Taking Advantage of the Benign Global Environment: A Time for Reforms

Remarks by IMF Deputy Managing Director Murilo Portugal at the Sixth Annual Regional Conference on Central America, Panama, and the Dominican Republic
Museo del Oro Precolombino
June 28, 2007

Thank you very much, Francisco, for these very kind words of introduction, and a very good evening.

Let me begin by expressing my sincere thanks to Francisco for his generous hospitality and to the Central Bank of Costa Rica for hosting this Sixth Annual Regional Conference. Let me also thank all of you, presidents of central banks, ministers of finance, superintendents, heads of regional institutions, other senior officials, and representatives of international financial institutions, for your participation in this conference.

It is a distinct pleasure to be here this evening in these exquisite surroundings, which remind us of the long, complex, and rich history of this country. It is particularly satisfying for me to take part for the first time, as Deputy Managing Director of the IMF, in a Regional Conference on Central America, Panama, and the Dominican Republic. In a previous incarnation, as IMF Executive Director, I had the honor to represent Panama and the Dominican Republic. More recently, during the IDB Annual Meetings in Guatemala City, I was privileged to get to know many of you. So I am particularly delighted to see some of my old friends again, and to be making new ones as well.

Over the course of the last six years, these annual conferences have become a hallmark of the close and cordial relations that have developed over time between the countries of the region and the IMF. Even more importantly, they have come to provide a vital opportunity to talk about important policy issues for the region, to take stock of the progress made on the regional agenda over the previous 12 months, and to discuss very openly how to take our cooperation forward. Viewed in this light, I must say that I found the first two sessions of this 6th conference extremely interesting; and I have no doubt that tomorrow's exchanges will be just as fruitful.

My theme for this evening is: "A time for reforms: taking advantage of the benign global environment." It is a theme that I feel is very apt both for the region and for the IMF. This is an essential time for reforms, first, because the world is changing very rapidly around us. And it is vital for us—the region and the Fund—to adapt to this changing global environment. Second, it is a propitious time for reforms because the favorable global economic conditions give us—again, the region and the Fund—the "breathing space" to design and put in place far-reaching policy changes. It is in the sunny day that we should fix the roof of the house. Third, reforms that are done in good times when we are not pressed by circumstances to adopt them generate greater credibility for policy-makers than reforms undertaken under the duress of a crisis, when there is no other option than implementing the reforms.

Reforms in Central America, Panama, and the Dominican Republic

Central America, Panama, and the Dominican Republic have made important progress over the past decade. I do not need to recount to this audience in exhaustive detail what has been achieved during this period, but three key advances are worth highlighting before turning to current challenges.

First, there has been progress toward democracy and greater political stability in the region. Political scientists have vigorous debates on the extent to which political systems are more stable now than before—and it is not our job, as economists at the IMF, to second guess them. I do believe, however, that there is a consensus that considerable progress has been made on the political front.

Second, the region has embraced macroeconomic stability. In a recent public event the IMF organized in Washington, the Ambassador of Guatemala vividly illustrated this point when he stressed that none of the five leading presidential candidates in Guatemala called responsible macroeconomic policies into question. In terms of concrete results, average inflation in the region fell to 6 percent at the end of 2006. Barring further external shocks, it should decline even further this year. Between 2003 and 2006, fiscal balances improved by 3 ½ percent of GDP on average across the region and by more than 5 percent of GDP in Panama. And, notwithstanding a large negative oil shock, countries of the region were able to avoid a significant deterioration of their current account balances, and to bolster their international reserves significantly.

Third, the region has actively sought greater integration with the world economy. The evolution of trade flows shows this: total exports and imports—a standard measure of trade openness—rose from 40 percent of GDP in the 1980's to 50 percent of GDP in the 1990's, and to 60 percent of GDP in the first half of this decade. Prominent among the actions to increase integration with the world economy are the implementation of the Central American-Dominican Republic Free Trade Agreement (CAFTA-DR), the strategy to complete the Central American customs union, and the forthcoming negotiations on an Association Agreement with the European Union.

Despite all these achievements, growth rates in the region are not yet where we would all like them to be. And poverty levels remain way too high. These are the key policy challenges that remain.

What can the region do in this period of relative calm to tackle these challenges? Let me highlight five areas where further reforms would be particularly important.

First, all countries of the region have to reduce public debt further in a durable way— with the exception of Guatemala that already has a low debt stock. This is essential to boosting the region's resilience to shocks or an eventual global economic downturn. It is key to entrenching the confidence of local and foreign investors in the economic stability of the region. This will require targeting stronger fiscal balances and improving public debt structures—a topic discussed at last year's conference and included in the regional technical assistance program that we will review tomorrow morning. Many countries in the region have made important strides in tax administration, which will help in this regard. I also believe that it will require further pension reform, given evolving demographics, the generosity of existing pension systems, their low coverage of the population, and their regressivity.

Second, inflation needs to be steadily brought down to low single digits. This is the de facto new international standard, applied by advanced economies and large emerging markets. As another clear demonstration of stability, this is what the region needs to aspire to. It is also an objective that would benefit the poor given that the burden of inflation falls most heavily on this population group. Apart from El Salvador and Panama, achieving this objective will necessitate enhancing monetary policy frameworks and, in some countries, recapitalizing central banks—an area where Costa Rica and the Dominican Republic have taken helpful first steps recently.

Third, as recent events in the region have demonstrated, more needs to be done to strengthen supervision and regulation of the financial sector. This would build on progress already made, such as the approval of wide-ranging financial sector legislation in Nicaragua a couple of years ago. It is imperative to have a better handle on large offshore financial activities. It is essential to get to a position where consolidated supervision of financial conglomerates can be fully effective. It will be necessary to adapt to the challenges posed by regionalization of financial services and the recent entry of large and highly sophisticated international financial groups. I was greatly heartened by the discussion we had in our first session this afternoon, which pointed to the strong will of policy-makers in the region to collaborate on these issues.

Fourth, there is much room to reduce the cost of doing business, which is an important element in investment decisions. On average, the region has typically not scored so well in widely used world-wide rankings—such as the World Economic Forum's Global Competitiveness indices or the World Bank's Doing Business indicators—particularly as regards the cost of starting a business, dealing with licenses, and enforcing contracts. Efforts in these areas can pay off handsomely, as possibly shown most vividly in recent years in the region by El Salvador and Guatemala.

Fifth but certainly not least, macroeconomic policies—and, particularly, fiscal policies—must do more to share widely the benefits of growth, reduce poverty, and, in so doing, broaden support for continued market-oriented reforms. I'm convinced that, in the region, this will require additional well-targeted social spending and, naturally, in parallel with it, further increase in tax revenue. There are already very good examples in this area, such as Red Solidaria in Honduras and other conditional cash transfers programs in the region. Tomorrow's presentation on the distributional impact of tax policy and social spending will convincingly show, I feel, that more can be done.

Fund Reforms

And now, staying on the same theme of change, let me say a few words about the challenges facing the IMF. Two years ago, the IMF Managing Director proposed a Medium Term Strategy for the organization. Its central goal was to ensure that the Fund be ready and able to help its members address the challenges of 21st century globalization. He has stressed the need for a Fund that is attentive to our members' challenges, and which has the resources to help them meet those challenges, and that is trusted to give even-handed advice and fair representation to all our members. These are the principles that inform the changes we are making in each of the IMF's main areas of work.

As you know, the Fund's Medium Term Strategy covers a very broad range of areas, and—you will probably be relieved to hear—I do not intend to touch on all of them tonight! I do want to touch on four key areas though: two related to strengthening our core activity of economic monitoring or surveillance, and two related to strengthening Fund governance, which of course is essential to our effectiveness.

Let me begin with our economic monitoring work. Two weeks ago, our Executive Board—with very broad support from industrial, emerging market and developing countries—approved a new legal framework for bilateral surveillance. Until now, we have based our economic monitoring work on a 30-year old board decision. As you might imagine, this decision did not address the developments that have posed the greatest challenges to global stability in recent years. Reflecting the period when it was drawn up, it focused on potential exchange rate manipulation undertaken for balance of payments reasons, and on short term exchange rate volatility.

The revised framework is the first ever comprehensive policy statement on surveillance. The reform confirms that dialogue and persuasion will continue be the key pillars of surveillance. It calls for surveillance to be even-handed amongst countries and to pay due regard to their domestic circumstances. It enshrines external stability as the overarching principle that will organize and focus our surveillance. It puts exchange rate assessment at the center of IMF surveillance. Exchange rates are a key link between countries' economies, and developments in exchange markets are often a leading indicator of economic problems. When economic relations between countries become disorderly, exchange rates can move abruptly, often with very serious consequences. These are the things that it is the Fund's job to try and prevent. I believe our new surveillance decision will allow us to be more effective in that endeavor; and our success in doing so is of course particularly important for small open economies, such as those in this region, that are particularly vulnerable to external instability.

A second key initiative to strengthen our economic monitoring has been the introduction of multilateral consultations. The aim of such consultations is to bring together, around one table, a group of countries that are party to a particular problem of systemic importance, in order to foster debate and ultimately action on how best to address that problem. Of course, there are many international fora in which such issues can be discussed, but multilateral consultations have two particularly desirable features. First, membership is not fixed, allowing a suitably small group of relevant participants to be selected according to the nature of the problem at hand. Second, because the discussion takes place under the auspices of the IMF, other countries that are not direct parties to the consultation would also have a voice in the discussion, through the Fund's Executive Board and through the International Monetary and Financial Committee (IMFC).

Our first multilateral consultation, which began just over a year ago, focused on an issue of central importance to all our members: to reduce global imbalances—the large current account deficit in the United States, accompanied by large surpluses elsewhere—while sustaining strong global growth. During this year's Spring Meetings in April, the five participants of this consultation—China, the euro area, Japan, Saudi Arabia, and the United States—jointly set out their policy plans in a document circulated to ministers representing the IMF's 185 members. This was a very significant development. The fact that the participating countries agreed to put forward these policies and discuss them in a multilateral setting shows their recognition of the global nature of the problem, as well as their commitment to multilateralism. Moreover, the policy plans are reasonably concrete, mutually consistent, and include significant steps in all the areas that the IMF has been recommending. The key now is implementation, and the Fund will be playing an active role in monitoring progress, through its regular surveillance activities and through discussions in the Executive Board and the IMFC.

Let me now turn to two other issues related to Fund governance. From its inception, the Fund has financed its activities with the spread between its lending and its borrowing. Our lending has dropped significantly in recent years. This is due to an improved global environment, strong global liquidity, and the significantly improved economic policies in many countries. This is very good news. It is a welcome development when our members do not have to borrow from us but can avail themselves of other sources like capital markets and the like. But this underscores the need to reform a financing model in which the Fund's income—more than paradoxically—depends on lending to help address the very crises that we seek to prevent.

Last year our managing director, Mr. Rato, appointed a very eminent committee to study this issue, chaired by Andrew Crockett, a former head of the Bank for International Settlements. The committee recommended that the IMF adopt a new income model to sustain its activities for the long term. It recommended a package of measures to diversify the Fund's income base, including broadening the range of the investments of the Fund's current reserves, in line with the policy of the World Bank, so as to raise our average returns; investing a limited portion of the Fund's quota resources, which currently generate income only when used to finance lending; and selling a small portion of the Fund's gold reserves and investing the proceeds to create an endowment. We have already had some discussions with our members on these recommendations during the Spring meetings, and our Board will be discussing in the period ahead the main issues involved in implementing them. While there is no immediate urgency—the IMF has abundant reserves that it can draw on for several years do come—we need to establish reliable income sources to give our members confidence that the Fund will be able to carry out its mandate in the future.

Last, but certainly not least, let me turn to the issue of voice and representation. It is crucial for the IMF's legitimacy that all members feel assured that they have adequate representation at the Fund. Therefore, as one of the cornerstones of our reform efforts, we are discussing how to update members' quotas, with the aim of increasing the representation of countries whose economic weight has increased in recent years, while also protecting the voice and representation of low-income countries. We began with a first round of quota ad hoc increases last year for four dynamic emerging markets—China, Mexico, Korea, and Turkey. We are currently discussing proposals for a new quota formula which would form the basis for further quota changes. And we have set in motion the legal work necessary for an increase in basic votes, which will safeguard the position of low-income countries.

The next challenge is to reach agreement on a new quota formula. There is broad consensus among our membership that the new formula should be simple and transparent, consistent with the roles of quotas, and appropriately captures the relative positions of members in the global economy. There is also agreement that the reform should result in higher shares for dynamic economies, many of which are emerging market economies, whose weight and role in the global economy have increased. Our objective remains to agree on a new formula before the 2007 Annual Meetings if possible, but no later than the 2008 Spring Meetings. Meeting this target will require leadership from members, and compromises among them. But I believe that we can and must renew the spirit of multilateral cooperation that we saw at our Singapore meetings.

Conclusion

In closing, let me come back to the main theme of my remarks. This is a time for reforms both for Central America and for the IMF. We both clearly have much to do. I can assure you that the Fund stands ready to continue supporting Central America's reform efforts through a close policy dialogue, technical assistance, and, where needed, financial arrangements. Our primary goal is to be a trusted advisor to each of our member country. I very much hope that Central America will remain a strong supporter of reforms at the Fund as we strive to better serve our members.

Thank you.



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