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Reform of the International Financial Architecture:|
A Work in Progress
Remarks by Horst Köhler
International Monetary Fund
Given at the Central Bank Governors' Symposium
Bank of England Conference Center
July 5, 2002
1. Ladies and gentlemen, it is a special pleasure to address this distinguished gathering. The actions you take as central bank governors and, in many cases, regulators of national financial systems, will be crucial for the success of efforts to safeguard the stability of the international financial system and promote sustained growth in the world economy.
2. The Asian crisis sparked a broad, critical debate about the costs and benefits of globalization and the need to reform and strengthen the international financial architecture. We could perhaps have spent our energies defending the IMF against its critics. But in my view it was clearly preferable to consider the problem with an open mind, seeking out different points of view and working hard to identify necessary changes. Nearly five years later, the debate is by no means concluded, but we have used that time productively to set in motion an active process of reform.
3. You have been on the front lines of all of these initiatives, and I do not need to tell you how demanding and difficult they can be. But I also think it is clear that your efforts have made a difference! Over the past year, the international financial system has shown remarkable resiliency in the face of a sharp slowdown in global economic growth, a fundamental reassessment of the technology and telecommunications sectors, and the terrorist attacks on the United States. Decisive policy action by the US and other industrial countries had a lot to do with this—including the coordinated actions by central banks, supervisors, and private financial institutions to safeguard the international financial and payments system in the immediate aftermath of the September 11 attacks. And I think it was also important that the membership of the IMF came together last November in Ottawa to define a collaborative approach to strengthen the global economy.
4. Today it appears that a recovery in the global economy is underway. But there are still uncertainties and risks, in particular related to the strength and durability of the upswing in the United States, financial market volatility, and political tensions in the Middle East and South Asia. Overcoming these challenges will require a shift in focus from short-term considerations, to tackling decisively the underlying economic and financial imbalances. This calls for strong leadership of the advanced industrial countries, by taking action to strengthen the prospects for sustained growth in their own economies and through leading by example in the effort to make globalization work for the benefit of all.
5. Strong US growth in the second half of the 1990s served the global economy well. But this has been accompanied by a widening current account deficit which raises concerns over the sustainability of capital inflows to the United States and the possibility of disorderly exchange rate adjustments. In this situation, it will be crucial for the US to ensure that the budget remains balanced over the medium term, as part of a strategy for increasing national savings. But this is not just an issue for the United States: what is also needed to strengthen the global economy is more robust, domestic demand-driven growth in other advanced economies. It is clear that it would be possible to raise potential growth rates in Europe to 3 percent a year or even more, if there would be more ambition for structural reforms. Similarly, in Japan the return to a growth performance that corresponds to the country's size and potential demands accelerated action to dispose of nonperforming loans, deregulate key industries, and restructure Japan's banking and corporate sectors. The recent improvement in economic activity should not reduce the determination to move ahead with these necessary reforms.
6. For emerging markets and other developing countries, the events of the past year confirmed the important lesson that good policies pay off. Countries with sound fiscal and monetary policies and a commitment to structural reform have weathered the storm better than others, and demonstrated that it was possible to decouple from contagion. But there is no room for complacency. In Latin America, despite the progress that has been made in promoting democracy and economic stability over the past decade, weak institutions and glaring inequalities in income distribution remain a breeding ground for economic and political disruption. Indeed, uncertainty about the political sustainability of reforms is one of the factors behind the deterioration of financial market conditions for Latin American borrowers in recent weeks. Moreover, the fact that it has not been possible to avoid the meltdown of the Argentine financial system, or to do a better job of limiting overshooting in equity and capital markets of the advanced economies, suggests that we still have a lot to learn.
7. It is clear that we must combine even greater ambition to prevent crises, with a sense of realism about the extent to which this is possible. A market economy draws its lifeblood from competition, which leads to a continuous search for better results, better products, and higher productivity. Some degree of overshooting and correction—and hence, some risk of crises—will always be part of that process.
8. But within these limits, the IMFC has endorsed a multi-pronged effort to strengthen the IMF's capabilities for crisis prevention. This focuses in two main areas: improving the quality of our analysis and policy advice, and enhancing its impact.
9. To improve the quality of the IMF's advice, we need of course to persevere in the reforms that are already in train. And through our surveillance and technical assistance, we need to help member countries put in place "shock absorbers" that make their economies more resilient to adverse external developments. These include more flexible exchange rate regimes; stronger net international reserve positions; budgets that leave some room to maneuver in difficult times; efficient and diversified financial systems; and more effective social safety nets.
10. Just as important, we must draw firmer conclusions about the indispensable role of sound institutions and good governance for sustained growth and financial stability. As part of this effort, I am convinced that the IMF needs to improve its own understanding of institutions and political dynamics in member countries, while also drawing more effectively on the expertise of other institutions—notably the World Bank but possibly also NGO's, such as Transparency International. I am also convinced of the need for procedural changes to ensure that IMF surveillance takes a step back from our lending operations, so that we can form a truly independent and unbiased judgment of the risks and priorities.
11. To increase the impact of the IMF's policy advice, we need to become better at persuading countries to take early action to address emerging problems and imbalances. This applies both to advanced and developing economies, because risks to global economic and financial stability do not originate in emerging markets alone but from the major economic and financial centers as well. More transparency and greater candor in our advice certainly is one major avenue toward this objective. A more proactive engagement of the Fund to reward good policies through contingent or precautionary financing is another.
12. The IMF's multilateral surveillance also has an important role to play in the effort to strengthen crisis prevention, by detecting and heightening awareness of systemic risks and interdependencies in the global economy. Over the past year we have stepped up the IMF's monitoring and analysis of developments in international financial markets, through the creation of our new International Capital Markets Department and the initiation of quarterly Financial Stability Reports. Our informal but regular dialogue with representatives of internationally-active private institutions, through the Capital Markets Consultative Group, has enabled us to engage constructively with the private sector on issues such as the development of investor relations programs and the promotion of standards and codes. We are also sharpening our analysis of global interdependencies and imbalances in the context of the World Economic Outlook, including the critical link between trade and financial liberalization.
13. As highlighted by comparative analysis in the Fund's most recent World Economic Outlook, overall Latin America's external vulnerability is higher than that of other emerging market countries. Why? Because the expansion of trade by Latin American countries has lagged far behind their growing integration into global capital markets. Trade is crucial for growth, and I am deeply convinced that there is a need for more integration into the global economy, not less, particularly as a way to fight world poverty. But if we do not manage a better balance between the opening of capital accounts and the expansion of trade, we may see a cyclical reoccurrence of financial crises. To me, withstanding pressures for protectionism is key to strengthening confidence about the future prospects for strong global growth and shared prosperity in the world. There would be very significant benefits to all if the Doha round could duplicate the growth in trade that followed the Uruguay Round.
14. The Enron collapse and, even more, the WorldCom scandal have also made it clearer than ever that there is a need to give as much attention to risks and vulnerabilities arising in the advanced countries, as we do to problems in emerging markets and developing countries. I therefore welcome the broad discussion and legislative activities that are underway in the United States, in the aftermath of these revelations. But I also think that the international community as a whole should review issues related to accounting, disclosure, and corporate governance. Here I see an important role for the Financial Stability Forum.
15. Strengthening IMF surveillance and crisis prevention will always be our first line of defense in dealing with external shocks and vulnerabilities. But we must also have the ability to help our members manage and resolve crises, when these occur, in ways that are as nondisruptive as possible for themselves and for the functioning of the international financial system. Our approach to crisis resolution is based on the indispensable principle that debtors and private creditors must bear the responsibility for the risks they take. I also believe it is important to work, as much and as long as possible, with the markets. But even with the best efforts, there will continue to be some cases in which debt becomes unsustainable. And the experience in Argentina demonstrated that the present arrangements for resolving sovereign debt crises are not sufficiently transparent or predictable, and that they impose unnecessary costs on debtors, creditors, and the system as a whole.
16. Our work program to develop a clearer and stronger framework for crisis resolution focuses on three areas:
17. As a first essential element, we are reinforcing our analytical tools and procedures to reach better-informed and more systematic judgments about debt sustainability. This is essential for deciding whether a major debt restructuring, possibly involving a substantial write-down of claims, is called for; or whether it is appropriate for the Fund, in conjunction with others, to provide financial support for policy measures to help restore confidence and catalyze the resumption of private capital inflows.
18. As a second element of the framework for crisis resolution, we are working to establish a clearer definition of the conditions for and limits to access to IMF financing. This is a complex issue, but ultimately we cannot escape the fact that the IMF is not a global lender of last resort with the ability to create liquidity by issuing money. The Bank of England is among the participants in this debate who would like to establish quantitative limits on IMF financing, while others—including most emerging markets—believe that this would not be appropriate, in view of the widely differing circumstances that countries may face. I hope we will reach a consensus in the Fund on the way forward, in particular to find credible ways to keep exceptional access to Fund resources truly exceptional.
19. Finally, for cases where debt has become unsustainable, we are trying to develop ways to facilitate debt restructuring without unnecessary destruction of asset values or economic disruption. More ambitious use of collective action clauses will almost certainly be an important element in the solution, and we are actively engaged in an effort to design model clauses for this purpose. But I do not believe that the use of collective actions clauses alone would be sufficient. The proposal for a new Sovereign Debt Restructuring Mechanism (SDRM) developed by Anne Krueger and Fund staff in my view is farsighted and will close an important gap in the existing framework for crisis resolution. Work remains to be done in these areas, but I hope that we can count on your active engagement and support in finding a broad consensus on the SDRM by the time of the IMF's Annual Meetings this fall.
20. Let me conclude by acknowledging how much we depend on central bankers in our member countries. Every day, you have to take tough decisions under pressure and live with the consequences. As a result, you are often in the best position to feel the winds of change blowing and start the rest of us thinking about what they mean. You can help show the way through prudent domestic policies, wholehearted adoption of internationally-recognized standards and codes, participation in the FSAP, and your technical assistance to other members countries. I am grateful for all of your contributions, and I look forward to our continuing cooperation in strengthening the international financial architecture.
IMF EXTERNAL RELATIONS DEPARTMENT