IMF Survey: How do you view the tremendous build up of foreign exchange reserves in Asia in recent years? How do you react to charges that all this “one-way intervention” amounts to currency manipulation and to concerns about a lack of exchange rate flexibility in Asia?
Kato: One of the lessons of the 1997-98 Asian financial crisis is that it makes sense for an emerging market economy to build up its foreign exchange reserve position to enable it to better handle short-term liquidity problems. So I can understand the desire of these countries to accumulate foreign exchange reserves. However, they now have the equivalent of about nine months’ worth of imports—which is eight times larger than their short- term debt—so they can feel quite comfortable with current reserve levels. A challenge for the IMF is to persuade some Asian member countries that it is in their own best interest to manage their exchange rates with greater flexibility. Supporting measures need to include developing an active foreign exchange market with instruments to allow participants to cover foreign exchange risks and a more general modernization of economic structures to increase resiliency against shocks.
IMF Survey: What about charges that some of these countries are manipulating their exchange rate to help their exports?
Kato: Manipulation is an emotional term that has been used too widely and too loosely. Some countries accused of manipulation have had longstanding exchange rate pegs; others so accused have seen large swings in their currencies over the period since the onset of the Asian financial crisis. Is it manipulation to “lean against the wind” of swings in currency markets? Or to maintain an exchange rate? Clearly not, as a matter of definition. A much more nuanced assessment is needed to evaluate whether a country’s exchange rate management is appropriate—which is exactly what the IMF seeks to provide in its annual Article IV consultation with a country’s authorities.
IMF Survey: Some have argued that the failure of IMF quotas to reflect the current economic importance of the Asian emerging market economies will add to the incentive for the region to create an Asian Monetary Fund independent of the IMF. How do you see those arguments? Do you favor stronger Asian monetary cooperation, and what would this mean potentially for the IMF?
Kato: Most countries in Asia recognize the benefits that can accrue from closer regional cooperation and integration, as exemplified by the European experience over several decades. There are differences of view as to how best to realize these benefits—whether through a series of concrete initiatives to foster cooperation in specific areas (such as the Asian Bond Fund) or more ambitious efforts to establish new institutions to promote integration (such as an Asian Monetary Fund). I am among those who favor the former approach. I believe the IMF can play a valuable role in assisting the cooperation process, through analysis and technical assistance.
IMF Survey: Do you foresee Asian countries pegging to the yen the way European countries did to the deutsche mark before European monetary union? If not, do you see monetary union occurring in Asia in some other way?
Kato: Right now, the major objective of Japan’s monetary policy orientation is to pull the country out of a recessionary phase and prolonged deflation, whereas most of the Asian emerging market countries—such as China—are focused on controlling “overheating” Given these differences, pegging to the yen wouldn’t be practical at this juncture.
Looking down the road, I expect to see gradual movement toward more coordination of monetary policies within the Asian region, as currencies become fully convertible and financial intermediation in key economies becomes fully market-based. Ideally, the basic conditions for closer integration should be put in place, step by step, so that an arrangement similar to the European Exchange Rate Mechanism, which led to a single currency, can eventually be introduced in Asia—although this will be a lengthy process, as indeed it was in Europe.
IMF Survey: The IMF has recently updated its 2004 GDP forecast for Japan to 4.5 percent. Can we breathe a sigh of relief that Japan has finally turned the corner after its lost decade?
Kato: As of end-June, Japan recorded positive growth in the preceding five consecutive quarters, and this positive growth was realized without fiscal stimulus. The engine of growth came from the private sector, which was good news, and the Japanese equity market responded quite positively. But many difficult challenges remain to be tackled. An immediate issue is the sizable fiscal deficit, which has, over time, contributed to the accumulation of an exceptionally large public debt—equivalent to about 170 percent of GDP, by far the highest debt-to-GDP ratio among the Group of Seven major industrial countries. Recovery in the financial system is under way, but the major banks need to boost their profitability, and the financial supervisors will have to remain vigilant and, where warranted, proactive.
IMF Survey: You’re responsible for IMF staff safety. In light of the recent al Qaeda security threat, how can the IMF continue to help its member countries when it is explicitly targeted? Are we ready to go back into Iraq, a little more than a year after the bombing of the UN office in Baghdad?
Kato: We were all surprised and shocked to learn that the IMF was one of a small number of key financial institutions to be the subject of detailed reconnaissance efforts by al Qaeda. As a multilateral institution, we see ourselves as being above the fray of international politics, but clearly not all parties see us in this light. We need to handle risks prudently, seeking lower-risk alternative forms of engagement where warranted, while at the same time carrying on the work required of us by our 184 member countries.
As for Iraq, the IMF has been providing technical assistance to Iraqi officials for some time—albeit outside the borders of Iraq—and is now engaged in policy dialogue with the interim Iraqi government, which plans to take part in the early October IMF–World Bank Annual Meetings. We are currently exploring how best to provide financial assistance to the government—which will need broad-based assistance from the international community if Iraq is to achieve a lasting economic recovery.
IMF Survey: In what ways do you think your background helps you in the job of Deputy Managing Director?
Kato: I have been fortunate to have had an interesting and varied career to date. I worked at the Organization for Economic Cooperation and Development Secretariat doing balance of payments forecasting, just prior to the breakdown of the Bretton Woods system in 1971. I was Executive Director at the Asian Development Bank when the Philippines experienced a “people power” regime change from President Marcos to President Aquino in 1986. I was responsible for Japan’s foreign exchange rate policy when the yen appreciated to 80 yen to the dollar in April 1995. And I was Japan’s Vice-Minister of Finance for International Affairs when the Thai baht was floated in 1997 and an international support package had to be put together to assist Thailand. At the time, I thought that the package of support provided to Thailand would have a favorable demonstration effect on its neighboring countries, but this proved too optimistic an assessment, given the strong contagion that affected the region. Like others, I didn’t expect the severity of the macroeconomic damage that came out of a balance sheet crisis.
So I’ve had the opportunity to observe many dramatic economic events, and later had the chance to step back and reflect on what lessons we could learn. In fact, this is a subject that I taught in both Japanese and U.S. universities. One thing I have learned myself is the need for careful analysis of problems—reexamining one’s assumptions to see if they are still relevant and being aware of the political dimension of economic policies—before taking actions. This is certainly a good guideline for the IMF as well. It is what we at the IMF should do and have the capability to do exceptionally well.
IMF Survey: You’ve also served on the World Health Organization’s Commission on Macroeconomics and Health. Does the IMF have a role to play in fighting HIV/AIDS?
Kato: HIV/AIDS is having a catastrophic effect in several countries, cutting life expectancy and the working-age population, eroding government revenues and health system capabilities while producing an explosion in demand for HIV-related health services. For a few countries, large inflows of HIV/AIDS assistance, though welcome, are complicating the management of the exchange rate. The IMF needs to help countries that are severely affected by HIV/AIDS to develop viable economic frameworks. We can offer technical assistance, policy advice, and, in some cases, financial assistance—although the loans we can provide are often not the ideal choice for poor countries handling severe long-term supply shocks. Such countries would benefit most from the grant-based assistance bilateral donors can provide. We can help countries explore ways not only to streamline health-related expenditures but also to raise domestic revenues to fund health-related expenses.