Speech

Luncheon Remarks by Michel Camdessus

October 6, 1995

It is a great pleasure for me to be with you. We are used to hearing speakers at conferences say how timely is the subject being discussed. Well this time it is true. We have seen in very recent years the costs that banking and financial crises can impose; and in many places--in the United States, with the Savings and Loans crisis, some Nordic countries, countries of the European Union, Japan, and the list could be longer--we have seen their impact on economic growth and development. Several countries in Latin America are now facing the challenge of resolving difficulties in their banking systems. I shall turn in a moment to the importance of establishing and maintaining a strong domestic banking system, but let me first try to place these difficulties (1) within the context of the recent crises in Mexico and other Latin American countries, and (2) in the context of the rapidly changing nature of international capital markets.

Let me say first that the increased challenges we face today in preventing and resolving both domestic and international financial crises are, somewhat paradoxically, to a large extent a consequence of economic progress. Globalization of capital markets and the rapid mobility of funds that technological progress allows has contributed to this progress. And the recent problems in Latin America illustrate this point: they can be understood only in the context of the region's economic progress of the past decade. Mexico's remarkable economic progress between 1988 and 1993 is an example. During this short period of time, Mexico strengthened its process of macroeconomic stabilization and structural transformation. There was remarkable success on many fronts, and Mexico entered 1994 with a strengthened economy and an economy more deeply integrated into global markets. But its deeper integration into global markets required Mexico to be even more disciplined in its policies, to attend to its weak saving performance and large external current account deficit, and to be especially vigilant about its external competitiveness. In 1994, however, there were a number of unfortunate domestic disturbances, there was also this excessively long political interval between the beginning of the official campaign and the inauguration of the new president--a propitious time indeed for policy slippages, and as a matter of fact a constitutional calamity not only in Mexico but in many other Latin American countries--and the result...well, we know it.

The crisis in Mexico has been described, by I don't know whom, as the first financial crisis of the 21st century, meaning the first major crisis to hit an emerging market economy in our new world of globalized financial markets. And this says a lot about its significance. The increasing international integration of financial markets has brought great benefits, by fostering a more efficient allocation of global savings and boosting investment and growth in many countries. But we know there is a downside: vastly increased financial flows across national borders have also made countries more vulnerable to changes in investment portfolios. As we have seen, concerns about economic fundamentals and policy shortcomings can lead to sudden, massive, and destabilizing adjustments in these portfolios. Furthermore, financial globalization has increased the speed with which disturbances in one country can be transmitted to others. So financial globalization, both a product of and a contributor to the economic progress of our time, has heightened the desirability of preventing financial crises, and of resolving them quickly when they occur.

The Mexican crisis showed clearly that openness to international financial markets imposes an obligation of unfailing discipline on economic policy. Financial market integration may ease financing constraints, but it has not altered the fact that domestic saving is the key to investment and growth. Large-scale capital inflows, certainly when they are easily reversible, and when they are financing domestic consumption, provide no grounds for relaxation of adjustment and reform efforts: in fact the reverse is true. Mexico's crisis demonstrated the high costs that can arise when a country lowers its guard and markets exercise their discipline instead. Mexico's crisis was resolved by means of a strong policy program and large-scale financial support by the international community. Argentina's quick and strong response to the spillover effects of the crisis also showed the effectiveness of stronger policy efforts. By transforming the crisis into an opportunity to address weaknesses that had developed, for example in the financial position of its banking system, Argentina, with strong support from the IDB, the World Bank, and the IMF, has paid a great service not only to itself but to the region and the world at large. Brazil also responded quickly with policy measures. With the situation under control in Mexico, Argentina, and Brazil spillover effects were quickly contained. One can also observe that many of the countries that suffered the least were countries with sound policies and strong reputations for fiscal and monetary discipline, and with strong banking systems--let me repeat, strong banking systems. Markets are not always right, but they are often appropriately discriminating.

I have said that Mexico's crisis was resolved by the strengthening of its adjustment and reform effort and large-scale international financial support. The IMF arrangement with Mexico is the largest ever approved for a member country, both in absolute amount and in relation to the country's quota in the Fund. Why such exceptional support? For a very simple reason, the basic mandate of the IMF. Article I of our Articles of Agreement states that it is the IMF's mission: "To give confidence to members by making the general resources of the Fund temporarily available to them under adequate safeguards, thus providing them with opportunity to correct maladjustments in their balance of payments without resorting"--note these words--"to measures destructive of national or international prosperity." On January 31 of this year, this was the problem: Either the IMF contributed quickly and substantially to a major international financial package for Mexico or Mexico may have had no solution other than to resort to a moratorium on foreign debt or a reimposition of trade and exchange restrictions--truly "measures destructive of national or international prosperity"--with a major risk of the spread of such measures to a number of countries.

In the weeks following the eruption of the crisis, stock markets and exchange markets came under pressure, particularly in Latin America but also in a number of more distant emerging market economies, including in Asia. These immediate spillover effects indicated that Mexico's crisis could raise doubts, unwarranted by fundamentals, about the viability of policies in several other countries. A major interruption in the flow of capital to developing countries could have ensued, and thus one of the driving forces of global growth in recent years could have vanished.

Following the adoption of the strong adjustment program markets stabilized in Mexico but activity has contracted sharply. No doubt, however, that the decline would surely have been much larger and more prolonged in the absence of a strong program and international support. If the authorities continue to implement the program steadfastly and consistently--and I fully expect they will do so--Mexico's economy is headed toward recovery in the coming months, and given the acceleration of reforms in the program Mexico should emerge from the crisis stronger than before. And thanks to the resolution of the crisis, earlier expectations of a marked and prolonged slowdown of private capital flows to Latin American countries and other emerging markets have not been borne out. The renewed access by several Latin American countries, including Mexico, to international bond markets has been striking, and there has also been a resumption of activity in new international equity issues.

As I said at the beginning, the new economic challenges that have to be addressed by many countries are to a large extent a consequence of economic progress. The countries of Latin America have shown in their responses to the Mexican crisis that they are fully aware that it would be a serious mistake to try to avoid such crises by reverting to closed economic systems with exchange controls and less open markets: to do this would be to turn the clock back and forego the benefits of globalization.

With the crisis behind us, there is now the challenging work of strengthening the financial systems in those countries that are becoming increasingly integrated into international capital markets. In most emerging market countries, banks are responsible for intermediating a predominant share of financial resources, so an increased importance attaches to the efforts of several countries in Latin America now trying to resolve banking problems that became more apparent in the wake of the crisis.

As we have observed on many occasions, the financial position of a country's banking system can act as a severe constraint on its ability to manage crises, and in particular an exchange rate crisis. The classical policy response of a central bank facing an attack on its pegged exchange rate is to use its foreign exchange reserves to buy its own currency and to tighten domestic credit conditions. The effect is to raise domestic interest rates. The problem, however, is that such interest rate increases may put critical pressure on the financial condition of the banking system, especially in countries with only emerging capital markets. If these countries are to efficiently allocate resources and to withstand the pressures associated with being full-fledged participants in international capital markets, including the effects of large-scale and volatile capital flows, their banking systems will need to be strengthened and put on a sound footing. This can be accomplished by ensuring that banking systems are strongly capitalized, with appropriate accounting, legal, and supervisory infrastructures, and effective mechanisms for the enforcement of regulations on a consolidated basis.

Banking problems often arise also as the result of bad credit allocation decisions, inadequate bank supervision, and ineffective enforcement of financial regulations. But such problems also take place against the background of macroeconomic developments and structural reform efforts--including financial liberalization--and banking crises are often triggered by macroeconomic imbalances. In some cases imbalances are created by policy mistakes and in other cases by external developments beyond the control of national authorities. The IMF can help countries avoid and resolve banking problems both through its surveillance activities and its technical assistance efforts. The IMF concentrates its surveillance efforts on trying to achieve the proper mix of macroeconomic policies and structural policies oriented toward private-sector-led growth. Partly in response to the Mexican crisis, our efforts to strengthen country surveillance have been stepped up considerably. I would note in particular, that we are paying greater attention to capital account developments, and to financial flows and their sustainability. And the Fund's technical assistance in the area of central banking has the purpose of helping countries design and put in place financial infrastructures--including sound regulations and proper supervisory arrangements--that provide the backbone of sound financial systems.

But, in the end, of course, countries are responsible for managing their own economies. In this regard, the main message I would like to leave you with is this: As is well understood in Latin America, the countries of the region have no choice but to maintain their access to international capital markets if they are to achieve their potential for economic growth and development in the period ahead. Although the recent financial crises in some Latin American countries constitute a setback in terms of economic growth and access to capital markets, tremendous economic progress has been achieved since the days of the 1982 debt crises. As long as adjustment and reform efforts are maintained, these recent setbacks will be temporary and short-lived.

But there is no denying that there are important and difficult challenges ahead. In order to maintain access to international capital markets, the countries of Latin America must be vigilant in re-establishing and sustaining macroeconomic stability, and in achieving further progress toward financial market liberalization. These countries also will have to continue to strive to establish and maintain sound banking systems--more generally sound financial systems. This conference will surely confirm the essential linkages among these objectives; I wish it every success.