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at the 53rd meeting of the Interim Committee of the Board of Governors on the International Monetary System
September 26, 1999
(1) The world economy
First, regarding the effects of the international financial crises (which began with the Asian crisis in 1997) on the global economy, the steady cooperative efforts by the international community toward strengthening the international financial system have begun to bear fruit, and as a result the world economy has been regaining stability over the past year.
In the United States, while the good economic performance continues, there are potential risks, as evidenced by the further rise in stock prices, the continuing decline in personal savings rates, and the rapid increase in the current account deficit. The authorities are expected to continue their prudent and appropriate economic management.
In the Euro zone, economic conditions are becoming brighter, backed by the ECB's relaxation of monetary policy and the recovery in foreign demand. To achieve sustainable economic growth over the medium to long term, structural problems, such as those in the labor market, will have to be addressed.
In the emerging market countries of Asia (Korea, Indonesia, Malaysia, the Philippines, and Thailand) which suffered from the 1997 crisis, economic activity is improving remarkably. Almost all these economies are expected to record positive growth this year, and still higher growth rates are projected for the year 2000. Nevertheless, these countries are expected to move forward with the restructuring of their corporate sectors in addition to the reform of their financial sectors.
(2) The Japanese economy
The Japanese economy seems to have got out of the worst of the economic situation, and economic activity is improving somewhat. This year, for the first time in two years, it recorded positive real GDP growth rates for two quarters in a row. This improvement was reflected in the upward revision of the IMF's WEO projections for Japanese economic growth for 1999 from -1.4 percent in the spring WEO to 1 percent in the current WEO. We believe this positive performance is due to the macroeconomic and structural policies implemented by the government. Since last summer, the government has made economic recovery its main priority, while recognizing the eventual need to implement fiscal structural reform. We have also tackled the problems of the financial sector by recapitalizing banks with public funds on condition that they implement far-reaching restructuring plans.
Japan's financial sector is now regaining the confidence of the markets, and the so-called Japan premium, which had grown to approximately 70 basis points in autumn 1998, has virtually disappeared since April. Reflecting these improved conditions in the financial sector and the progress of the so called Japanese financial "Big Bang" reforms, three top Japanese banks agreed to consolidate by setting up a joint stock holding company and forming a comprehensive financial group. Dramatic moves such as this will facilitate the reform of the financial sector.
The government intends to continue to monitor economic developments carefully and to make every effort to implement policies to reinforce the foundation for economic recovery.
2. Strengthening the international financial system
While conditions in the international financial markets have improved considerably, it is not possible to completely eliminate the risk of crisis caused by large-scale and abrupt capital movements amid the progress of the information technology revolution, the liberalization of international financial and capital markets, and the ongoing globalization. It is crucial to consider ways to prevent such crises before they occur, as well as measures to resolve crises expeditiously and appropriately when they do occur.
For this purpose, it is indispensable to strengthen the international financial system. However, there is no single major reform that can serve as a panacea. Our goals can only be achieved through the cumulative results of various reforms, including measures to increase transparency, and through the efforts of various entities, such as emerging market economies, which need to strengthen their macroeconomic policies and financial systems; private sector investors who invest in these economies and should be expected to play a greater role in the prevention and management of crises; industrialized countries, which have a responsibility for prudential regulation; and the IMF and other international financial institutions that are working to strengthen the international financial architecture.
Valuable progress is being achieved by the IMF's Board in several areas, and also by the Financial Stability Forum. Nevertheless, there are still numerous outstanding issues that need to be examined, and on this occasion I should like to present the Japanese viewpoint on the reforms to be sought in the emerging market countries, the industrialized countries, and the international financial institutions.
(1) Strengthening the Financial Sector in the Emerging Market Countries
While large-scale cross-border capital movements provide the emerging market countries with opportunities for high economic growth, they also entail risk. To minimize the risk, it is essential first of all that each country pursue sound macroeconomic and structural policies. The Asian crisis also highlighted the need for each country to strengthen its financial system, by putting in place appropriate prudential regulations and strengthening supervisory systems.
In this connection, we must not forget that the progress of capital account liberalization implies an even greater need to monitor the financial situation, especially debt, of the private sector, including the financial sector. It has been pointed out that the main cause of the Asian crisis was excessive borrowing by the private sector from the private sector, and the subsequent inefficient investment of the borrowed funds. Poor understanding of the situation of the private sector, including the amount and nature of the debt when the crisis broke out, aggravated the crisis. If we are to learn from this experience, we must, when liberalizing capital accounts, be sure to monitor the banking sector, the non-bank sector, and the corporate sector continuously, and require them to report on their financial condition in much greater detail than previously. The IMF and other international institutions should play an active role in providing needed technical assistance.
There is also a need to enhance countries' debt management and liquidity management capabilities. The Fund and other institutions are currently examining this issue, and we look forward to the results of their efforts.
(2) Selection of an appropriate foreign exchange regime
Concerning the type of foreign exchange regime that should be adopted by emerging market countries, the Government of Japan has long expressed its reservations about the so-called two corner solution, which calls for either a fixed exchange rate system based on a currency board or some other rigid system, or a freely floating exchange rate system. A consensus emerged during recent IMF Board discussions that the appropriate exchange rate regime will vary, depending upon a country's particular conditions. For example, for a country belonging to a regional group, such as ASEAN or Mercosur, one option is to aim at stabilizing the currency through pegging the exchange rate to a basket of currencies of the major trade and investment partner countries, or to adopt such a basket as a reference. Given that efforts to maintain virtually fixed exchange rates against a single industrial country's currency in an inappropriate manner have been the cause of crisis in numerous countries, the IMF is expected to provide appropriate advice in its programs and surveillance on the issue of choice of exchange rate regime, based on the valuable experiences that have accumulated over time.
(3) Capital Account Liberalization and Capital Controls
Capital account liberalization and capital controls remain important issues. In recent IMF discussions, it has been noted that countries with wide-ranging capital controls that were not integrated into the international financial system did not suffer much during the Asian crisis. This suggests that capital account liberalization should be carried out in a well-sequenced manner in the emerging market countries. In implementing capital account liberalization it is necessary to equip financial sectors with the necessary prudential regulations as well as to adopt consistent macroeconomic policies. Moreover, the liberalization of direct investment, which is inevitably of a longer-term and more stable nature, should be preceded by the liberalization of short-term capital flows.
In general, capital controls are no substitute for sound macroeconomic and structural policies, and they entail costs due to the inefficiency and misallocation of resources. Nevertheless, Japan's position--that controls on capital inflows, appropriately combined with policies to increase the flexibility of exchange rates and other measures, can restrain short-term speculative capital inflows--has recently been gaining support. The recent case of Malaysia, where the government successfully defended its currency against speculative attack without the IMF's assistance and where fears that the controls would be evaded did not materialize, can be considered a success. In Malaysia's case, capital controls contributed to the stability of the exchange rate as well as to recovery of the economy. Of course, such measures cannot always be justified, or applied in exactly the same form to other countries. They should, however, be evaluated positively as one possible response when a country faces the danger of sudden capital flight.
Some have argued that capital controls can be permitted as a second-best measure until fragile financial sectors and prudential regulations are strengthened. But, prudential regulations cannot cover all unstable capital flows, because they primarily cover transactions by financial institutions. We therefore think that capital controls, especially those on inflows, are worth considering as measures to supplement prudential regulations and appropriate macroeconomic policies.
At any rate, the IMF as well as member countries should learn from the valuable experience that has accumulated on measures to control speculative capital movements in many countries, including Malaysia, and consider practical responses appropriate to each situation.
(4) Response to highly leveraged institutions (HLIs)
Investors, too, should be expected to implement various improvements, including appropriate risk management, to bring greater stability to the international monetary system. The issue of HLIs is particularly important and is now being discussed at the Financial Stability Forum. In the international discussions to date, a consensus has been reached on enhancing disclosure by market participants, including HLIs, and ensuring appropriate counter-party risk management in their transactions. Achieving progress in putting in place and implementing the necessary measures in this respect is certainly important.
At the same time, it is also important to make greater progress in identifying the impact of the HLIs' activities on emerging economies. I would also suggest that we consider measures that crisis-hit countries can take to defend their markets, such as (a) the requirement that HLIs report on their activities in the interest of maintaining market integrity when there is a possibility of market manipulation; and (b) "non-standard" policy intervention measures like those taken recently by Hong Kong and Malaysia, which differed from traditional approaches such as intervention in foreign exchange markets and adjustment of interest rates.
(5) Strengthening the Involvement of the Private Sector
It is extremely important to strengthen the involvement of the private sector in preventing and resolving crises. Since it would be difficult to continue the bailout of private investors using public funds, and this involves moral hazard, there is an international consensus that it is essential to seek appropriate cooperation of all private sector creditors, including bondholders. Nonetheless, the actual implementation of such efforts is fraught with difficulty. Following are some points to be borne in mind in eliciting greater private sector involvement. (a) Strategies to involve the private sector should take into account the extent to which the debtor country is able to repay, as well as the appropriate form of financing in light of both need and capacity to repay in the medium term. (b) It should be made clear that the objective is not to prevent a debtor country from repaying its creditors nor to penalize private creditors, but is rather to achieve appropriate burden sharing and cooperation between the debtor country and private creditors. (c) From this perspective, dialogue should be promoted between the public sector and the private sector regarding conditions in the country and ways to move forward with private sector involvement. Frameworks for a cooperative approach should be devised on a country-by-country basis. In sum, we should move forward with more in-depth examination centered on the IMF, and the cooperation of the international community as a whole is important in eliciting greater private sector involvement.
The necessity of introducing collective action clauses (CACs) at the time of issuance of bonds is being examined as a measure to strengthen private sector involvement. This is an effort to encourage the smooth restructuring of those bonds, under circumstances where the involvement of the private sector has become much more difficult compared with the time when credits mostly took the form of bank syndicated loans due to the diversification of debt instruments. The Government of Japan would like to promote a more detailed examination of exactly how such clauses could be incorporated into sovereign debts. Also, although the promotion of dialogue between the governments of debtor nations and private sector creditors through the establishment of creditors' committees is a difficult issue, we expect that discussions of specific measures in this respect will move forward at the IMF.
(6) Issues concerning international financial institutions
As the central institution of the international financial system, the IMF should continue to strengthen its function of providing appropriate advice to member states and providing financial assistance, under appropriate conditions, to countries in economic crisis. The IMF's Interim Committee is now expected to be reorganized as a permanent body and renamed the International Monetary and Financial Committee. This Committee is expected to play a major role in enhancing the functions of the Fund and in addressing international financial issues on behalf of the international community.
Based on the experience of the Asian crisis, the Government of Japan has offered numerous proposals, including a reconsideration of the content of policy advice in IMF programs and surveillance activities and improving the transparency and the policy decision-making procedures of the Fund and other international financial institutions. The Fund has made progress in various areas. We appreciate these developments. At this time, I should like to address various items on which concrete proposals have to be made and implemented by the IMF Board.
First, we welcome the efforts that have been made to enhance the transparency and accountability of the IMF through disclosure of the contents of Fund discussions, publication of IMF staff papers, and the voluntary disclosure of Article IV consultation papers, including that on Japan.
Regarding the external evaluations of Fund activities, those on surveillance and research activities have been conducted this year, and many valuable proposals have been made. In particular, as pointed out by the evaluators, the emphasis of IMF surveillance and programs should be on core fields such as fiscal policy, financial policy, foreign-exchange rate regimes, the financial sector and capital movements, and on issues directly related to those areas. Additionally, we would like to see progress in greater involvement by the Executive Board in key Fund issues, for example, through holding informal discussions on the major policies for negotiation between the Fund and authorities, before the mission leaves for the country in question.
As to the extent to which the IMF should be involved in the promotion and implementation of international standards, we believe the Fund should examine this issue cautiously, in light of the Fund's fundamental character as a specialized institution for macroeconomic issues, the constraint to IMF resources, and the negative implications of the mechanical application of standards developed by other standard-setting bodies through the various kinds of leverage that the Fund has. Basically, we believe the Fund's activities should be limited to the above-mentioned core areas.
Turning to the Y2K problem, I would note in particular the concerns about the belated response in the emerging market countries. The international community should actively provide assistance to these countries, including technical assistance, prior to the year 2000. In this context, we welcome the IMF's decision to establish a temporary short-term facility whereby countries facing balance of payments needs arising from Y2K-related problems can have access to IMF funds.
3. Assistance to heavily indebted poor countries (HIPCs)
We welcome the agreement which has been reached on the framework for a strengthened HIPC initiative to provide "faster, deeper, and broader" debt relief to the heavily indebted poor countries. The next task is to formulate a consensus on ways to secure the necessary financial resources and strengthen the linkages between this initiative and poverty reduction policies in the recipient countries, as well as on the role the IMF should play, through in-depth discussions.
With the strengthening of the HIPC initiative, the international financial institutions will require substantial financial resources to cover their increased burden. The Government of Japan believes all donor countries should contribute according to the principle of fair burden sharing, and the international institutions should maximize the use of the funds on hand. We welcome that the framework for securing financing for the ESAF-HIPC trust fund of the IMF is being finalized. Under the strengthened initiative, Japan not only will provide more debt relief of bilateral ODA credit than any other creditor country, but it is also one of the small number of countries that have already made disbursements to the ESAF-HIPC trust fund. Since the ESAF-HIPC trust fund is likely to face liquidity difficulties in the near term even if the financing itself is secured, we strongly hope that many other countries will make their disbursements soon.
In implementing the HIPC initiative, it is important to secure linkages between debt relief and poverty reduction. Since the World Bank has the foremost expertise in the filed of poverty reduction, it is essential for the IMF to work towards strengthening its close ties with the World Bank in order to benefit from the Bank's wealth of expertise. From this perspective, the introduction of the Poverty Reduction Strategy Paper (PRSP), which will be jointly prepared by the recipient countries, the Fund and the Bank, will be beneficial to the Fund's and the Bank's cooperative efforts to assist the HIPCs as well as to the coordination of macroeconomic and social policies. While giving consideration to the impact of its programs on social policy issues -- especially in the case of ESAF-supported programs, through utilization of the PSRP framework--, the IMF should continue its efforts to secure macroeconomic stability and support economic growth in member countries, as these are necessary conditions for poverty reduction and are the areas where the Fund has the foremost expertise.