The seventh G20 summit was held at Los Cabos on June 18 and 19. On the eve of the summit I had written in this newspaper (‘New Lows at Los Cabos?’, Business Standard, June 9, 2012) that expectations were so low that the G20’s leaders could only surprise on the upside. I had also said that while the medium-term agenda of the G20 was progressing satisfactorily, the outcome of the Los Cabos summit was likely to be assessed on its ability to effectively deal with (a) German sensitivities on the euro zone, Brazilian sensitivities on the Rio+20 Summit, and Chinese sensitivities on the exchange rate; and (b) four big imminent threats to the global economy that were not satisfactorily addressed at the sixth G20 (Cannes) summit — namely, instability in the euro zone, faltering growth, demand rebalancing and the threat of disruption of oil supplies. How did things pan out?
The Los Cabos Leaders’ Declaration consists of 86 paragraphs, with statements on all ongoing G20 agenda items such as financial regulatory reform, financial inclusion, employment, social protection, trade, food security, commodity price volatility, development, green growth, the fight against corruption, etc. However, it is what the Declaration had to say on the euro zone and on reviving growth, in the first 19 paragraphs, that expectedly determined the outcome of the summit.
German sensitivities on the euro zone were handled well. The extent to which Germany was forthcoming on euro-zone issues at Los Cabos was surprising. The G20 has for long talked about global rebalancing. But the Los Cabos Action Plan is the first G20 document that acknowledges the need for internal rebalancing in the euro zone. Also, while no specific commitments were given, pointers to the banking union, the severance of the negative “feedback loop between sovereigns and banks” and measures to support growth agreed at the EU summit ten days later are all there in the Los Cabos Leaders’ Declaration and Action Plan.
It is true that nothing definitive was stated about fiscal union, the issue of common “Eurobonds” and conversion of the European Central Bank into a regular central bank that can insulate sovereign bonds from market revolt. But this was primarily because there is no consensus amongst European leaders themselves on these issues. G20 commitments, it must be remembered, are country-led. Failure to address these fatal flaws in the euro zone’s design is also a major failing of the recent European summit, and tantamount to kicking the can further down the road yet again. Having discovered these major weaknesses, markets can be expected to revolt again from time to time. Seeking the comfort of a bottomless Coke that only fiscal union and a central bank can provide, markets see instead Dear Henry’s leaky bucket.
Chancellor Merkel’s statement that the euro zone is in a race against markets might well prove prophetic, eventually pushing the euro zone kicking and screaming into a fiscal union to prevent a catastrophic break-up — and sooner rather than later. Even a banking union might appear shaky to markets unless it is underwritten by harmonised and enforceable euro-wide tax-and-spend policies. Be it as it may, since the major outcomes of the European summit were all anticipated in the Los Cabos Leaders’ Declaration and Action Plan, on the euro zone issue, at least, the Los Cabos Summit surprised on the upside.
Despite the imperative of focusing more on growth and jobs, and providing global leadership on the trade-off between austerity and growth, neither the Leaders’ Declaration nor the Los Cabos Action Plan went one whit beyond Cannes: continue to stimulate if you have the fiscal space, and consolidate if you do not. Arguably the only new thinking on growth was the inclusion of the suggestion of the Indian prime minister that infrastructure investment has a role to play in the global recovery.
It is intriguing that while the Los Cabos Leaders’ Declaration exhorts countries with fiscal space to continue with stimulus, the linkage between fiscal space and stimulus that featured prominently in the Cannes Action Plan has been dropped in the Los Cabos Action Plan. This is perhaps because the general government debt-to-GDP ratios of the countries committing to further discretionary measures have deteriorated beyond the prudential 60 per cent (IMF Fiscal Monitor) and even 90 per cent (Reinhart and Rogoff). The borrowing costs of these countries are no doubt low currently because of the flight to quality, but market confidence can be fickle. This severance between fiscal space and stimulus allowed the US, which was not included in the group of countries with fiscal space at Cannes, and now faces a “fiscal cliff” deriving from the double whammy of automatic federal expenditure cuts and expiry of tax cuts, to now commit to continuing stimulus.
With the sharp decline in the Chinese current account surplus, and the muddying of the “rebalancing” argument by the new narrative on trade that highlights the growing importance of processing trade — and has the effect of sharply reducing China’s bilateral trade surpluses — there was little option but to accommodate Chinese sensitivities on its exchange rate policy. Little attention was however given to the policy implications of the shift in the structure of global imbalances in the direction of oil-exporting countries.
With oil prices dipping below the three-figure mark, the issue of high oil prices and disruption of supplies was to all intents and purposes off the table at Los Cabos, even though the latter threat remains. The Mexicans also considerably watered down their “green growth” initiative to accommodate the concerns of Brazil and other emerging markets, including India.
To sum up, while the seventh G20 Summit at Los Cabos went according to script in most respects, it nevertheless had something significant to say on the euro zone. It could, therefore, be said that it has indeed surprised on the upside.
The writer is a civil servant. These views are personal