Issues in Reserves Adequacy and Management
October 15, 2001

Report of the Managing Director to the International Monetary and Financial Committee on The IMF in the Process of Change
April 25, 2001

See also:
Documents Related to the International Monetary and Financial Committtee Meeting of April 29, 2001

The IMF in the Process of Change
Statement by Horst Köhler Managing Director of the International Monetary Fund On the Occasion of the Spring Meeting of the International Monetary and Financial Committee

April 29, 2001

1.  Keeping the World Economy on Track

In Prague, the membership of the IMF underscored that globalization requires, more than ever, international cooperation. This is now even clearer in light of the interdependencies and spillovers revealed by the current slowdown in world economic activity. First and foremost, the Spring Meetings should boost confidence that the global economy will regain new momentum, by demonstrating the determination of members to act in a timely and appropriate manner.

The deceleration of the U.S. economy--which served as the engine of global economic growth during the past decade--is faster and deeper than expected some months ago. Other regions of the world have not taken up the slack. Declines in world equity markets and the financial difficulties faced by Argentina and Turkey heighten further the risks in the global outlook.

There is room to maneuver to keep these risks from materializing. The major industrial countries in particular must be proactive. The U.S. Federal Reserve has demonstrated its determination to resist a further weakening of growth prospects, and the tax cuts now under discussion should help to underpin economic activity in the United States. With inflation risks receding, an easing of monetary policy would also be helpful in most other industrial countries. While members should refrain from hectic fiscal policy action, automatic stabilizers should be permitted to work. Beyond that, there is a need to build confidence by demonstrating the resolve to press ahead with growth-oriented structural reform, particularly in Japan and Europe. Forceful action to open markets and liberalize trade would be of benefit to all members. Emerging market and developing countries, for their part, should stay the course of structural reform and sound macroeconomic policies.

2.  Strengthening Crisis Prevention

Following the Asian crisis, the IMF embarked on a process of reforms in many areas. The initiatives that have been taken--to enhance the availability of economic and financial data, to improve our analytical tools for assessing vulnerability, to strengthen domestic financial systems, to provide guidelines for debt and reserve management, and to develop and implement standards and codes--have already laid good foundations to make the international financial system more resilient. These initiatives should be implemented with ambition and strong commitment of the full membership of the IMF.

But it is also clear that the IMF needs to work even harder to put crisis prevention at the heart of its activities. In particular, we have to find ways to sharpen our analysis, reach concrete conclusions, and use these more effectively in the Fund's policy advice, as well as in underpinning members' political will and ability to take early and pre-emptive action. And in this context, the risks for the global financial system from possible imbalances in advanced economies need to be addressed with the same vigor as those posed by developments in emerging market economies. Highest on our agenda for the coming months should be further work on early warning systems. There is a need to combine quantitative indicators of vulnerability with judgment from the field and from the markets, and to bring this in a systematic manner to the attention of management and the Executive Board.

The economics profession in general, and the IMF in particular, needs to do a better job of keeping up with developments in international capital markets. The new International Capital Markets Department should enable the IMF to deepen its understanding of, and judgment on, capital market issues. And the informal but regular dialogue with high-level representatives of private financial institutions, through the Capital Markets Consultative Group, will further strengthen our work on crisis prevention and resolution. I also believe that such a systematic dialogue can help build a financial culture which is oriented toward sustainable value creation, and helps mobilize forces within the private sector that countervail "irrational exuberance." It is time to start a work process to review in a systematic way the experiences with bubbles and disruptive volatility and on this basis to contribute to forward-looking financial markets policy. My advice is to conduct this work in consultation with the private sector.

Good policies are still the best precaution that members can take against crises. We must therefore seek ways to encourage countries to be ambitious in the adoption of good policies in non-crisis situations. It is time to make the Contingent Credit Lines (CCL)--an instrument to resist contagion in international financial markets--operational. This should be understood as a reward for countries with a strong track record of sound policies and institutional arrangements.

The further liberalization of capital flows remains an important goal. However, progress in this regard has to draw on the experience gained in the past. That means, in my view, that capital account liberalization must be carefully sequenced, in terms of timing and degree, with the development of a sound domestic financial sector, including of adequate regulatory and monitoring frameworks. I have asked staff to work on this and to come up with a proposal for an operational concept, including practical suggestions on sequencing.

3.  Effective Tools for Crisis Management

A stronger focus on crisis prevention should help to reduce the frequency and severity of crises, as well as the need for more and bigger rescue packages. But no matter how much effort goes into crisis prevention, we must recognize that economic disruptions and crises cannot be ruled out in an open and dynamic global economy. The IMF has to play a central role in crisis management, which requires sound judgment, adequate financial resources, and instruments for this purpose. A basic operating principle is that IMF financing should not relieve debtors or creditors of their responsibility for the risks they take. And on this basis the membership, in Prague, adopted a framework for private sector involvement in the resolution of crises.

In my understanding this framework is based on the recognition that, in an open market economy with a predominance of private capital flows and private sector investment, it is appropriate to rely as much as possible on voluntary, market-oriented approaches. This is all the more true and advisable if a country itself wishes to base its adjustment efforts on this approach. And this also has guided and is guiding our actions in the cases of Argentina and Turkey.

But there is also agreement among the membership that there may be exceptional cases where a more concerted approach becomes unavoidable. The Fund is in a process of defining the circumstances and criteria for such cases. Careful analysis and judgment are needed on a number of complex issues--including how to better judge debt sustainability and the risk of contagion; the comparability of treatment between official and private creditors; the process by which countries rebuild confidence and regain access to capital markets after a crisis; and the specific role of the IMF in this.

4.  Focus on the Financial Sector

With the successful conclusion of the pilot phase for the Financial Sector Assessment Program (FSAP), the Fund--in cooperation with the World Bank--has taken an important step forward to strengthen fundamentals in domestic financial systems. We are now in the process of defining the continuation of this program for at least 24 additional countries in each of the coming two years. Furthermore, the Fund has actively engaged in the review of Offshore Financial Centers (OFCs); and, most recently, the Executive Board has agreed on an ambitious work program to enhance international efforts to counter money laundering. These three elements together form a comprehensive approach to strengthening the soundness of financial systems in member countries and, thereby, the international financial system as a whole. I consider these areas as a priority activity of a focused IMF and an important contribution to crisis prevention.

This approach will have its full benefit only if the elements are defined with the consent of the entire membership. Through working together in a cooperative manner, I trust that members will see that participation in these initiatives is in their interest, not least as a way to obtain sustained access to international capital markets. Recent developments have once again highlighted the need to focus the FSAP even more on systemically important countries. And I would like to underscore in particular how important it is that the major industrial countries lead by example, by participating in the FSAP and through their efforts to fight money laundering within their own borders.

5.  Conditionality and Ownership

Conditionality remains indispensable for safeguarding the Fund's resources by ensuring that they are used appropriately to promote adjustment. It is also clear that structural change is indispensable for sustained growth. But countries cannot do everything overnight. Thus, there is a need to decide on priorities, focusing the Fund's conditionality on those measures that are critical to the macroeconomic objectives of country programs. The aim of streamlining should be to leave member countries scope to make their own policy choices and thus develop the political support necessary for a sustained reform process, while tackling vigorously the main problems that have brought them to the IMF for financial support.

The process of reviewing conditionality in the Executive Board is moving forward constructively. We have agreed to proceed on the basis of interim guidelines, on a case-by-case basis, while keeping the issues that arise under careful scrutiny. We all agree that the objective is not to weaken conditionality, but to make it more efficient, effective, and focused. In the process, we will need to cooperate closely with other international organizations, and especially the World Bank. And we must also make greater efforts to help countries build the administrative capacity needed to safeguard the sustained implementation of structural reforms.

There is also broad agreement that the IMF must continue playing an active role in promoting good governance, both through initiatives that promote good governance across the membership--such as the work on standards and codes--and through specific measures to address particular instances of poor governance and corruption. In applying conditionality on governance issues, we will have to balance the need for decisive progress with the necessary respect for the sovereignty of member countries.

This is still a work in progress. The views of Ministers and Governors at the IMFC on the right balance among the various objectives will be a crucial contribution to this effort. The Executive Board will resume its consideration of conditionality after the Spring Meetings, on the basis of discussions at the IMFC, input received from outside the Fund, and a staff review of experience in applying the interim guidelines.

6.  Growth and Poverty Reduction

Jim Wolfensohn and I recently circulated a joint progress report on the efforts of the IMF and World Bank to assist our poorest member countries. These reflect our determination to work closely together, and with other institutions and donors, to ensure that globalization works for the benefit of all. It is clear that decisive progress in the fight against world poverty will be essential to safeguard world peace and stability in the 21st Century.

The Poverty Reduction and Growth Facility (PRGF) and the PRSP process were introduced to heighten the effectiveness of our assistance by ensuring strong country ownership of poverty reduction strategies. While the track record is short, the PRGF programs have already brought positive results, including better growth performance in a number of countries, as well as increased and better-targeted social expenditures. The PRSP process is increasingly welcomed by poor countries and the donor community, as a critical tool for developing and monitoring poverty reduction programs. At the same time, it is clear that this new tool is placing severe demands on the limited administrative capacities of low-income members. We are trying to be as flexible as possible on the time-frame for moving toward full PRSPs, to build on countries' existing consultative and planning mechanisms, and to encourage other international institutions and donors to harmonize their own procedures with this process.

In my discussions with authorities in poor countries, I have been encouraged by the growing sense of leadership and determination to address the home-grown causes of poverty. It is clear that an effective strategy to reduce poverty must start with and build on efforts by poor countries to improve governance and fight corruption, establish respect for the rule of law, end armed conflict, and provide a good climate for private investment. Based on that, the poor countries can and should ask for more decisive support from the international community--through debt relief, capacity-building, aid, and access to markets.

The IMF and World Bank have spearheaded an effort under the enhanced HIPC Initiative that has already brought debt relief to 22 countries in Africa and Latin America, and we are doing our utmost to see that it becomes available to the remaining eligible countries. In the process, we will heighten our efforts to address the special problems of post-conflict countries. But debt relief is not a panacea. Credit is an indispensable element for economic development, and that is why, in the longer run, it will be crucial for poor countries to win the trust of investors in their ability and willingness to repay what they borrow. This also underscores the need to make good use of the resources freed by debt relief.

The potential benefits from enhanced opportunities for trade and more adequate levels of aid are far greater than the savings from debt relief. Thus, a crucial test of the credibility--both for governments in the advanced countries and for civil society--in their support for reducing world poverty lies in the willingness to open markets to exports from poor countries and to live up to the promise to provide 0.7 percent of GNP in official development assistance.

The IMF can and should play a role--within its expertise and mandate--to contribute to the achievement of the UN development goals. We are actively cooperating with the UN in the preparation of the Financing For Development event in 2002.

7.  Capacity-building

Successful implementation of the initiatives now under way in the IMF will require increased support for capacity-building in member countries, because lack of implementation capacity is often a bigger constraint than lack of political will.

It is clear that the international community will need both to make increased resources available for this purpose, and to make sure that those resources are used in an efficient and well-coordinated manner. We are focusing and prioritizing the IMF's own technical assistance activities, to make most effective use of our limited resources, and strengthening our cooperation with the World Bank and donors. We are approaching member countries, and particularly the advanced countries, to provide expert resources and financing. These will need to play a crucial role, for instance, in the FSAP, in our work on standards and codes, in the strengthened approach to money laundering, in our assistance to post-conflict countries, and in our efforts to enhance implementation capacities in countries with PRGF programs.

8.  An Institution that Listens and Learns

I think it is crucial to develop further a culture of openness at the IMF. A lot has been done in publishing Fund documents, explaining Fund policies and enhancing the dialogue with the public. My personal experience is that listening to both political leaders and civil society in program countries helps us do a better job of understanding their problems and needs and designing programs to respond to them. And I am confident that the new Independent Evaluation Office (EVO), under the guidance of Mr. Montek Singh Ahluwalia, will help further to reinforce the learning culture at the Fund and enhance the transparency and accountability of our work. The Executive Board should be commended for the manner in which it has handled the selection process and the ultimate decision.