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Statement by H.E. Masajuro Shiokawa, Minister of Finance of Japan at the Third Meeting of the International Monetary and Financial Committee

April 29, 2001

I. World Economic Outlook

1. World Economy

The world economy, which enjoyed vigorous growth until several months ago, is now slowing down faster than expected. Policy efforts by each country will be even more important to prevent the slowdown from becoming more serious and leading to a deeper recession. Interrelations among markets are increasing. As evidenced by the effect of the volatile movement of U.S. high-tech stocks throughout the world, future developments in the U.S. economy may decide prospects for the world economy. Appropriate policy measures by the U.S. authorities are therefore doubly important.

Compared to the last few months of 2000, the slowdown of the U.S. economy has moderated somewhat. However, the economic prospects remain uncertain. Any decline following an extended period of asset price increases can have a substantial impact on the economy and there is a possibility that the slowdown may continue for some time. Since the U.S. authorities still have plenty of room for maneuver in setting policy measures in the event the economic weakness continues, an appropriate policy response is necessary.

In the euro area, while the economy as a whole is still expanding, I am concerned that there are signs the economy is being influenced by the slowdown in the world economy. The authorities are expected to keep a close watch on developments in prices and business and to take timely monetary measures if necessary. In addition, I believe the authorities will need to deal boldly with structural reforms in areas such as the labor market and pension systems.

In recent years the crisis-hit Asian countries have enjoyed a rapid recovery and have significantly lessened their vulnerability by reducing their short-tem external debt and increasing their foreign reserves. However, since the latter half of last year their stock and exchange markets have softened and growth has decelerated noticeably as a result of the worsening world economic environment. In order to strengthen the confidence of domestic and foreign investors and to establish a sustained recovery of business investment, it is important to continue the structural reform, including of the financial and corporative sectors.

2. The Japanese Economy

After growing 1.7 percent in 2000, the Japanese economy has recently been showing signs of weakening. Although there has been a move toward self-sustained recovery in the corporate sector, industrial production is decreasing and private consumption remains generally flat. Regarding fiscal policy, we are doing our best to put the economy on a self-sustained recovery track through smooth and steady implementation of the FY2001 budget. Concerning monetary policy, the Bank of Japan (BOJ) took the bold step of adopting a new monetary policy framework that includes a quantitative target for its monetary operations. The BOJ has expressed its strong commitment to maintain this new policy, which in practice has the effect of a zero interest rate policy, until the continuous price decline ends. We have also adopted the Emergency Economic Package, which tackles in an integrated manner such structural reforms as the resolution of the problems of non-performing loans of banks and excessive corporate debt, as well as establishing a limit on shareholdings by banks and, as a temporary measure, the Banks' Shareholding Acquisition Corporation.

II. Strengthening the International Financial Architecture

The IMF is performing a leading role in promoting the stability of the international financial system. But for the IMF to be a truly universal institution that represents the entire world, it is crucial for it to be transparent and accountable to its members as well as to the public, and to improve its own governance. In this context, we welcome the selection of the Director of the independent Evaluation Office (EVO) and hope the EVO will successfully carry out its expected mission. We also welcome the fact that a joint report was submitted to the Committee on the review of the process for selection of the Managing Director/President by the Fund Working Group to Review the Process for Selection of the Managing Director and the Bank Working Group to Review the Process for Selection of the President.

1. Review of conditionality in IMF-supported programs

Conditionality in IMF-supported programs is as significant as surveillance under Article IV consultations to the relationship between the IMF and its members.

Conditionality is the linkage of the IMF's financial support to a member's economic program. No one would deny that conditionality is necessary for the IMF's financial support. It ensures the implementation of policy measures envisaged under a member's economic program in addition to safeguarding the IMF's resources. However, the scope and details of conditionality have sometimes been criticized for going too far and for being beyond a member's capacity to implement.

Japan believes that it is crucial to streamline conditionality in light of the need to strengthen program ownership by member countries. In this context, since the IMF's mandate is to promote macroeconomic stability, conditionality should be limited to areas that have a significant macroeconomic impact. Also, when deciding conditionality, due consideration should be given to each member's actual situation and different circumstances.

Japan welcomes the leadership of the Managing Director in addressing this issue. I expect that the discussion at the Executive Board on streamlining conditionality will result in a revision of the IMF's guidelines on conditionality. I also hope that the whole staff will share a common understanding of the problems that led up to the guidelines' revision and will actually change its approach to conditionality.

2. Review of Quotas

During the past decades, we have seen substantial changes in the international economy, including the rapid development and economic success of emerging market economies, especially in Asia. Japan has repeatedly argued that a review of the allocation of quota shares, voting powers, and representation on the Executive Board to more appropriately reflect such changes is unavoidable both to improve the IMF's relationship with its members and to enhance the IMF's effectiveness and governance.

In light of the proposal made by the Quota Formula Review Group last summer, the Executive Board is expected to meet to follow up on this issue before the next meeting of this Committee. I strongly urge the Executive Board to hold such a meeting as soon as possible. I also request IMF management to make a concrete proposal at that meeting on the selective adjustment of quotas for members whose quotas are out of line with their position in the world economy.

More fundamentally, since the establishment of the IMF in 1946, the increase in the total amount of quotas is dwarfed by the increase in trade and capital flows among member countries. As a result, the amount of IMF resources that a member country can mobilize based on its quota is limited. Recent events in Argentina and Turkey show how important it is for members' quotas to be in line with their economic power so that sufficient financial support will be provided by the IMF when a crisis hits members. This underlines the importance of a general quota increase.

It has been three years since the Eleventh General Review of Quotas was resolved. We have less than two years to meet the deadline of the Twelfth General Review, which is set for January 2003. Considering that the Committee of the Whole for the Eleventh General Review was established three years before the deadline, we should immediately establish a Committee of the Whole to consider the Twelfth General Review.

Japan looks forward to strong leadership from the Managing Director toward resolving this critical issue which is related to the legitimacy of the IMF.

3. Measures to prevent and resolve financial crises, and reduce vulnerability to financial crises

(1) Implementation of the internationally agreed Codes and Standards

It is gratifying that the international community has become more aware of the importance of implementing internationally agreed codes and standards to help prevent financial crises and reduce countries' vulnerability to crises. In order to promote the implementation of codes and standards, it is essential that the IMF take a leading role in assessing the implementation status of member countries. I hope that the IMF will further strengthen its work in this area through the Reports on the Observance of Standards and Codes (ROSCs) as well as the Financial Sector Assessment Programs (FSAPs).

I also welcome that the IMF recognized the 40 recommendations made by the Financial Action Task Force (FATF) as the appropriate international standard for anti-money laundering with a view to preventing abuse of the international financial system. I expect the IMF, in close cooperation with relevant international organizations, to enhance its efforts in this area.

It is particularly important to implement the internationally recognized twelve key codes and standards, including the FATF 40 recommendations. In order to implement these codes and standards, country ownership should be secured, and it should be affirmed that it is up to member countries to prioritize standards according to their stage of economic development and institutional capacity. We should also recognize the importance of providing appropriate incentives to encourage these efforts and sufficient technical assistance by the international community, especially the IMF.

Given the limited resources of the IMF and other international organizations, however, it is critical to prioritize the assessment of the observance of codes and standards as well as the provision of technical assistance. For the time being, priority should be given to emerging market economies undertaking various reforms, as this will help promote stability in the international monetary and financial system.

In this context, I welcome the submission to the Committee of the Guidelines for Public Debt Management. The Guidelines will help member countries share the same basic principles in conducting policies for public debt management. However, the actual operation of the principles should be determined by member countries according to their specific situation.

(2) Ensuring private sector involvement (PSI)

During the recent crises in Argentina and Turkey, the private sector made a contribution toward meeting the financing requirements of these countries. The importance of private sector involvement (PSI) in the prevention and resolution of financial crises is now widely recognized. The successful restructuring of international sovereign bonds in Ecuador and other countries is another remarkable development. However, I believe there are some practical issues that remain to be addressed in implementing PSI. These include comparability of treatment between private sector creditors and official bilateral creditors, as well as the possible use of standstills by debtor countries to ensure effective PSI. I strongly hope the Board will make progress on this issue.

Effective communication with market players and the private sector in general is essential in order to improve the IMF's approach to PSI. I hope the new International Capital Markets Department will contribute to this process.

(3) Capital account liberalization

Although unrestricted capital movements can be a driving force for growth of the world economy through the efficient distribution of resources, if capital accounts are liberalized too hastily in the absence of macroeconomic stability and a solid domestic financial system, there are risks that it could increase an economy's vulnerability. For this reason, it is essential for each country to sequence capital liberalization according to its particular circumstances. Such a view has come to be widely shared, particularly since the Asian currency crisis.

Although there is no single prescription for sequencing appropriate for all, countries wishing to undertake capital account liberalization can draw useful lessons from the experiences of countries that have already liberalized their capital account. Case studies of countries' experiences with capital account liberalization are therefore helpful. Moreover, as interdependence among national economies deepens, the international community has a legitimate interest in the success of each country's efforts at capital account liberalization. I expect the IMF, in cooperation with other relevant international bodies such as the World Bank, will continue to accumulate valuable knowledge and expertise on capital account liberalization.

As a country opens up its economy to international capital flows, the risks associated with abrupt short-term capital flows can increase. As more countries begin to liberalize their capital accounts, measures such as comprehensive monitoring of short-term capital flows as well as an enhanced disclosure policy for highly leveraged institutions to mitigate the risks will become more important. We also believe that it is justified to maintain market-friendly controls on capital inflows to restrain abrupt short-term capital inflows. Controls on capital outflows, too, although they are no substitute for sound macroeconomic policies, can be justified as an exceptional measure under certain circumstances.

(4) Selection of an appropriate exchange rate regime

No one exchange rate regime is suitable for all countries. What is appropriate will vary according to a country's particular circumstances, including trade structure and the maturity of its financial and capital markets. It is important to recognize that exchange rate stability is crucial if economic entities in small open economies are to engage in stable economic activity. We should not underestimate how vital stable currencies are for these countries.

An extreme version of the so-called two-corner solution holds that only a perfect free-floating regime or a hard-peg regime such as a currency board arrangement are sustainable. In my view, this is inappropriate since it overlooks the fact that a hard-peg regime has some of the same disadvantages as softer fixed exchange rate regimes. We can, however, support a moderate version of the two-corner solution, which holds that a crawling-peg regime with a wide band and a managed floating regime varieties of a free-floating regime, and that each country should be given a certain amount of discretion in selecting an exchange rate regime, taking into account its own institutional system and circumstances.

The two-corner solution should be recognized as explaining the hollowing out in recent years of the middle of the distribution of exchange rate regimes. I do not believe it should be the norm for the selection of a desirable exchange rate regime.

In sum, in determining which exchange rate regime is most appropriate, a country should look at a broad range of options along the spectrum between a free-floating regime and a hard-peg regime, taking into consideration the advantages and disadvantages of each regime for its own circumstances. It should not look to the two-corner solution to provide the absolute truth. Moreover, no exchange rate regime is sustainable unless it is underpinned by appropriate macroeconomic policies.

(5) Promoting regional financial arrangements

In order to promote the stability of the international monetary and financial system, it is important to enhance regional financial cooperation to supplement the functions of the IMF.

In East Asia, there are ongoing efforts among the ASEAN countries and Japan, China, and the Republic of Korea (ASEAN+3) under the Chiang Mai Initiative agreed in May of last year to prevent the recurrence of events like the Asian currency crisis and to quickly address such situations if they should occur. At present, Japan is proceeding with bilateral negotiations on swap arrangements, based on the main principles agreed among ASEAN+3. It is expected that the progress on negotiations on bilateral swap arrangements will be reported at the ASEAN + 3 Finance Ministers' Meeting in Honolulu next month.

We expect these regional efforts to contribute to the stability of currency and financial markets, supplementing the multinational framework of the IMF.


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