The IMF and the Private Sector
The IMF is examining the important and complex issues associated with involving the private sector in forestalling and resolving financial crises. By involving private creditors and private enterprises in crisis-fighting, the international community aims to limit both moral hazard (the perception that international rescues encourage risky investments) and a "rush for the exits" by private investors during a crisis.
Involvement of the private sector in the resolution of financial crises is appropriate in order to have the burden of crisis resolution shared equitably with the official sector, strengthen market discipline, and, in the process, increase the efficiency of international capital markets and the ability of emerging market borrowers to protect themselves against volatility and contagion. An additional goal is avoiding moral hazard—the encouraging of imprudent or unsustainable behavior by creditors or debtors that can increase the potential magnitude and frequency of future crises.
Since the Asian crisis, the IMF Executive Board has met several times to discuss guiding principles and concrete options to involve the private sector in forestalling and resolving international financial crises. The IMF Interim Committee has followed this issue and in September 1999, reiterated the importance of ongoing efforts to involve the private sector in forestalling and resolving financial crises.
Prevention—First Line of Defense Against Financial Crises
Adoption of consistent macroeconomic and exchange rate policies, sound debt management, and prudential supervision of financial systems are critical elements of a policy framework designed to prevent and mitigate the severity of crises. In addition, policies designed to improve the environment for private sector decision-making can also be expected to contribute to reducing buildups of vulnerability. Improvements in the transparency of both the public and private sectors, as well as efforts to promote the adoption of and adherence to standards, should facilitate risk management on the part of investors. It is also important for country authorities to maintain regular contacts with private market participants, to ensure the regular provision of information on economic developments and policies, and to maintain lines of communication both in good times and when possible difficulties in the country's economic situation begin to emerge.
Experience with Securing Private Sector Involvement
Experience has been gained from recent efforts to secure private sector involvement in the resolution of crises. Agreements for the maintenance of exposure on short-term bank credit have been achieved both voluntarily and through the application of moral suasion by central monetary authorities. In addition, international sovereign bonds have been restructured through voluntary debt exchanges.
Progress Toward Framework for Private Sector Involvement
Based on practical experience gained in involving the private sector in specific country cases, and drawing upon the principles articulated by the G-7 Finance Ministers in their report to the Cologne Economic Summit, progress has been made toward a framework which could help guide decisions on issues associated with private sector involvement in the resolution of financial crises.
The framework under discussion is based on broad consensus that has emerged among IMF member countries on the need to seek private sector involvement in the resolution of crises, while providing for flexibility in the form of involvement and in the methods used to ensure it. Under the framework, private sector involvement in the resolution of a financial crisis can, in some cases, be achieved primarily on the basis of the Fund's traditional catalytic role in restoring spontaneous private capital inflows. In cases where greater assurance is needed, the catalytic role of the Fund would have to be supplemented by measures to improve coordination among creditors and efforts to seek concerted private sector involvement.
In adopting the appropriate approach and means to secure private sector involvement in individual cases, however, a range of issues, requiring considerable judgment, need to be addressed. These include estimating the size of the financing requirements, the prospects for a spontaneous return to capital market access, the availability of tools for securing appropriate private sector involvement, the impact on the country's future cost of borrowing, and the possible impact of spillover effects on other countries.
Principles Guiding the Fund's Approach
Basic principles guiding the Fund's approach toward private sector involvement include allowing the Fund to support effective balance of payments adjustment programs that will lead to growth and medium-term viability, while providing adequate safeguards to maintain the revolving character of Fund resources. In addition, it is important that the availability of official financing, including from the Fund, insofar as possible, not create moral hazard by providing incentives for inappropriate lending or borrowing. Further, an operational framework for private sector involvement should allow contracts to be honored to the extent possible, provide for cooperating solutions to emerging debt difficulties, and provide for an approach that reflects a member's specific circumstances.
Choice Between the Fund's Catalytic Role and More Concerted Form of Private Sector Involvement
Under the framework discussed, private sector involvement could be ensured primarily through reliance on the Fund's traditional catalytic role if the member's financing requirements are moderate, or even if the financing requirements are large, but the member has good prospects of rapidly regaining market access on appropriate terms. More concerted forms of private sector involvement could be required if the financing requirement is large and the member has poor prospects of regaining market access in the near future, or if the member has a debt burden that appears unsustainable in the medium term.
The proposed framework raises a number of complex analytic issues. Further work is underway to make this framework operational.