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A Public-Private Partnership for Financial StabilityAddress by Horst Köhler
Managing Director of the IMF
Institute for International Finance
Hong Kong SAR, May 31, 2001
1. I am happy to be here, to discuss issues of international financial stability at this critical juncture for the global economy. I welcome the decision to hold this meeting in Hong Kong, as a demonstration of its important role in regional and international financial markets. That is also the reason that the IMF decided to open an office here last October, with the help and encouragement of the Chinese and Hong Kong SAR authorities. This has strengthened our monitoring of regional and global financial markets, at a time when careful attention to market developments is particularly needed.
The global and regional economic outlook
2. The current slowdown in world economic activity has intensified pressures on vulnerable countries and weak financial institutions. Declines in world equity markets and the recent difficulties in Turkey and Argentina have also heightened consciousness of the downside risks and interdependencies in the global economy. But still our best guess is that the slowdown in global growth will be relatively short-lived, with a recovery beginning later this year and gathering strength in 2002. What is important is vigorous policy action to ensure this outcome materializes.
3. For this reason, I am encouraged that discussions last month at the IMF's International Monetary and Financial Committee (IMFC) demonstrated a growing sense of shared responsibility among the IMF's member countries to safeguard global economic growth. In the United States, the probability of an upturn later this year has increased, as a result of aggressive interest rate reductions by the Federal Reserve and the recently approved tax cut. But we know that there are still considerable uncertainties. The goods news is that, worldwide, there is a growing awareness of interconnections. For instance, the effects of the US slowdown on growth in Europe have proved stronger than expected. I welcome the recent reduction in interest rates by the European Central Bank, and I am sure that the ECB is now more vigilant than ever. But we are also aware that the key to stronger European growth is not monetary policy, but the adoption of more ambitious structural reforms, particularly in labor and product markets and tax and pension systems. Japan, for its part, has rightly adopted a new monetary framework to fight the risk of deflation. Even more encouraging is the recognition by the new Prime Minister of the importance of accelerating overdue structural reforms of the banking and corporate sectors, which we hope will soon be translated into action. To further underpin world economic growth, we need leadership by the advanced countries in resisting protectionist pressures and supporting a new round of multilateral trade negotiations.
4. The slowdown in global activity is also testing the resilience of emerging market economies. Here in Asia, the past two years have brought a sharp recovery from the financial crises of 1997 and 1998. As a result of domestic policy reforms and strong export demand from the advanced economies, growth in Asia has resumed, fiscal and external positions have strengthened, and many countries have regained access to international capital markets. Now there are concerns that the weakening of exports and capital inflows may trigger a reversal of these gains. I believe that Asia will weather the storm. In most Asian countries the risk of a new crisis has been greatly reduced through stronger macroeconomic fundamentals and the adoption of more flexible exchange rate policies. Unfortunately, the record is mixed when it comes to financial sector reform, improving governance, and strengthening the investment climate, and these remain sources of vulnerability in some cases. But it is clear that markets do differentiate, and countries that stay the course on these essential reforms should experience relatively good growth performance. And it also goes without saying that political stability and respect for law and order are crucial for investment, growth, and job creation.
5. The IMF, for its part, can make its greatest contribution to continued world economic expansion:
By focusing on these core areas of responsibility, the IMF can help its member countries to take advantage of the opportunities and contain the risks of globalization. Asian countries have demonstrated that integration into the global trade and financial systems can bring opportunities for higher productivity, increased trade, stronger growth, and more jobs and higher incomes. But the pace of change constantly challenges the ability of societies and political structures to adapt. Support for integration into the global economy is undermined by the fact that too many people in the world have so far failed to share in the benefits. And some countries in Asia feel that they have been left too exposed to volatility in international capital flows. Safeguarding stability and world prosperity obliges us to find better methods of international cooperation to address all of these concerns.
6. In the wake of the Asian crisis, a broad work program was launched to strengthen the international financial architecture. This has drawn on efforts by multilateral institutions, like the IMF and World Bank; standard-setting organizations, like the Basle Committee on Banking Supervision; and other regional and international bodies.
I do think that these initiatives are making the international financial system more resilient. And while there can be no guarantees, this should give us greater confidence that the international financial system will withstand the current period of testing.
7. In parallel with the initiatives to strengthen the international financial system, the IMF has increased its support for regional cooperation and integration, as a way to promote strong policies and institutions in neighboring countries and stepping stone toward successful integration into global markets. I am encouraged by the recent announcement of enhanced swap arrangements among several Asian countries under the Chiang Mai Initiative, which I view as a potentially important complement to the IMF's activities in the region.
Crisis prevention and international financial stability
8. Despite all that has been accomplished, developments in international financial markets over the past few months underscore the importance of concentrating even more on crisis prevention. Last month's IMFC meeting confirmed the IMF's strategy and work program in this area. We will be looking, in particular, for ways to heighten the impact of the IMF's surveillance. In the process, the risks to global financial stability stemming from imbalances in advanced economies will need to be addressed with the same vigor as those posed by developments in emerging market economies.
9. Highest on our agenda for the coming months will be further work on early warning of potential crises. By this I do not mean that the IMF would intend to become a rating agency. What is crucial is that we sharpen our ability to identify emerging problems and bring about early and preemptive policy action in member countries. For this, we need to combine quantitative indicators of vulnerability with judgment from the field and from the markets. To ensure the maximum beneficial impact, it will be important for this work to move forward with the full participation of the IMF's membership. In the process, we will need to take care that our warnings about potential crises do not become self-fulfilling prophecies.
10. The new International Capital Markets Department in the IMF will have to play a major role in this effort. The new department will serve as the IMF's center of expertise, information and analysis on capital market issues and its primary point of contact with private and official institutions working in this area. By deepening our understanding and judgment about the operation of capital markets, this new department will strengthen the IMF's capacities for crisis prevention and management, and for safeguarding the stability of the international financial system. This department will also play a major role in the IMF's efforts to address conceptual issues affecting global financial markets. For example, I would like to review-together with the private sector-the experiences with financial bubbles and volatility in international capital flows and, on this basis, to contribute to a forward-looking financial markets policy. I also see an important role for the new department in helping members in their efforts to gain access to international capital markets.
A new public/private partnership
11. International capital markets have been an engine of innovation and rapid economic growth in the postwar era, and they will take on an even more crucial role in the 21st Century. Net private capital flows to developing countries reached about $250 billion a year by the time of the Asian crisis, while total official flows-grants and loans, bilateral and multilateral-are less than one-third of that amount. International capital markets have thus become indispensable for economic and social development. We must also recognize that markets are now much more differentiated and sophisticated that they were 10 or 20 years ago. The bulk of financing no longer comes in the form of bank loans, but through bonded debt, direct investment, and other instruments, and new instruments are being devised all the time to meet the requirements of an evolving global economy. There is obviously a need to adjust economic policy concepts to these developments. I do think this change should include building a new partnership between the private financial sector and public institutions like the IMF.
12. A year ago, in outlining my initial thoughts on the future role of the IMF, I gave a commitment to work constructively with the private financial market participants. This approach is now reflected in a number of key elements of the IMF's work program, including our informal but regular dialogue with senior representatives of private financial institutions, through the Capital Markets Consultative Group (CMCG). Our membership has welcomed this dialogue as an integral part of the task of safeguarding the stability of the international financial system. And indeed, I see the common ground for this in the fact that we all have a strong interest in limiting the risk of financial crises and thereby contributing to sustained growth and development in the world. Such enhanced interactions should not be seen as a way for selected creditors to gain a competitive advantage, but as a way to achieve that common interest.
13. Last year in Prague, the IMF's membership took a major step forward with the agreement on a framework for private sector involvement in crisis prevention and resolution. Because prevention remains the first and best line of defense against crises, we are looking to private creditors to make better use of information on standards and codes, and to exploit the full potential of collective action clauses, contingent lines of credit, and procedures for a regular dialogue with borrowing country officials, as a complement to preventive actions by the IMF and its member countries. Notwithstanding these steps, the basic principle of the framework is that a market economy requires debtors and private creditors to bear the consequences of their decisions. This means they cannot expect to be "bailed out" by the official sector. I appreciate that the members of the IIF also recognize this principle. With this in mind, I do think it is right to work as much and as long as possible with market-oriented, voluntary solutions negotiated between debtors and creditors.
14. We have applied this approach most recently in both Turkey and Argentina. In each of these countries, the authorities deliberately chose to use a growth-oriented policy approach and market-oriented solutions for meeting their large external financing requirements and restoring access to private capital markets. The adjustment programs of Turkey and Argentina reflect strong commitments not only to fiscal discipline, but also to eliminating state interference in the economy, integrating further into the global economy, and preserving a culture of respect for property rights. All of these are crucial ingredients of a good investment climate. Although there are risks, the IMF's members unanimously agreed that this way of proceeding deserves support. An integral part of their supportive approach to Turkey and Argentina was and is the expectation that the private sector remains engaged. Given Turkey's strong, market-oriented adjustment program, it should be quite natural that Turkey's private creditors will maintain and even increase their exposure. And I look forward to a positive conclusion of the debt exchange operation with Argentina, as a constructive action by the private sector which improves the country's ability to manage its debt service burden.
15. The Prague framework also made it clear that more concerted approaches to private sector involvement may be required in exceptional cases-including, as a last resort, the use of temporary payment standstills to provide breathing space for working out an orderly and cooperative solution. Obviously any decision to move in this direction would need to be based on a careful weighing of the costs and benefits. We do not want to risk blocking the creativity of markets and harming emerging market economies. But we have also to recognize concerns about moral hazard. To provide a basis for sound judgment about the approach to take in concrete cases, we will need more adequate information and research-for instance, on the assessment of debt sustainability, prospects for regaining market access after a crisis, comparability of treatment among creditors, and the risks of contagion. The IMF will be engaged in a work program in these areas over the coming months, including outreach to private investors and creditors. I am confident that we will come to solutions that strike the right balance between a rules-based approach and judgment based on the situation in individual country cases. I recognize that the private sector is not one homogeneous entity, but consists of a differentiated set of institutions with different investor perspectives and interests. Therefore it is all the more important to hear more concretely your views (possibly through the IIF) on the issues of rules and predictability, and how best to strengthen the role of the private sector in crisis resolution.
16. I expect the Capital Markets Consultative Group will also play an important part in this process. The Working Group on Creditor-Debtor Relations, co-chaired by Robert Pozen and Stan Fischer, has produced a very useful report outlining principles for transparency and good communication. We plan to discuss this report with the Executive Board of the IMF in the coming months. At our CMCG meeting earlier today we considered ways that private creditors can make better use of information on standards and codes, and how the private sector can become engaged at an earlier stage in crisis prevention and resolution. This work should provide further content to the envisaged public/private partnership for international financial stability.
17. We know that "the business of business is business." But business leaders also need to be aware of a wider responsibility. There is a growing critical discussion about globalization, and there is the potential for a political backlash against capital market liberalization and integration into the global economy. Therefore, it is important for the financial industry to demonstrate not only political sensitivity but also concrete capability for self-policing. I would, for example, encourage the private sector to work more ambitiously and systematically on voluntary codes of conduct to reduce the incentives for excessive risk-taking. Or, to put it differently, I encourage you to show leadership in promoting a culture of sustainable value creation. This is an objective for which it is well worth joining forces between the private and the public sector.The IMF looks forward to working with you.
IMF EXTERNAL RELATIONS DEPARTMENT