincides with that of two other reports covering actual risk management practices in some financial conglomerates during the credit crisis. ‘Observations on Risk Management Practices during the Recent Market Turbulence’ [March 2008] is a survey conducted by a Senior Supervisors Group from France, Germany, Switzerland, the United Kingdom and the United States of eleven of the largest banking and securities firms. The second, ‘Shareholder Report on UBS’s Write-Downs’ [April 2008] is a review of the key findings of a report by the Swiss bank, UBS, to the Swiss federal Banking Commission on the reasons for its huge losses due to structuring, trading and investment activities, in particular, those due to securities with a value which referenced United States sub-prime mortgages.

The establishment of the Joint Forum in 1996 was the outgrowth of work of the Basel Committee on Banking Supervision and of the International Organization of Securities Commissions (IOSCO) in 1992 on principles for the supervision of financial conglomerates. This work led to the establishment of a working group called the Tripartite Group of Banking, Insurance and Securities Regulators, which was reconstituted as the Joint Forum in 1996 and now comprises the International Association of Insurance Supervisors (IAIS) as well as the Basel Committee and IOSCO. The membership of the Joint Forum is limited to banking, insurance and securities supervisors from 13 industrial countries.

The risks which the Joint Forum is concerned with are those which arise from the mixing of banking, securities and insurance activities in a single business structure. Such mixing creates new connections between the risks of the separate activities. The connections are a potential source of contagion within the financial firms themselves as well as, more broadly, throughout the financial sector. Moreover, the mixing poses new problems for management and supervisors in areas such as conflicts of interest between different parties participating in or affected by the firm’s activities, internal transparency and financial reporting, and setting levels of capital appropriate to the different activities of the conglomerate as well as for the firm overall.

For the purpose of the work of the Joint Forum, a financial conglomerate refers to a group of companies under common control whose activities consist of the provision of services in at least two of the sectors, banking, securities and insurance. Such conglomerates have a history which long antedates the 1990s. In the United Kingdom, for example, in the 1960s, large commercial banks established subsidiaries to provide hire-purchase and other specialized financial services. In continental Europe, conglomeration often took place through internal expansion of the operations of universal banks and through an increase in the number of Bancassurance and Bancaffianz groups which provide both banking and insurance services. In the United States, financial conglomeration received a huge fillip from the 1999 Gram-Leach-Bliley Act which ended the comparmentalisation of banking embodied in legislation of the 1930s (the Glass-Steagall Act) and opened up new possibilities for the integration of banking, insurance and securities business.

The initial focus of the Joint Forum was the internal organization and management of financial conglomerates, and its recommendations responded to concerns regarding the internal transfer of risks which might threaten the stability of the more sensitive parts of conglomerates such as their banking activities. The April 2008 paper was originally intended to be a sequel to earlier technical work on the management and supervision of concentration risk. However, drafting was overtaken by events beginning in summer 2007, and in consequence, the discussion covers features of concentration risk highlighted by the credit crisis and connections between concentration risk and other key financial risks such as liquidity and market risk.

For the purpose of the Joint Forum paper, risk concentrations are defined as exposures with the potential to produce losses large enough to threaten a financial conglomerate. The concentrations may involve the conglomerate’s assets, liabilities, off-balance-sheet positions, and the execution and processing of transactions.

These definitions make it possible for the Joint Forum to maintain in the paper its customary primarily microeconomic focus on internal risk management and firm-level supervision. However, the transmission of risks between financial conglomerates and the broader markets in which they operate nonetheless intrudes owing to the need to include principles for the management of liquidity risk - a subject which necessarily reflects conditions in these markets.

Such definitions also in principle exclude traditional concentration risk in the form of external exposures to a single firm, sector or set of related economic activities. Here too, however, recent events intrude, and the paper itself acknowledges certain concentration risks that arise owing to developments external to the conglomerate in the markets in which it operates.

Nevertheless, the definitions chosen by the Joint Forum mean that the paper does not address the concentration risks which are typically a major concern of regulators of commercial banks and financial conglomerates in emerging-market countries. In Asia, concentration risk is often part of the same set of problems as related-party lending. Identification of risk concentrations due to exposures of financial firms to particular groups can be handicapped by use of multiple legal entities by borrowers. This can take a bewildering number of forms such as lending by a bank to an apparently independent company or individual that on-lends the funds to a related company or arranging for another bank to lend to a related company against a guarantee not recorded in the books of the originating bank.

Moreover, risks due the denomination of the assets and liabilities of banks and their borrowers in foreign currencies, which have proved of great importance in combined banking and currency crises in emerging markets, are also not covered in the Joint Forum paper. Owing to the effect of depreciation of the currency and deflation on the ability of borrowers to meet obligations denominated in foreign currencies, these crises often bring into the open hitherto concealed concentration risks involving financial and non-financial firms and sectors.

The focus of the Joint Forum paper reflects its membership and mandates. This does not imply that the contents of the paper do not merit wider attention. With the development of their own financial markets, financial firms and their supervisors in emerging-market and other developing countries are increasingly likely to confront issues related to financial conglomeration similar to those exercising their counterparts in developed countries. Moreover, subjects raised in the paper are relevant to understanding international financial markets to which, for good and ill, most countries are now exposed in varying degrees.

The first section of the Joint Forum paper reviews traditional approaches to the management of concentration risks. The following section focuses on the increasingly active management of concentration risks in the context of the rapid growth of the market in financial instruments which transfer risks between different parties. This is followed by a discussion of the challenges posed to the corporate governance of financial conglomerates by more integrated approaches to risk management. The next section of the paper takes up a number of technical issues related to the identification and management of concentration risks. These include the measurement of the capital required for concentration risks, and stress testing and scenario analysis. An annex takes up selected features of the regulatory regimes in major industrial countries.

The survey of industry practice discussed in the first section of the paper indicated that risk identification and management in financial conglomerates still tends to be managed within silos corresponding to major risk categories. Under a silo-based approach, personnel, processes and systems are grouped by risk categories such as credit, insurance, liquidity and market risk. Credit risk concentrations are controlled through risk limits on exposures to particular names, economic sectors and sub-sectors, geographic regions and countries, and products (such as real-estate or consumer lending). Such an approach is not conducive to integrated risk management.

The survey also found that securitisation exposures - so important in the current credit crisis - are usually grouped by tranches corresponding to different levels of risk and return for investors. This approach attributes a key role to the credit ratings of different tranches. The Joint Forum’s survey found that only a few conglomerates use a “look through” approach to securitisation exposures which entails assessment of the credit risk of the assets underlying the tranches of the securitisation.

A non-integrated, silo approach to risk management can be particularly problematic with respect to liquidity risk which reflects developments at the interface between the conglomerate and the markets in which it operates. Financial firms encounter three types of liquidity risk: (1) funding mismatch risk, that is the risk that the firm will not have sufficient funds to meet its normal obligations; (2) market liquidity risk, that is the risk that the firm will not be able to convert assets to cash or to access financing on reasonable terms (owing to a lack of buyers or uncertainty over valuation); and (3) contingent liquidity risk which results from difficulties in meeting obligations due to firm-specific or market-wide unexpected events.

All three types of liquidity risk have been pervasive during the credit crisis. Under contingent liquidity risk, banks have had to reconcentrate on their balance sheets liquidity and credit risks from off-balance-sheets entities which the banks originally created or sponsored but for which funding from investors subsequently ceased to be available. The verdict of the Joint Forum is that, in comparison with other risk categories, liquidity risk tends to be less well integrated into systems of conglomerate-wide risk management in spite of its special importance in stressful market conditions.

These conclusions are reinforced by findings in the reports of the Senior Supervisors Group and of the UBS. The Senior Supervisors found that the firms which had been more successful in managing their problems were those which “aligned treasury functions more closely with risk management processes, incorporating information from all businesses in global liquidity planning, including actual and contingent liquidity risk”.

The Senior Supervisors also viewed the disappearance of liquidity as a major cause of the huge losses incurred by some financial firms on their holdings of Super Senior tranches of Collateralized Debt Obligations (securities backed by portfolios of loans, bonds and other assets including mortgages). These tranches were at the very top of the securitisation structures of CDO tranches, not only carrying the highest possible rating from credit rating agencies but also classified as even safer than other tranches with such ratings.

Owing to their low capital requirements and thus low financing costs, Super Senior tranches were an investment favoured by banks for their own portfolios. However, the result of banks’ own investments in these tranches was a heavy concentration of holdings of Super Senior tranches in a single category of institution. During the flight to liquidity in the late summer of 2007, when banks wanted to sell these assets, there were few buyers so that the banks had to take huge losses. The conclusion of UBS, for which 75 per cent of the losses of its CDO desk (or 50 per cent of the bank’s total losses) up to December 2007 were due to Super Senior positions, is “that there does not appear to have been a liquid secondary market and that the business tended to retain the Super Senior tranche”.

As the Joint Forum paper notes in the second section of the paper, in recent years, there has been an enormous growth in the markets for instruments transferring risk. The gross notional value of all positions in over-the-counter (OTC) derivatives (i. e. derivatives not traded on organized exchanges) exceeded $500 trillion in mid-2007. Of this total, more than $40 trillion consisted of credit default swaps, a derivative which transfers credit risk. Financial conglomerates participate in the markets for risk transfer in various ways and for various purposes: to fund assets which they originate; to manage the credit, market and insurance risks of positions retained on their balance sheets; to invest in securitised products; and to generate revenues from trading on their own account as well as from distribution to their customers.

However, according to the Joint Forum, “Often, the process of so-called risk transfer more closely resembles a transformation of a variety of risks into credit exposures to the counter-parties to which they were transferred”.

Moreover, the complexity of the products available through these markets has generated new risk management challenges. Some of these are due to features of the products themselves. Among these are increased systematic risk (i. e. risk which cannot be diversified away) due to the way the assets backing CDOs are pooled, the opacity of the products, and additional leverage which increases the rapidity of the changes in value of a product or portfolio in response to changes in market, credit and liquidity risk.

Moreover, the challenges to integrated risk management are the more formidable, the broader the conglomerate’s participation in different risk-transfer activities. Active risk management or other forms of involvement in risk-transfer activities through the markets for risk-transfer products leads to additional exposures to liquidity risk since the effectiveness of the products for both hedging and income generation depend on their marketability and their value as collateral for financing.

In this context, the report of the Senior Supervisors Group draws attention to the role in the credit crisis of innovative products which “had been created during the period of more benign market conditions” so that “banks and securities firms had not observed how such products would behave during a significant market downturn and found their risk management practices tested to various degrees”.

UBS’s criticisms of its own processes include the absence of a comprehensive view of its exposures to sub-prime mortgages in different parts of the UBS Investment Bank. This view was required for the setting of overall portfolio limits to complement transaction-by-transaction approval for CDO positions and related hedges. Such a view would be an essential part of integrated risk management. However, UBS’s priorities were elsewhere: “the emphasis was generally on speeding up approvals as opposed to ensuring that the process achieved the goal of delivering substantive and holistic assessment of the proposals presented”.

Under the features of good corporate governance required for integrated risk management, the paper returns to subjects also covered in an earlier 2003 report of the Joint Forum. Failings regarding corporate governance, the Joint Forum acknowledges, are still common and are exemplified in the UBS report. In addition to the absence of holistic assessment just mentioned, the UBS report also notes that members of [Investment Bank] Senior Management “did not sufficiently challenge each other in relation to the development of their various businesses”.

Under corporate governance, the focus of the Joint Forum is on organizational structures. Missing from the paper is discussion of the way in which in a financial conglomerate, even a well designed organogram, does not necessarily ensure that senior decision takers have at their disposal the information required for successful risk management. Multiple organizational layers put distance between data gatherers and users in senior management, and information gets lost in the summarizing of data as they are transmitted up the organizational chain.

Failures on this front in major financial firms during the credit crisis raise questions about the still-widely-held assumptions as to the optimum size of financial conglomerates. These questions include how far the drive to expand through the establishment or purchase of new entities in both home markets and across borders, which can still be observed among major international banks, is compatible with the maintenance of effective internal information transmission and controls, even allowing for the aid furnished by the latest technology.

As the complexity of financial transactions and organizations has grown, regulation and supervision have come to rely increasingly on the vetting of systems of internal control of the financial firms. At the same time, an increasingly important part of such systems are procedures which depend on computer simulation. Two of these procedures covered in the Joint Forum paper are the estimation of economic capital and stress testing and scenario analysis.

Economic capital is the amount which a financial firm believes is necessary to absorb potential losses due to major categories of financial risk. Stress testing is a tool used to evaluate through computer simulation the potential impact of an event or movement in a set of financial indicators.

The appeal of economic capital is the common measure of risk which it imposes across different businesses and risk categories. On the other hand, the models used have the limitation that they often fail to take account of indirect and second-order effects. For example, they may not capture the indirect credit exposure of a bank to the collateral of a loan as well as the direct exposure to the borrower, thus missing the potential risk concentration due to the joint exposure.

Moreover, the estimates of risk correlation used in the models are often subject to shortcomings. Partly, these are due to insufficient data, especially for periods characterized by disturbances. But the shortcomings also reflect the way in which risks due to different factors are aggregated. For example, in the case of a loan backed by collateral, a simple correlation between market and credit risks may take account of the effect of an increase in interest rates on the likelihood of default but not of the negative effect of the higher interest rates on the value of the assets serving as collateral which are seized by the bank.

Stress testing and scenario analysis have advantages of flexibility and transparency over models of economic capital. The two techniques can be used to investigate the potential effects of a wide range of risks specified in ways more susceptible to intuitive understanding. These include business risks, reputational risks, legal risks, country/transfer risks, and various other event risks. However, stress testing and scenario analysis are subject to the limitations of the expert judgment used to select them. Moreover, there is a lack of widely recognized procedures for stress tests as a tool for measuring risk concentrations and liquidity risks, especially those which manifest themselves as part of scenarios involving other risks with potentially market-wide effects.

The points raised under stress testing and scenario analysis by the Joint Forum are reinforced by the findings of the Senior Supervisors Group: “Some [firms] found that their stress tests or scenario analyses generally matched the movements in markets, but others found that the actual shocks to credit spreads [and thus to asset prices] tended to be wider and longer lasting than their prior analyses had suggested”. In particular, high credit ratings proved to be poor proxies for low price volatility.

The Joint Forum’s discussion of economic capital and of stress testing and scenario analysis indicate that, useful though they can be, they are neither magic bullets nor quick fixes for the problems for internal control and supervision posed by increasingly complex financial firms.

As shown by the annex of the Joint Forum paper, regulatory control of concentration risk in major industrial countries consists mainly of limits on exposures to particular borrowers or other counter-parties.

In the European Union, rules for large exposures are included in the Capital Requirements Directive (which implements Basel 2) and set limits to such exposures in relation to the capital of financial firms. There are also rules limiting large exposures in relation to capital in Japan and Canada. Rules in the United States reflect the multi-tier character of its regulatory regime with different regulators at both federal and state levels. They include not only limits on large or concentrated exposures in relation to capital but also ceilings on loans in relation to value for exposures to residential and commercial property. The qualitative dimension of risk concentrations in these countries are addressed in rules to be followed by the supervisors of financial firms.

Reflecting the Joint Forum’s consultative character, the paper does not attempt to provide a blueprint for regulatory reform. Each section concludes with Considerations designed to flag the principal points of the preceding diagnostics. The results of the paper’s recommendations will, or alternatively will not, eventually be reflected in new regulation at the national level and in improved risk management in financial conglomerates themselves.

By and large, the trend to financial conglomeration is not as advanced in emerging-market and other developing countries as in the member countries of the Joint Forum. The paper’s value lies in the attention it draws to problems to which such conglomeration can give rise. But there is no reason why the authorities in developing countries should accept the view, implicit or explicit, in much of the literature on the subject that financial conglomeration according to models found in industrial countries is an inevitable feature of financial development.

Both the institutional structures of financial conglomeration and the complex transactions which usually accompany it are the subject of regulatory permission for domestic firms and of procedures for granting market access to foreign financial firms. The latitude for conglomeration of different financial activities in a single firm should reflect decisions by the authorities based on national priorities. Historically, compartmentalization and specialisation were long features of the financial sectors of several industrial countries.

As for any presumption that the complex financial products typically associated with financial conglomeration necessarily bring wider economic benefits, the last word can be left to Paul Volcker, former chairman of the United States Federal System who, in a speech to the Economic Club of New York in April 2008, noted of the move from “a commercial bank centred, highly regulated financial system to an enormously more complicated and highly engineered system” that “It is hard to argue that the new system has brought exceptional benefits to the economy generally”.

This is a contrarian observation coming from this source and one which should be borne in mind by those responsible for financial-system design in emerging-market and other developing countries.

*Andrew Cornford was formerly a senior UNCTAD economist and is currently Research Fellow at the Financial Markets Center.

Multinationals Make Billions In Profit Out of Growing Global Food Crisis

Speculators blamed for driving up price of basic foods as 100 million face severe hunger.

By Geoffrey Lean, May 4, 2008. CommonDreams.org

Giant agribusinesses are enjoying soaring earnings and profits out of the world food crisis which is driving millions of people towards starvation, The Independent on Sunday can reveal. And speculation is helping to drive the prices of basic foodstuffs out of the reach of the hungry.

The prices of wheat, corn and rice have soared over the past year driving the world’s poor - who already spend about 80 per cent of their income on food - into hunger and destitution.

The World Bank says that 100 million more people are facing severe hunger. Yet some of the world’s richest food companies are making record profits. Monsanto last month reported that its net income for the three months up to the end of February this year had more than doubled over the same period in 2007, from $543m (£275m) to $1.12bn. Its profits increased from $1.44bn to $2.22bn.

Cargill’s net earnings soared by 86 per cent from $553m to $1.030bn over the same three months. And Archer Daniels Midland, one of the world’s largest agricultural processors of soy, corn and wheat, increased its net earnings by 42 per cent in the first three months of this year from $363m to $517m. The operating profit of its grains merchandising and handling operations jumped 16-fold from $21m to $341m.

Similarly, the Mosaic Company, one of the world’s largest fertiliser companies, saw its income for the three months ending 29 February rise more than 12-fold, from $42.2m to $520.8m, on the back of a shortage of fertiliser. The prices of some kinds of fertiliser have more than tripled over the past year as demand has outstripped supply. As a result, plans to increase harvests in developing countries have been hit hard.

The Food and Agriculture Organisation reports that 37 developing countries are in urgent need of food. And food riots are breaking out across the globe from Bangladesh to Burkina Faso, from China to Cameroon, and from Uzbekistan to the United Arab Emirates.

Benedict Southworth, director of the World Development Movement, called the escalating earnings and profits “immoral” late last week. He said that the benefits of the food price increases were being kept by the big companies, and were not finding their way down to farmers in the developing world.

The soaring prices of food and fertilisers mainly come from increased demand. This has partly been caused by the boom in biofuels, which require vast amounts of grain, but even more by increasing appetites for meat, especially in India and China; producing 1lb of beef in a feedlot, for example, takes 7lbs of grain.

World food stocks at record lows, export bans and a drought in Australia have contributed to the crisis, but experts are also fingering food speculation. Professor Bob Watson - chief scientist at the Department for Environment, Food and Rural Affairs, who led the giant International Assessment of Agricultural Science and Technology for Development - last week identified it as a factor.

Index-fund investment in grain and meat has increased almost fivefold to over $47bn in the past year, concludes AgResource Co, a Chicago-based research firm. And the official US Commodity Futures Trading Commission held special hearings in Washington two weeks ago to examine how much speculators were helping to push up food prices.

Cargill says that its results “reflect the cumulative effect of having invested more than $18bn in fixed and working capital over the past seven years to expand our physical facilities, service capabilities, and knowledge around the world”.

The revelations are bound to increase outrage over multinational companies following last week’s disclosure that Shell and BP between them recorded profits of £14bn in the first three months of the year - or £3m an hour - on the back of rising oil prices. Shell promptly attracted even greater condemnation by announcing that it was pulling out of plans to build the world’s biggest wind farm off the Kent coast.

World leaders are to meet next month at a special summit on the food crisis, and it will be high on the agenda of the G8 summit of the world’s richest countries in Hokkaido, Japan, in July.

Additional research by Vandna Synghal

Central Planning and Market Freedom: Manifestations of the Same Fundamentalist Mindset

Walden Bello*, Focus on the Global South, April 11, 2008

Walden Bello was invited to participate in the Economist’s Debate Series on “Freedom and its Digital Discontents.” The proposition of the debate was “By intervening to regulate business and financial risks, governments have made things worse.” The debate can be accessed at http://www. Economist.com/debate/

There are two doctrinaire positions that have proved singularly destructive over the last half century. One is that the government riding herd on the economy is the way to go. The other is that the market is always right.

The first brought us the gem that was central planning; and the second, the wondrous neoliberal economics that has reigned over the last 25 years. Despite opposite locations on the ideological spectrum, both approaches were united at a metaphysical level by the Platonic paradigm that there is one ideal straitjacket into which you can cram all actually existing economies.

We all know where central planning and the elimination of the market brought the Soviet Union and eastern Europe. Over the last few decades, we have witnessed how the holy trinity of radical liberalization, deregulation and privatization has increased the numbers of people living in absolute poverty, redistributed income towards the rich and reduced global economic growth per year in the 1980-2000 period by more than half of what it was during the 1960-80 period. Despite claims to the contrary, what we have had under the reign of unfettered market processes is not Schumpeterian creative destruction, but long-term stagnation combined with periodic destabilization.

The current financial crisis that may lead to what the former Federal Reserve chairman, Alan Greenspan, describes as possibly the “world’s worst economic crisis since the second world war” provides a cautionary tale of what happens if you eliminate all effective controls on the market. The housing bubble is but the latest of some 100 financial crises that have swiftly followed one another ever since Depression-era capital controls began to be lifted during the Thatcher-Reagan years.

Owing to the devastating impact of uncontrolled gyrations and permutations of speculative capital, there were calls for capital controls and a return to strong financial regulation following the Asian financial crisis in 1997 and the dot.com craze of the late 1990s. The first event led to the economic collapse of all the so-called Asian tiger economies that did not impose capital controls, the second to the wiping out of $7 trillion in investor wealth and the US recession of 2001.

Instead of heeding these calls, Washington caved in to Wall Street’s insistence on private sector “self-surveillance” and “self policing”. Instead of stronger monitoring and regulation of sophisticated financial instruments such as derivatives,, governments meekly agreed to leave this to market players who were supposed to have access to complex quantitative computer models that would undertake sophisticated risk assessment.

Instead of busting the housing bubble by decisively raising interest rates, Mr Greenspan simply stood by, as he did during the dot.com mania, and allowed another bubble to grow and grow. Instead of pushing Mr Greenspan to prick the bubble, the then US Council of Economic Advisers chairman, Ben Bernanke, provided his guru with technocratic cover and attributed the rise in US housing prices to “strong economic fundamentals” instead of speculative mania. Both Mr Greenspan and Mr Bernanke disregarded the overwhelming evidence that, as the economist Dean Baker put it a few years ago, when the bubble was taking off, “Like the stock bubble, the housing bubble will burst. Eventually, it must. When it does, the economy will be thrown into severe recession, and tens of millions of homeowners, who never imagined that house prices could fall, likely will face serious hardship.”

What happened to self-policing? When it came to risk assessment of derivatives such as collateralized debt obligations (CDOs) and structured investment vehicles (SIVs), the process collapsed almost completely, with the most sophisticated quantitative risk models left in the dust as risk was priced according to one simple rule by the sellers of securities: underestimate the real risk and pass it on to the suckers down the line.

What happens when you leave the market unregulated is best described by the Wall Street Journal’s summary of the report of the meeting of the Group of Seven’s Financial Stability Forum in Tokyo in early February: “[T]here is plenty of blame to go around for the financial chaos: The US subprime mortgage market was marked by poor underwriting standards and ‘some fraudulent practices.’ Investors didn’t carry out sufficient due diligence when they bought mortgage-backed securities. Banks and other firms managed their financial risks poorly and failed to disclose to the public the dangers on and off their balance sheets. Credit-rating companies did an inadequate job of evaluating the risk of complex securities. And the financial institutions compensated employees in ways that encouraged excessive risk-taking and insufficient regard to long-term risks.”

In other words, a bloody mess.

With the global economy on the brink of a deep recession, citizens in the developed and developing worlds have had their fill of doctrinaire policymakers from the far left and the far right imposing their fundamentalist views on them. Just as they were disillusioned with central planning, they have had enough of government inaction as speculative capital triggered permanent instability and redistributed the national income towards a small minority of market players. They want the market to be subjected to the discipline of the public interest. We are now entering what the great Hungarian economist Karl Polanyi described as the second phase of the “double movement” under capitalism: an era following a period of uncontrolled market gyrations when, forced by a civil society that is up in arms, governments again intervene, this time to stabilise the economy, bring about a just income distribution, eliminate poverty and - a critical goal in this era of global warming - promote environmental sustainability.

* Walden Bello is Senior Analyst with Focus on the Global South

Press Release: Asian Development Bank Pulls Out of Controversial Phulbari Coal Project in Bangladesh!

Press Release: April 3, 2008

 

BanglaPraxis ● Bank Information Center

● International Accountability Project

Urgewald ● World Development Movement

 

Photo: Munem Wasif/DrikNews 

The Director of the Asian Development Bank’s Private Sector Operations Department, Robert Bestani, notified the Bank’s Board last week that it will no longer ask for approval of the Phulbari Coal Project in Bangladesh. The ADB’s Board was slated to approve a US$ 100 mio. loan and US$ 200 mio. political risk guarantee for the project on June 3, 2008.

This comes as another major blow to the UK based company GCM Resources (formerly known as Asia Energy), which aims to establish one of the world’s largest open pit coal mines near the town of Phulbari in northwestern Bangladesh. GCM/Asia Energy was forced to shut down its operations and flee the project area after a major protest of over 50,000 people in 2006 resulted in three deaths and hundreds being injured as government-backed paramilitary forces fired upon the protesters. 

Since then and in spite of the Bangladesh Government’s Emergency Power Rules that ban major civil liberties such as the right to public assembly of more than five people, widespread opposition in the project area has continued. National opposition has been led by the National Committee to Protect Oil, Gas, Mineral Resources and Ports (NC). Although its General Secretary Prof. Anu Muhammad has received death threats and its local leader Mr. Nuruzuman was publicly tortured by the military in February 2007, the, NC and other civil society organizations have remained undaunted in their opposition to the Phulbari project. 

As Prof. Muhammad says:  “The area around Phulbari is extremely fertile and densely populated. It is also one of the few regions in Bangladesh that are safe from flooding and other natural catastrophes and therefore plays a key role for the food security of the entire country. The proposed “development” project is merely a scheme to loot natural resources from a poor country for the rich. We will not allow GCM Resources to turn a land of food for the people into a black hole for corporate profit.”

According to the company’s own estimates, the mine would displace some 50,000 people. However, an Expert Committee commissioned by the Bangladesh Government in 2005 found these numbers to be grossly underestimated. The Expert Committee reports that 130,000 people would be displaced for the mine and a further 220,000 would be impacted through the massive draw-down of the water table, which is necessary to keep water from running into the 300 meter deep mine pit. This would have major impacts on drinking water and irrigation for many miles beyond the actual mine. Furthermore, the company has no viable plan to prevent acid mine contamination of the soil and water as a result of mining 15 million tons of coal for over 35 years.

Mining expert Roger Moody says:  “It is extremely costly to adequately prevent and mitigate acid mine drainage in a mine of this size.  The acid is likely to stay in the environment for decades after the mine closes contaminating the land, rivers and streams.  And GCM has not provided any financial details as to who would cover the bill for such an environmental disaster.”

Various community leaders and representatives of the Phulbari area wrote a letter to the ADB’s Executive Directors in December 2007, followed by a letter by over 60 international civil society organizations protesting ADB’s involvement in the project. As international NGOs point out, the project would also cause extensive damage to the Sundarbans mangrove forest, an UNESCO declared World Heritage Site where the port facilities for exporting the coal are to be constructed. As several of the ADB’s Executive Directors began raising questions about Phulbari, the Bank’s management finally decided to take the project out of ADB’s funding pipeline.

Shefali Sharma from the US NGO Bank Information Center, which monitors the activities of multilateral development banks, comments: “Phulbari is a singularly bad project and we are amazed that the ADB spent 3 years preparing a venture, which was clearly going to impoverish an immense number of people and risk an environmental catastrophe in the entire region. This raises serious questions about the bank’s due diligence and should encourage donor countries to strengthen their oversight and call for a reform of the institution.” 

Tim Jones of the World Development Movement adds: “ The Phulbari project is truely a British and international scandal. GCM Resources is a British company and is backed by banks such as Barclays (UK), UBS and Credit Suisse (Switzerland). Among its other investors are the British hedge fund RAB Capital and the mutual funds manager Fidelity from the US. The ADB’s decision sends an important signal to these institutions about the inacceptability of their investment into this project.”

Bangladesh, British and international civil society organizations are now calling on these financial institutions to follow suit and pull the plug on the Phulbari coal project.

For further information contact:

Zakir Kibria, Tel: +8801714116020 (Dhaka, Bangladesh)

Heffa  Schücking, Tel: +49-160-96761436 (Germany)

Tim Jones, Tel: +447817628196 (WDM, London, UK)

Shefali Sharma, Tel: +91 9871168212 (Bank Information Center, South Asia Office, Delhi, India)

Jennifer Kalafut, Tel: +12024154047 (International Accountability Project, U.S.)

Notes to the editor:

The Bangladesh Government originally awarded an exploration license to the Australian company BHP Minerals in 1994, which however, decided against developing a coal mining operation in the area. In 1999 its licenses were transferred to Asia Energy Corporation (Bangladesh) Pty Ltd. Asia Energy PLC was incorporated in London Stock Exchange Alternative Investment Market (Ticker code: GCM) in September 2003 and acquired 100% of Asia Energy Corp. It subsequently changed its name to Global Coal Management after August 2006 killings in Phulbari and to GCM Resources Plc in December 2007. According to the company’s 2007 annual report, its major shareholders are RAB Capital, UBS, Fidelity Group, Barclays, Credit Suisse, LR Global, Ospraie Management, Capital Group and Argos Greater Europe Fund. GCM Resource’s financial advisor is Barclays and its principal banker is the Bank of Scotland. 

Further information: 

Read a news report: Asian bank scuppers UK mine project in Bangladesh (Observer, UK)

Read a critique of the Phulbari Coal Project: Phulbari coal mine - losses beyond compensation (By Chris Lang)

 

Walden Bello: Capitalism in an Apocalyptic Mood

Walden Bello*, AlterNet, February 25, 2008

Yes, global capitalism may be resilient. But it looks like its options are increasingly limited. 

Skyrocketing oil prices, a falling dollar, and collapsing financial markets are the key ingredients in an economic brew that could end up in more than just an ordinary recession. The falling dollar and rising oil prices have been rattling the global economy for sometime. But it is the dramatic implosion of financial markets that is driving the financial elite to panic.

And panic there is. Even as it characterized Federal Reserve Board Chairman Ben Bernanke’s deep cuts amounting to a 1.25 points off the prime rate in late January as a sign of panic the Economist admitted that “there is no doubt that this is a frightening moment.” The losses stemming from bad securities tied up with defaulted mortgage loans by “subprime” borrowers are now estimated to be in the range of about $400 billion. But as the Financial Times warned, “the big question is what else is out there” at a time that the global financial system “is wide open to a catastrophic failure.” In the last few weeks, for instance, several Swiss, Japanese, and Korean banks have owned up to billions of dollars in subprime-related losses. The globalization of finance was, from the beginning, the cutting edge of the globalization process, and it was always an illusion to think that the subprime crisis could be confined to U.S. financial institutions, as some analysts had thought.

Some key movers and shakers sounded less panicky than resigned to some sort of apocalypse. At the global elite’s annual week-long party at Davos in late January, George Soros sounded positively necrological, declaring to one and all that the world was witnessing “the end of an era.” World Economic Forum host Klaus Schwab spokeof capitalism getting its just desserts, saying, “We have to pay for the sins of the past.” He told the press, “It’s not that the pendulum is now swinging back to Marxist socialism, but people are asking themselves, ‘What are the boundaries of the capitalist system?’ They think the market may not always be the best mechanism for providing solutions.”

Ruined Reputations and Policy Failures

While some appear to have lost their nerve, others have seen the financial collapse diminish their stature.

As chairman of President Bush’s Council of Economic Advisers in 2005, Ben Bernanke attributed the rise in U.S. housing prices to “strong economic fundamentals” instead of speculative activity. So is it any wonder why, as Federal Reserve chairman, he failed to anticipate the housing market’s collapse stemming from the subprime mortgage crisis? His predecessor, Alan Greenspan, however, has suffered a bigger hit, moving from iconic status to villain in the eyes of some. They blame the bubble on his aggressively cutting the prime rate to get the United States out of recession in 2003 and restraining it at low levels for over a year. Others say he ignored warnings about aggressive and unscrupulous mortgage originators enticing “subprime” borrowers with mortgage deals they could never afford.

The scrutiny of Greenspan’s record and the failure of Bernanke’s rate cuts so far to reignite bank lending has raised serious doubts about the effectiveness of monetary policy in warding off a recession that is now seen as all but inevitable. Nor will fiscal policy or putting money into the hands of consumers do the trick, according to some weighty voices. The $156 billion stimulus package recently approved by the White House and Congress consists largely of tax rebates, and most of these, according to New York Times columnist Paul Krugman, will go to those who don’t really need them. The tendency will thus be to save rather than spend the rebates in a period of uncertainty, defeating their purpose of stimulating the economy. The specter that now haunts the U.S. economy is Japan’s experience of virtually zero annual growth and deflation despite a succession of stimulus packages after Tokyo’s great housing bubble deflated in the late 1980s.

The Inevitable Bubble

Even with the finger-pointing in progress, many analysts remind us that if anything, the housing crisis should have been expected all along. The only question was when it would break. As progressive economist Dean Baker of the Center for Economic Policy Research noted in an analysis several years ago, “Like the stock bubble, the housing bubble will burst. Eventually, it must. When it does, the economy will be thrown into a severe recession, and tens of millions of homeowners, who never imagined that house prices could fall, likely will face serious hardship.”

The subprime mortgage crisis was not a case of supply outrunning real demand. The “demand” was largely fabricated by speculative mania on the part of developers and financiers that wanted to make great profits from their access to foreign money that flooded the United States in the last decade. Big ticket mortgages were aggressively sold to millions who could not normally afford them by offering low “teaser” interest rates that would later be readjusted to jack up payments from the new homeowners. These assets were then “securitized” with other assets into complex derivative products called “collateralized debt obligations” (CDOs) by the mortgage originators working with different layers of middlemen who understated risk so as to offload them as quickly as possible to other banks and institutional investors. The shooting up of interest rates triggered a wave of defaults, and many of the big name banks and investors — including Merrill Lynch, Citigroup, and Wells Fargo — found themselves with billions of dollars worth of bad assets that had been given the green light by their risk assessment systems.

The Failure of Self-Regulation

The housing bubble is only the latest of some 100 financial crises that have swiftly followed one another ever since the lifting of Depression-era capital controls at the onset of the neoliberal era in the early 1980s. The calls now coming from some quarters for curbs on speculative capital have an air of deja vu. After the Asian Financial Crisis of 1997, in particular, there was a strong clamor for capital controls, for a “new global financial architecture.” The more radical of these called for currency transactions taxes such as the famed Tobin Tax, which would have slowed down capital movements, or for the creation of some kind of global financial authority that would, among other things, regulate relations between northern creditors and indebted developing countries.

Global finance capital, however, resisted any return to state regulation. Nothing came of the proposals for Tobin taxes. The banks killed even a relatively weak “sovereign debt restructuring mechanism” akin to the U.S. Chapter Eleven to provide some maneuvering room to developing countries undergoing debt repayment problems, even though the proposal came from Ann Krueger, the conservative American deputy managing director of the IMF. Instead, finance capital promoted what came to be known as the Basel II process, described by political economist Robert Wade as steps toward global economic standardization that “maximize [global financial firms'] freedom of geographical and sectoral maneuver while setting collective constraints on their competitive strategies.” The emphasis was on private sector self-surveillance and self-policing aimed at greater transparency of financial operations and new standards for capital. Despite the fact that it was finance capital from the industrialized countries that triggered the Asian crisis, the Basel process focused on making developing country financial institutions and processes transparent and standardized along the lines of what Wade calls the “Anglo-American” financial model.

Calls to regulate the proliferation of these new, sophisticated financial instruments, such as derivatives placed on the market by developed country financial institutions, went nowhere. Assessment and regulation of derivatives were left to market players who had access to sophisticated quantitative “risk assessment” models.

Focused on disciplining developing countries, the Basel II process accomplished so little in the way of self-regulation of global financial from the North that even Wall Street banker Robert Rubin, former secretary of treasury under President Clinton, warned in 2003 that “future financial crises are almost surely inevitable and could be even more severe.”

As for risk assessment of derivatives such as the “collaterized debt obligations” (CDOs) and “structured investment vehicles” (SIVs) — the cutting edge of what the Financial Times has described as “the vastly increased complexity of hyperfinance” — the process collapsed almost completely. The most sophisticated quantitative risk models were left in the dust. The sellers of securities priced risk by one rule only: underestimate the real risk and pass it on to the suckers down the line. In the end, it was difficult to distinguish what was fraudulent, what was poor judgment, what was plain foolish, and what was out of anybody’s control. “The U.S. subprime mortgage market was marked by poor underwriting standards and ’some fraudulent practices,’” as one report on the conclusions of a recent meeting of the Group of Seven’s Financial Stability Forum put it. “Investors didn’t carry out sufficient due diligence when they bought mortgage-backed securities. Banks and other firms managed their financial risks poorly and failed to disclose to the public the dangers on and off their balance sheets. Credit-rating companies did an inadequate job of evaluating the risk of complex securities. And the financial institutions compensated their employees in ways that encouraged excessive risk-taking and insufficient regard to long-term risks.”

The Specter of Overproduction

It is not surprising that the G-7 report sounded very much like the post-mortems of the Asian financial crisis and the dot.com bubble. One financial corporation chief writing in the Financial Times captured the basic