CHAPTER X Capital Movements Under an Amendment of the IMF’s Articles
- International Monetary Fund
- Published Date:
- September 1998
During 1997/98, the Executive Board met to discuss various aspects of an amendment to the IMF’s Articles of Agreement with respect to liberalization of capital movements and the IMF’s role, including the methodology and scope of jurisdiction; the treatment of inward direct investment, transitional arrangements, and approval policies; and the legal aspects of capital movements, including considerations regarding financing and conditionality. In their discussions, Directors emphasized that, given the scope and complexity of the issues involved, their views remained preliminary and without prejudice to their final positions.
At the Annual Meetings in Hong Kong SAR, in September 1997, the Interim Committee issued a Statement on the Liberalization of Capital Movements Under an Amendment of the IMF’s Articles of Agreement (Box 13). The statement invited the Board to complete its work on a proposed amendment of the IMF’s Articles to make the liberalization of capital movements one of the purposes of the IMF and extend, as needed, the IMF’s jurisdiction through the establishment of carefully defined and uniformly applied obligations regarding the liberalization of such movements.
Seminar on Capital Account Liberalization
To help inform its work on bringing the liberalization of capital movements within its mandate, the IMF hosted a seminar on the subject in March 1998 to elicit views from a wide range of private and official observers outside the IMF. Participants included senior government officials, private sector representatives, academicians, and representatives from international organizations. IMF senior staff, management, and members of the Executive Board also participated.
Seminar participants generally agreed that the Asian financial crisis confirmed the importance of orderly and properly sequenced liberalization of capital movements, the need for appropriate macroeconomic and exchange rate policies, and the critical role of a sound financial sector. Participants broadly recognized that, in the current globalized environment, the trend toward greater liberalization was here to stay. The real issues were how, when, and under what circumstances capital flows should be liberalized. A number of speakers noted that weakness in the financial sector lay at the heart of the crises in Indonesia, Korea, and Thailand. The main problems were the limited capacity of financial institutions to assess and manage risks, inadequate prudential supervision, and ad hoc liberalization of capital movements. With respect to the latter, it was noted that it was not liberalization per se, but its form and sequence that rendered countries vulnerable to changes in market sentiment. A number of speakers felt that the Asian crisis demonstrated that liberalization should be approached cautiously in concert with progress in other areas to realize fully the benefits of liberalization. Participants acknowledged that the IMF had a central role to play in promoting the orderly liberalization of capital movements, but views differed as to whether IMF “advocacy” of freer capital markets or “jurisdiction” over its members’ capital flows was the more appropriate means for the IMF to achieve this goal.
Is Liberalization Necessary?
The trend toward capital account convertibility is “irreversible,” IMF Managing Director Michel Camdessus said at a luncheon address on March 9, and “all countries have an important stake in seeing that the process takes place in an orderly way,” no matter where they stood on the opening of their own capital accounts. The benefits of open capital markets were well known, but free-flowing capital could be highly disruptive, as several speakers noted, creating financial crises that threatened the stability of the international monetary system. Certainly, massive capital flows were a major element behind the financial crisis in Asia. If the trend toward open capital movements was irreversible, and if the benefits from free access to capital markets were undeniable, how, then, could the costs and risks be minimized? Seminar participants noted the importance of an orderly and properly sequenced approach to liberalization of capital movements. In this context, they discussed the role the IMF could play in encouraging the orderly liberalization of capital movements, including a possible amendment of the Articles of Agreement to extend IMF jurisdiction to include capital movements.
Box 13Interim Committee Statement on Liberalization of Capital Movements Under an Amendment of the IMF’s Articles, as Adopted, Hong Kong SAR, September 21, 1997
- It is time to add a new chapter to the Bretton Woods agreement. Private capital flows have become much more important to the international monetary system, and an increasingly open and liberal system has proved to be highly beneficial to the world economy. By facilitating the flow of savings to their most productive uses, capital movements increase investment, growth, and prosperity. Provided it is introduced in an orderly manner, and backed both by adequate national policies and a solid multilateral system for surveillance and financial support, the liberalization of capital flows is an essential element of an efficient international monetary system in this age of globalization. The IMF’s central role in the international monetary system, and its near universal membership, make it uniquely placed to help this process. The Committee sees the IMF’s proposed new mandate as bold in its vision, but requiring cautious implementation.
- International capital flows are highly sensitive to, among other things, the stability of the international monetary system, the quality of macroeconomic policies, and the soundness of domestic financial systems. The recent turmoil in financial markets has demonstrated again the importance of underpinning liberalization with a broad range of structural measures, especially in the monetary and financial sector, and within the framework of a solid mix of macroeconomic and exchange rate policies. Particular importance will need to be attached to establishing an environment conducive to the efficient use of capital and to building sound financial systems solid enough to cope with fluctuations in capital flows. This phased but comprehensive approach will tailor capital account liberalization to the circumstances of individual countries, thereby maximizing the chances of success, not only for each country but also for the international monetary system.
- These efforts should lead to the establishment of a multilateral and nondiscriminatory system to promote the liberalization of capital movements. The IMF will have the task of assisting in the establishment of such a system and stands ready to support members’ efforts in this regard. Its role is also key to the adoption of policies that would facilitate properly sequenced liberalization and reduce the likelihood of financial and balance of payments crises.
- In light of the foregoing, the Committee invites the Executive Board to complete its work on a proposed amendment of the Fund’s Articles that would make the liberalization of capital movements one of the purposes of the Fund and extend, as needed, the Fund’s jurisdiction through the establishment of carefully defined and uniformly applied obligations regarding the liberalization of such movements. Safeguards and transitional arrangements are necessary for the success of this major endeavor. Flexible approval policies will have to be adopted. In both the preparation of an amendment to the IMF’s Articles and its implementation, the members’ obligations under other international agreements will be respected. In pursuing this work, the Committee expects the IMF and other institutions to cooperate closely.
- Sound liberalization and expanded access to capital markets should reduce the frequency of recourse to Fund resources and other exceptional financing. Nevertheless, the Committee recognizes that, in some circumstances, there could be a large need for financing from the Fund and other sources. The Fund will continue to play a critical role in helping to mobilize financial support for members’ adjustment programs. In such endeavors, the Fund will continue its central catalytic role while limiting moral hazard.
- In view of the importance of moving decisively toward this new worldwide regime of liberalized capital movements, and welcoming the very broad consensus of the membership on these basic guidelines, the Committee invites the Executive Board to give high priority to the completion of the required amendment of the Fund’s Articles of Agreement.
Although it was not possible to say with any certainty how long a country should hold off opening its capital account, there was consensus, according to IMF First Deputy Managing Director Stanley Fischer, that “liberalization without a necessary set of preconditions in place may be extremely risky.” The absence of such preconditions could promote a crisis or reveal weaknesses in the financial system that could have been overcome had the authorities been allowed more time to strengthen the system before the capital markets were opened.
Participants generally recognized that the Asian financial crisis had not negated the contribution that substantial inflows of capital had made to economic progress in the Asian countries before the crisis erupted. The crisis demonstrated the risks of liberalization that is not properly sequenced and adequately supported by sound policies on a wide range of other fronts. Some speakers noted, however, that appropriate sequencing should not mean that liberalization should, or could, wait for other reforms to be completed.
Rather, both should proceed hand in hand to rake advantage of windows of political opportunity. Most speakers stressed the importance of making progress in:
- achieving sound and consistent macroeconomic policies, sustainable current account positions, and appropriate exchange rate regimes;
- having sound and well-supervised domestic financial systems, including improved supervision and prudential regulations covering capital adequacy, lending standards, asset valuation, effective loan recovery mechanisms, and provisions ensuring that insolvent institutions were dealt with promptly;
- improving transparency through disclosure of accurate financial and economic information, based on internationally recognized standards and practices; and
- liberalizing financial services to allow for greater competition and the transfer of skills, capital, and best practices.
Path to Liberalization Should Be Orderly
The Asian experience demonstrated the need for adapting the pace of liberalization to the circumstances of individual countries in order to limit their vulnerability to wide fluctuations in capital movements. A number of seminar speakers advocated a gradual opening of the capital account, noting that for many developing countries the costs of disruption occasioned by reversals in capital flows were high, given their limited capacity to absorb risk and the absence of institutional structures to deal with such reversals.
Several speakers considered it important to avoid ad hoc liberalization that might create a bias toward short-term inflows. They suggested that in the initial stages, the emphasis should be on liberalizing medium- and long-term investments. For emerging market economies, the improper management of the opening of financial markets could easily lead to a boom-and-bust cycle during the transition period.
Speakers noted that the experience of countries—not just in Asia—demonstrated that appropriate regulatory requirements and controls could help discourage volatile short-term capital inflows. A number of speakers argued that appropriate prudential measures, aimed particularly at limiting banks’ external exposures, were necessary. A fairly wide cross-section of participants—from developed and developing countries and representing both the public and private sectors—saw scope for introducing controls on short-term inflows in some circumstances, even for well-managed economies; to be effective, they concluded, any such controls should be market based, transparent, and temporary. At the same time, a number of speakers were wary of controls, noting that, like tariffs, they were generally undesirable. Such controls could easily become permanent and a way of avoiding necessary policy adjustment.
All seminar participants agreed that, given its mandate to oversee the international monetary system, the IMF had an important role to play in promoting the orderly liberalization of capital movements and was better placed than other international organizations to do so. Differing views were expressed, however, about whether the IMF could best achieve that goal through advocacy or jurisdiction.
A few speakers argued that an amendment to extend jurisdiction to capital movements was not necessary to achieve the goal of capital market liberalization. In their view, the IMF was already promoting capital account convertibility in the context of surveillance, conditionality, and technical assistance. Although an amendment of Article 1 to make the liberalization of capital movements a purpose of the IMF could be useful, further amending the Articles to extend IMF jurisdiction to cover both payments and transfers and the underlying transactions would not provide an effective mechanism for promoting liberalization. Furthermore, these participants contended, it would involve the IMF in activities beyond its designated responsibilities in the balance of payments area and could raise difficulties of overlap and potential conflict with other international treaties.
Those favoring extending IMF jurisdiction to capital movements held that the IMF was the ideal agency to undertake this function, because it could deal with each country on a case-by-case basis, adjusting the progress toward full liberalization to the country’s individual capacity and complementary structural reforms. Although the IMF had encouraged countries with IMF-supported adjustment programs to free up their capital accounts, legal jurisdiction would allow the IMF to apply the principles of capital liberalization to all member countries through its surveillance activities, not just those using its financial resources. Furthermore, as an organization that promoted good governance among its members, the IMF had to set an example by ensuring that the legal basis for its activities was transparent. Such transparency would also clarity, rather than undermine, the IMF’s relationship with other organizations. Speakers from other international Organizations, such as the World Trade Organization, the Organization for Economic Cooperation and Development, and the European Union, noted the complementarity of the IMF’s role in this area with that of their own organizations and considered that a well-defined code of conduct for capital movements would help clarify the respective roles of the IMF and other international institutions.
Some speakers cautioned that without commitment, advocacy earned little conviction. A country’s resolution to open its capital account and its agreement not to impose restrictions at a later date would not be credible without the commitment, transparency, and conviction imparted by its obligations as a member of the IMF to proceed toward an open capital account. Nevertheless, the seminar discussion highlighted that, given the undefined and open-ended transition period, obligations themselves would imply no more conviction than advocacy.
Some private sector representatives pressed for greater transparency in the IMF’s deliberations on an amendment. In particular, they would like to see specific language on the proposed amendment before lending their support to an amendment.
In summing up the seminar. First Deputy Managing Director Stanley Fischer cited several issues yet to be resolved. Despite considerable enthusiasm for an amendment of the IMF’s Articles—from both official sources and the private sector—he noted that some “severe doubts” had been expressed, both on whether capital account liberalization per se was a good idea and on whether advocacy was not sufficient and legalized jurisdiction too painful, complicated, and unnecessary.
A pressing unresolved issue, Fischer said, was how the international system could ensure that banking supervisory standards and the quality of banking systems were improved and what could be done at the international level. Also unresolved was how to determine when an economy was sufficiently insulated by preconditions to risk opening the capital account. Fischer noted that some seminar participants had expressed the fear that too much talking about preconditions might discourage countries that would end up waiting forever for preconditions to be in place. On the other hand, some participants suggested that change did not happen until it was forced. Such a way of proceeding was “pretty risky,” said Fischer, since the consequences of potential accidents were very large.
The consequences of uncontrolled short-term flows posed another set of problems. Aside from their dislocating effect on the economy, short-term flows could do serious damage to a vulnerable banking system. There was no established body of analysis on capital controls—what worked and what did not—and a “host of questions” had to be examined. A capital account amendment of the IMF’s Articles, Fischer said, would provide an appropriate context in which to conduct such an analysis.
Finally, other international organizations and institutions were closely associated with both the regulation and liberalization of capital movements. It was clear, Fischer said, that if the IMF’s Articles were amended to include jurisdiction over capital movements, the existing close cooperation between the IMF and these organizations would have to be strengthened further.
At an April 1998 discussion following the seminar, the Executive Board agreed that the IMF and its members faced a world vastly different from that of the 1940s, when the IMF’s Articles—with their emphasis on the liberalization, and financing, of current account transactions—were conceived. The benefits for the world economy of an open and liberal system of capital movements were now widely recognized. Balance of payments difficulties associated with the capital account, although stemming from underlying policy issues, also dominated many of the problems the IMF was dealing with now, which would no doubt be even more the case in the future. Directors thus saw a tension between the focus of the existing Articles and the realities faced by the IMF that had to be addressed.
The increasing openness and integration of capital markets was being driven to a large extent by markets themselves and by the advantages that members saw in liberalization. This phenomenon should not be reversed. One lesson of the Asian financial crisis, Directors agreed, was that it was necessary to achieve a better pace and sequencing of liberalization with other reforms, most notably in the domestic financial sector, and for countries to adopt appropriate macroeconomic and exchange rate policies. Given the IMF’s mandate and its universal membership. Directors saw the institution as uniquely placed to foster prudent, well-considered, and orderly liberalization worldwide. It could do this while respecting the interests and roles of other organizations active in this area.
In reporting to the Interim Committee in April 1998, the Managing Director noted that Executive Directors had reaffirmed that the orderly liberalization of capital movements should be one of the IMF’s purposes and had reached provisional agreement on the text of an amendment that would express that purpose in general terms. Directors would continue work on other aspects, including policy issues, jurisdiction, and financing.
Subsequently, at its April 1998 meeting, the Interim Committee reaffirmed its view, expressed in its Hong Kong communique of September 1997, that it was time to add a new chapter to the Bretton Woods agreement by making the liberalization of capital movements one of the IMF’s purposes and extending, as needed, the IMF’s jurisdiction for this purpose. The Committee noted the progress made to date and the provisional agreement reached by the Executive Board on that part of an amendment dealing with the IMF’s purposes. It asked the Board to pursue with determination its work on other aspects, including policy issues, with the aim of submitting an appropriate amendment of the Articles for the Committee’s consideration as soon as possible.