Ordinarily, high-level global meetings aren’t expected to produce much of substance. But the G20 meeting, to be held on April 2 in London, may be the exception.

As policy-makers around the world grapple with a rapidly deteriorating global economy, the G20 summit is shaping up as policy-makers’ best opportunity to revive growth and reshape the future of finance.

When the leaders of the G20 countries hurriedly convened in Washington, D.C., this past November, the financial crisis was growing serious, and the spillover effects into the real economy were becoming evident. In response, participating countries pledged to deliver substantial fiscal stimulus, avoid protectionism and work on the regulatory reforms that the market failures exposed by the crisis seemed to demand.

Since then, many countries (including Canada) have tabled fiscal stimulus packages that represent, as agreed, at least 2% of gross domestic product. Monetary policy has also done its part, as central banks around the world have slashed rates effectively to zero and have moved into alternative ways of boosting money supply through credit and quantitative easing.

Yet, the global economic outlook continues to deteriorate. The International Monetary Fund recently reduced its forecast for global growth in 2009; it is now expecting a contraction of 0.5%-1% this year, down from 3.2% growth in 2008.

The so-called “advanced economies” are the big drag on the global economy, with the IMF forecasting a drop of 3%-3.5% in their collective GDP in 2009. The IMF predicts overwhelmingly modest but still positive growth of 1.5%-2.5% in the emerging and developing economies this year.

The IMF report notes that despite major stimulus packages from many of the advanced economies and several emerging markets: “Trade volumes have shrunk rapidly, while production and employment data suggest that global activity continues to contract.”

Private-sector economic forecasts are also being pared back. In a mid-March research note, economists at New York-based Morgan Stanley Inc. chopped their estimate for 2009 global GDP growth , calling for a contraction of 1.2%, vs an earlier 0.3% contraction.

“The global economy is currently in its deepest and most synchronized postwar recession,” the Morgan Stanley research note says. “In fact, with the exception of China, India and another lucky few, GDP is likely to contract in almost every country around the globe that we cover.”

Canada appears unlikely to escape this simultaneous worldwide downturn. A recent Merrill Lynch Canada Inc. report slashed Merrill’s 2009 GDP forecast for Canada, calling for a 3% contraction, vs the previously forecast 2.1% decline, because of lower expected capital expenditures, consumption and inventories — factors, the report says, that are being only modestly offset by higher government spending.

Indeed, in the same way that globalization boosted economic growth on the upside, it is similarly aggravating the decline on the downside. “The single most important factor behind the latest revisions [to GDP forecasts],” Morgan Stanley’s report explains, “is the transmission of shocks around the world from a vertiginous drop in global trade.” According to the report, global trade is down by 25% from a year ago. “As a consequence, global industrial output has kept spiralling downward since the start of the year. Companies are busy slashing inventories and [capital expenditures].”

The immediate challenge for the G20 is in arresting this trend. The basic prescription hasn’t changed much since the November meeting — governments need to provide fiscal stimulus, resist protectionism and help banks restart the flow of credit. But the governments of the G20 countries do need to be persuaded to redouble their efforts, given that existing programs have yet to do the trick.

“The mutually reinforcing negative feedback loop between the stalling real economy and the still corrosive financial services sector has intensified,” warns the IMF report. As a result, the report states worries that the prospects for recovery before the middle of 2010 are fading.

“Delays in implementing comprehensive policies to stabilize financial conditions would result in a further intensification of the negative feedback loops between the real economy and the financial system,” the IMF has warned G20 policy-makers, “leading to an even deeper and prolonged recession.”

This stance is echoed by the Institute of International Finance, which is calling for countries to increase their fiscal stimulus efforts and revive credit markets by working to remove toxic assets from bank balance sheets. In particular, the IIF calls on policy-makers to adopt the “bad bank” approach, in which governments set up institutions to buy impaired assets from troubled banks, clearing the way for those banks to lend again.

@page_break@The original U.S. bank bailout plan was supposed to be used to buy up troubled assets. Instead, it went to recapitalize banks. The second phase of the bailout plan has promised to remove these assets by establishing a public/private mechanism to buy these assets rather than taking the “bad bank” approach. Details of the U.S. Treasury Department’s latest plan to clean up bank balance sheets have just been released, and its efficacy remains uncertain.

That said, an international forum such as the G20 probably won’t produce anything concrete beyond a general commitment to try to restart credit and, possibly, some agreement on how best to do that. It’s probably not going to lead to a global bad bank, or anything like that.

Measures such as this are surely a local prerogative. So, while the G20 can press for these sorts of solutions, it remains up to national governments to implement the approach that fits their economic and political realities.

For example, while the last meeting produced an agreement to provide 2% of GDP in fiscal stimulus, the response hasn’t been uniform spending plans. Some countries have been able to meet the target, while others have fallen short.

In the coming summit, there will probably be calls from some countries for more stimulus, with others feeling that they are already tapped out.

Notably, the members of the European Union met in Brussels in late March to agree on their approach to the G20 meeting. While they explicitly rejected protectionism, they didn’t produce commitments for further fiscal stimulus (beyond 5 billion euros for renewable energy and broadband projects, and up to 50 billion euros in assistance to struggling central and Eastern European countries).

The EU did agree to loan the IMF another US$100 billion, if necessary, to support growth in the developing world. And the EU also agreed to develop principles for reforming the banking sector.

Indeed, while reviving the global economy is the most immediate challenge facing the G20, financial services sector reform is its other top priority. Given the global nature of finance — and the global nature of financial crises — reaching some sort of international consensus on just how regulation must change is imperative.

In the weeks leading up to the summit, that consensus appears to be emerging. First, at the meeting of finance ministers and central bank governors from the G20 in mid-March, policy-makers agreed that credit-rating agencies must face regulatory oversight; firms must be required to reveal their exposures to off-balance sheet vehicles; there needs to be improvements in accounting standards; and greater standardization in credit derivatives markets is needed, among other things.

Participants at the March meeting also called on the leaders attending the London Summit to modify capital requirements to combat pro-cyclicality and constrain leverage, and increase vigilance for mounting systemic risks. They also suggested that systemically important financial services firms, including hedge funds, must face adequate oversight, and that international co-operation to prevent and deal with future financial crises be improved.

To boost global co-operation and risk monitoring, the IIF is calling for the establishment of a global body, comprising regulators and central banks, which will harmonize standards, enhance co-operation and co-ordinate supervision and oversight of the financial services industry. The IIF has already established the Market Monitoring Group, which is being co-chaired by former Bank of Canada governor David Dodge (along with Jacques de Larosière, former managing director of the IMF and former governor of the Banque de France). The group will watch for gathering systemic risks such as liquidity and concentration risk, mispriced risk, excessive leverage and crowded trades.

An even more detailed road map to future financial services regulation came with the release of a review by Britain’s Financial Services Authority of global banking regulation, which calls for sweeping regulatory changes.

The FSA’s review echoes demands for greater oversight of important market players such as hedge funds and credit-rating agencies. It also recommends tougher capital and liquidity requirements, including requiring banks to hold more — and higher quality — capital, and that risky activities such as trading face much higher capital charges than they have in the past.

The FSA also proposes changes to combat pro-cyclicality by requiring banks to accumulate more capital in good times, so that they have more to draw on in bad times. And the FSA is calling for international action to ensure that industry compensation policies don’t provide perverse incentives for excessive risk-taking, among various other things.

Overall, a consensus seems to be building toward a more tightly regulated, capital-intensive — and, therefore, less efficient, less profitable — financial services industry. And increasing regulation isn’t the only headwind facing the industry.

The current economic outlook, while universally bleak, is also highly uncertain. The global recession could be much deeper and longer than many expect. Or, if policy action is bolder and more effective than many expect, the rebound could be sharper and faster — possibly giving way to new problems, such as inflation caused by the massive fiscal and monetary stimuli being pumped into the global economy.

However, once this period of extreme uncertainty and volatility subsides, the economic outlook for the longer term could well be fundamentally gloomier.

Economists at Morgan Stanley caution that, beyond 2010, there are “strong reasons” to expect significantly lower average economic growth rates. This could mean lower private-sector leverage, reduced economic efficiency resulting from the bigger presence of governments in the global economy, and the ongoing rapid decline in capital expenditures, which, the Morgan Stanley report notes, “is likely to reduce potential output growth over the next several years.”

At best, the upcoming summit may produce enough concerted policy action to arrest the economic decline, and the regulatory reforms will put the financial services business in a safer albeit less lucrative place. But the road back to real prosperity looks to be still well off in the distance. IE