Dinner Speech by Michel Camdessus
May 18, 199595/7 Managing Director of the International Monetary Fund
at an IFC Meeting for Representatives of Co-Financing Institutions
Washington, D.C., May 18, 1995
It is a great pleasure for me to be with you this evening, and to share some thoughts with you on the challenges posed by developments in the world economy, and the role the institutions of our Bretton Woods family can play in addressing them.
But first, I wish to take this opportunity to say a few words about Lew Preston, whose memorial service many of us attended today. His recent death has made this a sad time for the World Bank Group, for its sister institution, the IMF, and for me personally. For us at the IMF, he was a friend and colleague we greatly admired and a supporter we could rely upon. In fact, in one of his last public statements, in late March, he stressed the need to increase the resources of the Fund and pressed the industrial countries to give stronger support to the Fund in its role. The world needs graciousness and wisdom of the kind we saw in him; and needless to say, we shall be missing him greatly.
One of Lew Preston's important contributions as President was to sharpen the focus of the work of the Bank Group on promoting private sector development, as an essential means of pursuing the Group's central mission of helping countries reduce poverty and improve living standards. When he spoke last year at a conference marking the 50th Anniversary of the World Bank and the IMF, one of his main points, as he looked ahead, was that "strengthening (its) support for the private sector will be one of the hallmarks of the Bank Group in the future."1 He saw clearly that despite the increased flows of private capital to developing countries and countries in transition, the Bank Group continues to have a major role to play, not only in helping the public sector foster an enabling environment for private enterprise, but also by lending directly to the private sector and mobilizing capital for companies that would not otherwise have access to international financial markets. The IFC and its partnership with co-financing institutions were therefore of great importance to him and, as he envisaged, will surely continue to be a growing part of the Bank Group's work.
The IMF, unlike the IFC, does not lend to, or borrow from the private sector. Nor does it provide advice to the private sector: some would like the IMF to serve as a credit-rating agency, but that is not its job. Nor does the IMF have co-financing arrangements with private financial institutions, although it does, through its activities, mobilize financing for countries from commercial as well as official sources. The IMF's direct dealings are almost entirely with governments and central banks. Nevertheless, the objective of our activities is also the promotion of private-sector-led, sustainable growth. The Fund's role is to help its member countries establish a macroeconomic environment, in their own economies and in the global economy, that will foster such growth. Well, how does that environment look today?
In many respects, the world economic outlook is more positive than for many years. Following the slowdown of the early 1990s, world growth is now close to its long-term trend rate, and IMF staff are expecting it to strengthen further next year. In most industrial countries, prospects for sustained growth are good as a result of success in the reduction of inflation. In the developing world, growth performance has improved markedly as a result of stabilization and reform efforts supported by the IMF in many countries; and if policy improvements are maintained, growth should continue at around 6 percent a year in the period ahead. Close to half of the countries in transition in Europe and the former Soviet Union are now seeing positive economic growth, on the basis of programs supported by the Fund; and if policies remain on track the group as a whole should see growth in 1996 for the first time in many years.
Of course there are immense problems still to be tackled--including, in many industrial countries, high levels of structural unemployment and large fiscal deficits, and in many developing and transition economies, macroeconomic instability and structural distortions calling for radical reform. Nevertheless, the global outlook is encouraging.
What are the risks to this outlook? Two key risks have been vividly illustrated by developments in recent months. One is that the global expansion could be adversely affected by instability and misalignments of exchange rates among the key currencies. The sharp weakening of the U.S. dollar against the yen, the deutsche mark, and other European currencies since the beginning of the year has threatened to exacerbate inflationary pressures in the United States, weaken the expansion in Europe, and stall the recovery in Japan. When the IMF's Interim Committee of finance ministers and central bank governors met in Washington three weeks ago, they agreed that "exchange rate movements for some major currencies had gone further than warranted by fundamentals and...that orderly reversal of these movements is desirable." How can this be achieved and currency instability be reduced? This is one question we must face.
The second risk I would highlight is that of a sharper than expected slowdown in capital flows to emerging market economies. Our projections incorporate some further weakening in these capital flows following their rapid growth in the early 1990s: this is in part a result of the recovery in the industrial countries. But the risk is that there could be a much sharper fall-off, perhaps triggered by financial crisis in one or two countries, but threatening growth prospects much more widely. This risk was vividly illustrated by Mexico's financial crisis and its spillover effects, which reached many countries in this hemisphere and further afield.
These two risks have something in common. They both originate in part from the globalization of financial markets: they are both magnified by the highly mobile, large-scale international capital flows that characterize the world in which we live today. How should such risks be minimized? I am sure the answer does not lie in reverting to exchange controls and less open markets, and thereby foregoing or jeopardizing the great benefits and opportunities that arise from the global mobilization of financial saving. The answer lies rather, partly in improvements in economic policies at the national level, and partly in stronger international monetary cooperation at the global level, through the IMF.
Consider first the role of policies and the exchange rate problem. The industrial countries have gone a long way to promote greater exchange rate stability since the early 1980s, by making so much progress toward low inflation. This achievement must be safeguarded, but we always knew that it would not be enough. In the recent episode, most of the countries whose currencies have weakened--for example, the United States, Canada, and Italy --suffer from chronic fiscal deficits, associated in some cases--including the United States--with chronic balance of payments weakness. Stronger efforts to restore fiscal balance in these countries would help to achieve both the orderly reversal of exchange rates called for by the Interim Committee and greater stability in exchange markets. I also believe that there is greater scope for international cooperation in monetary policy than we have seen recently, and that well-timed and coordinated interest rate actions could have had a powerful stabilizing effect on exchange markets.
Turning to the risk of a downturn in capital flows to emerging market economies, we can see in the Mexican case a number of policy lessons. The crisis showed, in particular, that large-scale private capital inflows do not signal that internal macroeconomic discipline can be relaxed. The crisis arose from many factors, some unrelated to Mexico's economic policies. But it is clear that a steep real appreciation of the peso and a deterioration in domestic saving performance, which contributed to a large and growing external current account deficit, together with an excessive reliance on short-term capital inflows, and an accommodating monetary policy during 1994, all played a role. The crisis provided an impressive demonstration of how suddenly market assessments of a country's situation can turn around when the country lowers its guard and allows its economic policies to weaken. The lesson in crisis prevention is clear for all emerging market economies--indeed, for all economies: unfailing vigilance and discipline provide the only sure defense against financial market setbacks. And the way the crisis has been turned into what by now seems a manageable problem--through a stringent adjustment program supported by an international financial rescue package, including exceptional financial assistance from the IMF--carries lessons for the resolution of such crises which are also important.
So let me turn to the role of the IMF: what can it do to help minimize the risks I have been referring to? Essentially two things: it can help countries--and help them more effectively--to improve their policies, so that currency misalignments and balance of payments crises are less likely to occur; and it can provide financial support for corrective policy action when crises do occur. In both areas, the Fund is seeking to ensure that it is strong enough to serve its purposes in the new environment of globalized markets.
The IMF's work in promoting exchange rate stability and preventing financial crises is carried out mainly through the exercise of its responsibility for surveillance over the international monetary system and countries' exchange rate policies. IMF surveillance is conducted mainly through the annual consultations held with all member countries and through the regular discussions in its Executive Board on the world economic outlook and financial market developments. It is an international cooperative effort aimed at improvements in policies and the prevention of policy mistakes. In recent years the Fund has been endeavoring to make surveillance more continuous and effective, and significant progress has been made. But recent developments, and especially Mexico's crisis, have shown that further significant changes are needed:
- first, stricter requirements are needed concerning the regular and
timely communication by countries to the Fund of data on key economic and
financial variables, and standards need to be established for their timely
publication so that countries' economic fundamentals are more transparent
to financial markets. I would add here that I believe the Fund also needs
to make greater use of financial market data, and to collaborate more closely
with the IFC in this respect;
- second, the Fund's policy dialogue with member countries must be made
a more continuous process, and must remain close when financial arrangements
with the Fund have expired;
- third, in its policy dialogue with member countries the Fund must
be prepared to be more critical and demanding--yes, even more critical
and demanding than in the past--especially with countries whose policies
have systemic implications;
- and fourth, surveillance must pay more attention to capital account
flows and their sustainability;
These are some of the items on our agenda to strengthen surveillance, which was endorsed by the Interim Committee at the end of April. It is a demanding agenda, and we shall be able to implement it only with the full and active cooperation of our member countries.
But even with the most effective IMF surveillance, crises would still be likely to occur from time to time; and the IMF must ensure that it has the means to provide countries with financial assistance adequate to contribute effectively to their resolution. It was able to do so in the case of Mexico, by applying the rules allowing it in exceptional circumstances to exceed limits that apply to its credit, on the grounds of the exceptional risk of contagion that was entailed. The Fund's commitment to Mexico is the largest in the Fund's history. But there have been a number of other large arrangements in recent months, most notably in support of programs of stabilization and reform in Argentina, Russia, and Ukraine. Because of these and other expected commitments, the Fund's liquidity position, adequate at present, is projected to weaken sharply over the next two years. The Fund's resources are probably sufficient for our normal business during this period, and if emergencies call for it the General Arrangements to Borrow (GAB) from some of our largest member countries can be activated. But we must look beyond the next couple of years, and see what action needs to be taken to ensure that the Fund's resources are strong enough to meet the requirements that the Fund may face in the closing years of this century and beyond. This was agreed by our Interim Committee, and following their preliminary discussion we shall in the next few months be considering a number of courses of action:
- the first priority is the Eleventh Review of Quotas, which are our
member countries' capital subscriptions to the IMF. This review must be
initiated expeditiously and should in my view lead roughly to a doubling
in quotas, in order to ensure that the size of the Fund keeps pace with
the secular growth in the world economy and takes some account of the scale
of international financial flows that is now characteristic of the system;
- second, we shall be reviewing the role of the General Arrangements
to Borrow and exploring ways to increase the potential resources available
to the Fund through borrowing from our members;
- third, a possibility we shall be exploring is the introduction of
arrangements whereby SDRs--the international reserve asset that the IMF
can create in carefully defined circumstances--could be issued on a temporary
basis or lent to countries in support of strong policy programs in the
context of a liquidity crisis. We are also undertaking a wide-ranging review
of the role and function of the SDR; in this study we shall take expert
advice from outside the Fund;
- fourth, we shall be examining ways to ensure the continued availability
of concessional balance of payments assistance to low-income countries
following the expiration within the next few years of the existing enhanced
structural adjustment facility (ESAF). One possibility to be considered
is the sale of a modest part of the Fund's gold holdings and the use of
earnings from the invested profits of such sales, combined with bilateral
contributions from member countries, to provide the subsidy element that
- finally, we shall be exploring the possibility of developing procedures
for more orderly international debt adjustment, taking into account the
experience with debt reorganization under national laws. Consideration
of this approach raises a number of complex economic, political, and legal
issues, and I should emphasize that our work on this is still exploratory.
So here again we have a full agenda.
This evening I have indicated a number of possible ways in which the IMF can increase its effectiveness in helping to minimize the risks to the world economic outlook--risks magnified by financial globalization. Some, on the surveillance side, are already being implemented, while others are in stages of preliminary exploration. They amount to a task that is as essential as it is challenging--the task of ensuring that the IMF is as strong and effective as the world economy needs it to be at the turn of this century. It is gratifying that the Interim Committee is guiding us in this direction, and I am sure that the G-7 Summit in Halifax next month will give added support to our efforts.
1. Lewis Preston, "Future of the World Bank" in Bretton Woods: Looking to the Future, Bretton Woods Commission Conference Proceedings (Washington, D.C.: Bretton Woods Committee, 1994).