Speech

The Challenges to Economic Policy -- Address by Shigemitsu Sugisaki

June 16, 2000

I. Introduction

I speak to you in a panel discussion titled "Challenges to Economic Policy". Where I work, such a topic could attract thousands of suggestions but I would like to concentrate on merely three issues which have occupied most of our time during the last 15 years. These are: (a) the promotion of growth and poverty reduction in the world's poorest countries; (b) managing the transition from centralized to market economies; and (c) reforms in policy making and at the IMF as a consequence of the economic crisis in Asia, Russia and Latin America. I would like to take up each of these three issues in turn.

II. Poverty Reduction and Growth

In the last 15 years, the IMF has consistently increased its role and sharpened the focus of its policies directed towards achieving rapid economic growth and a sustainable increase in the living standards in its poorest member countries. More than a decade ago, the IMF set up concessional lending facilities to help these adjustment efforts as well as to provide a vehicle to address the social consequences of adjustment programs more directly. Although there was a noticeable increase in growth rates as well as an improvement in key social indicators, poverty has persisted and even grown deeper roots in some parts of the world. Thus, in recent months, the Fund—together with the international community—has fully embraced the enhanced Heavily Indebted Poor Countries (HIPC) Initiative which deepens the Fund's involvement with developing countries through faster, deeper and broader debt relief to low-income countries which are able to strengthen the link between debt relief and poverty reduction. Also, through the provision of technical assistance, emphasis is being put on national capacity building.

Looking ahead, the centerpiece of IMF's strategy is a concessional loan facility which will make HIPC debt relief an integral part of broader efforts to reduce poverty. Programs under this facility will be prepared in an open and consultative manner and will entail important changes in the way the IMF and the World Bank operate and collaborate. A key change is that the complementarity of macro-economic, structural and social policies will now be given greater recognition and the Poverty Reduction Strategy Paper will provide a new vehicle to integrate these policies in a mutually reinforcing way.

I should reiterate that the fundamental objective remains sustained poverty reduction and the experience of successful reformers shows that sustained policy implementation is required to attain this objective. This also requires strengthening the incentives to undertake the needed reforms. Industrial countries can contribute to this effort by providing higher concessional assistance as well as significantly improved access for exports of developing countries to their markets. On their part, developing countries not only need to maintain a stable macro-economic environment but also implement supporting structural policies which are critical to a supply response. It goes without saying that this requires making the most effective use of fiscal resources and in this context I regret the magnitude on which violence has recently erupted in many countries, especially in Africa, which has usurped precious resources. Finally, history has shown the importance of maintaining high quality of governance and strict accountability in policy making which are essential to generating domestic and foreign investment.

II. Managing the Transition from Centrally Planned Economies

It is clear that during the last decade, the process of transforming centrally planned socialist economies has indeed been very complex with far reaching changes in the political, economic and social relations that existed within each of these countries. In every case, the key reform measures included macro-economic stabilization, price and market liberalization including that of the exchange and trade systems, restructuring and privatization, and redefining the role of the state where it provides and enforces a level playing field as well as corrects market imperfections as and when they occur.

As you know, the IMF—along with the World Bank and other national and international agencies—has been heavily involved in assisting with the transformation of centrally planned economies. All of our efforts have been centered around achieving and consolidating macro-economic stabilization, and accelerating structural reform. With respect to the latter area, IMF efforts, along with those of the World Bank, in the transition economies in many respects broke new grounds, both in advising on why structural reforms were essential and how they could be carried out. Our technical assistance program to transition countries has played a key role in helping the authorities adapt their monetary, exchange rate, fiscal and statistical systems to the requirements of a market economy. Training of officials from these countries—together with technical assistance—has importantly contributed to institutional building.

The key lesson we have learnt is that financial stabilization is only a necessary condition for growth and that comprehensive progress on all fronts of a broad structural reform agenda is indispensable for sustained growth. In this context, the most successful transition economies are those which have undertaken more and faster reform. There are also areas where we have met with considerable challenge. For example, while privatization is a key element in the reform process, both the absence of hard budget constraint as well as insider privatization have failed to lead to self-induced restructuring. Similarly, poor governance—ranging from the government not pulling back enough from interventions in economic activity to not providing the discipline of law and order—has often delayed and even impeded reform by discouraging foreign investment and encouraging the flight of capital.

With the above as background, you may ask as to what is the agenda ahead? For most of the Central European and Baltic countries, the reform process is very advanced and the issues they face are similar to those faced by many middle-income market economies. For example, there are the challenges of joining the European Union, a strong recovery running ahead of itself, possible reversals of capital inflows, efficient intermediation by the financial sector, and rationalization of expensive social programs. There are other countries in the former Soviet Union, who are in varied stages of recovery and where the agenda ahead remains quite large. In particular, there is a need to consolidate macro-stabilization, push ahead with key structural reforms, provide for an effective rule of law and fair tax and regulatory systems, strengthen the financial system so that it conforms to internationally accepted codes and standards, and improve governance. Much too many resources continue to be devoted to unproductive expenditure and corruption is at unacceptably high levels. Finally, there are a handful of countries in the region who have scarcely begun reform and are in the danger of backsliding.

III. Reform in Policy Making and at the IMF

As you know, the IMF is a cooperative institution of 182 members and, on an ongoing basis, our membership sets the priorities for the institution and the Fund adapts its policies and operations to reflect these conclusions. Thus, it will come as no surprise to you that the recent debate outside the Fund has been matched—in intensity—by the debate and actions within the Fund about reforms in economic policy making and within the IMF itself.

As for the work of the Fund, surveillance—policy dialogue of the IMF with the authorities of each country and the implication of these policies for the international financial system—remains at the core of IMF operations. This core activity has been transformed significantly following the Asian crisis. The focus now is on new sets of codes and standards—relating to financial sector soundness; transparency in fiscal, monetary and financial policies; data provisions; and corporate governance—to guide the conduct of economic policy in a variety of areas. This emphasis, which is supported by a significant amount of technical assistance, increases policy-making accountability and allows for better-informed lending and investment decisions. In particular, you all know that the Fund, together with the World Bank, has embarked on an ambitious Financial Sector Assessment Program (FSAP) to assess financial sector vulnerabilities as well as observance of financial system standards. This work (culminating in Financial System Stability Assessments) is discussed in the context of the annual surveillance discussions. These new directions for the Fund also pose new challenges in cooperating with other standard setting bodies who possess substantial expertise in developing assessment methodologies, refining standards, and conducting assessments.

It will come as no surprise to you that in recent times much discussion has also taken place about the virtues and pitfalls of pegged exchange rates. Experience shows that there is no question that getting the exchange rate right is an essential element of a sound macro package. It is also clear that the macroeconomic and structural policy requirements of maintaining a pegged rate are demanding, particularly in an environment of increased mobility of international capital. At the same time, a number of economies with fixed exchange rate arrangements, including under currency boards, have been successful in maintaining exchange rate parities. All in all, experience has shown that countries that maintained consistent monetary and exchange rate policies and supported liberalization with financial sector reform have been better able to handle capital inflows and their subsequent reversals.

The Asian crisis also aroused a spirited debate about capital account liberalization where the Fund has emphasized an orderly and well-sequenced liberalization process, to be supported by an adequate institutional set up to strengthen the ability of financial intermediaries and other market participants to manage risk. I would like to note that introducing or tightening capital controls is not an appropriate response to deal effectively with fundamental economic imbalances. Any temporary breathing space that such measures may bring has to be used wisely and needs to be weighed against the long-term damage to investor confidence and the distorting effects on resource allocation.

This brings me to the topic of the role of the private sector in crisis prevention and in a crisis. There is no denying the fact that private capital markets are the engines of growth around the world and "good business practices" on the part of the country and the lender would mean the implementation of sound policies and good risk appraisal, respectively. There is thus a need for cooperation—or constructive engagement—amongst borrowing countries, the private sector and the official sector to develop broad rules which would apply in a crisis which are and perceived to be fair to both creditors and countries.

An essential element of the reform of the international financial system is the provision of comprehensive, timely, high quality and accurate information to the markets. The Fund releases a vast array of information to the public like its assessment of the countries' economic policies, individual modules as part of the overall report on standards and codes. In addition, countries borrowing from the Fund are encouraged to release to the public their policy commitments under the program. Transparency on the part of the IMF itself can also contribute to a better understanding of policies of member countries. Here too, important progress has been made. Also, regular internal and external evaluations of Fund operations—which are also released to the public—also provide another assessment of our work.

Over time the Fund's financial operations have also been adapted to the changing economic environment. In the period ahead we will review whether our current facilities fully meet the needs of our members. As this discussion proceeds ahead, we will be guided by a number of underlying principles including the need to preserve the Fund's ability to provide and catalyze support for individual countries; retain the Fund's ability to respond quickly and effectively to short-term balance of payments problems; continue to support reforms that deal with structural problems closely related to IMF's area of expertise; and be in a position to respond rapidly and on an appropriate scale to crises of confidence in the capital markets. Clearly, the long-run goal must be to discourage undue reliance on the use of IMF resources and encourage countries to move towards sustainable access to, and reliance upon, private capital.