Ron Nechemia│At the Epicenter:Where the Financial System Meets the Real Economy

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COVER STORY
At the Epicenter:
Where the Financial System Meets the Real Economy
Cover 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 fi nancial 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 outfl ows would jolt the economy while the
his outlook for the global economy and the world’s supply of securities has been increasing; demand has
fi nancial systems. During this interview, he announced
been even stronger, given limited outlets for savings.
that he saw a systemic fi nancial 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 fi nancial crisis, an oil shock,
months later.
sharply declining consumer confi dence and, ultimately,
a deep recession. Mr. Nechemia’s forecast included As we enter 2009, global fi nancial 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 fi nancial
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 fi nancial institutions
large stand-alone investment banks disappeared from
like Fannie Mae and Freddie Mac. While some viewed
the U.S. fi nancial 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 fi nancial 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.
8 ¦ 2009 FEBRUARY

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International Financing
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 fi nancial
widening swath of the fi nancial sys-
stantial increase in the level of access to
and economic situation?
tem. The ongoing deleveraging process resources.
outlined in my interview in May 2008
Mr. Nechemia: The world economy with International Finance Magazine
is facing its most diffi cult situation in has accelerated and become disorderly—
IFM: What lead global economy
years, against the backdrop of a deep-
marked by a rapid decline in fi nancial
to this global fi nancial crisis?
ening fi nancial crisis that originated in
institutions’ share prices, higher costs
mature 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 and
already in recession. The continued has been sudden failures of institutions
supervisory failure in advanced econo-
strained fi nancial conditions will damp-
as markets have become unwilling (or mies; a failure in risk management in the
en global growth prospects.
unable) to provide capital and funding or
private fi nancial 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 general
face of the present shocks on account of
expected to contract markedly, placing requirements for fi nding an acceptable
solid fundamentals and sound policies, a drag on economic growth not just in
level of market discipline: (1) a market in
coupled with fi nancial buffers built-up the United States, but in other advanced
the fi nancial instruments of the issuer;
over recent years, most emerging mar-
and emerging economies. Global infl a-
(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 from
global fi nancial crisis, with some coun-
mid-year highs. However, the volatility
tries more affected than others.
of infl ation expectations, particularly in
IFM: Where do you think that
emerging markets, is challenging mon-
reform shoud be considered or is
I am greatly concerned about fi nancial
etary authorities in an environment of needed?
contagion spreading to several emerging
slowing growth, and may hamper their
market economies in the form of rever-
ability to respond to potential fi nancial
Mr. Nechemia: Let us also look at
sals in capital infl ows, increased funding
stability concerns.
the issue of reform. Reform is not only
costs, and shifts in investor sentiment
for developing countries. All the coun-
unrelated to fundamentals.
IFM: In the face of all of these tries of the world need to reform and the
Considering that preventing macroeco-
considerations, what can or should
reform needs to be in depth. Because, as
nomic volatility from fi nancial spillovers
be done to mitigate economic risks
we have seen in recent years and realized
and sustaining continuous growth are to developing countries as well as that this system that is some 60 years old
key priorities for developing countries, in advanced economies?
is no longer working, and so we can’t re-
greater fl exibility is needed with regard
form using old instruments. We have to
to fi scal and monetary policies in the
come up with appropriate instruments to
Mr. Nechemia: What we need is
short-run to soften the impact of these
deal with this crisis and the new situa-
comprehensive response to address
external shocks on their economies as
tion facing us.
the strains in fi nancial markets and
country circumstances warrant, while restore market confi dence. I considered The global fi nancial architecture is now
reaffi
rming 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 to
stress that the balance of risks in many
ulation in advanced countries’ fi nancial
take a very in-depth approach to reform.
countries is shifting as infl ation risks
sectors that led to excessive risk-taking We need a new fi nancial order to deal with
have begun to recede and downside risks
and speculation. In this connection, we
this situation. The effects are extremely
to growth have intensifi ed.
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 clearer
IFM: What are the strains af-
accounting rules and transparency.
On March 19, 2002, at the International
fl icting the global fi nancial system
Summit on Financing for Development
at 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 of
Mr. Nechemia: The strains affl icting
from contagion, I advise moving expe-
reform as I saw the need then. The need
the global fi nancial system are expected
ditiously to put in place new fi nancial
applies today, but the message today is
to deepen the downturn in global growth
instruments and mechanism to help even more important than it was in the
and 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 facilities
loop between the fi nancial system and are long overdue. I am calling on the This fi rst United Nations-hosted summit
the broader economy represents a criti-
international fi nancial institutions to to address key fi nancial and develop-
cal threat. The combination of mounting
establish new liquidity instruments in ment issues attracted 50 Heads of State
losses, falling asset prices, and a deep-
order to adequately meet the needs of or Government. In addition to a number
ening economic downturn, has caused
of Presidents and Prime Ministers, over
2 0 0 9 F E B R U A R Y ¦ 9

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COVER STORY
200 ministers participated in the Sum-
their external economic and fi nancial
fl ows to a greater number of developing
mit, including ministers of fi nance, trade
regimes, to the volatile fl uctuations of
countries, but also to maximize their
and foreign affairs; the United Nations private capital fl ows in international fi -
contribution to development.
Secretary-General; the heads of the nancial markets. I stress the importance
World Bank, International Monetary at the national level in the countries con-
I emphasize the need to explore ways
Fund and World Trade Organization; the
cerned of a favorable climate for private
to broaden cooperation and, where
representatives of civil society and the fi nancial fl ows, sound macroeconomic appropriate, coordination of macroeco-
leaders from the private sector. Senior of-
policies and appropriate functioning nomic policy among interested countries,
fi cials of all the major intergovernmental
markets.
monetary and fi nancial authorities, and
fi nancial, 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 promoting
In my address to the Monterrey Summit
ness is done and reduced the costs and a stable international fi nancial environ-
seven years ago, I emphasized the need
increased the speed of international ment conducive to economic growth,
for ‘coherence,’ particularly between fi nancial transactions and that, as policy
particularly of developing countries, tak-
national and international responsi-
liberalization has facilitated international
ing into account the needs of developing
bilities. Lack of concerted action to bring
capital fl ows, fi nancial institutions have
countries as well as situations that may
the benefi ts of development to the vast increasingly added emerging market as-
have a signifi cant impact upon the inter-
majority of humanity that lives in the
sets as part of their portfolios, paving the
national fi nancial system.
developing world would only increase way towards the phenomenon of global
the `ravages of poverty.’ I warned the fi nancial integration.
We need to seek development solutions
respected audience that the road to
that go beyond the trade liberalization,
development is an arduous one and the
Global fi nancial integration presents as trade liberalization is not an ends in
decisions 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. Now
increasingly diffi cult. Finally, I stressed
constitute a very important element, as a day, development policies focus on
that our actions in the area of fi nancing
in order for us to meet the Millennium price stability, rather than growth and
for development are perhaps unique in Development Goals it is imperative to the stability of output. Given the current
that they directly affect the lives and se-
signifi cantly increase the size of overseas
situation we fi nd ourselves in, it’s clear
curity of billions of less fortunate human
development assistant fl ows. This is es-
that we failed to recognize that strength-
beings around the world.
pecially important for the least developed
ening fi nancial institutions is every bit
countries, most of which do not have ac-
as important to economic stability as
I pointed out in the Summit the need to
cess to international fi nancial markets
controlling budget defi cits and increas-
focus, above all things, on coherence and
and do not even constitute a systemic ing the money supply. We focused on
on fi nding better ways of dealing with risk as they are totally marginalised from
privatization, but paid too little attention
the increasing frequency, intensity and the system. Appropriate policies are im-
to the institutional infrastructure that
destructive power of fi nancial and mon-
portant, not only to help attract private
etary crises, such as, but not limited to,
the Asian Financial Crisis (1997 – 1999)
and in Argentina (1999 - 2002), showing
that this is a systemic problem that can
only be solved through coherence among
trade, fi nance, and monetary policies,
coherence between short-term and
long-term development policy objectives,
coherence between the national and in-
ternational responsibilities, the regional
and the interregional cooperation, the
governmental and the intergovernmen-
tal spheres.
The increasingly interdependent world
economy requires a holistic approach
to the interconnected national, inter-
national, and systemic challenges of
fi nancing for development. In address-
ing these challenges, we reaffi rm their
importance.
I have a great concern that a number of
developing countries have become more
The Chairman of the EurOrient Financial Group, Mr. Ron Nechemia addressing the
vulnerable, in the course of liberalizing
UNCTAD-ICC Investment Advisory Council, June 14th, São Paulo - Brazil
10 ¦ 2009 FEBRUARY

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International Financing
is required to make markets work, and
ing and in many ways unprecedented it would be very surprising if a power like
especially to the importance of competi-
challenges of the current crisis. By any China was observing the crisis without
tion.
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 signifi cant 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 fi ve to six
Mr. Nechemia:
Looking beyond the meeting, a new world economic order -point decrease. It is a lot. On the other
the 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 and
are needed in at least three areas related
yet seen. The most important outcome its growth will slow. Nevertheless, the
to the global fi nancial architecture. First, of this G-20 meeting is agreement on an rate of growth will remain higher than
the design of fi nancial 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 the
Third, the mechanisms for more effec-
to act together to meet global macroeco-
Chinese government to rebalance growth
tive, coordinated actions are needed to nomic challenges, using both monetary from trade-led growth to a more domestic
reduce the risk of crises and to address
and fi scal policy.
consumption-led growth, which is what I
them 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 important
current regulatory and supervisory role of the International fi nancial insti- China’s contribution to the resolution of
frameworks at both the domestic and tutions (IFIs) in crisis management and the crisis, at least as growth is concerned,
international levels. Open fi nancial mar-
the reform of the international fi nancial
is mainly linked to its capacity to shift
kets can provide tremendous benefi ts by
architecture. In addition, the commit-
the main driver for growth from external
lowering 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 diffi cult circumstances
this potential. As has been demonstrated
with rapid and effective support, the
all too graphically, fi nancial innova-
availability of a new short-term liquidity
IFM:
You mentioned China’s
tion and integration have increased the
facility and other instruments and other
stimulus plan. Given that there is
speed and extent to which shocks are facilities are of signifi cant importance.
some debate about how much of
being transmitted across asset classes
China’s stimulus package is really
and economies. However, regulation
new spending, do you think China
and supervision remain geared at indi-
IFM:
The economic stimulus needs to consider more stimulus?
vidual fi nancial institutions and do not packages: Will it work, and for
adequately consider the systemic and whom?
Mr. Nechemia: I think China defi -
international implications of domestic
nitely has room for more stimulus. The
institutions’ actions. Moreover, macro-
Mr. Nechemia: I welcome the em-
government announced this initial
prudential tools do not suffi ciently take
phasis on fi scal stimulus, which I believe
stimulus package, and they could poten-
into account business and fi nancial
is now essential to restore global growth. tially announce another one later on. We
cycles, which has led to an excessive If coordinated, each country’s fi scal will see more clarity around that when
buildup of leverage.
stimulus can be twice as effective in rais-
China announces the budget for next
year, which will be around March. But
The challenge, therefore, is to design ing domestic output growth if its major
there has already been discussion within
new rules and institutions that reduce trading partners also have a stimulus China about further stimulus, including
systemic risks, improve fi nancial in-
package.
some measures to stimulate private con-
termediation, and properly adjust the How will this fi nancial crisis affect sumption. I think China defi nitely has
perimeter 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 defi nitely should look at.
against this fi nancial turmoil?
IFM: What is the signifi cant
outcome of the G-20 Summit on
IFM: Who should lead the fi -
Financial Markets and the World IFM: How will this fi nancial nance of the fi scal expansion that
Economy 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 recognize
Mr. Nechemia: The G-20 Summit participation in the world action that some countries have more room to
on Financial Markets and the World against this fi nancial turmoil?
maneuver than others. Those countries—
Economy demonstrated the increasingly
advanced and emerging economies—with
powerful agreement in favor of broad Mr. Nechemia: I reemphasize, there the strongest fi scal policy frameworks
action in order to confront the daunt-
is no part of the world that is immune and
and with the ability to fi nance fi scal ex-
2 0 0 9 F E B R U A R Y ¦ 11

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COVER STORY
pansion, and the most clearly sustainable
adjustment can help absorb some of the
IFM: What is your near-term
debt 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 outfl ows.
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 should
IFM: What are the deepening remain under pressure from global fi nan-
concentrate their efforts on achieving
global challenges and policy re-
cial deleveraging for some time.
such an outcome, as the emergence of
sponses?
substantial output gaps in economies
around the world would leave a legacy
Mr. Nechemia: Let me begin with IFM: Is there a negative impact of reduced output, lost opportunities
the challenges confronting the global to the move toward permanently and sacrifi ced well-being. The measures
economy more generally. As I have noted, higher capital ratios?
needed to avoid this encompass both
global growth prospects have deteriorated
renewed efforts at stabilizing fi nancial
sharply. At the EurOrient Financial Group,
Mr. Nechemia: The ongoing uncer-
systems, as well as monetary and budget
we now project that the world economy tainty surrounding valuations of what measures to support fi nal demand.
will grow by a maximum of two percent
were once thought to be low-risk assets
next year, and that advanced economies
has led to diffi culties in judging capital At the present, global fi nancial markets
will contract by at least a quarter percent
adequacy. Therefore, capital buffers will
appear to have stepped back from the
over the same period. Growth prospects
need to be higher than previously thought, brink in response to aggressive policy
for many fast-growing emerging econo-
eight percent. Moreover, they should be
support measures. Nonetheless, the great
mies have also been undermined by the
based on a forward-looking analysis of danger of renewed deterioration remains
sharp 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 severely
emerging economies will expand by fi ve
strained. These negative developments
percent in 2009, although with consid-
To the extent that the move to perma-
refl ect deep shocks that have undermined
erable regional variation and signifi cant
nently higher capital ratios is mandated, confi dence in fi nancial market counter-
downside risks. Thus, a priority for many
the ratios should be phased in and shall
parties, persistent concerns over future
emerging market economies will be to
be increased gradually and over an losses and funding needs, and large losses
take actions that bolster confi dence 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 existing
social safety nets.
cyclical downturn of the real economy. Restoration of fi nancial stability would
Though achieving higher levels will fur-
now benefi t from a publicly-stated col-
Around the world, the policy responses
ther slow the restoration of normal credit
lective commitment by the authorities
to unfolding global economic challenges
conditions, the process should be under of the affected countries to address the
have been varied. Advanced countries way by late 2009 in order to put fi nancial
issue in a consistent and coherent man-
have actively sought to address underly-
institutions in a better position to sup-
ner. However, piecemeal interventions of
ing weaknesses through the use of public
port the recovery.
the authorities in their effort to address
balance sheets to recapitalize fi nancial
institutions, provide comprehensive gov-
ernment guarantees, and extend liquidity
provisions. Monetary and fi scal initia-
tives to help support global demand are
also being pursued. Indeed, with infl a-
tion receding, central banks in advanced
and emerging market countries have also
taken steps to ease monetary policy.
While macroeconomic policies are cru-
cial to sustaining demand, emerging
economies face an additional challenge.
That is, to ensure that the unfolding li-
quidity squeeze does not transform into
a solvency crisis. Indeed, deleveraging is
now impacting emerging market coun-
tries in general, including those with
relatively strong fundamentals. Some
countries with liquid domestic fi nancial
markets, which previously received large
capital infl ows, have experienced abrupt
reversals of external fi nancing fl ows. Past
experience 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
12 ¦ 2009 FEBRUARY

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International Financing
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 fi nancial condi-
damentals—including its substantial
ited to no succeed in restoring market tions and strengthen demand support cushion in offi cial reserves, improved
confi dence, as they have not addressed
measures could still enable a gradual macroeconomic policy frameworks
the widespread nature of the underlying
recovery on or about June of 2009, pres-
and generally robust corporate balance
problems. The intensifying worries about
ently it seems that further reduction to sheets and banking systems—the region
counterparty risks have created a near the growth forecast is likely.
is being rattled by the crisis due to its
lock-up of global money markets.
close trade and fi nancial integration with
the rest of the world. Any hope that the
In the broadest sense, the authorities’ IFM: Do you see a substantial region would escape the crisis unscathed
principal 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-cyclical
policy 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-
Thus, fi nancial market deleveraging is cisive actions are warranted to maintain
Mr. Nechemia: In summary, ac-
still underway, underpinning our base fi nancial stability and support growth in
tion across a range of areas is needed
case expectation of a substantial and the region, as exports weaken and spill-
to help the global economy and fi nan-
sustained slowdown in credit growth overs from the global fi nancial turmoil
cial systems regain their footing. With
through the coming year. Moreover, fi -
weigh on domestic activity.
fi
nancial markets worldwide facing
nancial stresses have spread to emerging
growing turmoil, internationally coher-
While the baseline scenario for Asia
markets, where equity market downturns
ent and decisive policy measures will
sees recovery beginning in the second
by now have equaled or outstripped those
be required to restore confi dence in the
half of 2009, risks to the outlook are
in advanced economy markets, and where
global fi nancial system. Failure to do
signifi cantly larger than usual and tilted
outfl ows from debt markets threaten to
so could usher in a period in which the
to the downside. A deeper and more
reverse the structural progress that has
ongoing deleveraging process becomes
protracted global slowdown than cur-
been one of the most striking recent fi -
increasingly disorderly and costly for the
rently anticipated, combined with tighter
nancial market developments.
real economy. Macroeconomic policies—
international fi nancial conditions from especially fi scal stimulus—should play
Against the background of weak fi nancial
the ongoing global deleveraging, could an important role in bolstering demand,
markets, my forecast based on current have signifi cant spillovers to the region
while fi nancial sector policies continue
fi nancial and economic policies is for through both exports and a range of fi -
to be implemented and fi ne tuned as
global economic growth to decelerate to
nancial channels. It remains unclear how
needed.
maximum of two percent in 2009, down
domestic demand in the region would
from about fi ve percent last year. I’m also
stand up to a sharp decline in export The broad picture that I have sought to
scaling back my economic projections for
growth and tighter fi nancial conditions.
develop here today is one where it has
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 fi nancial sys-
tem regain their footing. An impressive
consensus has emerged about the re-
forms required to redesign the fi nancial
system, and they are substantial. Macro-
economic policy action—especially fi scal
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
fi ne tuned as needed. And collectively,
we must work together to strengthen the
global fi nancial 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
fi nancial integration and cross-border
fi nancing 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
2 0 0 9 F E B R U A R Y ¦ 13

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