The Global Economic Outlook and Developments in Financial Markets

We share the IMF's cautiously optimistic assessment on the global economic outlook. This cautious optimism, however, is clouded by a number of down-side risks which originate both from political and economic factors. From our point of view, three developments deserve special attention: (i) cyclical developments in industrial countries, (ii) further shifts in sentiment on financial markets, and (iii) the evolving situation in key emerging market economies.

The most recent economic indicators in the United States still fail to show a clearly-defined upward trend. Private consumer demand has remained comparatively robust and hitherto managed to compensate for other less favourable developments. The current policy mix in the US is overall appropriate. However, the near-term outlook remains uncertain. In the medium term, a gradual but marked reduction of the internal and external imbalances will be necessary.

The cyclical recovery of the economies of the Euro-area has been underway since the beginning of the year, though with considerable uncertainties regarding its strength. Early indicators point to continued growth in the coming months.

In line with overall developments in the Euro-area, in Germany the economy began to grow again at the beginning of this year. Following two quarters of slightly negative growth in 2001, German GDP rose by 0.3 per cent in each of the first and second quarters of 2002. Taken together, latest data support our expectation of a continued moderate recovery, although increased risks at the global level have dampened these prospects somewhat. We still expect GDP growth for the year 2002 totalling ¾ per cent. The achievement of more dynamic economic growth rates depends on the stabilization of consumer and investor confidence. The Federal Government's key contribution in this respect will be a continuation of structural reforms, in particular with regard to labour markets. Therefore, the new Federal Government will start implementing additional labour market reforms as quickly as possible. These new measures, as well as those reforms which have already been implemented (e.g. tax reform, pension reform, 4th Financial Market Promotion Law) will unlock hitherto unused growth potential of the German economy, thereby reducing unemployment - still Germany's main economic challenge.

In Japan, it would be premature to qualify the slight rise of GDP in the second quarter as a sustainable upturn: the observed growth was almost exclusively attributable to export demand, while domestic demand has not yet strengthened. Fiscal and interest rate policy have almost exhausted their potential. The Bank of Japan recently announced new and unconventional measures to stabilize domestic financial markets. The success of this new approach depends on the implementation of overdue structural reforms in financial and product markets. Dealing decisively with the problem of non-performing loans in the Japanese banking sector will remain the central issue in this regard.

Global stock markets experienced sharp price adjustments during the past months. Investor confidence has been depressed by recent corporate accounting scandals as well as the uncertainties surrounding the development of the oil price, especially in view of the tensions in the Middle East. Persisting doubts about the strength and sustainability of the global economic recovery put further pressure on stock markets. This may weaken private consumption through negative wealth effects, while worsened financing conditions and a negative effect on the business climate could hamper private investment activity. Falling stock prices also put pressure on balance sheets of institutional investors.

Despite these tensions, the financial sectors in the US and Europe are sound and stable. Generally, banks have a sound capital basis and are now reaping the fruit of increased investment in the area of risk management.

We appreciate the important work of the Financial Stability Forum (FSF). At the same time, the IMF's contributions to strengthen market integrity and the stability of the international financial system remain essential. In particular, we wish to highlight the increasing number of Financial Sector Stability Assessments (FSSA), the wide-spread Reports on the Implementation of Standards and Codes (ROSCs), and the intensified fight against money laundering and the financing of terrorism.

As far as prospects for emerging market economies are concerned, one needs to differentiate. Prevailing uncertainties have contributed to the fact that international investors are re-examining their exposure more cautiously than at the beginning of this year. In emerging Asia, economic signs point to an impressive recovery, while other countries have come under serious pressures in recent months. Countries with underlying weaknesses experience contagion effects. While a number of countries in the western hemisphere are facing a significant break down of private capital inflows, Asia and emerging Europe continue to attract capital inflows at a substantial level. In this situation, it is all the more important to reinforce the commitment to sound economic policies to renew and strengthen confidence of domestic and foreign investors. Countries not successful in this regard will have to face lower growth rates.

Notwithstanding current crises, much has been achieved in the past few years. Some emerging markets enjoy impressive successes in macroeconomic stabilization, and many have made important progress concerning liberalization and privatization. Still, deficiencies in

economic policy formulation and implementation, or the coincidence of economic and political shocks, have contributed to the deterioration of investor's sentiment regarding emerging markets. We see the following key challenges:

• Formulating and implementing coherent and effective budgetary policies
  
  
• Preserving and strengthening the stability of domestic financial and banking systems;
  
  
• Increasing awareness concerning risks emanating from the currency composition and term structure of a country's financial assets and liabilities, including improved analysis of the sustainability of domestic and external debt.

There is an important role to play for the IMF in all of these areas to further strengthen crisis prevention.

To conclude our views on the global economic outlook and financial market developments: Uncertainties do not yet add up to trends. It is now essential to stabilize and improve confidence.

• While macroeconomic policies in advanced economies are accommodating structural reform efforts have to be continued.
  
  
• Regarding developments in financial markets, national and international efforts to strengthen market integrity and improve corporate governance must be reinforced.
  
  
• A commitment to free international trade and to overcome different views on trade issues will contribute to stabilize the global economic recovery.

Strengthening Surveillance and Crisis Prevention

We welcome the progress achieved so far in strengthening the IMF's surveillance. The Fund's surveillance function is the most important tool to prevent crises. Therefore, we should continue to further improve the framework for surveillance.

The increasing number of assessments of members' observance of standards and codes and the intensified financial sector assessment efforts are encouraging and are serving as a valuable instrument to promote better risk assessments by market participants. In the same vein, enhanced transparency both on the part of members and the Fund itself will facilitate better assessments of risks by borrowers and creditors. However, we must also make sure that the desired increase in transparency does not impair the candor, frankness and openness of consultations between Fund staff and authorities.

The publication of Global Financial Stability Reports is a major step in strengthening the Fund's multilateral surveillance of international financial markets. We commend the frank and balanced presentation of risks and vulnerabilities of the international financial system. Furthermore, the report is a valuable contribution to the necessary outreach of the IMF to the private sector.

Regarding bilateral surveillance, particular attention should be paid to the assessment of exchange rate developments and exchange rate regimes. Past crises have shown that the choice of the exchange rate regime can have an important impact on a country's external vulnerability. We support the inclusion of a debt sustainability analysis and the public and private sector's balance sheets exposure to interest rate, exchange rate, and other macroeconomic shocks into Article IV staff consultations. Furthermore, we welcome the intention to include into every Article IV staff report an assessment of the policy actions taken by the authorities in response to the advice offered by the Fund in the past.

It is important to ensure the independence of surveillance-work, in particular in countries which have an adjustment program supported by IMF financial resources. In this vein, we welcome the program-work of the IMF is now subject to a more critical and regular internal examination. An institutional separation of surveillance and program activities would, however, sacrifice valuable synergy effects and could make a coherent and conclusive country analysis more difficult to achieve.

In light of the experience of recent years, crisis prevention is more important than ever. However, whether the Fund's Contingent Credit Lines (CCL) can effectively contribute to such crisis prevention, is doubtful. Therefore, there is little reason to make access to the CCL easier to facilitate its use. Since demand from potential users of the CCL is lacking, we see no merit in further promoting this instrument. Recent developments have also demonstrated that important policy issues still need to be clarified. For example, in cases of dollarization, associated risks and possible institutional implications would need to be analyzed and fully understood.

Crisis Resolution

Some progress has been made in our joint effort to ensure better involvement of the private sector in preventing and resolving sovereign debt crises. We support the ongoing parallel work on Collective Action Clauses (CACs) and a Sovereign Debt Restructuring Mechanism (SDRM). CACs should become a market standard in all major financial centres for foreign currency bond issues, thus broadening the positive experience of jurisdictions, where CACs have been applied for a long time. However, it will not be easy to proceed from design to implementation. Progress has also been made in outlining specific features of a SDRM. Discussion in the IMF Board has shown that there is broad support for a SDRM, with a limited role of the Fund. Yet, many practical and legal issues require further analysis. In our view, it is important to maintain the current momentum of work on a SDRM. We welcome the work done to date by the IMF on statutory sovereign debt restructuring mechanism and look forward to considering a concrete proposal at its spring meeting.

To facilitate a voluntary agreement between debtors and creditors for a timely and comprehensive debt restructuring, a rules-based IMF lending policy, based on the existing quota-related access limits, would be a necessary requirement. Capital account crises do not

justify per se exceptional access. Rather to the contrary: the distinct character of capital account crises requires a particularly high contribution from the private sector.

Exceptional access to IMF resources should be limited to rare, truly exceptional circumstances. As a starting point, exceptional access decisions must be predicated on very prudent debt sustainability analyses. In this respect, the fact that a crisis has happened should always be warning enough that the country's debt sustainability might have been seriously shaken. Enhanced debt sustainability assessments will therefore strengthen the case for debt restructuring in the resolution of capital account problems.

The sustainability of the country's debt situation is also a necessary precondition for both—access to Fund resources above normal limits and the restoration of access to private markets. In cases of exceptional access particular consideration should also be given to the extent to which balance of payments problems could by their character or size threaten the stability of the international monetary system. However, exceptional access should in principle also be open for smaller debtor countries. The terms of the New Arrangements to Borrow (NAB) could in this context provide useful guidance, since the NAB terms include not only a systemic threat from the "size" of a debt crisis but also from the "character" of such a crisis.

The Fund's Role in Low Income Countries

It is generally the poorest countries that are hardest hit when the global economy weakens. Yet the developing countries as a group held up surprisingly well in the past global slowdown. They clearly benefittet from improved macroeconomic policies, fewer armed conflicts and debt cancellation under the enhanced HIPC. The two international conferences this year in Monterrey and Johannesburg have confirmed that combating poverty can succeed only through true partnership between developed and developing economies (Global Compact).

The IMF, under its mandate as a monetary institution, can make an important contribution in this respect by promoting macroeconomic and financial stability also in the poorest of its member countries - an essential prerequisite for effectively reducing poverty. The Poverty Reduction and Growth Facility (PRGF), the IMF's key instrument in its cooperation with the poorest countries, is based on the concept of assigning responsibility and "ownership", and is thus an important starting-point for achieving more effective and better-coordinated development assistance and, by extension, for implementing the concept of a global compact.

Implementation of the enhanced HIPC initiative is making good headway. However, it is clear from the progress report submitted by IMF and World Bank staffs that problem areas remain. In this connection, we call on all creditors, and especially non-Paris-Club creditors, to make

their contribution to debt cancellation under the HIPC initiative. While progress has been made in this area, further efforts are required to make sure that countries receive the full relief provided for under the initiative.

Moreover, further efforts by donor countries are needed in respect of the financing of multilateral debt remission under the HIPC initiative. Current IMF and World Bank estimates put the funding gap in the HIPC Trust Fund at US$ 750–800 million. Commitments must be undertaken by as many donors as possible in order to close this gap. Germany is prepared to make its contribution, subject to appropriate burden-sharing.

The principle of good governance has special significance within the framework of the HIPC initiative. Thus only such countries that comply with good governance principles should benefit from extensive debt cancellation under the HIPC initiative.

The objective of bringing down the debt of HIPCs to sustainable levels means that realistic economic and export growth forecasts are needed as impute for the debt sustainability analysis for HIPCs. We welcome the improvements reached in this area, for example by including stress tests. If countries at the completion point have a debt level exceeding the target for HIPCs on the account of exogenous shocks (such as a marked fall in the price of key export goods), the existing HIPC initiative which provides scope for additional debt relief at the completion point is already flexible enough to cope with this problem. Besides this, We consider it important for the debt sustainability of HIPCs to continue to be monitored after they have reached the completion point, to preclude any renewed unsustainable rise in the debt level.

Combating Money Laundering and the Financing of Terrorism

Germany like other IMF members has made considerable progress in putting into place the agreed upon anti-money laundering and counter-terrorist financing measures. [As a member of the FATF, Germany has implemented the 8 FATF Special Recommendations on combating terrorist financing by enacting several new provisions within the framework of the Act on Combating Money Laundering and the Banking Act. and will focus on promoting these FATF Standards in non-member countries and concentrate all efforts on encouraging all jurisdictions world-wide to implement the necessary measures to combat money laundering and terrorist financing.

We believe that the cooperation between FATF, IMF and World Bank will further help to incorporate these standards internationally.] We welcome the intensification of cooperation between IMF and FATF in anti-money laundering and counter-terrorist financing matters. We also welcome the progress of the common and comprehensive methodology of IMF, World Bank and FATF, which is intended to become the basis for both Fund/Bank-led assessments and the mutual evaluations by the FATF.

The Twelfth General Review of IMF Quotas

In assessing the financial position of the Fund, the developments in the world economy as well as the future role of the Fund as creditor must be taken into account. Against the backdrop of current IMF lending policies and its overall financial position, the IMF has sufficient financial resources to fulfill its tasks. Discussions in the context of the Twelfth General Review of Quotas have shown that there is broad agreement that quota subscriptions should remain the principal source of financing for the Fund. Given the current liquidity situation of the Fund we are confident that the Fund will be able to respond adequately to members' future financing needs.

Ample Fund resources could bring about wrong incentives and could thus prove counterproductive. The expectation of large financial packages would distort risk evaluation of private investors and hence, increase the probability of future financial crises. The efforts to stabilize the international financial system would be weakened.

For these reasons, Germany supports concluding the Twelfth General Quota Review without a quota increase.

Streamlining Conditionality and Enhancing Ownership

We welcome the important steps that have been taken to streamline the Fund's conditionality which are reflected in the new Guidelines on Conditionality. The limited and more focused use of structural measures will strengthen ownership and therefore will help to ensure the success of a program. Close co-operation between the IMF and the World Bank on the issue of conditionality will further strengthen coherence of both institutions' programs. In any case, greater ownership cannot be "bought" by dispensing with conditionality. The ultimate goal of all our efforts to improve conditionality is not minimal or soft conditionality but optimal conditionality.

Independent Evaluation Office

We welcome the first report of the Independent Evaluation Office (IEO) on ,,prolonged use" of Fund resources. In general, we agree with the analysis and support most of the recommendations and look forward to their early implementation.