Public Information Notice: IMF Discusses Status Report on Crisis Prevention and Precautionary Arrangements
October 6, 2004
Review of Exceptional Access Policy
March 23, 2004
Adapting Precautionary Arrangements to Crisis Prevention
June 11, 2003
Review of Contingent Credit Lines
February 11, 2003
Sovereign Debt Structure for Crisis Prevention
July 2, 2004
Crisis Prevention and Precautionary Arrangements—Status Report
Prepared by the Policy Development and Review Department
In consultation with other Departments
September 3, 2004
1. The Board has discussed on a number of recent occasions the possible use of precautionary arrangements in capital account crisis prevention.1 While Directors have strongly supported the objective of promoting crisis prevention, fundamental differences of view exist on the means for doing so, in particular over the need for and desirability of a policy on exceptional access under precautionary arrangements.
2. This paper provides a status report and proposes directions for future work. It begins with an outline of the broader context of crisis prevention and Fund policies. It notes the broad consensus among Directors on the nature of the problem and the areas of agreement on existing Fund policies. It then summarizes the main arguments for and against a policy on exceptional access under precautionary arrangements to help prevent crises. The arguments are grounded in alternative interpretations of available evidence on crisis prevention, particularly pertaining to moral hazard, and the different points of view are in large part due to different weights put on the potential benefits and risks of such a policy. At the heart of these differences lie difficult empirical questions for which unambiguous evidence is limited and likely to remain elusive. Recognizing the lack of consensus among Executive Directors, the final section proposes directions for future work that would include assessments of alternative proposals for country insurance against capital account shocks.
3. The debate on a crisis prevention and Fund financing has been framed by three main stylized facts:
4. There is broad agreement on the Fund's objectives to help member countries in crisis prevention. First, the Fund should promote the early adoption by members of sound economic policies and strong regulatory regimes designed to reduce their vulnerability to sudden capital outflows. Second, the Fund should provide assurances both to its members and to market participants of its readiness to provide financial support, including above the normal access limits where warranted, in support of an appropriate policy response should a crisis occur.
5. There is also broad agreement on the importance of the wide range of measures that the Fund has taken to improve its surveillance tools for crisis prevention. Policy initiatives include (i) ongoing vulnerability assessments; (ii) the enhancement and dissemination of international data standards; (iii) more disciplined and transparent assessments of debt sustainability; (iv) further work on tools to better assess balance sheet weaknesses; (v) greater emphasis on financial sector surveillance including through the Financial Sector Assessment Program; and (vi) steps to improve surveillance in program countries.
6. Regarding the Fund's financial support, Directors recognize that the experience with regular precautionary arrangements (i.e., those within the normal access limits) has been very positive. The benefits to members include: (i) incentives to adopt better policies; (ii) a commitment device for policy discipline, which can help the member implement its economic program and improve the credibility of its policies; and (iii) an unambiguous Fund seal of approval, which can help catalyze other sources of financing.
7. Finally, Directors support strongly the Exceptional Access Framework. A key objective of this framework is to enhance the clarity and predictability for both members and markets of the Fund's response to capital account crises, while also strengthening the decision-making procedures for considering requests for exceptional access. At the review in April 2004, most Directors felt that the four exceptional access criteria remain appropriate, and the new procedures for decision making were working well.
8. Views differ on whether a policy on exceptional access under precautionary arrangements would strengthen further the Fund's crisis prevention efforts. A possible new policy would involve specifying when exceptional access could be used in a precautionary setting and could also include one or more of the following (which have been put forward in previous Board papers): (i) modifications to the structure of precautionary arrangements (e.g., more upfront phasing, more continuous availability of resources); (ii) a modification of the Supplemental Reserve Facility (SRF) to permit use of its resources when a member has only a potential balance of payments need; and (iii) a new name to distinguish the policy from regular precautionary arrangements.
9. One perspective is that existing Fund policies are adequate. This view emphasizes that the quality of a country's own economic policies is the most important factor in reducing vulnerability. The main arguments are:
10. The alternative perspective sees an important role for a new policy on exceptional access in precautionary arrangements. This view sees a gap in the Fund's tool-kit left by the expiration of the Contingent Credit Lines in late 2003. A new policy would help to fill this gap by enhancing the Fund's ability to meet its crisis prevention objectives in the following way:
11. Both perspectives recognize the risks associated with exceptional access in precautionary settings, but differ in their assessments of the importance of these risks as well as the benefits. In addition, those who favor a new policy point out that many of the risks discussed below also apply to existing Fund instruments. Some risks depend on how widely the new policy would be used, which in turn can be affected by the design of the policy. Risks include:
12. Underlying the differences in the assessments of the risks and benefits are difficult questions for which decisive empirical evidence does not yet exist and more experience is needed. These questions include: (i) does higher access to Fund resources affect the probability of a crisis, and does the impact depend on the country's circumstances and policies; (ii) how important is moral hazard, are the debtor or creditor channels more crucial, and how does a precautionary policy that involves exceptional access change moral hazard materially; and (iii) do access levels and Fund conditionality affect incentives to implement strong policies?
13. Several operational questions have some bearing on the assessment of the cost-benefit tradeoff of a high-access precautionary policy:
14. It is unlikely that the differences in Directors' views can be bridged with a detailed policy proposal at this stage. Many differences relate to fundamental issues pertaining to the role of the Fund, and difficult empirical questions balancing the benefits and risks associated with exceptional access. A convergence of views appears unlikely, at least until more information becomes available on the main tradeoffs, and more experience has been gained with existing policies. At that time, staff could return to work further on the outstanding operational issues noted above.
15. Existing Fund policies provide some support for crisis prevention. The Fund stands ready to provide rapid financial assistance to the extent possible to members should a capital account crisis occur. The exceptional access criteria are designed to provide clarity to both members and markets on the conditions for such assistance. The Fund's surveillance tools have enhanced our capacity to advise members on emerging vulnerabilities at an early stage. The Fund will continue its efforts to sharpen its surveillance so that, should a crisis occur, the transition from surveillance to a Fund arrangement is more predictable for the member and markets.
16. There seems to be sufficient interest among Directors to continue the exploration of financing mechanisms to help prevent crises. Looking ahead, if Directors agree, staff could step back and consider the feasibility and tradeoffs of possible alternative approaches to providing country insurance against capital account shocks. Existing research in these areas remains somewhat preliminary, making it difficult to gauge their operational potential at this stage. However, staff could, for example, assess the pros and cons of reserve pooling arrangement proposals, under which members could voluntarily pool some of their existing reserves for use by the participating member countries in the event of a capital account crisis. Use of these resources could be linked, formally or informally, to a Fund monitoring mechanism or the use of Fund resources. Staff could also examine the feasibility and the costs and benefits of the development of markets for new contingent instruments to help countries hedge macroeconomic risk.4 Another possible direction is to examine the extent to which the design of Fund facilities encourages country insurance, or the adoption of prudent macroeconomic policies more generally, including outside the framework of a Fund program.5
1See "Review of Contingent Credit Lines" (SM/03/64, 2/12/03), and "The Acting Chair's Summing Up on the Review of Contingent Credit Lines" (BUFF/03/38, 3/20/03); "Adapting Precautionary Arrangements to Crisis Prevention" (SM/03/207, 6/11/03), and "The Acting Chair's Summing Up on Adapting Precautionary Arrangements to Crisis Prevention" (BUFF/03/112, 7/9/03); "Completion of the Review of the Contingent Credit Lines and Consideration of Some Possible Alternatives" (SM/03/372, 11/12/03); and the "Review of Exceptional Access Policy" (SM/04/99, 3/23/04). There were also informal Board seminars on the Contingent Credit Lines on November 19, 2003 and on precautionary arrangements on July 19, 2004. Finally, a precautionary arrangement involving exceptional access was discussed in conjunction with the "Fifth Review of Brazil's Stand-By Arrangement" (EBS/03/157, 11/24/03).
2At the review of the Exceptional Access Policy in April 2004, Executive Directors "acknowledged that in rare circumstances a need for exceptional access could arise in situations other than a capital account crisis, and that in those cases a member could not be expected to meet all four criteria. Directors took note of the flexibility to grant access under the exceptional circumstances clause". See "Summing Up by the Acting Chair on the Review of Exceptional Access Policy" (BUFF/04/81, 4/23/04).
3Under current policies, the SRF can only be used in support of an actual balance of payments need stemming from pressures on the capital account.
4Some proposals were recently discussed in a Board seminar (see "Sovereign Debt Structure for Crisis Prevention," SM/04/140; 4/20/2004).
5One recent paper in this area is "Country Insurance", by Cordella and Levy Yeati (WP/04/148).