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Statement by Mr. Hans Eichel, Federal Minister of Finance,
Federal Republic of Germany,
to the Interim Committee Meeting on September 26, 1999

Washington, D.C.
September 26, 1999

Mature Market Economies: Adjustment Towards Better Balanced Growth

1. The situation and prospects of the world economy are clearly more favourable now than they were at our meeting five months ago.

  • The U.S. economy continues to make a vigorous contribution to world economic growth, though this will tapering off next year.
  • In the Euro zone economic activity is picking up.
  • In Japan there are encouraging signs of economic revitalisation.
  • The Asian countries, hardest hit by the crises in 1997/1998, are recovering more rapidly than expected.

2. This basic constellation - a somewhat less buoyant U.S. economy, accompanied by recovery in Europe and Japan - warrants some degree of optimism with regard to the elimination of the external imbalances that have become more acute in the past few years. But there are also risks, and monetary, budgetary and economic policies will continue to face major challenges. The avoidance of an abrupt slump in growth in the United States is of crucial importance both for the United States in particular and for the world economy in general. This will continue to require a highly vigilant and perceptive approach in monetary policy in order to prevent overhasty reactions in the markets. But Europe and Japan are also called upon to contribute towards better balanced growth in the world economy.

3. I share the view of the IMF that the Euro zone has not yet fully exploited its growth potential. We must continue to steer the course of fiscal consolidating in accordance with the provisions of the Stability and Growth Pact if we are to establish a firm foundation for growth, regain scope for fiscal policy and provide incentives to increase private-sector investment.

4. The savings and tax reform package launched by the German government is in line with these requirements. It provides for total savings of some DM 30 billion in the federal budget for 2000. The medium-term financial plan envisages an increase in savings of up to DM 50 billion in the year 2003. We expect to be able to bring down the government deficit to 1 % of GDP as early as 2001. Additionally, the package contains key measures to reform the individual and corporate income taxation, some of which have already been put into effect. There are plans to simplify the law on corporate income taxation substantially as from 2001 onwards in connection with a major cut in the rates of tax on investment yields. This will result in additional net relief of DM 8 billion for corporations.

5. A further aim is to make use of the mechanisms to promote growth and employment recently brought together in the European Employment Pact. Structural reforms in product, services and capital markets, an active labour market and qualification policy and a regular macroeconomic dialogue involving all the key players in the economic process will help to further revitalise growth and to bring down high unemployment without endangering price stability.

Emerging Market Economies: Prospects, Risks and Policy Requirements

6. A general improvement in the economic situation - in some instances even a marked improvement - can be noted in the emerging market economies. However, there remain substantial downward risks in Latin America. A resolute reduction of fiscal deficits that are not sustainable in the long run would send an important signal to the international capital markets. Many weaknesses in the banking sector and high current account deficits also point to the need for further structural reform. The Asian countries most severely hit by the crises in 1997/1998 are now clearly on course for recovery, and the IMF expects most of them to register positive and in some instances high growth rates.

7. But further efforts must be undertaken to secure the recovery. These efforts must focus on restructuring the banking and corporate sectors. International standards of financial market supervision must be resolutely applied and the plans drawn up for financial sector reform must be implemented. It will be important to ensure adequate burden-sharing between the private and public sectors, to maintain the pressure for reform and to limit the burden on public budgets. Further efforts are also required to restructure the corporate sector, which is making only relatively slow progress. As the most recent experience in these countries has shown, inadequate progress in this sector can also impede the consolidation of the financial sector.

Policy Challenges at Low Inflation

8. In its World Economic Outlook, the IMF poses the question of whether macroeconomic instabilities have increased despite the economic improvements which were achieved in the nineties. Here, the most recent currency crises in major emerging market economies are referred to as one example. This issue calls, however, for a differentiated approach, and care must be taken not to draw the wrong conclusions. The progress achieved in countering inflation in the United States and Europe were of great benefit for both regions as well as for the world economy. It has helped to ensure that exchange rate fluctuations have been much less severe than in the eighties and now tend to better reflect differentials in the development of the real economy.

9. The nineties also brought a marked improvement in the macroeconomic situation of the emerging market economies and developing countries. On the issue of instabilities, however, allowance must be made for the fact that it was only in the present decade that these countries gained extensive access to the international capital markets. We now know that it was in many instances the financial sector that proved to be the weak spot in this process. Our efforts to reform the international financial architecture build on this experience. With further progress in economic development and with further efforts towards macroeconomic stabilisation and structural reforms, these countries too will become less vulnerable to shocks.

10. In concluding my comments on this issue, I would like to reflect briefly on the role of monetary policy in an environment of high asset prices which are currently to be noted in major equity markets. There is certainly a need for central banks to take account of trends in asset prices, in addition to the analysis of other relevant indicators, in taking their monetary policy decisions. However, gearing monetary policy to trends in asset prices gives rise to considerable theoretical and practical problems, for example:

  • Central banks are likely to encounter the same problem as others in reliably assessing whether asset prices or asset price changes are reasonable.

  • It is difficult to gauge the direct influence of monetary policy on asset price movements. In general, declining or low interest rates favour price rises in the equity market. But proving a precise link between liquidity supply and asset prices is likely to be virtually impossible.

11. These unsettled issues are one argument against including asset prices in the catalogue of monetary policy targets. Monetary policy should continue to be geared towards a stable price level for goods and services.

12. However, asset prices may well have a part to play in monetary policy. Where there is a comparatively broad spread of shareholdings (as for instance in the United States), asset effects may well have a part to play in determining demand and hence the general price level. In countries such as Germany where there are appreciably fewer equity holders such effects are likely to be negligible.

13. In taking stock, I would say that there has been a marked improvement in the conditions underlying global economy, although there are still risks. The recovery process now taking shape must be secured by further stabilisation and structural reform efforts. This is a task in which we are all called to play our part.

Involving the Private Sector in Forestalling and Resolving Financial Crises

14. Recent experience confirm the need to set up a framework for involving the private sector. This is needed both to identify coherent solutions and to provide private investors and banks with a clearly-defined framework to which they can become accustomed at an early stage as a means of crisis prevention. A framework of this kind should in particular be geared to the following "rules of the game":

  • Fair burden-sharing between the public and the private sector should be ensured in the provision of funds. A bail-out of private creditors by official financing must be excluded.

  • The country in crisis should have some flexibility in procuring the necessary financing from the private sector (for instance either by new financing or by restructuring).

  • It is important that the principle of equality of treatment or the principle that all public and private debt should be given comparable treatment should be acknowledged. No individual categories of debt should be inherently privileged. The integrity of the Paris Club guidelines on private-sector involvement in debt rescheduling must be guaranteed.

  • Moreover, in connection with an IMF-supported adjustment programme, an external financing plan ensuring sustainability over the medium term should be submitted. Public creditors would be prepared to close the financing gap on the condition that external private sector creditors are appropriately involved. At the same time, such a financing plan would ensure that the terms on which the private sector is to be involved are consistent with medium-term sustainability.

  • Debtors and creditors should work cooperatively to find a solution to the country's debt problems. In this context, the idea put forward by the IMF for setting up creditor committees to be convened in the event of a crisis that could negotiate debt restructuring with the aid of an intermediary is to be welcomed. Such committees could become an effective instrument.

15. Within this framework, the IMF has a central part to play. But it is evident that the IMF, given its catalytic role, can cover only part of a country's financing needs. At the same time, the IMF should not get into the business of micro-managing negotiations between a country and its private sector creditors. In contrast, the role of the IMF should be to set up a general, medium-term framework, i.e. an external financing plan which is consistent with medium-term sustainability and which incorporates appropriate burden-sharing between the public and the private sector. This framework would then have to be filled out case-by-case by the countries concerned. The IMF would make its disbursements conditional upon satisfactory progress of the negotiations of the country in crisis with its private creditors.

16. On the issue of involving the private sector, allowance should also be made for extreme cases of protracted negotiations between a country and its private creditors, i.e. for cases where concrete results are not in sight or where agreement between creditors and debtors on rescheduling or new financing cannot be reached or cannot be reached on sustainable terms. In such cases, suspension of payments or lending into arrears should be envisaged. The recently modified IMF policy of lending into arrears provides the appropriate framework to disburse IMF loans despite existing arrears to the private sector and thus to financially involve the private sector. This also enhances the negotiating strength of the crisis country vis--vis its influential private creditors.

17. There are many details that need to be settled still before such a framework can be introduced, but we should aim at developing an appropriate framework by the next Spring Meeting.

18. Regrettably, there has been little progress to date on the question of modifying government bond contracts incorporating provisions applicable in the event of crisis. The voluntary introduction of collective action clauses (CACs) could be an effective tool in helping to achieve cooperative solutions in international financial crises. Emerging market economies cannot be expected to introduce CACs in their own government bonds unless the major industrial countries are prepared to take the lead. Germany is prepared to work towards achieving progress on this issue in close collaboration with other industrial countries.

Exchange Rate Regime

19. Given the growing role of international financial markets, selecting the appropriate exchange rate regime is of crucial importance for ensuring a country's lasting economic and financial stability. The experience of the past two years has shown that holding on to inappropriate exchange rates can have severe consequences.

20. In selecting the exchange rate regime, there is no patent solution for all countries in all circumstances. But three generally valid observations may be made:

  • A flexible exchange rate regime will, in all likelihood, be more appropriate for emerging market economies the more closely they are integrated in global trade and financial markets.

  • The choice of a "hard" exchange rate link (i.e. currency boards or dollarisation) can serve as an alternative. But in this case, the country must consistently subordinate its economic policy, in particular its monetary policy, to its exchange rate link and must provide for a sound institutional and legal framework.

  • Fixed exchange rate regimes, in particular as a nominal anchor to combat inflation, can also be useful in developing and transition countries with a lesser degree of global integration.

21. In all instances the choice of the exchange rate regime must be underpinned by sound, credible economic and fiscal policies and institutionally backed if it is to inspire market confidence over the long term. At the same time, the regime must be constantly monitored to check whether it is appropriate. In the framework of its economic policy consultations and Fund programmes, the IMF should state clearly which exchange rate regime it recommends for a specific country.

22. But the responsibility for selecting an appropriate exchange rate regime will always lie with the country itself. The international community, however, should as a rule refrain from making available extensive public funds to a country undertaking massive interventions to defend certain exchange rate levels against market trends.

23. Credits provided by the Fund are warranted only if the respective country's exchange rate policy is considered sustainable in the long run. Moreover, a country will at the same time have to meet certain requirements, such as a strong, credible commitment to the exchange rate policy, including supporting institutional arrangements, and a consistent domestic economic policy.

Orderly Liberalisation of Capital Movements

24. The free movement of capital is essential for an optimal allocation of resources. Empirical evidence shows that capital movements foster growth and increase income. But most recent experience in emerging market economies also demonstrates the importance of an orderly and appropriately sequenced liberalisation of capital movements. In this context, the IMF is in the unique position to assist countries with the well-sequenced and balanced liberalisation of their capital accounts. We should proceed with the discussion on the amendment of the IMF Articles so as to give the IMF a well-defined legal role in the liberalisation of capital movements.

Institutional Reform and Strengthening and/or Transforming the Interim Committee

25. Germany can agree to the resolution on the transformation of the Interim Committee into the International Monetary and Financial Committee. In the meantime, our deputies have come together twice to prepare our meetings. This practice has proved valuable and should be continued. I am also pleased to note that the President of the World Bank will have a privileged role in the Committee and that the Chairman of the Financial Stability Forum has been granted observer status. Joint meetings of the Interim and the Development Committee, such as today's on HIPC issues, are a good idea. We should in future continue to make use of the opportunity for joint meetings where issues of special importance and overlapping responsibilities are to be addressed. All in all, I expect these measures to result in a substantial strengthening of the work of this Committee.

Y2K Contingency Planning

26. The IMF has promptly acted in setting up a special facility to cope with the Y2K problem. This provides the IMF with an instrument to assist individual countries in overcoming Y2K related difficulties they may encounter. The higher interest rate and the short credit period of this facility are in line with its objective. Nonetheless, all countries should continue to make intensive and credible preparations for the turn of the millennium to ensure that it presents no problems for the world economy. Such precautions will also exert a steadying effect on financial markets.

Reforming ESAF

27. Debt relief can be only the first step in initiating a comprehensive, ongoing process of reform designed to bring about an appreciable reduction in poverty. Also, a stable macroeconomic environment, good governance and social stability are essential prerequisites for sustained growth that will enhance per capita income and promote the fight against poverty in heavily indebted poor countries. Against this background we support the approach that debt relief resulting from the HIPC initiative should be incorporated in a comprehensive strategy to alleviate poverty.

28. One first step will have to be to determine the essential outcome indicators, to define the principal causes of poverty in the specific country and to set priorities to ensure that the resources made available do in fact benefit the poorest among the population. In this context, we also endorse the proposal to combine the separate elements of a programme to combat poverty in a "Poverty Reduction Strategy Paper (PRSP)" in which the government of the beneficiary country, the World Bank and the IMF agree on the anti-poverty strategy and which provides the basis for lending by the IMF, the World Bank and other donors. The PRSP should prove the "ownership" of reform measures and list plausible steps in countering poverty.

29. In formulating its programme policy, however, the IMF should concentrate on its core mandate of balance-of-payments assistance and macroeconomic stabilisation. This is an area in which it is competent and has an impressive record of achievements. The IMF should not strive to compete with the World Bank in the programme-relevant areas of social policy and poverty eradication but should rely on the World Bank's expertise.

Securing IMF Financing for ESAF and the HIPC initiative

30. I am pleased to note the progress made in financing the IMF contribution. The currently envisaged truly one-time market-neutral mobilisation of a limited proportion of IMF gold and the provision of additional bilateral funds have brought us close to solving the problems of financing the IMF contribution to the ESAF and HIPC Initiative. The technical details will have to be discussed by the Executive Board. Germany will make a substantial contribution towards the bilateral financing. We will extend to the IMF an interest-free credit with a grant element equal to the German SCA-2 share. It is now important to reach a final agreement as soon as possible based on adequate burden-sharing. It must also be ensured that the ESAF financing continues to remain separate from regular IMF resources.

Integrating Social Sector Issues in Fund Policy Advice and Fund-Supported Programs

31. The initiatives to achieve a more intensive analysis of the social dimension in IMF programmes are to be welcomed. Improving the social situation, in particular the extension of social security systems and the promotion of health care and education, are crucial prerequisites for sustained economic development and thus for economic and political stability.

32. But here, too, the IMF should concentrate on its monetary mandate and should not strive to compete with the World Bank. The IMF should rely on the World Bank's expertise in promoting social reform and setting up social safety nets. Here also a coordinated approach by both institutions is necessary.

33. Economic growth without a human face cannot achieve sustained development and overcome poverty. In the same way, the efforts of the World Bank and the IMF as well as the bilateral and other multilateral donors will fail unless they are backed by vigorous efforts on the part of the program countries themselves. This includes creating a political and economic environment within the country which motivates individuals and allows them to use their skills productively. In this context, encouraging transparency and good governance is indispensable in securing the effective deployment of bilateral and multilateral assistance. Analysis has shown that explicit inclusion of social reforms has enabled particularly ESAF and HIPC countries to make encouraging progress in improving the social indicators.

Standards and Transparency Initiatives

34. Considerable progress has been made in developing new codes of conduct and standards and in adapting those already in place. I should like to thank the IMF for developing the Code of Good Practices on Transparency in Monetary and Financial Policies. This standard can be of considerable assistance in enhancing the credibility of central banks and financial market supervisory bodies.

35. The Report on Strengthening the Architecture of the International Financial System shows that we now have to focus on the implementation of standards. Close cooperation with other standard-setting institutions will be required for standards that are not within the IMF's competence. The IMF as the central institution for international financial and monetary issues should, however, take the leading part in accordance with its surveillance function while each of the institutions involved should also assume responsibility for its area of competence.

36. The IMF transparency report should play an important role in connection with monitoring compliance with standards and codes of conduct. I would endorse the proposal by the IMF for these reports to be progressively integrated into the Article IV consultation procedure.

37. A series of measures have been adopted to enhance the Fund's information policy and the transparency of its own operations. In this context, the release of staff reports for Article IV consultations is of special significance. We shall carefully evaluate the experience with this pilot-project.

Financial Sector Reform

38. I welcome the strengthened cooperation between the IMF and the World Bank on the issue of financial sector reform, and I hope that the Financial Sector Assessment Program (FSAP) of both institutions will soon enter the operational phase. The programme will enable an intensive dialogue to be conducted with member countries within the framework of Article IV consultations concerning the stability and soundness of the financial sector. The crises of the past few years have highlighted the central significance of this sector.

39. The Basle Committee has developed a new scheme for assessing compliance with the core principles for effective banking supervision. I hope that the IMF will be able to submit its comments as soon as possible.

40. I also welcome the intention of the IMF to present a paper concerning the operations of offshore financial centres and offshore banking soon. In this connection, it will be important to cooperate closely with the Financial Stability Forum, which is also dealing with this issue.