Speech

Address by Mr. Alassane D. Ouattara
Deputy Managing Director of the International Monetary Fund
to the CERAM Sophia Antipolis
Nice, France, January 22, 1999

Mr. Chairman,
Mr. Director,
Ladies and Gentlemen:

It is an honor and a great pleasure for me to have the opportunity to address such an illustrious audience in an institution of the renown of the CERAM. I would like to thank Mr. Perrin and Mr. Bouchet for having extended this invitation to me, as well as the staff of the CERAM for their excellent organization of this event. I have chosen as my theme today "Globalization and the Third Millennium: Challenges and Issues," a topic of great interest to all policy makers, public and private. No doubt you would agree with me that a difficult year for many countries-- particularly many emerging market economies--has just ended. In its wake, a new year, and the promise of something better, has begun. The euro has just made a smooth debut. I salute this remarkable achievement. The outlook for the Asian countries touched by crisis is brighter. The chances of a world recession are much smaller, although the situation remains quite fragile.

It is traditional at this time of year to take stock of what we have just left behind and where we are headed. Taking stock is something we constantly do at the IMF, trying to learn from both the successes and failures. But this is a particularly fitting time to do so, given the unprecedented events of the past two years, and the challenges that await us as we near the dawn of the third millennium.

Where does the global economy stand? What lessons can we learn from the Asian crisis? What is the international community--and the IMF in particular--doing to ensure a more stable and better functioning international monetary system? These are the three questions that I would like to address today.

World economic outlook

So what is the latest outlook for the world economy? It is with much relief that we can now say that the worst of the crisis that began in Asia in mid-1997 is probably behind us--although we are clearly still not out of the woods. There are a number of reasons for the improving picture:

• First, the Asian countries that were struck by crisis have persevered with the stabilization and reform programs agreed with the Fund, paving the way for a recovery of growth. This is true especially of Korea and Thailand, where growth is expected to resume this year. The Indonesian economy should at least bottom out during this year.

• Second, most industrial countries have moved swiftly to ease interest rates, recognizing that the balance of global risks has shifted away from concern about inflation, which is now under control, to a need for them to support growth. In Europe, this has meant rates converging toward the lower levels prevailing in the core countries, reducing the average for the area as a whole.

• Third, Japan has adopted new policy measures to stimulate domestic demand and tackle banking system problems. Vigorous implementation of these measures--and possibly other reinforcing ones--will be critical, as a reinvigorated Japan holds the key to recovery elsewhere in Asia.

• Fourth, most countries have resisted the temptation to adopt protectionist and other market-closing measures, even in the face of competitiveness pressures and financial strains.

• Fifth, the international community has taken several steps to ensure that sufficient resources are at hand to assist countries in crisis. The way is now clear for the IMF's quota increase and the activation of the New Arrangements to Borrow. Japan, through the "Miyazawa Initiative," has promised financial support to Asian countries in crisis. And the Group of Seven has proposed enhanced financial facilities at the IMF and World Bank to help ward off financial market contagion.

As a result of all of these developments, the IMF is looking for growth of around 2.25 percent a year in both 1998 and 1999. I would like to point out, however, that this forecast was made at end-1998 and therefore does not take into account the latest financial turmoil in Brazil. This level is well below the strong growth of previous years, to be sure. But with the continued pursuit of sound policies, and with a little luck, growth of about 3.5 percent should not be out of reach in the first year of the new millennium.

I say with a little luck because, obviously, important uncertainties and risks of recession remain:

• There is considerable uncertainty about the extent and speed of recovery of private capital flows to the emerging markets, which have been running at extremely low levels since August 1998.

• There is considerable uncertainty about the extent and speed of recovery in Japan, owing to questions about the adequacy and implementation of recent initiatives adopted to turn the economy around.

• There is considerable uncertainty about the very uneven pattern of trade adjustment that has been taking place in the wake of the large shifts toward surpluses in the Asian crisis economies. The United States has been assuming by far the bulk of this adjustment, a welcome contribution to easing tensions elsewhere. But if the very large U.S. current account deficit continues, it could bring with it destabilizing movements in exchange rates among the dollar, yen, and euro.

• There is also considerable uncertainty about whether these large trade adjustments will unleash a resurgence of protectionist pressures.

• And there is considerable uncertainty about the sustainability of the recent stock market rebound--especially in the United States, where the private sector saving rate has deteriorated sharply.

The bottom line is that if these areas of uncertainty give way to disappointment, even on a relatively moderate scale, world growth could be less than the 2.25 percent predicted for this year. The outcome, as always, will hinge crucially on policies.

Here there is no single recipe. The policy needs will vary among countries, depending on priorities and economic circumstances. Even so, a few generalizations can be made. In recent months, there has been a widespread easing of monetary policies, and appropriately so. This means that in a large part of the world, macroeconomic policies--or at least monetary policy--have been helping to stimulate economic activity.

But there are two main exceptions to the scope for expansionary policies. First, North America and Western Europe already face significant debt loads and aging populations. Thus, it would not be advisable for these economies to loosen up fiscal policy any more so than is automatically happening as slower growth brings lower tax revenues and higher social outlays. Second, some emerging market economies must continue to implement relatively tight macroeconomic policies to tackle unsustainable fiscal or external imbalances, if they hope to regain investors' confidence and adjust to adverse developments in financial and commodity markets. This is clearly also true for Brazil.

How can the euro area contribute to recovery? A successful economic and monetary union (EMU) holds great promise for the world economy. It will bring a broader and deeper European capital market, offering new opportunities to savers and borrowers the world over. It should facilitate European growth, and all that entails for the world economy. It also offers new scope for global cooperation--and the IMF looks forward to playing a full part in this process.

But challenges remain to be addressed if EMU is to realize its full promise. In the fiscal area, the task of bringing budgets into balance or small surplus is not yet complete. But it is in improving the working of labor and product markets, reforming public spending programs, and lightening the burden of taxation that the progress now needs to be made. These are the key to realizing Europe's full potential for lasting job creation and growth. And on a lighter note, I might point out the ongoing debate over which cartoon character should symbolize the New Europe--Captain Euro and Tintin right now being the top two contenders. And the debate over the name for the euro area: "Euroland", "Eurolande," or "Euro Zone." Don't worry, the IMF will steer clear of these issues!

Lessons from Asia

Let me turn now to the lessons of the Asian crisis, both for the countries concerned, and for the international monetary system as a whole.

The events that consumed Thailand, Korea, and Indonesia did not emanate from profligate government policies. Rather, they originated in latent cronyism and financial sector weakness, which led to a capital crisis sparked by massive outflows of funds from these countries. These three countries were particularly vulnerable to a change in investor sentiment because of their very large short-term debt exposures.

There has been no shortage of controversy on how to deal with confidence crises. We have debated the issues within the IMF as part of our established review process, and we have recently completed an internal review of our handling of the crisis. The report--which is candid--and the Executive Board's views on the report have just been released, in the hopes of contributing to the public debate on the handling of the crisis and how to forestall new crises. It is very much a preliminary assessment at this still early stage, but a number of broad themes seem reasonably clear.

Was monetary policy held too tight in Indonesia, Korea and Thailand? Did these countries really need to jack up their interest rates to contain the decline of their currencies? Several critics of the IMF would have preferred a different approach--one that would have allowed these currencies to depreciate much further than they did. But the report concludes that this would have set in motion a more damaging cycle of devaluation, inflation, and recession. Moreover, in none of the countries concerned does the evidence indicate that the monetary policy applied was the main reason for the economic downturn.

As it turned out, the Thai baht and Korean won began to strengthen as the tight monetary policy took hold--these currencies have now recovered over half of the initial sharp depreciation--enabling interest rates to retreat to below pre-crisis levels. It is our firm belief that, faced with a crisis of confidence--one that brings currency collapse and threatens to carry rapidly accelerating inflation in its wake--a government has little choice but to take tough monetary action. Indeed, Indonesia's highly expansionary monetary policy in early 1998 contributed to market turmoil and enabled inflation to take off.

How about fiscal policy? In this area, the programs underwent significant changes as it became clear that the countries were sliding into a deep recession. Initially, a degree of fiscal adjustment--more so in Thailand than in Korea and Indonesia--was envisaged to support external adjustment and make room for the cost of financial sector restructuring. If the programs had stuck to the initial fiscal targets as the outlook worsened, fiscal policy would have become very contractionary. But we changed the targets. Beginning in 1998, fiscal policy became increasingly oriented toward supporting economic activity. Increased spending on social safety nets to mitigate the effects of the crisis on the poorest segments of society also became an important goal. In the end, the programs allowed for substantial increases in fiscal deficits.

As for structural policies, the Asian adjustment programs broke new ground. Structural weakness was at the root of the crisis, and reform in these areas was central--ranging from restructuring insolvent financial institutions, to promoting competition in the domestic economy, to improving governance and transparency, to modernizing the legal and regulatory framework, to strengthening social safety nets. In all of these areas, we worked closely with the World Bank and the Asian Development Bank.

Was this reform agenda too ambitious? Did the programs try to do too much too fast? The report outlines four key lessons:

• First, structural reforms were central to the programs. Failure to address the underlying structural weaknesses and lay the basis for a return to sustained growth would have undermined the myriad efforts to restore confidence. Nevertheless, concerns that the programs were overloaded with structural measures cannot entirely be dismissed, and we will have to take a close look at the appropriate pace and sequencing of such reforms.

• Second, it would be useful for the IMF, together with the World Bank, to elaborate policies of financial crisis management and restructuring. This would include issues such as the coverage of government guarantees during a banking crisis.

• Third, one needs to recognize that financial and corporate restructuring go hand in hand. Thus, efforts to deal with problems in the corporate sector--including measures to facilitate corporate debt work-outs and bankruptcy procedures--should not be delayed.

• Fourth, high priority needs to be given at a very early stage of a program to the necessary changes in the institutional and legal framework. Such changes are critical for the success of structural reforms, and they frequently take considerable time.

Plans for the 21st century

Ladies and Gentlemen, anticipating crises better and moderating their contagion in a highly integrated world economy will also be crucial to a better world economy in the coming century.

The cracks that were exposed so brutally in Asia were, indeed, not entirely home grown. Looking ahead, into the next century and the challenges that await us, the financial crises in Asia and more recently in Russia and Brazil have driven home the need for rethinking the very architecture of the international monetary system. For they revealed weaknesses not only in the financial systems of emerging market economies but also raised questions about some features of financial systems in the advanced economies--as reflected in the severe liquidity problems and extreme price movements in the financial markets of the industrial countries in the fall of 1998.

We need to modernize the system to catch up with the breathtaking developments in international capital markets. Such modernization, of course, will not occur overnight. The task is monumental. But financial leaders have zeroed in on a mix of building blocks. They are aimed at changes in the way countries monitor and discipline themselves, changes in the way banks and borrowers interact, changes in the way financial markets behave, changes in the way the IMF operates, and changes in the way multilateral bodies like the Fund and the World Bank interact. The key elements include :

• the development and adoption of internationally consistent standards and codes of good practice for the behavior of corporations, financial institutions, and governments;

• the pursuit of transparency--and this pertains to all the major players: the public and private sectors, financial markets, and the multilateral institutions, such as the IMF;

• the strengthening of domestic financial systems, since a sound global financial system will require sound and resilient national systems;

• the liberalization of the capital account in an orderly fashion;

• the search for market-based mechanisms that would involve private creditors in resolving and forestalling crises;

• the formulation of equitable social policies and support for the most vulnerable; and

• the adaptation of the international institutions, especially the IMF.

Let me just expand on the last item, that is, to consider transforming the IMF's ministerial level advisory body--the Interim Committee--into a "Council" with decision-making, rather than merely consultative powers. This idea, along with others on stabilizing the international currency system--possibly moving to a tripolar system, with the euro, yen, and dollar; possibly providing for a lender of last resort--are also on the international reform agenda, and currently matters under discussion in the IMF.

The IMF was founded--and here I quote from our Articles of Agreement--"to promote international cooperation by providing the machinery for consultation and collaboration by members on international monetary issues." You may rest assured that we will continue to fulfill that role.