Steering a Course Through the Torrent of Change: Principles for Reform of the International Monetary Fund, Speech by Rodrigo de Rato, Managing Director of the International Monetary Fund, to the Bretton Woods Committee, Washington, D.C.

June 12, 2007

Speech by Rodrigo de Rato, Managing Director of the International Monetary Fund, to the Bretton Woods Committee
Washington, D.C., June 12, 2007

View a webcast of the Managing Director's address

1. Thank you very much.

2. I'd like to welcome all of you here. The Bretton Woods Committee is an important source of advice and inspiration for us, and Gerry Corrigan and Bill Frenzel have long been friends of the Fund. I would also like to thank Jim Orr for all his work in organizing these meetings.

3. In his introductory note for this meeting, Jim Orr outlined some of the challenges that international financial institutions are facing at the moment. The British writer and poet, G.K. Chesterton, said that there is a false belief that "...if you leave things alone, you leave things as they are. But you do not. If you leave a thing alone, you leave it to a torrent of change."

4. I believe that this is the situation of the International Monetary Fund. Financial globalization is subjecting the world to a torrent of change. We can try to resist it, and fail to take the opportunities it gives us. We can abandon ourselves to it, and be swept away. Or we can try to understand change and shape it. We can assess the implications of change for macroeconomic and financial stability and then adapt ourselves so that we can continue to provide the public goods that our membership needs. This is the path I believe the Fund should take, and this is the goal of the strategy we have laid out to reform the Fund.

5. The central goal of the Fund's Medium-Term Strategy is to help our members address the challenges of 21st century globalization. To do this, we need a Fund that is attentive to the challenges our members face; a Fund that has the resources to help them meet these challenges; and a Fund that is trusted to give evenhanded advice and fair representation to all of our members. And we need to apply these principles to the changes we are making in each of the Fund's main areas of work, and to reform of our own governance and financing.

6. I would like to concentrate mostly today on surveillance of our members' economies and of the global economy, which is the core mandate of the Fund. I will begin by talking about how we can be more attentive to our members' needs. Being more attentive requires at a minimum two things: that we focus on the right issues and that we are responsive to new challenges.

7. On the question of focus, I proposed some time ago that the Fund revisit the legal framework for our surveillance, which is set out in the 1977 Decision on Surveillance over Exchange Rate Policies. Work on reviewing this is now well advanced, and our Executive Board will be meeting later this week to consider the issue further. I don't want to go into detail today on what I expect to come out of that discussion—that would preempt the Board—but I do want to give some background on the motivation for proposing changes.

8. The Fund's core mandate is to promote international financial stability. Our monitoring of exchange rates plays an important role in enabling us to perform this task. Exchange rates are a key link between countries' economies, and developments in exchange markets are often a leading indicator of economic problems. When economic relations between countries become disorderly, exchange rates can move abruptly, often with terrible consequences. And when a country maintains an exchange rate for a sustained period of time that is out of line with fundamentals, it may gain an unfair competitive advantage if the rate is undervalued. Or it may set itself up for a crisis if the rate is overvalued. In either case its policies are likely to result in misallocated investment, for partner countries as well as for itself. These are the things that, since the Second Amendment of our Articles almost thirty years ago, it has been the Fund's job to try to prevent.

9. But exchange rates are not the whole story. Balance of payments problems can come from many sources, not just "wrong" exchange rates. And it is not always exchange rates that need to change. Sometimes it is domestic policies that need to change to make an exchange rate sustainable. Or more often it is both exchange rates and domestic policies that need to change. Of course, we should always be looking at where the exchange rate is and what policies are driving it there, and paying special attention to exchange rate policies—both intervention and related policies. But I see it as a major deficiency of the 1977 Decision that it has nothing to say about policies other than exchange rate policies. At the same time, the Fund must preserve its focus and not be distracted from its mandate and comparative advantage.

10. Putting these things together, I would like to see a revised Decision which reaffirms the Fund's mandate and makes clear which risks surveillance should focus on, consistent with this mandate. These should include—but not be limited to—the risks that can stem from exchange rate policies. A new Decision mostly would reflect our members' agreement on what is already best practice. This is important in itself: in the modern world organizations should not be portraying their activity as one thing and doing another. The revised Decision is also an opportunity to reassert our members' common understanding on what the Fund should be doing. Certainly, it will help focus everyone's minds on what is expected of Fund staff and of member countries.

11. There is another aspect to attentiveness, which is identifying and responding to problems in innovative ways. This is what the Fund has done on the issue of global economic imbalances. You all know about our first Multilateral Consultation, which focused on reducing global imbalances while sustaining strong global growth. During the recent Spring Meetings, the five participants—China, the euro area, Japan, Saudi Arabia, and the United States—jointly set out their policies in a document circulated to ministers representing the Fund's 185 members. This is a very significant development. The policy plans set out by the participants were concrete and mutually consistent. If implemented, they will reduce imbalances while sustaining growth. And the fact that the participating countries agreed to put forward these policies and discuss them in a multilateral setting shows their recognition of the global nature of the problem, and shows their commitment to multilateralism.

12. Both the Multilateral Consultation and the discussion of the 1977 Decision have taken time, and some—including some of this audience—have occasionally been impatient with the pace of change. And I will not deceive you: what has been agreed and will be agreed will take time to be implemented and show results. But this is not necessarily a bad thing. Change is likely to be better and more durable if it results from shared analysis and shared ownership of agreed actions. The Fund has learned this lesson in our lending. It is equally valid in our surveillance.

13. Innovation is important in other areas, too. One critical area in which we must deepen our work is on financial markets and financial systems. Specifically, we need to better integrate our work on financial sectors with our work on macroeconomic issues. We also need to deepen our analysis of spillovers between countries and markets. And we need to have the very best analysis of exchange rates, and we have already strengthened our assessments of equilibrium real exchange rates in a multilateral context.

14. Let me now say something about resources. To fulfill its mandate properly, the Fund must have the necessary resources. Last year I appointed a committee of people with eminent standing in the international financial system to study this issue. Andrew Crockett, a former head of the BIS, chaired this committee, and the other committee members were Mohamed El-Erian, Alan Greenspan, Tito Mboweni, Guillermo Ortiz, Hamad Al-Sayari, Jean-Claude Trichet, and Zhou Xiaochuan.

15. The committee produced a strong report. Their central recommendation is that the Fund adopt a new income model to sustain its activities for the long term. They recommend a package of measures to diversify the Fund's income. These include:

• Broadening the range of the Fund's investments, in line with the policy of the World Bank, so as to raise our average returns;

• Investing a limited portion of the Fund's quota resources, which currently generate income only when used to finance lending; and

• Selling a small proportion of the Fund's gold reserves—400 metric tons, which is equivalent to one-eighth of total Fund holdings of gold—and investing the proceeds. Recognizing the need not to disrupt the gold market, the committee urged the Fund to coordinate with the Central Bank Gold Agreement so as not to add to the announced volume of official gold sales.

• The Committee also suggests that we consider charging for services, such as technical assistance, provided to individual members; and reestablish the practice of the PRGF Trust reimbursing the Fund for the administrative costs of concessional lending.

16. Let me make a few points about these recommendations. First, the Fund will need to be properly financed to fulfill the mandate that members have given the institution through their support for the Medium-Term Strategy. Second, there would be a need for a new income model—and there would be a need for a new model even if Fund lending picked up again—because the Fund cannot continue to rely on lending to finance public goods such as surveillance and technical assistance. Both of these considerations suggest a need to change our financing model.

17. I have already had some discussions with our members on these recommendations, during the recent Spring meetings, and we will have a further Board discussion next month on the main issues in implementing the recommendations. There is not an urgent financial need to resolve the income issue: the Fund has plentiful reserves that it can draw on for some time. But establishing reliable income sources is important to give our members confidence that the Fund will be able to carry out its mandate in the future and to enable us to make reliable plans to implement agreed policies.

18. The third principle that I set out was that the Fund must be trusted to give evenhanded advice and fair representation to all of our members. We must meet this duty in our surveillance work. Some of the aspects of the Board's discussion of surveillance on which there has been very strong agreement is that surveillance must be evenhanded and candid, regardless of the member concerned. If you look at our reports I hope that you will find our discussion of China's exchange rate as candid as that of Chile's, and our discussion of fiscal policy in the United States as firm and direct as our discussion of the budget of the United Arab Emirates.

19. It is also crucial for the Fund's legitimacy that all members believe that they have adequate representation and that the Fund is the property of the whole membership. Therefore, as one of the cornerstones of our reform efforts, we are updating the Fund's governance structure, with the aim of increasing the representation of countries whose economic weight has increased in recent years, while also protecting the voice and representation of low-income countries. We began with a first round of quota increases last year for four dynamic emerging markets—China, Mexico, Korea, and Turkey. We are currently discussing proposals for a new quota formula which would form the basis for further quota changes. And we have set in train the legal work necessary for an increase in basic votes, which will safeguard the position of low-income countries.

20. The next challenge is to reach agreement on a new quota formula. There is broad consensus among our membership that the new formula should be simple and transparent, consistent with the roles of quotas, and appropriately capture the relative positions of members in the global economy. There is also agreement that the reform should result in higher shares for dynamic economies, many of which are emerging market economies, whose weight and role in the global economy have increased. Our objective remains to agree on a new formula before the 2007 Annual Meetings, and no later than the 2008 Spring Meetings. Meeting this target will require leadership from members, and compromises among them. But I believe that we can renew the spirit of multilateral cooperation that we saw at our Singapore meetings. We can reap great benefits from reforming our governance. President Mbeki of South Africa put the point very well in a speech earlier this month when he said, "Gains to legitimacy will translate into gains in effectiveness; we must have the courage to make them happen." I believe that this is an idea whose time has come, and the more people making the case for needed change, the more likely we are to secure it.

21. I have not talked today about some key areas of our work: for example, our efforts to design a new instrument to support emerging markets, that would provide a mechanism for countries to commit to sound policies, while making high-access financing available during adverse shocks. And I have not talked about our work on low-income countries. On this, I will just say that the Fund will certainly continue to be engaged with low-income countries, focusing on critical macroeconomic and financial areas, which are both what we do best and where we can make the greatest contribution. We must also continue to work in partnership with the World Bank and other development agencies.

22. In these areas of our work, as in all of our work, the same principles must apply. We must be attentive to the challenges our members face; being both focused at all times and innovative when needed. We must have the resources to help our members meet these challenges and we must deploy them efficiently and wisely. And we must be trusted by our members, something that requires both giving evenhanded advice and also fair representation through reform of quotas. If we hold to these principles we can steer a course through the torrent of change that the world faces, and help our members do the same. All of you here today, and especially all of you who have worked with the Fund and with the Bretton Woods Committee, recognize the importance of dialogue between countries and the usefulness of institutions like the Fund and the Bank as places for this dialogue. Strong international institutions will be even more essential as globalization continues. I ask for your support of the Fund in the months and years ahead, and I thank you for your presence here today.

23. Thank you very much.


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