Intervention by Mr. Nout Wellink
World Economic Outlook
Prospects for the global economy have weakened over the past months. This holds in particular for the United States, where a marked slowdown has taken place since the fourth quarter of 2000. The outlook for the Japanese economy remains grim, as the earlier recovery proved short lived. The euro area economy looks more robust, although global imbalances, manifest in the increased volatility of financial markets and the large US current account deficit, point at downside risks. Prospects for emerging economies are affected as well, given the above-mentioned downside risks and the risk of spillover effects from the slowdown in the United States. After all, strong import demand by the United States was a driving factor behind the export-led recovery in countries such as Brazil, Korea and Thailand in the past years.
In a situation of insecurity about future economic developments, it is all the more important that governments conduct prudent and predictable economic policies. In this regard, there are also encouraging factors. In many countries, macroeconomic policy has improved in the past decades. For instance, more attention is paid to transparency of monetary policy and central bank independence. In addition, most governments have significantly reduced their budget deficits in the past years, which is to be welcomed in the light of longer-term developments such as those related to ageing. An increasing number of countries even have significant surpluses. This positive overall picture does not hold for all countries, however. Especially the rapidly deteriorating fiscal position of the Japanese government is a cause for concern, given the fact that demographic pressures will build more rapidly in Japan than in most other countries. Finally, improvements in many countries' macroeconomic policies notwithstanding, there remains scope for structural adjustments that will foster long-term growth, especially in Europe, Japan and emerging economies.
Developments in financial markets reflect the worsened conditions of the global economy. This is clearly visible in significant downward corrections in stock prices, which will have a negative impact on the real economy through wealth effects and other transmission channels. In addition, financial risks in specific sectors (especially telecom) have increased, as is evident from downgrades in credit ratings and higher interest rate spreads. However, despite increased vulnerability in some economies with fragile financial institutions, many banks have become better capitalized in the past decade, which should provide an adequate safety belt.
Refocusing conditionality in Fund programs
I very much welcome the discussion the Executive Board had last March on the scope of the Fund's conditionality. Consensus seems to exist on several issues, first and foremost on the need to streamline and focus the Fund's conditionality and second, on the necessity of enhanced co-operation with the World Bank with a clear division of labor between the Fund and the Bank. I wholeheartedly support the Managing Director's vision for (re)focusing the Fund on its core areas of expertise.
Conditionality is crucial to IMF-programs and should also cover critical structural measures. Indeed, in countries where macro-economic instability is rooted in weak structural policies and a lack of good governance, the IMF should address this. However, the effectiveness of Fund programs would be hampered by an excess of structural measures that do not address core issues, that weaken ownership and, on balance, that decrease the chances of success of the entire program.In my view, the Fund's conditionality has indeed delved too deeply into non-core areas in recent years. We have witnessed an increase in both the number of conditions and their level of detail. This is vividly illustrated by the Indonesian and Ukrainian programs, where the sheer number of measures to be taken would lead most finance ministers to despair. In this regard, I am not just concerned about the trend towards increased conditionality in structural areas - but also about the differences in the degree of conditionality applied across a broad range of IMF programs. This seems to signal difficulty in the application of our principle of comparability of treatment.
I belief that conditions that focus on the essential issues will strengthen IMF programs, rather than weaken them.Revising the guidelines may help to streamline IMF conditionality, but only if the guidelines are more strictly interpreted and adhered to. In this respect, the Board has a special responsibility in assessing which specific structural conditions should be included in Fund programs. I feel that the following points should be touched upon in a discussion on the guidelines, which I hope can be finalized in the months to come.
First, as conditions in IMF arrangements should relate closely to the Fund's mandate, their primary focus should be on macro-economic and financial stability. Second, staff should clarify the macro-economic relevance of each structural condition in a Fund program as well as the degree to which this condition is considered critical for the success of the program. If it is not critical, it should be left out. In this light, I would welcome an assessment of the experiences so far with the interim conditionality guidelines. Third, because very detailed conditions could undermine ownership and thereby the effectiveness of IMF programs, the Fund should generally restrict itself to setting conditions at levels as macro and aggregate as possible. Fourth, critical measures outside the Fund's mandate should primary be dealt with by other institutions, based on their respective mandates and expertise. In this respect, improved co-ordination with the World Bank Group is necessary to limit overlap and gaps in reform programs. Fifth, the variation in the number and nature of conditions among IMF programs should properly reflect the principle of comparable treatment. Once the Board has defined the new set of guidelines, it would be worthwhile to revisit, say biennially, the guidelines and their application. This could be helpful in monitoring the adherence of management, staff and the Executive Board to the guidelines and the spirit in which they have been (re)written.
In order to collect different views from outside the Fund, the Executive Board recently decided to make public the different conditionality staff papers on the IMF's website and decided to organise a seminar on this important subject. I welcome this outreach and I hope it will stimulate a discussion on what I consider the four vital M's in this respect: Mandate, Macro, Motivation and Multilateral co-operation.
Private sector involvement
At its April and September 2000 meetings, the IMFC endorsed a broad framework for private sector involvement. In the period ahead it is important to advance the implementation of this framework. A first element in this respect concerns tightening the requirements for exceptional access to IMF resources and linking it more closely to private sector involvement. Over the past decade, there has been a trend for the IMF to grant increasingly large financial support to countries in financial distress. In the process, we have seen an increasingly flexible application of access rules, as evidenced by a rising number of cases where countries were granted access beyond the normal access limits. In view of the limited IMF resources, the importance of minimizing moral hazard in financial markets and the need to ensure uniform treatment of countries, IMF access policy should be applied consistently and restrictively. Therefore, as a rule, the access limits under the Stand-by Arrangement and Extended Fund Facility should be adhered to. In extreme cases involving substantial risk of contagion, drawings should be made on the Supplemental Reserve Facility, which has a higher interest rate and a shorter maturity. In any case, the sustainability of the medium term debt profile should remain a precondition for all drawings on the Fund. If this precondition is not met, renegotiation of the existing debt is inevitable. When normal access limits are to be exceeded, the IMF-staff should justify the proposed access on the basis of realistic assumptions regarding key economic parameters, and the Board should be consulted prior to the conclusion of the negotiations. An approach could be to formally require a separate "Board meeting on exceptional access" in relevant cases. In all circumstances, exceptional access and SRF-drawings should explicitly require private sector involvement. In this regard, IMF-staff documents should provide a clear assessment of the efforts of the debtor country to secure PSI. Beyond this, as a second more practical element, IMF policies should continue to promote ex ante measures that enhance PSI. In particular, it remains important that regular contacts between debtor counties and their creditors are strengthened through debtor/creditor councils. In addition, recent experience has underlined the usefulness of incorporating Collective Action Clauses in bond contracts. Progress in these fields should also be monitored in the context of Fund surveillance.
I welcome the ad-hoc quota increase of China. This increase illustrates that the current system contains sufficient flexibility to do justice to divergence in economic development between member states. Meanwhile, we support the Fund's work to make quota formulas less complicated, although we would stress that there is a trade-off between simplicity and adequacy. The review of quota formulas should lead to a balanced result that satisfies the relevant criteria determining IMF quota and that continues to serve the Fund's mandate of stability and openness. In particular, a review of quota formula should result in a quota distribution that adequately reflects member countries' weight in the international financial system and which safeguards the financial solidity of the Fund.
Exchange rate regimes
The financial upheaval that took place in the 1990s, first in the industrial countries (in particular in the European Monetary System) and later in emerging markets, provides firm evidence that the surge in international capital movements has increased the risk of exchange rate related crises. One reason for these disorderly exits, mostly from pegged exchange rates, is that in many cases the economic development in the countries with exchange rate pegs did not move in tandem with that in the anchor country. Another reason is that unanticipated exogenous economic or political setbacks have occurred in the crisis hit countries. As an additional factor, imprudent monetary and budgetary policies, a weak banking system and inadequate banking supervision and debt management, often undermined the exchange rate regime.
In recent years, a number of these disorderly exits from fixed exchange rates occurred despite the presence of an IMF-supported program. What does this imply for prospective Fund policies? First, although ultimately, the choice of an exchange rate system is a sovereign decision of national authorities, the role of the Fund is to clearly set out the requirements attached to a specific exchange rate regime. These requirements are obviously more demanding in cases of fixed exchange rate regimes. Second, when there are indications that these requirements are too heavy, it is desirable to strive for a timely and orderly adjustment of the regime, if necessary in the context of an IMF-program, rather than accepting the risk of a disorderly exit driven by market forces. The bottom line is that the Fund needs to be willing to `just say no' to unsustainable exchange rates. Finally, we need to further enhance our understanding of how financial markets work. The new financial markets department is an excellent step forward in this regard and I commend the Managing Director for taking that decision.
All together, whatever the reasons for the fallen pegs, it is vital that we avoid past mistakes and learn from them. Therefore, it would be worthwhile to have an evaluation of IMF policies with respect to exchange rate regimes in Fund supported programs. The ERM experience with adjustable exchange rate pegs could provide background for such an analysis.
Combating financial abuse/money laundering
The fight against financial abuse helps to strengthen the international financial system and the institutions with expertise in this field, like the OECD and the Financial Action Task Force, have rightly placed this topic high on their agendas. I support the international attention for this important issue.
With respect to the role of the Bretton Woods Institutions, I see room for a supportive role of both institutions to advance financial integrity, as it falls within their mandate. This is already embodied in these institution's program conditionality and technical assistance. In particular, there is a role for the IMF in cases where abuses of the financial system threaten macro economic stability or jeopardise IMF resources. A good example of such support is the joint Financial Sector Assessment Program, where in close co-operation with the World Bank, the issue of money laundering is already incorporated through assessing the Basle Core Principles. All together, the Fund should stay focused on macroeconomic advice in its core area of expertise and keep its macro-economists out of the law enforcement business. Such a strategy, I think would fit well with the Managing Director's call for streamlining and focusing on the expertise of the Fund. This is a strategy I can fully support.