Statement by H.E. Didier Reynders, Minister of Finance of Belgium
Speaking on behalf of Austria, Belarus, Belgium, Czech Republic, Hungary, Kazakhstan, Luxembourg, Slovak Republic, Slovenia and Turkey
International Monetary and Financial Committee
1. The World Economy
A. Recent developments
World economic growth is weakening rapidly. Some slowdown of growth in fast-growing industrial and developing economies has been expected. In the United States, growth of around 5 percent was unsustainable. Similarly, countries in Southeast Asia experienced a sharp acceleration of growth after the crisis of 1997-98. To some extent, this acceleration reflected temporary effects.
The global outlook is most affected by the sharp slowdown in the US. In Japan, despite repeated efforts to resuscitate the economy, growth remains elusive. As the effects of last year's financial stimulus have faded, the economy has stalled again. Deflationary pressures continue.
For the euro zone, the EU Commission now expects growth to be 2.8 percent this year, which is a moderate slowdown from last year's 3.4 percent. Growth remains well in line with potential output. Good economic fundamentals, growing employment and strong consumer confidence will mitigate the effects of the worsening external environment on the EU economy. The threat of inflation is certainly diminishing, but remains a concern.
So far, the EU accession countries are not much affected by the worsening external environment. For several reasons, growth in these countries is expected to remain robust. Exports are not very dependent on trade with the United States. The current account deficits are financed mostly by foreign direct investment, which is less affected by adverse external sentiments than short-term capital inflows. Also, these countries benefit from good progress in structural reforms and prospect of EU accession.
Emerging markets in the Western Hemisphere, and also Turkey, face a different problem. These countries have generally large financing needs, and continued access to external financing is a necessary condition for rapid economic growth. But weak economic activity and declining equity prices in developed countries make investors more risk averse. Generally, countries which suffer from domestic structural distortions, and which at the same time have to rely on extensive external borrowing, are the most affected by the present adverse global conditions.
B. Policy responses
I agree with the Managing Director that with the right policy response there is a good chance that the global slowdown could be relatively short-lived. Coordination of policies is critical since risks are not unrelated. A weakening of economic activity or of investors' confidence in one region rapidly spreads, and affects many countries. Therefore, policy response to these developments in individual countries or regions must be guided by the recognition of these global risks.
In the environment of weakening global growth, the main objective of economic policy in the developed countries is to support domestic demand.
Interest rates have been reduced significantly in the United States, and further cuts could be needed. However,the transmission mechanism of monetary policy decisions has to function efficiently. The strong dollar, falling equity prices, and widening spreads for low quality borrowers all suggest that, despite recent rate cuts, financial conditions remain relatively tight.
As a result of rapid expansion of investment, particularly in the high-tech industries, the U.S. economy may now suffer from excess capacity. The rapid decline in capacity utilization in the face of the decelerating domestic demand is indicative in this respect. Adjusting the capital stock to lower demand growth would imply a period of weak investment demand, despite lower interest rates.
The fiscal surplus in the U.S. allows policy makers to use fiscal policy in a countercyclical manner. There is room for a moderate upfront tax cut. However, it would be cautious if more ambitious tax cuts are postponed until the projected fiscal surpluses materialize. Tax cuts imply lower public savings. It would require higher private savings and/or lower national investment to arrest and eventually reverse the widening current account deficit. The financing of this deficit has not posed any problem so far. However, this deficit could become a destabilizing factor if foreign investors become less willing to finance it.
In view of the precarious situation of public finances in Japan, there is hardly any room for further fiscal stimulus. Similarly, monetary policy has now nearly exhausted the room for relaxing financial conditions. The only remaining option for monetary easing is for the Bank of Japan to expand the range of assets it buys. However, the most important task is to restore the health of the financial sector, to recognize the losses and to restructure debts so that assets can be put back to productive use. Structural reforms in the corporate sector should also be intensified.
In the European Union fiscal policies should aim at a balanced budget or a surplus. The tax burden on the economy should be lowered. Measures should be taken now to prepare for the future cost of the aging population. Employment creation is a primary tool to support growth. To that end, the EU countries will continue reforming product and financial markets and improve the functioning of labor markets. This will raise Europe's productive potential and promote balanced developments in the world economy.
In the EU accession countries further structural and institutional reform, especially enterprise restructuring and financial sector reform will promote high sustainable growth and facilitate accession to the European Union. The policy mix should be rebalanced if weaker external demand would widen current account deficits.
The authorities of Turkey are determined to continue their efforts toward stabilizing and restructuring the economy. This will prevent the reemergence of crises and achieve high, sustainable growth. There is strong political commitment to take all necessary measures to strengthen public finances, restructure the banking system, and continue the disinflation process. This ambitious program deserves the full support of the international community, including exceptional financial assistance.
Emerging market countries have achieved a remarkable progress in reducing inflation, which is now lowest in many decades. However, price stability does not yet guarantee financial stability. Many countries, particularly in Latin America, continue to have large current account deficits. As a result, economic growth in these countries is vulnerable to changing conditions in international capital market. Establishing price stability is the first important step in developing a deeper domestic capital market that could mobilize domestic savings and reduce thus the vulnerability resulting from excessive reliance on external financing. Making further progress in fiscal consolidation and creating a more robust domestic banking system are other important challenges facing policy makers in emerging market countries.
The low-income countries in Africa face a different set of challenges. These countries have not sufficiently participated in the accelerated trade and financial integration that has taken place during the 1990s. The causes of their economic difficulties are multiple and complex, and no one should expect that a single measure, even a far-reaching reduction of debt burden, would in itself suffice to change the situation. Financial resources released as a result of debt forgiveness would soon evaporate if not accompanied by the rapid removal of policy distortions, governance problems and military conflicts. It is agreed that the poorest countries could benefit significantly from a better access to markets in developed countries.
2. The IMF in the Process of Change
A. Strengthening the IMF's focus on financial markets and crisis prevention through surveillance
I welcome the creation of the International Capital Markets Department. It is essential to the relevance of the Fund's advice that it fully understands developments in today's complex financial markets and integrates this intelligence into its surveillance and conditionality. This Department will be in close contact with financial institutions that supply the bulk of private capital worldwide. It must be careful not to give privileged access to the Fund's intelligence.
The Capital Markets Consultative Group will facilitate regular high-level communication between major financial institutions and the Fund's management. The Executive Board should be associated with its functioning in a manner that does not diminish the effectiveness of the consultations.
The countries in my group that have participated in the Financial Sector Assessment Program (FSAP) all praise the professionalism of the staff in conducting the very useful in depth assessments of their financial sectors. The FSAP is a major improvement in the Fund's surveillance of countries' macroeconomic and financial stability. This program not only benefits the countries involved but also enhances the stability of the international financial system as a whole. This obviously serves the common good of the entire Fund membership.
Assessing financial stability is an integral part of the Fund's surveillance. Although Fund surveillance is mandatory for every member, the Fund must not conduct in-depth financial sector assessments with the same intensity for every country on every occasion. The Fund must carefully and selectively apportion its time and attention to the counties that are most likely to experience financial sector problems with systemic implications.
Past financial crises offer many examples of situations that involve high risks for banks. These occur during periods of rapid disinflation, when banks must adjust to the change from easy profits in an inflationary environment to the low interest margins that prevail when prices are stable. Monetary policies of the currency-board type create another kind of stress for banks. They must be able to cope with greater interest volatility than usual. A pegged exchange rate regime, as we all know, can lead to excessive currency mismatches when banks try to profit from large interest rate differentials by borrowing in foreign currencies and investing in domestic currencies without due regard to exchange rate risk. Liberalization of international capital flows is another source of stress for banks that are not well equipped to prudently intermediate these flows. Moreover, weak fiscal positions, particularly those largely financed by banks, warn of potential banking sector problems, as do asset price bubbles and more or less severe cyclical downturns.
B. Streamlining conditionality and strengthening ownership
Structural conditionality in Fund supported programs, as well as the structural content of Fund surveillance, has expanded over the years, and for good reasons.
As early as 1974, when the Extended Fund Facility (EFF) was created, the Fund recognized that balance of payment problems could be rooted in structural distortions. The structural causes of chronic balance-of-payment weaknesses and of the low growth of the poorest countries justified the creation of the Structural Adjustment Facility (SAF) and the Enhanced Structural Adjustment Facility (ESAF)—now the Poverty Reduction and Growth Facility (PRGF)—in the second half of the `80s. The trend of increasing structural conditionality continued in the 1990s: in the early 90s with the transition programs of the former command economies and more recently as emerging market economies have been affected by crises in their capital accounts.
The increase in structural conditions in emerging market economies' programs illustrates a more general point. The main macroeconomic objectives of Fund-supported programs are strong and sustainable growth and achieving a viable medium term external position. Policy requirements for meeting these objectives have radically changed during the 1990s for countries that have access to the international capital markets. Changes in the international financial system and in the way individual economies with open capital accounts operate have significantly affected the nature of balance of payments problems, and therefore the policy response required to restore external viability.
Current account imbalances used to be the most important form of external disequilibria, in former times when most economies were relatively closed to capital flows, and when the state played a more important economic role. Restrictive macroeconomic policies, accompanied by exchange rate adjustment were the main solution. In the `90s, the world changed dramatically. Many countries have liberalized their economies and international capital flows. Private investors exert a much greater influence on countries' economic performance. Capital flows now exceed by far current account flows. Capital account disequilibria are now a more frequent source of balance of payments problems. Restoring external equilibrium is thus likely to require a different set of policies.
Restoring investor confidence becomes one of the most important objectives in a situation of sudden large capital outflow. This is clearly shown by recent episodes of financial crisis. However, restoring investor confidence often requires a whole range of measures, not all of them within the traditional purview of the Fund. Examples would include the closure of individual banks or firms, the privatization of public enterprises, the implementation of an effective bankruptcy regime, or effective measures to improve corporate and public governance and even to root out pervasive corruption. As a result, restoration of external equilibrium, which is the main objective of Fund-supported programs, now requires measures that were traditionally outside the Fund's responsibility.
The Fund must keep its focus on ensuring that restored macroeconomic and financial stability are sustainable. Conditionality should support that main objective. Streamlining conditions in favor of leaner programs will not necessarily enhance ownership. However, requesting a vast array of reforms within a short period of time is not effective if clearly beyond the administrative capacity of a country.
C. Combating financial abuse/money laundering
Close international cooperation is essential for effectively combating financial abuse and money laundering. The increased involvement of the Fund and the Bank in this area is beneficial. I support a close cooperation between the IMF and other international fora involved in money laundering and welcome the initiative already taken in this direction by the Financial Action Task Force on Money Laundering (FATF).
The Fund should recognize the FATF's 40 Recommendations as the anti-money laundering standard for its own operational work. This recognition by the Fund will support the FATF's efforts.
FATF experts should be invited to help the Fund review the compliance of member countries with those FATF recommendations that are relevant for financial stability. It is in line with its mandate for the Fund to produce Reports on the Observance of Standards and Codes (ROSCs) in this area.
Determining which FATF recommendations are relevant for financial stability requires further research. In the meantime, the Fund must pay due attention during Financial Sector Assessments and article IV consultations to supervisory rules and practices intended to combat money laundering.
D. Private sector involvement in the resolution of financial crises
I welcome the progress achieved thus far in the development of a framework on Private Sector Involvement (PSI), as reflected in the principles adopted at last year's spring meeting. Both these principles and the Fund's approach to the resolution of recent crises have made the private sector more aware that PSI is a standard element of crisis resolution, prompting lenders to make more thorough risk assessments.
The Fund naturally plays a major role in every PSI case through its debt sustainability analysis, its willingness or refusal to lend to a country in arrears to private creditors, and by judging the good faith behavior of the debtor when negotiating a work-out with its creditors.
The framework for PSI must be both transparent and flexible. Transparency is needed to guide the private sector's behavior in ways that promote financial system stability and reduce distortive incentives. This requires clear rules, or at least clear guidelines. Last September, the IMFC agreed that this framework should consist of a set of guidelines for debtor countries, creditors both private and public, and the IFIs, to resolve financial crises in an orderly manner. Therefore, the Fund should now establish formal PSI guidelines as was already requested in last spring's IMFC Communiqué. At the same time, flexibility is needed in individual cases to find the most effective, least disruptive solution given the particular circumstances of every case. As experience with individual cases accumulates, the broad guidelines will be refined and adjusted.