Japan and the IMF
United States and the IMF
A Medium-Term Strategy for the IMF: Meeting the Challenge of Globalization
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The Role of the IMF in Safeguarding Global Financial Stability|
Remarks by Rodrigo de Rato
Managing Director, International Monetary Fund
At the l'Institut International d'Etudes Bancaires (IIEB)
Barcelona, Spain, October 21, 2005
1. Thank you for inviting me to this distinguished gathering of top executives from banks across Europe. I welcome the opportunity—only a few weeks after the Annual Meetings of the IMF and World Bank—to share with you the Fund's assessment of the outlook for the global economy and potential risks for the international financial system. I will also describe some cornerstones of the Fund's recently issued Medium-Term Strategy. Finally, in view of the importance of the interaction between the IMF and the private sector, I would like to offer some thoughts on how we can make the most of this dialogue in the future.
Assessment of economic and financial risks
2. How do we at the IMF see the risks in the global financial system? In a nutshell: We believe the momentum of the global expansion will be maintained and that inflation will stay under control. But the outlook is subject to great uncertainty, and the balance of risks is toward the downside.
3. The destruction caused by hurricanes Katrina and Rita is expected to slow U.S. economic growth somewhat in the last four months of 2005, but the economy retains considerable momentum, which reconstruction will reinforce in the first half of 2006. The Chinese economy, the other major pillar of the expansion, continues as strongly as ever, and the growth of emerging and developing economies as a group is still quite robust. Elsewhere, in particular in Europe, the growth outlook is less favorable than it was six months ago. While the Japanese economy appears to gain momentum, the pace of recovery in the Euro Area remains disappointing, underlining the need for policies to boost confidence and growth.
4. The principal risks in our current outlook are: first, the rising trend and volatility of energy prices and their potential impact on output and inflation; second, protectionism in the event that the Doha Round of negotiations were not to conclude successfully; third, a disorderly adjustment of the global imbalances; and fourth, the possibility of an sharp correction of the still rather favorable financial market environment. Let me comment briefly on the latter two risks.
5. The persistence of global imbalances has become an increasingly worrisome source of vulnerability in the medium-term. The question is not whether they will be reduced, but whether their reduction will happen in an orderly or a disorderly way. During the past year some progress has been made. Fiscal revenues in the United States have rebounded. The prospects for structural reform in Japan are brighter than for many years. And we have begun to see greater exchange rate flexibility in Asia. However, there is a need to move forward more decisively. The world needs to move away from a pattern of growth where investment in most of Asia is too low, high consumption in the United States is financed by rapidly increasing debt, and growth of domestic demand in Europe and Japan is too weak.
6. Many countries need to share the work of reducing global imbalances and sustaining growth.
• In Europe, there is a need to strengthen confidence. Governments need to articulate comprehensive, growth-oriented strategies that address both unemployment and aging, mainly through reducing the rigidities prevailing in labor, product and service markets. They should also extend the Single Market to the provision of services, including financial services.
• In emerging Asia, there is scope for greater exchange rate flexibility and increased domestic demand. The recent moves in China and Malaysia are welcome, and I hope that the authorities will use the flexibility afforded by their new arrangements. I also hope that other countries in Asia which have been managing their exchange rates more flexibly will continue to do so. In addition, faster domestic demand growth in Asia through a continuation of structural reforms, to encourage investment, has to be part of an orderly adjustment process.
• As so often in the recent past, the U.S. economy has been one of the main engines driving global growth. But as the net external liabilities of the United States continue to increase, so do its external vulnerabilities. Therefore, the U.S. part of the equation on global imbalances—reducing the fiscal and current account deficits—is particularly urgent. The administration's plan to reduce the fiscal deficit is welcome, but the unprecedented cuts in non-defense discretionary spending that it requires would have been difficult to achieve even before the devastation wrought by Hurricane Katrina. I believe that actions on the revenue side, preferably through reforms to broaden and simplify the tax base, will also be needed.
7. In global financial markets, the risks are superimposed on a cyclical situation that has already lasted longer than expected. Credit conditions remain unusually favorable, including for sub-prime borrowers, and we expect the currently tight credit spreads to widen as the credit cycle peaks. The key question at this juncture is the speed and extent of the likely market corrections. Much uncertainty surrounds this question, especially since credit derivatives and collateralized debt obligations have played an important role in distributing and pricing risk. As these markets are not yet fully understood by all investors or supervisors, they need to be closely monitored. Nevertheless, over the last four years, the resilience of the global financial system has clearly strengthened. There are important buffers in the system that can serve as shock absorbers even when risks materialize:
• first, the much strengthened balance sheets of the financial and corporate sectors in many countries;
• second, the increased diversity of investors and their investment behavior;
• third, improved risk management, and the enhanced transparency and disclosure in financial markets;
• fourth, the wide dispersal of financial risk from banking to nonbanking sectors; and
• last but not least, the inability of investors "to sit on the fence" for long; the bottom line for asset managers is: "no risk, no return"—therefore, to shun all risk is only a short-term or temporary option for them.
8. Turning to emerging market countries, it is encouraging to observe a reduction of crisis vulnerability and contagion over the past year or two. This group of countries is benefiting from a substantial increase in private capital inflows. In aggregate this year, these should be almost comparable in magnitude to flows into the United States, but with a much higher proportion in form of foreign direct investment (FDI). These inflows are supporting the widespread build-up of reserves in many emerging market countries. This development is only partly due to favorable cyclical factors. It also owes a lot to improvements in the fundamentals of many emerging market economies. Their more sophisticated debt management and the greater development of local capital markets as well their recent ability to sell local currency debt to international investors have also played important roles. The diversification of the investor base for emerging market debt is facilitating those trends and contributing to the growing maturity of this asset class.
9. Nevertheless, in a situation in which the state of the global economy is generally good and when financial market conditions are very supportive, one of the biggest risks to beware of is complacency. Emerging market economies need to stay the course of prudent macroeconomic policies and structural reform. Strengthened fundamentals, in particular sustained fiscal efforts to bring down the debt burdens, are a key to reducing their vulnerability to external shocks. I also encourage policy makers in these countries to continue their pro-active debt management and to take further steps to develop local capital markets. If these endeavors prove successful, there may be less reason to fear that a slowdown in global growth or a correction in the global imbalances will actually lead to a sharp reduction in private capital inflows to emerging market economies.
The Fund's Medium-Term Strategy as it relates to the financial sector
10. The Fund's Medium-Term Strategy, which I have developed over the past year, is based on one central tenet: helping the Fund's members meet the challenges of globalization. Nowhere have globalization and the changes it has brought about become more visible than in global financial markets. Financial globalization has pulled the world economy in a hugely beneficial direction, helping to allocate world savings to more productive and diversified investments. But it also has created new challenges, as the integration of capital markets has increased the size, speed, and reach of potential shocks across mature and emerging market economies. This has altered the context of the Fund's mission. Safeguarding the stability of the international monetary system is now a qualitatively and quantitatively different task than it was 15 years ago. The Fund must remain in step with a rapidly changing world. And our main activity—surveillance—has to adapt to capture more effectively the potential risks to systemic stability in a global marketplace.
11. The Fund's tool box has already changed over the past several years. We have developed the Financial Sector Assessment Program—a systematic and comprehensive "health check" of our members' financial sectors. We have been promoting international best practice through Standards and Codes; this initiative serves as an important tool to help enhance the quality of economic institutions and improve the quality and transparency of data. We have developed better tools for assessing debt sustainability and fragilities in national balance sheets. And we created an International Capital Markets department, which regularly monitors and analyzes financial market developments and risks, in particular, through the Global Financial Stability Report (GFSR).
12. But much remains to be done: We will have to continue improving our "risk-reporting systems." Not the least with this in mind, the GFSR has recently begun to focus on the global asset allocation process. If we develop a better understanding of the forces and factors that drive the decisions to allocate or re-allocate assets by banks and institutional investors, we will be better able to anticipate shifts in capital flows across sectors and borders. In this respect, our surveillance is becoming ever more global, or "multilateral" as we say. In our surveillance work we therefore intend to better integrate global issues and country risk assessments. In other words, we need to optimize the matrix between "client coverage"—in our case country work—and product expertise which, by definition, is global. The Managing Director of the IMF struggles in many ways with the same matrix organization issues that many of you around the table struggle with.
Dialogue between the IMF and the private sector
13. International capital flows are now overwhelmingly private flows of funds. Hence, learning from you and understanding the investment decisions of both financial and nonfinancial firms is critical for a comprehensive assessment and management of risk. Let me be clear: I do not envision the IMF as a global super-bureaucracy for regulating and supervising financial markets, but rather as a global forum in which those in charge of monitoring risk at the national level can meet and share their assessments. I see it as an institution that provides a "radar screen" which gathers all relevant information—from public as well as from private sources—to gain a fuller global view of risks in the system. And, on this basis, we should be better able to advise members on appropriate risk management strategies.
14. Risk and risk-taking are not something suspicious, but essential ingredients in an efficient vibrant market economy which should not be stifled. In fact, the system should include enough participants willing to assume and hold risk, not least to have enough players who provide market liquidity at times when it is most needed. And we need to ensure that there are adequate cushions to absorb risks. This is also one of the reasons why we have begun to weigh in on the international accounting debate.
15. Just as the Fund benefits from its dialogue with private financial institutions, the private sector can also benefit in many ways from the Fund:
• It is the only international institution that is capable of providing truly global systemic surveillance.
• Its activities are crucial for crisis prevention, in particular: by promoting best practice among its members on macroeconomic and financial policy; by fostering transparency; by helping to strengthen core economic institutions; and by setting broad incentives for improving the investment climate.
• Its lending facilities are available to help countries in crisis get their feet back on the ground when almost all other external financing has dried up.
17. As a general rule, we do not shout our judgments in the market place—we see our role as that of a trusted advisor, helping our members become less vulnerable to external shocks or changes in market sentiment. One example is the increasingly successful effort to help countries develop their local capital markets. Local currency borrowing shifts foreign exchange risk to those who can better absorb it. As such, this is another chapter in the "risk transfer saga" that is being written as we speak.
18. The Fund's crisis lending and conditionality has been subject to much critical debate. But the fact is that the IMF is the only international body that can effectively help anchor crisis resolution strategies; this includes giving advice to members on complex debt operations. Our work has also given impetus to market initiatives, including the adoption of collective action clauses in sovereign bond contracts. Even so, recovery from financial crisis is a complicated endeavor, and among the priorities in the near future, we need to review the effectiveness of the Fund's instruments to facilitate crisis resolution, including the Lending Into Arrears Policy.
16. Integrated financial institutions like those assembled here today can also make major contributions to global financial stability:
• By continuing to make every effort to improve risk management in your key markets. I applaud the work undertaken recently (in the Counterparty Risk Management Policy Group II) under the chairmanship of Gerald Corrigan and encourage you to follow up speedily in the implementation of the report's recommendations.
• By transferring know-how and strengthening corporate governance in the financial sector while operating in emerging market and developing countries; and
• By contributing to effective crisis resolution efforts, such as the development of the "Principles for Stable Capital Flows and Fair Debt Restructuring in Emerging Markets." This initiative between private sector representatives and emerging market officials holds promise, especially, if it continues to gain broad support among all concerned parties.
17. The last two decades have witnessed tremendous change in the global financial system. Work on financial stability issues has moved to center stage across the IMF membership, in national and multilateral institutions alike, and rightly so. An efficient IMF is critical in this context, because it is the only truly universal institution that can monitor and assess the system as a whole and provide a platform for joint efforts by all participants in the system to strengthen its resilience. In 1944, the Fund was given the mandate to safeguard the stability of the international monetary system. This mandate is more relevant than ever today when the internationalization of finance has become a reality. Sustained success in performing this key task relies not only on the good interaction between the Fund and the policy makers in member countries; it also requires permanent efforts by the private sector to bolster market discipline.
Thank you for your attention!
IMF EXTERNAL RELATIONS DEPARTMENT