The Reform Process at the International Monetary Fund

By John Lipsky, First Deputy Managing Director
International Monetary Fund
Xianghe, People's Republic of China
September 13, 2006

Thank you for the invitation to participate in this panel. The theme of this session is one I am especially pleased to have a chance to discuss with you. The IMF itself is undertaking far-reaching reforms. These reforms-though geared to address global issues-are particularly meaningful for Asia.

My starting point is straightforward and well-known, but still worth stating: The global economy and financial markets have changed substantially since the crisis years of 1997/98, and these changes by and large have been to the good. In particular, many emerging market countries substantially improved their macroeconomic performance by strengthening their monetary and budget policies. They also have been developing more complete and stable domestic financial markets.

The combination of policy improvements and good economic performance has helped to produce an unprecedented increase in cross-border capital flows. In addition, many emerging market countries have taken advantage of the generally favorable environment to build cushions against external shocks. They have accomplished this by improving their debt structures, by accumulating international reserves and by expanding regional reserve pooling arrangements, particularly in Asia.

As a result, international investors increasingly have been purchasing emerging market securities denominated in the issuer's local currency. Thus, many emerging market countries are beginning to overcome earlier limitations that many experts had assumed were more or less permanent. Of course, I am referring to the once-fashionable concept of "original sin." The proponents of that view claimed that emerging market economies could only borrow internationally in foreign currencies, reflecting a "permanent" lack of market credibility. Thus the latest developments require an important vote of confidence in future economic and market stability.

It is not surprising that in these circumstances, IMF members' need to call on the Fund's financial resources has receded. According to the IMF's latest World Economic Outlook forecast, it is most likely that the current favorable international environment will be sustained, at least for now. This is very good news.

However, there are notable and widely-recognized risks regarding both the fundamental and financial outlook. Thus, it is imperative that the current relative calm be utilized to adapt the international system to the new realities. In particular, the changing distribution of global economic activity - and the changing structure of international trade and finance - call for an updating of IMF mechanisms intended to provide crisis prevention and crisis resolution. In other words, the key objective of the Fund-to create an international system that promotes both growth and financial stability-remains as relevant as ever, but the focus, scope, and specific details of its activities have to be brought up to date.

In response to this challenge, the IMF has developed a Medium-Term Strategy for making the institution better able in the future to fulfill its role of promoting global growth and stability. With this in mind, I will discuss briefly the three key themes that are at the heart of this strategy, and that are likely to shape the Fund's work in the coming years. First, the IMF is taking steps to ensure it remains representative of its global membership. Second, the IMF is reshaping its analysis of economic issues in order to respond to the impact of globalization. And third, the IMF is considering ways to better support emerging market countries.

On the first point-ensuring that the IMF remains truly representative of its global membership-it is important that all countries have a fair voice in IMF decision-making. On August 31, the Fund's Executive Board agreed on a two-year program of fundamental reforms of quotas-the Fund's voting shares. The proposed reforms have been endorsed by our Executive Board and presented to our Board of Governors for action at the IMF's Annual Meetings next week in Singapore. These reforms are crucial for the IMF's continued credibility and effectiveness.

The reform program has two main goals. One is to realign quota shares with members' actual weight in the world economy and to make voting shares more responsive to future changes in global economic realities. The other objective is to enhance the participation and voice of low-income countries in the institution.

Our Executive Board recommended initial ad-hoc increases in quotas for four clearly underrepresented countries: China, Korea, Mexico, and Turkey. More far-reaching reforms will take place over the next two years, with discussions beginning very soon on a new, simpler and more transparent quota formula. The new formula will be crafted to capture more accurately members' positions in the global economy. Our hope is that as soon as the 2007 Annual Meetings, our Executive Board will agree on a new formula, and recommend further ad-hoc increases in quotas for a broader range of members. At the same time, basic votes-which are equal for all members-will at a minimum be doubled. This action will protect the existing voting power of low income countries now and in the future. By the way, this and other measures will help strengthen the position of the IMF's African chairs.

Asian countries stand to gain from these reforms. In addition to the countries benefiting from the first round of ad hoc increases, a larger group of Asian countries will be candidates for second round increases. Moreover, given the economic dynamism of Asian nations, the region is likely to benefit over time from the commitment to keep quota shares in line with future changes in the world economy.

A second area of reform is adapting our country analysis framework and analytical tools to respond to the challenges of globalization. In particular, exchange rate analysis is at the core of the Fund's work. Reviewing and reshaping our understanding of the forces that influence exchange rates will enhance the Fund's ability to carry out its basic responsibilities. The reason for the review is easy to understand: A lot has changed in the past three decades. Most countries have adopted flexible exchange rage regimes, current account restrictions are becoming increasingly rare, and private capital flows have increased to unprecedented levels. Against this backdrop, the IMF's analytical techniques have been evolving. Nonetheless, it is time for new initiatives.

For example, we are reviewing the methodological underpinnings of the IMF's exchange rate surveillance. Our Research Department is applying the same methods to the currencies of the major emerging economies that the Fund already applies in advanced economies in order to assess whether exchange rates are broadly in line with fundamentals. Of course, this process needs to be handled with caution, as there is no single correct method of exchange rate analysis. Nonetheless, this new work is an important step that will fortify the Fund's work on competitiveness.

In a world of integrated financial markets and large-scale capital flows, the IMF cannot monitor the international monetary system and the global economy effectively unless such surveillance is underpinned by a solid analysis of macro-financial linkages and cross-country spillovers. To address these challenges, the Fund is developing new analytical tools. For example, one methodology is designed to capture the potential spillover effects of countries' fiscal policies. In addition, we are studying how the Fund can improve its analysis of financial issues, and how this analysis can be better integrated into country surveillance.

One of our basic goals is to sustain progress in the international monetary system and the global economy. As part of this effort, the IMF holds annual consultations with most member countries, focusing on their fiscal and monetary policies, exchange rate change, the balance of payments, and external debt development. We also take into account the regional and international implications of their policies. We are now complementing these bilateral discussions with multilateral consultations. These new consultations allow us to take up important challenges comprehensively and collectively, by holding issue-focused discussions with a relevant group of countries.

Our first multilateral consultation is focusing on the challenge of narrowing global imbalances while maintaining robust global growth. Our staff already has held bilateral discussions with the participants in this first multilateral consultation-including China, the Euro area, Japan, Saudi Arabia, and the United States. Over the coming months, we will hold roundtable meetings with all of the participants together. This consultation is focusing on the spillovers and linkages among these and other economies, and on actions that could sustain growth and promote an orderly reduction of the current imbalances. This process will take time, both to complete the consultation, and for actions taken to produce effects. This isn't surprising. After all, today's record imbalances have been built up over several years.

The IMF is also considering ways to better support to emerging market countries. To accomplish this, we intend to make sure that our lending framework provides sufficient predictability and flexibility to meet our member's needs. In the current relatively benign global environment, not many emerging market countries need to borrow from the Fund. However, the Fund still needs to be prepared for times when market access for emerging market borrowers could become constrained.

With this in mind, we are considering a new instrument that would provide liquidity to emerging market countries that have strong fundamentals but that remain vulnerable to financial shocks. The aim would be to reinforce crisis prevention efforts by providing a framework for countries to make commitments to economic policies that will help ensure stable growth. Such an instrument also would provide both member countries and the financial markets with the assurances that substantial financing will be available in times of need. There are important challenges to designing an effective instrument, but discussions are continuing with a view to making concrete progress in the coming months.

I have described a long agenda of reform. The first practical step is to adopt the measures on voting shares. We hope that there will be concrete progress to report next week at the Singapore Annual Meetings of the Fund's Board of Governors. If this first step is approved, this will be good news for China and for the IMF.

Progress on IMF reform will demonstrate-that the multilateral approach to economic development that has produced the greatest period of economic progress-remains relevant and effective.



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