Speech

Achieving Financial Stability: An International Perspective -- Address by Shigemitsu Sugisaki, Deputy Managing Director of the IMF

May 26, 2002

1. It is a great honor to attend the First Annual Forum of APEC's Finance and Development Program. This is a significant initiative, which recognizes the critical importance of a robust and well-managed financial sector to economic growth and financial stability. Indeed, financial sector issues lie at the heart of the challenges facing many countries represented here today, and the international community more generally. We have frequently seen the costs of poorly managed and regulated financial sectors, and countries in APEC and elsewhere are still dealing with the legacy of crises that had their origins in the financial sector. Thus, we have much to learn from our joint experience in how to prevent such crises, how to promote needed financial and corporate restructuring, and how to ensure that the financial sector plays its full role in promoting sustainable growth and poverty reduction.

2. So, this initiative is very timely, and I commend the Chinese authorities for proposing it, and APEC for bringing it to fruition. For our part, the IMF remains ready to support this and the other activities of APEC in those areas where the expertise of our staff can be of most use. You have already discussed the important linkages between financial sector development and growth, and the lessons and prospects for financial restructuring in Asia. This session focuses on the international perspective. I propose to briefly review our efforts to strengthen the international financial system—in particular, the role of the IMF—and then turn to how individual countries can contribute to global financial stability.

I. Strengthening the International Financial Architecture

3. As you know, reform of the international financial system took center stage in the aftermath of the crises of the 1990s, and we have since strengthened our approach to promoting international financial stability. Vulnerabilities linked to volatile private capital flows, weaknesses in banking and corporate sectors, and contagion revealed by the recent financial crises have been at the root of these changes.

4. Our main priorities at the IMF have been on strengthening surveillance and crisis prevention. We cannot expect to eliminate all future crises, nor can we expect to be able to fully anticipate them. However, we can do a better job of reducing the risks of crises by promoting sound policies and the development of strong institutions by our member countries, as well as better risk assessments and investment decisions by market participants. Let me enlarge on our recent work in this area.

Crisis Prevention Initiatives

5. The first initiative has been enhanced surveillance of capital markets and assessments of external vulnerability. Here, we seek to combine qualitative analysis of individual country circumstances with vulnerability indicators and other quantitative tools. These assessments draw on a broad range of inputs, including our latest global forecasts, capital market indicators, detailed assessments of the financing requirements for borrowing countries, financial sector vulnerability assessments, early warning system models, and the country- and region-specific expertise of our staff. In recognition of the predominant role of large and potentially volatile private capital flows, we have also created a new International Capital Markets Department, which has begun publishing a quarterly report on global financial market developments.

6. The second initiative is on standards and codes, where among other things we are seeking to provide a stronger basis for investors to make judgments about the allocation of private capital. The IMF has begun producing Reports on the Observance of Standards and Codes (ROSCs), which aim to enhance the coverage of institutional issues, in particular on data dissemination, fiscal transparency, monetary and financial policy transparency, and financial sector issues. We have already made considerable progress—as of end-March, 221 ROSC modules had been completed for 73 countries (including 33 for APEC members), of which 74 percent had been published. The Fund is also consulting with the Financial Action Task Force regarding the preparation of a ROSC module on anti-money laundering.

7. The third area is financial sector strengthening. A key initiative in this regard is the Fund-Bank Financial Sector Assessment Program (FSAP), which aims to strengthen the monitoring of financial systems, identify vulnerabilities, and help countries develop appropriate responses. Member countries that have undertaken an FSAP have found the process to be valuable in providing, among other things, an independent review of their national financial systems that draws upon best international practices and provides them with important information on areas where their frameworks can be strengthened. We have also extended our financial sector work to include offshore financial centers (OFCs). As of end-March 2002, 27 FSAPs had been completed (of which three were for APEC members, with a further four expected in the next year or so). Twenty-two voluntary assessments of OFCs have been completed, and 3 such assessments are planned for APEC members.

8. The fourth area is transparency. Here, the Fund has made a fundamental shift in its approach and now publishes most of its assessments of its members' policies. Since the January 2001 transparency decision, 89 percent of Article IV consultations have led to Public Information Notices (PINs), which summarize the Executive Board's discussion, and we have published more than half of all country staff reports—for Fund members in general and for APEC members in particular—and 96 percent of the Letters of Intent and Memoranda of Economic Policy describing countries' plans for economic reform supported by IMF programs. The Fund has also become much more open in its own policy work, publishing almost all of its policy papers; increasing its dialogue with non-governmental organizations and the private sector on policy issues; and creating a new Independent Evaluation Unit (IEO) to complement its existing review and evaluation procedures.

Crisis Resolution

9. In parallel with these efforts, we are working on ways to strengthen the Fund's capacity to assist members to handle crises appropriately, and also to develop crisis-resolution mechanisms that serve to strengthen the international financial architecture.

10. Here, we are focussing on three core areas: increasing the Fund's capacity to assess the sustainability of a country's macroeconomic policies and debt profile; clarifying the Fund's access policy, particularly for members facing capital account crises; and working towards a more orderly and transparent legal framework for sovereign debt restructurings.

11. This work recognizes that judgments on whether financial support from the Fund, combined with strong adjustment policies, will be sufficient to restore financial and economic viability to a member in difficulty, are rarely clearcut, and that the financial resources that the Fund has available to help its member countries are inherently limited. These issues are particularly important in the case of capital account crises, involving countries with significant interactions with global financial markets.

12. It also recognizes that we need a framework that makes reaching agreement between a sovereign debtor and its creditors more rapid, orderly, and transparent in those cases where the debt burden is unsustainable. This is among the most crucial but also the most complex components of international financial reform.

13. A number of options for improving the framework for sovereign debt restructuring are being considered, and progress has accelerated in the past six months. This work has benefited from preliminary discussion by the IMF's Executive Board; support from the International Financial and Monetary Committee at the recent Spring Meetings; and inputs and feedback from our member countries, non-governmental organizations, the private sector, and academics. The options include a change in the contractual provisions used in individual sovereign debt contracts to incorporate comprehensive restructuring clauses, and a more far-reaching statutory approach that would allow a range of claims to be aggregated for the purpose of reaching a binding agreement with all creditors. We will be continuing to work intensively on these issues in the period ahead.

14. In summary, reform of the international financial system has involved a number of changes in the ways in which the international financial institutions do business. The increasingly integrated international financial system has raised the need for greater coordination within the international community on the reform agenda, including at the regional level, and for intensified collaboration with the private sector. Yet, more remains to be done, and the IMF is continuing to work to strengthen its analysis and policy advice on the issues that matter most for macroeconomic stability, external viability, and growth. This implies, for example, greater candor in the assessment of exchange arrangements and exchange rates, uniformly rigorous coverage of financial sectors, strengthened vulnerability assessments, and deeper coverage of relevant structural and institutional issues. Also, particular attention needs to be paid in bilateral surveillance to the systemic impact of the policies of the largest economies.

II. Individual Country Actions

15. Let me now turn to how individual countries can contribute to the stability of the global financial system. The key here is for them to address their points of vulnerability to crisis—with each individual country taking the necessary actions to become more resilient to shocks, so the entire system will become more resilient. Overall, there is evidence that the actions taken by national authorities to reduce their vulnerability to crises are beginning to bear fruit. This reflects efforts in several areas, including the shift to more flexible exchange rate regimes, except in cases where a peg is judged to be a suitable alternative; the adoption of sounder macroeconomic policies; and progress in the restructuring of financial institutions and corporations.

Exchange rate arrangements

16. One of the key lessons drawn from recent experience is that, for the emerging countries in Asia as well as countries elsewhere with heavy involvement in global financial markets, the policy requirements for maintaining a currency peg have become increasingly demanding. Recent experience has also demonstrated that the costs of a forced exit from a fixed exchange rate regime, after a period of resistance against mounting pressures, can be huge. Against this background, floating exchange rate regimes have become the preferred choice for many emerging market economies that, by definition, have substantial involvement in global financial markets. Of course, this is not to say that, for certain economies, a pegged exchange rate regime, buttressed by the requisite supporting policies and institutions, cannot be a viable alternative. For such economies, in general, the harder and more rigid the peg, the better.

17. I should add a couple of observations on the appropriate modus operandi of floating rate regimes.

· First, for floating regimes to function effectively, it is important that exchange rates are allowed to actually move—in both directions—in response to market forces. Only such movements can persuade economic agents to recognize, and to manage prudently, the foreign exchange risks that are inescapable for countries open to global financial markets.

· Second, this does not imply a policy of benign neglect toward the exchange rate. For emerging market countries, with their high degree of involvement with global trade and finance, movements in exchange rates have important economic consequences, and economic policies, including monetary policy and exchange market intervention, need to take account of these movements.

Macroeconomic policies

18. A more flexible exchange rate regime means a need for an alternative nominal anchor. In this regard, many advanced economies and an increasing number of emerging market economies with flexible exchange rates have moved to formal or informal inflation targeting regimes.

19. Making these efforts successful requires work on several fronts, including:

· Developing an institutional framework that allows for greater central bank independence in the conduct of monetary policy.

· A strengthened analytical and forecasting framework as a basis for making monetary policy judgments.

· Efforts to strengthen the monetary policy transmission mechanism, including through market-determined interest rates and sound financial institutions making loans on a strictly commercial basis.

· Greater transparency in explaining the central bank's monetary policy objectives and policy actions to enhance the predictability of those actions and build policy credibility.

20. Successful inflation targeting—and indeed, any form of sound monetary policy on a sustained basis—is not possible in the face of fiscal dominance. More generally, the importance of consistent implementation of sound fiscal policy with medium-term debt sustainability has been proven time and again. I am aware that many of the countries represented in this forum have had a tradition of prudent fiscal management and low public debt. However, in recent years, several of them have witnessed a significant deterioration in their fiscal balances and increases in debt levels, partly because of the huge needs related to cleaning up of the banking system. Accordingly, I must stress that putting fiscal policy on a sustainable medium-term path must be a priority.

Structural reforms

21. The effectiveness of macroeconomic policies in responding to external shocks also depends critically on the structural soundness of the economy and the efficiency of its key institutions. In particular, the recent crises have amply demonstrated that a strong and healthy financial sector is key to weathering shocks and sustaining growth. While there are signs of progress in financial sector restructuring in many countries, further efforts are necessary, including:

· Additional progress on bank restructuring, including strengthening loan approval practices, improving risk assessments, tightening internal controls, rationalizing branch networks, and reducing staffing;

· reducing further nonperforming loans of banks;

· continuing to improve prudential oversight geared toward sound risk management; and

· removing government interference in lending decisions and improving internal governance, so that banks follow commercial principles.

22. The other side of the coin is the performance of the corporate sector. On this front, progress has been slower and incomplete, both in Asia and elsewhere, with the debt overhang still high in many countries. Among the reforms needed to help improve performance in this sector are:

· improved legal frameworks and judicial systems to speed up debt resolution; and

· strengthened corporate governance through enhanced minority shareholder rights, disclosure requirements, and accounting standards to foster greater market discipline and ensure that corporations are not taking excessive risks and are acting in the best financial interest of all owners and creditors.

23. Structural reforms are needed also in other areas, but the set of policies I have outlined is critical to achieving sustained growth and financial stability in each country. In turn, the efforts of individual countries will be reflected in greater global financial stability (as reflected in the Chinese proverb "a cloth is not woven from one thread").

24. The numerous efforts underway to strengthen regional economic and financial cooperation in Asia, such as APEC itself, the Manila Framework Group, ASEAN, and the "Chiang Mai" initiative also can play a very useful role in helping to foster regional and global financial stability. These fora and initiatives promote the exchange of information and policy dialogue among countries, which I see as a very useful complement to the efforts of global institutions like the IMF to promote stability and prosperity in the world economy.

III. Concluding Remarks

25. In conclusion, today I have talked about the efforts that are underway in individual countries and the international community to achieve and maintain financial stability. My remarks have focused more on efforts to prevent a crisis than those to deal with a crisis. The latter of course is an important issue, and has recently been hotly debated in many international fora, but I believe that the first priority should be to prevent a crisis.

26. Most, if not all, of recent external crises are so-called capital account crises, where international capital flows play an important role. The steps I have spoken about today to strengthen international financial architecture and to improve individual countries' policies and institutions should go a long way not only toward safeguarding global and domestic financial stability against volatility of international capital flows but also toward maximizing the economic benefits of such flows. Of course there are further issues that need to be addressed, such as an appropriate sequencing of capital account liberalization and pros and cons of capital controls. These, however, are topics for another occasion.

With these remarks, I wish the APEC Finance and Development Program every success. Thank you.