Looking Beyond Today's Financial Crisis: Moving Forward with International Financial Reform - Address by Michel Camdessus

February 24, 1999

99/3 Remarks by Michel Camdessus
Managing Director of the International Monetary Fund
to the Foreign Policy Association
New York, February 24, 1999

I am very happy to join you for what is—for me at least—the real occasion of the day, namely to honor Alice Rivlin. I am really very proud to have been chosen to play my part in this duet. It is also a great honor to acknowledge your award tonight. I acknowledge it with special gratitude as it entails a somewhat infrequent recognition of the extraordinary demands that have been placed on the IMF during the financial crisis of the past four years. For reaching such a decision, you must be remarkably nonconformist, a virtue in dramatically short supply at present.

Mr. Chairman, you invited me to try, this evening, to look beyond today's financial crisis. But, what is this crisis? Why did it arise? And are we still in crisis?

The crises in the emerging market economies have arisen from complex interactions among shortcomings associated with three highly positive global trends:

  • The growth of capital markets, facilitated by high technology and sophisticated financial instruments, led to an upsurge in capital flows to emerging markets, some of it highly mobile. But decisions were too often based on inadequate risk assessment by the investors.

  • Many emerging markets tried to open their capital accounts to reap the benefits of competition and international finance. But too often the sequence of liberalization was not appropriate, and supporting policies were too weak. The creation of conditions that would encourage more stable, longer term flows lagged behind the rapid de facto freeing of short-term flows, as banks and corporations in the emerging markets sought ways of taking advantage of abundant finance.

  • Economic policy in most countries has leaned toward freer markets, a smaller role for the state, and the use of indirect instruments of macroeconomic management. But countries in many cases were deficient in one or both of two vital areas: they did not strengthen their governance or their economic institutions, especially prudential and risk management mechanisms; and their macroeconomic management was not sufficiently robust.

A moment's reflection on all the recent crises reveals elements of each of these factors, in varying proportions. In Asia the dominant factors were shortcomings in governance and financial sector soundness. In Brazil, concerns over the past several years had related to the sustainability of fiscal policy. And in Russia, after only a few years of uneven reform, following seventy years of Soviet rule, clearly the deficiencies were too widespread for the economy to withstand major external shocks and policy shortcomings.

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Are we still in crisis? It may seem paradoxical, at first, to suggest that we face a global crisis:

  • when economies accounting for the major part of world output still seem to be in quite sound health;

  • when Asia clearly is on the mend;

  • when Brazil is strengthening its post-float economic policy framework—and I am confident that you will soon hear some good news about it; and

  • when markets seem to be differentiating better than in the past between countries still in crisis, and other countries, like Argentina and Mexico, that have already implemented substantial economic reforms.

There are positive indications that, while many risks are still with us, the worst seems to be past—albeit at a great cost, and thanks also to tremendous efforts and courageous programs of reform. I would like to salute here the Philippines, Thailand, Korea, Indonesia, and many of the 60 countries that are now implementing IMF-supported programs. These programs are bearing fruit even if each country still faces the continuing challenges of pursuing deep structural reform. It is clear that Thailand and Korea are emerging from crisis. As it has recently been a fashionable pastime to identify flaws or mistakes in the IMF programs in Asia, let me help you in identifying another one. Less than three months ago when we last published our global projections, we said that although recovery was coming in Korea, it would be slow, and for the year as a whole, output would fall by 1 percent in 1999. But the people of Korea were so courageous, and the program worked so well that we have already had to correct our forecast. We are beginning to see what could be a V-shaped recovery practically as speedy as Mexico's in 1996. Now Korea is expected to expand by 2 percent in 1999, that is, 3 percentage points faster than we thought in December. Another mistake? It is good to be mistaken that way!

Yes, a number of countries are starting to emerge stronger than before but not all the factors of the crisis have been eradicated, and the sequels will be with us for some time. To mention just one: capital flows to the emerging markets remain—and will remain for some time—far below pre-crisis levels. This leads to some far-reaching questions. How can the world continue to reap the benefits of globalization without suffering the pitfalls and periodic country crises? How can capital flows be encouraged to resume to the emerging markets? How can the economic and financial systems of emerging market economies be strengthened to reduce the risk of future crises? And, if crises do occur, how will they be managed? These questions summarize the issues that governments and the main international financial institutions are now striving to address, as they attempt, as we say a little pompously, to redesign the global financial architecture.

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These crises are, in large part, the product of a global financial system whose speedy evolution has outpaced the adaptation of institutions and regulatory devices. In this country and other successful national financial systems, a complex, constantly evolving, blend of law, regulation, voluntary codes of behavior, and ethics, define both the way in which market participants interact, and the appropriate roles of government and regulators. This is what is conspicuously missing at the international level, and this is why the search for global reform largely focuses on the establishment of an analogous framework in the international arena. This is a huge task indeed.

Where are we heading to now? Broadly speaking, consensus has emerged on the nature of the problem, and on an agenda for action which, last October, was defined by the IMF Interim Committee, and is now reflected in the work of many other international fora and bodies. If I had to capture in one sentence the basic thrust of all this work, I would say: no new machinery, no new heavy public intervention, but for all players, both public and private, better behavior and practices based on transparency, accountability, and cooperation. Could this suffice? Let us see how it may work by analyzing the key features that seem to be emerging from all this work.

First, even if the crisis has made a few commentators—and thankfully even fewer policymakers—nostalgic for a system relying on exchange controls, I believe it will be a financial system based on integrated, open capital markets. History tells us that it is foolhardy to resist progress or new inventions. Globalization is a trend that is with us to stay, and our challenge is to tap its full potential while making sure that the process is an orderly one. The international community continues to endorse the principles and the orderly approach for liberalizing capital markets adopted at our 1997 Hong Kong Annual Meetings. The turbulence of the past two years should strengthen rather than diminish our commitment to the integration of financial markets through properly sequenced capital liberalization, underpinned by a broad range of structural measures—especially in the financial and banking sector—and by sound macroeconomic and exchange rate policies.

But the process of liberalization will need to be monitored, and, I repeat, properly sequenced. This will be the task of the IMF. The adaptation of our Articles of Agreement for this purpose is one of the important topics we are now concentrating on.

Second, in international life, good governance will gain increasing prominence, based on the tenets of transparency and accountability, in both the public and private domains. What does this mean in practice? It requires:

  • Governments to conduct macroeconomic policy and financial sector regulation in a transparent framework, and to provide timely, high-quality information;

  • Private sector participants to adhere to internationally recognized standards of accounting, reporting, and auditing, and to behave according to accepted standards of corporate governance;

  • International institutions to become more transparent and accountable to all their members.

On that also, work is advancing. Within the IMF, we are pressing our members to adopt a new code on transparency in their fiscal policies, and we are working with others to design a similar code for monetary and financial policies. We are also on the verge of consensus on an important enhancement to the Fund's established standard for data dissemination that will strengthen the reporting of countries' international reserves positions and attached liabilities—a critical element in contributing to the ability of markets and institutions to assess countries' economic positions more accurately. Other agencies have developed or are working on standards for securities markets, accounting, auditing, and bankruptcy. And work is under way in the OECD and the World Bank on defining clear standards for corporate governance.

But the greater challenge lies beyond the mere definition of standards—in the process of implementation. Countries need new laws, new institutions, and strong professionals to adopt and apply the new standards. And the international community needs mechanisms to make the standards operational and to monitor progress. The IMF, which has been given a universal mandate for surveillance, will have here a critical role—a daunting task indeed—for which it will need to avail itself of the support of the variety of other bodies with more practical experience in each of these specific areas.

Third—and this cannot be emphasized enough—the soundness of the global financial system will rest squarely on the existence of sound national financial institutions based on internationally recognized standards for the regulation and supervision of financial institutions. Already the broad principles are well established: a set of Core Principles was finalized in a global effort led by the Basle Committee on Banking Supervision. Let me pay tribute here to the extraordinary work of Bill McDonough whom you so rightly honored earlier. We in the IMF are already actively engaged in helping to make these principles fully operational by highlighting them in our policy dialogue with countries, especially those that are seeking early access to international capital markets.

But here also considerable challenges remain. First, we face a straightforward global resource constraint: there are simply not enough people with the necessary skills to make these standards workable around the world in short order. Second, already many feel that the Basle Capital Accord needs to be updated in light of the rapidly changing global environment, and this update is in progress. And third, national regulators, especially in the industrial countries, face the difficult but inescapable issue of establishing a better regime of regulation and supervision of hedge funds and other highly leveraged operations. In moving forward, we will be strongly helped by the creation of the "financial stability forum"—the centerpiece of the Hans Tietmeyer Report, endorsed last Saturday in Bonn. But all of that will take some time to be fully operational.

Fourth—what initiatives are needed to create the conditions encouraging the private sector to seek more and more opportunities in world markets while shouldering a fair share of the risks and responsibilities that may arise? These are complex issues certainly calling for more innovative thinking than so far. The nub of the issue is to help to channel private capital flows to where they will be used best, and to enable investors to assess risks realistically while accepting the consequences of poor decisions. Indeed, that is the objective of most elements of the reforms that I have already mentioned. But when things do go wrong and crisis breaks out, what role should be expected of the private sector?

Even if at times exaggerated, moral hazard issues pervade the debate on this question. Clearly we must reduce the perception—and the reality—of easy bailouts either for countries or for their creditors. In fact, as you are well—and at times, painfully—aware, both investors and countries in crisis have taken sharp losses. One challenge, critical to preventing crises in the first place, is to make sure that we do not protect either unduly risky behavior by investors or lax policies by debtor governments. Another challenge in designing crisis management mechanisms is to ensure that officially-supported rescue packages are adequately financed—including voluntary private sector sources—and to ensure that the burden of adjustment does not fall on debtor nations disproportionately. The range of issues to be addressed is daunting. But it is in everyone's interest that solutions are found, as the active and well-conceived involvement of the private sector—including in post-crisis financing—should ultimately improve the prospects for both the countries and the investors themselves.

Fifth, the concept of good governance will have to be rounded off with a firm commitment to sound social and human development policies, as we must endeavor to spread the benefits of globalization widely across nations and within nations. This is key for the sustainability of our programs. Sound economic policies and equitable social policies are mutually reinforcing. High-quality growth is the most effective antidote to poverty. Preventing crises is the best way of avoiding the loss of income to the poor. Stronger financial systems, better governance, and all the other improvements we seek through the new architecture, must contribute to crisis prevention. And if crises do occur, strong and well-articulated social protection will be central in generating broad-based support among the population for the necessary adjustment effort. I have taken great encouragement from the G-7 ministers of finance and central bank governors, who, in their communiqué on international financial reform a few days ago, reiterated their call for the development of a set of general principles of good practice in social policies to protect the most vulnerable groups in society.

The monetary character of the IMF has not deterred it, especially since the 1980s, from taking an increasingly robust stance on social policies, expenditures, and safety nets. But other institutions, especially the World Bank and the ILO, have more precise mandates for advising governments on social policies. The task ahead is to find ways of encouraging governments, while pursuing sound fiscal policy, to make adequate budgetary provision for social spending, and to enter into a dialogue with their natural partners: employers and unions. I acknowledge that this is not an easy task, but as advancement of human welfare is our ultimate objective, this social pillar, coupled with the strong focus on alleviation of poverty of Jim Wolfensohn's initiative for a comprehensive development framework at the World Bank, will have to be central to the new architecture.

Sixth—even if this does not call for any very spectacular architectural creation—it is crystal clear that a renewed commitment to—and if needed, strengthened arrangements for—intensified cooperation among the leading industrial countries is essential for the pursuit of more balanced growth and greater stability in the international monetary system.

In a globalized economy, every country is dependent on the good performance of the others, and now we know only too well about the systemic consequences of mistakes even in small or medium-sized countries. This tells us a lot about the formidable responsibilities of the "Seven" in their common but still too elusive pursuit of higher, domestically-generated, growth. It is our task to encourage them to counter excessive volatility in exchange markets and to compete for excellence in their policy mix and structural policies. This is what "responsible internationalism" would primarily mean for them.

Finally, the international financial institutions, including the IMF, must be adapted and strengthened. For the IFIs as a whole, I see three aspects of this adaptation: first, their internal reform toward more efficiency; second, clearer mandates from the international community for their respective roles in a reformed system; and third, the coordination of their activities not only with each other but also with the objectives of overall international reform.

Let me tell you briefly what this could mean for the IMF.

First, we are seeking ways of building on the extensive steps we have taken in recent years to increase the transparency of our operations, except of course where this might compromise the confidentiality which is key to an effective policy dialogue with our members.

Second—this may disappoint our most vociferous critics—the IMF will not be abolished! Neither will it be transformed into a global central bank nor into a full-fledged lender of last resort. Nevertheless, there are some aspects of this latter function that can usefully be developed at this stage—difficult though it may be. Specifically, the proposed contingency financing mechanism would permit rapid, large-scale lending to pre-qualified countries and at higher rates of charge than our ordinary facilities. We are actively working on a first generation of such contingency credit lines. You could, of course, observe that such an instrument will not offer an adequate response to what you could call the "mother of all crises," one resulting from a protracted interruption of private sector lending to a broad range of developing or emerging countries. True! But to believe that when the international community does start to concentrate on that not totally unrealistic risk, we will have to ask ourselves if the SDR, which was created in a quite different context, perhaps offers a valuable instrument to confront such a major threat.

Finally, the international community is seeking ways of reforming or transforming the Interim Committee, the ministerial-level body—representative of the IMF's global membership—that currently has only an advisory role in formulating IMF policies. I believe the case is growing ever stronger for giving this body more authority and decisiveness. To crown the new architecture, the world needs a mechanism for making sure that all countries are legitimately and actively represented at the place where key monetary and financial orientation are adopted. This was precisely the intention of those who introduced to our Articles of Agreement the possibility of replacing the Interim Committee by a council with similar composition but endowed with real decision-making powers. This is an initiative for which the only question to answer is "When?" I personally believe the sooner the better, but the debate on this simple question may well take some time.

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In conclusion, let me bring you back to the present. Some commentators are worried that the sense of urgency for reform seems to have dissipated in recent weeks or that with so many fora, the debate lacks a cohesive framework for achieving resolution. I can sympathize with the bewilderment and the frustration of these observers, but we must keep moving forward steadily and injecting the best possible contributions to this process. As I cannot conceive any place in the world where imagination, sense of initiative, and influence could be in better supply than here, this evening, let me call on all of you, who have been exceedingly generous in your appreciation for me, to join forces with us and use imagination, initiative, and influence to make sure, as Alice would put it, that we "revive the world's dreams" and enter the 21st century with better chances for stability and growth with a human face.


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