How European Financial Sector Reforms affect Developing Countries

The currency wars which were hotly discussed at the G20 are a typical example of the problems faced by developing countries, according to a new SOMO discussion paper. This paper analyses the financial sector reforms enacted upon by the European Union (EU) from the perspective of developing countries and proposes remedies to prevent potential problems.

The author of the paper concludes that many financial reforms which were agreed at several G20 meetings were postponed, not yet implemented or not strictly enacted upon by the EU. Consequently, developing countries – and the EU itself – are still vulnerable to speculation attacks by unregulated hedge funds and currency derivative markets whose reformed supervisors are not yet being installed. The EU law on hedge funds was decided upon yesterday, 11 November, and will not be implemented before 2013.

The fact that developing countries responded with capital controls to the dollar printing by the US and their resulting current currency problems, is a challenge for the EU and also for the G20. The EU is currently negotiating trade and investment agreements with developing countries. Some already negotiated free trade agreements, e.g. the new EU-South Korea free trade agreement, prohibits restrictions on capital movements. Capital controls can only be imposed in exceptional circumstances, and then only for a short period of time. This hardly allows countries to take preventive measures and apply the precautionary principle against speculative attacks. In fact, these trade and investment agreements integrate the EU’s own rules of freedom of capital movement on developing countries. The Lisbon Treaty (Art. 63-66) only allows temporary restrictions on cross-border capital movements with third countries in exceptional circumstances after difficult procedures.

The paper concludes with recommendations to make the EU policy of liberalising financial services through free trade and investment agreements coherent with the EU financial reforms.