Uncertainty overshadows the world economy

Whereas over the past year the world economy has performed better than expected, prospects for 2003 have deteriorated. Forecasts have been adjusted downwards, in line with the unfavorable development of leading indicators. The global economy has been and still is in the grip of uncertainty, which makes accurate assessments of current and future growth very difficult. While the war has undoubtedly taken its toll on the world economy, there are also a number of other problems that might further moderate growth prospects. One of them relates to financial market developments. Both short-term and long-term interest rates have dropped significantly, due to expansionary monetary policy measures and because many investors are changing their portfolio mix, substituting bonds for shares. In the expectation of future interest rate increases, which could negatively affect the financial sector, there is a need for close monitoring and supervision. Higher interest rates would also imply higher servicing costs of government debt. This underscores the importance to keep government spending under control and - for the EU countries - to meet the requirements in the Stability and Growth Pact.

Another risk is the high current account deficit of the US in conjunction with the rising government deficit due to the recent tax cut proposal and the rising expenditures related to the strike on Iraq. The "twin-deficit" problem not only calls for balanced policies in the US, but also requires for other countries to promote robust domestic growth through a deepening of structural reforms. Within Europe, further progress is needed in the framework of the Lisbon process, especially with regard to the labor market. It is essential to increase labor participation and labor productivity by promoting entrepreneurship, flexible labour markets and investments in knowledge and innovation.

From a global perspective, the world should decrease its dependence on the US as a source of growth. In this respect, there are also a number of positive developments worth highlighting. First of all, the economic performance in the Asia-Pacific region, notably in China, India and South-Korea, remains impressive with annual growth figures well above 5 percent. Economic growth in EU candidate countries with around 4 percent is also significantly higher than in advanced economies. The historic agreement reached during the Copenhagen Summit last December underscores the progress made over the past decade in transforming these economies into well-functioning market economies. Croatia has meanwhile also applied for EU-membership. Recent economic performance has also been relatively good in the CIS-countries, with especially high growth for more advanced reformers, such as Armenia, Georgia and Moldova and Ukraine. Finally, African GDP growth is expected to pick up to 4 percent in 2003.

With uncertainty overshadowing the world economy, the IMF has an important role to play. In crisis prevention, it can help reduce uncertainties to manageable risks. In crisis resolution, it can increase the predictability with regard to the availability of its own resources as well as the predictability of sovereign debt restructuring processes. With regard to low income countries, the Fund can further improve its signaling role towards the international donor community. These messages will be elaborated below.

Crisis prevention: reducing uncertainty to manageable risks

Given the high degree of uncertainty that markets face, the need for high quality surveillance is greater than ever. IMF surveillance is key in reducing uncertainties to manageable risks. In response to the capital account crisis of the 1990s, a great number of initiatives have been introduced to make the international financial system more resilient to crisis. My constituency commends the IMF with these initiatives, particularly in the areas of data provision and dissemination, financial sector surveillance, standards and codes, and debt sustainability assessments, which are reinforced by the IMF's improved transparency policy.¹ Taken together, they strengthen accountability and give markets better and more continuous information for decision-making.

While it is essential that the complex interlinkages between a country's macroeconomic development and the quality of its institutions are acknowledged and monitored, an undue expansion of the scope of IMF surveillance should be avoided. This not only requires a proper prioritization with regard to the countries that are being assessed, but also underscores the need to keep individual surveillance exercises focused on key issues to avoid diluting the Fund's policy advice. More generally, the IMF's role in surveillance activities should be consistent with its mandate and its competence. Areas that are not convincingly macro-relevant should in principle be left to other international organizations, notably the World Bank, the OECD or the EU.

So, maybe the Fund should sometimes do less, but what it does could still be done better to ensure that the Fund's advice is sound and has impact. My constituency therefore welcomes the new guidance for staff on the basis of the 2002 biennial surveillance review. In order to further improve the overall effectiveness of the surveillance process, we would like to emphasize the importance of five concrete measures:

• Article IV consultation reports are expected to contain a brief assessment of staff advice and of the authorities' response to the key policy challenges addressed in previous Article IV reports. To give surveillance even more bite, we suggest that the extent to which countries have not followed up on appropriate earlier Fund advice is factored into program decisions. Countries that have neglected sound policy advice and consequently run into balance of payment problems should have an especially convincing program in order to gain access to Fund resources. Such a practice will also foster the accountability of the IMF in delivering clear and high quality advice.



• While preserving the consistency between the program strategy and surveillance, the guidance rightly underscores the need for comprehensive assessments that offer a fresh perspective on economic conditions and policies. Consultation cycles for program countries need to be flexible to allow for consultations to take place at a time when they are most valuable. The delay in the completion of the Article IV reports of Argentina and Uruguay until a new credit line was more or less agreed upon illustrates that there is still room for improvement on this account.



• The possible risk of "tunnel vision" can also be reduced by promoting that surveillance and program missions have somewhat different staff compositions provided there are suitable continuity and coordination safeguards.



• It should become standard practice that alternative scenarios and possible policy responses are discussed with national authorities in the context of Article IV consultations and reflected upon in the reports. This would enable countries to better anticipate to adverse developments, while fostering greater ownership for policies.



• Finally, we encourage the Fund and its members to move towards full publication of Article IV reports, including debt sustainability analyses. Transparency allows peer pressure becoming market pressure. This will promote the adoption of sound policy and adherence to international standards as well as facilitate private parties in assessing risks and thus smoothen the functioning of international markets.

Crisis resolution: increasing predictability towards markets

The on-going difficulties in various emerging markets seem to have given birth to three new or renewed initiatives. The first is the new framework for debt sustainability as part of both crisis prevention and crisis resolution. It is especially valuable in highlighting the linkages between exchange rate fluctuations and debt dynamics, which reflect a common feature of most countries under stress in for example Latin America. We look forward to the discussion on the review of the framework that is expected to be available over the next months. The second initiative is the impetus given to the discussion on ways to smooth a debt restructuring process, which is so badly needed in Argentina and seems to have started in Uruguay. Third, the Fund's assistance to Brazil, Argentina, Uruguay and Turkey has revived the discussion on the financing role of the IMF in mitigating financial crises, especially with regard to exceptional access to Fund resources.

Starting with the latter, my constituency has consistently argued that it is essential that the Fund is predictable with regard to the financing it will provide in order to reduce uncertainty and moral hazard. The private sector should contribute to close the financing gap of countries in distress. We therefore welcome the Fund's renewed framework for exceptional access in capital account crisis, which establishes substantive criteria, including a clearly sustainable debt, and stronger procedures for decision making on exceptional access proposals. In addition to the criteria, we wish to underscore that the member's best efforts to secure private sector involvement in program financing should be an important consideration for justifying exceptional access. The best practices of debtor-creditor consultations, creditor coordination and private sector involvement that may be identified in the context of a Code of Conduct could be useful in this respect. Concerning the procedures, we particularly value the early consultation of the Executive Board. The framework, however, is only applicable to cases where debts are sustainable.

In case of unsustainable debts, my constituency supports the two-track approach to improve the process of sovereign debt restructuring: the contractual one, based on Collective Action Clauses (CACs) and the statutory one, based on a Sovereign Debt Restructuring Mechanism (SDRM). The recently suggested codes of (good) conduct may usefully complement, but not substitute for, these approaches in guiding the behavior of all parties concerned in the event of debt crises.

We particularly welcome the Mexican step to introduce CACs into the terms of a new New York-law governed medium-term note issue, and its announcement that it will continue to use CACs in its upcoming bond issues. It is now important for other sovereign issuers to follow Mexico's lead in order to trigger a real shift in market practices. In this regard, it is worth noting that half of my constituency has been issuing foreign bonds with CACs for quite some time already. Last year, the EU-members, including the Netherlands, also committed themselves to include CACs in government bond issues under foreign jurisdiction.

We remain convinced that the SDRM, as an ultimum remedium, could make an essential contribution to improving the crisis resolution framework. Here again, increasing predictability will reduce uncertainty in the markets. The SDRM will provide for a comprehensive approach to debt restructuring that entails a road map for the restructuring process, if voluntary approaches of a debtor country and its creditors fail to materialize. We welcome the efforts made so far by the Fund to develop the key features of an SDRM and its ongoing dialogue with market participants and sovereign issuers. We recognize that the design of the mechanism has been adapted to meet the views of the private sector. The changes make the SDRM a mechanism operated by the debtor country and its creditors with a supportive role of the Fund. This role for the Fund in crisis resolution in the context of the SDRM will take shape mainly through its lending decisions and its debt sustainability analyses. We invite the Fund to continue its work on the technical issues of the SDRM, to consult broadly with all interested parties, and to report to the IMFC.

Low income countries: strengthening the Fund's signaling function

Global uncertainties and the delay of economic recovery also dim the prospects of sustained growth and poverty reduction in low income countries. As the Managing Director recently underlined, the Monterrey Consensus, re-affirmed in Johannesburg, defined two equally strong pillars to achieve the Millennium Development Goals (MDGs) by 2015: on the one hand, self-responsibility in developing countries to pursue sound policies and good governance, matched on the other hand by solidarity on the part of the international community to provide strong and comprehensive support.²

Self-responsibility and country ownership are mutually reinforcing, being the essence of the national processes based on Poverty Reduction Strategy Papers (PRSP) which are successfully being developed in a growing number of countries. My constituency supports the Fund's own role in support to sound policies as part of the processes. While acknowledging the progress, we urge the Fund to better align the Poverty Reduction and Growth Facility (PRGF) with the national PRSPs in terms of contents, timing and documentation. More specifically, the Fund can assist countries to bridge the gap between domestic and international resources and policy measures needed to make progress towards the MDGs through its macroeconomic analyses, policy advice and assistance to capacity building. In this context, we value the consideration that is increasingly being given to the macroeconomic implications of growing aid flows to individual countries which may not be consistent with the country's absorption capacity. Finally, we favor more attention to Poverty and Social Impact Analyses (PSIA), an area in which the World Bank is the lead agency in providing technical guidance.

Solidarity requires a swift realization of the UN target of 0.7 percent of GNP for official development assistance. Both the EU-members and the US have committed to increase their development assistance, but for many countries a huge gap remains to be bridged. Next to aid, trade is crucial to durable poverty reduction. Regretfully, the international trading system remains heavily distorted, and especially biased against developing countries. Markets in which developing countries enjoy a comparative advantage, such as agricultural products, are among those most protected. As we enter a critical phase in the Doha trade round, rhetoric has to be matched by action. This is not only a matter of solidarity but also of enlightened self-interest. Consistent with its mandate, my constituency endorses the Fund's intention to assess in its Article IV reports the extent to which countries observe the conditions for truly open trade regimes.

The IMF's interactions with low income members have an important signaling function towards other multilateral organizations and bilateral donors. According to the first study by the Independent Evaluation Office, IMF lending arrangements increasingly provide a "seal of approval" on a country's policies and institutions for other sources of financing, notably development aid, to go forward. Although a practice of linking aid to IMF-supported programs may assist the international community in the efficient aid allocation, it bears two important risks. On the one hand, in order to fulfill the expectation of donors some programs might not meet minimum standards of policy content. The Fund should therefore consistently guard the quality of the program and, hence, the quality of the seal of approval. On the other hand, there is a risk that countries that wish to receive the Fund's advice and monitoring for signaling purposes feel obliged to also take the Fund's credit which adds to their already high repayment obligations. We therefore encourage donors to accept informal ways of monitoring. It may also be worth promoting the use of low access PRGF-arrangements or PRGF-arrangements on a precautionary basis.³ They also reduce the risk that countries become unnecessarily prolonged users of Fund credit.

We commend the Fund, together with the World Bank, European Bank for Reconstruction and Development and the Asian Development Bank, with the fruitful Lucerne conference on the seven poorest countries of the Commonwealth of Independent States (CIS7-initiative). The conference underlined that achieving ownership of the reform agenda by governments and people, notably through PRSP-processes, is key in assuring implementation of policy and institutional reforms. Equally important for recovery and future prosperity of the small and relatively isolated CIS-7 economies are successful regional cooperation and improved access to markets. We look forward to further progress as well as to the evaluation of the CIS7-initiative.

Finally, we take note of the work by the Fund and the Bank to enhance the participation of developing countries and countries in transition in decision-making. We support an increase in the staffing of the two largest multi-country constituencies. We could also further explore other avenues, including an increase of basic votes, an expansion of staff training and an improvement of the administrative capacity at country level as well as strengthening the PRSP-process. In the context of this discussion, we wish to emphasize the benefits of multi-country constituencies consisting of both creditor and debtor countries. Our constituency, as well as others, are good examples of promoting the interest of both groups of countries. On the one side, we all profit from the substantial share of voting rights of mixed constituencies, whereas on the other, transfers of knowledge and expertise within the constituency can support capacity building in the countries themselves. Finally, multi-country constituencies have a bridging function and prevent polarisation of discussions between debtor and creditor countries in the Executive Board. In this process, multi-country constituencies enhance ownership of Fund decisions and policies by all members.

¹ Macedonia, Moldova, the Netherlands and Romania will follow Armenia, Bulgaria, Croatia, Georgia, Israel and Ukraine as the next countries in our constituency to do an FSAP.

² The Role of the IMF in a Globalizing World Economy, Remarks by Horst Köhler at the Fourth Annual Conference of the Parliamentary Network on the World Bank, March 2003.

³ In comparison, there have been nearly fifty precautionary stand-by arrangements for middle-income countries in the period 1990-2003.