Proposals for a Sovereign Debt Restructuring Mechanism (SDRM) -- A Factsheet
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The IMF at 60: Equipped for Today's Challenges?|
Address to the American Academy
By Anne O. Krueger
First Deputy Managing Director
International Monetary Fund
Berlin, June 23, 2004
Good afternoon, and thank you for that kind introduction. I am very pleased to be here at this distinguished institution.
The American Academy has played—and continues to play—an important part in fostering the important ties between Germany and the United States. It provides an invaluable opportunity for American scholars to spend time here working on their research interests and interacting with their German counterparts. My only regret today is that I am merely passing through, without the chance for a longer stay!
The timing of my visit is particularly appropriate, since it comes on the eve of an important anniversary—important for the Fund, of course, because next week it will be sixty years since the delegates to the Bretton Woods Conference assembled in New Hampshire, and that conference led directly to the creation of the International Monetary Fund.
But I don't see this as merely an institutional celebration. The Bretton Woods Conference was far more significant than that. Those delegates agreed on a new international economic order that would both prevent a repetition of the economic unilateralism of the 1930s, when competitive devaluations and beggar-thy-neighbour trade policies had inflicted so much damage; and help speed recovery from the ravages of war.
Sixty years is quite a milestone, especially when we consider the importance of the event we are marking. Anniversaries can provide an important opportunity for reflection. For the Fund, this anniversary period gives us—and the governments who are our shareholders, and the citizens who are the intended beneficiaries of what we do—a chance to ask whether we have succeeded in the tasks we were charged with all those years ago.
Where have we fallen short of what we could have achieved? Have we learned the right lessons from our experience over the past decades? And, perhaps most important, are we equipped for the modern global economy?
My aim today is to try to give brief answers to those questions. I think it is clear that the Fund has been successful in meeting the objectives which were set at Bretton Woods. It is also clear that the Fund, along with academics and policymakers, has had to learn and adapt as the world economy has evolved. But it is important to remember that we are there to take risks—our job is to help when others are reluctant to do so. Of course, with twenty-twenty hindsight there are things the Fund might have done differently, but the institution has always been remarkably quick to learn from experience, and that in turn has been of direct benefit to our members.
An enduring system
Given the pace of change in the modern global economy—a direct consequence, remember, of the rapid pace of growth in the post-war period—both the Fund and the international system in which it plays a central role have proved durable and adaptable.
That the post-war economic order has survived and flourished owes a great deal to those far-sighted delegates sixty years ago and their political masters. They grasped what was needed and were willing to confront the political and technical challenges that might have discouraged lesser figures.
But understanding what was required was only half the story. The framework established at Bretton Woods has survived for so long and has been so successful in large part because its design allowed the system to evolve.
The core principles adopted in 1944 remain intact, of course. The promotion of economic growth through the expansion of trade, all underpinned by the stable international financial system: these are as important to us today as they were to the foresighted founders of the Bretton Woods system.
Central to the framework is its multilateral character. The extent of international interdependence was explicitly recognized by Henry Morgenthau at the opening of the Bretton Woods Conference. Morgenthau, then the American Secretary of the Treasury, was appointed Permanent President of the Bretton Woods Conference; and in his speech at the inaugural session he emphasised that economic growth and poverty reduction were not a zero-sum game.
The two principal architects of the system adopted at Bretton Woods, America's Harry Dexter White and Britain's John Maynard Keynes, had attached great important to full employment and growth in their long deliberations. They assumed—rightly—that poverty reduction would result from sustained economic growth.
While much remains the same, much has changed, of course. White and Keynes were mainly focused on the economic policies of industrial countries. Twenty-nine countries signed the Bretton Woods agreement; today we have 184 members. Much of what we do is very different from the way the Fund operated in those early years. It has to be. The world economy has changed beyond recognition. But we still apply those same core principles. International financial stability and the prevention of crises are at the heart of our work.
Indeed, there is a strong case for arguing that global financial stability has become even more important as the years have gone on. It has delivered rapid economic growth. Globalization—which, in its most fundamental sense, I take to be the rapid integration of the world economy—has made stability crucial for growth and prosperity. A stable, well-functioning international financial system helps all countries exploit the benefits that globalization has already brought. It also enables policymakers in both developed and developing economies to adapt to the changes that globalization brings. And that in turn means their citizens can continue to gain from the more rapid growth and rising living standards that only the multilateral framework makes possible.
After the disastrous economic policies of the 1930s, and then the ravages of war, restoring global economic growth would in itself have been a major achievement. But the framework put in place at Bretton Woods set the stage for something far more spectacular. The global economy was, truly, transformed.
In the immediate post-war period, the growth rates of the major industrial countries made the achievements of the nineteenth century seem modest. America saw per capita income growth averaging 2.4 percent a year between 1950 and 1973: Germany grew on average by 5 percent a year, and Japan by more than 8 percent. Even developing countries whose policies were inward-looking, such as India, achieved per capita income growth at rates much above any earlier realized.
Impressive though this performance seemed at the time, it was only a foretaste of what was to come for the newly-industrializing countries. Korea and the other so-called `Asian tigers' set world records in the 1960s and 1970s with growth rates of real GDP of 8, 10 and even 13 percent a year. Most of the other Asian economies followed with annual rates of 7 percent, 8 percent or more between 1985 and 1994. China averaged GDP growth of more than 10 percent a year during the same period, according to the official statistics.
Some economies have been transformed in the post-war period. We're all familiar with the rapid growth of China as a force in the global economy. But look, too, at Korea: its per capita income in real terms rose almost sevenfold between 1962 and 1992. Even India, slow at first to engage with the world economy, has recently enjoyed very good economic performance: in the 1990s, following the first wave of economic reforms, it averaged GDP growth of about 6 percent a year, making it one of the most rapidly-growing of all developing economies.
This surge in economic growth, to levels that have no historical parallel, owed much to the Bretton Woods system. It is clear that between 1946 and 1973 the system of fixed exchange rates established at the original conference served the world economy well, in spite of occasional bouts of turbulence. This was what many people still refer to as the golden age.
Yet the switch to floating exchange rates among the industrial countries from 1973 onwards was, in its turn, far more successful than many anticipated, and has also contributed to sustained economic growth. The oil price shocks of the mid and late 1970s were disruptive, of course: but much less than they might have been, because of the flexibility that floating exchange rates provided.
The oil shocks are sometimes seen as a turning point in post-war economic history. As oil prices rise again today, we see some people wondering if history is about to repeat itself. But the rise in oil prices in the 1970s was related to the worldwide surge in inflation in the late 1960s and early 1970s. Dearer oil certainly brought important changes in the nature of the Fund's work, because it was in this period, and after, that developing countries became the IMF's biggest customers. Britain was the last major industrial country to borrow from the Fund, in 1976.
But in the context of the recent rise we have seen in oil prices, it is important to remember that the prices rises of 1973 and 1979 were supply shocks: the latest oil price increases mainly reflect the impact of rising demand. When dearer oil is a consequence of accelerating growth in the US and elsewhere there are economic benefits from that higher growth that largely offset the rise in oil prices.
When oil prices shot up in 1973, the oil producing countries suddenly found themselves awash with cash surpluses in need of a home. As oil revenues were recycled, Western commercial banks lent aggressively to oil-importing developing countries, usually on a floating rate basis. With hindsight, the result was predictable: many countries were unable to service their debts as interest rates rose in the early 1980s in the drive to curb inflation in the industrial countries. The IMF played a leading role in helping resolve what became known as the third world debt crisis of the early 1980s.
Of course, the 1980s now seem very remote—and in terms of the global financial system, they are. Official capital accounted for the bulk of international capital flows at that time. But there were some important lessons learned that still resonate today.
It was during this period that the degree to which sound policies mattered first became apparent. Policymakers in East Asia succeeded in implementing macroeconomic policies that fostered growth to a much greater extent than Latin America, for example, where inflation and inward-looking trade policies persistently undermined economic performance in several countries.
And with higher export to GDP ratios, Asian economies (which are highly dependent on oil imports) were able to maintain and even accelerate growth while Latin American economies foundered.
Another clear example of the extent to which policies mattered more than natural resources was the performance of the oil exporting developing countries: they generally grew less rapidly than oil importing developing countries where policy adjustments had been more urgent and, in many cases, more radical.
The 1990s were a decade of profound change in the global economic and political system. The changes we witnessed posed the Fund some of the biggest challenges it has yet faced. But the 1990s were, a period that saw remarkably rapid growth, not least in the United States.
And the decade as a whole was, ultimately, an enriching period for the Fund. Meeting those challenges—and in doing so confounding our critics—has left the Fund a stronger institution. Many of our members benefited directly from this.
The most dramatic change, of course, was the collapse of the Soviet empire. The political upheaval was momentous and altered the character of international relations. It brought the Fund a large number of new members, all urgently needing our help. They needed financial support, of course. But they also needed advice on how to develop normally functioning market economies. We, along with other agencies and governments, tried to provide that advice.
In the early days, the learning curve was steep for everybody concerned: the sort of economic transformation needed had never been attempted before. But it is perhaps a measure of how far all those involved succeeded that many of the countries that for decades had been completely outside the international financial system have just joined the European Union.
Towards the end of last year, the IMF recognized the extent of the progress made when we closed the department known as European II, which had housed the CIS transition economies, and merged its responsibilities into other Fund departments. We concluded that those countries once under the yoke of Communism have made sufficient progress so that they no longer need a special department of their own.
But the former Comecon countries weren't the IMF's only pre-occupation during the nineties. One crucially important development was the rapid growth in private international capital flows that followed the deregulation of capital markets in many countries. Some of the biggest financial crises the Fund has ever dealt with erupted over the past decade or so. The Mexican debt crisis in 1994; the Asian crises of 1997-98, Russia in 1998, Turkey in 2000 and Argentina in 2001: these all involved enormous upheaval for the countries concerned, for the IMF and, to a greater extent than usual, for the international financial system.
These crises were different in nature as well as scale. The most significant factor was that they were capital account crises, rather than the current account crises that the IMF had been used to handling. Capital account crises are distinctive: they can occur rapidly; they occur because holders of a country's debt are concerned about its ability and/or willingness to service; and because there are doubts about underlying macroeconomic policies to service that debt.
And, too, capital account crises erupted very quickly, and the provision of support was often much more urgently needed. At the time, the judgment of the international financial markets can sometimes seem harsh; it can certainly be unforgiving. But we and our member countries are learning, as I shall explain in a moment, to live with and benefit from the discipline that the market can impart.
I noted that capital account crises can occur very rapidly and require an immediate response. Such crises occur because the holders of a country's debt lose confidence in its ability to service that debt—usually, I have to say, with reason. Given current macroeconomic policies and debt levels, debts and debt service costs will increase very rapidly.
In principle, a crisis can occur even if the country's current macroeconomic policies are sound, if the creditors believe such policies will not be sustained. When there are real, and justified, doubts about a country's economic policy, these can erupt into a full-blown crisis with astonishing speed. The only effective response is to restore creditors' confidence that a country will be able to meet its debt obligations in full. That, I hardly need add, is easier said than done.
So the past decade or so has been a very steep learning curve for the IMF, for economists in general, and for governments. We have been trying to do better at detecting crises when a crisis is imminent, how best to respond to the warning signs and, of course, how to handle crises when they do occur. Our conclusions have led us to shift the focus of much of our work, as I shall describe in a moment—though as I have already pointed out, the learning process is continuous as we adapt to new information and developments.
We now know how important debt sustainability is in judging whether a country has sound economic policies that will deliver lasting economic growth. And we have also learned that many more fundamental reforms are needed if emerging market countries are to benefit from greater economic stability.
What sort of reforms do I have in mind? Our experience in the former Communist countries is relevant here. This underlined the importance of properly functioning judicial systems, enforceable property rights, accountable and transparent public institutions, efficient tax systems, and modern and effective public expenditure management. Their absence impedes everyday economic activity.
All these issues are now an essential part of the Fund's work. We regularly examine the economies and the economic policies of all our members, in our Article IV surveillance work. As part of that process, we now pay far more attention to what we call the Financial Sector Assessment Program, aimed at looking more closely at how banks and other financial institutions are regulated and supervised. This does not involve examining individual banks but the regulatory system as a whole.
We also help countries adopt internationally established Standards and Codes. We provide technical assistance to countries that need help in implementing some of the reforms I've mentioned. And of course we continue to provide advice on macroeconomic policy.
Low income countries
One area of increasing importance to the Fund's work is what we do to help low income countries. Some years ago, the Fund concluded that it had a clear and important role, working in close cooperation with the World Bank. Hörst Kohler, the Managing Director of the IMF until March this year and now the German President-elect, put considerable emphasis on this aspect of our work, and our newly-arrived Managing Director, Rodrigo de Rato, has wholeheartedly endorsed this.
It takes no more than a moment's reflection to see why this makes sense, and why our work with poorer countries is wholly in line with our central mission. Low income countries share the same economic objectives as middle income and rich countries. They want rapid, sustainable growth, since that brings rising living standards and falling poverty rates.
And in many respects the solutions are the same for all countries. Macroeconomic stability is a sine qua non for the growth hopes of poor countries, just as it is with rich ones. Of course it is true that poor countries have special needs. But these include help to provide better governance, better-functioning financial systems, improved tax collection regimes—just the sort of thing I described earlier as part of our more comprehensive definition of sound and sustainable macroeconomic policies.
Poor countries need more resource transfers, too, but that is not our job. The aid agencies exist to handle development assistance. More aid cannot substitute for sound policies, however, and, indeed, better macroeconomic policies are essential to help countries better absorb and exploit the benefits of larger aid flows.
The Monterrey Consensus of 2002 agreed that both rich countries and the poor themselves share responsibility for improving the lot of the developing world. Yes, rich countries should provide more bilateral or multilateral aid; but poor countries should undertake the structural and macro reforms that will ensure they can put such aid to good use.
The Monterrey Consensus was specifically targeted at achieving the ambitious Millennium Development Goals. The Fund is wholly committed to doing what it can to help countries make progress towards these goals, which include universal primary education and a large reduction in poverty by 2015.
And the focus on sound macroeconomic performance is beginning to bear fruit. In Africa, several countries that have worked hard to put appropriate policies in place are recording better growth performance, with low inflation.
We put so much emphasis on our preventive work because prevention is invariably better than cure. The better the economic policy framework that is in place, the better-equipped a country will be to cope with outside shocks. The more resilient an economy is, the more easily it will weather a global slowdown. And the better-prepared individual economies are, the milder that global downturn will be.
But there will always be crises: I can say that with certainty, though I cannot go beyond that to predict where or when trouble will strike.
Crises have always been part of the Fund's work. The challenge for the IMF is to do as much as possible to prevent them, but, once crises occur, to resolve them as smoothly as possible. Of course, even if the Fund were always right in detecting trouble ahead, governments would not necessarily follow the advice on offer. There are many reasons why a government might want to delay acting on external advice or might choose to ignore it altogether. And unless a government seeks financial assistance from the Fund, the staff ultimately has little leverage in persuading reluctant governments to introduce reform.
Failure to heed warnings by the Fund will lead to crisis in some cases. I've already mentioned what we learned about the origins and nature of crises from our experience of the 1990s. But it is important to remember that each crisis is unique. There may be similarities, but each situation will be different—and, of course, the international economy continues to evolve. Trouble might strike because of inadequate macroeconomic policies, or because of weaknesses in the domestic banking system, or because of an unsustainable debt burden. Most crises do not involve default. And each situation requires a different response.
Sovereign debt restructuring
Particular problems arise when a crisis is caused by, or accompanied by an unsustainable sovereign debt burden. There has been much debate in recent years about how the resolution of such crises could be improved and made more orderly. One of the difficulties in such cases has been the challenge of coordinating the response of the private sector creditors. There is always an incentive for one or more creditors to hold out in the hope of getting better terms than the rest, for example.
This problem is not new. But the rapid growth of international capital flows in the 1990s and the consequent proliferation in the numbers both of debtors and debt instruments lent new impetus to the search for a solution. We in the Fund contributed to that debate with the proposal floated in 2001 for a Sovereign Debt Restructuring Mechanism (SDRM). This led to a vigorous discussion about the various proposals, all of which recognized the need for private sector involvement.
In April 2003, the International Monetary and Financial Committee concluded that it was not then feasible to proceed to establish the SDRM. The IMFC did, however, strongly endorse the use of Collective Action Clauses in sovereign bond issues. Essentially, these make it easier for debtors to negotiate with a large number of creditors by binding all creditors to the outcome of negotiations if a large enough proportion of creditors accept them.
The IMFC called for the use of CACs to become the standard market practice. And this is what has happened. It soon became clear that the inclusion of CACs in bond issues carried no financial penalty, and they have become commonplace, much sooner than many people anticipated. It is, however, much too soon to evaluate the contribution such clauses can make to improving the orderly resolution of debt crises.
The IMFC also endorsed the idea of a voluntary code of conduct for debtors and creditors. The Fund is contributing to the work under way on this.
Crises in individual countries have been frequent. But they have rarely brought widespread disruption to the global financial system. This reinforces my point: that the multilateral framework put in place in the 1940s has served the international economy well.
So are we equipped for today's challenges? I've never been one to tempt fate, and I don't intend to start now. I am not here to tell you there will be no more crises, or that they will always be straightforward and easy to handle. That is unrealistic.
We have a strong motivation for our work in crisis prevention. If by equipped for today's challenges we mean aiming to forestall trouble by encouraging sound economic policies and providing assistance to implement those policies, and if we mean trying to anticipate where trouble might erupt and then trying to take pre-emotive action, then I do believe we are as prepared as any organization can be.
That doesn't mean we always get it right, or that there is no room for improvement. Of course there are always ways in which we could do better. After all, as I said at the outset, we exist to take risks when nobody wants to lend. But as I also said, the design of the post-war framework incorporated adaptability. The Fund tries hard to adapt, to learn, and to stay ahead of the curve.
Yes, it is a big challenge. It is one we try hard to meet.
IMF EXTERNAL RELATIONS DEPARTMENT