March 13, 2007
As Prepared for Delivery
Good morning. I would like to welcome all of you who are joining us today for this seminar. Allow me to express my particular appreciation to the many of you who have traveled from other locations to come to Singapore for this event.
Globalization and Exchange Rates
This conference offers an opportunity to examine a key topic in the IMF's effort to promote global economic progress and financial stability, namely the analysis of exchange rates and related policies. It takes place just ahead of the tenth anniversary of the Asian financial crisis—an opportune time to reflect and exchange views on the lessons learned from the crisis and its aftermath. Rapidly increasing trade and financial globalization have made the analysis of exchange rate issues more important—but also much more complex.
Globalization offers both promises and challenges at the same time. The large and wide-ranging movement of goods and services across national borders has contributed to sustained expansion in the world economy. But it also requires all countries to adapt flexibly to the consequent changes in production processes and employment opportunities. Likewise, the extensive development of private capital markets has greatly improved the allocation of global savings and investment. In fact, as recent research undertaken by the Fund's Research Department shows, over the last 30-35 years, emerging-market economies on average have grown close to three times faster than the group of developing countries that have not actively participated in financial globalization. But financial globalization also requires countries to remain vigilant against the risks posed by the size and complexity of international financial flows.
Asian countries are familiar with the two sides of globalization. Over the past several decades, many Asian countries have become an important driving force in the global economy, and the region now accounts for nearly a third of world GDP in PPP terms. Many countries have embraced an outward-oriented strategy for growth, integrating themselves fully into the global economic system. In the process, they have also suffered from the hazard of volatile capital flows—the financial crisis in the late 1990s was clearly a setback for many countries. However, thanks in large measure to the resolute action taken by the authorities in the region, the subsequent recovery has been swift, and robust economic growth has returned to the region. The strength of capital inflows attests to the market's confidence in Asia's economic prospects. The Fund has also reviewed carefully the experience from the Asian crisis, and introduced many change to its practices in light of the lessons learned.
Looking ahead, Asian countries face new challenges to maintain the momentum of economic progress. The roots of Asia's recovery from the crisis lie not just in the restoration of macroeconomic stability, but also in reforms, especially in strengthening financial and corporate sectors whose weakness contributed to the severity of the crisis. Reaping the benefits from global financial integration will require strengthening and further developing domestic financial markets. And a recovery of investment in many countries, together with looming demographic changes, may entail a rebalancing of growth patterns, including a greater role for private domestic demand in driving future growth. This rebalancing should help to reduce the vulnerability of Asia's economies to external economic developments, and allow them to reap the benefit of high growth directly in the form of higher consumption and welfare. Combined with other reforms that improve the investment climate and strengthen competition and flexibility, greater exchange rate flexibility would facilitate this rebalancing of growth patterns of Asian economies over the medium term, while also allowing monetary policy greater independence to secure domestic policy objectives, and to cope with the side effects of volatile capital flows.
Of course, I do not need to mention to this audience that exchange rate issues are at the heart of the IMF's raison d'être. The Fund originally was set up to ensure that the world never again experiences the massive disruptions of the Great Depression, with its painful memory of competitive devaluations. Since the institution's establishment at the end of World War II, the IMF has overseen an era of fixed exchange rates, witnessed the breakdown of that system, and is currently mandated to help the world navigate a system in which members are free to choose their own exchange rate regimes. I would now like to briefly illustrate to you how the institution is responding to the challenges posed by this role, before turning more specifically to exchange rate analysis, the topic of today's conference.
Medium-Term Strategy
To better discharge our mandate and help member countries meet the new challenges associated with globalization, the IMF has developed a comprehensive Medium-Term Strategy under the direction of its Managing Director Rodrigo de Rato. I would like to highlight several areas of the Strategy that are particularly relevant to Asia.
Our membership is in the midst of reforming IMF quotas and voting rights to better reflect changes in the world economy. At last September's Annual Meetings here in Singapore, Fund members approved an increase in the quotas of four countries (China, Korea, Mexico, and Turkey). This increase was intended to rectify the most extreme case of underrepresentation, but constitutes only the first step in a broader reform process. The reform of quotas will continue over the next two years, with a view to better aligning quota shares with economic weight, while ensuring effective participation of low-income countries in the governance of the Fund.
We are also addressing the crisis prevention needs of emerging market countries. Discussion has started on a new contingent financing instrument for countries that remain vulnerable to shocks despite having maintained a strong macroeconomic framework. The objective of the Reserve Augmentation Line now under study in the Fund is to boost the amount of contingent financing available to countries that have no need for immediate financing or policy adjustment. And the Fund is helping to build the foundations for sustained growth in the low-income countries.
But in terms of our discussion today, what I would like to touch upon now is the importance given to strengthening Fund surveillance in the Medium-Term Strategy. As you know, bilateral surveillance consists of an extensive program of macroeconomic analysis and our policy dialogue with member governments. However, surveillance increasingly has become regional and global in scope. Most of you are familiar with the Fund's two multilateral surveillance publications, the World Economic Outlook and the Global Financial Stability Report. Under an innovation proposed in the Medium-Term Strategy, we are also engaged in "multilateral consultations" with a set of key economies to address the challenges posed by record global imbalances.
In terms of bilateral surveillance, Article IV of the IMF Articles of Agreement, in essence, lays out a code of conduct for countries' exchange rate and domestic policies. Regular consultations take place between Fund staff and member governments to discuss those policies. Within this broad setting, Article IV consultations use exchange rate assessments to monitor countries' competitiveness and vulnerabilities to balance of payments crises.
However, global developments in recent years confronted the Fund with several challenges regarding exchange rate surveillance. With the shifting focus within the Fund toward crisis prevention, renewed emphasis has been placed on surveillance, especially exchange rate surveillance, as a critical pillar of the policy dialogue between the IMF and member countries. Rapid changes in the global economy have also increased the likelihood of substantial exchange rate adjustments that should facilitate structural transformation in member countries, and the need, therefore, for tools that can help us to disentangle short-run exchange rate changes from broader medium-run trends.
Exchange Rate Surveillance and CGER
In light of all these changes, it is quite natural that the strengthening of IMF surveillance should involve a thorough review of exchange rate surveillance. So we are currently reviewing the 1977 Executive Board decision that established the basis for exchange rate surveillance to make sure that this basis is sound.
A recent "stock-taking" paper on the nature and effectiveness of the Fund's bilateral exchange rate surveillance, presented to the Board last August, suggests that important progress is being made in this area. The paper, which is available on our website, examined exchange rate surveillance for 30 large economies accounting for about 90 percent of world GDP. It concluded that almost all recent Article IV reports in the sample provided an accurate description of the de facto exchange rate regime—and not simply a report on the de jure regime. The reports also assessed a regime's adequacy, as well as analyzing the consistency between exchange rate and other policies and external stability. Most importantly—and I think this point needs to be emphasized—almost all Article IV reports included a clear staff assessment of exchange rate misalignments. These views on misalignments were often expressed in qualitative terms. But in several cases, quantitative estimates—including for example the recent staff reports for Australia and India—were also included.
However, the report also shows that there is room for further improvement in our surveillance work. In a number of cases, staff reports could have provided a richer analytical discussion of the factors that staff considered in reaching conclusions about exchange rate misalignments. There still is room for improvement in the analysis of external competitiveness and the appropriate exchange rate level over the medium term—of course, within the bounds set by the current state of economic and technical knowledge.
In parallel with bilateral surveillance, the IMF is also conducting multilateral exchange rate surveillance through the Consultative Group on Exchange Rate Issues (the so-called "CGER"). This has served as the framework for producing multilaterally consistent exchange rate assessments that provide an important complement to the country-specific exchange rate analysis conducted in the course of Article IV consultations. We have recently expanded and updated the methodology, which now covers about 30 major advanced and emerging markets.
My colleagues in the Research Department will discuss the gist of the CGER framework today, but allow me to comment on one aspect. The process aims to assess the medium-term consistency between the real exchange rate and underlying economic fundamentals. This focus is justified by the existing evidence that the exchange rate tends to reflect economic fundamentals better in the medium than in the short term. It is also consistent with the lesson that policy makers should not lose sight of the medium-term effects of policy choices and of likely trends in key economic variables. I would also hasten to add that the CGER approach says little about exchange rate movements at short-term horizons, which tend to be driven by factors other than fundamentals, though we may well hear views on this subject from participants in the various sessions today.
The IMF work on data development also helps to strengthen the base for the analytical work on exchange rates. For example, we have reasonably good data on capital flows, but less complete information on stocks—that is to say, the asset and liability positions that can influence exchange rate adjustment. However, we are also making progress here. The Fund's work has been at the forefront of efforts in this area, with data initiatives such as the Special Data Dissemination Standard, the development of International Investment Position data, and the Coordinated Portfolio Investment Survey. We also are conducting analytical work, for example, on the balance sheet approach and early-warning systems for currency crises.
Concluding remarks
Despite the work program that is under way, challenges remain. Exchange rate assessments need to disentangle factors that are relevant for the medium term from those affecting short-term dynamics. Similarly, the IMF, and the economics profession as a whole, must achieve a deeper understanding of the interaction of financial sector developments and exchange rate trends. The IMF needs to emerge as a center of excellence in this area; indeed, this is a key objective of the Medium Term Strategy.
All of this brings me back to this conference. There are many issues relevant to our discussion today: how do exchange rates interact with short- and long-term trends in financial flows? What lessons can we draw from recent academic advances on exchange rate modeling? How can policy makers cope with the inherent uncertainty of floating rate regimes? The ongoing process of globalization calls for a constant rethinking of these issues.
Understanding the trends that I have outlined briefly here—and then putting them to work in our policy analysis—is a significant challenge. It requires the best minds in all sectors—markets, academia, governments, and international institutions—working together. Today's meeting is a useful part of that process. I am eager to hear your perspectives.
Thank you very much.
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