## _file03pdf

## Source details

**Canonical URL:** [_file03pdf](https://www.imf.org/-/media/websites/imf/imported-flagship-issues/external/pubs/ft/ar/98/pdf/_file03pdf.pdf)

## Other formats

- [Markdown version](/-/media/websites/imf/imported-flagship-issues/external/pubs/ft/ar/98/pdf/_file03pdf.pdf.md)
- [Structured JSON version](/-/media/websites/imf/imported-flagship-issues/external/pubs/ft/ar/98/pdf/_file03pdf.pdf.json)

---

### The IMF’s Response to the Asian Crisis (Box 1)
- Origin and evolution
  - Crisis drivers: weak financial systems, large external deficits, inflated property and stock markets, relatively fixed exchange rates, overdependence on short-term capital flows allocated to less-productive investment.
  - Yen/dollar swings affected competitiveness; pressures most acute in Thailand with spillovers to Indonesia, Malaysia, and the Philippines.
  - Resulted in flexible exchange rate adoption, sizable currency depreciations, and sharp declines in asset values.
  - Directors’ identified contributors: large capital inflows, U.S. dollar appreciation and slower export growth in 1996–97, prolonged inflexible exchange rate arrangements, implicit guarantees encouraging external borrowing, inadequate banking regulation/supervision, excessive government intervention and poor data availability, and delays in remedial measures.

- IMF response and actions
  - Helped Indonesia, Korea, and Thailand arrange IMF-supported reform programs; extended and augmented the Philippines’ program in 1997 and approved a Stand-By Arrangement in 1998.
  - Approved some SDR 26 billion of IMF financial support for Indonesia, Korea, and Thailand and spearheaded the mobilization of some $77 billion of additional financing commitments from multilateral and bilateral sources in support of these reform programs in 1997.
  - Augmented committed assistance for Indonesia by SDR 1 billion (mid-1998) with an estimated $5 billion from multilateral and bilateral sources.
  - Disbursed some SDR 18 billion of IMF commitments to the three countries by July 23, 1998.
  - Intensified consultations with affected members both within and outside the region.

- Implementation modalities
  - Used accelerated procedures under the Emergency Financing Mechanism and the exceptional circumstances clause; close monitoring and program adaptations followed.
  - Created the Supplemental Reserve Facility (SRF) for members with exceptional balance of payments difficulties from sudden loss of market confidence.
  - Stepped up coordination with World Bank, Asian Development Bank, and bilateral donors.
  - Strengthened dialogue in program countries (consultations with opposition and labor groups, press/public contacts).
  - Provided staff support to coordinate resolution of private sector financing problems.
  - Posted Letters of Intent of Indonesia, Korea, and Thailand on IMF website (with consent).
  - Reinforced communication via Special Advisor to the President of Indonesia, resident representative posts in Korea and Thailand, and the IMF’s Asia and Pacific Regional Office.

- Commitments of the international community and IMF disbursements (as of July 23, 1998) — preserved lines from source
  - Indonesia 11.2 10.0 21.1 4 42.3 5.0
  - Korea 20.9 14.0 23.3 58.2 17.0
  - Thailand 4.0 2.7 10.5 17.2 2.8
  - Total 36.1 26.7 54.9 4 117.7 24.8
  - Footnotes: 1 IMF commitments to the Philippines are not included. 2 World Bank and Asian Development Bank. 3 Bilateral contributions to Indonesia and Korea were a contingent second line of defense. 4 Estimate; amount of new commitments not finalized as of July 23, 1998.

- Directors’ policy emphasis (appropriate policy response)
  - Primary responsibility rests with affected countries; hesitation worsens crisis and contagion.
  - Four key areas:
    - Reassure domestic and foreign investors; fiscal adjustment should balance current account adjustment, financial restructuring costs, and avoid excessive compression of domestic demand. Some Directors questioned need for significant fiscal tightening.
    - Maintain sufficiently firm monetary policies to resist excessive depreciation and inflation while avoiding undue squeeze on domestic demand; encourage rollovers of external short-term loans where repaying would worsen exchange rate pressures.
    - Address financial sector weaknesses boldly: close insolvent institutions; restructure and recapitalize weak but viable institutions transparently without shielding creditors/equity holders.
    - Strengthen public and corporate governance, transparency, and timely financial/banking data.

- Role of the international community
  - Cautioned major industrial countries about further monetary tightening amid unsettled markets; most felt further tightening should be put on hold.
  - Urged resolute action by Japanese authorities to address financial sector strains and modest expansionary fiscal measures until recovery reestablished; speed up deregulation to reduce Japan’s large external surplus.
  - Noted sustained growth in North America and Europe would likely provide external support.
  - Stressed international support should not substitute for private-sector participation; private creditors should play a part.
  - Executive Board’s December 1997 decision to adopt the SRF reflected these concerns.

### SRF Financing and Private Creditor Involvement (Chapter VIII)
- SRF features
  - SRF financing carries higher interest rates than are charged on other IMF financing to encourage early repayment, to minimize the risk of moral hazard, and to ensure that only those countries with a compelling need will seek recourse to the facility.
  - Decision establishing the facility encourages members using IMF resources to seek creditor participation (official and private) until balance of payments pressure ceases and states all options should be considered to ensure appropriate burden sharing.

- Private sector involvement and Board/Committee guidance
  - Directors (February 1998) emphasized early involvement of private creditors to ensure burden sharing and limit moral hazard.
  - Interim Committee (April 1998) requested the Board to intensify consideration of steps to strengthen private sector involvement, suggested different mechanisms, and asked for a report by the fall meeting.

- Early surveillance lessons related to SRF and crisis response
  - Need to develop "vulnerability indicators" and early warning signals, while recognizing limits of reliability.
  - Improve coverage, timeliness, and quality of financial statistics (bank profitability, interest rate spreads, nonperforming loans, competitiveness).
  - Study contagion processes and preconditions for capital account liberalization (consistent domestic policies, sound financial system, transparency).
  - Exchange rate regime considerations: weigh costs/benefits of pegs and design exit strategies where appropriate; greater flexibility not guaranteed to avert crises.

### Country Programs — Thailand (selected)
- Crisis onset and IMF support
  - Baht under attacks in May 1997; authorities ceased maintaining exchange rate peg on July 2, 1997.
  - Executive Board approved financial support on August 20, 1997, of up to SDR 2.9 billion, equivalent to 505 percent of Thailand’s quota, over a 34-month period.

- Initial program features
  - Financial sector restructuring: identification and closure of unviable institutions (including 56 finance companies), intervention in weakest banks, recapitalization.
  - Fiscal measures equivalent to about 3 percent of GDP to shift consolidated public sector deficit into a surplus of 1 percent of GDP in 1997/98.
  - New monetary policy framework under managed float; structural reforms (civil service reform, privatization, attract foreign capital).

- Modifications and further changes
  - November 25, 1997 Letter of Intent: additional measures to maintain public sector surplus at 1 percent of GDP; timetable for financial sector restructuring; social protection acceleration.
  - February 24 and May 26, 1998 Letters of Intent: prioritize exchange rate stabilization and social protection; fiscal target adjusted from public sector surplus of about 1 percent of GDP to a deficit of 3 percent of GDP; accelerate privatization of four intervened banks; improve governance; strengthen social safety net; legal/regulatory reforms.

- Selected economic indicators for Thailand (as of July 23, 1998; Thai authorities and IMF staff estimates)
  - Real GDP growth: 1995 = 8.8; 1996 = 5.5; 1997 = –0.4 (Estimate); 1998 = –4.0 to –5.5 (May 1998 program).
  - Consumer prices (end of period): 1995 = 7.4; 1996 = 4.8; 1997 = 7.7 (Estimate); 1998 = 10.0 (May 1998 program).
  - Central government balance (Percent of GDP): 1995 = 3.0; 1996 = 2.4; 1997 = –0.9 (Estimate); 1998 = –2.4 (May 1998 program).
  - Current account balance (Percent of GDP): 1995 = –7.8; 1996 = –7.9; 1997 = –2.0 (Estimate); 1998 = 6.9 (May 1998 program).
  - External debt (Billions of U.S. dollars): 1995 = 82.6; 1996 = 90.5; 1997 = 91.8 (Estimate); 1998 = 89.7 (May 1998 program).
  - Of which: short-term debt (Billions of U.S. dollars): 1995 = 41.1; 1996 = 37.6; 1997 = 29.9 (Estimate); 1998 = 22.8 (May 1998 program).
  - External debt (Percent of GDP): 1995 = 49.1; 1996 = 49.9; 1997 = 59.6 (Estimate); 1998 = 72.5 (May 1998 program).

- Chronology (selected)
  - August 11, 1997: IMF convenes meeting in Tokyo; total support pledged for Thailand eventually reaches about $17.2 billion.
  - August 20, 1997: Board approves SDR 2.9 billion Stand-By Arrangement and releases SDR 1.2 billion.
  - December 8, 1997: Board completes first review and disburses SDR 600 million.
  - March 4, 1998: Board completes second review and disburses SDR 200 million.
  - June 10, 1998: Board completes third review, approves disbursement of SDR 100 million and concludes 1998/99 Article IV consultation.

### Country Programs — Indonesia (selected)
- Crisis exposure and IMF support
  - Executive Board approved financial support on November 5, 1997, of up to SDR 7.3 billion, equivalent to 490 percent of Indonesia’s quota, over the next three years.

- Initial program envisaged
  - Tight monetary policy to stabilize the rupiah; financial sector restructuring (closing unviable institutions, merging state banks, legal/regulatory improvements); structural reforms (trade/investment liberalization, privatization); fiscal measures of about 1 percent of GDP in 1997/98 and 2 percent in 1998/99 to yield public sector surplus of 1 percent of GDP.

- Reinforcement and supplementary measures
  - January 15, 1998 Memorandum: cancel 12 infrastructure projects, strengthen bank/corporate restructuring, establish IBRA, government guarantee on bank deposits/credits, limit BULOG monopoly to rice, deregulate agricultural trade, adjust 1998/99 budget to public sector deficit of about 1 percent of GDP, measures for drought-related food supplies.
  - April 10, 1998 Supplementary Memorandum: strengthen monetary policy; accelerated bank restructuring (IBRA takeovers/closures, IBRA bond issuance, eliminate foreign ownership restrictions), bankruptcy law issuance, privatization of major state enterprises, arrangements with foreign creditors, strengthened social safety net, daily monitoring by Indonesian Executive Committee with IMF/World Bank/ADB.
  - June 24, 1998 Second Supplementary Memorandum: increase social expenditure to 7.5 percent of GDP; limit budget deficit to 8.5 percent of GDP financeable with foreign funds; rehabilitate distribution systems; recapitalize/merge/close weak banks; guarantee all depositors and creditors; establish Financial Sector Advisory Committee; establish effective bankruptcy system.

- Selected economic indicators for Indonesia (as of July 23, 1998; Indonesian authorities and IMF staff estimates)
  - Real GDP growth: 1995 = 8.2; 1996 = 8.0; 1997 = 4.6 (Estimate); 1998 = –13 to –14 (June 1998 program).
  - Consumer prices (end of period): 1995 = 9.0; 1996 = 6.6; 1997 = 11.6 (Estimate); 1998 = 80.6 (June 1998 program).
  - Central government balance (Percent of GDP): 1995 = 0.9; 1996 = 1.2; 1997 = –0.9 (Estimate); 1998 = –8.5 (June 1998 program).
  - Current account balance (Percent of GDP): 1995 = –3.2; 1996 = –3.3; 1997 = –1.8 (Estimate); 1998 = 1.6 (June 1998 program).
  - External debt (Billions of U.S. dollars): 1995 = 107.8; 1996 = 110.2; 1997 = 136.1 (Estimate); 1998 = 135.0 (June 1998 program).
  - Of which: short-term debt (Billions of U.S. dollars): 1995 = 9.5; 1996 = 13.4; 1997 = 18.8 (Estimate); 1998 = . . . (June 1998 program).
  - External debt (Percent of GDP): 1995 = 53.3; 1996 = 48.5; 1997 = 64.5 (Estimate); 1998 = 162.7 (June 1998 program).

- Chronology (selected)
  - November 5, 1997: Board approves Stand-By Arrangement authorizing drawings up to SDR 7.3 billion and disburses SDR 2.2 billion.
  - Mid-January 1998: IMF management visits Jakarta to consult on acceleration of reforms.
  - May 4, 1998: Board completes first review and disburses SDR 734 million.
  - July 15, 1998: Board completes second review, disbursing SDR 734 million, and approves increase in IMF financing by SDR 1 billion; additional multilateral and bilateral financing committed for more than $6 billion including IMF increase.

### Country Programs — Korea (selected)
- Crisis context and IMF support
  - Executive Board approved financing on December 4, 1997, of up to SDR 15.5 billion, equivalent to 1,939 percent of Korea’s quota, over the next three years.

- Initial program features
  - Comprehensive financial sector restructuring with firm exit policy for weak institutions; suspension of nine insolvent merchant banks; capital injections for distressed banks; recapitalization plans.
  - Fiscal measures expected to yield savings equivalent to about 2 percent of GDP to cover financial sector restructuring.
  - Dismantle nontransparent ties among government, banks, and businesses; upgrade accounting/auditing/disclosure; trade and capital account liberalization; labor market reform; publish key economic and financial data.

- Intensification and subsequent measures
  - December 24, 1997 Letter of Intent: further monetary tightening and abolition of daily exchange rate band; speed up capital/money market liberalization.
  - 1998 Letters of Intent: target fiscal deficit of about 1 percent of GDP for 1998; broaden financial sector restructuring; increase foreign investor access; improve corporate transparency.
  - May 2, 1998 Letter of Intent: recapitalization appraisal committee with international experts; publish regulations by August 15, 1998 to align prudential regulations with international best practices; phased capital account liberalization.

- Selected economic indicators for Korea (as of July 23, 1998; Korean authorities and IMF staff estimates)
  - Real GDP growth: 1995 = 8.9; 1996 = 7.1; 1997 = 5.5; 1998 = –1 to –2 (May 1998 program).
  - Consumer prices (end of period): 1995 = 4.7; 1996 = 4.9; 1997 = 6.6; 1998 = 8.2 (May 1998 program).
  - Central government balance (Percent of GDP): 1995 = 0.3; 1996 = 0.3; 1997 = 0.0; 1998 = –1.7 (May 1998 program).
  - Current account balance (Percent of GDP): 1995 = –1.9; 1996 = –4.7; 1997 = –1.9; 1998 = 7.3 (May 1998 program).
  - External debt (Billions of U.S. dollars): 1995 = 119.7; 1996 = 157.5; 1997 = 154.4; 1998 = 163.3 (May 1998 program).
  - Of which: short-term debt (Billions of U.S. dollars): 1995 = 78.7; 1996 = 100.0; 1997 = 68.4; 1998 = 39.6 (May 1998 program).
  - External debt (Percent of GDP): 1995 = 26.4; 1996 = 32.5; 1997 = 34.9; 1998 = 51.5 (May 1998 program).

- Chronology (selected)
  - December 4, 1997: Board approves SDR 15.5 billion Stand-By Arrangement and releases SDR 4.1 billion.
  - December 18, 1997: Board concludes first biweekly review and releases SDR 2.6 billion, activating the SRF.
  - December 30, 1997: Board approves modification and disburses SDR 1.5 billion.
  - January 29, 1998: government, domestic financial institutions, and international banks announce a debt-rescheduling agreement.
  - May 29, 1998: Board completes second quarterly review, disbursing SDR 1.4 billion and concluding the 1998 Article IV consultation.

### Surveillance, Article IV Consultations, and Lessons (Chapter VI)
- Surveillance modalities
  - Multilateral surveillance: Executive Board reviews based on World Economic Outlook and discussions of international capital market developments.
  - Bilateral surveillance: Article IV consultations (annual for most members) involving staff visits and Board discussions.
  - Other tools: Stand-By and Extended Arrangements, precautionary arrangements, Informal Staff-Monitored Programs, and Enhanced Surveillance.

- Assessment and agreed follow-up (March 1998 Executive Board review)
  - Mixed record in early identification of tensions; Thailand: early IMF concern beginning in 1996; Korea: IMF had not attached sufficient urgency in early 1997.
  - Lack of requisite information and contagion effects led to surprises about severity in several cases.
  - Agreed follow-up agenda for 1998/99:
    - Review IMF program experience in Asian crisis countries.
    - Examine lessons in World Economic Outlook and international capital markets reporting.
    - Reflect lessons in papers on international monetary system architecture, data availability/dissemination, transparency, and international standards.
    - Further Board discussion on incentives for international financial flows and private sector involvement.
    - Incorporate lessons into work on orderly and sequenced capital account liberalization.
    - Review World Bank–IMF collaboration on financial sector reform.

- Five main lessons identified by Directors (March 1998)
  - Lesson One: Timely availability of accurate information is critical; emphasis on Special Data Dissemination Standard (SDDS) and monitoring compliance; compile timely data on short-term external debt; technical assistance where countries cannot collect data.
  - Lesson Two: Surveillance must extend beyond short-term macro issues to structural policies, especially financial sector policies; need for more IMF expertise and staff resources; close collaboration with World Bank and BIS; importance of international standards (Basle Committee Core Principles).
  - Lesson Three: Greater attention to policy interdependence and contagion; examine spillovers from systemically important countries and integrate multilateral and bilateral surveillance.
  - Lesson Four: Credibility and transparency crucial to restoring market confidence; welcomed release of Letters of Intent and increasing PIN issuance; mixed views on more public warnings.
  - Lesson Five: Effectiveness depends on members’ willingness to take IMF advice; IMF staff should engage more actively in regional forums.

- Enhancing information on Article IV consultations (Box 3)
  - Since May 1997, Executive Board issued Press/Public Information Notices (PINs) following Article IV consultations.
  - PINs contain background description, Board assessment, and a table of selected economic indicators.
  - Of the 136 consultations completed during 1997/98, 77 resulted in issuance of PINs.

- Article IV consultations concluded in 1997/98 — key data points
  - Total consultations completed: 136.
  - Consultations resulting in PINs: 77.
  - Example entries (preserved exactly): Algeria — June 27, 1997 — July 23, 1997; Antigua and Barbuda — December 3, 1997 — December 17, 1997; Argentina — February 4, 1998 — February 23, 1998; Armenia — February 6, 1998 — March 12, 1998; Austria — June 13, 1997 — June 20, 1997; Brazil — February 11, 1998 — March 13, 1998; China, People’s Republic of — June 30, 1997 — —; India — July 2, 1997 — July 16, 1997; Indonesia — July 9, 1997 — —; Malaysia — September 5, 1997 — —; Malaysia’s 1998/99 Article IV consultation was advanced to April 20, 1998 (April 20, 1998 — April 27, 1998); Thailand — June 13, 1997 — —; United States — July 28, 1997 — August 4, 1997; United Kingdom — October 27, 1997 — November 6, 1997.

### Governance, Fiscal Transparency, and Data Dissemination (Box 4 and Data sections)
- IMF regional presence
  - IMF Regional Office for Asia and the Pacific established in Tokyo; Director: Kunio Saito; staff of 10.
  - Functions: regional policy forums (Manila Framework Group Secretariat), financial market surveillance, external relations, technical assistance/training facilitation.

- Good governance and IMF role
  - Executive Directors (May 1997) endorsed importance of good governance for economic efficiency and growth.
  - IMF roles: policy advice and technical assistance on governance within IMF mandate; more comprehensive treatment in Article IV consultations and IMF-supported programs; collaborate with World Bank.
  - IMF involvement should focus on economic aspects: public resource management, transparent regulatory environment, transparency and accountability, and be apolitical.
  - Executive Board adopted guidelines on July 25, 1997 to promote IMF attention to governance issues within mandate.

- Transparency in budgetary operations and fiscal policy rules
  - Fiscal transparency defined as openness about government structure/functions, fiscal intentions, accounts, projections, and reliable timely data including off-budget operations and quasi-fiscal activities.
  - Board discussions: draft code of good practices on fiscal transparency (April 1998); Directors supported a manual of practical good practices; IMF to provide technical assistance.
  - Fiscal policy rules: potential usefulness in specific circumstances; cautions about limitations and need for political consensus.

- Code of Good Practices on Fiscal Transparency
  - Draft code submitted April 1998; Interim Committee adopted the Code at April 1998 meeting recognizing varied implementation capacity.
  - Principles: clarity of roles/responsibilities; public provision of government activity information; open budget preparation/execution/reporting; independent assurances of fiscal information integrity.

- Data issues, SDDS, GDDS, and members’ provision/dissemination of data
  - Two-tier approach: SDDS (March 1996) for members seeking market access; GDDS (December 1997) for all members.
  - Members’ provision of information: core indicators improving modestly but timeliness/frequency concerns persist; supplementary data (reserve-related liabilities, central bank derivatives, private sector external debt, prudential bank indicators) desirable.
  - Data quality concerns: inadequate coverage/compilation methods impair usefulness; staff to assess data quality; technical assistance costs high.
  - SDDS review (December 1997): number of subscribers: 43; procedures for modifying SDDS components agreed (reserve-related liabilities shift from "encouraged" to "prescribed"; add prescribed component for net commitments under derivatives); consideration for indicators of financial soundness pending standards development.
  - Interim Committee emphasized full observance by end of transition period in December 1998.

### Dissemination Standards Bulletin Board and GDDS Implementation (Box 6)
- Dissemination Standards Bulletin Board (DSBB)
  - Tool describing statistical practices and data release calendars of SDDS subscribers; hyperlinks to national data sites established beginning April 1997.
  - Access: http://dsbb.imf.org or IMF website (http://www.imf.org) as described.

- Subscribers to the SDDS (as of the end of April 1998) — preserved list with asterisks where indicated in source
  - Argentina*
  - Australia
  - Austria
  - Belgium
  - Canada*
  - Chile
  - Colombia*
  - Croatia
  - Czech Republic
  - Denmark
  - Ecuador
  - Finland
  - France
  - Germany
  - Hong Kong SAR*
  - Hungary
  - Iceland
  - India
  - Indonesia
  - Ireland
  - Israel*
  - Italy
  - Japan*
  - Korea
  - Latvia
  - Lithuania
  - Malaysia
  - Mexico*
  - Netherlands
  - Norway
  - Peru*
  - Philippines
  - Poland
  - Portugal
  - Singapore*
  - Slovak Republic
  - Slovenia*
  - South Africa*
  - Spain
  - Sweden
  - Switzerland*
  - Thailand
  - Turkey*
  - United Kingdom*
  - United States

- Transition, observance, and Board guidance
  - Directors urged subscribers to implement transition plans rapidly; Interim Committee emphasized full observance by December 1998.
  - Board to differentiate minor and serious breaches of SDDS after transition period; costs of SDDS and bulletin board to remain not borne by users for present.

- GDDS purpose and implementation
  - GDDS aims to improve data quality and dissemination for all members across real, fiscal, financial, external sectors and sociodemographic indicators.
  - Implementation in two phases:
    - Phase 1: education and training (eight regional seminars/workshops mid-1998 to fall 1999 for up to 120 countries).
    - Phase 2: direct country work with IMF staff assistance.
  - As of April 1998, about 25 countries had indicated preliminary interest by appointing a country coordinator; formal invitations sent to non-SDDS subscribers after guidance materials completed.

### Dollarization, Exchange Rate, and Monetary Policy Issues (introduction of the euro—their discussion centered on)
- Benefits and risks of dollarization
  - Dollarization reflects lack of confidence in domestic currency in many developing and transition economies.
  - Potential benefits: foreign currency deposits can promote domestic financial sector growth; sometimes only effective means to remonetize in extreme price instability/capital flight.
  - Potential risks: deterioration in foreign-currency loan portfolio upon sharp domestic devaluation; limited central bank ability to act as lender of last resort in foreign currency; loss of seigniorage.

- Exchange rate and monetary policy implications
  - High currency substitution likely raises volatility of money demand, making exchange rate more unstable and limiting monetary policy effectiveness.
  - Some Directors favored fixed rate or currency board arrangements with appropriate macro policies; degree of currency substitution is one of many considerations in regime choice.
  - Foreign currency aggregates should be monitored; some Directors suggested inflation-targeting could be suitable in certain dollarized economies.

- Monetary operations and prudential risk
  - Preference for domestic currency monetary operations; foreign-currency instruments may be useful where most credits/interbank operations are foreign-currency denominated.
  - Foreign currency interbank settlement on central bank books should be backed by ample reserves and measures to limit settlement risk.
  - Prudential safeguards: banks in developing countries should exceed Basle guidelines for capital adequacy in face of dollarization; sizable currency reserves and contingent credit lines can limit systemic liquidity risk; monitor off-balance-sheet operations and maturity/composition of FX exposures.

- Policy recommendations to limit dollarization
  - Focus on macroeconomic stabilization and improving attractiveness of domestic currency rather than restrictive measures.
  - Medium-term avenues: interest rate liberalization, financial deepening, effective domestic payments system, independent monetary authority.
  - For weak financial systems: sequence financial liberalization with strong macroeconomic policies; be cautious about indexed instruments due to risk of inflationary inertia.
  - Rejection of restrictive measures: avoid restricting residents’ ability to hold foreign currency accounts or imposing punitive reserve requirements on foreign currency deposits.

- IMF-supported program design with dollarization
  - Programs should account for prevalence of dollarization rather than attack it directly; address policies to restore confidence and domestic currency credibility; focus on development of domestic financial systems and necessary prudential measures.
  - Reserve treatment: domestic banks’ reserves with central bank against foreign currency deposits generally considered part of central bank liabilities for measuring net international reserves.

*Annual Report 1998 — THE IMF IN 1997/98 (Chapter excerpts as provided).*

### Box 1, and summaries of the evolution of IMF-sup-

### Box 1 — The IMF’s Response to the Asian Crisis

### Origin and evolution
- The crisis unfolded against severe financial market pressures in several Asian economies linked to weak financial systems, large external deficits, inflated property and stock market values, relatively fixed exchange rates, and overdependence on short-term capital flows allocated to less-productive investment.
- Shifts in competitiveness associated with wide swings in the yen/dollar exchange rate contributed to pressures.
- Pressures were most acute in Thailand; spillovers affected Indonesia, Malaysia, and the Philippines.
- Acute exchange market pressures led to the adoption of more flexible exchange rate arrangements, sizable depreciations of currencies, and sharp declines in asset values.
- Directors identified several contributing factors to the deepening crisis and spillovers:
  - Large capital inflows attracted by past strong economic performance placed heavy demands on policies and institutions.
  - Appreciation of the U.S. dollar (to which most affected currencies were pegged) and slower export market growth in 1996–97 worsened external positions.
  - Inflexible exchange rate arrangements maintained too long constrained monetary policy responses.
  - Implicit guarantees of exchange value and banking support encouraged external borrowing and excessive foreign-exchange exposure, often at short maturities.
  - Inadequate banking regulation, supervision, and prudential rules led to fragile balance sheets of banks and nonfinancial corporations.
  - Excessive government intervention and poor data availability impeded market discipline and distorted capital allocation.
  - Delays in confronting problems and adopting remedial monetary and structural measures compounded difficulties and contagion.

### IMF response and actions
- The IMF responded quickly to help restore confidence in the region by:
  - Helping the three countries most affected—Indonesia, Korea, and Thailand—arrange programs of economic reform supported by the IMF. The Philippines’ existing IMF-supported program was extended and augmented in 1997, and a Stand-By Arrangement was approved in 1998.
  - Approving some SDR 26 billion of IMF financial support for reform programs in Indonesia, Korea, and Thailand and spearheading the mobilization of some $77 billion of additional financing commitments from multilateral and bilateral sources in support of these reform programs in 1997.
  - Augmenting the IMF’s committed assistance for Indonesia in mid-1998 by SDR 1 billion, with an estimated $5 billion from multilateral and bilateral sources.
  - Disbursing some SDR 18 billion of IMF commitments to the three countries by July 23, 1998.
  - Intensifying consultations with other members, both within and outside the region, affected by the crisis.
- To implement its response, the IMF:
  - Used accelerated procedures under the Emergency Financing Mechanism and the exceptional circumstances clause to meet exceptional needs in approval time and access, followed by close monitoring and program adaptations.
  - Created the Supplemental Reserve Facility (SRF) to help members experiencing exceptional balance of payments difficulties owing to a large short-term financing need from a sudden loss of market confidence.
  - Stepped up coordination with the World Bank, the Asian Development Bank, and bilateral donors to augment international support for reform programs.
  - Strengthened dialogue with constituencies in program countries—including consultations with opposition and labor groups, and extensive contacts with the press and public.
  - Provided staff support to coordinate efforts by international creditor banks and debtors to resolve severe private sector financing problems.
  - Posted Letters of Intent of Indonesia, Korea, and Thailand on the IMF website (with the governments’ consent) to make program details widely available.
  - Reinforced communication and consensus-building support via appointment of a Special Advisor to the President of Indonesia, establishment of resident representative posts in Korea and Thailand (in addition to Indonesia), and the work of the IMF’s new Asia and Pacific Regional Office.

### Commitments of the international community and IMF disbursements (as of July 23, 1998)
- Commitments of the International Community and Disbursements of the IMF in Response to the Asian Crisis, as of July 23, 1998 (Billions of U.S. dollars)
  - Indonesia 11.2 10.0 21.1 4 42.3 5.0
  - Korea 20.9 14.0 23.3 58.2 17.0
  - Thailand 4.0 2.7 10.5 17.2 2.8
  - Total 36.1 26.7 54.9 4 117.7 24.8
- Footnotes from the original table:
  - 1 IMF commitments to the Philippines are not included.
  - 2 World Bank and Asian Development Bank.
  - 3 Bilateral contributions to Indonesia and Korea were a contingent second line of defense.
  - 4 Estimate; amount of new commitments not finalized as of July 23, 1998.

### Appropriate policy response (Directors’ emphasis)
- Primary responsibility for resolving the turmoil rested with affected countries; hesitation in implementing reforms would worsen the crisis and contagion.
- Four key areas for action:
  - Reassure domestic and foreign investors that macroeconomic stability will be restored. Fiscal adjustment should balance contributing to current account adjustment, meeting costs of financial system restructuring, and avoiding excessive compression of domestic demand. Some Directors questioned the need for significant fiscal tightening since the Asian economies in crisis generally did not suffer from fiscal imbalances.
  - Maintain sufficiently firm monetary policies to resist excessive depreciation and inflationary consequences, while avoiding undue squeezing of domestic demand or overstraining the banking sector. Some Directors advocated strong, early monetary tightening to restore market confidence, with easing only as confidence returned and structural reforms progressed; premature easing was warned against. Encourage rollovers of external short-term loans where repaying them would worsen downward pressures on the exchange rate.
  - Address financial sector weaknesses through bold, comprehensive measures to dispel uncertainties: close insolvent institutions while protecting small depositors; restructure and recapitalize weak but viable institutions transparently without inappropriately shielding creditors and equity holders from losses or exacerbating moral hazard.
  - Strengthen public and corporate governance to enhance transparency and accountability, and provide accurate and timely financial and banking sector data.

### Role of the international community (Directors’ observations)
- Directors cautioned major industrial countries to be cautious about further tightening of monetary policy amid unsettled market conditions; most felt further tightening should be put on hold given the prospect of subdued inflation.
- Directors urged resolute action by Japanese authorities to address strains in Japan’s financial sector (including closure of insolvent institutions and targeted use of public funds for restructuring), and modest expansionary fiscal measures in Japan to avoid withdrawal of fiscal stimulus until recovery is reestablished. They also emphasized speeding up deregulation to enhance domestic investment opportunities and reduce Japan’s large external surplus.
- Directors noted sustained growth in North America and Europe would likely provide external support to the global economy and benefit crisis countries through a relatively favorable external environment.
- Directors stressed that international support should not substitute for private-sector participation; IMF and official financing should not serve to bail out private creditors and moral hazard concerns required that private sector creditors play a part.
- The Executive Board’s December 1997 decision to adopt the Supplemental Reserve Facility reflected these concerns.

*Source: Box 1 and chapter summary (updated through mid-July 1998).*

### Chapter VIII). SRF financing carries higher interest

### Chapter VIII). SRF financing carries higher interest rates than are charged on other IMF financing to encourage early repayment, to minimize the risk of moral hazard, and to ensure that only those countries with a compelling need will seek recourse to the facility.

### SRF features and private creditor involvement
- SRF financing carries higher interest rates than are charged on other IMF financing to:
  - encourage early repayment;
  - minimize the risk of moral hazard; and
  - ensure that only those countries with a compelling need will seek recourse to the facility.
- The decision establishing the new facility:
  - encourages a member using IMF resources under the decision to seek to maintain participation of creditors, both official and private, until the pressure on the balance of payments ceases;
  - states that all options should be considered to ensure appropriate burden sharing.
- Directors (February 1998 discussion of IMF policy on sovereign arrears to private creditors) emphasized:
  - the need to involve private creditors at an early stage of the crisis to ensure adequate burden sharing and limit moral hazard.
- Interim Committee (April 1998) requested the Board to:
  - intensify consideration of possible steps to strengthen private sector involvement;
  - suggested different mechanisms for meeting this objective;
  - asked the Board to report on all aspects of its work in these areas at the fall meeting of the Committee.

### Early lessons from the Asian financial crisis
- Executive Directors identified several major lessons in IMF surveillance (see Chapter VI).
- Directors (World Economic Outlook discussion, March 1998) highlighted:
  - need for greater efforts to identify emerging vulnerabilities for preemptive action, while recognizing impossibility of detecting all incipient banking and exchange market crises;
  - utility of studying the Asian financial crisis to develop “vulnerability indicators” and early warning signals of imminent crises;
  - concerns about the reliability of such indicators given crisis complexity.
- Directors stressed improvements needed in:
  - coverage, timeliness, and quality of financial statistics, including indicators of bank profitability, interest rate spreads, levels of nonperforming loans, and indicators of competitiveness.
- Directors called for further study of the contagion process.
- Lessons on capital account liberalization and related preconditions:
  - countries must prepare carefully for liberalization to enjoy benefits while reducing disruption risks;
  - important preconditions: consistent domestic policies, a sound financial system, removal of economic distortions, progress in transparency and disclosure by governments and financial institutions;
  - suggestion that emerging market countries might adopt market-based safeguards during a transition period to limit exposure of financial and corporate sectors to reversals of short-term capital movements.
- Exchange rate regime considerations:
  - currency pegs have served many countries well, but costs and benefits should be weighed and exit strategies designed where appropriate;
  - greater exchange rate flexibility is not a guaranteed prescription for averting financial crises; attention must be paid to overall policy consistency, establishment of an alternative monetary anchor or inflation target, and preemptive strengthening of the banking system.

### Thailand: evolution of IMF-supported adjustment program
- Crisis onset and IMF support:
  - baht under attacks in May 1997; authorities ceased maintaining exchange rate peg on July 2, 1997;
  - Executive Board approved financial support on August 20, 1997, of up to SDR 2.9 billion, equivalent to 505 percent of Thailand’s quota, over a 34-month period.
- Initial program features:
  - financial sector restructuring: identification and closure of unviable financial institutions (including 56 finance companies), intervention in weakest banks, recapitalization of banking system;
  - fiscal measures equivalent to about 3 percent of GDP to shift consolidated public sector deficit into a surplus of 1 percent of GDP in 1997/98, support improvement in current account deficit, and cover interest costs of financial restructuring;
  - new framework for monetary policy in line with the new managed float regime;
  - structural initiatives: civil service reform, privatization, initiatives to attract foreign capital, deepen private sector role, and reinforce outward orientation.
- Modifications (Letter of Intent, November 25, 1997) in response to larger-than-expected baht depreciation and sharper slowdown:
  - additional measures to maintain public sector surplus at 1 percent of GDP;
  - specific timetable for financial sector restructuring, including preemptive recapitalization and strengthening strategies;
  - acceleration of plans to protect weaker sectors of society.
- Further modifications (Letters of Intent, February 24 and May 26, 1998) prioritizing exchange rate stabilization and limiting social impact:
  - accelerate financial system restructuring, including privatization of four intervened banks;
  - adjust fiscal policy targets from a targeted public sector surplus of about 1 percent of GDP to a deficit of 3 percent of GDP to allow automatic stabilizers and finance higher social spending;
  - ensure adequate credit availability while maintaining a tight monetary stance for exchange rate stability;
  - improve governance in corporate and government sectors;
  - strengthen social safety net;
  - bring legal and regulatory framework, including bankruptcy law, in line with international standards to facilitate corporate debt restructuring;
  - deepen private sector role and attract foreign capital.
- Selected economic indicators for Thailand (as of July 23, 1998; data: Thai authorities; and IMF staff estimates):
  - Real GDP growth: 1995 = 8.8; 1996 = 5.5; 1997 = –0.4 (Estimate); 1998 = –4.0 to –5.5 (May 1998 program).
  - Consumer prices (end of period): 1995 = 7.4; 1996 = 4.8; 1997 = 7.7 (Estimate); 1998 = 10.0 (May 1998 program).
  - Central government balance (Percent of GDP): 1995 = 3.0; 1996 = 2.4; 1997 = –0.9 (Estimate); 1998 = –2.4 (May 1998 program).
  - Current account balance (Percent of GDP): 1995 = –7.8; 1996 = –7.9; 1997 = –2.0 (Estimate); 1998 = 6.9 (May 1998 program).
  - External debt (Billions of U.S. dollars): 1995 = 82.6; 1996 = 90.5; 1997 = 91.8 (Estimate); 1998 = 89.7 (May 1998 program).
  - Of which: short-term debt (Billions of U.S. dollars): 1995 = 41.1; 1996 = 37.6; 1997 = 29.9 (Estimate); 1998 = 22.8 (May 1998 program).
  - External debt (Percent of GDP): 1995 = 49.1; 1996 = 49.9; 1997 = 59.6 (Estimate); 1998 = 72.5 (May 1998 program).
- Chronological highlights (selected):
  - August 11, 1997: IMF convenes meeting in Tokyo; total support pledged for Thailand eventually reaches about $17.2 billion.
  - August 20, 1997: Board approves SDR 2.9 billion Stand-By Arrangement and releases SDR 1.2 billion.
  - December 8, 1997: Board completes first review under Stand-By Arrangement and disburses SDR 600 million.
  - March 4, 1998: Board completes second review and disburses SDR 200 million.
  - June 10, 1998: Board completes third review, approving a disbursement of SDR 100 million and concluding the 1998/99 Article IV consultation.

### Indonesia: evolution of IMF-supported adjustment program
- Crisis exposure and IMF support:
  - financial market sentiment shift exposed structural weaknesses in Indonesia, notably weak banking system and large unhedged short-term foreign debt in corporate sector;
  - Executive Board approved financial support on November 5, 1997, of up to SDR 7.3 billion, equivalent to 490 percent of Indonesia’s quota, over the next three years.
- Initial program envisaged:
  - stabilizing the rupiah by retaining a tight monetary policy;
  - financial sector restructuring: closing unviable institutions, merging state banks, establishing timetable and improving institutional, legal, and regulatory framework;
  - structural reforms: liberalization of foreign trade and investment, dismantling domestic monopolies, expanding privatization;
  - fiscal measures equivalent to about 1 percent of GDP in 1997/98 and 2 percent in 1998/99 to yield public sector surplus of 1 percent of GDP in both years; measures included cutting low-priority expenditures, postponing or rescheduling major state enterprise infrastructure projects, reducing subsidies, eliminating VAT exemptions, and adjusting administered prices.
- Reinforcement (Memorandum of Economic and Financial Policies, January 15, 1998) included:
  - canceling 12 infrastructure projects and revoking financial privileges for IPTN airplane projects and National Car project;
  - strengthening bank and corporate sector restructuring, establishment of IBRA, government guarantee on bank deposits and credits, and framework for voluntary case-by-case dealings with creditors and debtors;
  - limiting BULOG monopoly to rice, deregulating domestic agricultural trade, eliminating restrictive market arrangements;
  - adjusting 1998/99 budget to provide for public sector deficit of about 1 percent of GDP;
  - measures to alleviate drought-related suffering and ensure food supplies at reasonable prices.
- Subsequent slippages and deterioration prompted Supplementary Memorandum (April 10, 1998) with measures including:
  - substantial strengthening of monetary policy to stabilize the rupiah;
  - accelerated bank restructuring: IBRA takeover/closure of weak institutions, IBRA empowered to issue bonds to finance restoration for qualified institutions; elimination of restrictions on foreign ownership of banks; issuance of a new bankruptcy law;
  - extensive structural reforms including further privatization of six major state enterprises and identification of seven new enterprises for privatization in 1998/99;
  - arrangements with foreign creditors to restore trade financing and resolve corporate debt and interbank credit issues;
  - strengthened social safety net: temporary maintenance of subsidies on food and essentials, support for small and medium-sized enterprises, public works programs;
  - enhanced implementation and credibility via daily monitoring by Indonesian Executive Committee of the Resilience Council in cooperation with IMF, World Bank, and ADB; substantive actions prior to Board approval; and frequent Board reviews.
- Second Supplementary Memorandum (June 24, 1998) following social disturbances and political change prioritized:
  - strengthening social safety net by increasing social expenditure to 7.5 percent of GDP, expansion of employment-generating programs, and aid to students;
  - measures to limit budget deficit to 8.5 percent of GDP, financeable with foreign funds, including cuts in infrastructure projects and efficiency improvements in state-run operations;
  - rehabilitating and strengthening distribution system to ensure supplies of essentials and establishment of special monitoring unit for potential shortages;
  - restructuring banking system: recapitalize, merge, or close weak banks, infuse new capital into relatively sound banks, guarantee all depositors and creditors, establish high-level Financial Sector Advisory Committee for coordination;
  - establish effective bankruptcy system as essential to corporate debt-restructuring strategy (June 4 agreement between government and creditor banks);
  - strengthen monitoring of economic program.
- Selected economic indicators for Indonesia (as of July 23, 1998; data: Indonesian authorities; and IMF staff estimates):
  - Real GDP growth: 1995 = 8.2; 1996 = 8.0; 1997 = 4.6 (Estimate); 1998 = –13 to –14 (June 1998 program).
  - Consumer prices (end of period): 1995 = 9.0; 1996 = 6.6; 1997 = 11.6 (Estimate); 1998 = 80.6 (June 1998 program).
  - Central government balance (Percent of GDP): 1995 = 0.9; 1996 = 1.2; 1997 = –0.9 (Estimate); 1998 = –8.5 (June 1998 program).
  - Current account balance (Percent of GDP): 1995 = –3.2; 1996 = –3.3; 1997 = –1.8 (Estimate); 1998 = 1.6 (June 1998 program).
  - External debt (Billions of U.S. dollars): 1995 = 107.8; 1996 = 110.2; 1997 = 136.1 (Estimate); 1998 = 135.0 (June 1998 program).
  - Of which: short-term debt (Billions of U.S. dollars): 1995 = 9.5; 1996 = 13.4; 1997 = 18.8 (Estimate); 1998 = . . . (June 1998 program).
  - External debt (Percent of GDP): 1995 = 53.3; 1996 = 48.5; 1997 = 64.5 (Estimate); 1998 = 162.7 (June 1998 program).
- Chronological highlights (selected):
  - November 5, 1997: Executive Board approves Stand-By Arrangement authorizing drawings up to SDR 7.3 billion and disburses SDR 2.2 billion.
  - Mid-January 1998: IMF management visits Jakarta to consult on acceleration of reforms.
  - May 4, 1998: Board completes first review under Stand-By Arrangement and disburses SDR 734 million.
  - July 15, 1998: Board completes second review, disbursing SDR 734 million, and approves increase in IMF financing under Stand-By Arrangement by SDR 1 billion; additional multilateral and bilateral financing committed for more than $6 billion including IMF increase.

### Korea: evolution of IMF-supported adjustment program
- Crisis context and IMF support:
  - Korea became an advanced industrial economy but faced structural problems: excessive government interference, close bank–conglomerate linkages, inadequate sequencing of capital account liberalization, and lack of prudential regulation;
  - loss of market confidence in late 1997 brought Korea close to depleting foreign exchange reserves;
  - Executive Board approved financing on December 4, 1997, of up to SDR 15.5 billion, equivalent to 1,939 percent of Korea’s quota, over the next three years.
- Initial program features:
  - comprehensive financial sector restructuring with firm exit policy for weak institutions, stronger market and supervisory discipline, more independence for central bank; suspension of operations of nine insolvent merchant banks, capital injections for two large distressed commercial banks, recapitalization plans for commercial banks with inadequate capital;
  - fiscal measures expected to yield savings equivalent to about 2 percent of GDP to cover financial sector restructuring costs while maintaining prudent fiscal stance; measures included widening corporate, income, and VAT tax bases;
  - dismantling nontransparent ties among government, banks, and businesses: upgrade accounting, auditing, and disclosure standards; require consolidated corporate financial statements certified by external auditors; phase out cross guarantees within conglomerates;
  - trade liberalization: timetable to eliminate trade-related subsidies and import diversification program; streamline and improve transparency of import certification procedures;
  - capital account liberalization: open money, bond, and equity markets to capital inflows and liberalize foreign direct investment;
  - labor market reform to facilitate redeployment of labor;
  - publication and dissemination of key economic and financial data.
- Intensification and acceleration (Letter of Intent, December 24, 1997) as crisis worsened and concerns about rollovers of short-term external debt:
  - further monetary tightening and abolition of the daily exchange rate band;
  - speed up liberalization of capital and money markets, including lifting all capital account restrictions on foreign investors’ access to Korean bond market by December 31, 1997;
  - accelerate financial sector restructuring, establish high-level team to negotiate with foreign creditors, reduce recourse of Korean banks to central bank foreign exchange window.
- Letters of Intent (January 7, 1998 and February 7, 1998) and subsequent measures for 1998 included:
  - target fiscal deficit of about 1 percent of GDP for 1998 to accommodate weaker activity and allow higher social safety net expenditure;
  - broaden strategy of financial sector restructuring after immediate dangers contained;
  - increase range and amounts of financial instruments available to foreign investors, increase access of Korean companies to foreign capital, liberalize mergers and acquisitions;
  - improve corporate transparency: strengthen oversight by corporate boards, increase accountability to shareholders, introduce outside directors and external audit committees.
- Letter of Intent (May 2, 1998) updated program reflecting progress and weaker outlook:
  - recapitalization appraisal committee (including international experts) to evaluate undercapitalized commercial banks;
  - publication by August 15, 1998, of regulations to bring prudential regulations closer to international best practices, strengthen compliance with guidelines on foreign exchange maturity mismatches;
  - further phased capital account liberalization: loosen restrictions on foreign exchange transactions, foreign ownership of certain assets, and ceilings on foreign equity investment in nonlisted companies.
- Selected economic indicators for Korea (as of July 23, 1998; data: Korean authorities; and IMF staff estimates):
  - Real GDP growth: 1995 = 8.9; 1996 = 7.1; 1997 = 5.5; 1998 = –1 to –2 (May 1998 program).
  - Consumer prices (end of period): 1995 = 4.7; 1996 = 4.9; 1997 = 6.6; 1998 = 8.2 (May 1998 program).
  - Central government balance (Percent of GDP): 1995 = 0.3; 1996 = 0.3; 1997 = 0.0; 1998 = –1.7 (May 1998 program).
  - Current account balance (Percent of GDP): 1995 = –1.9; 1996 = –4.7; 1997 = –1.9; 1998 = 7.3 (May 1998 program).
  - External debt (Billions of U.S. dollars): 1995 = 119.7; 1996 = 157.5; 1997 = 154.4; 1998 = 163.3 (May 1998 program).
  - Of which: short-term debt (Billions of U.S. dollars): 1995 = 78.7; 1996 = 100.0; 1997 = 68.4; 1998 = 39.6 (May 1998 program).
  - External debt (Percent of GDP): 1995 = 26.4; 1996 = 32.5; 1997 = 34.9; 1998 = 51.5 (May 1998 program).
- Chronological highlights (selected):
  - December 4, 1997: Board approves SDR 15.5 billion Stand-By Arrangement and releases SDR 4.1 billion.
  - December 18, 1997: Board concludes first biweekly review and releases SDR 2.6 billion, activating the IMF’s new Supplemental Reserve Facility.
  - December 30, 1997: Board approves modification of schedule of drawings and disburses SDR 1.5 billion.
  - January 29, 1998: government, domestic financial institutions, and international banks announce a debt-rescheduling agreement.
  - May 29, 1998: Board completes second quarterly review, disbursing SDR 1.4 billion and concluding the 1998 Article IV consultation.

### Surveillance, Article IV consultations, and other IMF surveillance tools
- IMF surveillance mandate: exercise firm surveillance over exchange rate policies of members under Articles of Agreement.
- Surveillance channels:
  - Multilateral surveillance: Executive Board reviews of international monetary system based principally on staff’s World Economic Outlook and periodic discussions of international capital market developments.
  - Bilateral surveillance: Article IV consultations—annual consultations for most members including staff visits, concluding statements, staff reports, Executive Board discussions, and “summing up” transmitted to authorities and optionally released as Press/Public Information Notices.
- Article IV consultations in 1997/98:
  - IMF concluded 136 Article IV consultations (Table 7 referenced).
- Board supplements Article IV monitoring with:
  - regular informal sessions on significant developments in selected countries and regions (sometimes monthly or more frequently);
  - regular meetings to discuss world economic and financial market developments.
- Other surveillance and collaboration tools for members facing balance of payments difficulties:
  - formal financial arrangements (Stand-By or Extended Arrangements) provide a framework for more intensive collaboration (see Chapter VIII);
  - precautionary arrangements: members agree on Stand-By or Extended Arrangement without intending to use resources committed unless circumstances warrant; right to draw resources if conditions agreed are met; such arrangements help by providing a framework for economic policy and highlighting IMF endorsement of its policies.

*Italic source attribution: Annual Report 1998 — THE IMF IN 1997/98 (Chapter excerpts as provided).*

### CHAPTER VI

### CHAPTER VI

### Intensified Monitoring and Surveillance Modalities
- Stand-By and Compensatory Financing: IMF support under agreed conditions can bolster confidence in members’ policies and assure availability of IMF resources if needed.
- Informal Staff-Monitored Programs: IMF staff monitor a country’s economic program and regularly discuss progress with the authorities; there is no formal IMF endorsement of the member’s policies.
- Enhanced Surveillance: Does not constitute formal IMF endorsement. Emphasis on close and formal monitoring by the IMF; initially established to facilitate debt-rescheduling with commercial banks but used occasionally in other situations.
- Use of intensified monitoring:
  - Sometimes a prelude to an IMF-supported adjustment program.
  - More often provides a framework to reassure donors, creditors, or financial markets.

### Lessons for Surveillance from the Asian Crisis — Overview
- In March 1998, the Executive Board reviewed members’ policies in the context of surveillance, focusing on lessons from the Asian crisis.
- Assessment of IMF performance:
  - Mixed record in identifying emerging tensions early.
  - Thailand: IMF expressed serious concerns beginning in 1996 and appeared more aware of risks than most market observers.
  - Korea: IMF had not attached sufficient urgency to financial tensions developing in early 1997.
  - In several Asian cases, lack of access to requisite information and difficulty seeing full consequences of structural weaknesses plus contagion effects led to surprise about severity.
- Directors noted some emerging market economies took timely and sustained policy measures to fend off turmoil; in those cases, close IMF surveillance had been helpful.
- Agreed agenda items for follow-up (to be pursued in 1998/99 and before the October 1998 Annual Meetings):
  - Review experience with IMF programs in Asian crisis countries, including program orientation, design, implementation, and early results.
  - Examine lessons as part of the world economic outlook and annual report on international capital markets.
  - Reflect lessons in papers on international monetary system architecture, data availability/dissemination, transparency in member policies and IMF surveillance, and role of international standards.
  - Further Board discussion on incentives for international financial flows and involving the private sector in crisis prevention/resolution.
  - Incorporate lessons into work on orderly and appropriately sequenced capital account liberalization.
  - Review World Bank–IMF collaboration experience, especially on financial sector reform.

### Box 2 — Second-Generation Reforms (areas where IMF and World Bank contribute)
- Help members strengthen the efficiency and robustness of financial sectors, including through appropriate prudential oversight.
- Help members enhance transparency of fiscal policy and practices and the quality, timeliness, and dissemination of economic and financial data to reduce risk of disruptive changes in investor confidence.
- Help members improve governance by establishing a simple and transparent regulatory environment and a professional and independent judicial system that will uphold the rule of law, including property rights.
- Assist members in redefining the role of the state in the economy to support private sector activity, including restructuring and privatization of state-owned enterprises and reducing government intervention where market forces provide greater efficiency.
- Help improve the quality of public expenditure, for example through greater attention to education and health spending.
- Help members promote greater flexibility of labor markets.

### Five Main Lessons Identified by Directors (March 1998)
- Lesson One — Timely availability of accurate information is critical:
  - Some improvement since 1995 in provision of data to IMF and markets, but further progress essential.
  - Crisis revealed importance of data not available due to reluctance (e.g., reserve-related liabilities of central bank) or absence of systems (e.g., private short-term debt).
  - Adequate public provision of data promotes transparency and market confidence.
  - Special Data Dissemination Standard seen as an avenue for progress; monitoring of compliance must be strengthened.
  - Importance of compiling timely and accurate data on short-term external debt emphasized.
  - Where countries cannot collect required data, technical assistance (including IMF competence) is important.
  - Attention to using and improving existing data sources, including Bank for International Settlements data.
  - Some Directors suggested not concluding Article IV consultations where willingness to provide required data is in question; Interim Committee recommended in April 1998 that persistent deficiencies in disclosing relevant data to IMF that seriously impede surveillance should delay conclusion of Article IV consultations.

- Lesson Two — Surveillance must extend beyond short-term macroeconomic issues:
  - Increased coverage and analysis of key structural policies, especially financial sector policies, since 1995.
  - Financial sector problems often complex and long in gestation; IMF needs more expertise and staff resources with relevant experience.
  - Debate on comparative advantage: IMF in macroeconomic analysis; World Bank and others in financial sector restructuring — but distinction not always clear in crisis context.
  - Collaboration with World Bank, national supervisory authorities, and BIS should be close and avoid duplication.
  - Development and use of international standards (e.g., Basle Committee Core Principles on Banking Supervision) can aid surveillance.
  - Importance of surveillance over capital account issues: monitor sequencing and pace of capital account liberalization, risks from reversal of large capital flows, rapid accumulation of short-term external debt, and effects of selective liberalization.
  - Some Directors suggested consultation reports systematically address progress toward capital account liberalization.
  - While a few supported selective capital controls as temporary measures, most Directors were skeptical that controls in already open economies would be helpful beyond temporary breathing space.

- Lesson Three — Greater attention to policy interdependence and contagion:
  - Surveillance at country level should pay greater attention to how policies in systemically or regionally important countries affect others.
  - Domestic vulnerability to external developments should be examined in bilateral consultations with objective of urging early, forceful action to mitigate contagion risk.
  - Multilateral surveillance can help identify spillovers; integrate multilateral exercises with bilateral dialogue.
  - Use staff expertise in capital market and financial sector issues in bilateral surveillance.
  - Support for more frequent and systematic exchange of views between staff and market participants; in relevant cases, staff reports should include a summary assessment of market sentiment, while respecting confidentiality of IMF–member dialogue.

- Lesson Four — Credibility and transparency are crucial in restoring market confidence:
  - Directors welcomed Indonesia, Korea, and Thailand releasing Letters of Intent to the IMF detailing adjustment programs.
  - Increasing number of countries agreeing to release Press/Public Information Notices (PINs) summarizing Article IV consultations seen positively.
  - Some Directors urged IMF could do more to disseminate its views (e.g., revisiting publication of staff reports for Article IV consultations), while others cautioned confidentiality is key to effective surveillance.
  - A few Directors supported using Article XII, Section 8, of the Articles of Agreement to make concerns public if members ignor warnings; most Directors doubted more public warnings would increase surveillance effectiveness and feared they could accelerate crises.

- Lesson Five — Effectiveness of surveillance depends on members’ willingness to take IMF advice:
  - Candid dialogue and IMF focus on issues important to individual members are vital.
  - Directors emphasized IMF staff engaging more actively in regional forums to harness international community opinion; peer pressure in regional forums and through the Board seen as important.
  - IMF’s involvement in Asia-Pacific Economic Cooperation Council and Second Manila Framework Meeting welcomed.

### Enhancing Information on Article IV Consultations (Box 3)
- Since May 1997, Executive Board has issued Press/Public Information Notices (PINs) following conclusion of Article IV consultations:
  - PINs set out:
    - A background description of the country’s economic situation at the time of the consultation.
    - The Board’s assessment of that situation and the country’s policies as detailed in the Chairman’s summing up.
    - A table of selected economic indicators.
  - PINs are issued on a voluntary basis at the request of countries wishing to make public IMF views on their policies and prospects.
  - Of the 136 consultations completed during 1997/98, 77 resulted in the issuance of PINs.
  - Full text of PINs is available on the IMF’s website and collections are published three times a year in IMF Economic Reviews; first issue released in May 1998.

### Article IV Consultations Concluded in 1997/98 — Key data points
- Total consultations completed during 1997/98: 136.
- Number of consultations that resulted in issuance of PINs: 77.
- Example dated entries from Table 7 (selected exactly as in source):
  - Algeria — June 27, 1997 — July 23, 1997
  - Antigua and Barbuda — December 3, 1997 — December 17, 1997
  - Argentina — February 4, 1998 — February 23, 1998
  - Armenia — February 6, 1998 — March 12, 1998
  - Austria — June 13, 1997 — June 20, 1997
  - Brazil — February 11, 1998 — March 13, 1998
  - China, People’s Republic of — June 30, 1997 — —
  - India — July 2, 1997 — July 16, 1997
  - Indonesia — July 9, 1997 — —
  - Malaysia — September 5, 1997 — —; Malaysia’s 1998/99 Article IV consultation was advanced to April 20, 1998 (April 20, 1998 — April 27, 1998)
  - Thailand — June 13, 1997 — —
  - United States — July 28, 1997 — August 4, 1997
  - United Kingdom — October 27, 1997 — November 6, 1997
- (Table 7 in the source lists many additional country board dates and PIN issuance status; the above examples are preserved exactly as presented in the source.)

### Government Transparency, Accountability, and Governance Work
- IMF continues to advise and provide technical assistance to promote public sector transparency and accountability.
- Interim Committee actions:
  - September 1996 Declaration on Partnership for Sustainable Global Growth identified promoting good governance (rule of law, public sector efficiency and accountability, tackling corruption) as essential.
  - April 1998 Interim Committee adopted a Code of Good Practices on Fiscal Transparency: Declaration on Principles to enhance accountability and credibility of fiscal policy.
- In 1997/98, IMF Executive Board met multiple times to develop guidance on governance issues and a code of good practices for member countries on fiscal transparency.

*Source: CHAPTER VI, ANNUAL REPORT 1998*

### Box 4

### Box 4

### IMF Regional Office for Asia and the Pacific
- Established in Tokyo to reflect the importance of the Asia-Pacific region for the global economy and IMF work.
- Director: Kunio Saito.
- Staff: administers a staff of 10.
- Main functions:
  - Regional Policy Forums
    - Responsible for IMF dialogue with Asian policymakers through regional policy forums including the Manila Framework Group, Asia-Pacific Economic Cooperation (APEC), Association of South East Asian Nations (ASEAN), and the Executives’ Meeting of East Asian and Pacific Central Banks and Monetary Authorities (EMEAP).
    - Facilitates regional and mutual surveillance activities.
    - The Manila Framework Group brings together deputies from ministries of finance and central banks of 14 economies across the region; it is the principal new grouping aimed at strengthening surveillance, enhancing cooperation, and promoting financial stability in the region.
    - The Regional Office provides the Secretariat for the Manila Framework Group.
  - Financial Market Surveillance
    - Monitors and analyzes financial markets in the region to ensure the IMF has timely and comprehensive knowledge of market developments and trends.
    - This analysis deepens the IMF’s understanding of economic developments in the region and strengthens surveillance.
  - External relations activities, and facilitation of technical assistance and training delivery in the region.

### Good Governance
- Executive Directors (May 1997) strongly endorsed the importance of good governance for economic efficiency and growth.
- Evolution of IMF role: pragmatic expansion as more is learned about governance contributions to macroeconomic stability and sustainable growth.
- Directors’ views and guidance:
  - Strong support for IMF policy advice and technical assistance on governance within IMF mandate and expertise, with more comprehensive treatment in both Article IV consultations and IMF-supported programs.
  - Need for evenhanded treatment of governance issues across all member countries.
  - Enhanced collaboration with other multilateral institutions, in particular the World Bank, to use complementary expertise.
  - Governance is primarily the responsibility of national authorities; IMF should build on authorities’ willingness to address issues.
  - IMF mandate does not allow it to act as an investigative agency or guardian of financial integrity in member countries.
  - IMF involvement should focus on economic aspects of governance:
    - Improving management of public resources.
    - Supporting development and maintenance of a transparent and stable regulatory environment conducive to efficient private sector activity.
    - Emphasis on enhancing transparency and accountability of public sector activities and providing a level playing field for the private sector.
  - IMF advice should be based on solid economic considerations within its mandate and remain apolitical; recognizing delineation between economic and political dimensions is often difficult.
  - Weak governance that threatens macroeconomic performance should be tackled early in reform efforts.
  - Conditionality could be attached to governance-related policy measures if necessary for achievement of program objectives.
- Executive Board action:
  - On July 25, 1997, the Executive Board adopted guidelines addressing the IMF’s role in governance issues.
  - The guidelines seek to promote greater attention by the IMF to governance issues through:
    - a more comprehensive treatment in Article IV consultations and IMF-supported adjustment programs of governance issues within the IMF’s mandate and expertise;
    - a more proactive approach in advocating policies and the development of institutions and administrative systems that eliminate the opportunity for bribery, corruption, and fraudulent activity in the management of public resources;
    - an evenhanded treatment of governance issues in all member countries; and
    - enhanced collaboration with other multilateral institutions, in particular the World Bank, to make better use of complementary areas of expertise.

### Transparency in Budgetary Operations
- Definition: Fiscal transparency is openness toward the public about government structure and functions, fiscal policy intentions, public sector accounts, and projections; access to reliable, comprehensive, timely, understandable, and internationally comparable information on government activities—including those undertaken outside the government sector.
- Executive Board actions and discussions:
  - Board took up transparency in government operations and fiscal policy rules in October 1997.
  - In April 1998, the Board agreed on a draft code of good practices in the area of fiscal transparency for submission to the Interim Committee.
- Directors’ conclusions (October 1997):
  - Transparency in government operations is conducive to fiscal discipline, sound public sector management, good governance, and improved macroeconomic performance.
  - Fiscal transparency helps instill confidence in government economic policies, especially in a globalized economy.
  - Fiscal transparency entails: setting clear fiscal objectives; building clear institutional arrangements (including proper budgetary process); using transparent and widely accepted accounting methods; providing timely and reliable information.
  - IMF should help members achieve greater fiscal transparency through surveillance, technical assistance, and program design.
  - Improving fiscal transparency is a multiyear endeavor; priorities differ among countries and IMF should consider specific country circumstances.
  - IMF involvement in fiscal transparency should focus on issues of macroeconomic significance and be evenhanded.
  - Staff should emphasize promoting transparency in government operations in surveillance work; many Directors favored a brief manual of good practices for fiscal transparency, while some expressed reservations about establishing “best practices.”
  - Timely and comprehensive reporting of public sector accounts is important; Directors urged extending coverage to the general government level and include off-budget operations and the cost of quasi-fiscal activities.
  - Cash-based recording should be supplemented with accrual-based recording where possible.
  - Authorities should publish information on guarantees and unfunded public sector liabilities where possible.
  - Need for transparent and stable tax systems and estimates of tax expenditures as part of the budget process.

### Fiscal Policy Rules
- October 1997 Board discussion on strengths and weaknesses of fiscal policy rules (examples: balanced budget or deficit rules, borrowing rules, and debt or reserve rules).
- Directors’ observations:
  - Many commented favorably on the potential usefulness of rules in strengthening or restoring policy credibility in specific circumstances.
  - Some noted usefulness of fiscal rules in common currency areas and cited benefits from Maastricht Treaty fiscal reference values for the European Union.
  - Cautions:
    - Fiscal rules are not a panacea; good economic performance depends on political will to implement sound policies.
    - Simply promulgating rules without political consensus is unlikely to yield desired results.
    - Practical difficulties in embodying all properties of the model rule (well-defined, transparent, adequate, consistent, simple, flexible for exogenous shocks and cyclical fluctuations, enforceable, and efficient).
    - Attempts to comply with a fiscal rule via excessive tax rate increases, unsustainable or cosmetic expenditure cuts, or one-off measures may be counterproductive.
  - Where members are interested in formulating fiscal rules or incorporating them in adjustment programs, IMF should provide policy advice and technical assistance.

### Code of Good Practices on Fiscal Transparency
- Draft code submitted to the Board in April 1998; rationale: fiscal transparency can lead to better-informed public debate, increase government accountability, promote good governance, strengthen credibility, and mobilize popular support for sound macroeconomic policies.
- IMF role: well placed to take the lead in promoting greater fiscal transparency because of fiscal management expertise.
- Draft code principles and practices ensure governments implement measures to:
  - roles and responsibilities in the government are clear;
  - information on government activities is provided to the public;
  - budget preparation, execution, and reporting are undertaken in an open manner; and
  - fiscal information is subjected to independent assurances of integrity.
- Directors’ reactions:
  - Generally welcomed the draft code; most saw merit in consensus on broad principles and essential elements of a transparent fiscal management approach.
  - Emphasized importance of moving ahead with a proposed manual to address practical issues.
  - Suggested periodic review and revision of the code.
  - Implementation should be tailored to individual country circumstances, recognizing legitimate differences in approach.
  - For countries with weaker institutions or binding legal constraints, progress toward achieving fiscal transparency consistent with the code might take time.
  - IMF should be prepared to provide technical assistance, in cooperation with other international organizations, to countries requesting it.
- Interim Committee action:
  - At its April 1998 meeting, the Interim Committee adopted the Code of Good Practices on Fiscal Transparency—Declaration on Principles (Box 5; full text reproduced in Appendix VI), recognizing implementation would be affected by diversity in fiscal institutions, legal systems, and implementation capacity.

### Data Issues
- Rationale: Policymakers and markets rely on information; poor information, limited disclosure, or withheld damaging information reduces efficiency of national and international financial systems.
- IMF attention: increasing focus on comprehensiveness, quality, frequency, and timeliness of data members provide to the IMF and disseminate to the public.
- Two-tiered approach endorsed by the Board:
  - Special Data Dissemination Standard (SDDS), established in March 1996, to guide member countries that have or might seek access to international financial markets.
  - General Data Dissemination System (GDDS), approved in December 1997, to guide all member countries.
  - In September 1996, IMF opened an electronic bulletin board on the Internet providing public access to information about data dissemination practices of SDDS subscribers.

Members’ Provision of Information to the IMF
- December 1997 Board review (third review) of members’ progress in providing data to the IMF for surveillance:
  - Provision of core indicators continued to improve modestly. Core indicators: exchange rates, international reserves, reserve or base money, broad money, interest rates, consumer prices, exports and imports, external current account balance, overall government balance, gross domestic product or gross national income, and external debt.
  - Concern that some members did not provide these data regularly or in a timely way; in some cases, lags had continued or increased.
  - Directors urged members to improve timeliness and frequency of data reporting.
- Need for supplementary data to complement core indicators, given country circumstances, to increase surveillance effectiveness between Article IV consultations and to identify emerging financial market tensions.
  - Desirable supplementary data categories: reserve-related liabilities, central bank derivative transactions, private sector external debt, and prudential-type bank indicators.
  - Specific desirable items include: forward transactions (outright or arising from swaps), maturity structure of external debt, composition of short-term external debt, information on foreign exchange reserves, and information on the financial sector.
  - Some Directors suggested expanding the definition of core data to include these additional data and consideration of a common standard for timeliness and frequency of data provided to the IMF.
- Data quality concerns:
  - Inadequate coverage and deficiencies in compilation methods have compromised usefulness of reported data and posed problems for program design and monitoring, especially national accounts, government finance, and balance of payments statistics.
  - Directors urged staff to continue assessment of data quality.
  - Several Directors stressed high cost of technical assistance and suggested monitoring recipient countries’ implementation of recommendations.
  - Efforts to improve data quality must be part of a broad effort to build solid statistical frameworks in member countries, consistent with SDDS and GDDS.
  - Some Directors suggested staff papers indicate data adjustments to help authorities identify data deficiencies and required improvements.

Members’ Dissemination of Data to the Public
- Review of SDDS (December 1997):
  - Number of subscribers: 43.
  - Directors welcomed growing external use of the Dissemination Standards Bulletin Board, especially with hyperlinks to national data sites.
  - SDDS provides incentives and a structure for improvements in data dissemination; subscribers’ initial experiences generally positive.
  - Proposals for updating the SDDS were timely given economic and financial developments in Southeast Asia and elsewhere.
  - Endorsed procedures for modifying the SDDS, including:
    - shifting data components for countries’ reserve-related liabilities from an “encouraged” to a “prescribed” component;
    - adding a prescribed component for net commitments under derivative positions.
  - Some Directors expressed reservations, citing definitional problems and confidentiality issues.
  - Procedure for modifying SDDS to include indicators of financial soundness should await development of standards for disclosure of macroprudential data and draw on work of other organizations, including the BIS.
  - Directors agreed to consider in the next SDDS review the possibility of establishing a more precise timetable for dissemination by subscribing countries of data on international investment positions, which would include data on short-term external indebtedness of the private nonbank sector.
  - Directors considered future credibility of the IMF and SDDS subscribers would depend on ensuring subscribers had imple- [text ends]

*Source: _file03pdf - Box 4*

### Box 6

### Box 6

### Dissemination Standards Bulletin Board (DSBB)
- The DSBB is a tool for market analysts and others who track economic growth, inflation, and other economic and financial developments in countries around the world.
- It describes the statistical practices—such as methodologies and data release calendars—of countries subscribing to the Special Data Dissemination Standard (SDDS) in key areas: the real, fiscal, financial, and external sectors.
- It also describes steps subscribers have taken to improve practices to move toward full observance of the SDDS by the end of the transition period.
- Beginning in April 1997, electronic links (hyperlinks) between the bulletin board and actual data on national data sites have been established, enabling users to move directly from the bulletin board to current economic and financial data on an Internet site maintained by the subscriber. (The links do not indicate IMF endorsement of the data.)
- The bulletin board can be accessed on the Internet at http://dsbb.imf.org, or through the IMF’s website, http://www.imf.org.

### Subscribers to the SDDS (as of the end of April 1998)
- Subscribers listed (those for which hyperlinks were in place are indicated by an asterisk):
  - Argentina*
  - Australia
  - Austria
  - Belgium
  - Canada*
  - Chile
  - Colombia*
  - Croatia
  - Czech Republic
  - Denmark
  - Ecuador
  - Finland
  - France
  - Germany
  - Hong Kong SAR*
  - Hungary
  - Iceland
  - India
  - Indonesia
  - Ireland
  - Israel*
  - Italy
  - Japan*
  - Korea
  - Latvia
  - Lithuania
  - Malaysia
  - Mexico*
  - Netherlands
  - Norway
  - Peru*
  - Philippines
  - Poland
  - Portugal
  - Singapore*
  - Slovak Republic
  - Slovenia*
  - South Africa*
  - Spain
  - Sweden
  - Switzerland*
  - Thailand
  - Turkey*
  - United Kingdom*
  - United States

### Transition, observance, and Board guidance
- Directors noted some current subscribers had made limited progress in completing outstanding actions to fully comply with the Special Standard by the end of the transition period.
- Directors urged members to implement rapidly their announced transition plans and asked staff to give priority to assisting subscribers in successfully concluding the transition period.
- Directors agreed it would be prudent for members intending to subscribe during 1998 to assess carefully the likelihood of fully observing the Special Standard by the end of the transition period.
- The Interim Committee, in its April 1998 meeting, emphasized the importance of subscribers being in full observance of the standards by the end of the transition period in December 1998.
- In discussing possible nonobservance after the end of the transition period, Directors noted the need to differentiate between minor and serious breaches and agreed to reconsider the issue during the next review of the SDDS.
- Although some Directors suggested exploring some form of cost recovery, the Board agreed that, for the present, the costs associated with the Special Standard and maintenance of the associated bulletin board should not be borne by users, on the grounds that the wide reach of the bulletin board benefited the entire international community.

### General Data Dissemination System (GDDS): purpose and scope
- In contrast to the SDDS, the GDDS aims primarily to improve the quality of data for all members and focuses on the development and dissemination of a full range of economic, financial, and sociodemographic data.
- The GDDS objectives include comprehensive statistical frameworks comprising:
  - national accounts for the real sector,
  - central government accounts for the fiscal sector,
  - a broad money survey for the financial sector, and
  - balance of payments accounts for the external sector,
  - as well as a set of sociodemographic indicators.
- In December 1997, Directors recognized the GDDS as an important step for all IMF members—not only in guiding the provision of data to the public, but also in encouraging improvements in the quality and accessibility of data.
- Directors emphasized:
  - improvements in data quality are often a necessary precursor to enhanced dissemination to the public;
  - the GDDS provides a useful framework and clear links to the SDDS, particularly for countries wishing to use GDDS participation as a step toward SDDS subscription;
  - inclusion of sociode mographic indicators in the GDDS was supported by most Directors, though some Directors felt responsibility for developing social indicators should lie mainly with other international organizations.
- The Board affirmed the importance of the GDDS dimensions of access and integrity as aspects of open-ness and transparency and noted these were not yet standard practice in many countries.

### GDDS implementation approach and training
- Most Directors supported a phased approach in implementing the GDDS, focusing first on education and training through appropriate documentation, seminars, and workshops.
- The GDDS will be implemented in two phases:
  - Phase 1: education and training;
  - Phase 2: direct country work.
- Training-phase details:
  - The training phase will include eight regional seminars and workshops, beginning in mid-1998 and ending in the fall of 1999, for up to 120 member countries.
  - Following the training phase, IMF staff will work directly with member countries to assist them in assessing their practice against those of the GDDS and developing plans for improvement.
- As of April 1998, some 25 countries had indicated preliminary interest in the GDDS by appointing a country coordinator.
- Formal invitations to participate have been sent to all member countries that have not subscribed to the SDDS following completion of guidance materials on the GDDS.

*Source: _file03pdf - Box 6*

### introduction of the euro—their discussion centered on

### _file03pdf - introduction of the euro—their discussion centered on

### Benefits and Risks of Dollarization
- Dollarization indicated a lack of confidence in the ability of the domestic currency to perform its functions effectively in many developing and transition economies.
- Potential benefits:
  - Foreign currency deposits could promote the growth of the domestic financial sector by allowing domestic banks to compete with cross-border accounts.
  - Dollarization was sometimes the only effective way to remonetize an economy in cases of extreme price instability and capital flight.
- Potential risks, especially in weak and immature financial systems:
  - Increased risks in the financial sector stemming from a deterioration in the quality of the foreign currency loan portfolio in the case of a sharp devaluation of the domestic currency.
  - Limited ability of the central bank to act as the lender of last resort in foreign currency.
  - Loss of seigniorage revenues in countries with large cash holdings of foreign money.

### Implications for Exchange Rate and Monetary Policy
- Likely higher volatility of money demand in economies with high currency substitution would tend to make the exchange rate more unstable and limit the effectiveness of monetary policy.
- Policy regime considerations:
  - Several Directors favored the adoption of a fixed rate or a currency board arrangement supported by appropriate macroeconomic policies to handle monetary shocks associated with dollarization.
  - A number of Directors stressed that the degree of currency substitution was only one of many elements in choosing an exchange rate regime; other significant considerations included the importance of real shocks, the degree of capital mobility, the scope for fiscal adjustment, and the overall macroeconomic situation.
- Effects on inflation:
  - Although essentially an empirical question without a unique answer, Directors felt that foreign currency aggregates should not be discounted and despite measurement difficulties, these aggregates should be included among the broader set of indicators monitored by the monetary authorities.
  - Some Directors thought that certain dollarized economies could suitably adopt an inflation-targeting framework for monetary policy.

### Monetary Operations and Prudential Risk
- Directors generally preferred that monetary operations be conducted in domestic currency.
- Qualifications:
  - Monetary instruments denominated in foreign currency could be useful in highly dollarized economies where the bulk of credits and interbank operations were already denominated in that currency.
  - Provision of foreign currency interbank settlement on the books of the central bank should be backed by ample international reserves and effective measures to limit settlement risk.
- Prudential safeguards recommended:
  - Special vigilance to limit prudential risk in highly dollarized economies.
  - Banks in developing countries should exceed Basle guidelines for capital adequacy because of the impact of dollarization on credit risk and risks to the banking system.
  - Central banks have limited ability to act as lender of last resort in foreign currency; sizable currency reserves and contingent credit lines could usefully contribute to limiting systemic liquidity risk.
  - Importance of closely monitoring off-balance-sheet operations, as well as the maturity and composition of foreign exchange exposures, despite difficulties in monitoring limits on foreign exchange positions given the sophistication of financial markets.

### Policy Recommendations to Limit Dollarization
- Focus monetary policy on macroeconomic stabilization.
- Measures to improve the attractiveness of the domestic currency preferred over measures to discourage the use of foreign currency.
- Recommended avenues for limiting dollarization over the medium term:
  - Interest rate liberalization.
  - Measures to increase financial deepening.
  - An effective domestic payments system.
  - An independent monetary authority.
- Additional recommendations for countries with weak financial systems:
  - Appropriate sequence of financial liberalization measures supported by strong macroeconomic policies.
  - Caution regarding indexed financial instruments: while they could limit dollarization, the risks of promoting inflationary inertia must be carefully weighed.
- Rejection of restrictive measures:
  - Directors broadly agreed that dollarization should not be tackled by restricting residents’ ability to maintain accounts in foreign currency or imposing punitive reserve requirements on foreign currency deposits, as such measures would be counterproductive, weakening financial intermediation or leading to capital outflows.

### Dollarization and the Design of IMF-Supported Adjustment Programs
- The Board stressed the need to consider the prevalence of dollarization in designing adjustment programs supported by the IMF.
- Observations:
  - Dollarization had not seriously hampered the attainment of growth and inflation objectives, but velocity and the money multiplier appeared to be more variable in dollarized economies, pointing to potential problems in selecting intermediate monetary aggregates.
- Program design guidance:
  - Programs should apply conditionality in a way that takes into account the presence of dollarization rather than attacking it directly.
  - Programs should address the fundamental policies needed to restore confidence and the long-term credibility of the domestic currency.
  - Programs should continue to focus on the underlying causes of dollarization, the development of domestic financial systems, and, where necessary, the adoption of prudential measures.
  - Noting that the costs of dollarization might outweigh the benefits, a few Directors saw greater merit in pursuing an active de-dollarization strategy.
- Reserve treatment:
  - In view of the uncertain duration of foreign currency deposits in the banking system, the Board generally agreed that domestic banks’ reserves with the central bank against foreign currency deposits be considered part of the central bank’s liabilities for purposes of measuring net international reserves.

*ANNUAL REPORT 1998 — _file03pdf - introduction of the euro—their discussion centered on*

---


_Source: https://www.imf.org/-/media/websites/imf/imported-flagship-issues/external/pubs/ft/ar/98/pdf/_file03pdf.pdf_