The Reform of Global Exchange and Financial Systems
Since the Eruption of the Asian Crisis

General Vieira, your excellencies, distinguished guests, ladies and gentlemen. I am indeed pleased to be able to take part in this conference organized by the Monetary and Foreign Exchange Authority of Macau and to share with you my thoughts on a topic that has been the subject of widespread debate during the last two years: the reform of the global exchange and financial systems since the eruption of the asian crisis. We must draw lessons from the events of the last 24 months and reflect on what went wrong and what can be done to prevent future financial instability. It is also an opportune time to assess how much progress has been made in the various aspects of strengthening the architecture of the international monetary system, since many economies around the world were affected by the events in Asia, Russia, and Brazil, and more generally, by the turbulence in international financial markets.

As you well know, about two years ago, the sharp decline in activity in Thailand, Indonesia, Korea, and Malaysia heralded what is now described as the Asian Crisis. As a broad generalization, the crisis in Asia was the result of the interaction of macroeconomic imbalances, fundamental structural problems, and shortcomings in the international financial system. The macroeconomic imbalances were reflected in rising and unsustainable external current account deficits and a buildup of external debt-in particular short-term debt-which were linked to the maintenance of exchange rate pegs. Most important, there were deep-seated structural weaknesses of financial institutions, insufficient bank supervision, and nontransparent relationships among government, banks, and corporations. Corporate debt also became a particular problem when exchange rates tumbled and corporations became insolvent because of their large dollar debt. Several of the countries experienced volatility in prices and sudden market movements that ultimately precipitated a crisis. What made the crisis so different from previous ones, and so difficult to tackle once it started, were the financial vulnerabilities in the banking and corporate sectors, and the speed and size of capital flow reversals that occurred once those vulnerabilities were revealed. And the counterpart of this buildup of financial vulnerabilities was considerable deficiency in creditors' risk assessment.

While efforts were under way to deal with the crisis in Asia, the international financial system was dealt a severe blow by the Russian default in August 1998 when the government de facto devalued the ruble, unilaterally restructured ruble-denominated public debt, and imposed a moratorium on foreign credit repayments. The crisis emerged because fiscal consolidation remained elusive and little headway was made in solving the underlying structural weaknesses. Moreover, insufficient progress was made in strengthening the rule of law and governance more generally. In the end, when markets doubted the sustainability of the commitment of Russian policymakers to implement the economic policies, the crisis erupted. The crisis in Brazil-where the root cause were public sector imbalances-was another dramatic episode in the bouts of instability that have plagued global financial markets since the onset of the Asian crisis.

The recent crisis which struck countries with pegged exchange rates, and broader experience with contagion, has rekindled the debate on the most appropriate exchange arrangement. It is clear that the macroeconomic and structural policy requirements of maintaining a pegged rate are demanding, particularly in an environment of increased mobility of international capital. At the same time, it is also clear that a number of economies with fixed exchange rate arrangements, including under currency boards as in Hong Kong and Macau, have been successful in maintaining exchange rate parities. On the other hand, flexible exchange rate arrangements do not either remove the need for policy discipline. All in all, experience has shown that countries that maintained consistent monetary and exchange rate policies and supported liberalization with financial sector reform have been better able to handle capital inflows and their subsequent reversals.

The IMF is pleased that significant progress is being made in dealing with the crisis and there is renewed hope that economic growth will return sooner rather than later. Economic activity has recently turned around in Korea and seems to have bottomed out in Malaysia and Thailand. Although Indonesia remains behind Korea and Thailand in its stabilization efforts, owing to initial delays as well as political and social tensions, it is hoped that recovery will begin to take hold in the latter part of this year. In other parts of the world, the contagion from the crisis in Brazil has been limited, and Brazil itself has stabilized. In recent weeks, a long-sought agreement with Russia has been reached and it is hoped that the Russian authorities will adopt coherent polices to promote stabilization and reform with vigor.

There is no denying that we live in a new world where globalized financial markets offer tremendous opportunities but also pose the risk of disruptive capital flow reversals. For individual countries, crisis prevention in the new global market requires an uncompromising effort to avoid the buildup of imbalances and disruptive capital flows and to make domestic systems more robust in the face of shocks. In turn, this requires not only appropriate macroeconomic policies, but also close attention to structural and social issues. While efforts of individual countries' efforts are essential, the current crisis has demonstrated the need to adapt the international financial system to the realities of global markets, in order to reduce the frequency and size of future crises. Work is under way inside and outside the IMF in this area, and I would like to touch upon some of these efforts now.

A strengthening of the international financial architecture embodies several elements, all of which are intrinsically interrelated. Adequate standards must be created, disseminated, and monitored in order to strengthen financial systems. To ensure that the process of capital account liberalization is orderly, a strong supervisory framework is essential, including an appropriate exchange rate regime. To reduce the volatility of private sector flows we need reliable data, increased transparency of government policies, and more openness on the part of the Fund itself. Working in partnership, governments, the private sector, and multilateral institutions must create an environment to nurture a strong financial system. The responsibility of governments is to establish and disseminate standards, strengthen supervisory and regulatory agencies, and adopt prudent and transparent macroeconomic and financial policies. The private financial institutions and corporations need to comply with the standards. And, international institutions need to move ahead in a coordinated and collaborative manner. The architecture work has focused on five areas: development of internationally accepted standards; increased transparency; orderly integration of international financial markets; involvement of the private sector in the prevention and resolution of financial crises; and the addition of a "social building block" to the edifice of the new international architecture.

The development, dissemination, and adoption of internationally accepted standards or codes of good practice contribute to a stronger financial architecture by allowing market participants to compare information on country practices against internationally agreed benchmarks of good practice and to make more sound investment decisions. The IMF's role here is both to help develop or refine standards in areas of direct operational concern to the Fund (data dissemination, monetary and financial policies, banking supervision, and fiscal transparency), and, more generally, to assist in the dissemination of standards and to encourage members to adopt them. The Fund is also exploring the preparation and publication of transparency reports that would summarize the extent to which members observe internationally recognized standards.

Another key pillar in strengthening the architecture of the international financial system relates to enhancing the transparency of the policy process. Transparency on the part of individual countries provides a means to foster better economic performance, in part by encouraging more widespread discussion and analysis of a country's policies. At the same time, greater access to information on the flow of credit to emerging markets could provide early indication of excessive concentration of debt, which, together with more accurate assessment of economic risk, could lead to more prudent behavior on the lenders side. Transparency on the part of the IMF (greater openness and clarity on our policies and advice) can also contribute to a better understanding of our role and operations and of our views on the policies of member countries. Here too, important progress has been made recently, including increased release of information on the Fund's financial practices; the publication of Press Information Notices following Article IV consultations with member governments; the release of documents relating to the Debt Initiative for the Heavily Indebted Poor Countries; and the release of internal and external evaluations of Fund operations. This information is now made available on the IMF's website. The Fund is also considering the voluntary release of staff reports and other documents relating to a members commitment under an arrangement with the Fund, although more deliberation is needed in this area.

Integrated international capital markets bring substantial benefits, but carry risks and need to be managed carefully. Consequently, with respect to capital account liberalization, the emphasis should be on an orderly and well-sequenced liberalization process, to be supported by an adequate institutional set up to strengthen the ability of financial intermediaries and other market participants to manage risk. I would like to note that introducing or tightening capital controls is not always appropriate to deal effectively with fundamental economic imbalances. Any temporary breathing space that such measures may bring needs to be weighed against the long-term damage to investor confidence and the distorting effects in resource allocation. However, the IMF will review the experience with temporary controls on capital movements and the circumstances under which such measures may be appropriate. As you are undoubtedly aware, views differ on the usefulness and effectiveness of capital controls. Nonetheless, effective international coordination and supervision of such liberalization is at the heart of ongoing efforts to enhance the IMF's role in this area.

The international community is examining measures that can involve the private sector more systematically in preventing and resolving financial crises. The aim here is to bring about a more orderly adjustment process; limit moral hazard and strengthen market discipline; and help emerging market borrowers protect themselves against volatility and contagion. In the crisis countries, the involvement of the private sector has been varied. For example, in Korea and Indonesia, private sector financing in support of each country's adjustment efforts was secured through moral suasion and Fund involvement. In the case of Brazil, voluntary agreement was reached with commercial bank creditors to maintain their credit exposure. Other countries in difficulties will have to approach their bondholders for refinancing to spread out the payment stream and reduce the burden of debt service. This is one of the most complex issues being considered in the continuing discussions of the new financial architecture, and a consensus has yet to emerge.

Finally, the new architecture could well include a social building block, which would seek an international commitment to appropriate social safety nets, core labor standards, consensus-building in countries, and common social goals.

As we look ahead, crisis prevention will be the key. In this area, there will be added demand on IMF surveillance activities. Prevention will also be helped by the recently established contingent credit line in the IMF which will enhance the ability of countries pursuing sound policies to stay the course, even when there is a marked deterioration in the external financial environment. This facility will also increase the incentive for countries to follow strong fiscal, monetary, exchange rate and debt management policies as well to adhere to internationally accepted standards.

In concluding, I would like to say that important inroads have been made in the reform of the global system since the onset of the Asian crisis. While progress is being made, there is much to be done, and an internationally coordinated and sustained effort is needed to complete the task. The IMF will continue to be a focal point of the policy debate, and of coordination and implementation, but the major contribution must also come from member countries and other international organizations. The IMF will play its part with the support of its membership.