ANALYSIS-IMF reserve proposal may stall in emerging markets

Published: 05 Nov 2009 17:29:26 PST

* IMF common reserve proposal may not achieve rebalancing

* Emerging markets unlikely to forgo accumulating reserves

* Diversification out of U.S. dollars may be the answer

BRASILIA, Nov 5 - An IMF proposal to build a common pool of reserves may not be the best way to rebalance the global economy since emerging powers are unlikely to forego savings that served them well during the crisis.

The economic system may instead level out automatically as emerging powerhouses like Russia and Brazil diversify their portfolios away from the U.S. dollar.

The International Monetary Fund proposal is likely to come into play as the Group of 20 nations meet in Scotland this weekend to develop a framework to help achieve economic equilibrium. Brazil's Finance Minister Guido Mantega told Reuters on Thursday G20 finance officials would discuss managing excess global reserves.

The imbalances built up as U.S. consumers freely tapped rising home equity and credit cards to support their spending. As the U.S. trade deficit swelled, currency reserves in trade surplus countries like China and elsewhere mushroomed.

In Asia, countries were also motivated to build large reserves as a way of self-insuring against economic crises.

The IMF idea is that common reserves will reduce the need for large emerging market savings because they will have access to a multilateral pot in times of crisis.

The Fund argues that if its plan works -- and it is only in the discussion stage -- countries would be able to put their resources to better use by directing them into much-needed infrastructure, education and health spending.

But the IMF proposal is still vague and some BRIC countries -- an acronym that refers to the fast-growing economies of Brazil, Russia, India and China -- have already expressed skepticism over whether it can work.

"The best alternative is self-protection," Brazil's central bank chief Henrique Meirelles said through a spokesman. Brazil lent from its foreign exchange coffers during the global credit crunch to keep liquidity and the economy running.

"For now we are not viewing it in any way because there is nothing concrete," said Andrei Bokarev, a Russian finance ministry official.

BRIC POWER

Doubts remain over who would contribute, how much, and whether the IMF would impose conditions on when countries could access the funds.

IMF data shows emerging and developing economies hold $4.2 trillion of the $6.8 trillion in total reserves. China has over $2 trillion, followed by Russia with more than $400 billion and Brazil and India with above $200 billion each.

"To abandon self-protection as a strategy only makes sense in a context where you have guaranteed access to automatic liquidity and without conditions," an official at Brazil's finance ministry said on condition of anonymity.

Those in favor of conditions argue that without them there is a danger of "free-riders," or countries that would overspend knowing that they have a financial back-up from the IMF.

Others say major emerging markets that have had tense relations with the IMF in the past are unlikely to adhere to any conditionality now that they are providing the cash.

"Such proposals are more likely to interest countries which don't have enough reserves, rather than countries which have a great deal," said Julia Tsepliaeva, chief economist for Russia at Merrill Lynch in Moscow.

For the proposal to take off, the IMF must first build trust and persuade advanced countries to shift some of their voting power to emerging markets.

The G20 has proposed shifting at least 5 percent of the voting power from over-represented countries but emerging economies say it should be more than 7 percent.

China might be open to contributing to a common pool of reserves, as it has done in Asia, but could be reluctant to participate in an IMF-run fund on worries the United States would wield too much control over it, said Zhang Bin, a researcher at the Chinese Academy of Social Sciences in Beijing, a top government think-tank.

Nor does China need any incentive to cut back on its foreign exchange holdings as it already has more than enough to buffer against any potential balance of payment problems.

"The Chinese government, they really see the rapid growth of foreign exchange reserves as a burden," Zhang added.

UNMIGHTY DOLLAR

The rebalancing of the global financial system may even come naturally, with countries like Russia and Brazil already beginning to diversify their foreign reserve holdings.

There is still ample demand for U.S. assets. Taking the portion of reserves for which the composition is known, dollars make up 63 percent of the global total, followed by the euro with 27 percent, according to the Center for Geoeconomic Studies at the U.S.-based Council on Foreign Relations.

But a weakening dollar could speed up diversification, if the U.S. economy keeps struggling and emerging markets question the greenback's status as the world's reserve currency.

Whatever the outcome, the IMF proposal does highlight one thing: the growing importance of emerging markets in the world economy. The faster the IMF formally recognizes this, the quicker it will get emerging markets on board, analysts say.

"I don't see this thing flying for many years," said Alexandre Schwartsman, a former director of Brazil's central bank and currently chief economist at Santander in Sao Paulo.