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Maintaining the Momentum:|
Emerging Market Policy Reform in 2004
Anne O. Krueger, First Deputy Managing Director, IMF
Keynote Address at the Asia Society Conference:
Investing Across Emerging Markets 2004
New York, November 20, 2003
It is a great pleasure for me to be here in New York this morning. I always enjoy being involved in conferences organized by the Asia Society: and I think today's meeting shows every prospect of maintaining the Society's high standards.
The gathering has been long in the planning, I know. But it comes at an important juncture for many emerging market economies, not least in Asia. After the past few difficult years, there is renewed optimism about the future in many countries. It is an opportunity that governments cannot afford to waste.
I want today to say something about the global outlook over the next year or so, and how we at the Fund think this will affect emerging market economies. I would then like to share with you some thoughts about why we think it is so important that governments do not lose the chance to press on with economic reform.
It is always tempting, in an economic upturn, to sit back and enjoy the ride. But governments owe it to their citizens to keep their eye on the longer term. I do not want to be a killjoy. I am not particularly fond of hair shirts and nor, in spite of what some might think, is the Fund as a whole. But I am anxious to ensure that policymakers seize the chance to build on recent successes and, in so doing, make their economies more resilient against whatever shocks the future might—and, indeed, certainly will bring.
The current outlook
In the past few years, the world economy has been on a rollercoaster ride. There was the series of emerging market financial crises of the late 1990s and the early years of the new century. There was the extraordinary economic boom that the United States enjoyed and from which many other countries reaped great benefit. There was the bursting of the high-tech bubble and the synchronized global downturn, the first for more than a decade. And there has been a significant increase in geopolitical tensions, including the terrorist attacks of 2001 and subsequently, and the wars in Afghanistan and Iraq.
I will not pretend these have been easy times. But I think it is remarkable how resilient the global economy has been. Recovery from financial crises has, on the whole, been speedier than we might have hoped, and the international repercussions fewer and less severe. The downturn was global in scope, but more moderate than many had predicted. Recovery is picking up a little faster than anticipated in most places, in spite of continuing uncertainty about international security.
In fact, the IMF is now expecting global growth to be a little stronger than was suggested in the World Economic Outlook published in September—around 3¼% this year, rising to something like 4% next. The US continues to lead the recovery—and output growth was unexpectedly strong in the third quarter. But there are now more encouraging signs from Europe, too, although current activity remains weak. Even in Japan, a modest recovery appears to be in place.
In emerging market economies the picture is mixed. But in Latin America, a tentative recovery is still on track, helped by rising exports following earlier exchange rate depreciations.
And emerging Asia has made an impressive recovery from the SARS-related slowdown earlier this year. It is currently the world's fastest-growing region.
Of course, as always, there are risks associated with any forecast. But the risks are noticeably more balanced than in the spring, and there is now some upside potential in the short-term. Several industrial and emerging market economies currently appear to be better placed than just a short time ago.
On the downside, we cannot ignore the breakdown of the Cancun talks in September. A meeting that was supposed to inject new momentum into the Doha round instead ended in deadlock. Failure to resolve the problems encountered at Cancun and restart the Doha process would have seriously unpleasant consequences. Trade liberalization, in a multilateral context, offers the best hope of a significant improvement in medium and longer term growth prospects—for all economies, industrial and developing.
We cannot afford—especially at this juncture—any risk of a return to protectionism. Trade can often be a controversial domestic policy issue. But governments need to resist the pressure to give in to the lobbying of narrow interest groups who can only benefit at the expense of the wider public. The multilateral trading framework has served us well in the period since it was established at the end of the second world war. It has played a crucial role in the rapid economic growth and rising living standards that most of the world—including the poor—has enjoyed since 1945.
The industrial countries need to do more—far more—to reduce agricultural subsidies and open their markets. They need to do this because it makes sense, because it is good for them, and because it is essential in the Doha context.
But I cannot emphasize too strongly that emerging market and developing economies must also focus on liberalizing themselves. The evidence is overwhelming: many of the gains from liberalizing accrue directly to the country doing the liberalizing, even if it is on a unilateral basis. The gains from a multilateral round of trade liberalization will be far greater and the bulk of those will flow to the poorer countries.
We in the Fund believe that the Doha talks should restart as soon as possible, based either on the WTO Secretariat's draft, or the Cancun chairman's text. Last week, Horst Kohler, Managing Director of the IMF, and James Wolfensohn, President of the World Bank, sent a joint letter to all WTO heads of government and their trade ministers pressing the case for an early resumption of talks.
Trade is not the only potential cloud on the horizon. The continuing reliance of the world economy on the United States makes countries uncomfortably vulnerable to setbacks in the world's biggest economy. Sustained medium growth in other countries is therefore essential, in order to reduce the heavy dependence of global growth on the United States. But this can only be achieved if governments adopt the structural measures needed to boost growth outside the US.
That means, especially, labor and product market reforms in Europe, corporate and financial restructuring in Japan, and wide-ranging reforms to improve the level of growth in, and resilience of, emerging market economies. Of course, a stronger medium-term fiscal position in the United States would also help. Overall, more balanced global growth would help reduce current account imbalances, and lower the risk of abrupt exchange rate movements.
The need for reform
Economic reform has to be continuous. That might sound obvious, but it is striking how, over the years, governments of all kinds have tended to think of reform as a discrete process, one that has a clear ending. But that is to misunderstand the nature of economic change. As economies evolve, so should their structures and institutions. Failure to reform impedes progress and impairs the growth of living standards.
I'm not referring here to emerging market countries in particular. Several countries in Europe are only now confronting the need for structural change in order to make their economies more competitive and dynamic. The struggle some countries are having with the stability and growth pact underlines how difficult implementing change can be.
I mentioned the recovery in Japan a moment ago—and the fact that it is modest. The country's long-standing structural problems are likely to constrain growth over the medium-term. There is still much to be done in the banking and corporate sectors—non-performing loans remain a problem for many banks, at least in part because the pace of corporate restructuring remains sluggish.
But none of this diminishes the urgent need for emerging market economies to press ahead with their own reform agendas. The breathing space offered by the economic upturn should be used to maximum advantage. It is always easier to push ahead with reform, when—as now—growth is accelerating, rather than—as has so often been the case—policy change is in response to a crisis. Governments need to take steps now to ensure that economies are more resilient in the future, and less vulnerable to downturn.
There will always be the temptation to postpone difficult decisions: it should be resisted, especially since it can be easy to misread the durability of an upturn. The brighter economic outlook may lead governments to think they have time to spare before embarking on a reform program. They haven't. The sustained growth that will benefit all citizens can only come from the development of a stable macroeconomic framework which in turn requires reform at both the macro and micro level. Such reforms should mean that future downturns are less severe because governments will have more room for policy maneuver.
We at the Fund are particularly concerned at present by the high level of public debt in emerging market economies. The brighter economic outlook has brought with it a recovery in capital flows to emerging market countries as a whole, and a slowing of capital outflows. Indeed, it looks as if 2003 will see net inflows of around $100 billion—the highest level since 1997. And foreign direct investment to emerging market economies exceeds this net figure. About half of these flows are expected to go to Asia, and the bulk of these to China.
But the rebound masks the continuing vulnerability of many countries to even modest economic shocks, and this represents a potential threat to global financial stability that it would be dangerous—and irresponsible—to ignore. The levels of public debt in many of these countries are high, and rising. On average, they are higher as a proportion of GDP than in the industrial countries, some of whom are themselves struggling to reduce their indebtedness. In an uncomfortably large number of emerging market countries, the debt has grown beyond what would be sustainable if countries fail to improve on their historical growth and budgetary performance and if, later in the recovery, real interest rates rise.
Action is needed to correct this problem and give economies more of a cushion against sudden shocks. Fiscal balances need to adjust to render debt burdens more sustainable. Tax collection and public expenditure management needs to be improved. Stronger growth, accompanied by base-broadening tax reform, would help reduce the need for pro-cyclical tightening during periods of slowdown.
A diverse group of countries
Of course, even within Asia, we are looking at a diverse group of countries: economies at different stages of economic development and at difference stages in the reform process. Some have made more headway in some areas than others. China and Vietnam, for example, are countries still in transition towards being fully-fledged market economies, and full participants in the global economy.
China's growth performance has been spectacular. It is rapidly assuming the role of a regional engine of growth—a role once held by Japan. But China it is only now beginning to confront some of the problems that need to be tackled as part of the process of integration with the international economy.
There has been much talk of the need for China to adopt a more flexible exchange rate policy and this issue was addressed in the recently-concluded Article IV consultations with China. The Fund took the view that increased flexibility of the exchange rate over time would be in the best interest of China—though the timing of any move should be left to the Chinese authorities to decide. Greater exchange rate flexibility would allow more room to pursue an independent monetary policy, help cushion China's economy against adverse shocks, and facilitate adjustment to the major structural reforms that are underway. But those reforms remain of crucial importance. China needs to act to put its banking system in order, and address the problem of the large number of non-performing loans. Japan's difficulties in confronting the NPL problems at an early stage are an example from which China could learn much.
Thailand has come a long way but it, too, needs to do more to deal with the problem of non-performing loans in the private banking sector. Indonesia needs to continue with its efforts to strengthen the banking system as part of the process of building up and sustaining investor confidence. Other countries, such as Singapore, have already worked hard to strengthen their financial sector.
I do not mean to dismiss the substantial reforms undertaken by many emerging market economies in the wake of the financial crises of the late 1990s. Some, like Korea, for example, responded impressively to the enormous setback that the crisis represented. In many cases, Asian countries succeeded in putting the effects of the crisis behind them much more quickly than anyone could have foreseen. Indonesia's Fund-supported program ends later this year: it is the last of the countries affected by the 1997-98 crisis to be involved in a Fund program. But that very success should not now be seen as a reason for countries to rest on their laurels. As I said, reform, or at least the need for it, never ceases.
Role of the Fund
The Asian financial crisis of 1997-98, and Mexico's Tequila crisis in 1994, triggered a great deal soul-searching by the countries affected. Many of them had grown accustomed to rapidly rising living standards. They had begun to think they were invulnerable. They discovered they weren't in an unusually painful way.
But the dramatic reversal of fortunes for the so-called Asian tiger economies came as a shock to many of us. The financial crises of the late 1990s led economists inside and outside the Fund to explore ways of improving crisis prevention—and eventually led to significant changes in the way governments, often with Fund help, seek to avoid trouble in the future.
Hence our current concerns about public debt levels in many countries. What we learned in the 1990s is enough to see these high debt levels as a warning sign. Nowadays the Fund attaches great weight to the assessments of debt sustainability that are now an integral feature of the surveillance process. Twenty years ago such Fund assessments were unheard of.
There is also much more emphasis on financial sector soundness in the regular Article IV surveillance consultations that the Fund conducts with every member country. Strong, well-regulated financial systems are essential for macroeconomic and financial stability in a world of increased capital flows.
One important addition to our armory has been the Financial Sector Assessment program, introduced in 1999. The FSAP was designed to support member governments' own efforts to strengthen their financial systems. It aims to facilitate the early detection of financial sector vulnerabilities, to identify key issues that need to be tackled, and to give some order of priority to policy responses, as well as providing technical assistance when this is needed to strengthen supervisory and reporting frameworks. The work under the program is carried out by staff from the IMF and the World Bank, with the help of outside experts from a range of national agencies and standard-setting bodies.
The FSAP also forms the basis of Financial System Stability Assessments (FSAAs) in which IMF staff address issues relevant to overall surveillance—including risks to macroeconomic stability stemming from the financial sector, and the capacity of the sector to absorb macroeconomic shocks. Nearly sixty such assessments have now been prepared.
Alongside this work, we have been helping our member governments put in place relevant standards and codes which give rise to—forgive the obvious—Reports on the Observance of Standards and Codes. These reports summarize the extent to which countries have made, or are making, progress towards internationally recognized best practice. We support the development of, and adherence to, codes in twelve areas, and I think it is worth spelling these out. They comprise: data dissemination; fiscal transparency; monetary and financial policy transparency; banking supervision; securities regulation; insurance supervision; payments systems; anti-money laundering and countering the financing of terrorism; accounting; auditing; and insolvency and creditor rights.
The financial sector ROSCs are an integral part of the Financial Assessment program. All ROSCs are prepared and published at the request of member governments. They are also used to help focus policy discussions of the Fund, and the World Bank, with national authorities; and in the private sector (including ratings agencies) for risk assessment.
Of course it has taken time to build up a sufficient body of these assessments and reports for them to be useful in a wider market context, for example. But it is worth noting that recent research done by the Fund shows that these reports and—critically—the fact that they are usually published has brought tangible gains for emerging market countries, in the form of lower sovereign spreads. The research found that markets respond both to the publication of reports such as ROSCs: and also to their content.
The Fund's principal objective is the maintenance of international financial stability which in turn fosters economic growth and the expansion of trade. Our aims have changed little in the almost sixty years since we were founded. How we seek to achieve those aims, however, is radically different than from just a few years ago. The rapid growth of private capital flows, for example, presented governments—and us—with new challenges.
I think we are beginning to see the benefits of a greater focus on macroeconomic sustainability. Many emerging market countries are working to put in place fundamental reforms that will strengthen their judicial systems, their institutions, their financial sectors and their macroeconomic management. All these are closely interlinked, far more than most of us fully realized until a few years ago.
We are also seeing a global economic upturn—now stengthening markedly. For some emerging market economies, there is the prospect of those faster growth rates that can help raise the living standards of their citizens and reduce the incidence of poverty. This is indeed a time of opportunity. A brighter global outlook is indeed to be welcomed.
It is precisely for that reason that I am today also keen to sound a warning note. The Fund—and I'm sure governments and their citizens—prefers not to have to deal with financial and economic crises. We would far rather help prevent them. Much the best way of doing that is through the development of sound, sustainable economic policies.
If 2004 delivers what the forecasters currently expect it will be a time for many countries to enjoy accelerating growth. The more they are able wisely to exploit the opportunities that presents for economic reform, the longer we can all expect the upturn to last.
IMF EXTERNAL RELATIONS DEPARTMENT