Progress in Implementing the Fund's Medium-Term StrategySpeech by Rodrigo de Rato
Managing Director of the International Monetary Fund
At the Foreign Correspondents' Club
August 3, 2006
As Prepared for Delivery
1. I would like to thank the Foreign Correspondents' Club for hosting this event, and Daniel Sloan for that very kind introduction. It is a pleasure to be here.
2. I would like to talk to you today about some of the elements of the International Monetary Fund's Medium-Term Strategy, and about the implications of the strategy for Japan. I will also say a few words about economic developments and prospects in Japan.
3. The Medium-Term Strategy is the framework for the future direction of the Fund. The motivation behind it is that the Fund needs to adapt to help all of its members deal with the challenges of 21st century globalization. In April, I made proposals for implementing the strategy, which were welcomed by our Board and by ministers representing our membership at the International Monetary and Financial Committee. In a month's time the Fund's members will meet again at the 2006 Annual Meetings in Singapore. So this is a good time to take stock of where we are, and where we expect to go over the next few months.
4. The Medium-Term Strategy covers all areas of the Fund's activities. It proposes changes in the way we conduct surveillance of individual members' economies and of the global economy; changes in our approach to preventing and dealing with crises in emerging market economies; a refocusing of our activities in low-income countries; and changes in the Fund's own governance to improve voice and representation. It also proposes that the Fund streamline its activities, and that we consider broadening our sources of financing for them. I will not talk about all aspects of the strategy today, but I would like to go into more detail on a few areas, on which I hope to see significant progress in the months following the Singapore meetings.
5. A key element of the Medium-Term Strategy is improving surveillance. We have already made or are in the process of making some important changes in both the policies and practice of surveillance to make it more effective in helping members tackle problems. Let me mention just two of these:
• The Fund has a new tool for surveillance: Multilateral Consultations, in which particular issues of global or regional significance can be taken up comprehensively and collectively with several members of the Fund and, where relevant, with groups of members. The aim is to provide a vehicle for analysis and consensus-building and a framework that helps our members overcome some of the hurdles to individual action by emphasizing the benefits of joint action for all. Our first Multilateral Consultation has already begun, and will continue during the remainder of 2006. It focuses on narrowing global payments imbalances—the large current account deficit of the United States and large surpluses in the external accounts of other countries—while maintaining robust global growth. Japan, as a major economy which also has a large current account surplus, is an important participant in this Consultation, along with China, the euro area, Saudi Arabia and the United States. The Consultation is at a relatively early stage, and it will take time: global imbalances did not build up overnight and the problem will not be solved in one shot. But I am confident that with action by many countries, the international community can make progress on tackling it.
• I am also implementing plans that will enable the Fund to put greater emphasis on financial sector issues. Understanding financial and capital markets is as fundamental to the Fund today as understanding fiscal, monetary, and exchange rate policies, and we must make sure that its importance is systematically reflected in the work of the institution. This effort will take many forms. I envisage enhanced analysis of financial sectors in the Fund's country reports. I also envisage a renewed emphasis on risks to financial market stability, building on the work that we do in our annual Global Financial Stability Report.
6. Another important element of the Fund's Medium-Term Strategy is ensuring that the representation of members in the Fund is fair and that all members have an adequate voice in the Fund. There have not been significant revisions to relative shareholdings since the early1990's, when Japan's quota was increased substantially to reflect its rising economic weight. It is now time to recognize the rising economic weight of a number of other countries, including some of the largest emerging market economies, including some Asian countries, by increasing their relative quotas and voting shares. At this stage, I envisage that we tackle the issue in a two-year program of action beginning with some key decisions in Singapore in September. These would include immediate action on quota increases for a few countries whose quotas are most clearly out of line with their weight in the global economy. But I would also want our members to agree in Singapore to move during the next two years on more fundamental changes. These would include a further round of ad hoc quota increases for underrepresented members following a review of the formula that is used to calculate quotas. It would also include measures to protect the voice and representation of low-income countries that continue to borrow from the Fund but have only a limited share in Fund voting. To achieve this, I would like to see an increase in the number of "basic votes," which are the minimum and equal number of votes, unrelated to quota size, to which each member is entitled.
7. Multilateral Consultations and quota changes are issues on which there is a great deal of activity at the moment, but there are other aspects of the Medium-Term Strategy where changes are proceeding more gradually, but which are also very important. Let me briefly mention two of them.
8. First, we are revisiting the instruments that we have to help prevent and respond to crises in emerging market countries. At present, not many of our emerging market country members are borrowers from the Fund. This is partly a reflection of good conditions in the global economy and financial markets, and partly of improved economic management in emerging market countries themselves. But we need to make sure that if conditions worsen we have the tools we need to support these countries.
9. Second, the Medium-Term Strategy reaffirms the Fund's commitment to our low-income country members and to the international effort to reduce poverty in low-income countries. It aims to improve the Fund's effectiveness by focusing its efforts more sharply on areas of responsibility where the Fund has a comparative advantage, especially those relating to macroeconomic and financial sector policies, and issues related to debt and the macroeconomic management of aid flows.
10. I will say something in a few minutes about the implications of the Medium-Term Strategy for Japan. But first let me put what I am about to say in context by talking a little about economic developments and prospects in Japan.
11. Some of you may be aware that last month the Fund concluded the 2006 Article IV consultation-our annual examination of each member's economy-with Japan. Developments recently have been very encouraging. Deflation has, by most measures, ended. The Fund projects that output growth in Japan will be close to 3 percent this year; employment is rising, and the financial and corporate sectors are in their best shape in over a decade. The Japanese economy and the Japanese people have been through some hard times over the past decade, but it now seems that better times are ahead.
12. Despite the strong momentum and improved underpinnings for growth, significant policy challenges remain:
• The most pressing challenge is regaining sustainability in the public finances. 13 years of deficits have left a legacy of uncomfortably high public debt. This leaves Japan ill-positioned to address the future demands on the budget from an aging society.
• Another important challenge is to lift potential growth. This is necessary to safeguard living standards with a shrinking population. It calls for far-reaching reforms to spur productivity growth.
• Last but not least, the Bank of Japan faces the challenge of implementing a post-deflation monetary strategy to support sustainable, non-inflationary growth.
13. The authorities are broadly taking the right approach to the budgetary issues facing Japan. The government has put in place a plan for fiscal consolidation, and are ahead of schedule in implementing it. And they have offered the outlines of tax and expenditure measures to meet the objectives they have set for themselves. However, the Fund believes that there is a case for somewhat more ambitious and front-loaded adjustment to take advantage of the recent upswing, to set the debt ratio on a declining path, and to allow more room for maneuver later. We would also urge policymakers not to be overoptimistic on what can be achieved through expenditure cuts, and to take a balanced approach to fiscal adjustment, using tax and spending measures. The Fund's economic analysis suggests that a balanced approach would also produce the biggest output gains over the medium term.
14. As regards a strategy to lift Japan's long term growth prospects, the government has a comprehensive reform program and much progress has been made to date, particularly in charting a path to privatize Japan Post and restructure other government financial institutions. Policy makers should continue to be ambitious in structural reforms. Given the aging population, it is especially important to take steps to encourage participation by women, marginalized youth, and older workers in the labor force. There is also scope for further product market reform, including deregulation of services, and for liberalization of agricultural trade. Experience in Western European countries that are grappling with similar structural problems shows that the gains from labor market reform are enhanced when it is undertaken in conjunction with product market reforms.
15. Finally, turning to the requirements for monetary policy in a post-deflation environment, the tightening cycle started in mid-July to return to more normal level of interest rates needs to be gradual, since the risks of a surge of inflation are limited for now, and a recurrence of deflation would be costly. The Bank of Japan is to be commended for adopting a new framework that helps anchor inflation expectations and brings to the fore what Alan Greenspan described as a "risk-management" approach to the conduct of policy. Careful attention to the longer-term risks of financial or macroeconomic imbalances can help forestall the recurrence of highly disruptive events like the asset price bubble in the late 1980's. It will be important that implementation of the new framework be accompanied by clear communications by the Bank of Japan.
16. The International Monetary Fund's relationship with Japan is one of its most important. Japan is the Fund's second largest shareholder, and the interventions of Japan's representatives at the Fund are listened to with great respect, both by the staff and by other members. As the largest economy in Asia and a very substantial contributor to low-income countries, both directly and through its support of the Fund's lending and technical assistance, Japan also has a hugely important role in many policy initiatives. I believe that this full and rich participation in the Fund and in the global economic community also conveys important benefits for Japan, increasingly so as real and financial globalization make the world more integrated.
17. The Multilateral Consultations initiative is very important in this context. As a major participant in the world economy, Japan has much to gain from an orderly resolution of global imbalances. Japan, along with other countries, also has a key role to play in contributing to a smooth resolution of global imbalances. Structural reforms that boost domestic demand in Japan would contribute to a lowering of the current account surplus as well as increasing growth. The gains will be even greater if actions by Japan are part of an agreed strategy including fiscal consolidation in the United States, greater exchange rate flexibility in emerging Asia, and structural reform in Europe.
18. As an important participant in the global economy Japan will also benefit from better focused Fund surveillance, including greater emphasis on financial markets. As a major player in emerging markets Japan will benefit from Fund having good instruments to prevent and respond to crises. And as a major aid donor, Japan will benefit from a more focused Fund role in low-income countries, which contributes to more effective use of aid.
19. Japan has long played a constructive role in the Fund, and I am sure that this will continue. I have had some very useful conversations during this visit with Prime Minister Koizumi, Minister Tanigaki, Vice-Minister Watanabe, and Governor Fukui. I have also had an interesting meeting with private sector representatives, and I now look forward to hearing your comments and your questions.
Thank you very much.