Europe was the centre in Toronto: Financial Express 29th June 2010

The crescendo leading to the G-20 summit in Toronto had scripted what would be discussed even before the meet took place. Everyone had spoken of the financial crisis and the need to rein in banks. Britain applied the bank tax to make sure that banks pay for a possible future bailout by the government. China, being aware that ‘renminbi bashing’ would be high on the agenda, pre-empted discussion by taking a decision to align its currency to the market with immediate effect, though it blew hot and cold on the extent to which this correction would be made. India also probably took the cue and increased fuel prices. This being done, the only other issue left for the G-20 to debate was the approach to government spending, deficits and debt, with the shadow of Greece lurking.

The summit addressed two sets of issues, one relating to banks and the other fiscal deficits. The meeting was hyped to become a battle between the European nations and the rest on whether or not Keynes was relevant. Keynes, as we know, had recommended governments spending their way out of trouble and this was what has been pursued relentlessly by all governments for the last two years. Now, after realising that some of the Euro nations had spent too much and built debt that could not be repaid, the G-20 has asked for governments to go back to the austerity path. Does this make sense?

The answer from an impassioned point of view is that theoretically all policies have to be geared towards local conditions. Also, we need to understand whether or not nations have gotten out of the low equilibrium trap to actually contemplate such action. There cannot be a case of one-size-fitting-all, as countries that are still to emerge from the economic slowdown cannot keep governments on the sidelines and talk of fiscal targeting. Also, those that have surpluses on current accounts and low debt/GDP ratios cannot be bracketed with those that have operated on a different looking canvas. Therefore, Germany and other Euro nations cannot be bracketed with, say, the emerging economies.

The US, with a fiscal deficit of over 10%, has naturally opposed this move as it argued that more jobs and enhanced spending today was required for higher growth tomorrow. Also, the so-called cuts that have been espoused by the summit would also mean that the G-8 nations would have to renege on the development aid promised to some of the African nations. Further, developing nations, especially in Latin America, like Argentina and Brazil, fear a double whammy if this rule were applied—their domestic growth would slow down if they spent less and their export-dependent economy would receive another blow in case the US deflated its economy.

The general agreement was that all nations would cut back on their fiscal deficit to half the current levels in three years time, which would be 2013. This would be coupled with efforts to stabilise debt ratios by 2016. In this situation, the IMF is quite worried that after all that has been done so far through government expenditure, a sudden rollback through an exit policy could affect growth in income and employment across the world, and up to $2.25 trillion of output could be in jeopardy.

The IMF thought is significant because it brings to the fore the conundrum faced by countries like Greece. They have to cut back on debt and hence deficit and spending, and top it up with tax hikes. This would lead to a fall in output and employment. In such a case, how could these countries be in a position to repay the debt that has built up? Therefore, such sudden drastic fiscal cuts at this stage could be inimical for them.

The debate on a bank tax was also expected to lead to an impasse. While the idea of keeping banks under check cannot be debated, the route chosen did not have a majority view. In the aftermath of the financial crisis, it was proposed that banks should pay a tax that would form a fund and would then be used to assist failed institutions. The debate was on why all banks should pay for something that they would never use. Hence, a bank tax was not accepted and countries were allowed to choose their options unilaterally in the absence of a consensus. On the contrary, it has been suggested that the capital norms be strengthened even further to ensure that sufficient buffers are built when there is a crisis.