Capital flows, crises, and the private sector -- Remarks by Michel Camdessus
March 1, 199999/4 Remarks by Michel Camdessus
Managing Director of the International Monetary Fund
to the Institute of International Bankers
Washington, D.C. March 1, 1999
Thank you for your welcome, and for rejuvenating me, as, in some way you bring me back to the time when as head of the Tresór or as governor of the Banque du France, I enjoyed very much the refreshing atmosphere and camaraderie of the Paris circle of foreign banks! But here it happens that both you and I are foreigners in this country, yet also together with our U.S. colleagues and friends, citizens of the same globalized financial village. All this will tell you that I am very pleased to join you at this conference, which takes place at a time of great challenges for all of us whether we are engaged in public policy issues or participating directly in the markets.
The crises in the emerging markets since the mid-1990s all started with abrupt shifts in investor sentiment that reversed the large inflows of private capital enjoyed by most of the countries for several years. Generally, the climate for financial flows to emerging markets deteriorated sharply, graphically illustrated in the soaring interest rates confronting emerging markets in late 1998. Although conditions in the markets have eased considerably since then, many risks remain. With some countries distinctly beginning to recover, but others still in crisis, inevitably thoughts turn on how to bring the nightmare to an end, how to restart these flows, and how to make them less volatile. You have invited me to discuss the international efforts to address the current difficulties confronting the global economy and financial markets, but as I cannot take too much of your time, I will dwell on just one aspect: the private sector’s role within the new financial architecture we are trying to put together. How can we create conditions for the private sector to benefit more from the opportunities of the globalized markets, while being a more efficient and responsible intermediary for channeling financial resources to their best use?
These conditions confront us with an imposing agenda, but not at all an idealistic dream. These are achievable objectives provided we try to base the reforms on three straightforward principles:
- the universal promotion of free market mechanisms strengthened by a set of standards and principles of good conduct;
- a mature partnership between banking and financial institutions and their sovereign and corporate clients; and
- a cooperative approach of crisis management in the mutual interest of all market participants.
Let me elaborate on these three objectives, and tell you how the IMF intends to contribute to their implementation.
1. Toward universal free markets harnessed by well-defined and implemented standards and principles of good conduct
To optimize the opportunities and to reduce the risks of globalization, we must head toward a world with open and integrated capital markets, achieved through a gradual process of liberalization supported by good macroeconomic policies and sound financial institutions. A world where financial institutions in the emerging markets—as elsewhere—will be better managed and more robust, as internationally accepted standards of regulation and supervision are implemented. Financial markets will be less prone to volatility because participants will have more information, and they will be able to assess risk more realistically. A world where market participants and governments will operate according to higher standards of transparency and governance. And, of course, a world where the benefits of globalization will be more widely dispersed than they are at present; first, because of efforts to ensure that no countries are marginalized, and second, through social policies designed to make sure that people in each country have equitable access to opportunities of education, health, livelihood, and social protection in times of crisis. And last, but not least, a world that will rely primarily on the private sector—both domestic and foreign on a truly equal footing—to mobilize resources for investment and growth. All this implies that it will be a world where markets must be able to function efficiently, with risks being assessed realistically and the rewards of success and the cost of failure fairly distributed.
This set of objectives is straightforward. It is noteworthy to observe that—in spite of the nostalgia for state intervention of a few observers, and fortunately, even fewer policymakers—the immense majority of the world community wants to achieve these objectives, not through controls or an onerous set of state regulations, but instead through the active promotion of well-conceived standards and principles of good conduct. After all, markets are about liberty and responsibility; they are about transparency, timely information and equality of condition for all players; and they are about enterprises’ decisions, accountability, and profits—but also losses as a sanction against bad or ill-informed decisions. Of course, we know only too well that in international markets these conditions are unevenly fulfilled. Therefore, our aim must be to create, at world level, the well-functioning markets you enjoy here and in your home countries. This imposes, without question, the tasks of defining essential standards and of strengthening the agencies charged with disseminating and monitoring the implementation of these standards. At this very moment, within the IMF, we are pressing our members to adopt a new code on transparency in their fiscal policies, and we are working with other agencies and members to design a similar code for monetary and financial policies. We are also on the verge of consensus of an important enhancement to the Fund’s established standard for data dissemination that will strengthen the reporting of countries’ international reserves and related liabilities. Other agencies have developed or are working on standards for securities markets, accounting, auditing, bankruptcy, and corporate governance.
We will have to make sure that progressively—with due regard to the situation of individual countries—steps are taken for the use of these standards to become generalized. This is where the IMF, with its unique and exclusive mandate for universal surveillance, will become more relevant than ever. The Fund’s permanent surveillance of its members will have to focus more on capital movements, on countries’ progress toward transparency and implementation of the principle of good governance to which they should voluntarily subscribe. Also, together with other international financial institutions and bilateral donors, we will need to mobilize technical assistance to help emerging and developing countries, including the offshore centers, to adapt themselves to these new standards. This, over time, should promote more efficient, more orderly, and more mature markets—at world level. In the final analysis, nothing could be more important.
2. Toward a more mature partnership between banking and financial institutions and their clients
In such mature markets, more mature relationships could be expected between banking and financial institutions and their clients. What would this mean?
Certainly an effort to avoid the excessively risky behavior that has recently taken such a toll on both financial institutions and recipient countries. Surges in capital inflows have tended to end badly when bankers and portfolio managers follow each other without assessing adequately the structural weaknesses of the financial system of the recipient countries. The interests of both the creditors and the recipient countries call for strengthening lending relations as much as possible.
Ideally, this calls for two basic, straightforward changes in the recent pattern of international financing, a task in which the IMF and other international financial institutions could help. These changes would:
- put more emphasis on non-debt creating flows, especially direct investment, as these are perhaps the most constructive of all the flows for emerging markets. By their very nature, such investments are less volatile, less prone to sudden withdrawal because of a shift in sentiment, although they are by no means immune from such shifts. For such flows, the crucial issue is the need for an environment that encourages foreign investment for the long haul: sound macroeconomic policies, good governance, a robust financial system, and a transparent legal framework. This is an enormous agenda that the IMF and other institutions must strive to promote. It is one that we will indeed promote whatever the clamor from those who consider that combating "crony capitalism" is not our business.
- encourage a shift from short-term lending to longer-term. Most of the crises have developed around the "rush for the exits" that was led by short-term creditors and the threat to liquidity that this posed. To guard against future stress, excessive short-term borrowing should be avoided in the first place. To do so, prudential limits on banks’ borrowing should be introduced. In particular, standards should be more tightly defined to reduce the mismatch of maturities, so that banks would perform their traditional role of "borrowing short and lending long" in a safe and balanced fashion.
Closely related to this, and perhaps one of the most workable innovations, has been suggested by Chairman Greenspan. It would involve adjustments to the pricing of debt. On the debtor side, the monetary authorities could charge domestic borrowers for sovereign guarantees which, in my view, should be avoided anyway. On the creditor side, it could be done by revising the risk-weights attached to various types of lending under the Basle capital adequacy standards. This approach, which is being explored by the Basle Committee on Banking Supervision, deserves to be pursued. One could also mention market-based measures to raise the cost of short-term capital imports already adopted in several countries.
Beyond these changes in the instruments for financing, the very nature of the relationship between creditors and debtors should be helped to mature and to adapt to this new world. What this means is quite straightforward:
- Contracts should be honored. Debtors must observe this basic principle. If extreme circumstances prevent them from making payments, then orderly amendments to loan contracts should be sought.
- Investors should expect to face an element of risk: therefore, they should have the opportunity and the responsibility to assess that risk, and they should accept the consequences of occasional failure. This should entail, on the debtor side, a greater readiness to share information with their creditors, who are entitled, if they are invited to establish a durable partnership with their debtors, to receive a permanent and relevant flow of information on the economic evolution of their clients. At the request of any member government, the IMF would be ready to assist with this provision of information.
- In a cooperative effort to avoid crisis, investors could equip their borrowers with appropriate means to forestall the need for drastic measures—provided they maintain a responsible macroeconomic stance. For instance, three countries (Argentina, Mexico, and Indonesia) have negotiated with foreign banks to provide contingent credit lines, which are voluntary, market-based arrangements intended to be drawn only if conditions were to deteriorate. Thus far, Indonesia and Mexico have drawn successfully on these lines. These private contingent credit lines are by no means the only available instrument. One could mention also the use of innovative financial instruments (call options, structured notes, etc.)—all with the potential of producing a more flexible debt structure, less vulnerable to disruption from external shocks.
Governments should also be ready to adopt new attitudes and take initiatives to avoid the risk of crisis or to promote an orderly handling of them, if they occur. Let me mention two:
- Governments need to avoid creating the impression of offering implicit guarantees, including those associated with exchange rate management. Thailand’s long peg to the U.S. dollar, and Indonesia’s predictable crawling peg, are both examples of arrangements that outlived their utility, encouraging excessive levels of unhedged foreign exchange exposure. But this takes us into the vast and contentious arena of exchange rate regimes and policy—a topic for another occasion!
- Governments—and financial institutions—should also reflect on a legal issue that can seriously disrupt the resolution of a country’s external liabilities, notably its bonds. To restructure them may involve a very large number of unidentifiable bondholders. As you know, it is possible under U.S. law, which is used in most bond contracts, for any one of those creditors, no matter how small, to pursue full, immediate payment by legal action. Such an event can completely disrupt a country’s restructuring, and indeed jeopardize its policy adjustment efforts. To avoid this possibility, suggestions have been put forward that bond contracts should contain clauses that would permit majority voting, sharing, and other provisions that are found under other legal systems (similar, for instance, to those that exist already under British-style bonds). Such a change would require little more than a voluntary recognition, especially by a number of the leading investing institutions, of the benefits associated with more flexible terms for issuing securities. Today I sow this seed in your minds for reflection!
We, in the IMF, are ready to contribute to countries’ efforts to avert crisis with an important innovation. We are now working to put in place a facility under which the Fund would commit resources—on a contingency and conditional basis—to countries that are in jeopardy of contagion from crises in other emerging markets. This could, and should, go well in parallel with the private instruments I have just mentioned. But I should not hide some difficult issues that we are wrestling with. For instance, how can large amounts of money be committed and possibly disbursed, while at the same time keeping the private sector "on board"? What types of policy commitments would be sought from the authorities? Will the countries most likely to need assistance be able to meet the conditions that will have to be stipulated to pre-qualify them? And what assurance is there that, once the funds are committed, the country would continue to implement sound policies? The complexity of these questions will not discourage us.
You have almost certainly observed that, due to the recent circumstances, the discussion in various fora about "involving" the private sector is concentrating on situations of crisis: how to anticipate a potential crisis, how to head it off, and how to react if it does strike. Let me therefore preface the rest of my remarks by stressing a point I have repeated ad nauseam: "Prevention is better than cure." The very best way of ensuring that private investors want to continue investing is to make sure that crises do not happen in the first place. That is why the international community is trying to reform the international financial system. And that is why it is so important that the IMF, the newly created Forum for Financial Stability, and all the relevant international agencies keep up an active dialogue with countries to ensure that they implement sound policies and keep their institutions and practices up to date and in line with accepted standards and codes of best practice.
Having forcefully reaffirmed all this, it remains true that crises will occur from time to time. Then, crisis resolution should always favor voluntary, market-based options.
3. Toward a cooperative and mutually beneficial approach to crisis management
Many proposals have been tabled to resolve crises in an orderly fashion. On that the debate is still alive—and lively. One suggestion emerging from recent experience is that creditor councils or committees can be critical in smoothing the process. They are worth establishing since they can effectively contribute to mutual understanding and to pragmatic solutions.
But what of the worst-case scenario, where a country is unable to service its debt in the near-term, but wishes to stabilize its economy and restructure its debt? How can it remain viable without descending into a vicious spiral of default, the loss of access to all forms of financial flows, and poverty? For such circumstances, the IMF accepts as its role—exceptional and risky as it may be—to stand ready to lend into a situation already characterized by arrears to non-preferred creditors. If the country is clearly trying to address its problems, including efforts to normalize relations with its creditors, the IMF is able to extend financial assistance under prudent safeguards, even in these cases. But this, of course, can only make sense if such Fund lending triggers reasonable cooperative contributions from other creditors, including from the private sector. The aim is not simply to provide near-term balance of payments support, but also to catalyze financial flows from other sources, including debt restructuring, and so, speed up the restoration of normal credit flows. This objective is so important that, in times of crisis, the IMF has to define the conditions of its loans in a way that ensures the private sector’s exposure is maintained or increased. I will mention here also, our efforts on several occasions to help in successful concerted debt rollovers (Korea being a good example).
But I must call to your attention that, even under extreme circumstances, legal action by individual "dissident" creditors can disrupt an otherwise orderly restructuring. Therefore, to maintain order, the international community may need to sanction a temporary halt to payments to all creditors, under clearly defined conditions. An effective means of doing this would be by explicitly recognizing the role—already suggested for the IMF in its Articles of Agreement—of allowing it to endorse a stay on litigation while a debt restructuring is in process. To make this role safe and unquestionable, it could be wise to amend Article VIII 2(b) of the IMF’s Articles of Agreement where a basis for such a role exists. The purpose of this action would not be, of course, to alter creditors’ rights permanently, but instead to oblige all creditors to accept a common procedure, refraining from litigation in circumstances where they would be both disruptive and not necessary. I have to confess that this has proved to be a controversial proposal, and so far no consensus has emerged. I am nevertheless personally of the view that such an initiative would be quite in tune with the cooperative approach of crisis situations that is called for in a world of globalized finance where serious market members—including on the creditor side—have every interest in an orderly and prudently handled procedure to allow for an early restoration of debtors’ payments capacity. I believe that such a device—equally protective of creditors and debtors against the risk of panic-stricken asset-destructive episodes—should merit more attention from those who are particularly concerned about creditor interests.
Mr. Chairman, as you can see, we are developing a comprehensive, but, I repeat, achievable agenda. If we are to avoid in the future such pitfalls as periodic country crises, erratic contagion, and even threats to global financial stability, we cannot go for less. We must create this new framework to facilitate a constructive engagement among the players in each country: private sector, public sector, and multilateral institutions alike. But we need not stop there. I would also like to see you, as private sector representatives, seize every opportunity to have a say in this extensive process of deliberation and consultation. The diversity and resourcefulness of the private sector can be a key ingredient in the debate over the structure of the financial system we envisage for the next century. More importantly, without question, it is the private sector that will provide the dynamism and impetus for renewed growth and progress as we enter the new century.