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Minister of Finance of Canada,
to the Interim Committee of the International Monetary Fund,
Washington, September 26, 1999
Thank you Mr. Chairman.
Colleagues, let me begin my remarks by congratulating Chancellor Gordon Brown on his election to the Chair of this committee. It has been a pleasure working with Chancellor Brown over the past two and a half years in a variety of international fora including this committee, the Group of Seven (G-7) and the Commonwealth. He is exceptionally well qualified to lead the Interim Committee in confronting the opportunities and challenges we now face.
The Global Economic Environment
Speaking of challenges and opportunities, it is with some relief that we can, in discussing the global economic outlook, put the emphasis this year a little more on "opportunities" and perhaps a little less on "challenges."
Last year at this time, we were facing a very tenuous situation. You may recall that the World Economic Outlook document opened with the warning:
International economic and financial conditions have deteriorated considerably in recent months as recessions have deepened in many Asian emerging market economies and Japan, and as Russia's financial crisis has raised the specter of default.
The document went on characterize the economic situation at the time as "unusually fragile."
Fortunately, for most of the world—though not all—the risks have not materialized. After the global financial turbulence of the past two years, and its devastating impact on economic activity and living standards in a wide range of countries, there are clear signs that the world economy is on the mend.
In happy contrast to last year, the current World Economic Outlook and other forecasts are showing upward revisions to growth projections for most emerging market and advanced economies. Recoveries in Asia have been surprisingly robust, while recessions in Brazil and Russia have been shallower than expected. Meanwhile, the U.S. economy continues to impress, with its buoyant growth and subdued inflation.
Economic Performance and Prospects in the Constituency
Developments in the Canadian economy have also been more favourable than many expected a year ago. In large measure, this reflects the government's commitment to sound economic and financial policies—low and stable inflation and balanced budgets or better.
Overall economic growth in Canada moderated to 3.1 per cent in 1998, down from 4.0 per cent in 1997. Growth in Canada slowed significantly in the middle of 1998, owing in part to the global financial uncertainty and turmoil of the time. As the effects of this turmoil have passed, growth has strengthened, averaging an annual rate of 4.0 per cent over the last three quarters.
Growth in production shas meant growth in jobs. More than 450,000 jobs were created in 1998, the strongest growth during any year since 1987. So far in 1999, a further 110,000 jobs have been created. The strong growth in employment has brought the unemployment rate down from near 10 per cent at the end of 1996 to 7.8 per cent in August 1999, near a 10-year low.
At the same time, inflation in Canada has remained subdued. Despite the depreciation of the Canadian dollar in 1998, consumer price inflation averaged 0.9 per cent in 1998, down from 1.6 per cent in 1997. Despite recent increases in oil prices, headline inflation in August was 2.1 per cent and core inflation was 1.6 per cent, well within the inflation control targets of 1 to 3 per cent.
Low inflation and the improvement in Canada's fiscal situation have provided the basis for low interest rates in Canada. Apart from the period of instability in international financial markets last fall, short- and long-term rates in Canada have been below corresponding rates in the United States for most of the last three years.
In the survey of private sector forecasts used in the February 1999 budget, private sector forecasters expected growth to average 2.0 per cent in 1999 and 2.5 per cent in 2000. The most recent consensus of private sector forecasters has real gross domestic product growth upgraded to 3.5 per cent in 1999 and 2.6 per cent in 2000. The most recent International Monetary Fund (IMF) Staff projections are consistent with the private sector consensus.
The Irish economy has continued to experience rapid growth with an increase in real gross national product (GNP) of 8 per cent in l998 and an expected 6.5 per cent this year. Consumer price inflation has remained relatively subdued and is expected to average less than 2 per cent in 1999, although underlying measures of inflation saw a somewhat stronger trend. The fiscal surplus is now forecast to be around 3 per cent of GNP and this, together with privatization receipts, is imparting further downward momentum to the debt ratio. Employment expanded by a remarkable 6 per cent in 1998, resulting in net inward migration and a further fall in the unemployment rate, which is now below 6 per cent.
The prospects are for a continuation of this robust performance. While there are growing signs of inflationary pressures in the labour market and in the housing sector, where there has been a persistent strong rise in property prices, the Irish authorities are well aware of the risks which a sustained pickup in inflation would present. Containing those risks is a key focus in their medium-term investment plan, which is currently in preparation, and in ongoing discussions about a possible new arrangement to follow the "Partnership 2000" social contract, which expires shortly.
(c) Caribbean Nations
Despite the turmoil in global financial markets in 1998, economic developments in the Caribbean were generally positive as well, although major risks in the small agriculture-based economies persist, and we have again witnessed the vulnerability of these countries to hurricanes—most recently in the Bahamas. The Caribbean members of the constituency, from the Bahamas in the north to Guyana to the south, with the Organization of Eastern Caribbean States countries and Jamaica in between, had relatively good results last year. While some exceptions were recorded, most economies registered positive real growth, low to moderate levels of inflation and reduced fiscal imbalances. Unemployment was reduced on average, but major pockets of joblessness persist, leaving too many people facing poverty.
For the most part, Caribbean governments have been working diligently to strengthen the international financial architecture. In their efforts, they have begun to improve transparency of fiscal and financial operations. A number of my Caribbean constituents have agreed to participate in the Fund's pilot project on transparency and have put in place mechanisms to adhere to best practices in fiscal and monetary policy. Room for improvement remains in building more robust tax systems and statistical bases, and the region is in need of the Fund's continued support for technical assistance in these areas.
Some members of our constituency, whose economies still rely on export earnings from commodities including bananas, are adjusting to the harsh realities of a new trade regime in the aftermath of the adverse World Trade Organization ruling on bananas. Part of the adjustment strategy includes diversification into services, including tourism and offshore banking as alternatives to agriculture. With respect to offshore banking, these governments are committed to ensuring that this sector develops within the framework of a rigorous regulatory system.
We look forward to the continued support from the international community as the Caribbean pursues its path of economic development in efforts to build and sustain healthy, democratic and productive societies.
Policy Challenges Remain
In part, this year's more favourable global economic outlook reflects a number of policy steps taken over the past year, by both advanced and emerging market countries, to foster greater financial market stability and promote sustainable growth. We can therefore take satisfaction from the way the situation and outlook have improved over the past year. Clearly, however, significant policy challenges remain.
While financial markets may no longer be characterized as "unusually fragile," as they were last year at this time, they are nevertheless far from settled. It is not difficult to imagine situations in the major industrialized as well as the emerging market countries that could provoke a return to instability.
The best hope to avoid such instability lies first with stronger activity in Europe and Japan, combined with continued growth in the United States. This would help to gradually unwind the current account imbalances and facilitate more balanced global growth.
In this regard, it is imperative that the encouraging signs of recovery in Europe and Japan lead to sustained growth. This will require, in addition to appropriately supportive macroeconomic policies, the active implementation of key structural reforms, particularly in the financial sector in Japan and in labour markets in the Euro area.
Furthermore, it is important that emerging market countries continue on the policy course that has helped them exit from the crisis of the last two years. Failure to complete the necessary reform will carry serious risks for all of us.
But perhaps the most serious risk is that we do not succeed in making the reforms that will make our own financial systems and the international system less vulnerable to crisis.
There are at least two reasons why our efforts could fall short.
The first is complacency. We will be making a grave error if we let the return of relative calm in financial markets and the improvement in growth prospects lead us to believe that further reforms are not necessary. Nowhere, it seems, is the oft-quoted phrase that those who forget the past are doomed to repeat it, truer than in financial markets. In the 1990s, history, in the form of financial crisis, has been repeating at an accelerating rhythm.
The second danger is what could be called misdirection. That is, that we get caught up in a flurry of activity that, while giving the appearance of achievement, leaves critical issues or gaps unaddressed.
On the international level, over the past two years a lot has been started. The report by G-7 Finance Ministers to Leaders this past June on reforming the international financial system took more than 20 pages to list all of the reform efforts underway. There have been some real accomplishments in areas such as increasing transparency, in developing codes and best practices, and in the creation of tools for crisis management, such as the contingent credit line and the supplemental reserve facility. These and other measures taken certainly will contribute to more stable financial systems.
But despite this progress, some fundamental questions remain about where we are going with reforms to the international financial architecture. What kind of international financial system should we be working toward? How do we get there? What remains to be done? How do we create the momentum to see that necessary reforms are implemented?
Addressing these questions will require not only time, but the proper institutional infrastructure as well. This is an area where we are making progress.
Canada supports giving a revitalized Interim Committee permanent standing as the International Monetary and Financial Committee (IMFC). The International Monetary Fund must remain at the centre of the international monetary system. To do this, it must have the guidance and support of its members. The reformed IFMC must play this role. But the international system also requires that other institutions support these efforts in their respective areas.
Earlier this year, Canada and its G-7 partners created the Financial Stability Forum. This Forum has the critical role of identifying gaps in the regulation of financial systems and pointing to solutions to address these vulnerabilities. The Forum has set up three working groups that are studying important issues in the international financial system, and Canada looks forward to their reports next spring. Canada has always supported broad representation in the Forum and was therefore gratified to see the initial G-7 membership broadened to include four other major financial centres. Still other countries have been involved in the Forum working groups.
These steps contribute important improvements to the international architecture. As we have seen over recent years, however, we still need a forum that can provide a broad overview and that can address issues that go beyond the responsibilities of any one organization or that involve more than financial regulation per se. The crises of the last two years have clearly demonstrated that there are close links between exchange rate regimes, financial systems, the real sectors of our economies and society at large. The crises have also shown that what happens in emerging markets matters in a big way to everyone. There is therefore a need for an ongoing forum that includes not only industrialized economies, but key emerging and developing economies as well. This Forum will not supplant existing fora and their decision-making roles, but rather will support their efforts.
Canada therefore supports the formation of a new mechanism for ongoing consultation on matters pertaining to the international financial system—the new G-20. It is an honour to have been named its first chairman. This new group will be an effective instrument for focusing on the larger issues and for promoting consistency and coherence to the various efforts and fora aiming at reforming and strengthening the international financial system.
In order to help achieve this, it is important that the group be as flexible as possible, both in the way it operates and in the questions it considers. The group will be a forum where Ministers can talk candidly about important policy issues, in a format that encourages spontaneity. The broadness of the group's mandate will afford it ample opportunity for flexibility in the questions it considers.
At the same time, the new group must take care not to duplicate work underway in other fora. Rather, the G-20 should complement and help coordinate these efforts.
Here we can draw upon the most successful aspects of the G-22 and G-33., Experience with these for a, for example, demonstrated the value of ad hoc working groups of officials to look at technical issues, or to engage in consultations with countries outside the G-20, with international institutions, or with the private sector.
The International Financial Work Program
The workplan of the G-20 and the other fora just mentioned should be dictated by our vision of how we want to see the international financial system evolve.
In general, freer markets are more efficient than tightly controlled or repressed markets and provide the greatest opportunity for improving living standards, our primary objective. But opening markets, trade or financial, must be done in an orderly manner. The experience of the last couple of years, for example, has shown us that there is more to freeing capital markets than simply removing restrictions on the activities of financial institutions. For capital markets to be efficient, effective, and stable, they must rest upon a solid infrastructure comprising accounting standards, supervisory regimes, and coherent regulations and laws to ensure transparency and accountability. They must operate in a sound macroeconomic environment, with low inflation, healthy public finances and an exchange rate regime consistent with the policy framework.
In the last two years, the international community has been doing a great deal of work to flesh out the conditions and criteria necessary for effective and stable financial markets, including transparency codes, best practices and core standards in a variety of areas.
The challenge now is to continue to develop these codes and standards and to see that they are implemented. Two factors determine the extent to which these codes and standards are implemented: capability and incentives.
It makes little sense to develop and endorse codes if we do not assist countries to develop the capability to implement them. Gearing up to participate in world financial markets is not a straightforward task. It requires infrastructure and capabilities that countries may not have or may not even know they need. The IMF can play an extremely useful role in helping countries to establish the preconditions for an orderly and sustainable liberalization of their capital accounts. It can help countries to develop the macroeconomic policy environment necessary for capital account liberalization to succeed. It can advise countries on how best to go about capital account liberalization. And, working with the World Bank and the regional development banks, it can assist countries in developing the capabilities necessary to open their capital accounts successfully. Canada's position is that these advisory roles are the IMF's comparative advantage. Canada is gratified to see the IMF workplan assigning more importance to issues such as proper sequencing of capital market reforms and less to unproductive debates about jurisdiction.
Even when the capabilities exist, however, best practices will not be implemented unless there are the incentives for both governments and private sectors to do it. Overwhelmingly, the most important incentive that governments can put in place to encourage the adoption of best practices is to make the private sector bear the consequences of its own actions and its own bets in financial markets.
We all recognize that no matter how well we do in designing the international financial architecture, there will be other financial crises. It seems to be in the nature of markets to go through periods of excessive enthusiasm, followed by periods of correction, which, if they are sharp enough or serious enough, we call crises.
The question for us is how to ensure an adequate framework so that the private sector can be productively involved when a crisis does break out. The G-7 Finance Ministers, in their Report to Heads at Köln last June, set out a general framework for involving the private sector in crisis resolution. That report outlined tools that might be used, such as collective action clauses in bond contracts, contingent credit lines and creditor committees. Canada has consistently advocated prompt action to review these tools and implement them as appropriate.
What is lacking are not ideas, therefore, but rather a commitment to implement them at the international level. The commitment is lacking because there has up to now been inadequate incentives for creditors and debtors to work out ways of settling their differences in a period of crisis. And in part, the incentives have not existed because of the way we have come to handle crises—with infusions of official money, sometimes in very large amounts.
This has left creditors with the hope that if they do not get their money back, at least their losses will be moderated. Debtors, on the other hand, have been left with the hope that they can avoid the often difficult adjustments that crisis resolution requires.
This way of addressing financial crises cannot continue. In the first place, large-scale official financing, by creating the dynamic just described, may have encouraged excessive and imprudent capital flows, which in turn may have contributed to the frequency and severity of crises.
Secondly, the scale of private capital flows now dwarfs the resources available to the official sector. As a result, official money has usually not prevented the crisis or avoided the need for currency devaluation and debt rescheduling.
Almost of necessity, therefore, we have been moving toward a system where a substantial private sector contribution is an essential part of financing arrangements. The cooperation of private banks was a key element of the Korean and Brazilian assistance packages. In a number of cases more recently—namely for Ukraine, Romania, Pakistan, and Ecuador—private sector involvement has been a prior condition of official assistance or rescheduling.
Canada believes we should push this process further. Canada believes that we need to develop mechanisms that enable an orderly workout of debts. The role of the official sector should essentially be that of a neutral facilitator or a catalyst in the negotiation of this workout arrangement. The provision of large-scale official finance should be a rare occurrence.
In some cases, it has not been possible for the governments to line up adequate private sector funds—this has been the case for Ukraine and Romania. In Canada's view, however, this is in large part owing to the rather ad hoc way we have gone about securing private sector participation. Private money has been a required element of a small number of recent programs. There is not, therefore, acceptance on the part of the private sector that this is a development that is here to stay—that this is the way we plan to deal with crises from now on.
We have to be careful here not to let our rhetoric obscure the issue. There has been a lot of talk about competing approaches: rules versus case-by-case. In fact, these positions are not all that far apart. A rules approach does not imply that we will have a crisis management manual that will dictate strictly what mechanisms will be applied and when. To have the private sector involved in crisis prevention and resolution, however, we are going to have to build on the Köln framework so that private investors will know in advance their responsibilities in the event of a crisis. And we are going to have to ensure the mechanisms or tools, which operate within this framework, balance the rights of creditors and the responsibilities of debtors to ensure that both sides have an incentive to achieve a cooperative solution with adequate financing supplied at an appropriate price.
Each crisis, however, will be unique. Each will have elements that we may not have encountered before. For this reason, we are going to have to be flexible. We will have to be ready to adjust to circumstances.
But we are going to have to be able to lay out in general terms what the role of the private sector is in a crisis. Private investors will demand it. Just last month, for example, one of the major international investment houses wrote in a report on recent efforts by the IMF to involve the private sector in crisis resolution:
The problem with what's going on is not that it is unfair. . . . The markets don't need fairness to work. They do, however, require rules of the game that are comprehensible and reasonably predictable. . . . The danger is that...insistence on a case by case approach, which offers to policy makers . . . maximum discretion and markets maximum insecurity, will eventually pose a real threat to international debt markets.
Work on developing this framework for involving the private sector should be one of the first issues the G-20 deals with, in cooperation with the IMF, as it begins its activities.
Enhanced Structural Adjustment Facility (ESAF)/Heavily Indebted Poor Countries (HIPCs)
Most of my remarks up to now have been devoted to problems and issues facing the international financial system. Earlier, I mentioned a document on the international architecture that Finance Ministers presented to Leaders at the Köln Summit. At the same Summit, however, Finance Ministers also presented a four-page document that may have far more immediate significance to large numbers of people who live in countries too small, too poor, or too unstable to attract the interest of international financial markets. That was the report, endorsed by Leaders, on a more generous debt forgiveness initiative.
Before closing, let me address a few remarks to the HIPC Initiative. Finance Ministers at Köln recognized that the changes to the HIPC Initiative would entail significant costs. We asked the international financial institutions to mobilize their own resources to the greatest extent possible to support this initiative. Canada applauds the efforts that have been made so far at the IMF and the World Bank to identify sources of funds for this initiative.
Canada supports gold sales to enable the IMF to make a contribution to the financing of the ESAF/HIPC fund. At the same time, Canada, as a major gold producer, supports the agreement that has been secured on a way to accomplish this in a manner that will avoid significant disruption to private gold markets.
Additional financing is being provided from bilateral contributions made available through early termination of the Fund's Second Special Contingency Account (SCA-2). This account is no longer required and its resources should be refunded to the original contributors. Canada is prepared to contribute its SCA-2 refund of SDR 11.2 million to ESAF/HIPC.
We stand at a crossroad in the development of the world economy. Over the last 10 years or so, open, market-driven development has become the dominant economic model. More and more countries have adopted this model and, as a consequence, have provided rising living standards for their people.
But the challenges of globalization and the setbacks encountered by a number of countries during the recent crises have raised questions we must address. We need to work to ensure that all countries can benefit from the process of globalization and that we have the right framework to ensure that crises do not wipe out years of gains in living standards. The new architecture we are putting in place will be judged by its success in achieving this.