Report of the Acting Managing Director to the International Monetary and Financial Committee on Progress in Reforming the IMF and Strengthening the Architecture of the International Financial System

I.  Overview

1.  This report provides an update on progress in strengthening the architecture of the international financial system, focussing on the various steps taken in key areas―both by the IMF and by others—since the Managing Director’s report in September 1999.

2.  In the aftermath of the recent financial crises, broad international agreement has been reached on a number of key measures to ensure a more resilient international financial system. Many initiatives have already been implemented or are currently being made operational. In several areas—such as enhancing transparency and accountability, assessing standards and codes, and better identifying financial sector vulnerabilities—pilot programs are underway. These efforts are experimental and designed to set the stage for decisions on longer-term action. Work on developing and disseminating standards is focussing increasingly on facilitating implementation through the provision of technical assistance and work is underway to develop better analytical tools and data for the assessment of vulnerability.

3.  In other areas—such as capital account liberalization, exchange rate systems and involving the private sector in crisis resolution, progress has been made and discussions continue. Given their importance, momentum in these areas should not be allowed to dissipate.

4.  Many of these initiatives come together through the vehicle of IMF surveillance. But tensions between transparency and confidentiality, and between comprehensiveness and selectivity, need to be balanced. Bringing these initiatives into the surveillance process also has important resource implications. In addition, there is a need for new ways of cooperating with other institutions and agencies, in order to better inform IMF surveillance by drawing on work undertaken elsewhere.

5.  The changes in the global economy that have led to these initiatives on financial architecture also have possible implications for other IMF operations. A major review of IMF financial facilities has begun in order to assess the extent to which the ways in which the IMF provides financial assistance to its members may need to be modified in light of these changes.

6.  The IMF’s efforts are part of a coordinated and comprehensive response from the international community. A range of international institutions and fora are playing major roles in efforts to strengthen the international financial architecture, including the World Bank, the Financial Stability Forum (FSF), the Bank for International Settlements (BIS), other Basel-based groups, and the Organisation for Economic Cooperation and Development (OECD). In addition, the efforts of the international standard-setting bodies—such as the International Organization of Securities Commissions (IOSCO), the International Association of Insurance Supervisors (IAIS) and the various accounting bodies¹—and of fora such as the United Nations Commission of International Trade Law (UNCITRAL), have become increasingly important given the heightened focus on assessments of financial stability and on the development and observance of standards.

7.  The implementation of decisions taken in the last year on poverty reduction and social sector issues is an essential complement to efforts to strengthen the global financial architecture. The renewed impetus given to these areas under the Poverty Reduction and Growth Facility (PRGF) and the enhanced HIPC Initiative are critical to better integrate the poorest countries of the world into the global economy. Properly designed and sequenced trade liberalization is an important component of these efforts to foster growth and reduce poverty.

8.  This paper is organized as follows: Section II below discusses progress in strengthening IMF surveillance. Section III discusses private sector involvement in crisis prevention and resolution. Section IV reports briefly on the early discussions of IMF facilities. Detailed information on progress across the range of initiatives aimed at strengthening the international financial architecture is summarized in tabular form in Appendices I, II and III.

II.  IMF Surveillance

9.  To remain effective, IMF surveillance has to adapt continuously to new global realities, including those presented by the rapid evolution and growing integration of world financial markets. The focus of surveillance must be defined in terms of the IMF’s responsibility for the promotion of external sustainability of its member countries. Of primary interest are issues related to the sustainability of a country’s balance of payments; its overall macroeconomic developments and policies, including monetary, fiscal and exchange rate policies; and issues that bear on vulnerability to crises (including, inter alia, financial sector issues, the current account balance, and capital account flows and stocks). The analysis of each country’s situation often needs to be set in a regional or, for systemically important countries, in a global context. The boundaries of surveillance need to remain flexible to take account of the changing economic and institutional environment and the different circumstances facing countries. However, the farther the issues facing a country move beyond these key areas, the more the IMF’s involvement needs to be assessed explicitly in terms of the macroeconomic relevance of the issues.

10.  In reviewing the IMF’s surveillance activities for the period 1997-99 (the Biennial Review of Surveillance²), the Executive Board reiterated that surveillance must encompass analyses of financial sector soundness, capital account issues, and vulnerability to crises. The Board also emphasized that surveillance must be informed by timely, comprehensive and accurate data, and called for more candid assessments of data deficiencies. The Review noted that, in line with efforts to ensure a comprehensive discussion of relevant issues, private market views are increasingly being used to inform surveillance; the coverage of exchange rate policies has been strengthened through the use of more sophisticated analytical techniques; and policy advice has become more candid. There has also been progress in integrating regional and global issues into bilateral surveillance, and cross-country themes have come to play a more prominent role.

11.  Reform initiatives have also begun to influence the conduct of surveillance. In particular, surveillance is being influenced by efforts:

• to improve transparency and accountability of the IMF and its members;
   
• to develop and disseminate international standards in the areas of direct operational concern to the IMF;
   
• to undertake assessments of members’ observance of these standards and codes as well as of other relevant international standards and codes by drawing on assessments undertaken by the World Bank and other standard-setting bodies; and
   
• to conduct comprehensive financial sector assessments aimed at identifying vulnerabilities and priorities for institutional development.

12.  Many of these initiatives are currently in a pilot phase. Over the course of the coming year, the Executive Board will review these pilots and consider how they can best be incorporated into the surveillance process. An important issue is to determine how best to draw on the ongoing work and special expertise of other institutions to inform IMF surveillance. The Executive Board will return to this and other issues, including those arising in the internal and external evaluations of surveillance, in the work program to be developed for the remainder of the year.

A.  Transparency and Accountability

13.  Greater transparency in the IMF’s assessments of members’ policies is intended to improve the effectiveness of surveillance and Fund-supported programs and to enhance public dialogue on members’ policies. Providing the public and financial market participants with more information, including on the details of governments’ commitments under IMF-supported programs, can also contribute to a wider policy debate, enhanced ownership of the reform process, and sound investment decisions. However, these benefits must be balanced against the IMF’s role as confidential policy advisor to members and the need to maintain the quality and candor of staff assessments and policy advice.

14.  Several initiatives have been launched to improve the transparency of the IMF’s operations and its policy advice, including:

• the active encouragement of the release of Public Information Notices (PINs) following Article IV consultations;
   
• the establishment of a presumption to release Letters of Intent (LOIs), Memoranda of Economic and Financial Policies (MEFPs);
   
• the release of staff assessments of members’ Poverty Reduction Strategy Papers (PRSPs)—it is envisaged that the country-owned PRSPs will also be published;
   
• the release of the Chairman’s Statement following Executive Board discussions on the Use of Fund Resources (UFR);
   
• expanded public access to the IMF’s archives;
   
• the public release of key policy documents in a wide range of areas combined, in some instances, with requests for public comments;
   
• the publication of regular information on the IMF’s liquidity position and on member’s accounts with the IMF on the web site;
   
• the publication of the IMF's quarterly financial transactions plan (formerly called the operational budget); and
   
• the pilot program for the voluntary public release of Article IV staff reports.

15.  The implementation of these transparency initiatives has progressed significantly over the last eighteen months. The Executive Board will soon review, inter alia, the experience with issuing Chairman’s statements following UFR discussions and reviews, the experience with the release of Article IV PINs, and publication of LOIs/MEFPs. It will again consider the possible release of UFR PINs and stand-alone UFR staff reports, and the experience with the pilot program allowing the voluntary public release of Article IV staff reports will be reviewed in coming months.

16.  The commitment to increased transparency has also underpinned measures to explain better the IMF’s work to the wider community. Steps have been taken to increase the provision of information to the print media and to the public. Further efforts are being made to achieve greater outreach to civil society, strengthen the IMF’s publication program, and to increase dialogue with the private financial sector. The Executive Board has welcomed the implementation of a number of elements of a strategy for strengthening the IMF’s external communications, based on the review by external consultants completed in 1999.

B.  Developing Standards, Principles and Guidelines

17.  The discussion on strengthening the international financial architecture has emphasized the need to develop and implement internationally recognized standards and codes of good practice. The development and adoption of standards in areas central to economic and financial system stability can contribute to better informed lending and investment decisions, increased accountability of economic policy-makers and private sector decision-makers, and improved economic performance.

18.  Following the development of standards in areas of direct operational concern to the IMF—data dissemination, transparency of fiscal, monetary and financial policies, and banking supervision—efforts have increasingly focused on the dissemination and implementation of these standards, including through the provision of technical assistance. Significant progress has also been made in preparing material to assist countries in the implementation of standards. A manual to assist in the implementation of the Code of Good Practices on Fiscal Transparency has been available for some time. The IMF is in the final stages of preparing a supporting document to the Code of Good Practices on Transparency in Monetary and Financial Policies (MFP Transparency Code) to help guide members in their implementation of the Code. The operational guidelines for the data template on international reserves for the SDDS will be finalized by year-end after taking into account members’ experience in its implementation.

19.  The experience with the use of standards also needs to be reviewed periodically in order to ensure that their design and implementation remain appropriate. The Executive Board has recently reviewed the experience with the Special Data Dissemination Standard (SDDS) and the General Data Dissemination System (GDDS) and agreed upon changes in their design in areas of international reserves and external debt (Box 1). The Board will also shortly discuss the provision by members of external debt and international reserves data to the IMF for its surveillance activities, drawing on the decisions taken for the SDDS and GDDS. The Board will shortly review the experience with assessments of the implementation of the Basel Core Principles (BCP), and later in the year it will review the experience with assessments of the Code of Good Practices in Transparency in Monetary and Financial Policies. The Basel Committee on Banking Supervision (BCBS) has recently approved a Basle Core Principles methodology—prepared with input from the IMF and World Bank—designed to allow bank supervisors or external groups to review adherence to the BCP. The BCBS is continuing to work on its Core Principles and is hosting a workshop in May to consider the results of assessments done to date and to consider the possibility of updating and revising the principles. Work is also underway in other international fora to further develop and refine standards in areas such as securities regulation, insurance regulation, accounting and auditing, and payments systems. The current state of play in these areas is described in more detail in Appendix III.

C.  Assessing Standards

20.  In earlier discussions, the Executive Board has supported the view that IMF surveillance needs to take into account the extent to which standards are observed as part of efforts to evaluate whether member’s institutional structures and policy practices are consistent with economic and financial stability.³ While the adoption of any individual standard is voluntary, the international community has also recognized the importance of information on the extent to which countries implement standards and codes. It has called for the IMF, in collaboration with the World Bank and other standard-setting bodies, to prepare reports assessing the extent to which members observe internationally recognized standards and codes. How this work will be formally incorporated into IMF surveillance remains to be decided. However, support for the preparation of these "transparency reports"—now referred to as Reports on the Observance of Standards and Codes (ROSCs)—has been wide ranging and an experimental program has been underway since early 1999 (Box 2).⁴

21.  There is a critical distinction, however, between undertaking assessments of a member’s observance of particular standards and using those assessments in IMF surveillance. The former requires detailed knowledge of the relevant standards and the expertise to use this information to benchmark individual country practices. The latter involves an appreciation of how these practices have been changing over time and how they affect economic and financial system stability.

22.  The Executive Board has stressed that, in undertaking assessments, staff should concentrate primarily on those areas within the IMF’s direct operational focus. However, Directors also stressed the importance of assessing standards in other areas. In these areas, the task of undertaking assessments must draw on the skills of other expert bodies. To that end, the Executive Board has endorsed a shared ownership approach to the preparation of ROSCs whereby different international institutions take primary responsibility for undertaking assessments in different areas, in line with their mandates and expertise. The World Bank has agreed to join the IMF in co-preparing ROSCs and is now experimenting with assessments in the areas of corporate governance and accounting.

23.  Even working jointly, there are limits to what standards the IMF and World Bank can assess. Other international financial organizations, standard-setting bodies, and national authorities all have roles to play if the international community is to assess effectively the range of standards necessary to promote financial stability. Mechanisms need to be developed to involve a wider range of institutions and standard-setting bodies in the assessment process. In that regard, the joint World Bank-IMF Financial Sector Assessment Program (FSAP) has been particularly effective in bringing the expertise of national agencies and standard-setting bodies to the assessment process (see Section D below).

24.  Article IV surveillance provides the appropriate framework within which to organize and discuss the implications of assessments with national authorities although the modalities by which this is done remain experimental during the ROSC pilot. The extent of progress made in implementing and observing standards can be reviewed, and the implications for macroeconomic and financial vulnerability can be examined, in the course of consultation discussions.In endorsing the modular approach to the preparation of ROSCs— whereby standards are assessed separately, building over time into a comprehensive set of assessments—Directors observed that this would provide a suitable and flexible mechanism with which to incorporate information on standards into the surveillance process.

25.  Linking the monitoring of standards and codes to the IMF’s Article IV consultation process—with its near universal coverage and uniformity of treatment—can help ensure a continued focus on promoting the implementation and observance of standards. A comprehensive range of assessments will also be valuable for the World Bank’s work in helping countries determine reform and development priorities. Similarly, feedback from the assessment processes can help standard setters identify the strengths and weaknesses in existing standards and provide insights for future work. In the event that assessments are published, this should also assist markets in making better-informed lending and investment decisions which should, in turn, encourage greater efforts to implement, and adhere to, standards.

26.  Prior to the 2000 Annual Meetings, the IMF Executive Board will review the experience with the three rounds of experimental ROSCs. Staff will also discuss the usefulness of the evolving approach, and limitations to assessments, with the private and public sectors. In addition, the FSF Working Group on Offshore Financial Centres (OFCs) has recommended that the IMF organize assessments of the observance of standards by OFCs as part of a five stage process involving assisted self-assessment and independent assessment (Appendix II). The Executive Board will shortly consider a staff paper on the IMF’s involvement with OFCs.

D.  Strengthening Financial Systems

27.  Recent episodes of financial crisis in a number of countries and cross border contagion have underscored the need to strengthen countries’ financial systems and, in particular, to improve abilities to identify financial sector risks and vulnerabilities at an early stage. The IMF has, for some time, given prominence to financial sector issues in its surveillance and lending. Despite a considerable improvement in the coverage and assessment of financial sector soundness, there is a need for more in-depth analysis in this area, with better discussion of possible gaps in information and analysis. The priority is to focus systematically on the health of financial systems and identify the interlinkages among macroeconomic policies, the real economy and structural and developmental issues in the financial sector. To carry out this work most effectively, and to utilize scarce expert resources efficiently, this work in being carried out in collaboration with the World Bank.

28.  The joint IMF-World Bank Financial Sector Assessment Program (FSAP)—introduced on a one-year pilot basis during 1999—is intended to be the core instrument in the IMF and the World Bank for providing this more focused financial sector analysis. The FSAP, which operates in the context of Article IV consultations, is designed to underpin a more effective dialogue with national authorities, to help countries reduce vulnerabilities within their financial sectors and to assist in determining priorities for longer term financial sector development. To enhance collaboration and consistency in policy advice between the two institutions on broader aspects of their financial sector work, and to provide a coordinated approach to the provision of technical assistance, the World Bank-IMF Financial Sector Liaison Committee (FSLC) has been operating since late 1998.

29.  Within the IMF, Financial Sector Stability Assessments (FSSAs) are prepared on the basis of the FSAP reports for each country. FSSAs are designed to provide a sharper focus on vulnerabilities identified during the FSAP. Staff assessments of risks to the macroeconomy emanating from the financial sector are brought into the Article IV consultation, and are used in IMF program design.

30.  The FSAP pilot program is now well underway. During the pilot, assessments are to be prepared for twelve countries, covering a diverse range of financial systems and geographic regions. Owing to the resource-intensive nature of the program, the specialized skill requirements, and the limited staff resources in the World Bank and the IMF, national central banks and supervisory agencies, as well as international standard-setting bodies, have been invited to provide experts to participate with the World Bank and the IMF in the assessments of individual countries. To date, four of the pilot assessments have been completed and a further eight cases are close to completion. Feedback gained so far from the authorities of the countries involved has been generally positive, and their suggestions on how the FSAP can be further improved are helping to shape refinements to the Program.

31.  The Executive Boards of the IMF and World Bank recently considered a progress report on the FSAP pilot, which highlighted a number of important lessons (see Box 3). On the basis of the experience gained so far with the pilot, it has been agreed to continue the Program. It is envisaged that the pace of country coverage will pick up to 24 countries in the coming year. Experience gained with this next round of assessments, as well as with the twelve pilot cases, will develop a larger body of experience on how best to incorporate the assessments into surveillance.

32.  Work on strengthening financial systems has also progressed in other fora and institutions. (See Appendices I, II and III).

E.  External Vulnerability and Capital Flows

33.  Countries can benefit substantially from capital account liberalization but prosperity can be threatened if it is not properly sequenced and managed to minimize risk. IMF surveillance is designed to assess risks and vulnerabilities at both the national and international level. A necessary precondition for an effective assessment of vulnerability is the availability of timely, frequent, and high quality data. With hindsight, the limitations of such data delayed the early detection of some of the strains that led to the recent financial crises, and exacerbated the difficulties in developing and managing a timely policy response. As a result, considerable effort is now being focused on ways to improve the timeliness, frequency, and quality of relevant data. At the same time, efforts have continued to broaden and deepen the analysis of potential sources of risk and vulnerability in both bilateral and multilateral surveillance. These efforts draw heavily on analytical work underway in the IMF, World Bank, and other international institutions and fora. This analysis has utilized a broad range of vulnerability indicators in conjunction with standard economic analysis.

34.  Work to develop better methods for assessing external vulnerability has progressed on several fronts in the IMF and World Bank. Section II outlined the increased stress on the dissemination of comprehensive and timely data on external debt and official reserves under the SDDS. Work to strengthen the availability of data on external debt and foreign exchange liquidity is also underway in other fora. The IMF-chaired Task Force on Finance Statistics (TFFS)⁵ has maintained a quarterly database of creditor-side data on external debt on the Internet since March 1999. The TFFS is working to enhance the timeliness and coverage of these data. The BIS has announced a number of initiatives to enhance the coverage and analytical usefulness of its international banking statistics. The FSF Working Group on Capital Flows has recommended improvements in data from national, creditor, and market sources (Appendix II). Western Hemisphere Finance Ministers have called upon interested participants to prepare discussion papers on their debt and fiscal management policies and have asked the Inter-American Development Bank (IADB), IMF and World Bank to host a seminar to discuss these papers. Issues related to debt management are also likely to be discussed by the G-20 later this year.

35.  In response to a request from the FSF Working Group on Capital Flows, the IMF hosted a conference on capital flow and external debt data on February 23-24, 2000. This conference brought together a wide range of data users in the public and private sectors and data compilers for an exchange of views on the priorities for producing better and more timely data on debt and capital flows. Views among participants on directions for future work differed widely, although all considered that initiatives to date to promote methodological and data dissemination standards had been useful. The agenda, background material, and a summary of the conference have been posted on the IMF’s website.⁶

36.  The IMF and World Bank are also collaborating on a series of papers on aspects of external debt management.

• Drawing on research at the World Bank, IMF and elsewhere, work has been undertaken on debt and reserve-related indicators of external vulnerability which considers the analytical usefulness of various indicators and the scope for the derivation of simple benchmarks (such as threshold levels for certain indicators) to better gauge countries’ abilities to withstand external shocks.
   
• A manual on sound practices in sovereign debt management is in preparation. Drawing upon both country experience and the theoretical literature, this paper will provide information on the analytical basis for public sector debt policies, consider linkages to monetary and fiscal policy, discuss issues in determining the level and terms of external debt and the mix between domestic and external financing, and address legal and institutional arrangements for debt management and monitoring systems.
   
• A similar manual for the development of domestic capital markets is intended mainly to provide practical advice on how to establish and develop a market for public sector, domestic currency, bonds in order to help mobilize domestic saving and maintain a more balanced public financing strategy.
   
• Drawing upon the material in the other papers, including the detailed frameworks and reviews of country experience, a further paper to be considered during the summer will distill the main lessons and seek to arrive at a relatively compact set of "core principles" for sovereign debt management. As with the background papers (particularly the two manuals), this paper will be informed by consultation with IMF/World Bank members.

37.  In other related areas:

• A number of discussions have been held by the Executive Board during the past year dealing with structural and institutional factors in the management of foreign exchange reserves. The results of these discussions will feed into the IMF’s surveillance, financing and technical assistance activities.
   
• With IMF assistance, systems for high-frequency monitoring of external liabilities of domestic banking systems have been established in a number of countries to improve the authorities’ capacity to detect emerging signs of vulnerability and help in crisis management. The usefulness of these and other systems for high-frequency monitoring of foreign exchange transactions is presently being assessed by the IMF staff in consultation with member countries.
   
• In collaboration with other international organizations, the IMF is also developing macro-prudential indicators (MPI) of financial sector vulnerability. This work is at an early stage, and the Executive Board has agreed that it would be premature to include MPIs in the SDDS at this stage. The Executive Board will consider the results of further analytical work before the Annual Meeting later this year.
   
• The IMF has also participated in efforts to develop early warning systems for external crises—formal models that estimate the probability of crisis from a compact set of variables—in order to better inform surveillance. The Executive Board has noted that while early warning systems could be a useful additional tool for surveillance, caution is required in their use. Work is continuing to improve the accuracy of these models and to find their most useful applications.

38.  Work on the analytical framework for the assessment of external vulnerability, at the IMF and elsewhere, underscores the importance of timely information on the external liabilities and foreign exchange exposures of all sectors of the economy, as well as analysis of the risks posed by derivatives exposures and contingent liabilities. In parallel with the effort to develop better information on these sources of vulnerability, further research is underway on how to measure vulnerability from off-balance-sheet operations, such as through stress-testing. The World Bank is also conducting research on issues of corporate sector vulnerabilities.

F.  Capital Account Liberalization and Capital Controls

39.  In several discussions over the last year the Executive Board has emphasized the substantial benefits of capital account liberalization, but stressed the need to carefully manage and sequence liberalization in order to minimize risks. It has been agreed that while there is no single approach to ensure success, liberalization needs to be supported by a consistent macroeconomic framework and institutional arrangements that allow financial intermediaries and market participants to properly assess and manage risks. While there remain differences of view on the merits of capital controls, it is generally agreed that controls cannot substitute for sound macroeconomic policies, although they may provide a breathing space for corrective action.⁷ Discussions will continue on these issues during the summer when the Executive Board considers the implications of capital account liberalization for financial sector stability. The Board will also discuss policies to ensure stability in an environment of capital mobility; liberalization strategies, including the scope and sequencing of financial reforms; and prudential policies to safeguard financial stability in the course of capital account opening.

40.  Since the emerging markets crises, the surveillance of capital account developments has been given greater prominence in Article IV consultations. Staff reports have increasingly included a discussion of a range of vulnerability indicators, and assessments of policies have increasingly considered the extent of vulnerabilities arising from capital flows. Policy discussions have focused increasingly on the composition of capital flows and capital account regulations. Special attention is being given to risks posed by the potential reversal of capital inflows, the impact of selective capital account liberalization and the rapid accumulation of foreign-currency denominated debt. Looking ahead, there is room to expand the systematic use of vulnerability indicators in surveillance. The coverage of capital account issues in surveillance could also be broadened to include the adequacy of prudential safeguards to ensure the financial sector and the wider economy are resilient to possible shocks.

G.  Exchange Rate Regimes

41.  The choice of an appropriate exchange rate regime has become ever more important as an increasing number of countries have become more closely integrated in world capital markets in an environment of widespread liberalization and expansion of capital movements. In such an environment the requirements for sustaining a fixed exchange rate have become more stringent, as countries cannot simultaneously maintain a monetary policy directed at domestic objectives, open capital markets and an exchange rate peg. As a result of the recent crises, several countries have adopted flexible exchange rate regimes, while those with very hard pegs (e.g., the adoption of a common currency or of a currency board) have been able to maintain them. Irrespective of regime, credible supporting policies (including an alternative nominal anchor for countries with floating exchange rates) and institutional arrangements are critical to success. The Executive Board has revisited the issue of appropriate exchange rate regimes, emphasizing that sound exchange rate policies are central to the effective operation of the international monetary system (Box 4). It has stressed the need for the IMF to continue to exercise firm surveillance over the exchange rate policies of members and to provide candid advice to members on their choice of exchange rate regimes. The Board has also underlined the need to ensure that the spillover effects of macroeconomic and structural policies in major currency countries are fully taken into account in the surveillance process.

42.  In recent years, the assessment of exchange rate policies in the context of IMF surveillance has been significantly strengthened for most countries, and particularly so for advanced and emerging market economies. Analyses of exchange rate determinants have been deepened, and greater candor in assessments and policy advice is evident. There is scope, however, for further improving the analysis of exchange rate policy issues in developing countries, despite the constraints imposed by data limitations. Looking ahead, efforts are underway to extend to a broader group of members the existing framework used in the analysis of exchange rate behavior and policies in advanced countries.

III.  Involving the Private Sector in Forestalling And Resolving Crises

43.  The involvement of the private sector is critical to forestall and resolve financial crises, and prevention remains the first line of defense against crises. Recent experience confirms that consistent macroeconomic and exchange rate policies, sound debt management designed inter alia to ensure an appropriate debt-service profile, and effective prudential supervision of financial systems are all critical elements of a policy framework designed to manage vulnerabilities and thereby reduce the frequency and severity of crises. At the same time, policies designed to improve the environment for private sector decision making can also contribute to reducing vulnerability. Improvements in the transparency of both the public and private sectors, as well as efforts to promote the adoption of, and adherence to, standards, should facilitate risk management on the part of investors. Also of note is the importance attached by private market participants to regular contacts between the authorities and market participants, to ensure the regular provision of information on economic developments and policies, and to maintain lines of communication both in good times and when possible difficulties in the country’s economic situation begin to emerge.

44.  The Executive Board noted that the need to secure appropriate private sector involvement now seems reasonably well accepted, including by the private financial community. In reviewing recent experience, Directors considered that the two recent cases of efforts to secure private sector involvement with members that had lost spontaneous access to capital markets through the restructuring of international sovereign bonds had been encouraging. Debt exchanges had been arranged successfully and, while it is premature to assess whether litigation may ultimately become an issue, it appears that in recent cases the risks of disruptive litigation were not as great as previously thought. Successful debt exchanges in these cases involved the recognition by creditors of the limited debt-servicing capacity of the debtors involved, and of the lack of palatable alternative outcomes. The precise form of the recent debt restructurings⁸ depended on the structure of the payments falling due, and the particular country circumstances and did not necessarily involve comparable treatment of all debt or maturities.

45.  The Executive Board sees merit in continuing to work toward an operational framework for securing private sector involvement, building on the principles and framework articulated by the G-7 Finance Ministers in their report to the Köln Economic Summit.

46.  Flexibility will be required in handling individual cases. The form of continued private sector involvement would depend on the circumstances of each case, as would the methods used to ensure it. The financing of the adjustment program of a member coping with a financial crisis would normally be based on the expectation that private sector exposure to the country would either be maintained above some level, or begin to be rebuilt soon after the emergence of a crisis. In some cases, reliance would be placed primarily on the IMF’s traditional catalytic role, with the strength of the IMF-supported adjustment program enhancing market confidence and therefore expected to lead to the restoration of spontaneous private capital flows. In cases where greater assurance was needed, the catalytic role of the IMF would have to be supplemented by measures to improve coordination among creditors.

47.  Assessing the appropriate means to secure private sector involvement in individual cases raises complex issues, and will require considerable judgment. A range of issues have a bearing on the approach to private sector involvement in individual cases, including the size of the financing requirements, both during the program period and over the medium term; the prospects for a spontaneous return to capital market access; the availability of tools for securing concerted private sector involvement; and the desirability of minimizing possible spillover effects on other countries. Reaching these judgements will require addressing complicated analytical issues.

48.  The basic principles underlying the IMF’s approach to private sector involvement should be to allow the IMF to support effective balance of payments adjustment programs leading to sustained growth and medium-term viability, while providing adequate safeguards to maintain the revolving character of IMF resources. These principles, in turn, require that programs with member countries be fully financed. In addition, it is important that the availability of official financing, in so far as possible, not create moral hazard by providing incentives for inappropriate lending or borrowing. The Executive Board stressed that, in making operational a framework for private sector involvement:

• contracts should be honored to the extent possible;
   
• members should seek cooperative solutions to emerging debt difficulties;
   
• no one category of private creditor should be regarded as inherently privileged relative to others; and
   
• the approach taken in individual cases should reflect a member’s specific circumstances, including the composition of outstanding debt instruments; and should be based on a substantive analysis of a country’s medium-term balance of payments prospects and debt sustainability.

49.  Executive Directors considered that the framework suggested by staff for private sector involvement (outlined below), in conjunction with the principles outlined in the preceding paragraph, constituted a useful start, but pointed to several problems in making it operational, including the difficulty of the underlying analytical judgements. Under the approach discussed, private sector involvement could be ensured primarily through reliance on the IMF’s traditional catalytic role:

• if the member’s financing requirements are moderate, or
   
• if the member has good prospects of rapidly regaining market access on appropriate terms, even in cases in which the financing requirements are large.

More concerted forms of private sector involvement could be required:

• if the financing requirement is large and the member has poor prospects of regaining market access in the near future, or
   
• if the member has an unsustainable medium term debt burden.

50.  The IMF’s approach to a given case requires a decision on how much financing the official sector is willing to make available in support of a member’s adjustment program. Most Executive Directors noted that the availability of IMF financing beyond that provided under the IMF’s access policy is quite limited and, while the Supplemental Reserve Facility (SRF) is available under specified circumstances, care should be taken to avoid creating the impression that the IMF, or the official sector as a whole, would fill all financing gaps. At the same time, the difficulty of determining ex ante the precise distribution between official and private sector financing was noted. Some Directors considered that there should be a presumption that private sector involvement will be secured, should the IMF’s financing in relation to the member’s quota exceed some limit. Others, however, considered that the size of the financing requirement was only one factor in deciding on concerted involvement and placed more stress on the need for a strong program that would assure the rapid restoration of market confidence and limit the risk to official resources.

51.  In cases in which reliance is placed on the IMF’s catalytic role and the assumption about the return to market access proves to be wrong, the risks to the program financing and the IMF’s resources would increase unless there was a switch to more concerted forms of private sector involvement. To justify the strategy of relying on the catalytic role, it is crucial that the authorities’ program be directed to rebuilding market confidence and removing any factors that inhibit the right sort of capital inflows, and that the authorities be fully committed to its sustained implementation. Some Executive Directors consider that a reduction of official financing might be needed in certain cases to ensure an appropriate balance in the contributions of the private and official sectors.

52.  When a member has an unsustainable debt burden, private sector involvement in a restructuring or reduction of that burden would be required. Determining whether a debt burden is unsustainable is a judgmental exercise, and it could take time for the member and its creditors to reach agreement on the extent of the problem and its solution. In such cases, the IMF would be prepared to lend to a member in arrears to its private creditors, as in other cases in which early support for a member’s adjustment program is considered necessary and provided the member was negotiating with its creditors in good faith.

53.  Where private sector involvement is required, its precise form will have to be decided on a case by case basis. Some Executive Directors considered that the approach to be taken in individual cases should seek to avoid prohibitive increases in the future cost of borrowing for the country concerned. Directors believed that, in general, efforts to involve the private sector would be concentrated on the debt payments associated with the immediate financing problem, and would thus not necessarily be comprehensive across all classes of private instruments. However, experience suggests that comprehensiveness within an asset class can contribute to a successful outcome. In addition, it is particularly important that no one category of private creditor be regarded as inherently privileged.

54.  Only limited progress has been made in lifting institutional constraints to debt restructuring. Executive Directors encouraged the establishment of creditor committees if needed and on an ad hoc basis, and see merit in incorporating collective action clauses into international sovereign bond contracts. The inclusion of such clauses in certain United Kingdom sovereign bonds was welcomed, as was the recent clarification of the status of such clauses by the German Government. Directors considered that temporary and voluntary market-based standstill arrangements could be desirable in some circumstances to minimize the risk of disruptive litigation, and some considered that there should be further consideration of issues related to a modification of Article VIII, Section 2(b).

55.  IMF staff have a role in informing creditors of the status of negotiations with the IMF, and of the member’s economic situation, including its adjustment program and payments capacity, provided this is acceptable to the member concerned. Nevertheless, it is important to maintain the principle that the IMF is not a party to the negotiations between a member and its creditors.

IV.  IMF Financial Facilities

56.  The Executive Board has initiated a fundamental review of the design and operation of the IMF’s non-concessional financing facilities to determine whether and how they need to be modified to meet members’ needs in a changing world economy.⁹ This review is a part of the broader debate on the architecture of the international financial system and touches on issues that go to the core of the IMF’s role in that system.

57.  Although the discussion is in its early stages, the Board has made substantial progress in streamlining—eliminating facilities that are not being used or no longer serve member’s needs. The Board has decided to eliminate the IMF’s policies on support for Currency Stabilization Funds and commercial bank Debt and Debt Service Reduction. With the elimination earlier this year of the contingency element of the Compensatory and Contingency Financing Facility (CCFF) and the Buffer Stock Financing Facility, this brings to four the number of facilities that have been eliminated since January 2000, in the effort to simplify the IMF’s facilities and make them more transparent to both members and the general public. In addition, the Compensatory Financing Facility (the remaining element of the CCFF) will be simplified substantially. In addition, the temporary Y2K facility expired, as planned, on March 31, 2000. Policies on use of IMF resources in the first credit tranche and on emergency assistance for natural disasters and post-conflict cases will be retained.

58.  With this agreement on what might be called "housecleaning" questions, the debate focuses on the more fundamental issues involved in determining whether the spectrum of facilities meets today’s needs and whether the terms of the facilities remain appropriate. The Executive Board has affirmed the IMF’s role in helping members adjust to large-scale crises of capital market confidence such as had occurred in the 1990s. In doing so, it stressed again the importance of stemming moral hazard and of involving the private sector in the resolution of crises. There was general agreement that the Supplemental Reserve Facility (SRF) had proved itself an appropriate tool since its creation in 1997. In part reflecting the limited experience with this facility so far, no modifications to the SRF are proposed at this juncture. However, potential modifications to other facilities will be explored, in particular to encourage crisis prevention efforts by members, including possible changes in the design of the Contingent Credit Lines (CCL) and in the use of precautionary arrangements for this purpose.

59.  The IMF’s more traditional financial operations—use of the upper credit tranches under stand-by arrangements (SBA) or the Extended Fund Facility (EFF)—continue to constitute the majority of the IMF’s arrangements, and it is generally expected that the SBA will remain the IMF’s principal instrument. The Executive Board is reviewing the focus and design of these facilities. A range of views have been expressed regarding the degree to which the use of IMF resources by members with ongoing access to capital markets is warranted or, conversely, is a cause for concern. There was broad agreement that there continues to be an important role for the EFF, although a variety of views were expressed on some of its modalities. The Board stressed, however, that access to the EFF should be available only in circumstances that clearly require and warrant its use.

60.  Among the specific issues that will be considered in further discussions are policies on the rate of charge on use of IMF resources, including possible differentiation of charges within and between facilities; maturities on use of IMF resources, including possible improvements in the policy on early repurchase; steps to address better cases of weak program implementation and consequent repeated recourse to IMF resources; and procedures for improved post-program monitoring of policies by the IMF while IMF resources remain outstanding.

61.  The issues involved in the orientation and design of IMF financing facilities are complex. Concrete decisions will both require greater clarity on the role of the IMF in the international financial system and be influenced by progress on other key aspects of the system’s design. These issues will continue to shape much of the Executive Board’s work in coming months.

Appendix I.  Progress in Strengthening the International Financial Architecture

(ii)  Other fora

Appendix II.  Key Recommendations of FSF Working Groups

The Working Group on Highly Leveraged Institutions (HLIs) was asked to assess the challenges posed by HLIs to domestic and international financial stability and to achieve consensus on supervisory and regulatory actions which would minimize their destabilizing potential. It has recommended improved market discipline through:

• Enhanced risk management practices by HLIs and their counterparties, and enhanced regulatory oversight of HLI credit providers, notably in terms of the recommendations promulgated by the Basel Committee, IOSCO, and the Counterparty Risk Management Policy Group.
   
• The development and dissemination of sound practices for risk management, internal controls, disclosure and documentation throughout the HLI community.
   
• The formation of a small group of experts from the Basel Committee and IOSCO to assess industry progress in the area of counterparty risk management (e.g. stress testing, liquidity measures, etc.).
   
• Further steps to improve documentation harmonization, collateral and valuation practices.
   
• Enhanced public disclosure by HLIs, and more generally, more comparable risk-based public disclosure practices among all types of financial institutions.
   
• Revision and development of industry guidelines and good practices for foreign exchange trading.

The Working Group on Offshore Financial Centers (OFCs)¹ was convened to consider the significance of OFCs in relation to global financial stability. It has proposed the following:

• The establishment of a process for assessing OFCs’ adherence to international standards, developed, organized and conducted by the IMF; with priority placed on OFCs with existing procedures for supervision and cooperation but where there is substantial room for improvement and those with the most significant financial activity; the international standards to be assessed would relate to cross-border cooperation and information sharing, essential supervisory powers and practices, and customer identification and record keeping.
   
• Consideration of a menu of incentives to be applied by relevant bodies or groupings, which would encourage OFCs to adhere to standards.
   
• More effective consolidated supervision in banking and insurance by onshore jurisdictions.
   
• The development of best practices for reinsurance and its supervision by IAIS.
   
• The development or completion of assessment methodologies by standard-setting bodies.
   
• Consideration of development of a set of good practices for provision and sharing of timely information on activities and ownership of corporate vehicles.
   
• Enhanced reporting (quarterly) by OFCs with significant financial activities to BIS.

The FSF Working Group on Capital Flows (CF) was established to examine ways to reduce the risks associated with capital flows. It has proposed the following:

• Improved risk monitoring at the national level, focusing on both sectoral and economy-wide risks and liquidity.
   
• Improved risk management by the public sector, including the development by the IMF and World Bank of guidelines for the sound practice of debt and liquidity management.
   
• Improved risk management by the banking sector, particularly banks in emerging markets receiving flows and international banks extending cross-border credit, with the help of revised guidelines from the Basel Committee on managing liquidity risk and possibly more explicit regulations to manage foreign exchange exposure.
   
• Greater risk management by non-bank financial and non-financial institutions to ensure prudent behavior, including actions by national authorities to promote good corporate governance.
   
• A higher level of transparency by national authorities through, for example, the disclosure of national risk and liquidity management operations, publication of annual assessment of economy’s liquidity conditions, and adoption and implementation of sound accounting standards.
   
• Improved data on aggregate external financial flows and positions, with efforts to clarify the importance of enhanced reporting and to fill gaps on data provision, particularly from creditor and market-based sources of data on external debt.

Appendix III.  Developing International Standards in Areas Outside the Fund’s Direct Operational Concern