Review and analysis of the June 2010 meeting of world leaders in Toronto

By Craig Alexander, Senior Vice President and Chief Economist, TD Bank Financial Group

The G-20 Toronto Summit reconfirmed key policy areas that leaders are looking to make progress on and acknowledged the importance of fiscal consolidation.

The G-20 Toronto Summit Declaration (the Declaration) contained a commitment to maintain progress on the policy framework laid out at the Pittsburgh meeting in September 2009, with the added dimension of a dedication to fiscal consolidation. We will have to wait until the Seoul Summit in November before new rules on bank capital requirements, liquidity and leverage ratios are defined in detail.

The concluding theme of the Toronto G-20 meeting was that while countries agreed on many major policy objectives, they also acknowledged that a one-size-fits-all approach is not feasible. It remains to be seen if the same theme on financial reform will be repeated in Seoul. In the end, the Toronto Summit essentially laid out a broad range of issues where there was agreement on assessments and principles.

Fiscal consolidation

The substantive new development that came out of the Toronto Summit was that members outlined a specific framework for simultaneous fiscal adjustment. The Declaration noted that “advanced economies have committed to fiscal plans that will at least halve deficits by 2013 and stabilize or reduce government debt-to-GDP (gross domestic product) ratios by 2016.”

However, while formally recognizing that a specific timetable was a new development for the G-20, the focus on deficit-cutting was not. A number of G-20 countries had already pledged or introduced new budgets to reduce their fiscal deficits that are in line with “halving” by 2013. For instance, Germany’s current budget pledges to achieve its constitutional limit of 0.3% of GDP deficit by 2016. In turn, the United Kingdom, a week prior to the meeting, released a new budget including a decline of 9.9 percentage points in public sector net borrowing, from 11% of GDP in fiscal year 2009/10 to 1.1% of GDP in fiscal year 2015/16. So the commitments made by many of the countries at the G-20 were the same promises made to their constituents.

The greater challenge is dealing with the structural deficits that have accumulated. In addition, the time frame is merely guidance and not a hard target, as the Declaration stated that fiscal consolidation will be “differentiated to national circumstances,” and “those with serious fiscal challenges need to accelerate the pace of consolidation.”

The commitment to stabilize the debt-to-GDP ratio by 2016 certainly has some ambiguity attached to it because stabilization could mean different things to different countries. For instance, the U.S. Congressional Budget Office projects that this ratio will steadily climb from 63% of GDP in 2010 to 90% in 2020 under President Obama’s proposed budget in March. The rate at which this ratio climbs, however, decelerates over that period.

In contrast, Canada’s debt-to-GDP ratio is expected to peak in 2011/12 at roughly 35% and edge down thereafter. Ultimately, it will be the financial markets that will dictate what deficit and debt levels can be tolerated from a country and – as we saw with Greece – markets will enforce discipline on those that stray beyond their comfort level.

Financial reform

As expected, there were no specific guidelines defined on financial reform, as final proposals by the Basel Committee on Banking Supervision and the Financial Stability Board are scheduled for the next G-20 Summit to be held in Seoul on November 11th and 12th. Regarding capital requirements, the Declaration states that “the amount of capital will be significantly higher and the quality of capital will be significantly improved when the new reforms are fully implemented. This will enable banks to withstand – without extraordinary government support – stresses of a magnitude associated with the recent financial crisis.” The implementation deadline remains end of 2012.

However, once again there was acknowledgment in the Declaration that one size does not fit all, as “phase-in arrangements will reflect different national starting points and circumstances.” Reaching agreement on the specifics of a new capital framework, as well as calibration of new liquidity and leverage ratios, should be accomplished at the time of the Seoul Summit.

Leading into Toronto’s Summit, many countries (notably Germany and France) promoted the idea that financial institutions ought to pay for any costs associated with government intervention to repair the financial system. The G-20 leaders addressed the issue by recognizing that “there is a range of policy approaches. Some countries are pursuing a financial levy. Other countries are pursuing different approaches.” In other words, there will not be a universal bank tax, as was initially put forward by European members.

Global imbalances

On the issue of global imbalances, G-20 leaders agreed that “advanced deficit countries should take actions to boost national savings while maintaining open markets and enhancing export competitiveness.” Meanwhile, “surplus economies will undertake reforms to reduce their reliance on external demand and focus more on domestic sources of growth.” However, leaders “recognize that these measures will need to be implemented at the national level and will need to be tailored to individual country circumstances.”

Regarding the pending conclusion of the World Trade Organization (WTO) Doha round, G-20 leaders reiterated their support for a “balanced and ambitious conclusion as soon as possible, consistent with its mandate and based on the progress already made.” However, G-20 members missed the opportunity for setting a date for holding the concluding negotiations.

Concluding remarks

The G-20 Toronto Summit provided little in the way of new developments to highlight, but reconfirmed the key policy areas that leaders were looking to make progress on, acknowledging the importance of fiscal consolidation over the medium term and global-growth rebalancing. The Seoul Summit will be a tougher test for G-20 leaders because the expectation will be on achieving final agreement on financial regulation reform; decisions will have to be made on very specific issues that will not allow for vague statements.

However, the phase-in of new regulations will be conditioned to different national starting points, and recent trends set a worrisome precedent for the upcoming negotiations. Indeed, the U.S. intends to pass its own financial reform act, which stresses the prospects for individualistic approaches. The key risk is that an uncoordinated approach could fuel regulatory arbitrage, as firms try to exploit the differences in regulatory frameworks across jurisdictions.

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