Speech

99/16

Remarks by Michel Camdessus

Managing Director of the International Monetary Fund
at the Bretton Woods Committee 1999 Annual Meeting
Washington, D.C., June 9, 1999

I am most pleased to have this further opportunity of addressing the Bretton Woods Committee, and I would like to thank you for this further evidence of your interest in and support for the IMF, so effectively demonstrated recently in very demanding circumstances for the Fund.

It is a little over a year since I last spoke to you. Since then the world has passed through a period of deep turbulence. This led to determined and at times controversial action by governments and institutions around the world. Possibly before I elaborate on my topic today, you would like to hear briefly from the horse's mouth, what is the outlook now. Certainly, the worst of the emerging market crisis seems to be behind us. In Asia, the countries at the heart of the crisis are close to or even past the turning point: Korea in particular is seeing an upturn in activity, obliging us to revise upward our forecast to 4 percent perhaps more.

But we also have good news from Thailand, as well as the Philippines which shielded itself pretty well against the worst of the crisis by implementing courageously their kind of precautionary program with the IMF. And the news is also good from Indonesia where the positive effects of the program were delayed by political imbalances but where we are happy to see now, not only the first truly free, peaceful, and orderly elections in more than 40 years, but also that, this year growth is expected to become positive, with inflation falling to the single digit level. This, together with stability of the exchange rate, would allow the reduction of interest rates, further improving prospects for recovery, while market confidence.

Let us have no illusion. All of this is still extremely fragile and requires increased vigilance so that complacency does not reappear. But let me state that there are now good prospects for these countries to resume growth-high-quality growth-on a more sustainable basis than before the crisis. A heavily damaged financial system, a gravely weakened corporate sector, many structural rigidities, not to mention corruption, cronyism, and nepotism, were key among the underlying causes of the crisis. By dealing with these issues up front, governments restored confidence in economic policy and laid the basis for a resumption of high-quality growth. We helped them in doing that, we do not apologize for that, and we are grateful to our membership who supported us in these difficult and, at times innovative, but indispensable steps. I would say the same about the measures of social progress, particularly for the core labor rights our dialogue with the authorities has helped to provide.

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There is no need to speak about Brazil and other countries. More generally, the question is whether this tentative recovery can be extended into a new era of high-quality global growth, in which the emerging markets will play a dynamic role once again? That will depend, not just on skillful macroeconomic management, but also on whether the international community can advance convincingly with the challenge, on which it has embarked, to overhaul the architecture of the international financial and monetary system.

And in this debate, no topic has proved more challenging than the question of how to "involve the private sector in forestalling and resolving crises". You have invited me today to address this question, in this session entitled "Bailing in the private sector in debt crises." In my remarks today I shall not try to review the whole range of reform issues that are being debated by the international community, but instead will reflect on what should be expected of the private sector creditor and debtors, touching where necessary on the implications for their relationships with their governments. But two remarks in starting. First, "bailing in" carries connotations of "bailing out", and I do not accept that this is either the purpose or the effect of IMF or other international packages of financial support. Some in this audience may be able to attest at first hand to the losses that many investors have suffered as a result of the crises in the emerging markets. Second, rather than focus only on crises, my message is that "an ounce of prevention is better than a pound of cure", and that the bulk of our attention should be focused on strengthened national and international systems, even when there is no hint of crisis. Of course, crises cannot be avoided altogether, and therefore part of our work is to develop measures that will facilitate the resolution of crises if they occur.

If there is any characteristic distinguishing this series of crises from others, it is the prominence of the private sector-financial institutions and corporations-on both sides of the equation as creditors and debtors. It is instructive to contrast the recent round of crises with earlier ones, especially the debt crisis of the 1980s. With the explosive growth and increasing integration of the capital markets during the past decade, a number of notable trends stand out, all of which have tended to increase complexity:

· The domestic private sector-both banking and corporate-is typically a much more significant player now. Domestic financial and capital markets have sprung up around the world. Who would have forecast a decade and a half ago equity markets in Beijing, Warsaw, Prague, or Moscow?

· The "foreign investment community" is far more diverse: direct investors, portfolio investors, banks, bondholders, and other creditors have all become major players.

· The different types of investment have responded to crisis in very different ways. Even in this most difficult of periods, flows of direct investment have not flagged: they rose strongly in 1997 and held fairly steady in 1998. By contrast, banks having been the largest source of net inflows in 1996, had become major recipients of net outflows by 1998, the first full year of crisis.

· It is too simple to conceive of nations as belonging to one camp or the other: debtor or creditor. There are powerful flows in many directions. For instance, the largest source of direct foreign investment in Asia is Asia. Korea, Hong Kong, Thailand, Taiwan Province of China and, of course, Japan, are all important sources of foreign investment within the region, and remain so despite having been at the heart of the crisis.

These very selective observations point to some simple truths about markets. For much of the 1990s the markets were doing what they do best: seeking opportunities. The crises that appeared first in Mexico in 1994/95 and re-emerged with greater virulence during the past two years revealed that market players, regulators and policymakers had not fully perceived the risks, including some that were of systemic proportions, that accompanied those opportunities. And so, the second half of the 1990s, especially the past two years, have been devoted to seeking measures that aim to reform the critical features of the international financial system that were associated with the crises.

Inevitably, early attention has focussed on the resolution of crisis. The severity of the situation demanded an immediate response, but this was a new breed of crisis for which precedents were quite limited or only relatively relevant. Therefore we have in effect been developing a still incomplete body of "case law" based on the different experiences we had to go through. If there is one clear lesson to emerge from the experience it is that the diversity of country situations means that there is no "silver bullet", no "one-size-fits-all" solution. The circumstances and workouts of debt in each of the major crisis countries during the past two years have differed substantially-from the "concerted rollover" of a large volume of short-term debt in Korea, to the "consultative approach" adopted by Brazil, even though there was no intention and no need to consider debt restructuring. In Thailand and Indonesia different approaches were taken again. In all of these cases the cooperative approach stands in sharp contrast with Russia's disorderly and highly disruptive suspension of debt service.

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What kind of conclusions can we draw at this stage? Let me start with the obvious, if we are to build a more durable, integrated international financial system, the foundation for successful crisis resolution should exist long before crisis strikes. Quite simply, it should consist of the basic and effective market structures, practices and relationships that should exist under normal conditions. We need to foster a mature market, which is based on stable relationships among players that rely on enlightened self-interest, and in which official involvement can be limited to establishing strong legal, regulatory and supervisory frameworks.

What should we expect from the players, regulators, and supervisors in this market? As I review some of these expectations, I think you will quickly recognize that what I am calling for are the simple, basic values of good governance, transparency and cooperation.

I. Let us first think of the responsibilities of debtors. At the top of the list, clear and unambiguous, is the principle that contracts must be honored. I emphasize this at every opportunity, since it is the very foundation of the successful operation of mature markets. Proposals for involving the private sector, far from encouraging countries to take their commitments less seriously, must ensure that obligations are honored.

If there is an equivalent singular responsibility of governments, then it is the obligation to pursue the macroeconomic policy objectives of stability and growth within a transparent economic and financial policy framework, including the dissemination of comprehensive, accurate, and timely data.

Other obligations involve elements of a shared responsibility, and call for extensive cooperation and consultation:

· A strong legislative framework-including a workable bankruptcy law-and an independent judicial system;

· Adoption and adherence to internationally accepted standards of disclosure and governance. Even if some of these standards are still "work-in-progress", there are many that can be adopted already;

· The development of a robust regulatory and supervisory framework for the financial sector;

· Policies and practices that promote sound debt management and the high-frequency monitoring of private external liabilities, a key aim of which should be to avoid excessive short-term debt.

II. How can creditors, in other words the private sector-and their governments-contribute to a better system?

The first area is risk assessment and risk management. You do not need me to tell you that investment of any kind involves risk, carrying with it the obligation to develop adequate techniques and practices for assessing, pricing and managing risk. Many investors have taken substantial losses in the past two years, and are increasingly interested in and capable of differentiating among countries. But investors would do well continually to keep their practices under review, and national regulators should ensure that this happens.

Second, creditors can play an important role in encouraging adherence to internationally recognized standards. Not only should they themselves expect to adopt them-for instance by attaining high standards of disclosure-but they can also encourage borrowers to adopt good practices by factoring this into their investment and pricing decisions.

Third, creditors should accept that national authorities need to adapt the principles and standards that support their regulation and supervision of national financial systems. One practical suggestion, which has gained widespread support, is to reflect more adequately the risk of lending to emerging markets by increasing the risk weights assigned to short-term lending in the balance sheet of creditor banks under the Basle Core Principles. On this, we welcome the consultation document released by the Basle Committee last week. More generally, I am happy that the activities of offshore funds, and highly leveraged institutions-including hedge funds and the similar operations of other financial institutions-and the role of short-term credit, will be the subject of the first studies by the recently established Financial Stability Forum.

Fourth, private creditors can help-and in a few cases already are helping-countries to preserve their foreign exchange liquidity when there is a threat of contagion by establishing contingent financing arrangements that can be activated if crisis looms.

Fifth, since cooperation is vital, debtors and creditors need to establish and activate good lines of communication during normal times. Some recent cases of debt workouts-for instance Indonesia-have pointed to the importance of timely and effective consultation among debtors and creditors. Here countries may consider emulating Mexico's practice, established after the 1994/95 crisis, of regular consultation with international financial market participants, and Brazil's consultative approach to its creditors in the context of securing a voluntary rollover of interbank and trade related credit lines.

III. How can the IMF contribute? Less than two months ago the Fund took an innovative decision, which will enable it to offer financial resources to support crisis prevention, through the mechanism known as Contingent Credit Lines. These lines are designed to help countries that are in a relatively strong situation-with sound macroeconomic management, strong financial systems, and making progress in applying internationally recognized standards-withstand the pressure on their balance of payments that might arise from a sudden loss of confidence through contagion from developments elsewhere.

This will not divert us from our traditional activities. As a matter of fact, a defense in preserving the stability of the international financial system will always be our bilateral and multilateral surveillance, it is important for us to strengthen this function. And indeed, we are broadening the coverage of our surveillance:

· our consultations with members now routinely encompass financial sector issues, in collaboration with the World Bank and other agencies; and

· responding to the mandate given by the Interim Committee, we have begun to develop approaches that will promote the dissemination and application of standards and codes of good practice, among the entire membership.

All of this notwithstanding, we continue to update the technical assistance and training we offer to help countries build up their institutional capacity to manage their economies and to handle changes in their financial systems. And we continue to offer financial assistance to countries that have encountered balance of payments difficulties and are taking active steps to overcome the underlying causes of the imbalances. Business as usual, if I may say so.

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In spite of that, of course, occasionally crises will occur and, we need to be ready with measures to assist in their resolution. This requirement entails a delicate balance among the objectives of preserving countries' market access in normal times, ensuring equitable treatment of creditors if crisis strikes, and avoiding debtor and creditor moral hazard. All of that of course through market-based and market-friendly solutions. In particular, making sure, to start with, that measures intended to resolve crisis avoid the perverse effect of precipitating them.

The complexity of the issues arises because workable arrangements must consist not only of ex ante measures that are ready in case the threat from contagion develops. They should also offer mechanisms-or at least some principles-for resolving "extreme situations", where crisis has deepened to such an extent that normal payments can no longer be sustained.

Among ex ante measures and without further mentioning due attention to management of risk, I refer again to contingent financing arrangements from private lenders that could be an early recourse if crisis develops. This is one of the few ideas that can actually be said to be in place and workable, even if it is on a modest scale; three countries-Argentina, Indonesia, and Mexico-have concluded such arrangements. This deserves to be encouraged. But what when, as in a number of recent cases, it does not appear feasible to address the crisis by mobilizing new resources? Many questions arise then, including whether sovereign bonds should be included in comprehensive debt restructuring. We probably still have a lot to learn from the present case-by-case approach. But broadly speaking, bondholders must be viewed as a category of investors at par with others, needing to assess and price risk, and who, just like other creditors, cannot expect public funds from the international community to shield them from adverse outcomes. This being said, no debtor would wish to take default lightly, since, no matter how careful an approach is taken, debtors will perceive that their credibility has been most severely undermined and investors' confidence shaken. However, investors and debtors may have to accept that in extremis, a country may have no orderly way out of the crisis other than a comprehensive debt restructuring that includes bonds.

These issues again highlight the critical importance of debtors and creditors maintaining a dialogue that is established in good times, and is sufficiently robust to continue through periods of stress. Given the very large number of creditors that now typify many emerging market situations, one promising avenue is to introduce collective action clauses into new bond contracts. Rescheduling could then take place with the consent of a predetermined large majority of creditors rather than requiring unanimous consent as currently is the case in many contacts. This is an approach that may well require industrial country borrowers to lead the way, an issue that is currently under consideration.

And lastly, we must recognize that there may be a few instances in which, despite good faith efforts by countries to reach agreement with their creditors, agreement cannot be secured and default cannot be avoided. In such cases it will be important to keep proper working relations: debtors should seek to reestablish good faith negotiations with their creditors promptly, and both sides should be able to do so without finding that the process is blocked by a handful of dissident creditors. This has raised the questions whether and how the international community might introduce a temporary stay on legal action by creditors during the negotiations between a country and its creditors. One option-in the interest of both creditors and debtors-is to reach agreement on an interpretation or an amendment of the Fund's Articles of Agreement to allow it to declare such a stay. This suggestion has given rise to lively debate and consensus is not yet in sight, but I see it as an avenue worth pursuing, as-I repeat-both creditors and debtors have a distinct interest in an orderly process.

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I conclude this review of the framework for a mature relationship between creditors and debtors, by suggesting that we need to be prepared for exactly those extreme cases that such a mature relationship should make highly infrequent. This is precisely our objective in joining forces for crisis prevention. As a matter of fact, you may observe that I have covered a number of rather technical topics. I have not unveiled any kind of grand design, and my suggestions in this central field of the role of the private sector in strengthening the international financial architecture could be seen as quite down to earth. But let me view them for one last minute in the broader context we are striving to establish, which is an environment where:

· Governments should be convinced to pursue sounder macroeconomic, financial and structural policies;

· Central banks should be convinced to establish more appropriate exchange market arrangements;

· Prudential authorities should adapt their supervisory methods, rules and cooperation to the ever-evolving financial activities;

· All actors would be encouraged to accept the golden rule of transparency and the new sets of standards and codes of good practice currently being elaborated by various international bodies;

· All countries would move forward in an orderly but ambitious progress toward capital account liberalization.

Then one can see that, yes, a new architecture is patiently being established, a new framework is taking shape where your institutions and countries could deepen their cooperation in their mutual interest, in pursuit of a more stable, safer, and more prosperous world.