Public Information Notice No. 04/117

Public Information Notice: IMF Discusses Status Report on Crisis Prevention and Precautionary Arrangements

October 6, 2004

On September 24, 2004, the Executive Board of the International Monetary Fund (IMF) discussed the paper Crisis Prevention and Precautionary Arrangements—Status Report.

Background

The Executive Board returned to its discussion on the possible use of precautionary Stand-By Arrangements for capital account crisis prevention.¹ This subject was first discussed in June 2003 with the background of a staff paper that took a first look at the possibility that precautionary arrangements might achieve some of the objectives of the Contingent Credit Line (CCL).² Directors have strongly supported the IMF's existing policies to promote crisis prevention, and the use of precautionary arrangements with normal amounts of Fund financing. Fundamental differences of view exist about the need for and desirability of a policy for using exceptional amounts of financing under precautionary arrangements.

Executive Board Assessment

Executive Directors welcomed the opportunity to discuss the status report on Crisis Prevention and Precautionary Arrangements. The Board has discussed the possible use of precautionary arrangements in capital account crisis prevention on several occasions. Directors reiterated their strong support for the main elements of the Fund's crisis prevention strategy. This is focused on promoting the early adoption by members of sound policy frameworks as the first line of defense against vulnerability to sudden capital outflows. In addition, the Fund provides assurances to its members of its readiness to provide financial support, including above the normal access limits where warranted, in support of an appropriate policy response should a crisis occur.

Directors continue to support specific elements of the Fund's toolkit for crisis prevention. They agree that the overall experience with normal access precautionary arrangements has been positive. They support the exceptional access criteria, which are designed to provide clarity to both members and markets on the conditions for Fund financial assistance in the event of a capital account crisis, and to facilitate the rapid provision of such assistance. Also, they concur that the wide range of measures taken to improve the IMF's surveillance mechanisms has enhanced the capacity to advise members on emerging vulnerabilities at an early stage.

Against this background, Directors continued their debate on the need for, and desirability of, a new policy that would clarify the use of exceptional access under precautionary arrangements. On the one hand, many Directors take the view that existing Fund policies are adequate. Their view is based on the following considerations: first, that Fund membership itself provides sufficient insurance to members; second, that regular precautionary arrangements—that is, within the normal access limits—can, and do, provide support for members' strong policies; third, that innovations to Fund surveillance and efforts to increase transparency are bearing fruit; and fourth, that a new policy could undermine incentives to undertake reforms or to assess risk fully. Directors holding this view also note that the Fund can augment the resources it provides fairly quickly if the need arises. Furthermore, most Directors noted that exceptional access could be used in precautionary settings as part of an exit strategy for countries with outstanding IMF resources above the normal limits, under the flexibility provided by the exceptional circumstances clause.

Several Directors suggested that the Supplemental Reserve Facility be modified to allow its use in precautionary arrangements. The Board will have the opportunity to come back to this at a later stage in the context of the review of charges and maturities of Fund facilities.

The alternative view, held by many other Directors, remains that there is a gap in the Fund's toolkit left by the expiration of the Contingent Credit Line in late 2003. These Directors stress that, even if a country is a Fund member and maintains strong domestic policies under Fund surveillance, a capital account crisis can occur as a result of exogenous factors. A new policy that would provide ex ante assurances of appropriate financial support can help strengthen the Fund's role in crisis prevention. Such a policy would: first, provide increased assurances of the conditions under which Fund resources would be made available in a crisis; second, provide access to Fund resources more in line with the potential need of a member with capital account vulnerabilities or contagion risk; third, enhance incentives for members to adopt strong policies before capital account pressures emerge; and fourth, help to boost market confidence and hence reduce the probability of a costly crisis. Directors holding this view feel that regular precautionary arrangements—while useful in cases where pressures are likely to emerge in the current account—are not an effective tool of crisis prevention for members that pursue sound policies but still remain exposed to exogenous shocks and contagion. They regret the lack of progress in designing a policy on exceptional access under precautionary arrangements, and urge that this issue remain a high priority on the Fund's agenda.

Directors have expressed a variety of views on the alternative areas that could be explored to improve country insurance against capital account shocks. Some Directors have stressed that future research should not send a signal that the Fund is turning away from the objective of finding an effective means of assisting member countries in their efforts to prevent capital account crises, while some others have cautioned that the staff's work program should not be pursued with the aim of finding justifications for use of exceptional access in precautionary arrangements. There are differences of emphasis with respect to the orientation of our future work as proposed in the staff report. Today's discussion has brought out further ideas that could be explored. The staff will keep Directors informed, in the context of the work program discussion and at other opportunities, of how its work will be advanced, taking account of all the suggestions made.