Speech by Mr Peter Ong, Head, Civil Service, Permanent Secretary (Finance) at Lee Kuan Yew School of Public Policy Public Lecture

Introduction

1. Good evening. Thank you very much for this invitation to share with you some thoughts ahead of the upcoming G20 Summit in Los Cabos. I want to credit Ambassador Villegas for the excellent idea of proposing this lecture to generate discussion on the deliverables and expectations for the important Summit that Mexico will be hosting next month.

2. Indeed, there cannot be any discussion of the Los Cabos Summit without a discussion on the state of the global economy. Like the 2009 London G20 Summit, the Los Cabos Summit will be yet another crisis Summit.

Current State of the Global Economy

3. The global economy is facing intensifying downside risks. Four years since the collapse of Lehman Brothers, global economic growth remains feeble and confidence is still fragile.

4. I see three key risks currently facing the global economy that will no doubt shape the discussions of global leaders when they meet in Los Cabos.

a. First, the ensuing tentativeness of recovery in the US.

b. Second, the slowdown in growth in emerging economies, particularly China and India.

c. Third, and of particular concern, the Eurozone crisis, as this can bring significant spillover and contagion to the rest of the world. It is without doubt that the risks resulting from the Eurozone crisis will be the top concern at this upcoming Summit.

Eurozone crisis

5. The crisis has been amplified given recent political uncertainty in the Eurozone. In Greece, inconclusive results from its elections have led to fresh elections scheduled on 17 June. Given concerns that the new Greek government would seek to make substantive changes to the agreed bailout packages, markets have started to price in the risk of Greece’s exit from the Euro.

6. In Spain, the deepening crisis in the banking sector with the recent downgrade of 16 Spanish banks by Moody’s comes at a time when there is lack of confidence in Spain’s ability to recapitalise its banks and rein in its budget deficit, especially in the regions.

7. In recent weeks, Greece and Spain also experienced some bank runs as worried depositors transferred their assets to perceived safe havens in other parts of Europe. It will, therefore, be crucial to take decisive action and arrest this loss in confidence, or risk the contagion spreading.

8. Franco-German leadership is key to charting a path out of the current situation. However, ideological differences on the relative emphasis between growth and austerity could pose challenges to collective policy actions at this critical juncture.

9. Thus far, this debate has been focused on the choice between growth and austerity, for example,

• Trade off between cutting expenses to rebalance fiscal budgets versus the need for spending to spur demand and growth.

• Trade off between getting political support from the electorate and doing what is needed to maintain credibility with the markets.

10. The fact is that countries need both growth and austerity, especially countries which are in the midst of the crisis.

11. But what is crucial is for the respective governments to regain the confidence of the markets and commit to a credible plan for adjustment and reform. This is a tricky balance. This may require some overshooting in near term adjustments or financing. Given the heterogeneity within the Eurozone, the pace and extent of the fiscal adjustment and structural reform programmes would need to be specific to individual countries, as a one-size-fits-all approach will not make sense.

12. Moving forward, it would require the recognition of hard economic realities by governments and the people. Leaders will need to find the right balance between market demands and mounting political difficulties. Given the high level of regional economic integration, Leaders will have to ensure their policies can complement one another and yet persuade their citizens to go along for the collective good.

Significant spillover effects to the global economy

13. Beyond the challenges in the Eurozone, we have also observed significant developments to other key economies.

14. The US will continue to grapple with weak recovery. GDP growth decreased from 3% from the last quarter of 2011 to 2.2% in the first quarter of 2012.  Unemployment is trending in the right direction, but remains high at 8%.  In April, there were only 115,000 new jobs created, compared to the 12.5 million jobless Americans. On the other hand, increased consumer spending at 2.9% suggests a glimmering ray of hope at the end of the tunnel. Households have reduced their debt to disposable income by some 20 percentage points from its peak in 2008, to close to 2004 levels. Based on historical precedent, it could suggest that US households could be as much as halfway through the deleveraging process. However, any contagion from the Eurozone crisis could deal a blow to the momentum in the US economy.

15. Economies in Asia are not decoupled from the advanced economies. This is despite there being a dual-speed global economy, with low or negative growth in the advanced economies and relatively high growth in Asia. In fact, IMF’s recent study showed that advanced and emerging economies have grown more interlinked since the global financial crisis.

16. Emerging markets such as China and India are also expected to slow down. In India, growth is expected to slow to 7.1% in 2012 against 7.3% in 2011 due to high inflation which leaves limited space for the Reserve Bank of India to manoeuvre. Policy makers are concerned that they would face subdued growth given the record high trade deficit of US $185 billion, or 9.9% of GDP, in March 2012.

17. In China, economic growth has moderated since first quarter 2012. Export growth slowed to 4.9% year-on-year in April this year, due mainly to the weakness in Eurozone demand. Import growth also suffered a large dip to a meagre 0.3% year-on-year expansion, from 5% growth in the previous month. The biggest downside surprise was in industrial production in China which slowed by 2.6% points to 9.3% year-on-year in April, the first time it fell to single-digit growth since May 2009. Given this weaker-than-expected growth data, analysts have downgraded growth forecasts for the second quarter of 2012 from 8.5% to 7.6%.

18. More recently, policy makers have also signaled the implementation of more proactive fiscal and monetary policy to maintain this growth in China. On 12 May, the PBOC cut the Reserve Requirement Ratio, or RRR, by 50bps.

19. High global oil prices also present a risk to global growth. Oil prices have risen 20% since the start of the year to a high of over US$128 per barrel reported in March. While prices have fallen and supply has increased over the past few weeks, we must continue to monitor the risks and their economic impact, especially with geostrategic developments in the Middle East.

20. The relief is that Asia continues to grow at a high rate. The continued growth in local domestic demand would hopefully buffer the reduction in consumption and demand from Europe. Banking systems are also better capitalised in our part of the world.

Challenges faced by policy makers

21. Against this backdrop, there would be complex and difficult choices facing G20 policy makers. These would include –

(i) Stimulating growth through an innovative mix of fiscal and monetary policies in an environment of high public debt levels and an accommodative monetary policy stance in advanced economies.

(ii) Managing spillover ef fects of further easing of monetary policies in advanced economies, especially on emerging economies.

(iii) Ensuring sufficient credit flow to the real economy to support the growth agenda as banks are deleveraging.

(iv) Ensuring inclusive growth in Europe and US where high unemployment has resulted in strains in the social compact. According to the UN’s International Labour Organisation, the world needs to create 600 million new jobs over the next 10 years to sustain economic growth and maintain social stability.

(v) Fueling global growth, especially in emerging economies through rebalancing external demand with greater domestic demand.

(vi) Stimulating the multilateral trade system to generate sustainable economic activity.

22. Of course, the bigger question now is – what are the possible measures for Europe? As seen from the EU Summit last week, there are no easy solutions, but there are both immediate short term measures and also medium term considerations, mainly, 1) to ready the firewall and ring-fence any contagion, and 2) to ensure sustainable development and growth.

23. To ready the firewall and ring-fence any contagion,

• It would be important to ensure that the European Stability Mechanism (ESM), Europe’s bailout fund, is in force as scheduled on 1 July. National parliaments would need to ratify the treaty to effect this. This would be critical in securing a boost of confidence to markets that Europe has a permanent facility to combat any fallout.

• In terms of monetary policy, the European Central Bank (ECB) would need to make a firm and clear commitment to do whatever it takes to secure financial stability, including (i) Long-Term Refinancing Operations, or LTROs, and (ii) purchases of government debt.

• European leaders would also need to accelerate further integration with more fiscal union and have the necessary institutions to oversee and refinance banks, raise bank deposit guarantees; and provide greater fiscal backing for the Southern states.

• Another option which was raised is to have Eurobonds for further fiscal liability-sharing for a limited amount of debt from reforming Eurozone economies.

24. To promote sustainable development, jobs creation and growth reforms, there would need to be rebalancing within the Eurozone but without compromising fiscal discipline.

• In the near term, increased government engagement with the public and introduction of labour market reforms would be important to sustain public support and stave off negativity on austerity.

• Labour market reforms would be a key component to secure public support given its direct impact on the people’s livelihoods. At the same time, it also helps countries avoid a persistent low output trap following fiscal tightening.

• In the longer term, there is potential for more infrastructure investments in Germany and other AAA-rated countries like the Netherlands. It is encouraging to note that the EU leaders last week had reached consensus to recapitalise the European Investment Bank.

25. There is also scope for further service sector reforms in surplus countries, such as Germany. There are further economic reforms in the service sector which could bolster competitiveness – not only in Greece, Italy and Spain, but also in France and Germany.

Perspectives heading into the Los Cabos Summit

26. This brings us to the Los Cabos Summit next month where these policy options to deal with the Eurozone crisis will undoubtedly take centre stage.  In fact, the results of the Greek elections just the day before will shape both the tone and the outcomes of the Summit.

27. The international community has certainly high stakes riding on this Summit. The Mexican presidency faces the challenge of managing public expectations amidst the current crisis environment coupled with the agenda accumulated from past Summits. Given the narrow policy options available, Leaders will need to be innovative and have to make difficult decisions.

28. The G20 has been credited for responding well to the global financial crisis with the necessary leadership and decisive measures. The strong spirit of international cooperation marked that collective response. This same sense of international cooperation remains fundamental for achieving sustainable global growth going forward.

29. Alongside dealing with the immediate crisis in the Eurozone, it would also be necessary to find a way to sustain global growth over the medium term. G20 leaders should continue the emphasis on fundamentals for a better-balanced global economy and more sustainable growth. Otherwise, we will just lurch from one crisis to another.

30. For this Summit, three workstreams will undergird these fundamentals – the framework for strong sustainable and balanced growth, international financial architecture and financial regulation.

• The Framework (or the MAP) would set the tone for the summit beyond. I would think that the focus should be on implementation, and prioritising measures that would boost medium term growth.

• On the international financial architecture, there would be expectations of progress on the implementation of the 2010 quota and governance reform of the IMF by the G20 member countries as the deadline looms at the IMF Fall meetings in October this year. Progress in this area would be crucial to reiterate the confidence and credibility of countries’ commitments to increase IMF resources and strengthen the global firewall.

• There has also been much progress made in reforming the international financial regulatory environment. In the current transitioning from design to implementation, these generally include measures to improve the capacity of the Financial Stability Board, as well as implementation of various rules and regulations such as shadow banking and OTC derivatives; and policy measures to address systemically important financial institutions. Implementation of these financial regulatory reforms would also be one of the longer term priorities for G20, in order to strengthen the resilience of banking systems and prevent reemergence of the excesses of the last decade.

31. The development agenda of the G20 will also continue to be important.  There is a need to build on past work on the multi-year work plan. Given the recent cutbacks on project finance in emerging economies due to deleveraging of banks, we would likely see some emphasis on promoting infrastructure financing. In fact, infrastructure financing had also taken on greater importance in our regional discussions in Asia especially since European banks provide one-third of trade and project finance in Asia.  At their recent meeting in Manila, ASEAN+3 finance ministers agreed on infrastructure financing as a priority area to be discussed in ASEAN+3 work plan for the year.

Conclusion

32. I have tried, in this speech, to outline the critical components of the G20 Summit deliberations, viz. the need to address the ongoing Eurozone crisis and the need to generate medium term growth prospects. The policy options are not obvious, and the trade-offs would be difficult to make. Much depends on what happens between now and the Summit. We wish the Mexican Presidency all the very best as they steer the discussions and deliver a positive outcome for the global economy.

33. Thank you very much.