UNCORRECTED TRANSCRIPT OF ORAL EVIDENCE To be published as HC 615-i

House of COMMONS

MINUTES OF EVIDENCE

TAKEN BEFORE

TREASURY COMMITTEE

BANKING CRISIS: INTERNATIONAL DIMENSIONS

Tuesday 9 June 2009

MR PETER CHOWLA

Evidence heard in Public Questions 1 - 58

USE OF THE TRANSCRIPT

Oral Evidence

Taken before the Treasury Committee

on Tuesday 9 June 2009

Members present

John McFall, in the Chair

Nick Ainger

Mr Graham Brady

Mr Colin Breed

Mr Michael Fallon

Ms Sally Keeble

Mr Andrew Love

Mr George Mudie

Mr Andrew Tyrie

Sir Peter Viggers

________________

Memorandum submitted by Bretton Woods Project

Examination of Witness

Witness: Mr Peter Chowla, Policy and Advocacy Office, Bretton Woods Project, gave evidence.

Q1 Chairman: Mr Chowla, welcome to this evidence session on the international dimension of the banking crisis, an issue that has been of concern to us now for almost two years. Could you introduce yourself, please, for the shorthand writer?

Mr Chowla: Thank you for welcoming me. I am very happy to be here. I very much welcome this inquiry by the Committee into the international dimensions. We have been following closely the work of the Committee on the domestic dimensions of the banking crisis, and I am very pleased that this is being taken forward. My name is Peter Chowla; I work for the Bretton Woods Project. We are a think-tank/NGO here in London which focuses on international institutions and their impacts on environmental sustainability and development opportunities for developing countries, so we have focused quite heavily on the World Bank and the IMF in the past but have also looked at the ABIS, Financial Stability Forum.

Q2 Chairman: I was actually just looking for your name and your title.

Mr Chowla: Okay; sorry, go ahead.

Q3 Chairman: So you are Peter Chowla of the Bretton Woods Project.

Mr Chowla: Yes.

Q4 Chairman: Okay. I will ask you a question. We have got 90 minutes at the most. If we can get through all these points it will be good for us. There was a lot of talk at the time on international financial regulation and the need to get it changed and a lot of heat without light. Do you think there is much light now in terms of that momentum for change, or do we run the risk of it receding and nothing very much is going to happen?

Mr Chowla: I think it is hard to tell. If we wait until the end of the month, we will have a lot more information. For members of the Committee who are not aware, the UN is organising a major international conference on the impacts of the financial crisis on developing countries, from 24 to 26 June in New York, where many of the proposals that are now on the table coming from various sources - the G20, as well as UN commissions and experts, as well as UN bodies - are going to be debated by members of the UN in a format which will hopefully produce some results. The early indications are that the appetite for very deep structural change is not there amongst some of the rich countries particularly. Although there has been quite a bit of movement on some of the nitty-gritty details of changing regulation at the margins, in terms of the structural elements of how we might look at international aspects of regulation of our monetary system, the feeling is that so far the rich countries, particularly in Europe and in North America, are not being convinced that this is a need at the present time.

Q5 Chairman: On the issue of low-income and middle-income countries, I note that richer countries have provided just over 5% of additional development finance to compensate low-income countries for the shock they face as a result of this crisis. It seems a pretty small amount. How concerned are you that the low-income and middle-income countries will be left out of this reform process? I think we got a hint of that at the G20, and we felt maybe their voice was not heard there as much as it should have been.

Mr Chowla: There is certainly a feeling that low-income countries are being substantially left out of the process. Within the G20 you have only one or two countries which can be considered low-income, one of which is India, but by all accounts the Government treats itself as an emerging market and has very different concerns from what you might expect from a small, low-income country in South Asia, Africa, or Latin America for that matter. The feeling is definitely that low-income countries are being excluded from some of the discussions. The feeling is also that the middle-income countries, the smaller or medium sized ones, are also being sidelined in some of these discussions, and that is an important reason why the UN conference is being focused on by some of the developing countries, so that they can have a voice in some of the discussions around change in the international architecture and financial regulation.

Q6 Sir Peter Viggers: In your evidence you point out that the International Accounting Standards Board, which is a private body with no public accountability, set up a monitoring board recently. Do you welcome that development? Is it acceptable, do you think, on a longer-term basis, that there should be an international body which has no public accountability?

Mr Chowla: Our position has always been that things that affect people's lives people need to have say over, and citizens need to have say over them through the appropriate mechanisms, and that will often include representation from their governments but it can also include direct representation and accountability to citizens through transparency and participation, through mechanisms such as consultation, et cetera. The problem with the ISB and its new monitoring board is that there is still no direct accountability. These are new developments, and it is unclear how the institutional developments will move forward, but the monitoring board does not have the ability to direct what happens at the ISB; its remit is limited to appointing trustees and to raising issues with the foundation which sets the accounting standards. I can certainly say it is a start to bring public accountability into a private body, but I think in the long run the need is for bodies that are setting fundamentally important financial standards to have clear lines of accountability back to the public, and that would be through governments or other mechanisms of direct accountability that allowed people and their representatives to exercise control over the policies that are going to have an influential effect on their lives.

Q7 Sir Peter Viggers: Would you give such a body powers to compel and would you give it powers to compensate if there is an error?

Mr Chowla: There is a need within the international sphere to have international rules which are enforceable, and that is true, for example, about accounting standards or if you are talking about banking regulation or about insurance standards, all of which are across the financial sector sphere. It is clear that we do not yet have an institution which is legitimate and capable at the international level of undertaking that kind of compulsion or compensation. It would be an ideal case that you can create a system where regulations across an international sphere can be agreed multilaterally, everybody has a stake in their implementation and, by consensus, agrees to them, and those who do not implement properly can be either incentivised to improve their implementation or essentially sanctioned for not implementing properly, which can provide some of the mechanisms of compensation which you have talked about.

Q8 Sir Peter Viggers: Developing countries do not really have a say at the moment, do they?

Mr Chowla: No.

Q9 Sir Peter Viggers: Does this concern you, and how can that be rectified?

Mr Chowla: The legitimacy of current international institutions is heavily weakened by the fact that developing countries do not have the kind of participation that would be necessary. If you look at the institutions we have got, the IMF, for example, had some of the better representation of developing countries, but still the voting power is skewed in such a way that between OECD countries (you can add it up in multiple ways), the rich countries can always fix the agenda in the way that they want. If you look to the other committees, the Standard Setting Committee, the IASCO, which handles securities regulation and the ISB, which is a private sector body, or the IAIA, which is the insurance international body, in most cases developing countries are almost excluded from the decision-making process or only involved in a very formal way in a small portion at the very end. So until they can find a legitimate institution through which to express their desires and to influence the way that decision-making is made so that the impacts of international financial flows on their economies are well reflected into standards that are being proposed, then I think we will find it difficult for them to support any of the bodies that currently exist. We generally believe that a fundamental prerequisite is that you have some governance reform to bring the legitimacy up to current standards, not just on participation of developing countries, but we have also seen in some of the other international institutions the need for greater accountability to citizens who may not find themselves adequately represented by their own countries.

Q10 Sir Peter Viggers: Do the existing institutions that are involved have the appetite to develop the kind of mechanism you would like to see, or does it need some kind of external influence or impetus to get the thing going?

Mr Chowla: From what we have seen so far, they do not have that appetite, and there is a need for external pressure. That can come from forward-thinking governments and it can come from institutions like the UN and the committee of experts that the UN has appointed to think through some of these issues and propose ways forward.

Q11 Mr Mudie: Do you think developing countries would be better off creating a new international regulatory structure rather than demanding alternative structures committed to their needs?

Mr Chowla: This is a fundamental question which is often repeated in international political economies. Is it better to reform what we have or to get something new? I think that is a difficult choice. I think the proposal of new institutions can sometimes take a long time and require a lot of will which is not there. I think in this case, when we are talking about finance regulation, we have the nucleus of a body, which is the Financial Stability Forum, which has now become the Financial Stability Board. I think the nucleus is there to use that. Since this reform that has been proposed by the G20 in April, what is left to be decided? The details have not been spelt out of exactly what a new FSB would look like, what its structure would look like and what its mechanisms would be. So, I think, because we have a proposal already from the G20 without a lot of the details, we can use that as the basis on which to further identify how to make something like the FSB truly legitimate and representative so that it can reflect the interests of developing countries in the international sphere.

Q12 Mr Mudie: Do you have any confidence that the developed world will allow that to happen in that structure?

Mr Chowla: That is yet to be seen.

Q13 Mr Mudie: I know it is yet to be seen.

Mr Chowla: In the US we have an administration now which is more interested in multilateralism and in its responsibility to promote a sound global economy for everybody. I think we have, in Europe, some leaders who, though perhaps not naturally attuned to more regulatory environments, have also expressed a desire for more multilateralism. I think there is still resistance, not least of which sometimes comes from this country and sometimes from some other leading rich countries as well, but I do not think it is impossible to convince these countries that we can get there - this year perhaps. I think as the financial and economic crisis deepens (and the expectations are that it will in most places), as unemployment soars, I think the pressure will come to bear that we need something more radical and something more fundamental as we look to institutional responses and changes that can address this. If the economic crisis suddenly starts to dissipate, those famous green shoots start sprouting very quickly, we may lose the moment, we may lose the ability to convince the remaining hold-outs.

Q14 Mr Mudie: Have we not lost it, Peter? I looked at yesterday's Financial Times: a whole page devoted to our Chancellor being too pessimistic and that the recovery is going to start sooner, plus at the same time reporting that we are falling out with Europe about regulation as a sovereign nation, and it all points to the fact that we are already forgetting the disaster and starting to make sure that nothing much changes.

Mr Chowla: I think that some parties would like to see it move that way. There are interested parties who like the system as it was before because it provides certain advantages and benefits to them, and so they will certainly work hard to make sure that a more fundamental change does not come into play. I am not a soothsayer, I will not try to predict the state of the global economy in six months, but I do not think it impossible, for those who have watched the news to see Latvia not place a bond issue with the international markets and having to seriously consider again devaluing its currency quite heavily, to say that such a thing would not happen to a major emerging market. If, for example, something like what happened to Latvia happened to a Turkey or to a South Africa in the coming months - financial contagion spreads very rapidly around emerging markets - it is not impossible to say that things will get drastically worse, and that will provide some of those incentives and desires for countries to fundamentally rethink.

Q15 Mr Mudie: Why empower the Financial Stability Board instead of pulling the IMF in to do the job?

Mr Chowla: I think we have seen over the last ten to 15 years, essentially since the Asian financial crisis, calls for the IMF to improve its macro-financial analysis, meaning the links between macroeconomic issues, largely in the public sector and the financial sector, and its implications on the macro sector. For 15 years now those calls have been made and for 15 years the IMF has not responded, has not yet found itself able to do that work, to incorporate that analysis into its own surveillance. I think it comes down to the kind of institutional rigidity that exists at the IMF. I think there is a need to vision, to think about public sector issues, macroeconomic issues, and private sector issues, regulatory and financial issues, and though they link and are interplaying, just as trade links with finance, as development aid at the World Bank links with finance, I think there is a need to vision which can provide a good ability to create a specialised agency that can really delve into the issues related to regulation and financial sector oversight.

Q16 Mr Brady: You highlight the damaging effects of volatile exchange rates. Are there not some benefits, though, of freely floating exchange rates wherein countries need to rebalance their economies?

Mr Chowla: That is true. I think the volatility, though, is of a different order of the kind of benefits that you might get from moving exchange rates. So the kind of adjustments you might need to adjust your economy are not in the order of hourly or daily adjustments, they are in the order of monthly or yearly adjustments, so, as you have now got perhaps a burgeoning current account deficit, you need to make adjustments. Those adjustments in your economic cycle and your economic activity are going to take months and years to pull through, just as when you change interest rate policy it takes 12 to 18 months to pull through the economic cycle and to pull through the economic institutions and to impact on the market, and I think the second by second, hour by hour volatility in exchange rate markets does not necessarily provide that. If you look at some of the volatility in exchange rates for some of the big emerging markets, for example South Korea, which I was looking at this morning, you can see volatility that has shot up and down in the course of days and weeks over the last six months or 12 months since this crisis started, which do not really relate to fundamentals about economic production, sale, trade; nor do they provide the kind of long-term outlook which is necessary for adjustment. So the kind of excess volatility you are getting will not allow adjustment from the business sector, for example, because they cannot plan three years ahead on the exchange rate, which is the kind of planning cycles you need for productive investment in the real economy.

Q17 Mr Brady: I think we can all accept that there are instances of volatility that do not relate to fundamentals in currency exchange rate movements, but how do you find the appropriate market rate for a currency? How does a currency establish where it should be if you remove its exposure to those market movements?

Mr Chowla: The econometric and macro-financial analysis which produces real equilibrium exchange rates (REERs as they are called) is not perfect, and the IMF, the leading proponent and producer of these kinds of statistics, as well as other international institutions, international agencies, will tell you the same thing, that there is no way you can produce an exact number, and I think the fact that you cannot produce an exact number is tied to the fact that you also cannot produce an exact number through the market. This volatility has the same result. I think the system in place for the first 25 years after the war provides a kind of system that can work; it is workable. It is not perfect, and I think in this sphere that nothing is perfect, but the ability to adjust exchange rates over time, through looking at and analysing your surpluses and deficits in your capital current and trade accounts and by looking at your relative productivity gains and wage level gains, you can analyse and you can see over time if we are continuing building up deficits or surpluses (we have done for two years; maybe now we need to make an adjustment in policy), and I think that kind of regulated system is a possible way out. That is a long way to go from where we are right now, and I understand that transitional arrangements could be very tough, even some countries may not wish to move back to the kind of system we had under the Bretton Woods exchange rate system, and I think accommodation can be made for that. If you read the recently released UN Commission report, it talks about how you can create a system which allows some freedom of choice of which exchange rate system you want, but can build in broader stability in the market for using a global reserve currency system which would allow some better stability and some betting linking of currencies to an international standard.

Q18 Mr Tyrie: Can I come in on that. I have to say, I am rather confused now. Are you arguing for a managed exchange rate system in order to deal with short-term volatility or to deal with the quite different problem of long-term build-up of global imbalances?

Mr Chowla: I think a managed exchange rate system can help you tackle both at the same time. It will allow you to cut off some of the speculative activity which helps contribute to short-range volatility, and that is not the only thing that creates short-range volatility but which also contributes to it. By tackling that through cutting off some speculative avenues, you can create greater stability in the short run. That also improves business investment and planning in the real economy. You can also then remove the need, for some of the countries that feel the need, to build up self-insurance, because they have a guarantee system that they can plan on and that they can construct their economic models on and which they can also then, hopefully, avoid some of the competitive devaluations, or other kinds of other sudden devaluations, that come with financial crises. So as you reduce the necessity of holding reserves by, I cannot say eliminating financial crises, but drastically reducing the frequency and severity of financial crises, then you can decrease the reserve holdings and bring yourself back to a point where reserve holdings more closely match need from the real economy rather than perceived need in terms of financial risk.

Q19 Mr Tyrie: Do you think it is possible to run a globally managed exchange rate system with free capital markets?

Mr Chowla: It would be incredibly challenging. The necessity for free capital markets has not quite been demonstrated, and I think there are some micro gains. There was a commission that was heavily supported by DFID, called the Growth Commission, which produced a report which studied, over the last 30 years, evidence of countries which had consistently high growth paths - they grew over 5% for more than ten years at a time - and they studied what kind of policies they followed to enable them to pursue these kind of growth paths. This Growth Commission, which was headed by Noble Laureate Michael Spence at Stamford University, came up with the conclusion that there is no empirical evidence that capital market opening contributes to enhanced growth.

Q20 Mr Tyrie: So you are in favour of the reintroduction of capital controls on a global scale?

Mr Chowla: They need not be global. I think it comes back to giving countries choice and giving countries the policy space to chose what kind of economic and financial linkages they want to have with the world.

Q21 Mr Tyrie: Countries can impose capital controls tomorrow if they choose.

Mr Chowla: They have restrictions.

Q22 Mr Tyrie: We are only talking about global architecture here.

Mr Chowla: No, they have severe restrictions due to existing bilateral investment treaties, free trade agreements, commitments made under the WTO, as well as pressure that comes from the IMF and the World Bank in conditionality attached to lending programmes and policy advice. So the imposition of capital controls, though feasible, is highly incentivised against, and in some cases prohibited by, existing international arrangements under bilateral or investment treaties.

Q23 Mr Tyrie: You would like the removal of those restrictions on the reintroduction of capital controls to enable a number of countries to return to their imposition?

Mr Chowla: I think it is particularly useful for some developing countries to use capital controls at certain times. They can have counter-cyclical effects; they can buffer the kind of portfolio hot money flows in and out of countries.

Q24 Mr Tyrie: We are not talking about this here. These are very different types of issues: the hot money flows. We are back to this short-term volatility issue. I am trying to get at whether, as part of your long-term architecture to deal with global imbalances, you are in favour of the introduction of capital controls permanently.

Mr Chowla: I think they can be a very useful tool for some countries.

Q25 Mr Tyrie: I am asking whether you want them permanently?

Mr Chowla: I think they permanently need the option so they can use that option when it is made necessary or beneficial by the external environment. It is not to say that you must have capital controls all the time, but it is developing countries that need the ability to use those as and when needed.

Mr Tyrie: I think we will think carefully about your replies.

Q26 Sir Peter Viggers: In your memorandum to us you look at the accumulation of huge foreign currency reserves. You call it a kind of self-insurance, in fact you have just used the expression now, and you trace it back to a loss of confidence in the IMF after the manner in which the IMF dealt with certain crises, especially in the Far East. I suppose two questions arise from this, the first relating to the reserves themselves and the second relating to the restoration of confidence in the mechanisms of the IMF or other international bodies. Dealing first with the foreign currency reserves, do you see that it is likely that countries in the future will wish to have such high foreign currency reserves? As for self-insurance, do you see an ambition for that diminishing or continuing?

Mr Chowla: I think it depends on the resulting institutional changes that we see. If, as some have alluded to, we will have limited institutional changes, then I think we will see a continued desire to hold high levels of reserves. That may be moderated by increasingly advanced regional arrangements for reserve pooling, which we are seeing in Latin America and in Asia, and similar arrangements may be coming into place in other parts of the world that are being discussed. So, as those are taking place, we might see a slight moderation of this desire, but I think, in general, the desire to have self-insurance against highly volatile movements will be there. I think the recent evidence from the financial crisis and lending by the IMF is that, while there is a desire to change some of the conditionality that the IMF uses, that has happened for some subset of countries but not for others, and I think the countries will still face the risk, or still feel the risk that they will be subject to heavy pro-cyclical conditionality from the IMF when it comes to time for them to get a rescue package, and to avoid that necessity, when they go to the IMF, they will continue to want to self-insure. That said, I think, clearly, the biggest case that we need to discuss is China. I think for China, my understanding, from my reading of the evidence and opinions, including from some Chinese academics, is that the feeling is strongly that they have reached a point where this is now very counter-productive, and the Chinese are themselves seeing that we should perhaps not continue on this kind of policy in this programme. I think that is why particularly the Chinese have been very interested in institutional changes which might moderate some of the desire or push to hold these kinds of reserves.

Q27 Sir Peter Viggers: Looking at confidence in the institutions, is the IMF the key institution that we should be looking at? If so, what are the essential elements to improve confidence in it?

Mr Chowla: The IMF, I think, is the central one in regard to reserve holdings. There have been other arguments around the WTO and its need to look at the trade implications of managed exchange rates. I will put that aside, since I am not an expert on the WTO, and focus on the IMF. Clearly, at the IMF there are two areas where developing countries have strong concerns, and that is on governance and on conditionality, which I mentioned. So the moves for change in the governance structure of the IMF, as the Committee is probably aware from the 2006 report on the role of the IMF, the outcome was less than radical in terms of changes in government structure. The G20 has agreed to come back to that and bring forward further reform of the governance structure of the IMF. It is not clear how quickly that will happen. On the conditionality side, as I have mentioned, I think the IMF has made progress. So they have a new facility which allows countries who have "strong policies" to get money, conditionality, free. This has already been accessed by Poland, Columbia and Mexico, as the first three countries which have approached this facility. That kind of facility is a good improvement in innovation, but the worry is that the rest of the countries, which are deemed not to have strong policies according to the IMF, still face the same kind of conditionality. So until that conditionality can be streamlined, reduced or eliminated with altogether more facilities like the one that Mexico is accessing, countries, I feel, will still feel the pressure or the desire to build up the reserves to try and avoid facing the kind of imposition of conditionality.

Q28 Nick Ainger: Following on from what you were just saying, in the evidence that you presented to us, your Update 65, you are critical of the IMF. You basically say that they are not practising what they have been preaching about fiscal stimulus, and so on. What is your view of their performance so far in dealing with the current crisis?

Mr Chowla: Their performance is mixed. I think the new managing director of the IMF, Dominique Strauss-Kahn, has brought a change of attitude to the top of the IMF - I think that has been very clear - and he has played quite an active role in making pronouncements about the need for fiscal stimulus, for counter-cyclical policy, for countries to spend to buoy the economy and to create jobs. Unfortunately, I think that has not filtered all the way down into the IMF's strengths and into the IMF's programmes. So, while we have seen the three countries that I have mentioned have access to non-conditional money (Mexico, Poland and Columbia), we have also seen many countries like Hungary, Latvia and Pakistan, facing very strict and austere conditionality from the IMF and repeating, essentially, in Eastern Europe the kinds of things that happened in East Asia in 1997 and 1998, where you had extremely strong pro-cyclical conditions from the IMF, forcing spending cuts, deeper recessions, devaluations of currencies and then more bankruptcies by companies and individuals in debt. So I think we have had a mixed picture and the IMF needs to do more of the kind of programmes that they have been arguing for in a few countries, including now in a few low-income countries like Tanzania and Mozambique. We need to see than now in more countries across the board, including in Eastern Europe and Sub-Saharan Africa, who are facing severe constraints on their financing this year due to the financial crisis.

Q29 Nick Ainger: You say that Dominique Strauss-Kahn (and we met him a few weeks ago) has brought change at the top but that you do not think that further down it is actually having an impact. In many countries, particularly those that are developing, the IMF placed conditions on loans that were basically neo-liberal: there were very strict, fiscal and monetary conditions placed on them. Are you saying that at the top that attitude has changed but that the same people that were applying the policies may be five or ten years ago are still there and applying those same policies?

Mr Chowla: Yes, I think that is the case. I think from the top they have pushed change only so far, in that you have got the kind of facilities available that I have talked about, the flexible credit line which allows non-conditional money to be provided. We have also had an increase in the amount of money, though it is still very small, that is available conditionality-free under some of the facilities for low-income countries. So they now have a very small portion for which they can get 25% of their quota without any conditions, and those kinds of changes come from the top. They come from pressure at the board level where developing countries have been pushing for and demanding these changes for a long time, and they also come from their top management. I would say the second rung of management is not formally changed in opinion. There are three deputy managing directors. The first deputy managing director is always, by convention, from the United States. I would not proclaim to say that he is a post Keynesian or socialist of any kind, but the additional deputy managing directors also have recently come from Latin America, one of them, and the second deputy managing director generally comes from Japan. I think they have brought different kinds of attitudes, like Strauss-Kahn has, whereas the first deputy managing director maybe has not.

Q30 Nick Ainger: One final point. The G20 announced that the IMF was going to get an additional 750 billion in resources. I notice in your report you refer to the Third World Network. Rather than welcoming this, they actually say, "Additional resources to the IMF would give it the means by which to discipline crisis-hit countries the wrong way, worsening the crisis for them." I think this was in your April update. Have you seen anything from the IMF that would indicate that they are not going to follow that type of policy which is feared by the Third World Network?

Mr Chowla: I think we have seen in recent board discussions, in the cases of Tanzania and Mozambique, that they have proposed fiscal stimulus in low-income countries, which is unheard of in the IMF's history when you are talking about a programme country spending more money. That is generally not the practice from the past. So I think we have seen some small change, but, as I have said, I think the crisis-hit countries, for example in Eastern Europe, are being disciplined the wrong way. They are facing the exact kind of pro-cyclical conditionality that you had in Asia in 1988, and I think we should be very clear. My friends at the Third World Network, who I talk to quite regularly, are quite aware that in countries which have "lived beyond their means", according to the IMF and others, there is a need for adjustment. Everybody recognises that you cannot have deficits of 10% year after year forever; you have to bring things back onto a sustainable footing. It is a question of the timing of adjustment and, just as in this country when banks have gone to the wall, essentially, and been bailed out by the taxpayers, there is a desire for them to rebuild their capital adequacy ratios, but every policy-maker that has talked about this has said, very clearly, we will not force them to do it now; now is not the time. We will get through the crisis, we will restore growth, then we will increase the capital ratios of the banks. That is exactly the kind of policy that developing countries need to follow in terms of their own fiscal position: now we are in a crisis, we need to have more ability to produce counter-cyclical policy; when the crisis is over, when we have restored growth, then is the time to adjust back to a sustainable position. So it is about the timing of adjustment, it is not about the need for adjustment. Everybody recognises that you have to have some sustainable path of fiscal and monetary policy, but I think we are seeing that for the crisis-hit countries, not necessarily for the Tanzanias and Mozambiques, who are facing long-term development challenges, but particularly in Eastern Europe, the IMF is pursuing the same medicine that they always have.

Q31 Mr Fallon: Your paper says a little bit about transparency but slightly more on the IMF itself than on the record of the Member States, for example, in agreeing to publish surveillance reports. Why is that? Why do you not argue for that?

Mr Chowla: We are in favour of transparency of those surveillance reports as well.

Q32 Mr Fallon: It is not in your paper.

Mr Chowla: It is not in this paper. I can provide you with some other background material which talks about that. I think from our point of view the surveillance issues have largely been resolved. The number of countries that do not publish their Article 4 reports is very small now.

Q33 Mr Fallon: It is one in ten; so that is 18 or 19.

Mr Chowla: It is about right. It has sometimes been 95% on top or sometimes down to 89%. It goes up and down by year.

Q34 Mr Fallon: Why should it not be all?

Mr Chowla: I think it should be all, indeed.

Q35 Mr Fallon: Why do you not call for that?

Mr Chowla: We do call for that.

Q36 Mr Fallon: You do not in the paper.

Mr Chowla: Not in this paper. I can provide you with some other material we provided to the IMF.

Q37 Mr Fallon: Let us be absolutely clear about this. You believe that all countries, whatever the state of their finances, even if they are the ones in the developing world with the most difficulties, should publish in full the staff report and other accompanying analyses?

Mr Chowla: I think, yes, they should publish in full, with the caveat that there is a need to protect data that might create immediate market reactions that are adverse, and that has always been IMF policy. If you are going to talk about some of the very sensitive issues around exchange rates, countries might need to delay publication or prevent publication of that specific piece of data to prevent adverse market reactions.

Q38 Mr Fallon: That is not publication in full, is it?

Mr Chowla: That is following the line of freedom of information policies across the world, including in this country, where sensitive information is allowed to be redacted.

Q39 Mr Fallon: But it depends on the sensitivity, does it not?

Mr Chowla: Yes.

Q40 Mr Fallon: I understand your point about exchange rates, but what about, for example, if the staff report itself is extremely critical of that country's governance? Would you not agree that that should be published in full?

Mr Chowla: Yes.

Q41 Mr Fallon: With all the accompanying analyses?

Mr Chowla: Yes.

Q42 Ms Keeble: You said just now that you expected the economic crisis to deepen, and you also referred to the difficulty of developing countries in financing their budgets. Are you concerned about the debt levels and the possibility for managing debt in developing country economies?

Mr Chowla: This is a particularly large concern right now, and I think it is not yet clear what will happen. The G20 proposals included increasing the amount of money available under lending facilities at the IMF for low-income countries, and I think the worry is that in the time of the financial crisis, where some countries - thankfully not the UK - are cutting their aid budgets (and we have seen that in other countries across Europe), the low-income countries might be pushed into financing that loss of aid through lending, and that will then perhaps return us back to the horrible situation we were in during the 1980s and 1990s where countries ended up with more debt than they could service. The IMF and the World Bank and the G20 have pushed for more flexible consideration of the Debt Sustainability Framework, which is the framework that they use to assess whether a country can manage its debts sustainably. There are worries around that process, because I think there is a feeling that low-income countries who were being hit by the financial crisis should not be pushed into greater debt to deal with its consequences since they have had no part in making the crisis, and the wish amongst those society organisations is generally that levels of grants, not debt-based aid, be provided or increased so that these countries do not find themselves back in the situation they were in the 1980s.

Q43 Ms Keeble: Given the interest in increased regulation of innovative financial products here, including regulation of hedge funds, are you concerned about the activity of those innovations when it comes to looking at developing country debt, particularly around some of the activities of the vulture funds?

Mr Chowla: I think this is concerning, and this is part of the problem that we have seen across the landscape of low levels of regulation and regulatory gaps and regulatory havens, if you will, regulatory arbitrage, where financial institutions move or locate in places where they face low regulation. In terms of vulture funds, so far we know of 54 cases where companies are taking legal action against developing countries which are eligible for debt relief because of this debt problem. I think the recommendations around dealing with this need to be incorporated into the broader discussion around regulatory reform, and I do not think we have seen that happen yet in the UK or in the US, where they are talking about domestic regulatory reform. We have not seen as much of that discussion from the likes of Treasury Secretary Geithner or Lord Turner as we need to see. I am thankful that the UN commission of experts on financial reform, which has been appointed to study reforms in the international financial system, has devoted half of a chapter to discussing a sovereign debt restructuring mechanism, which is a way to bring bankruptcy court-like procedures to deal with sovereign debts.

Q44 Ms Keeble: You say you think it has not had enough attention yet. Do you think it should be on the agenda for the next G20 meeting, for example?

Mr Chowla: I certainly think it should be.

Q45 Ms Keeble: What do you think should be put forward?

Mr Chowla: The proposals around sovereign debt restructuring are incredibly important. This is something that has been on the table from about 1999, when it was originally proposed by the IMF as well but was never accepted in any format that everybody found acceptable. So I think we need to bring it back and have a serious multilateral discussion about what it could look like and how it should work, but I think that is not enough. That deals with some of the most egregious cases when countries are defaulting, but I think you should work at the beginning to try to prevent this, and so that is about tackling this question of regulatory arbitrage and regulatory competition across sectors through better international regulatory standards, which can bring up the playing field to a level which everybody works on, which can then prevent this kind of activity.

Q46 Ms Keeble: But if we have got the US and the UK looking at specific measures, how can you actually stop the activities of the fund, or prevent them, given that they can circumvent those jurisdictions, or do you think that the US and UK should provide an international lead on this?

Mr Chowla: I think the US and the UK can provide an international lead, and by acting first, or by pushing action further, they can bring everyone else along. The fact that a large portion of sovereign debt contracts are written with London as the jurisdiction provides the opportunity for the UK to take a leading role, because they can change the law on how these debt contracts are interpreted or dealt with when they come to court for cases. So that fact provides the UK with a lot of leverage to take a lead, but I do believe that while the UK can take a lead and can significantly change some of the practices for the better in some cases, to provide a wholesale solution to this problem we need an international approach.

Q47 Ms Keeble: Can you give an idea of the kind of measures you would like to see and, if you could, come back again to the issue about what you would like to see on the G20 agenda?

Mr Chowla: Definitely on the G20 agenda needs to be a sovereign debt restructuring mechanism or a fair and transparent sovereign debt arbitration process, a bankruptcy style approach to sovereign debt, so that all creditors, be they sovereigns or be they the private sector, are subject to jurisprudence around the debt resolution mechanism, just like you would for any kind of bankruptcy. I think that is a fundamentally important thing that needs to be on the agenda. We have kind of danced around this issue about whether you might have an international regulatory authority, and we have talked about FSB reform. As you deal with the FSB's governance and legitimacy problems, I think negotiations need to start now about the role and substantive work of what the FSB would do in terms of regulation of the kinds of actors that work in the vulture fund area.

Q48 Ms Keeble: And a limit on interest.

Mr Chowla: This is something that has also been proposed; this not on the official agenda. There has been what is called a Charter on Responsible Lending, which has been produced by some of our colleagues at the European Network on Debt and Development, which is a set of standards that should be applied to all lending and includes things like transparency, but also fairness and issues around interest rates and fair interest rates. I also have some colleagues - and I am not expert on this - who feel that regulation around (not here in the UK even) domestic interest rate policy is sometimes lacking in terms of usury interest rates which are being charged on domestic lending, and I think we can look at bringing some of those kind of usury regulatory issues into the agenda at the international level as well.

Q49 Ms Keeble: If the international community is going to look at continued debt relief, provision of debt relief, do you think there is a need to look very carefully at the activities of vulture funds, given that they do actually extract a large amount of that value, do they not?

Mr Chowla: There is a very concerted need to look at the activities of these vulture funds. I think I would also worry, from the sole stand point of a taxpayer, where my tax resources are going to. When we are providing debt relief, that is a kind of aid to developing countries. There are problems with the conditionality attached, but, setting those aside, this is taxpayers' money which is going to provide aid, and if it is being clawed back in the form of private profits for actors in the City or the Cayman Islands, I would be very concerned, and I think the UK and the Department for International Development can take a lead on bringing these issues to the fore at the international discussions at the G20, at the UN and in other places.

Q50 Mr Love: Can I take you back to a discussion earlier on where you were suggesting that there should be a permanent option for countries to introduce capital controls. At the moment most countries only do that in extremis, and they still have the right to do it, but there is an international consensus architecture that stops them doing that. What changes do we need to make to that architecture to make it easier for them? I am thinking mainly about smaller countries. Larger countries do not suffer this problem. What do the smaller countries need to allow them to introduce that?

Mr Chowla: We have seen it is not just smaller countries, I should say. Capital controls are in existence in India and China, some of the biggest emerging markets, and they have used them to great effect, in terms of producing volatility of portfolio flows coming into and out of the country and have used them also for domestic political purposes and other things. So, let us be clear, it is a broad sector. The area where action needs to be taken, if you are going to create the possibilities, is particularly around rolling back some of these commitments under financial services liberalisation and investment liberalisation so that, under bilateral investment treaties or free trade agreements, including through the European Union's economic partnership agreements, which have not yet been concluded but are being worked on with the African and Caribbean countries, these kind of capital liberalisation clauses are included. So you need to somehow roll back some of the existing agreements, and that has been talked about by the UN Commission of experts on financial reform and the kind of places where you can do that and where you need to do that. So I think you have got bilateral investment treaties, regional trade agreements, free trade agreements, economic partnership agreements and GATS (the General Agreement on Trade and Services), an annex of the WTO. That is the one that governs financial services liberalisation where countries have made levels of commitment which vary but some countries have made very high levels of commitments in terms of liberalisation. So those are some of the very structural areas where you need to address this. I think the other areas are, as I mentioned at the World Bank and the IMF, where capital mobility has been a very strong element of their policy advice and sometimes conditionality for the last 20 or 30 years. So you need to deal with that at those levels.

Q51 Mr Love: That is a revolution, if I may say so!

Mr Chowla: Yes.

Q52 Mr Love: You are talking about shifting the whole international consensus that there has been to lever an economic policy?

Mr Chowla: Yes, but I think it is probably not as radical as it seems, because I do not think anybody is arguing for going back to the kind of damaging and distorting capital mobility and currency exchange rules which have been problematic in the past in developing countries where you have had black markets operating, orders of magnitude above what you have in the official markets. I do not think that is what we want. I think what we want to see is the IMF engaging with countries to give them advice on how to introduce smart mechanisms of capital controls, smart mechanisms of financial investment controls, so that you can moderate some of the hot money flows and radical movements in capital around. The example that most people point to is Chile, where they have had for now ten, 15 years, essentially, a deposit that you must put on inward investment, and you put this deposit, and you lose it if you take your investment out - it is a very small half a percentage point kind of thing - but then, if you are in for long-term investment, you get the money back. It is just a deposit that the Government holds. Those kinds of measures are the kinds of things the IMF needs to be advising countries on how to implement, how to do properly, how to set up the structures to do it, how to enforce it - those are the kinds of things they need to be doing - and, to be fair to the IMF, they have not always advised against capital controls: there have been a few cases where they have advised the implementation of capital controls. I think it is just a matter of improving that advice, increasing its availability to developing countries and broadening it to make sure it is consistent across the IMF.

Q53 Mr Love: Can I take you on to conditionality. I think you are absolutely right about the IMF policies being pursued in Eastern Europe at the moment. It seems to be the old IMF, if I may say so. I think everybody accepts there has to be some form of conditionality. You were suggesting they need a breathing space to introduce the adjustments necessary. Is that the only change in terms of conditionality, or is there an acceptance that tough policies have to be pursued in order to bring people back to a sustainable position?

Mr Chowla: There are a couple of areas to mention. The IMF has, generally, two kinds of conditionality: they have what they call quantitative conditionality, which deals with regulatory macroeconomic indicators - your inflation levels, your budget deficit, your current account deficits - and then they have structural conditionality, where they deal with structural change in your economy requiring privatisation of enterprises or other kinds of measures. I think in the first one, quantitative, what people are asking for is more flexibility and a greater time differentiation of how we implement what are called sustainable policies, however you define those (and there is debate about how you define them), at least giving breathing room for adjustment and time to pursue counter-cyclical policies during a crisis. In the structural area there is a lot of evidence that the IMF's conditionality, however well-meaning it is and whether it is even correct or not (and, again, there is debate about how correct it is), is ineffective. Structural reforms are only pursued if the Government wants to pursue them, and structural reforms they commit to, to the IMF, simply to get a package are not pursued with the kind of vigour that they should be and, at the end of the programme, are often turned back. So there is a question about whether this kind of conditionality is effective at all, and I think it provides the analysis to think perhaps we should be doing away with this kind of conditionality altogether, and the IMF has made some changes in the last six months to this structural conditionality: they have now decided they will no longer have individual requirements. In the past, if you did not meet a single individual requirement, there was a risk your programme would not continue and you would not get the money that you were being lent from the IMF. They have announced a move away from that towards a more structural holistic approach, to say, "Have you done enough? If not, what more do you need to do?" - rather than a single, a wide-angled approach.

Q54 Mr Love: Is that change in the IMF recognition of the need to bring in the bigger economies who have built up balances? When they go and check with these countries as to why they are so opposed to having the IMF in, is this a critical issue for them?

Mr Chowla: Yes. As I have mentioned to your colleague, this is definitely a critical issue. It is one of the two main issues that they face in terms of the legitimacy. The changes have been driven by developing country demands, by also the managing director and his recognition that this is a problem, and also by the Independent Evaluation Office of the IMF which has done some excellent research in evaluation of recommendations in terms of how to deal with this. So they have made a lot of progress in terms of identifying that this is an area where there are problems, where the effectiveness of the IMF is low and how you can change it. I think further changes need to be made.

Q55 Mr Love: Can I take you on to tax havens and your call for greater transparency. This was reflected at the G20 meeting. Have they got the political will to do it?

Mr Chowla: I think, with all respect, you would know better than I would what the political will of the Government is in tackling this issue.

Q56 Mr Love: They are not saying so publicly, in fact they are being quite helpful publicly about tax havens, but the hope is that the political will will dissipate. Is that likely to happen, do you think?

Mr Chowla: I think the momentum for change and the forces that are demanding change are gaining strength and I think developing countries have recognised that this is an area where they need action. Civil society organisations in developed countries are demanding of their governments that they take action, and I think this is an area where we are likely to see change. The question is whether it will go far enough. The Prime Minister has taken quite strong steps, compared to what anyone could have imagined a year ago, in terms of disciplining overseas territories, commonwealth territories, his demands that they fully meet all the standards that are in existence and that they will be expected to exceed them. The question now becomes: can this Government and other rich governments be in the position to increase the standards to a level that is going to really provide a significant change to developing countries and their ability to raise revenue and not have revenue essentially taken out from under them by the activities of not only corrupt individuals but also foreign investors and other kinds of money laundering activities and drug activities?

Q57 Mr Love: Can I raise two problems with you. The first is that of the small places, the Andorras, the Monacos, the Cayman Islands, where these changes may well wreak economic havoc, admittedly in a very small area but where their whole existence economically may be affected, and, secondly, the much larger Singapores and Switzerlands where they have some clout in the world. How do we deal with those two separate problems?

Mr Chowla: The first problem is fairly straightforward. Most of these small territories that rely on financial centre activity are in the rubric of developing countries, middle-income countries or small island states. Measures need to be put in place to increase the ability of them to have other kinds of economic activity and that can be done through traditional aid programmes or development lending programmes through the various international institutions and bilaterally through DFID and others. That is a fairly straightforward problem. This has happened with trade negotiations over 20 years; you provide aid to adjust to a new economic position. The Singapores and Switzerlands of the world are a different story. I am not an expert in these tax competition matters, but I suspect that even if you produce a level playing field and up the regulatory stakes to a certain level and increased the transparency, and Switzerland and Singapore are brought along to that level, the substantial network effects they have in their banking sectors would continue to play into them being strong financial centres. I would not expect that you would see a lot of movement away from Singapore or Switzerland because they have such established institutions which allow them to have network effects where they interact with each other and with their clients. I suspect that the damage would not be as severe as some might predict because I cannot imagine that the banking industry would move completely away from these kinds of places.

Q58 Chairman: Mr Chowla, can I thank you very much for your evidence. It was very helpful. We have got further evidence from academics next week on the wider issues regarding not only emerging countries but what are termed as the richer, more developed countries, so it is a good introduction for us and we are grateful to you for taking the time to come along.

Mr Chowla: Thank you again. I really do appreciate it and I do welcome this. I look forward to your conclusions.