International Monetary and Financial Committee Meeting
April 29, 2001
Economic developments since our last meeting have once again underscored how fast the global environment can change. After several meetings, in which our discussions were held on the backdrop of increasingly strong global economic growth figures, we are now faced with a significant slowdown. The deterioration of the global outlook is a result of the stronger than expected slowdown of the US economy combined with a further setback in Japan's recovery, as well as declining growth rates in Europe.
This being said, I fully agree with the Managing Director's recent calls to avoid undue pessimism. The significant progress that has been achieved over the past years in improving global economic fundamentals, such as achieving historically low inflation rates and strongly reducing fiscal deficits, has laid a sound basis for managing the upcoming slowdown. Each country must build on its past success and continue to focus on implementing stability-oriented macroeconomic policies. Furthermore, it will be particularly important to push ahead forcefully to implement the many uncompleted structural reform agendas. Last but not least, we must continue with our efforts to strengthen the international financial system.
2. Global Economic Prospects
A crucial issue for the global economic outlook is the expected pattern of growth resumption in the US economy. The signs for a rapid rebound of economic activity in the second half of the year are becoming less clear, and in my view, the probability of a more severe economic slowdown has been steadily increasing. The Federal Reserve has reacted aggressively to counter such developments with four consecutive reductions in the federal funds rate since the beginning of the year. If the strong expansion in the US has been mainly caused by a shift in the trend rate of total factor productivity growth, substantial monetary easing could rapidly reverse the cyclical downturn. However, this is not yet clear. The fact that the recent unprecedented economic performance was accompanied by an increasing current account deficit and strong demand pressure on the labor market points to its unsustainable nature. There is a risk that the previous virtuous cycle is turning into a vicious cycle, in which slowing growth puts pressure on stock prices and leads to an increase in personal savings, a depreciation of the US dollar, and a current account adjustment. While a correction of the imbalances developed during the long expansionary period is welcome, the crucial question is in what time frame the adjustment will take place.
The room for economic policy to smooth the adjustment process may be quite limited, given the historically high levels of the macroeconomic imbalances. While I welcome the easing of monetary policy, caution is warranted because inflationary pressures remain present despite the marked deceleration in growth in view of the tight labor market. Furthermore, uncertainties as regards renewed upward movements in petroleum and other commodity prices remain. As regards fiscal policy measures, the counter-cyclical impact of tax cuts could also be constrained by the negative personal savings ratio and the decline in consumer and business confidence.
As regards Japan, I welcome the Bank of Japan's recent decision to change the stance and the focus of its policy. By adopting a quasi-inflation target, the monetary authorities showed their determination to change inflation expectations and to help the world's second-largest economy end a decade of economic underperformance. As I have noted on previous occasions, further structural reforms in the financial and banking sectors are crucial for the Japanese economy to return to a sustainable path of positive real growth. In this context, I welcome the recently announced measures to strengthen the banking system and restore its financial intermediation function. Overall, the required structural reforms will undoubtedly be painful and will put additional pressure on asset prices. This in turn will increase the vulnerability of the financial and corporate sectors. However, postponing the reforms would only unnecessarily prolong the stagnation of the Japanese economy.
In Europe, the balance of risks appears to be pointing to a sharper economic slowdown than previously expected. However, with the exception of Germany, most European countries are still growing at a relatively high pace, and inflation -particularly core inflation- is not yet abating. Given the marked wage moderation observed in recent years, the tightening labor market, and the depreciation of the euro, the risks of a delayed upward movement in wages have not yet dissipated. Moreover, the continuing weakness of the euro with respect to the dollar and the uncertainty as regards future movements in oil prices has increased the uncertainty concerning the inflation outlook. In my view, the ECB's cautious approach to relaxing its monetary stance must be assessed against this background. In this context, I am somewhat concerned by the recent overconfidence in monetary policy as a tool of demand management and the increasing calls for monetary policy to support asset prices. However, it is clear that the ECB should remain ready to act swiftly if the significant down-side risks of the growth outlook should materialize. In terms of structural reform, some progress has been made but there is still a long way to go. The euro area's potential growth would profit most from structural reforms aimed at improving the labor market flexibility.
As regards emerging market economies, my concerns are mainly based on the vulnerabilities associated with persistently high overall financing requirements and uncompleted structural reform agendas in many countries. I agree that significant progress has been made in moving away from unsustainable pegged exchange rate regimes and in improving debt sustainability by reducing the overall share of short-term debt. However, in Latin America, debt indicators remain high and the overall debt situation has worsened in some economies burdened with unfavorable debt dynamics. Furthermore, several countries have seen a rapid increase in the stock of public debt. These developments will severely restrict the possibilities of these countries to use fiscal policy to counter the projected slowdown in external demand. As regards structural reforms, many crisis-hit countries in Asia are still grappling with the broad structural reform agenda they embarked upon a few years ago. The unexpected rapid and strong resumption of growth in the region permitted some crucial and difficult reforms to be postponed. Unfortunately, the global slowdown will make the implementation of structural reforms even more difficult in the near future. Based on the vulnerabilities associated with high financing requirements and unresolved structural reform issues, external financing conditions for emerging market economies are likely to remain difficult in the near future.
Overall, developments in transition countries have been relatively favorable. Output continues to expand in all countries. However, significant differences in economic performance remain, stemming mainly from the varied degrees of progress in implementing market reforms and diversity in the endowment with natural resources. Unfortunately, political uncertainty has also continued to negatively impact the performance of some transition countries. In this context, I am very happy that positive political developments have allowed the last of the successor states of the former Yugoslavia, namely the Federal Republic of Yugoslavia, to become a member of the Fund. It is an honor for me to represent the interests of our new member. The Federal Republic of Yugoslavia faces enormous economic and financial challenges, which the newly elected government is tackling decisively. I hope the government can count on the necessary support from the Fund, the World Bank, as well as its bilateral creditors and donors.
Regarding the low-income CIS countries, I welcome the special attention that has been given to external debt situation in these countries. In the ten years since independence, these countries have not only experienced a dramatic deterioration of living standards, but have also seen their external debt rise to unsustainable levels. What is disturbing is that these developments have taken place notwithstanding the numerous Fund and World Bank-supported programs. Of course, underestimation of the problems of the transition process, inconsistent policy implementation, political constraints and exogenous shocks have, among many other factors, contributed to this development.
Looking forward, it is important, that we do not hide the problems these countries are facing by making unrealistically positive macroeconomic assumptions. Moreover, while recognizing that the debt situation is different for each country, we should aim at using existing instruments and frameworks for providing adequate debt relief to these countries. Given the size of the debt figures in these countries, creditors might have to consider the possibility of adopting Naples terms for both flow rescheduling and stock relief. Finally, we need to find a solution to the problem that significant amounts of the debt are held by other CIS countries, which are themselves poor and/or heavily indebted.
At our last meeting, I noted my concern regarding the pessimistic attitude that was developing toward the African continent. Unfortunately, the developments over the past six months do not give grounds for a more upbeat outlook. Increasing security concerns associated with wars and civil conflicts are seriously undermining the growth opportunities of low-income states. In several countries, the benefits achieved in the past through implementation of good macroeconomic policies have been undermined by the lack of persistence and follow through given the unstable political frameworks.
Given this rather bleak outlook, I was encouraged by the findings reported to us by the Heads of the Fund and the World Bank following their first joint visit to Africa. It is obvious to me that all our efforts to assist low-income countries through various forms of financial and technical assistance will remain unsuccessful, if the governments themselves do not recognize their own responsibilities. I fully concur with the emphasis of African leaders on the fact that any effort to reduce poverty must start with peace, democracy and good governance. The international community stands ready to assist countries, if its assistance can be provided in a framework that ensures aid effectiveness. The three elements are surely part of such a framework. Strong growth remains a sine qua non condition for poverty reduction. An important factor for enhancing growth opportunities is trade liberalization. I agree that this includes both liberalizing trade regimes in African countries and increasing trade opportunities between themselves, as well as reducing restrictions in advanced countries against exports stemming from poorer countries.
To address the pressing needs of the poorest developing countries, Switzerland hopes to be able to present in the near future, independently of the launching of a new round of multilateral trade liberalization, additional measures for improved market access. In international comparison, Switzerland is already fairly generous, especially with regard to LDCs, giving duty-free access for textiles, and for most of the agricultural products of interest to LDCs. In this context, however, it must be stressed that it is often not market access but supply-side constraints, as well as sanitary measures and technical barriers that impede LDCs from taking full advantage of export markets.
3. Refocusing the Activities of the International Monetary Fund
Let me state at the outset that I fully share the Managing Director's emphasis on the need for the Fund to refocus its activities on its core mandate. Only by focusing on its mandate can the Fund continue to live up to the high expectations as regards its role in the surveillance over member's economic policies, in the provision of high-quality advice and appropriately conditioned financial assistance. However, refocusing the Fund does not mean dropping the new tasks and objectives, which the membership has asked the Fund to take on board over the recent years. Most of the new areas represent crucial additions, which allow the Fund to fulfill its mandate effectively in an international financial system that has undergone significant changes. In my view, refocusing means consolidating the new experience gained in the various areas and prioritizing future work, as well as further improving the division of labor with other international organizations.
Conditionality plays a central role in the Fund's lending activities and, therefore, has been directly affected by the strong expansion of Fund activities. I am deeply convinced of the need for strong conditionality in Fund programs. A well-defined conditionality is crucial to safeguarding the Fund's resources and improving the effectiveness of Fund programs. While I welcome the review that has taken place with the aim of streamlining and focusing the Fund's conditionality, I think we should be careful not to unduly weaken overall conditionality in the process.
Experience has shown that ownership is one of the most important ingredients for the success of economic reform programs. The new approach to conditionality has a great potential for enhancing program countries' freedom in designing reforms. At the same time, we should be aware of the fact that streamlining conditionality does not automatically imply stronger program ownership. Discussing the various modalities of conditionality, will - per se - do little to ensure ownership, here we will have to learn from experience. In my view, the Fund should focus more strongly on assessing the degree of ownership and, consequently, become more selective in its lending practices.
The Interim Guidance Note on streamlining structural conditionality provides a good basis for moving forward. It will be particularly important to use structural conditionality selectively and judge the appropriateness of such conditionality by assessing its macroeconomic relevance. Selectivity should, however, not lead to avoiding crucial conditions, even if they are politically difficult to implement. More efforts must also be made to better define the division of labor between the Fund and the World Bank. Success in reducing the existing overlap in conditionality between the two institutions will contribute importantly to sharpening the focus of the Fund.
Standards and Codes
Developing and monitoring standards has become an essential instrument of the Fund in its crisis prevention work. The universal reach of the Fund and its surveillance mandate give the institution an obvious advantage in the area of implementing standards. I see great merit in promoting internationally recognized standards. However, given our aim to refocus the Fund, it is important not to overburden the institution in this area. When deciding on integrating new standards and covering new areas, we should carefully consider how these areas relate to the Fund's core mandate and how overlaps with other organizations can be avoided.
Refocusing the Fund's activities also has an important impact on a major and rapidly expanding area of work, namely technical assistance. Providing sufficient and high-quality technical assistance in the priority areas is a key element for the Fund's effectiveness. I welcome the discussion that has taken place to introduce greater focus and accountability in the provision of technical assistance. Also in this area, the success of refocusing will depend importantly on strengthening the cooperation with other providers, particularly with the World Bank and bilateral donors. In this respect I am happy to announce that Switzerland intends to increase its contribution to the technical assistance subaccount aimed at financing technical assistance activities of the IMF in Azerbaijan, the Kyrgyz Republic, Tajikistan, Turkmenistan, and Uzbekistan by US$5 million.
4. Strengthening the Fund's Financial Sector Work
I have always considered that our emphasis on strengthening the Fund's focus on financial sectors over the past years to be a crucial element of reforming the institution in light of the changes of the international financial system. The current financial crisis in Turkey has again highlighted the macroeconomic vulnerability that is associated with weak financial sectors. It also underscores that our strengthened surveillance framework is still in need of further improvement. I welcome the creation of the new International Capital Markets Department in the Fund, which will play an important role in enhancing the Fund's surveillance in the financial sector area and in delivering conceptual work related to the international financial system.
Financial Sector Assessment Program (FSAP)
An important element of the Fund's strengthened focus on financial sectors is clearly the FSAP. Experience has shown that the thorough analysis of the financial sector as a whole by a multi-disciplinary team of experts under this program can offer valuable insights regarding the weaknesses of domestic financial systems. I am encouraged by the broad acceptance the FSAP appears to enjoy and particularly urge emerging market and advanced economies to request an assessment under the FSAP. I am glad that the Fund was able to accommodate Switzerland's request for a FSA so promptly, notwithstanding the significant resource constraints it faces. I look forward to the results of the assessment by the time of the next Article IV consultation.
Poland was the first member of my constituency to participate in the FSAP. It views this experience very favorably because it not only confirmed that the Polish financial system is in a reasonably good health, but also helped to identify the areas where further improvements are needed. I am pleased to note that Poland will be the first member of the Fund to publish the whole FSSA report.
Combating Money Laundering
I welcome the intensified dialogue that has taken place between the Fund and the international organizations that are leading the efforts to combat money laundering. I attribute great importance to addressing the global issue of money laundering through international cooperation. This is the only effective way to tackle this issue, given the importance of cross-border financial flows for money laundering activities. With its 40 recommendations the Financial Action Task Force (FATF) has established a widely recognized anti-money laundering standard. It has also developed an effective system of mutual evaluation of compliance by its members. I welcome the broad acceptance of the FATF 40 recommendations as an international standard. In making these recommendations operational, the Fund should focus on areas within its core mandate and seek close collaboration with the FATF and other relevant organizations. The Fund can play a useful role regarding compliance with anti-money laundering elements in relevant supervisory principles. It could also provide technical assistance to help countries to develop preventive anti-money laundering systems. Finally, the Fund has a role to play in providing reliable estimates of the magnitude and the economic consequences of money laundering.
Private Sector Involvement
The appropriate involvement of private sector creditors in the resolution of financial crises should remain an important issue for the Fund's work. The framework we endorsed at our last meeting provides a good basis for a more uniform approach to this complex issue. However, several areas of the framework have been identified, which could benefit from stronger analytical underpinnings. Unfortunately, the Fund has made slower progress than envisaged in these areas. While I understand the analytical difficulties associated with issues such as assessing the pace and magnitude at which countries in crisis can regain market access and the degree of moral hazard associated with Fund programs, I sincerely believe that the work should continue with some urgency. The ongoing financial crises in important emerging market economies show that the issue has not lost any of its importance. Since these cases represent the first applications of the Fund's PSI framework, it will be important to provide full and timely information to the Executive Board on how effectively the policy is working.
5. Independent Evaluation Office
The establishment of the Independent Evaluation Office (EVO) last year was an important further step in the ongoing efforts to make the Fund more transparent and accountable. I warmly welcome the Executive Board's progress in making the EVO operational. I am confident that the appointment of Mr. Ahluwalia as the first Director will ensure that the EVO can establish itself as an effective, credible, and fully independent unit.