In combination with structural problems in Europe and the current worldwide repercussions of the US real estate turmoil, the current situation has provoked greater investor nervousness.
As long as those structural problems are not solved and macroeconomic imbalances further persist, I am rather pessimistic for 2008. Whether we will land softly depends on the willingness to take up these challenges ahead.
2. Is the renminbi overvalued or undervalued?
The renminbi is undervalued. The example of South Korea shows that China is bound to appreciate due to its prosperous economic development. Nevertheless, a further appreciation is not yet in the interest of the Chinese government. An appreciation of the national currency would risk stalling growth and reduce badly needed employment gains. Also, it would cause tremendous losses in Chinese foreign exchange reserves.
The undervaluation is not the only challenge to China: I am rather concerned about the growth of international excess liquidity and the looming asset bubbles around the globe.
3. What should be the role of the IMF/World Bank?
The amount of foreign exchange reserves in those emerging markets defending pegged exchange rates and the available liquidity are higher than ever before. Regarding a nowadays highly efficient international market for government bonds, the World Bank should focus on promoting the improvement of infrastructure and especially of financial institutions in developing markets.
The IMF should reform its distribution of votes by taking into account the increasingly important role of emerging markets and Africa. Today’s representation by votes still reflects the dominance of G8 countries and is a relic from the previous century. The new central task of the IMF will certainly be the surveillance of macro and exchange rate policies of emerging and developing countries.
4. Are sovereign wealth funds to be applauded or feared?
The proposed reactions to sovereign wealth funds do not convince me. It is in our interests to maintain an open economy and not to offer any loopholes for protectionist measures by arbitrary rules. This will compromise the confidence of international investors in the long run.
Some supporters of counter measures could refer to reciprocity as a means: Why should we open our markets if the others do not do the same? Plans like these are only credible and effective if we maintain a leading role in international competition. Thus, Europe should concentrate on reforming its own structural deficiencies rather than trying to keep invigorating competition outside.
5. Are emerging market crises a thing of the past?
Not necessarily. First of all, public finances in most emerging markets are doing well. However, let’s not forget that financial crises may also be triggered by problems in the financial system. To reduce the risk of future crises, the further development of financial sectors in most emerging markets should be supported by prudent regulations.
Most investors tend to ignore the risks linked to investments in emerging markets. Hence, in case of a reorientation among investors, worldwide capital liquidity enables investors to withdraw their funds quickly – even faster than during the payment crises in the last decade.