Chapter 5. Strengthening the Architecture of the International Financial System
- International Monetary Fund
- Published Date:
- September 1999
The financial crises in the emerging market economies of Asia, followed by those in Russia and Brazil, gave powerful impetus to proposals to strengthen the architecture of the international financial system to ensure that the potential benefits of globalization are realized by all member countries. Such proposals were a major focus of the Executive Board’s attention in 1998/99. A clear consensus had developed, both in the IMF and in the international financial community, in favor of strengthening the global financial system to reduce the risks posed by institutional weaknesses and the volatility of capital flows, and to facilitate access to capital markets by those countries that had yet to benefit from globalization.
The Board’s work program leading up to the spring 1999 meeting of the Interim Committee was ambitious in its consideration of various aspects of strengthening the global financial architecture. At the same time, other institutions and forums were also actively considering some of these aspects. By the end of April 1999, broad agreement had been reached on several key elements in strengthening the global financial architecture and important reforms had been introduced in a number of countries. The IMF itself took actions in several areas. It substantially increased the transparency of its policies and activities, approved a decision on Contingent Credit Lines to help protect well-managed economies from the effects of financial market contagion, and contributed to the establishment of standards of good practice in key policy areas. Nonetheless, as the Interim Committee noted in its April 1999 communiqué, some issues had to be developed further and several of the proposals had yet to be implemented.
Proposals commanding broad support from the international community, which required the involvement of many players to be implemented successfully, included:
- promoting transparency and accountability, and developing and disseminating internationally accepted standards and codes of good practice—including strengthening the Special Data Dissemination Standard (SDDS), notably with respect to international reserves and external debt;
- strengthening financial systems, including through better financial market supervision;
- paying greater attention to the orderly liberalization of capital markets;
- involving the private sector more fully in forestalling and resolving crises;
- ensuring the appropriateness of exchange rate regimes; and
- ensuring the adequacy of the IMF’s resources.
With respect to international standards, Executive Directors noted that while the private sector had a major role to play in encouraging the adoption of standards, the official sector could help strengthen incentives to adopt standards and help focus efforts to improve transparency. Most Directors considered that some form of monitoring of the observance of standards could play a useful role to this end; some Directors pointed to the role that market participants could also play in assessing compliance.
Board members shared the view that all aspects of a strengthened architecture are interdependent. These include observance of internationally accepted standards and principles; the choice of exchange rate regime and the strengthening of supervisory frameworks; better data; greater transparency of countries’ policies and the IMF’s assessments of them; and strengthened financial systems. All are also integral to an orderly process of capital account liberalization, to reduce the volatility of private sector flows, and to strengthen financial systems. Moreover, the private sector, national governments, and international institutions and forums would have to work together in this endeavor. National authorities would have to ensure that standards are established and met, that supervisory and regulatory agencies are strengthened, and that vulnerabilities are minimized through better management of macroeconomic and financial policies. At the same time, private financial institutions and corporations need to adhere to new standards that are being set, and the IMF and other international institutions and forums would have to ensure that their efforts are mutually reinforcing and effective.
A complement to the strengthened architecture of the international financial system is strengthened social policies. Countries need to be better prepared to absorb the impact of the inevitable changes that occur in a dynamic market economy and to allay some of the hardships and maximize the benefits of a globally integrated financial system. The IMF had worked closely with other institutions in establishing social safety nets in recent programs in Asia. More would need to be done by the international community, however, including developing codes of good practices in social policies, where the World Bank has taken the lead,6 and in developing social safety nets before a crisis strikes.
This chapter describes the consensus achieved and progress made with regard to the main elements of a strengthened architecture through the end of April 1999.7
Transparency, Standards, and Surveillance
Making the policy process more transparent is an important pillar of a strengthened global financial architecture, as greater transparency helps foster better decision making and economic performance by member countries and by international institutions. Here, the IMF has a dual role: to encourage member countries to be more transparent, and to be more open about IMF policies and advice to members—while at the same time respecting the legitimate need for confidentiality and candor in its policy discussions with members. Transparency also entails greater openness by the private sector, as many of the standards (e.g., accounting, auditing, bankruptcy, corporate governance, and securities market regulation) are ultimately implemented at the level of individual firms. Although questions remain—such as on offshore centers and on the appropriate level of disclosure and regulation of highly leveraged institutions—progress has been achieved on a number of fronts.
Improving Transparency and Accountability of the IMF and Member Countries
In the past two years, the Executive Board adopted a series of measures to improve substantially the transparency of the IMF’s activities and its members’ policies. Actions included:
- Development of a policy on the release of Public Information Notices (PINs) following Board discussions of member countries’ Article IV consultations.8 Members are actively encouraged to consent to their release, and PINs were released for more than 70 percent of Article IV consultations during 1998/99.
- Release of documents related to the Initiative for the Heavily Indebted Poor Countries and solicitation of public comment on the HIPC Initiative, as well as on the conclusions of the internal and external evaluations of the IMF’s Enhanced Structural Adjustment Facility. The IMF’s preliminary assessment of IMF-supported programs in Asia has also been released to the public.
- Commissioning external evaluations of the IMF’s surveillance and economic research activities—expected to be completed by the summer of 1999 and subsequently published.
- Regular publication of information on the IMF’s liquidity position and on members’ accounts with the IMF on the IMF’s website.
In March and April 1999, the Executive Board approved additional initiatives to enhance transparency. These included:
- Establishing a presumption that member countries would release Letters of Intent, Memoranda of Economic and Financial Policies, and Policy Framework Papers underpinning IMF-supported programs.9
- Releasing the Chairman’s concluding statement emphasizing key points made by Executive Directors following Executive Board decisions on the use of IMF resources by a country.
- Establishing a pilot project ending on October 4, 2000, for member countries’ voluntary public release of Article IV staff reports (including combined Article IV and use of Fund resources reports).
- Providing a systematic approach for the public release of PINs following Executive Board discussions of papers on policy issues.
- Expanding public access to the IMF’s archives. This includes reducing the waiting period for Executive Board documents to 5 years from 30 years and for other archived documents to 20 years.
Box 2Strengthening the SDDS and Improving Access to Debt Data
On March 26, 1999, the IMF announced that its Executive Board had strengthened the Special Data Dissemination Standard (SDDS) established in 1996. Key decisions included:
- Strengthening the prescriptions for the international reserve data category, including dissemination of detailed information on reserve assets and information on reserve related liabilities and other potential drains on reserves. The Board prescribed disseminating full data corresponding to the new reserve template monthly, with a lag of not more than one month; data on total reserve assets would still be prescribed for dissemination monthly with a lag of not more than a week. The dissemination of data for the full template weekly, with a one-week lag, will be encouraged;
- Introducing a separate category for external debt that could include quarterly disaggregation by sector and maturity. The transition period will be determined after further consultation with countries, users and international organizations;
- Setting a three-year transition period for disseminating data on the international investment position;
- Staff monitoring of subscribing countries’ observance of key SDDS commitments, namely, the data dimension (i.e., the coverage, periodicity and timeliness of release of data) and the provision of advance release calendars, indicating clearly the timetable for release of key data;
- By the end of 1999, requiring mandatory hyperlinks between the IMF’s Dissemination Standards Bulletin Board and national summary data pages on the Internet, to facilitate monitoring and help meet the needs of data users; and
- Establishing a quarterly certification by subscribers of the accuracy of the metadata on the Dissemination Standards Bulletin Board.
The Inter-Agency Task Force on Finance Statistics, chaired by the IMF, has implemented a joint presentation of external debt statistics from the BIS, the OECD, the World Bank, and the IMF to meet the general need for more comprehensive, timely, and accessible data, particularly for shorter maturities. This presentation is available on the external websites of all of these organizations.
In terms of next steps, the Board plans to:
- Review the experience with the pilot program for release of Article IV consultation reports within 18 months and the policy on access to archives in two years; revisit the issue of PINs for use of IMF resources cases and the release of use of IMF resources staff reports in six months.
- Continue to review the experience with IMF-supported programs and IMF surveillance.
- Take stock of the external evaluation activities undertaken for the ESAF, IMF surveillance, and IMF economic research activities with a view to considering proposals on future activities and modalities of external evaluation toward the end of calendar year 1999.
Developing Standards for Use by Members
As an important means of strengthening the international financial system, the IMF is seeking to foster the development, dissemination, and adoption of internationally accepted standards, or codes of practice, for economic, financial, and business activities. During 1998/99, the IMF made considerable progress in developing and refining voluntary standards in the areas of direct operational concern to the IMF (data dissemination; transparency of fiscal, monetary, and financial policies; and, in conjunction with others, banking supervision):
- The Special Data Dissemination Standard (SDDS)—a standard of good practice in the dissemination of economic and financial data for member countries with, or seeking, access to international capital markets—was strengthened, notably with respect to international reserves, external debt, and procedures for monitoring observance of the standard (see Box 2). As of the end of April 1999, there were 47 subscribers to the SDDS.
- Work will continue on the General Data Dissemination System (GDDS), which is targeted at those member countries not in a position to subscribe to the SDDS.
- A manual on fiscal transparency to assist members in implementing the Code of Good Practices on Fiscal Transparency: Declaration on Principles has been approved. The Code, Manual, questionnaire, and self-evaluation report are available on the IMF’s website. A dedicated electronic mailbox has also been set up so that country authorities can seek assistance with assessing the transparency of their fiscal management systems and formulating plans to improve fiscal transparency.
- A draft Code of Good Practices on Transparency in Monetary and Financial Policies is well advanced. The Code was developed by the IMF, in collaboration with the BIS, a representative group of central banks, other financial supervisory and regulatory agencies, the World Bank, the Organization for Economic Cooperation and Development (OECD), and academics. Following Board review of the draft Code in April 1999, it was placed on the IMF’s website as a consultative document.
- On banking supervision, a draft handbook on the methodology for assessing implementation of the Basle Core Principles was being developed by a working group—including the IMF and the World Bank—for early consideration by the Basle Committee on Banking Supervision.
The next steps in developing and refining standards include:
- For the SDDS, refining proposals on the transition period for observance of the new prescription on external debt, following further consultation with countries, users, and other international organizations; examining the inclusion of macro-prudential indicators in the SDDS; implementing the agreed monitoring procedures; and reassessing prescriptions for the periodicity and timeliness of reserve data dissemination in the context of the next review of the SDDS, to be conducted toward the end of 1999.
- Efforts are under way to encourage all countries to make assessments of fiscal transparency. For those countries where a lack of fiscal transparency affects policy formulation and implementation, national authorities are being encouraged to identify weaknesses and improve their practices, with technical assistance provided where necessary.
- Further work in developing the Code of Good Practices on Transparency in Monetary and Financial Policies will be undertaken with the expectation that a revised version be submitted for Interim Committee endorsement at the 1999 Annual Meetings. A supporting paper setting out examples of good practices will be developed to help members seeking to improve the transparency of their monetary and financial policies.
Role of Standards in IMF Surveillance
Following up an Executive Board discussion on standards and IMF surveillance in July 1998, the Board considered further the role of the IMF in relation to standards. The main areas of emerging consensus within the Executive Board as of the end of April 1999 included:
- Standards relevant for the functioning of domestic and international financial systems cover a range of areas, including data dissemination; fiscal, monetary, and financial policy transparency; banking regulation and supervision; securities and insurance regulation; accounting and auditing; bankruptcy; and corporate governance.
- The official sector can play a role in strengthening incentives for adopting standards—including by some form of monitoring the extent to which countries observe them—and in helping focus efforts on improving transparency.
- The focus in monitoring observance of standards may need to go beyond disclosure of elements of particular standards, and also consider, to the extent feasible, the substance of members’ policies relative to the standard.
- Care should be taken in the approach to monitoring to ensure it does not undermine the IMF’s traditional role as confidential advisor.
The issues and practical modalities in the preparation of “transparency reports"—which summarize the degree to which an economy meets internationally recognized disclosure standards—as recommended by the Group of Twenty-Two and Group of Seven, were complex. To help illuminate practical considerations involved in monitoring observance of standards, a first round of experimental case studies of transparency practices of individual member countries was prepared by the IMF staff and published.10 Given the complexity of the issues, the Executive Board agreed that a second round of experimental case studies—covering a wider range of countries, including those where implementation of standards is less advanced—should be undertaken to help develop the IMF’s role in this area, with a view to having concrete proposals by the 1999 Annual Meetings.
A few issues that required further consideration were:
- The role of the IMF in monitoring observance of international standards in areas of direct operational (or core) concern. The IMF has expertise that would allow it to assess members’ observance of international standards in four core areas: data dissemination; transparency of fiscal policy; transparency of monetary and financial policies; and, with other organizations, banking supervision.
- The IMF’s involvement with other standards that fall outside its direct operational (noncore) concern and expertise. Other noncore standards—accounting, auditing, bankruptcy, corporate governance, insurance and securities regulation—are also important for the effective operation of financial systems. Standard-setting bodies in a number of these non-core areas are not likely to be in a position to assess independently the observance of the standards they have developed. For noncore areas to be monitored, other international financial organizations or groups of organizations would need to provide systematic or widespread assessments of these standards.11
- Using the expertise of other organizations in particular areas and drawing this work effectively into the IMF’s surveillance, to better identify vulnerabilities.
Strengthening Financial Systems
Strengthening financial systems is an essential element of the new architecture. To this end, the IMF, the World Bank, the Basle Committee on Banking Supervision, other key international groupings, and financial supervisors across various regions have stepped up efforts in developing and disseminating international principles and good practices of sound financial systems. Key actions undertaken during the financial year included:
Box 3Enhanced IMF-World Bank Financial Sector Collaboration
In recognition that more effective collaboration between the IMF and the World Bank is important in strengthening financial systems, the Financial Sector Liaison Committee (FSLC) was established in September 1998 to enhance such collaboration. The aim of the collaboration is to ensure that the IMF and the Bank deliver high-quality, sound, and timely advice to countries and that expert staff from both institutions are used in the most effective way.
The Committee has:
- initiated actions to enhance coordination of both IMF and Bank work programs, developed guidelines and initiated actions to enhance coordination of both IMF and Bank work programs, developed guidelines and
- agreed, in principle, to coordinate a joint financial sector monitoring and assessment program aimed at improving evaluations of the health and vulnerabilities of member countries’ financial systems.
The Committee plans to develop further the proposal for collaboration in the form of jointly conducted “financial system stability assessments” that would draw on the resources and feed into the work programs of both institutions.
- Review by many national financial supervisory and regulatory agencies of their ongoing procedures to enhance oversight of financial sectors in light of recent events, including with respect to highly leveraged institutions.
- Review by the Basle Committee of gaps in existing work, including data-related issues, dealing with weak banks, safety nets, licensing, governance, and legal and judicial issues; establishment of a task force, with input from the IMF and World Bank, to review the 1988 Capital Accord, which defines the amount of capital international banks have to set aside against different categories of loans; and issuance by the Basle Committee of reports on standards for banks’ interactions with highly leveraged institutions.
- The establishment of the Financial Stability Forum to strengthen cooperation among international organizations, regulatory associations, and expert groups with responsibilities in financial regulation and oversight, and review areas of vulnerability on an ongoing basis. The forum set up three working groups to focus on highly leveraged institutions, offshore financial centers, and the potential problems for countries associated with short-term capital flows.
- Actions by the IMF and the World Bank to ensure effective collaboration, particularly with regard to the financial sector (see Box 3).
- Completion by the International Accounting Standards Committee (IASC) of its work program in developing a core set of international accounting standards that could be adopted for international cross-border listings.
- Progress by the OECD in finalizing principles of corporate governance.
In addition to the efforts on developing standards and good practices, the legal environment in which financial systems operate must be efficient and effective. To this end, several countries have taken welcome actions to improve their bankruptcy laws and procedures, but there is still a need to press ahead more broadly on this front. In this context, the IMF staff has prepared a report on orderly and effective insolvency procedures, which identifies and discusses key issues that arise for all countries regarding the design and applicability of such procedures. The World Bank also intends to develop guidelines for effective insolvency regimes for developing countries. In addition, the United Nations Commission on International Trade Law (UNCITRAL)—which has proposed a model law on cross-border insolvency and has contributed to the IMF report—has expressed strong interest in collaborating with the IMF and World Bank in this area. The Interim Committee, in its April 1999 communiqué, welcomed the IMF’s work in the area of insolvency laws and called on the IMF to continue collaborating with the World Bank, UNCITRAL, and other relevant institutions in promoting effective insolvency systems. While noting the voluntary nature of the new standards, the Committee also encouraged countries to adopt them as they were being developed.
Capital Account Issues
Although there is a broad consensus that financial integration, including capital account liberalization, brings substantial benefits, such liberalization carries risks and must be managed carefully. In 1998/99, the Board took up the issue of capital account liberalization on two occasions,12 with the later session—in March 1999—addressing members’ experiences with the use of capital controls and their liberalization. The Board agreed that:
- Capital account liberalization must be fully supported by a consistent macroeconomic framework, including monetary and exchange rate policies, and by an adequate institutional setup to strengthen the ability of financial intermediaries and other market participants to manage risk and to support monetary and exchange rate policies.
- Notwithstanding this general principle, countries had followed diverse approaches to the speed and sequencing of capital account liberalization. Directors’ views also differed on the usefulness and effectiveness of capital controls.
Experience from the crises of the last two years had highlighted that, in many cases, poorly sequenced or poorly supported liberalization and inconsistent monetary and exchange rate policies lay behind the accumulation of imbalances that preceded the crisis in emerging markets. Excessive accumulation of short-term debt and highly leveraged positions in the banking and corporate sectors left the economies vulnerable to external shocks or a loss of confidence. Poor risk assessments and herd behavior on the part of investors also contributed to increased vulnerability.
The experience from the crisis also underscored that once the financial turmoil began, and especially after it intensified following the Russian crisis in August 1998, even countries with seemingly appropriate policies were buffeted by volatile international capital markets. Countries that maintained consistent monetary and exchange rate policies, and that supported liberalization with financial sector reforms, were better able to handle capital inflows and subsequent reversals.
While supportive of the aim of further liberalization of capital flows, the Executive Board, at its March 1999 meeting, discussed the use and effectiveness of controls and found it helpful to distinguish between controls over capital outflows and over inflows.
Most Directors concluded that the reimposition of controls on capital outflows was not an effective policy instrument in a crisis. To be effective for even a short time, controls had to be wide ranging and strict; yet the more this was the case, the more likely they were to interfere with commercial transactions and debt service and, therefore, to discourage debt rollovers and new inflows. Thus, resort to controls on outflows was generally seen as likely to increase the severity of the external adjustment and have long-lasting damaging effects on countries’ access to international finance. Several Directors, however, considered that, in a crisis, the reimposition of controls on capital outflows—together with the appropriate involvement of the private sector and in the context of a broader adjustment effort—could play a useful role.
There was considerably more debate over the effectiveness of disincentives or controls on capital inflows. Although the impact of such controls on the total volume of inflows was controversial, there was more evidence supporting the view that with controls the composition of inflows shifts toward the longer end of the market. Countries using controls on inflows, however, had not avoided severe capital flow reversals when policies were inappropriate. Directors thus stressed that controls on inflows were not a substitute for more fundamental policy action and, when adopted, had to be part of a broader policy package. A case could be made that controls on inflows might be justified on prudential grounds in situations of a weak domestic institutional and regulatory environment, and as a means of coping with external market pressures. Nevertheless, it was emphasized that it was generally preferable to address prudential difficulties directly to avoid the risk to financial systems and the impact of capital controls on the efficient mobilization and allocation of financial resources.
In terms of next steps, Directors agreed that:
- To draw conclusions for best practices, IMF staff would continue to refine its analysis and review the experience of countries with the use (and the effectiveness) of specific controls, as well as their experiences with liberalizing different components of the capital account.
- Further efforts would be made to ensure that IMF surveillance focuses on the appropriate sequencing of capital account liberalization, and that effective safeguards are in place to help ensure the resilience of the economy, particularly the financial sector, to possible shocks.
- Work to improve the reporting and monitoring of capital flows would continue, including assisting countries to improve monitoring of private sector short-term flows, particularly with respect to interbank credit lines.
Involving the Private Sector in Forestalling and Resolving Crises
The effort to better involve the private sector in crisis prevention and resolution is seen as critical in bringing about a more orderly adjustment process, limiting moral hazard, strengthening market discipline, and helping emerging market borrowers protect themselves against volatility and contagion. In 1998/99, the IMF’s Executive Board, together with the international community, considered various proposals for involving the private sector.
The experience of the past two years suggests that the case-by-case approach has achieved a degree of success, although some Directors thought it would be appropriate to adopt a framework for involving the private sector in which rules would be clarified for private financial markets ex ante. In large part, the approach in such countries as Brazil, Indonesia, Korea, and Thailand relied on a combination of strengthened economic policies, official financing, and varying approaches to the private sector. In Korea, Indonesia, and Ukraine, moral suasion by the international community helped secure continued private sector financing in support of countries’ adjustment programs. Brazil reached voluntary agreement with commercial bank creditors to maintain their exposure. As a result of such cooperative efforts, exposures were maintained and some burden sharing achieved, but questions remained as to the general applicability of these efforts and whether they could have adverse effects (see Box 4).
Box 4Measures for Involving the Private Sector in Resolving Crises
Ex Ante Measures
Private contingent credit lines that could be drawn on in times of difficulty, if fairly priced, could provide efficient insurance against adverse market developments, including liquidity risk, and could contribute to effective burden sharing during periods of stress. At the same time, in complex financial markets, hedging strategies of private financial institutions could lead to offsetting transactions with the country concerned, or shift pressures to other markets, or both. Members should be encouraged to explore contingent credit lines with private financial institutions.
Call options in interbank credit lines could provide a contractual basis for extending maturities under specified conditions. However, interbank credit lines are often a key source of short-term liquidity for countries, and the triggering of such options could lead to a loss of maturing short-term credit lines in advance of a call, thereby worsening liquidity difficulties.
Debt-service insurance, including instruments commonly known as “structured notes” that can be adapted to generate a debt-service burden that varies countercyclically against overall economic developments of the country, could help reduce the risk of crisis. Such instruments are more likely to be feasible for members that have highly concentrated exports (such as many oil or primary commodities exporters), where contracts can be linked mainly to external developments.
Official guarantees of new debt through full or partial guarantees of new sovereign or private debt instruments may hold promise at times when market access is very limited, for example, while emerging from a crisis. Questions can be raised about the effectiveness of guarantees, however. The World Bank recently reviewed its experience with guarantees and proposed a limited policy-based guarantee program; the experience with this program will be assessed at a later date.
Concerted rollovers of external debt, in Korea, against a background of hemorrhaging official reserves, successfully stabilized a critical situation and facilitated a restructuring of interbank claims into sovereign guaranteed bonds. Korea’s success, however, reflected some special circumstances and could be difficult to replicate elsewhere. In deciding on such operations, the international community must pay special care to the danger that concerted operations in one case could lead creditors to withdraw credit lines in advance of a crisis elsewhere for fear of a concerted rollover.
Restructuring international sovereign bonds raises difficult issues, which need to be considered case by case. In practice, there is a trade-off between the immediate cash flow relief associated with bond restructuring and the resulting reduction over the medium term in the country’s ability to mobilize resources from private creditors.
At a March 1999 discussion, the Executive Board generally agreed that more had to be done to create market-based incentives and instruments for the private sector to remain involved.
Intensifying Efforts at Preventing Crises
Preventing financial crises is key and is the primary responsibility of member countries working in collaboration with the IMF and with the international community. In addition to implementing appropriate macroeconomic and structural policies, countries’ efforts need to be aimed at improving the environment for private sector risk assessment and decision making by enhancing the flow of information and the regulatory environment, and by limiting implicit and explicit guarantees to the private sector. Directors agreed on the following main elements:
- Countries should maintain an appropriate debt profile, by avoiding the excessive accumulation of short-term debt or an excessively rigid debt structure, and by ensuring adequate levels of both official reserves and banking system liquidity to help provide for orderly handling of a temporary reduction in capital market access. Countries should establish or strengthen systems for the high-frequency monitoring of private external liabilities, to better monitor short-term capital flows, and to provide early warning of emerging difficulties.
- Countries should exercise appropriate restraint with respect to the official sector’s off-balance-sheet transactions, including the use of financial derivatives, and should ensure that the supervisory authorities take account of financial entities’ vulnerability to financial derivatives. The IMF staff will give more attention to potential vulnerabilities associated with debt structures and financial derivatives in the context of both surveillance and the use of IMF resources.
- Effective communication between emerging market borrowers and private capital markets should be maintained. Such contacts have proved their worth during periods of market stress in Latin America. The IMF should consider ways to help member countries establish regular communication with their creditors—including assessing along with other international organizations the creation of creditor-debtor councils—giving due attention to potential problems such as insider information. The IMF is also seeking to expand its regular contacts with markets.
Measures to Facilitate Private Sector Involvement
Prevention needs to be buttressed by measures designed and adapted ex ante to better ensure the involvement of the private sector in crisis avoidance or orderly resolution. Such measures put in place before the event can help facilitate the orderly resolution of balance of payments pressures. These include mechanisms that effectively precommit private sector participants to maintain or provide additional net exposure, or reduce debt-service burdens, in times of crisis, while limiting moral hazard and the distortion to markets in normal times. Mechanisms are also needed for dealing with extreme situations when ex ante measures do not deliver the needed support and it is not possible to agree on an orderly refinancing or debt restructuring.
In considering options, two main principles are that contracts should be honored and that care is required to ensure that solutions adopted to help avoid or resolve a crisis in one case do not have broader adverse effects that could potentially cause more difficulties than they solve.
In addition to proposals that would seek to reduce any bias that might exist in the short-term interbank credit markets, and to modify the terms of bond contracts, several measures have been proposed (see Box 4).
As of March 1999, agreement seemed to be emerging within the Board in three areas:
- (1) Encourage the reassessment of capital standards by the Basle Committee to include measures to reduce the perceived bias toward short-term interbank credit lines from industrial countries to emerging market banks. (The Basle Committee on Banking Supervision (BCBS) subsequently announced reforms of the Basle Capital Accord in June 1999.)
- (2) Move forward with modification of bond contracts. This could be done by including sharing clauses, provisions for the modification of terms by qualified majorities, and collective representation provisions, or other modifications to achieve the same objectives. British-style trust deed bonds contained such clauses and could serve as a useful model for future issues, but they were not the only model. While consideration was being given to this issue in other forums, little progress had occurred. This suggests that some form of concerted action by major industrial countries to encourage emerging market borrowers to modify the terms of their new issues was required. Another approach would be to rely upon a demonstration effect, through the inclusion of new contractual terms in international bond issues by the Group of Ten. This would seek to establish the new instrument as an industry standard and could reduce the costs associated with its use.
- Consideration should also be given to a coordinated regulatory requirement for new sovereign issues admitted to domestic markets to meet specified minimum conditions regarding contractual provisions. A concerted regulatory approach, intended to reflect systemic concerns, may go beyond the traditional role of security market regulators to protect investors. For its part, the IMF would encourage members to include terms that would facilitate restructuring in bond issues. These steps could be complemented by efforts to build a consensus in support of these changes among the financial institutions involved in issuing and underwriting sovereign bonds.
- (3) Consider contingent financing and debt-service insurance. Borrowers should explore with their creditors possibilities for private contingent credit lines13 and other debt instruments that provide additional liquidity, or reduce debt-service burdens, in periods of severe balance of payments difficulties.
In extreme situations, if ex ante mechanisms put in place fail to deliver the needed support in sufficient amounts, efforts to reach agreement on voluntary debt restructuring fail, and pressures in the external accounts do not abate, members may be faced with a need to consider some combination of a default on sovereign bonds and the imposition of exchange controls. Such measures could interrupt the ability of nonsovereign states to service their external debts. There is little modern experience with restructuring sovereign bonds or with renegotiating private debt caught up in exchange controls, so it is difficult to predict how the process would unfold. To permit the IMF to support a member’s adjustment policies during the possibly protracted period of debt negotiations that could follow such action, the IMF’s financing assurances and arrears policies have been modified so as to permit the IMF to lend, case by case, into arrears. Certain issues remain for the Board to resolve, however, regarding the conditions under which the IMF would proceed.
Ways must also be explored to ensure that, in extreme situations, the process of debt negotiation following default, even if protracted, remains orderly. Some Directors felt that there was little danger of creditors resorting to litigation on a scale that could effectively disrupt a country’s adjustment efforts, or the capacity of the IMF to support those efforts. Others, however, saw a possibility that creditor litigation could block progress toward orderly debt restructuring and challenge the IMF’s ability to provide effective support for a member’s adjustment efforts. Against this background, further consideration could be given to the possibility of adopting some mechanism to allow the official community to endorse a temporary stay on creditor litigation, possibly through an amendment of Article VIII, Section 2(b) of the IMF’s Articles of Agreement.
The Interim Committee, at its April 1999 meeting, asked the Board to continue its work on all of these issues, including on ways to ensure more orderly debt workouts.
In strengthening the architecture of the international financial system, several Board discussions in 1998/99 addressed a number of systemic issues. In these discussions, the IMF’s objective was to contribute to the analysis of exchange rate regimes, propose ways to improve the functioning of the financial system, and adapt its financial facilities, resources, and organization to the evolving international monetary system.
Implications of Capital Mobility and Exchange Rate Volatility
The profound changes that the international monetary and financial system has undergone since the Bretton Woods agreement, in particular over the last two decades, raise broad systemic issues. In the preliminary discussion on IMF-supported programs in East Asia, one lesson drawn was that the stable exchange rates of the countries affected may have led borrowers and creditors alike largely to disregard currency risks, perceiving that they were implicitly guaranteed against related losses. Adoption of a more flexible exchange rate regime is no panacea, however, and regardless of the regime, vulnerabilities will continue to exist and standards for strengthened financial systems and improvements in transparency will still be required.
Before the 1999 Annual Meetings, the Board plans to address these issues. In the area of exchange rate regimes, the focus will be on the volatility of the exchange value of major currencies, the scope for measures to moderate such volatility, and the consequences for the exchange rate policies of emerging market economies. As for asset markets, the focus will be on the systemic aspects of major swings in capital flows to developing countries and on possible general, systemic, measures to moderate the boom phase of the cycle on the side of lenders as well as of borrowers, including some of the measures discussed above for strengthening financial systems and improving transparency and accountability.
Developing IMF Facilities
Progress was made in 1998/99 in adapting the IMF’s facilities to the new international environment. The Board reviewed the Supplemental Reserve Facility in January 1999 with an eye to ensuring that the IMF would be ready to respond promptly and effectively to a member’s need for balance of payments financing.
At the same time, the IMF also explored ways in which it could support members whose economies are fundamentally sound and well managed but that are concerned about the potential effects of contagion on their access to capital markets. In this regard, the Board agreed in April 1999 to establish the instrument of Contingent Credit Lines. This addition to the Supplemental Reserve Facility is intended to play an important role in preventing crises, including by creating further incentives for the adoption of strong policies and adherence to internationally recognized standards, encouraging the constructive involvement of the private sector, and thereby reducing the risks of financial market contagion (see Box 5).
Strengthening IMF Resources
To play its role in safeguarding the stability of the international monetary system effectively, the IMF needs sufficient financial resources. To this end, important actions were taken during the financial year:
- The New Arrangements to Borrow came into force on November 17, 1998. The combined amount of resources available to the IMF under the NAB and the General Arrangements to Borrow is SDR 34 billion (about $46 billion), double the amount under the GAB alone.
- The IMF quota increase under the Eleventh General Review of Quotas came into effect on January 22, 1999, raising overall quotas to SDR 212 billion (about $290 billion) from SDR 145.6 billion (about $204 billion). The increase in usable quota resources enabled repayment of amounts borrowed earlier under the GAB and NAB. At the end of April 1999, the IMF’s liquidity ratio stood at 89 percent, compared with 45 percent a year earlier.
Beyond these actions, a special SDR allocation has been proposed, through an amendment of the IMF’s Articles of Agreement, and is in the process of acceptance by the IMF’s membership. Securing full financing for the ESAF and the IMF’s participation in the HIPC Initiative remains a major challenge, however. Further efforts are urgently needed to ensure that the IMF has adequate resources to support the structural adjustment programs of the poorest member countries and to provide agreed debt relief.
Box 5To Tighten Defenses Against Contagion, IMF Establishes Contingent Credit Lines
At the end of April 1999, the Executive Board agreed to provide Contingent Credit Lines (CCL) for member countries with strong economic policies as a precautionary line of defense readily available against future balance of payments problems that might arise from international financial contagion. The approval of financing under the CCL would signal the IMF’s confidence in the member’s economic policies and in the member’s determination to adjust them as needed should contagion hit.
The CCL was established for a two-year period and will be reviewed after one year’s experience. It is intended to serve as a new instrument of crisis prevention by:
- creating further incentives for members to adopt strong policies, notably debt management and sustainable exchange rate policies, and adhere to internationally accepted standards;
- encouraging the constructive involvement of the private sector, thereby containing the risks of financial market contagion while taking into account the potential impact on the IMF’s liquidity; and
- signaling the IMF’s willingness to provide financing to a member struck by contagion.
The CCL provides short-term financing to help members overcome the exceptional balance of payments financing needs that can arise from a sudden and disruptive loss of market confidence owing to contagion—that is, circumstances that are largely beyond the member’s control and arise primarily from adverse developments in international capital markets consequent upon developments in other countries. It takes the form of an addition to the IMF’s existing decision on the Supplemental Reserve Facility (SRF). A key difference is that the SRF is to be used by members already in the throes of a crisis, whereas the CCL is a preventive measure intended solely for members concerned about potential vulnerability to contagion but that are not facing a crisis at the time of commitment.
The IMF has ensured the effective use and safeguarding of IMF resources by establishing the following criteria for access to the CCL:
- at the time of Board approval of a commitment of CCL resources, the member is implementing policies considered unlikely to give rise to a need to use IMF resources and is not already facing contagion-related balance of payments difficulties;
- the member’s economic performance has been assessed positively by the IMF in the last Article IV consultation and thereafter, taking into account its progress in adhering to relevant internationally accepted standards; in particular, the member should have subscribed to the Special Data Dissemination Standard and be judged to be making satisfactory progress toward meeting its requirements;
- the member should be maintaining constructive relations with private creditors with a view to facilitating appropriate private sector involvement and should have made satisfactory progress in limiting external vulnerability through management of its external debt and international reserves; and
- the member should submit a satisfactory economic and financial program, including a quantified framework, which the member stands ready to adjust as needed.
When a member requests actual use of CCL resources, a special “activation” review will be conducted expeditiously by the Board. At such reviews, the Board needs to ascertain that the member, having successfully implemented its program to date, is nevertheless severely affected by a crisis stemming from contagion and is committed to adjusting its policies as needed.
The CCL is not subject to general IMF access limits, but commitments under the CCL are expected to be in the range of 300–500 percent of the member’s quota in the IMF, unless otherwise warranted by exceptional circumstances, and with due regard to the IMF’s liquidity position.
CCL commitments are to be made for up to one year. At the time of the special activation review, the Board would decide on the amount to be released immediately and on the phasing of the balance remaining and the associated conditionality. Countries drawing under the CCL are expected to repay within one to one and one-half years of the date of each disbursement (the Board may extend this repayment period by up to one year). During the first year following the first drawing of CCL resources, the member will pay a surcharge of 300 basis points above the rate of charge on regular IMF drawings. (The rate of charge is a weighted average of short-term interest rates in the domestic money markets of the five countries whose currencies make up the SDR valuation basket.) The surcharge increases by 50 basis points every six months thereafter up to a maximum of 500 basis points.
Institutional Reform and Strengthening or Transforming the Interim Committee
During the financial year, the Board considered proposals for strengthening the Interim Committee or transforming it into a policymaking Council of the IMF’s Board of Governors. Directors held diverse views on the Council. Most Directors, at a March 1999 discussion, were still unconvinced of the merits of establishing a Council, noting that the Interim Committee—despite the absence of decision-making powers—in effect already discharged the responsibilities envisaged for the Council. Several felt that the current institutional structures provided the necessary legitimacy and accountability, and that emphasis should be placed on enhancing these structures, as well as, more broadly, on the pressing issue of reform of the international monetary system. Some Directors thought that further analysis was needed to come to a judgment on the establishment of a Council and noted the need to explore the impact of the Council on the work and responsibilities of the Executive Board. A few other Directors, however, felt it was important to involve IMF members at a political level to make decisions on key strategic issues. These Directors felt that, in particular, this would strongly underline legitimacy and ownership in the IMF’s decisions and the accountability of the institution.
At its April 27, 1999, meeting, the Interim Committee agreed that the IMF should remain at the center of the international monetary system, while improving, in a pragmatic manner, the modus operandi of its institutional components and its cooperation with other institutions and forums. The Committee asked the Executive Board to explore further the scope for institutional improvements, including the Interim Committee, and to report back at its fall 1999 meeting.
World Bank, Principles of Good Practice in Social Policy: A Draft Outline for Discussion and Guidance, April 14, 1999, DC/99-4 (Washington, 1999).
For updates on progress with the main elements of a strengthened international financial architecture, see “A Guide to Progress in Strengthening the Architecture of the International Financial System” on the IMF’s website (http://www.imf.org).
PINs are issued (1) at the request of a member country, following the conclusion of the bilateral Article IV consultation, to make known the views of the IMF; and (2) at the decision of the Board, following policy discussions in the Executive Board.
Letters of Intent and Memoranda of Economic and Financial Policies are prepared by the member country. They describe the policies that a country intends to implement in the context of its request for financial support from the IMF. Policy Framework Papers are prepared by the member country in collaboration with the staffs of the IMF and the World Bank. These documents, which are updated annually, describe the authorities’ economic objectives and macroeconomic and structural policies for three-year adjustment programs supported by resources under the ESAF, as well as associated external financing needs and major sources of financing.
The two experimental studies along the lines of transparency reports (for Argentina and the United Kingdom) and a third (for Australia) are posted on the IMF’s website, along with a solicitation for public feedback.
The World Bank is developing systems for assisting countries to assess structural sources of vulnerability and providing support for institutional strengthening and capacity building; see World Bank, Strengthening the Underpinnings of the Market Economy: International Standards, Principles and Best Practices, and the Role of the World Bank, April 22, 1999, DC/99-10 (Washington, 1999).
Published as Capital Account Liberalization: Theoretical and Practical Aspects, IMF Occasional Paper No. 172, by a staff team led by Barry Eichengreen and Michael Mussa (Washington, 1999).
Argentina and South Africa, among others, have entered into financing agreements with consortiums of foreign commercial banks with the aim of creating a mechanism to provide liquidity in times of crisis.