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G20 may buoy market sentiment but fiscal split worries

A broad commitment to doubling the resources of the International Monetary Fund and tripling the Asian Development Bank’s war chest for fighting the crisis could also, on the margins, support sentiment toward emerging markets.

But the lack of a globally coordinated fiscal response to the economic crisis from finance ministers and central bankers of the world’s 20 leading economies could yet dampen optimism and cap any followthrough from last week’s stock market bounce.

In a statement released on Saturday, G20 officials stressed their commitment to use whatever tools necessary, including non-standard monetary policies, to get out of the current crisis.

Central banks are open to using “unconventional” monetary policy, multilateral institutions’ resources should be substantially increased, cleaning up banks’ balance sheets is a priority and a pre-requisite to reviving growth, the G20 said.

There were few hard numbers in the statement following two days of meetings, a prelude to the G20 leaders’ summit in London on April 2, but investors’ expectations were low anyway.

Despite the lack of detail, the statement “ticks all the right boxes,” said Sarah Hewin, senior economist at Standard Chartered in London.

“Markets have learned not to expect too much from these summits, but this had the right emphasis. It’s more positive than negative,” Hewin said.

“More broadly, it’s probably slightly positive for risk assets.”

Fiscal divisions

Last week, world stock markets had their best week since a record surge in November, investors were net sellers of U.S. and euro zone government bonds, and oil prices rose for the fourth consecutive week.

The rebound in risk appetite was in large part driven by a strong rally in financial sector share prices after Citigroup and Bank of America, who have received tens of billions of dollars in government aid between them, issued positive statements on recent trading and the 2009 outlook.

The leading European index of banking stocks jumped 18 percent.

Emerging markets may take heart from the proposals to at least double IMF funding to $500 billion or more and triple the ADB’s capital to just over $150 billion.

But as Hewin and others noted, the G20 statement failed to paper over the cracks on fiscal policy between the United States, which favours bolder steps, and the euro zone, which is reluctant to crank up spending further or cut taxes.

“The absence of a coherent, coordinated fiscal reponse globally could damage consumer and business confidence going forward,” said Neil MacKinnon, director and chief economist at ECU Group, a hedge fund based in London.

“A lot of this may have been discounted (by markets) last week. I don’t think there’s anything (in the statement) to surprise the markets,” MacKinnon said.

He didn’t think markets would react strongly to the statement one way or the other, and instead highlighted the negative impact on financial assets that would result from the euro zone’s stance on fiscal policy.

Some analysts believe the euro zone isn’t acting aggressively enough to tackle the deepening recession, either conventional interest rate policy or unconventional measures to boost the money supply, known as “quantitative easing”.

The Bank of England has embarked on a programme, which could eventually be worth some 150 billion pounds, of buying government bonds, and the Bank of Japan and U.S. Federal Reserve have also started buying private sector assets.

The Swiss National Bank last week stunned markets with direct intervention in the foreign exchange market to weaken the Swiss franc, which some analysts said could trigger a wave of competitive currency devaluations.

The G20 statement, however, pledged to fight all forms of protectionism and participants said the issue of beggar-thy-neighbour FX devaluation didn’t arise in talks.