Speech

A Public-Private Partnership for Confidence-Building
Speech by Horst Köhler, Managing Director
International Monetary Fund
At the Spring Membership Meeting of the Institute of International Finance
Berlin, June 4, 2003
As Prepared for Delivery

1. It is a great pleasure to join you this evening here in Berlin at the occasion of your Spring Membership Meeting. It is a timely occasion to discuss with you what is clearly the most pressing issue on the minds of both policymakers and market participants: rebuilding confidence in the world economy and in financial markets.

Global Economic Setting

2. The global economy is currently at a critical juncture. The balance of risks has improved lately. But in order for the world to seize the upside potential, the overriding priority must be to restore global confidence. In an economically and politically interdependent world, this requires the credible demonstration of international cooperation. In my view, the Evian Summit has demonstrated the political will of the leaders from the G 8 and major developing and emerging market countries to work together in addressing the world's problems. This is encouraging. But, of course, we need to see action. The most important task for now is to bring the global economy back to strong sustained growth. And I trust that the leaders of the G 8 understand that it is first and foremost their responsibility to raise growth by accelerating the process of structural change in their economies.

3. A successful conclusion of the Doha Round by the end of 2004 is the single most important contribution to boosting confidence and growth at the international level. I am concerned about the slippages in the schedule that have already occurred, and it is crucial now to move ahead ambitiously in the negotiations to ensure visible progress by the time of the ministerial meeting in Cancún in September. At Evian, the Heads of the G 8 pledged to provide leadership in the ongoing negotiations. The world should take them by their word. And it would be very helpful if global financial leaders gathered here today in Berlin could publicly voice their strong support for the goals of the Doha development round. Securing a better balance between trade integration and financial market integration is also essential to reduce an important source of financial crises. In my view, a successful conclusion of the Doha Round is crisis prevention at its best.

4. I remain convinced that the benefits of globalization by far outweigh the risks. But we need to work for better globalization, where the benefits are more broadly shared across the world and the risks better contained. Global poverty is a huge and persistent problem that concerns all of us. Therefore, I do not consider it a surprise at all that Brazil's President Lula has rallied such tremendous support for his agenda of "growth with equity." This sends a clear-I would say, historical--message that market-oriented reform and integration into the global economy must pay off for the broad majority of the population.

Safeguarding the Stability of the International Financial System

5. We are still coming out of one of the most pronounced asset bubbles in economic history. All the more, we can take some comfort from the fact that the global financial system on the whole has demonstrated remarkable resilience in the face of extraordinary and multiple shocks over the past few years.

6. To a considerable degree, this resilience can be traced back to a stronger capital base and a much greater sophistication in risk management. Markets have altogether become much better at differentiating and pricing various risks. Most important, the system as a whole has benefited from the market's ability to distribute widely and share risks, including through various types of derivatives. At the same time, I consider it useful that there is now a lively discussion about more transparency related to derivatives. There is still room for improvement in gaining a better understanding of risk exposures and about the ultimate holders of financial risk. And I also think that the discussion about more transparency for the hedge fund market, especially about the extent of their leverage, is not yet concluded.

Progress in Strengthening Crisis Prevention ...

7. It is also fair to say that the initiatives undertaken by the international community and the IMF in the wake of the Asian financial crisis have begun to bear fruit. A lot has been achieved in strengthening crisis prevention and surveillance at the IMF. In particular, there has been a sea change in transparency among the Fund's member countries and in the IMF itself. And I am happy to note that the IMF's Special Data Dissemination Standard (SDDS) is also actively used and promoted by the IIF. The Fund now has a much clearer focus on the soundness of financial systems in our member countries. And our standards and codes initiative is helping to spread best practices and is contributing to a more level playing field for the globalized economy.

8. These initiatives have also led to better coordination and interaction between the various institutions concerned with financial stability, including the creation of the Financial Stability Forum (FSF). Improved networking between governments, central banks, supervisors and standard-setters, and the private sector is helping identify and fill gaps in the global financial architecture.

9. Last but not least, the IMF is engaged in an informal but more systematic dialogue with the private sector, in particular through the creation of the International Capital Markets Department -including its flagship publication, the Global Financial Stability Report-and the Capital Markets Consultative Group (CMCG). The CMCG also provides a platform for joint projects: When I last spoke at the IIF annual meeting in Hong Kong, we had just adopted a joint working group report on investor relations programs. And now we are engaged in a project on foreign direct investment flows to developing countries to help us better assess the determinants and obstacles to such flows.

10. While these are all welcome improvements, we nevertheless need to guard against complacency. Crises can and will occur again despite our best efforts at prevention. We have to accept to some extent that overshooting and correction are inherent features of an open, dynamic market economy. There may be few better examples to illustrate Karl Popper's axiom of "perpetual trial and error." It is important therefore to work towards greater flexibility of economies and to help strengthen shock absorbers through, amongst others, more flexible exchange rate regimes, adequate international reserves, more effective social safety nets, and budgets that leave room for maneuver in times of stress.

... and more Effective Crisis Resolution

11. While we have to be ambitious to reduce the frequency and severity of crises, we also need effective tools to manage and resolve crises that do occur. The debate the IMF triggered with its proposal for a Sovereign Debt Restructuring Mechanism (SDRM) over the past 1 ½ years to deal with unsustainable debt has--on the whole--been extremely productive. Not only has it been helpful in creating better awareness of the need to pay more attention to preventing the build-up of unsustainable debt. It has also helped to clarify and move forward a number of critical issues such as tackling collective action problems, inter-creditor equity, and better rules of engagement between debtors and creditors. Not the least, the recent successful conclusion of Uruguay's debt exchange has benefited from this discussion and clarification.

12. I am happy too that we seem to have turned the corner now on Collective Action Clauses (CACs) with the successful issuances by Mexico, Brazil, South Africa, and the Republic of Korea as well as their inclusion in Uruguay's debt exchange. And I count on the private sector to continue working with emerging market issuers to ensure that bonds with CACs will soon become the norm in all markets for international bonds and that an appropriate market standard will evolve. I also look forward to progress between private creditors and their debtors in the design of an international Code of Good Conduct as a mutually agreed set of best practices. The IMF will support this effort, and we will continue to work on issues of general relevance to the restructuring of sovereign debt.

Improving Conditions for Private Capital Flows

13. We have to work further on a sound framework for capital flows in the global economy. In this context, I would advise the international community to focus more than ever in the future on good governance, sound institutions, respect for creditor and property rights, and legal predictability. The IMF will do so. But here, we will need both the support of the Fund's membership, and, in particular, that of the private investor community.

14. Financing conditions for emerging markets have become relatively favorable in recent months. Mature markets are awash with liquidity and more and more emerging market countries are able to seize the opportunity to tap into this vast global savings pool. While this is certainly a welcome development, we must nevertheless beware of repeating past mistakes. One important lesson from experience is that countries need to rely more strongly on longer-term capital inflows and to develop a good mix of domestic and foreign sources of capital. The benefits of foreign direct investment, which brings with it not only much needed capital but important know-how as well, are already well documented. We now also see increasing evidence that countries with a sound and more diversified financial system and a broader domestic investor base tend to be better able to withstand the feast or famine dynamics in capital flows to emerging markets. In my view, helping countries develop deeper and broader local capital markets can be a good opportunity for private investors to work together with such public institutions as the IMF and the World Bank.

Rebuilding Confidence--The Responsibilities of the Private Sector

15. I believe we agree that it is best for capital allocation to rely mainly on the private sector, its sophistication and financing power. It is critical then to maintain a basic fabric of trust and confidence between savers, borrowers, and financial institutions. This is true in mature as well as emerging market economies. It is the responsibility of the official sector to establish a reliable and credible institutional framework. Global markets function better if there are coherent rules across geographical boundaries as well as industry sectors. If not uniform, such rules should at least be compatible along the lines of: same business, same risks, same rules.

16. Individuals placing their retirement savings in the hands of private money managers require a leap of faith. In this respect, the record of the recent past has not been spotless. The bursting of the equity bubble has exposed greed and sometimes outright fraudulent behavior which have undermined some of the trust so essential for well-functioning financial markets. The resulting loss of reputation may differ from region to region and from culture to culture. But looking for culprits only on the other side of the fence does not help to restore confidence in the system. It will only delay necessary action.

17. What is needed, in particular, is a visible process of reflection and correction by the private sector itself. It is in everybody's interest that the self-correcting forces of the market are shown to work. And this should not only apply to the correction of irrational pricing of financial assets but to irresponsible behavior as well. Recent experience has shown that a surge in economic productivity has not rendered obsolete the law of gravity in finance. And we have witnessed the pitfalls of focusing excessively on short-term earnings expectations. As a "new realism" replaces the culture of the "go-go years," what is fundamentally needed is a new culture of responsibility-a renewed sense of ethical responsibility, and a broadly-based recognition of the need to nurture a culture of more sustainable value creation.

18. I am a firm believer in the self-correcting forces of the market. But these do not come free or automatically. Boards, senior managements, and risk committees have a crucial role to play in this regard by exercising prudent oversight and self-restraint. This not only requires appropriate incentives but also the courage to take contrarian views when herd behavior prevails. It is in the private sector's own interest not to wait for legislators and regulators to be told what to do. I personally would certainly prefer to trust in the private sector's ability to come up itself with answers to conflicts of interest and on how to develop or improve circuit breakers that effectively prevent things from getting out of hand.

19. Of course, the recent failures of both public and private systems of checks and balances have underscored the need for more than just a little more enlightened self-discipline. What is also important, however, is not to have the pendulum of regulatory action swing too far from one extreme to the other. Ultimately, we should want to see private initiative and risk taking encouraged not overwhelmed by bureaucratic procedure. With this in mind, we need to strike the right balance between as much regulation as necessary and as little as possible. Here, such trade associations as the IIF have an important role to play in helping to strengthen the link between public policy objectives and practicability in the daily business of finance and commerce.

Conclusion

20. Looking ahead, I am not at all pessimistic. We have many of the ingredients needed to achieve stronger sustained global growth with financial stability. There is plenty of capital in the world searching for opportunities to be productively deployed. The bursting of the asset bubble has not diminished the quantum leap in technological progress made, and this will help generate further boosts to productivity. We also know very well which policy steps are needed. Emerging market and developing countries are witnessing that it pays off to stay the course of reform.

What is needed now is the critical spark that reignites confidence across regions and sectors. This requires bold policy leadership in the major economies: placing US fiscal policy back on a track that achieves balanced budgets over the business cycle; greater ambition to accelerate the process of structural change, in particular in Europe and Japan; and achieving a decisive break-through in removing barriers to international trade.

At the same time, leaders in the world of business, finance and commerce must live up to their responsibilities by reinforcing a culture of trust, sound risk taking, and entrepreneurship.

This is a public private partnership well worth all our energies.