Speech

The IMF and Developing Countries: from Myths to Realities -- Address by Alassane D. Ouattara

November 10, 1998

Mr. Chairman, ladies and gentlemen, thank you for inviting me to join in your reflections on what is at stake for industrial and developing countries as they prepare for the twenty-first century. Certainly, for developing countries these days, it is no easy task charting the best path forward. In some ways, the world seems turned upside down. Countries with strong track records on growth and poverty reduction—some of the "miracle" countries—get hit hard by financial crisis. Economic problems in Russia trigger bouts of loss of confidence in other emerging markets. And countries that are the least integrated into the world economy seem to fare the best in avoiding contagion.

Has the world gone mad? Has logic been turned on its head? Perhaps most important for us gathered here today, is the answer to pull back and eschew the benefits of integrating more closely into the global economy out of fear that the costs will prove too great?

I do not believe that is the answer. But, then, is enough being done to stop the spread of turbulence? In my remarks today I would like to address these two issues, and then take a look at efforts under way, looking beyond the near term, to minimize the costs of globalization and maximize the benefits.

Myth one

Myth one: developing countries should pull back and slow down liberalization to reduce their vulnerability. The reality is that East Asia benefitted greatly from its openness over the past few decades, with impressive economic growth and an enviable record on poverty reduction—achievements that the current crisis will not erase. Just take the case of Korea. By 1999, even after two years of recession, Korea’s real GDP will still be more than 50 percent higher than a decade before. And from there, it will build again.

So what went wrong in Asia? A question that will be debated for some time to come. We do not have all the answers yet, and we remain open to outside analysis. But we do know that times have changed, in the sense that high capital mobility makes deficiencies more readily apparent. Thus, it is no longer enough to concentrate only on high savings and investment and expanding trade. Also needed are predictable and rational economic policymaking; transparency and accountability in government and corporate affairs; reliable and timely information; a strong banking system that is well regulated and supervised; a level playing field; a sound legal system that guarantees security of contract and protects property rights; the elimination of corruption and nepotism, etc....

We also know that liberalization of the capital account must be carried out in an orderly, properly sequenced manner, carefully married to a strengthening of domestic financial systems. Let me give a few examples of the possible pitfalls, and here, Asia is not alone:

• Both Korea and Thailand encouraged short-term flows at the expense of long-term flows, so when pressure developed, the short-term exposure dramatically increased the vulnerability of the banking sector—and ultimately, of the nonbank corporate sector.

• Banks and corporations in Indonesia, Korea, and Thailand borrowed heavily in foreign currencies, failing to hedge themselves adequately against the exchange rate risks. When these countries’ currencies depreciated, the effect was devastating. Many banks and corporations were plunged into insolvency, contributing to a collapse of private investment in the region.

• Capital inflows to Asia helped finance booms in real estate and equity markets. When these booms turned to bust a year or so before the crisis, the resulting losses helped fuel the failures of financial institutions that built up to the crisis.

• Russia and Ukraine financed unduly large budget deficits over an unduly long period of time in a way that led to a level of short-term exposure that proved unmanageable.

But what is important here is that these vulnerabilities in the system can be corrected, while still providing the opportunity to exploit the real benefits that international capital flows can bring: providing scarce investment resources, encouraging allocative efficiency, and helping to effect a transfer of technologies. This message is particularly vital for Africa, with its low rates of domestic savings, high population growth, and an overdependence on a few primary commodities.

So let us not throw the baby out with the bathwater! As Poland’s Deputy Prime Minister, Leszek Balcerowicz, cautioned us at the Annual Meetings: "Globalization should not be the whipping boy in the debate about the current crisis. Globalization rewards those with responsible economic policies but carries risks for countries which avoid or delay reforms and disregard basic requirements of macroeconomic discipline." I could not agree with him more!

This being said, we do recognize that there might be circumstances when temporary capital controls could be called for—and this is a matter that we will be studying. Our main worry, however, is that any temporary breathing space such measures might bring would be outweighed by the long-term damage to investor confidence, the distorting effects in resource allocation, and the loss of discipline and incentives that capital flows can bring. We wonder, for example, whether the incentives to deal forcefully with problems in the domestic financial system would not be weakened by these controls.

Myth two

Myth two: the international response to the current financial crisis has been inadequate. The reality is that after 16 months of bleak economic news, there is more universal commitment to halt the economic virus and return the global economy to sustained health and growth. At last month’s Annual Meetings of the IMF and World Bank, the G-7 nations, in a major policy move, agreed that the balance of global risks had shifted from concern about inflation to a need for them to serve as engines of growth—a view reinforced by the G-7's recent statement. The United States has trimmed interest rates twice in a short period of time. Europe is nudging interest rates down to the French and German levels. And Japan has passed critical banking legislation and reaffirmed its commitment to tax cuts and higher public spending.

The international community has also reiterated its support for increasing the IMF’s financial resources so that it can continue to do its job. Shortly after the meetings, the U.S. Congress moved to approve what had been perceived as controversial IMF funding. It will free up funding from other countries as well—including the New Arrangements to Borrow—which should put a total of about $90 billion at the Fund’s disposal to tackle future crises.

The next major recipient will no doubt be Brazil, with a financial package—now being finalized—that should help lift a major element of uncertainty that has been hanging over world markets. Brazil has moved steadfastly to craft a three-year program of fiscal and structural reforms for its own sake and that of its neighbors. Indeed, Latin America as a whole deserves praise for its quick, decisive actions over the past year to fend off contagion.

Taken together, do these moves add up to an inadequate response by the international community to the crisis? I think not. Quite the opposite is true. Already, we see encouraging signs in Asian financial markets, with higher share prices, firmer currencies, and lower interest rates. In Thailand and Korea, growth is expected to resume in the latter half of next year, and in Indonesia, the steep fall in output is finally showing signs of bottoming out. These countries must now focus on rolling back the human cost of the crisis, by using fiscal policy, among other things, to back social safety nets and invest in health and education.

Moreover, as African finance ministers and central bank governors reminded us at the Annual Meetings, we must also turn our attention to quickly replenishing the IMF’s concessional loan facility (ESAF), so that the IMF can better support the reform efforts of low-income countries and the debt initiative for the heavily indebted poor countries—the HIPC Initiative.

On the HIPC front, two recent IMF Executive Board decisions spell good news for Africa and others. The first, to give countries an additional two years, until end-2000, to qualify for HIPC assistance—a move that will enable many more countries, some of which are emerging from conflict situations, to participate in the Initiative. The second, to allow programs supported by emergency post-conflict assistance to count toward the HIPC track record. In the two years since the Initiative was launched, commitments of more than $6 billion in debt service relief have been made to seven countries—Bolivia, Burkina Faso, Côte d’Ivoire, Guyana, Mali, Mozambique, and Uganda. Over the coming year, we hope to consider a number of others. So I call on all eligible countries, including those emerging from conflict, to take the needed policy measures with all possible speed so that they can take advantage of the Initiative.

A better system

All this said, the world needs to do better to lessen vulnerabilities. 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 issues are too complex. The task is monumental. But after much debate, in many fora, financial leaders have zeroed in on a mix of building blocks that embrace 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:

• First, greater transparency. This pertains to all the major players in the world economy: the public and private sectors, financial markets, and the multilateral institutions. Timely and detailed information has a crucial contribution to make to stabilizing markets by leading to more rational investment decisions and sounder policymaking. The IMF has taken a number of steps in this direction of late, including the establishment of standards to guide countries in publishing a regular and timely flow of comprehensive economic and financial data. These standards must now be beefed up, especially in the areas of international reserves and private external debt. We will also look into whether additional disclosure requirements or regulations are needed on the operations of institutional investors, including highly leveraged ones. The Fund has, I believe, made considerable strides itself in recent years in lifting the veil on its own work and processes. Please go to our website—www.imf.org—and judge for yourself. And we are doing more every day.

• Second, sounder financial systems. It is striking that around the world, for the past five years, every major financial crisis has been either caused, or exacerbated, by massive banking sector weaknesses. For some time, the Fund has been helping to disseminate a set of "best practices" in the banking supervision area—as developed by the Basle Committee—so that standards and practices that have worked well in some countries can be adapted and applied in others. We are stepping up our efforts to identify financial sector vulnerabilities with potential macroeconomic implications, suggesting corrective policy steps. And we are increasing our collaboration with the World Bank to ensure that the resources for financial sector supervision are efficiently deployed.

• Third, better international standards. In an effort to bring order to the unruly, fast-paced international markets, financial leaders agree that we need to quicken efforts to establish international standards and codes of good practice. Besides the best practices on banking, this includes the Fund’s recent adoption of a code of good practices on fiscal transparency, and in the months ahead, the Fund hopes to craft a similar code on financial and monetary policies. These efforts will now be stepped up and broadened to cover other important areas, such as accounting, auditing, disclosure, asset valuation, bankruptcy, and corporate governance—domains, of course, where the definition of standards will have to be the responsibility of other relevant international agencies.

• Fourth, greater private sector involvement. At a minimum, the private sector should be involved, in a voluntary and cooperative fashion, in forestalling and resolving financial crises. Indeed, this is essential, as the private sector is the primary source of finance for many countries. To this end, the Fund will study what market-based mechanisms can be used to cope with sudden changes in investor behavior. And it will widen the scope for lending to countries, still under very special circumstances, in arrears to the private sector. This notion of "bailing-in" investors and creditors is bound to be complicated. Indeed, it is the most complex and difficult of all the building blocks. But already a number of possible alternatives are being actively examined.

In closing, I would just like to go back to my opening question: Should developing countries pull back and slow down liberalization efforts to reduce their vulnerability? Clearly, my answer is no. For that would condemn them to marginalization and create even wider income disparities between the North and the South.

Thus, we must be careful to distinguish between the need to protect against vulnerabilities of the system, and the temptation to yield to superficially attractive options, such as protectionist measures. And the IMF will do its part to help ensure that these systemic vulnerabilities are reduced and a more durable international monetary system built—one that we can count on for the twenty-first century.