Eurorient ron nechemia at the epicenter where the financial system meets the real economy
COVER STORYAt the Epicenter:Where the Financial System Meets the Real EconomyCover Story Interview for International Finance Magazine on November 28, 2008. Mr. Ron Nechemia is the Chairman of the Board of On November 5, 2007, in a special interview to Viet Directors for EurOrient Financial Group, a private sector Nam Television, he warned that Viet Nam was likely to global development ﬁnancial institution that is accredited face economic deterioration and challenges to maintain by the United Nations General Assembly on Financing control of the stock market in the face of the boom in for Development. In May 2008, Mr. Nechemia was share prices. He further posited that a sudden reversal interviewed by International Finance Magazine regarding and capital outﬂows would jolt the economy while the his outlook for the global economy and the world’s supply of securities has been increasing; demand has ﬁnancial systems. During this interview, he announced been even stronger, given limited outlets for savings. that he saw a systemic ﬁnancial crisis brewing and warned In this case, Mr. Nechemia’s predictions were also that in the months to come the United States was likely stunningly accurate and these events did occur six to face a once-in-a-lifetime ﬁnancial crisis, an oil shock, months later. sharply declining consumer conﬁdence and, ultimately, a deep recession. Mr. Nechemia’s forecast included As we enter 2009, global ﬁnancial institutions and a bleak sequence of events: Homeowners defaulting markets have been badly shaken. Threats to systemic on mortgages, trillions of dollars of mortgage-backed stability became manifest in September 2008 with the securities unraveling worldwide and the global ﬁnancial collapse or near-collapse of several key institutions. The system shuddering to a halt. These developments, far-reaching nature of the events that are unfolding is he foretold, could cripple or destroy hedge funds, illustrated by the fact that within a period of only one week, investment banks and other major ﬁnancial institutions large stand-alone investment banks disappeared from like Fannie Mae and Freddie Mac. While some viewed the U.S. ﬁnancial landscape. It is against this challenging his comments to be overly pessimistic at the time, Mr. and still evolving backdrop that International Finance Nechemia’s predictions proved accurate in less than half Magazine gave Mr. Nechemia a second interview to ask a year. him his view on recent events in the ﬁnancial systems and to suggest potential policy measures that could be In fact, Mr. Nechemia has a strong record of correctly helpful in the present global economic climate. analyzing market data and predicting economic events.
IFM: Mr. Nechemia, can you de- serious doubts about the viability of a developing countries as well as for a sub-scribe the current global ﬁnancial widening swath of the ﬁnancial sys- stantial increase in the level of access toand economic situation? tem. The ongoing deleveraging process resources. outlined in my interview in May 2008Mr. Nechemia: The world economy with International Finance Magazineis facing its most difﬁcult situation in has accelerated and become disorderly— IFM: What lead global economyyears, against the backdrop of a deep- marked by a rapid decline in ﬁnancial to this global ﬁnancial crisis?ening ﬁnancial crisis that originated in institutions’ share prices, higher costsmature markets. Advanced economies of funding and credit default protection, Mr. Nechemia: The crisis is the re-are slowing markedly and some are and depressed asset prices. One result sult of three failures: A regulatory andalready in recession. The continued has been sudden failures of institutions supervisory failure in advanced econo-strained ﬁnancial conditions will damp- as markets have become unwilling (or mies; a failure in risk management in theen global growth prospects. unable) to provide capital and funding or private ﬁnancial institutions; and also a absorb assets. failure in market discipline mechanism.Although developing countries as a group Market discipline mechanism requi-have so far been relatively resilient in the In particular, the supply of credit is sites should including the three generalface of the present shocks on account of expected to contract markedly, placing requirements for ﬁnding an acceptablesolid fundamentals and sound policies, a drag on economic growth not just in level of market discipline: (1) a market incoupled with ﬁnancial buffers built-up the United States, but in other advanced the ﬁnancial instruments of the issuer;over recent years, most emerging mar- and emerging economies. Global inﬂa- (2) enforceable credit contracts; and (3)kets and developing economies are not tion risks have moderated on the back of a market for corporate control.immune to the spillovers of the ongoing sharp declines in commodity prices fromglobal ﬁnancial crisis, with some coun- mid-year highs. However, the volatilitytries more affected than others. of inﬂation expectations, particularly in IFM: Where do you think that emerging markets, is challenging mon- reform shoud be considered or isI am greatly concerned about ﬁnancial etary authorities in an environment of needed?contagion spreading to several emerging slowing growth, and may hamper theirmarket economies in the form of rever- ability to respond to potential ﬁnancial Mr. Nechemia: Let us also look atsals in capital inﬂows, increased funding stability concerns. the issue of reform. Reform is not onlycosts, and shifts in investor sentiment for developing countries. All the coun-unrelated to fundamentals. tries of the world need to reform and the IFM: In the face of all of theseConsidering that preventing macroeco- reform needs to be in depth. Because, as considerations, what can or shouldnomic volatility from ﬁnancial spillovers we have seen in recent years and realized be done to mitigate economic risksand sustaining continuous growth are that this system that is some 60 years old to developing countries as well askey priorities for developing countries, is no longer working, and so we can’t re- in advanced economies?greater ﬂexibility is needed with regard form using old instruments. We have toto ﬁscal and monetary policies in the come up with appropriate instruments to Mr. Nechemia: What we need is deal with this crisis and the new situa-short-run to soften the impact of these comprehensive response to addressexternal shocks on their economies as tion facing us. the strains in ﬁnancial markets andcountry circumstances warrant, while restore market conﬁdence. I considered The global ﬁnancial architecture is nowreafﬁrming their continued commit- it essential to address the deep-rooted showing its cracks, showing its weak-ment to prudent policies. Moreover, I weaknesses in risk management and reg- nesses, and therefore, we really have tostress that the balance of risks in many ulation in advanced countries’ ﬁnancial take a very in-depth approach to reform.countries is shifting as inﬂation risks sectors that led to excessive risk-taking We need a new ﬁnancial order to deal withhave begun to recede and downside risks and speculation. In this connection, we this situation. The effects are extremelyto growth have intensiﬁed. shall underscore the need for funda- serious, not only for developed countries, mental reform of the regulatory and but also for developing countries. supervisory framework as well as clearerIFM: What are the strains af- accounting rules and transparency. On March 19, 2002, at the Internationalﬂicting the global ﬁnancial system Summit on Financing for Developmentat the present time? In order to help reduce developing coun- held in Monterrey, Mexico, I delivered tries’ vulnerability to crises, including a speech on this very issue, the issue ofMr. Nechemia: The strains afﬂicting from contagion, I advise moving expe- reform as I saw the need then. The needthe global ﬁnancial system are expected ditiously to put in place new ﬁnancial applies today, but the message today isto deepen the downturn in global growth instruments and mechanism to help even more important than it was in theand restrain the recovery. Moreover, the prevent or deal with crises. The introduc- beginning of the new Millennium.risk of a more severe adverse feedback tions of new types of liquidity facilitiesloop between the ﬁnancial system and are long overdue. I am calling on the This ﬁrst United Nations-hosted summitthe broader economy represents a criti- international ﬁnancial institutions to to address key ﬁnancial and develop-cal threat. The combination of mounting establish new liquidity instruments in ment issues attracted 50 Heads of Statelosses, falling asset prices, and a deep- order to adequately meet the needs of or Government. In addition to a numberening economic downturn, has caused of Presidents and Prime Ministers, over
COVER STORY200 ministers participated in the Sum- their external economic and ﬁnancial ﬂows to a greater number of developingmit, including ministers of ﬁnance, trade regimes, to the volatile ﬂuctuations of countries, but also to maximize theirand foreign affairs; the United Nations private capital ﬂows in international ﬁ- contribution to development.Secretary-General; the heads of the nancial markets. I stress the importanceWorld Bank, International Monetary at the national level in the countries con- I emphasize the need to explore waysFund and World Trade Organization; the cerned of a favorable climate for private to broaden cooperation and, whererepresentatives of civil society and the ﬁnancial ﬂows, sound macroeconomic appropriate, coordination of macroeco-leaders from the private sector. Senior of- policies and appropriate functioning nomic policy among interested countries,ﬁcials of all the major intergovernmental markets. monetary and ﬁnancial authorities, andﬁnancial, trade, economic, and monetary institutions. We want to enhance preven-organizations were present. We recognize that where technological tive consultation arrangements between change has revolutionized the way busi- such institutions as a means of promotingIn my address to the Monterrey Summit ness is done and reduced the costs and a stable international ﬁnancial environ-seven years ago, I emphasized the need increased the speed of international ment conducive to economic growth,for ‘coherence,’ particularly between ﬁnancial transactions and that, as policy particularly of developing countries, tak-national and international responsi- liberalization has facilitated international ing into account the needs of developingbilities. Lack of concerted action to bring capital ﬂows, ﬁnancial institutions have countries as well as situations that maythe beneﬁts of development to the vast increasingly added emerging market as- have a signiﬁcant impact upon the inter-majority of humanity that lives in the sets as part of their portfolios, paving the national ﬁnancial system.developing world would only increase way towards the phenomenon of globalthe `ravages of poverty.’ I warned the ﬁnancial integration. We need to seek development solutionsrespected audience that the road to that go beyond the trade liberalization,development is an arduous one and the Global ﬁnancial integration presents as trade liberalization is not an ends indecisions facing the developing countries new challenges and opportunities for itself, but a means to more sustainable,and the international community will be the international community. It should equitable, and democratic growth. Nowincreasingly difﬁcult. Finally, I stressed constitute a very important element, as a day, development policies focus onthat our actions in the area of ﬁnancing in order for us to meet the Millennium price stability, rather than growth andfor development are perhaps unique in Development Goals it is imperative to the stability of output. Given the currentthat they directly affect the lives and se- signiﬁcantly increase the size of overseas situation we ﬁnd ourselves in, it’s clearcurity of billions of less fortunate human development assistant ﬂows. This is es- that we failed to recognize that strength-beings around the world. pecially important for the least developed ening ﬁnancial institutions is every bit countries, most of which do not have ac- as important to economic stability asI pointed out in the Summit the need to cess to international ﬁnancial markets controlling budget deﬁcits and increas-focus, above all things, on coherence and and do not even constitute a systemic ing the money supply. We focused onon ﬁnding better ways of dealing with risk as they are totally marginalised from privatization, but paid too little attentionthe increasing frequency, intensity and the system. Appropriate policies are im- to the institutional infrastructure thatdestructive power of ﬁnancial and mon- portant, not only to help attract privateetary crises, such as, but not limited to,the Asian Financial Crisis (1997 – 1999)and in Argentina (1999 - 2002), showingthat this is a systemic problem that canonly be solved through coherence amongtrade, ﬁnance, and monetary policies,coherence between short-term andlong-term development policy objectives,coherence between the national and in-ternational responsibilities, the regionaland the interregional cooperation, thegovernmental and the intergovernmen-tal spheres.The increasingly interdependent worldeconomy requires a holistic approachto the interconnected national, inter-national, and systemic challenges ofﬁnancing for development. In address-ing these challenges, we reafﬁrm theirimportance.I have a great concern that a number ofdeveloping countries have become more The Chairman of the EurOrient Financial Group, Mr. Ron Nechemia addressing thevulnerable, in the course of liberalizing UNCTAD-ICC Investment Advisory Council, June 14th, São Paulo - Brazil
is required to make markets work, and ing and in many ways unprecedented it would be very surprising if a power likeespecially to the importance of competi- challenges of the current crisis. By any China was observing the crisis withouttion. standards, the Summit laid out an ambi- being in any way concerned. tious agenda.IFM: Where do you think the global ﬁ- Of course, when growth in China de-nancial system can and should improve? The G-20 Summit was signiﬁcant because creases from 11 percent to 6 percent or of the people present. As an outcome of maybe 5 percent in 2009, it is a ﬁve to sixMr. Nechemia: Looking beyond the meeting, a new world economic order -point decrease. It is a lot. On the otherthe immediate challenges, the crisis has is developing that is more dynamic and hand, 6 percent of growth is also a lot. So,made clear that new thinking and action more inclusive than any that we have China will be impacted by the crisis andare needed in at least three areas related yet seen. The most important outcome its growth will slow. Nevertheless, theto the global ﬁnancial architecture. First, of this G-20 meeting is agreement on an rate of growth will remain higher thanthe design of ﬁnancial regulation needs action plan and the commitment of all other developing countries.to be improved. Second, a better way of participants to implement the plan vig-assessing systemic risk must be found. orously and fully; and the commitment I think it is a good opportunity for theThird, the mechanisms for more effec- to act together to meet global macroeco- Chinese government to rebalance growthtive, coordinated actions are needed to nomic challenges, using both monetary from trade-led growth to a more domesticreduce the risk of crises and to address and ﬁscal policy. consumption-led growth, which is what Ithem when they occur. am recommending. It will also have good I am very pleased about the G-20 lead- consequences on the exchange rate.This crisis has shown the limits of the ers’ strong support for the importantcurrent regulatory and supervisory role of the International ﬁnancial insti- China’s contribution to the resolution offrameworks at both the domestic and tutions (IFIs) in crisis management and the crisis, at least as growth is concerned,international levels. Open ﬁnancial mar- the reform of the international ﬁnancial is mainly linked to its capacity to shiftkets can provide tremendous beneﬁts by architecture. In addition, the commit- the main driver for growth from externallowering the cost of capital, but more ment that was made to helping countries demand to domestic demand.effective regulation is needed to realize that are facing difﬁcult circumstancesthis potential. As has been demonstrated with rapid and effective support, theall too graphically, ﬁnancial innova- availability of a new short-term liquidity IFM: You mentioned China’stion and integration have increased the facility and other instruments and other stimulus plan. Given that there isspeed and extent to which shocks are facilities are of signiﬁcant importance. some debate about how much ofbeing transmitted across asset classes China’s stimulus package is reallyand economies. However, regulation new spending, do you think Chinaand supervision remain geared at indi- IFM: The economic stimulus needs to consider more stimulus?vidual ﬁnancial institutions and do not packages: Will it work, and foradequately consider the systemic and whom? Mr. Nechemia: I think China deﬁ-international implications of domestic nitely has room for more stimulus. Theinstitutions’ actions. Moreover, macro- Mr. Nechemia: I welcome the em- government announced this initialprudential tools do not sufﬁciently take phasis on ﬁscal stimulus, which I believe stimulus package, and they could poten-into account business and ﬁnancial is now essential to restore global growth. tially announce another one later on. Wecycles, which has led to an excessive If coordinated, each country’s ﬁscal will see more clarity around that whenbuildup of leverage. stimulus can be twice as effective in rais- China announces the budget for next ing domestic output growth if its major year, which will be around March. ButThe challenge, therefore, is to design there has already been discussion within trading partners also have a stimulusnew rules and institutions that reduce China about further stimulus, including package.systemic risks, improve ﬁnancial in- some measures to stimulate private con-termediation, and properly adjust the How will this ﬁnancial crisis affect sumption. I think China deﬁnitely hasperimeter of regulation and supervision, China’s economic growth in the coming the room for that and, should the down-without imposing unnecessary burdens. years? Could you possibly comment on side scenario that I imagine evolve, that’s China’s participation in the world action something they deﬁnitely should look at. against this ﬁnancial turmoil?IFM: What is the signiﬁcantoutcome of the G-20 Summit on IFM: Who should lead the ﬁ-Financial Markets and the World IFM: How will this ﬁnancial nance of the ﬁ scal expansion thatEconomy in Washington, D.C., crisis affect China’s economic is necessary as a ﬁ scal stimulus?held on November 14- 15, 2008? growth in the coming years? Could you possibly comment on China’s Mr. Nechemia: We should recognizeMr. Nechemia: The G-20 Summit participation in the world action that some countries have more room toon Financial Markets and the World against this ﬁnancial turmoil? maneuver than others. Those countries—Economy demonstrated the increasingly advanced and emerging economies—withpowerful agreement in favor of broad Mr. Nechemia: I reemphasize, there the strongest ﬁscal policy frameworksaction in order to confront the daunt- is no part of the world that is immune and and with the ability to ﬁnance ﬁscal ex-
COVER STORYpansion, and the most clearly sustainable adjustment can help absorb some of the IFM: What is your near-termdebt should take the lead. This includes, pressures arising from external current economic outlook?but is not limited to, Japan and to China account weakening and capital outﬂows.in Asia. At the same time, comfortable reserve Mr. Nechemia: Vigorous policy ac- buffers help ensure the availability of tion is needed in order to avoid a serious foreign currency liquidity if countries global downturn. The authorities shouldIFM: What are the deepening remain under pressure from global ﬁnan- concentrate their efforts on achievingglobal challenges and policy re- cial deleveraging for some time. such an outcome, as the emergence ofsponses? substantial output gaps in economies around the world would leave a legacyMr. Nechemia: Let me begin with IFM: Is there a negative impact of reduced output, lost opportunitiesthe challenges confronting the global to the move toward permanently and sacriﬁced well-being. The measureseconomy more generally. As I have noted, higher capital ratios? needed to avoid this encompass bothglobal growth prospects have deteriorated renewed efforts at stabilizing ﬁnancialsharply. At the EurOrient Financial Group, Mr. Nechemia: The ongoing uncer- systems, as well as monetary and budgetwe now project that the world economy tainty surrounding valuations of what measures to support ﬁnal demand.will grow by a maximum of two percent were once thought to be low-risk assetsnext year, and that advanced economies has led to difﬁculties in judging capital At the present, global ﬁnancial marketswill contract by at least a quarter percent adequacy. Therefore, capital buffers will appear to have stepped back from theover the same period. Growth prospects need to be higher than previously thought, brink in response to aggressive policyfor many fast-growing emerging econo- eight percent. Moreover, they should be support measures. Nonetheless, the greatmies have also been undermined by the based on a forward-looking analysis of danger of renewed deterioration remainssharp declines in commodity prices and risk, rather than a mechanical applica- very high in several markets, while fund-their demand. We now anticipate that tion of regulatory ratios in the present. ing and liquidity markets are still severelyemerging economies will expand by ﬁve strained. These negative developmentspercent in 2009, although with consid- To the extent that the move to perma- reﬂect deep shocks that have underminederable regional variation and signiﬁcant nently higher capital ratios is mandated, conﬁdence in ﬁnancial market counter-downside risks. Thus, a priority for many the ratios should be phased in and shall parties, persistent concerns over futureemerging market economies will be to be increased gradually and over an losses and funding needs, and large lossestake actions that bolster conﬁdence in extended period of time so that their at- in bank and other institutions’ capital.their policies while strengthening the tainment does not amplify the existingsocial safety nets. cyclical downturn of the real economy. Restoration of ﬁnancial stability would Though achieving higher levels will fur- now beneﬁt from a publicly-stated col-Around the world, the policy responses ther slow the restoration of normal credit lective commitment by the authoritiesto unfolding global economic challenges conditions, the process should be under of the affected countries to address thehave been varied. Advanced countries way by late 2009 in order to put ﬁnancial issue in a consistent and coherent man-have actively sought to address underly- institutions in a better position to sup- ner. However, piecemeal interventions ofing weaknesses through the use of public port the recovery. the authorities in their effort to addressbalance sheets to recapitalize ﬁnancialinstitutions, provide comprehensive gov-ernment guarantees, and extend liquidityprovisions. Monetary and ﬁscal initia-tives to help support global demand arealso being pursued. Indeed, with inﬂa-tion receding, central banks in advancedand emerging market countries have alsotaken steps to ease monetary policy.While macroeconomic policies are cru-cial to sustaining demand, emergingeconomies face an additional challenge.That is, to ensure that the unfolding li-quidity squeeze does not transform intoa solvency crisis. Indeed, deleveraging isnow impacting emerging market coun-tries in general, including those withrelatively strong fundamentals. Somecountries with liquid domestic ﬁnancialmarkets, which previously received largecapital inﬂows, have experienced abruptreversals of external ﬁnancing ﬂows. Pastexperience suggests that exchange rate EurOrient Delegation lead by Ron Nechemia meets with His Excellency the Prime Minister Hun Sen and the Supreme Economic Council, Royal Government of Cambodia on April 24, 2002
the liquidity constraints and resolve the the recovery in 2010. While I believe that Despite Asia’s generally strong fun-troubled institutions will have very lim- the efforts to stabilize ﬁnancial condi- damentals—including its substantialited to no succeed in restoring market tions and strengthen demand support cushion in ofﬁcial reserves, improvedconﬁdence, as they have not addressed measures could still enable a gradual macroeconomic policy frameworksthe widespread nature of the underlying recovery on or about June of 2009, pres- and generally robust corporate balanceproblems. The intensifying worries about ently it seems that further reduction to sheets and banking systems—the regioncounterparty risks have created a near the growth forecast is likely. is being rattled by the crisis due to itslock-up of global money markets. close trade and ﬁnancial integration with the rest of the world. Any hope that theIn the broadest sense, the authorities’ IFM: Do you see a substantial region would escape the crisis unscathedprincipal tasks are to help reduce the slowdown in Asia due to the global has by now evaporated.global economy’s systemic instabilities turmoil?and to promote effective counter-cyclicalpolicy action, as well as to respond Mr. Nechemia: Asia is facing the IFM: Can we conclude this inter-timely to both a structural and a cyclical risk of a sharp slowdown as the global view with a brief summary?changes. economy enters a major downturn. De- cisive actions are warranted to maintain Mr. Nechemia: In summary, ac-Thus, ﬁnancial market deleveraging is ﬁnancial stability and support growth in tion across a range of areas is neededstill underway, underpinning our base the region, as exports weaken and spill- to help the global economy and ﬁnan-case expectation of a substantial and overs from the global ﬁnancial turmoil cial systems regain their footing. Withsustained slowdown in credit growth weigh on domestic activity. ﬁnancial markets worldwide facingthrough the coming year. Moreover, ﬁ- growing turmoil, internationally coher-nancial stresses have spread to emerging While the baseline scenario for Asia ent and decisive policy measures willmarkets, where equity market downturns sees recovery beginning in the second be required to restore conﬁdence in theby now have equaled or outstripped those half of 2009, risks to the outlook are global ﬁnancial system. Failure to doin advanced economy markets, and where signiﬁcantly larger than usual and tilted so could usher in a period in which theoutﬂows from debt markets threaten to to the downside. A deeper and more ongoing deleveraging process becomesreverse the structural progress that has protracted global slowdown than cur- increasingly disorderly and costly for thebeen one of the most striking recent ﬁ- rently anticipated, combined with tighter real economy. Macroeconomic policies—nancial market developments. international ﬁnancial conditions from especially ﬁscal stimulus—should play the ongoing global deleveraging, could an important role in bolstering demand,Against the background of weak ﬁnancial have signiﬁcant spillovers to the region while ﬁnancial sector policies continuemarkets, my forecast based on current through both exports and a range of ﬁ- to be implemented and ﬁne tuned asﬁnancial and economic policies is for nancial channels. It remains unclear how needed.global economic growth to decelerate to domestic demand in the region wouldmaximum of two percent in 2009, down stand up to a sharp decline in export The broad picture that I have sought tofrom about ﬁve percent last year. I’m also growth and tighter ﬁnancial conditions. develop here today is one where it hasscaling back my economic projections for been recognized at the highest level of political authority that action across a range of areas is needed urgently to help the global economy and the ﬁnancial sys- tem regain their footing. An impressive consensus has emerged about the re- forms required to redesign the ﬁnancial system, and they are substantial. Macro- economic policy action—especially ﬁscal policy—is becoming increasingly relevant and necessary for a broad swath of coun- tries. Financial sector policy reforms also must continue to be implemented and ﬁne tuned as needed. And collectively, we must work together to strengthen the global ﬁnancial architecture in a way that reduces future risks by re-examining regulatory weaknesses, forging ahead with new tools for detecting vulnerabili- ties, and recognizing the importance of ﬁnancial integration and cross-border ﬁnancing in designing regulations and new mechanisms for crisis prevention and resolution. IFM The Chairman of the EurOrient Financial Group, Mr. Ron Nechemia during the interview with International Finance Magazine, May 15th 2008, Beijing, The People’s Republic of China