2001 Spring Meetings
Statement by Mr. Aleksei Kudrin
Governor for the Russian Federation
Deputy Chairman of the Government
Minister of Finance of the Russian Federation
International Monetary and Financial Committee of the IMF Board of Governors
Sunday, April 29, 2001
1. World Economic Outlook
1.1. Risks and Vulnerabilities in the World Economy
We are convening this year for the Spring Meetings of the IMF and the IBRD in an atmosphere of considerable uncertainty about the world economy and when chances of adverse developments are high. Compared with the previous issue of World Economic Outlook, the forecast for global economic growth in 2001 was revised downward from 4.2 to 3.2 percent. This is explained primarily by a cyclical slowdown of the U.S. economy combined with continuing stagnation in Japan and moderating growth in Europe. With the United States entering the downward phase of the cycle, the world economy could essentially appear to have no "engine." Under these conditions it may be far more painful than before to resolve individual financial crises.
The new issue of World Economic Outlook cites a number of factors that may cushion the "hard landing" scenario, including the possibility of a monetary and fiscal easing in industrial countries (except in Japan) and lower vulnerability to crises in emerging market economies. While we acknowledge, in principle, that such expectations are appropriate, we still feel that the existing risks make the possibility of a "hard landing" far more likely than before.
These risks were analyzed thoroughly in World Economic Outlook. We would, therefore, like to highlight only the two most important ones, namely, the possibility of further downward pressures on equity markets in the United States and of large swings in the exchange rates among the major currencies. Apart from having a negative impact on growth and making it difficult to implement macroeconomic policies, both of these events are also capable of noticeably souring the global investment climate, and, correspondingly, making external financing conditions tougher for emerging market countries.
In this environment there is an appreciably greater need to pursue a concerted policy of rebalancing of growth and demand in the United States, the European Union, and Japan. As was noted correctly in World Economic Outlook, the absence of serious inflationary pressures on a global scale makes monetary policy the most appropriate tool for this purpose.
Easier access to industrial countries' markets could become another factor of relief, especially for low-income developing countries. This pertains especially to the restrictions that developed countries generally place on imports of food and textiles—that is, goods for which poor countries enjoy a comparative advantage. It has been long known that the losses suffered by these countries from protectionism far exceed their gains from grants and other forms of financial assistance. We believe that this problem should be addressed adequately during a new multilateral round of trade liberalization talks being planned under the auspices of the WTO.
1.2. Economic Prospects for Industrial Countries
In the wake of a significant slowdown of the U.S. economy in the second half of 2000, there recently began a correction of imbalances accumulated during the prolonged economic expansion. Thus far, the adjustment has occurred mainly in the valuation of the stock market, which fell almost 25 percent from its March 2000 peak, wiping out "paper wealth" amounting to more than $4 trillion. Despite this significant drop, the valuation of the U.S. stocks remains high by historical standards, which suggests that stock prices may be in for a further decline.
However, other types of economic imbalances persist. This applies primarily to the interlinked problems of a large current account deficit, the negative household savings rate, and an overvalued dollar. It is expected that sooner or later, the deterioration of consumer confidence and the negative "wealth effect" will lead to a decline in demand and an increase in savings. While this will help to improve the current account position, it can in turn provoke further deceleration of growth. What remains unclear is whether these developments will lead to a recession, or a "softer" outcome.
At this phase of the cycle, monetary policy remains the main instrument against a possible recession. Given that the risk of a higher inflation appears minimal, a policy of cutting interest rates is justified if economic conditions deteriorate further. The tax cuts presently under discussion could do some good as well, although the mechanism of their stimulatory influence is not altogether obvious. Consumers usually react to a tax cut with a sizable time lag, thus such cuts may not be as effective as desired in influencing the present cyclical situation. Moreover, with personal consumption surpassing income, extra money from a tax cut will more likely go to savings than to spending. In addition, we are concerned that the proposed easing of fiscal policy could exacerbate the problem of the already severe imbalance in the current account.
Even despite extremely expansionary macroeconomic policies, the economic recovery in Japan is faltering. This suggests that the source of Japan's economic difficulties lies outside the macro area and is linked to the problems in the financial sector. We feel that given the record level of public debt and the very limited impact of the fiscal stimuli, it would be appropriate to pursue a policy of gradual fiscal consolidation. The recent return to a zero interest rate policy is justified, especially in an environment of continuing deflation. If needed, application of unorthodox measures to expand liquidity is also a possibility—for example, purchase of longer-term government bonds in the secondary market by the Bank of Japan.
Ultimately, however, the economic situation in Japan can be improved only by eliminating the existing weaknesses in the banking and corporate sectors. In this sense, it would be far more effective to use public funds for strengthening the banking system than for continued fiscal stimulation. The latest reform package announced by the Japanese authorities is an important step in this direction. However, we see it as more appropriate for this package to contain more vigorous measures to address problem loans, the large volume of which is the main reason for the weakness of Japanese banks.
We have long expected that the leading countries of the European Union would be able to assume leadership in the global economy after an inevitable slowdown in the United States. Now, that this time has come, the downward revision of growth forecasts for Europe in 2001 raises great concerns. While part of this revision can be attributed to higher oil prices and weaker external demand, the deceleration of growth indicates that the awaited significant strengthening of domestic demand has failed to materialize. Under these conditions, and taking account of the absence of pronounced inflationary pressures (mainly in the region's large economies), a moderate cut in interest rates could be considered. Further cuts could follow, especially if the long-awaited strengthening of the euro against the dollar shows up. To increase the potential for economic growth, countries in the euro area need to decisively accelerate structural reforms. In particular, they need to strive to reduce the excessive tax burden, increase the flexibility of labor markets, and reform their pension systems. In addition to positive supply side effects, these measures will help to reduce unemployment, the level of which continues to remain high in a number of European countries.
1.3. Economic Situation in Emerging Market Countries
Events in industrial countries have worsened the external environment for the emerging market economies. Their equity markets have fallen back sharply as a result of revaluation of technology stocks in developed countries, spreads on their sovereign bonds have grown, and external financing conditions have become extremely volatile. The global economic slowdown has impacted the economies of a number of emerging market countries through trade linkages. But the main danger to them may come from events unfolding on financial markets, especially if the exchange rates between the leading world currencies experience a sharp correction. Deterioration of the global environment makes the situation particularly difficult for countries now wrestling with worsening internal economic problems-Argentina and Turkey, for example. We are concerned that an adverse string of events in these countries could have sharp negative consequences for the entire group of emerging market economies. Under these conditions, the Fund, with the support of the international financial community, should apply a maximum effort to keeping events in these countries from developing according to a worst-case scenario.
The Asian countries are experiencing a slowdown of economic growth as a result of high oil prices, a decline in the economic activity of their main trading partners—the United States and Japan and a weak electronics market. The newly industrialized countries and ASEAN countries are being hit especially hard. Structural reforms in the corporate and banking sectors should be accelerated in a number of these countries in order to enhance the potential for growth. We are pleased that against this adverse background, growth remains well sustained in large countries such as China and India. At the same time, the persistence of a high budget deficit in India raises concern.
The Latin American countries are reacting in various ways to the deceleration of growth in the United States. The latter will have its largest impact on Mexico, which has extensive trade ties with its neighbor to the north. On the other hand, growth is anticipated to accelerate in 2001 in the less-open economies of Brazil and Argentina. A current account deficit continues to be a common characteristic of all Latin American countries (except Venezuela). Against the backdrop of unstable financial markets, a need for external financing must compel these countries to pursue a more prudent fiscal policy and to speed up structural reforms.
In 2000 a significant acceleration of growth occurred in all CIS countries and was brought about to a significant degree by a substantial improvement of the economic situation in Russia. Growth is continuing this year, albeit, at a slightly lower level than last. In the new issue of World Economic Outlook, differences in economic performance of CIS countries are rightfully linked with their energy endowment. In fact, in energy-rich CIS countries, the recent upsurge of world oil and gas prices led to an increase in exports, faster growth, and a stronger budget and balance of payments. On the other hand, higher energy prices negatively impacted the situation in energy importing CIS countries, placing a number of them on the brink of insolvency. Some energy exporting countries have shown symptoms of a "Dutch disease," stemming from the real appreciation of their domestic currencies in response to the influx of petrodollars. This, in turn, jeopardizes the continuation of a strong economic growth.
Three years after its severe financial crisis, Russia is experiencing robust economic growth. In the period immediately after the crisis, the main factor of growth was import substitution, which was a consequence of a dramatic drop of the ruble. Later on, however, this factor no longer had its former significance, since the real exchange rate strengthened substantially. An increase in output can now be seen in many sectors of the Russian economy. Expansion of domestic demand is driven mainly by investments, although recently growth of personal consumption has also become noticeable.
This is already the second straight year that the federal budget has been executed with a general and a primary surplus. The sizable increase in world oil prices did of course provide us with significant support. Still, we should not underestimate the significance of the prudent fiscal policy pursued by the Russian government in the last two years. As a result of a considerable strengthening of Russia's fiscal position, we were able to resume external debt service in its full amount without resorting to another round of restructuring. To preserve macroeconomic stability in the medium and long-term, we intend to establish a budget stabilization fund to accumulate extra revenues from high oil and gas prices.
A large current account surplus makes implementation of monetary policy very difficult. Even so, thus far, the Central Bank of Russia has managed to provide for the rapid accumulation of foreign exchange reserves without permitting either an excessive strengthening of the real exchange rate or a sizeable increase in inflationary pressures. Recently, however, price inflation has risen. This will require more effort from the monetary authorities to introduce effective instruments for sterilizing the inflows of foreign exchange.
Sustained economic growth is not possible without decisive acceleration of structural reforms. While we were able to obtain the Russian parliament's approval of far-reaching tax reforms, there is still much to be done in this area. We also intend to considerably speed up the restructuring of Russia's banking sector. A number of important laws in this area have already gone through the main stages of a parliamentary confirmation. Significant progress has been achieved in reducing barter and non-payments in the Russian economy. The reform program of the Russian government also includes improving conditions for development of private sector, strengthening ownership rights, further privatization, restructuring of infrastructure monopolies, reform of the social safety net, and pension reform.
2. The IMF in the Process of Change
2.1. Progress Report of the Managing Director
We have read with great interest the Managing Director's report "The IMF in the Process of Change." As it follows from the report, the Executive Board has achieved substantial progress in a number of areas of Fund activities in the six months since our Committee's last meeting. For example, shortly after our meeting in Prague the Executive Board completed work on its review of Fund facilities. We also acknowledge the efforts of the IMF aimed at reducing member countries' external vulnerability to the threat of financial crises, discussions on external reserves and debt management, and, together with the IBRD, the development of guidelines on external debt management. Further progress has also been made on the application of standards and codes and on increasing transparency and accountability in the Fund's own activities.
The report also sets out the agenda for the near future. We would especially like to emphasize the issue of private sector involvement in the prevention and resolution of financial crises. We recognize that this is a very complex and delicate matter and that a lot of work still remains to be done in this area. At the same time, we see the list of papers planned for the consideration by the Executive Board in the near term as extremely important. Here, we have in mind such topics as the promotion of constructive relations between sovereign borrowers and creditors, the resumption of access to international capital markets for post-crisis countries, and the relative treatment of the claims of official bilateral and private creditors.
2.2. Strengthening the IMF's Focus on Financial Markets and Crisis Prevention Through Surveillance
Crisis prevention continues to be one of the IMF's most important challenges. In this regard, further efforts should be made to strengthen Fund surveillance of the international financial system and the development of financial markets. For many years, the semi-annual International Capital Markets Reports have served as the main instrument for such surveillance. The recent initiative in this area—the publication of quarterly reports on financial markets developments in emerging market economies—was a timely and important addition to the already existing surveillance tools. We also welcome the establishment of the International Capital Markets Department, which undoubtedly will help improve the quality of the financial market analysis and the effectiveness of Fund surveillance. Also of great importance is the continuation of the dialogue with market participants under the auspices of the Capital Markets Consultative Group established last year. Such a dialogue should facilitate a clearer understanding of the forces driving the behavior of private investors and financial markets in general.
Crisis prevention requires not only a study of financial markets, but also the provision of direct technical assistance to member countries. Here, we would particularly like to note the efforts by the Fund and the World Bank to strengthen national financial systems. The Financial Sector Assessment Program (FSAP) has been a key element of the work in this area. This program not only helps to evaluate the vulnerability of the financial sector, but also aids in determining ways and means for strengthening it. Of special significance in this context is the provision of timely technical assistance to facilitate the implementation of the experts' recommendations and reduce financial sector vulnerability. Given the constraints the Fund and the Bank face in the provision of resources for the implementation of FSAPs, we believe that the priority in the assessments should be given to the emerging market countries of systemic importance and those with vulnerable financial sectors. We also fully support the principles of a voluntary participation in the FSAP and of a voluntary publication of its results.
2.3. Streamlining Conditionality and Strengthening Ownership
We believe that no conditions, however detailed and strict, can replace national ownership of reforms. If the reforms are to succeed, the authorities should have an adequate administrative capacity to implement them, and changes should be well understood and accepted by the civil society and supported by the country's legislative bodies. Without taking into consideration this wider context, Fund programs cannot be effective. It is from the perspective of strengthening national ownership that we endorse the proposed approach to streamlining and focusing conditionality. Steady streamlining of conditionality should lead to strengthening, rather than weakening, of programs, as well as to strengthening of the Fund's own credibility.
Conditionality is at the heart of all of the IMF's activities, and it would be a mistake to expect simple solutions in this area. Only thorough discussions of conditions during each program review, with due regard to the specificity of a situation in a particular country, can lead to an appropriate focusing of conditionality. We would like to call special attention to the responsibility of the staff in justifying the inclusion of various structural measures in a program, especially when their relevance to the core areas of the Fund's expertise is not immediately apparent. Each such measure and its significance to the macroeconomic stability—ideally, in quantitative terms—should be discussed in detail by the Executive Board. Only such close attention to the conditions in question can gradually result in a more streamlined approach.
In its discussions with program countries the IMF should be strict with regard to achieving the end result, yet, at the same time, flexible in determining the ways to attain it. Experience shows that in program countries the Fund makes most progress where it engages in consultations with the authorities on an equal basis. We expect that by removing unnecessary intermediate steps from conditionality and placing an emphasis on end results, the Fund will contribute to fostering the authorities' ownership of programs and motivate their search for alternative ways of implementing reforms. At the same time, the IMF should be more selective when taking decisions on cooperation with countries demonstrating limited interest in the implementation of reforms.
If the Fund devotes significant effort to streamlining conditionality in the coming months, approval of a new version of the "Guidelines on Conditionality" by the end of the year seems realistic. As for longer-term plans, among the specific measures already proposed by the Executive Board, we especially welcome the decision to review the application of conditionality in the IMF programs on a regular basis.
2.4. Combating Financial Abuse and Money Laundering
Money laundering, or concealing the sources of money obtained illegally, has long been an international problem. We, therefore, welcome increased international coordination of various initiatives to combat financial abuse and money laundering. The well-known activities of the United Nations, of the Financial Action Task Force (FATF) on Money Laundering and of a number of regional organizations, are examples of such international coordination. Russia does not stay away from these efforts, and is taking decisive steps in this area. A few days ago, the Duma has ratified the Convention on Laundering, Search, Seizure and Confiscation of the Proceeds from Crime, initiated in Strasburg in 1990. An important new law "On Combating Concealment of the Sources of Money Obtained Illegally (Money Laundering)" will serve to intensify the fight against money laundering and to enhance Russia's participation in the international coordination of activities in this area. A draft of the new law was recently approved by the Russian government and has been submitted for the Parliament's approval.
In preparing the draft of the new anti-money laundering law, Russia cooperated closely with the FATF and incorporated the Task Force's recommendations to the maximum degree possible. We recognize the key role of the FATF in the international coordination of anti-money laundering activities and we are thankful for the technical assistance provided by the Task Force. At the same time, we object most strenuously to the FATF process, to the methods employed by this organization for the achievement of its goals. It is our conviction that the policy of confrontation reflected in publishing blacklists and threatening to apply sanctions is absolutely inadmissible in the context of international cooperation and coordination of activities, and such a practice can only be detrimental. Moreover, a number of FATF's recommendations do not fit all countries in an equal manner. Therefore, in the application of the recommendations, differences in the degree of financial market development should be taken into account. The existing deficiencies in the FATF process are hardly surprising given the limited membership of the FATF. We think that an inadequate degree of representation in the FATF will continue to hamper future efforts to improve the effectiveness of the Task Force's activities.
It is clear that combating money laundering is well beyond the IMF's mandate, given that financial crime does not directly affect macroeconomic stability. At the same time, the ongoing work of the IMF and the IBRD assists member countries in combating money laundering in a number of ways. In particular, efforts of the IMF and the IBRD to improve financial regulation and supervision, to upgrade financial legislation, and to promote transparency not only enhance the soundness of national financial systems, but also help to prevent financial abuse. Moreover, in the context of the FSAP, the Fund and the Bank assess compliance with a number of principles closely related to some of the FATF 40 recommendations. The FSAP work could become more focused on the money laundering aspects of the financial standards, and we welcome the intention to develop a supporting methodology. In general, the intention of the IMF and the IBRD to increase cooperation with the FATF in their areas of expertise seems logical to us, and we do not object to it. It is important, however, that the IMF and the IBRD do not attempt to enter the law enforcement business or assess compliance with the standards that do not pertain to the financial soundness.
We have certain difficulties with a formal recognition by the Fund of the FATF 40 recommendations as the appropriate standard for combating money laundering. On the one hand, we recognize the key role of the FATF in the international coordination of anti-money laundering activities, and we ourselves relied on the Task Force's recommendations when drafting our new law. On the other hand, recognition of the FATF 40 recommendations should not in any way signify an endorsement of the Task Force's process and methods by the Fund. Only after the FATF makes its practices consistent with the ROSC process adopted at the IMF and the IBRD and starts applying its recommendations uniformly, cooperatively, and on a voluntary basis can there be a discussion of possible forms of cooperation between the Fund and the FATF on fighting money laundering. Furthermore, this sort of joint activity of the FATF and the Fund should necessarily cover all the countries, including the industrial ones, and address the role of their large financial centers in money laundering business.
3. Fighting Poverty and Strengthening Growth
We support efforts aimed at turning the HIPC Initiative into an effective tool for reducing the debt burden and providing for the social and economic development of the poorest countries. We are satisfied with the progress achieved in both the implementation of the Initiative and the provision for its financing. We also welcome new Fund initiatives aimed at strengthening tracking of poverty-reducing budget spending in HIPC countries and at ensuring their long-term external debt sustainability.
We would like to emphasize, however, that debt relief does not by itself ensure a sustainable economic growth or a decline in the poverty level in those countries. The HIPC Initiative is an important but not sufficient condition in ensuring external debt sustainability over the long term. Above all, HIPC countries should themselves create conditions for growth by means of effective implementation of programs agreed with the Fund and the Bank. In particular, HIPC countries should pursue a balanced macroeconomic policy and structural reforms aimed at strengthening the macro framework, diversification of exports, and attraction of investments. Sound policy for external debt management and refraining from active new borrowing on nonconcessional terms should also be integral elements of that strategy.
As for applying the HIPC framework to post-conflict countries, we do not object to a certain degree of flexibility in the assessment of their track records. It should be emphasized, however, that the HIPC requirements with regard to the implementation of the necessary reforms are uniform for all countries, and that flexibility does not imply leniency or disregard for the general rules of the Initiative. The decision point on a country's participation in the HIPC Initiative should be inseparably linked with progress on the implementation of a PRGF program and a successful completion of at least one midterm review. A relatively early decision point should be combined with a relatively long period for reaching the completion point under the Initiative.