Chapter 6. Surveillance

International Monetary Fund
Published Date:
September 1999
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Central to the IMF’s purposes and operations is its oversight of the effective operation of the international monetary system. Accordingly, the IMF’s Articles of Agreement direct it to exercise firm surveillance over the exchange rate policies of its member countries. To carry out this mandate, the IMF typically analyzes the appropriateness of each country’s economic and financial policies for achieving orderly economic growth and assesses the consequences of these policies on other countries and for the global economy. In recent years, fundamental shifts in the global economy—such as the rapid growth of private capital markets, increased regional and monetary integration, and the implementation of current account convertibility and market-oriented reform in many countries—have heightened the importance of effective and timely surveillance. These changes are being mirrored in increased responsibilities for the IMF (see Box 6).

Typically, IMF surveillance has focused on encouraging countries to correct macroeconomic imbalances, reduce inflation, and undertake key trade, exchange, and other market reforms. But depending on the situation in each country, a much broader array of structural and institutional reforms—so-called second-generation reforms—have increasingly been seen as necessary for countries to establish and maintain private sector confidence and lay the groundwork for sustained growth. These areas include strengthening the efficiency of the financial sector, improving data collection and disclosure, making government budgets and monetary and financial policy more transparent, promoting the autonomy and operational independence of central banks, and promoting legal reforms and good governance. (Chapter 5 discusses initiatives in many of these areas.)

Traditionally, the IMF has conducted surveillance on two levels:

  • Bilaterally—through Article IV consultations, generally conducted annually, with member countries; and
  • Multilaterally—through reviews of developments in the staff’s World Economic Outlook exercises and its periodic discussion of developments in international capital markets and financial systems. (See Chapters 2 and 3 for reviews of these Board discussions.)

More recently, the IMF has also undertaken surveillance on a regional basis, for example, through its discussion of developments in the European Economic and Monetary Union and in the West African Economic and Monetary Union. Also, in 1998/99, the Board discussed the experience to date with growth and disinflation in the economies in transition to market- oriented systems.

To ensure more continuous and effective surveillance, the Board supplements its scheduled, systematic monitoring with regular informal sessions—sometimes monthly, or even more frequently—on significant developments in selected countries and regions. In 1998/99, in addition to its discussions on Article IV consultations with member countries, which took 173 hours of Board time, the Board met 29 times—a total of over 87 hours—on policy issues related to surveillance (including discussions of the World Economic Outlook, transparency in members’ policies and surveillance, and staff-monitored programs). The Board also meets regularly to discuss world economic and financial market developments. These continuing assessments by the Board inform and guide the work of IMF staff on member countries and are communicated to national authorities by Executive Directors.

Bilateral Surveillance

The IMF conducts consultations with its member countries, as mandated under Article IV of its Articles of Agreement, generally every year, to review each member’s economic developments and policies. An IMF staff team visits the country, collects economic and financial information, and discusses with the authorities the economic developments that occurred since the last such visit, and the monetary, fiscal, and structural policies that the country is following. The Executive Director for the member country usually participates. The staff normally prepares a concluding statement or memorandum summarizing the discussions with the mission and leaves this statement with the authorities. If a country decides to release the staff’s concluding statement to the public, the IMF makes the statement available on its website. Back at IMF headquarters, the staff prepares a detailed written report describing the economic situation in the country and evaluating the country’s policy stance. The Executive Board then discusses this report. The views expressed by the Directors during the meeting are summarized by the Chairman of the Board (the Managing Director), and the summary is later issued as an IMF “summing up.” The IMF sends the summing up to the country as the record of what was said at the meeting and, if the country agrees, also releases the summing up to the public, together with introductory background material, as a Public Information Notice. In 1998/99, the Board conducted 125 Article IV consultations with member countries, 91 of which resulted in the issuance of a PIN (see Table 4); PINs are also available on the IMF’s website.14

Table 4Article IV Consultations Concluded in 1998/99
CountryBoard DatePIN IssuedCountryBoard DatePIN Issued
AlbaniaMay 13, 1998MacauMarch 25, 1999May 7, 1999
AlgeriaJuly 24, 1998August 24, 1998Macedonia, FYRJune 19, 1998
AngolaFebruary 24, 1999MadagascarFebruary 8, 1999March 2, 1999
ArgentinaMarch 3, 1999March 11, 1999MalawiDecember 17, 1998December 30, 1998
AustraliaOctober 28, 1998November 17, 1998MaliFebruary 10, 1999February 25, 1999
AustriaJune 17, 1998June 24, 1998Marshall IslandsJune 26, 1998
AzerbaijanJune 26, 1998August 17, 1998MauritaniaJanuary 29, 1999
BangladeshOctober 28, 1998MauritiusJune 1, 1998June 29, 1998
BelarusJuly 24, 1998MexicoSeptember 4, 1998
BelgiumFebruary 12, 1999March 8, 1999Micronesia, Federated States of
BelizeAugust 28, 1998September 22, 1998June 26, 1998August 27, 1998
BeninJuly 6, 1998October 23, 1998MongoliaNovember 23, 1998
BoliviaSeptember 18, 1998October 2, 1998MyanmarJune 5, 1998
Bosnia and HerzegovinaMay 29, 1998July 14, 1998NamibiaJanuary 8, 1999
Brunei DarussalamJanuary 6, 1999NepalFebruary 8, 1999February 24, 1999
BulgariaFebruary 19, 1999March 10, 1999NetherlandsJune 12, 1998June 24, 1998
Burkina FasoMay 18, 1998June 12, 1998NigerAugust 28, 1998
BurundiJanuary 8, 1999January 28, 1999NigeriaJune 12, 1998
CambodiaMarch 17, 1999April 6, 1999NorwayJanuary 15, 1999February 1, 1999
CameroonApril 7, 1999April 15, 1999OmanJune 10, 1998July 21, 1998
CanadaJanuary 22, 1999February 5, 1999PakistanJanuary 14, 1999January 27, 1999
Central African RepublicJuly 20, 1998August 11, 1998PanamaDecember 16, 1998January 5, 1999
ChadMarch 29, 1999May 14, 1999ParaguayJanuary 8, 1999January 29, 1999
ChileJanuary 25, 1999February 3, 1999PeruJune 3, 1998June 22, 1998
China, P.R. ofJuly 29, 1998PolandMarch 11, 1999April 8, 1999
ColombiaDecember 9, 1998December 11, 1998PortugalOctober 26, 1998November 2, 1998
CroatiaJuly 10, 1998July 27, 1998RomaniaSeptember 15, 1998October 6, 1998
CyprusJuly 24, 1998August 14, 1998RwandaJune 24, 1998September 1, 1998
DjiboutiJune 1, 1998SamoaFebruary 17, 1999March 12, 1999
DominicaAugust 25, 1998September 22, 1998San MarinoFebruary 25, 1999March 11, 1999
EgyptJanuary 11, 1999São Tomé and PríncipeJuly 13, 1998
EritreaJuly 13, 1998Saudi ArabiaJuly 1, 1998
FijiSeptember 14, 1998October 1, 1998SenegalNovember 25, 1998
FinlandAugust 28, 1998September 10, 1998SeychellesJuly 17, 1998
FranceOctober 28, 1998November 11, 1998SingaporeMarch 15, 1999March 26, 1999
GabonJanuary 15, 1999SloveniaJanuary 7, 1999January 22, 1999
GeorgiaJuly 27, 1998September 11, 1998Solomon IslandsJune 10, 1998July 16, 1998
GermanySeptember 2, 1998September 18, 1998South AfricaJuly 17, 1998September 2, 1998
GhanaDecember 2, 1998January 12, 1999Sri LankaJuly 27, 1998August 12, 1998
GreeceAugust 5, 1998August 10, 1998St. LuciaMarch 23, 1999April 8, 1999
GrenadaMarch 23, 1999April 2, 1999SwazilandJanuary 11, 1999March 8, 1999
GuatemalaMay 27, 1998SwedenSeptember 14, 1998September 25, 1998
HaitiJuly 20, 1998September 10, 1998SwitzerlandFebruary 22, 1999March 1, 1999
HondurasSeptember 14, 1998Syrian Arab RepublicJune 15, 1998
Hong Kong SARJanuary 29, 1999February 11, 1999TajikistanDecember 17, 1998December 21, 1998
HungaryFebruary 22, 1999March 4, 1999TanzaniaFebruary 8, 1999March 31, 1999
IndiaAugust 31, 1998September 22, 1998ThailandJune 10, 1998June 25, 1998
IndonesiaMarch 25, 1999April 13, 1999TongaOctober 23, 1998November 9, 1998
Iran, Islamic Republic ofMarch 19, 1999Trinidad and TobagoJune 15, 1998June 24, 1998
IrelandOctober 14, 1998October 22, 1998TunisiaJune 17, 1998June 26, 1998
IsraelMarch 12, 1999March 23, 1999TurkeyAugust 6, 1998August 13, 1998
JamaicaJuly 15, 1998August 10, 1998TurkmenistanJune 19, 1998
JapanAugust 5, 1998August 13, 1998UkraineMarch 26, 1999April 27, 1999
JordanApril 15, 1999United Arab EmiratesNovember 4, 1998
KazakhstanJune 24, 1998July 1, 1998United KingdomMarch 3, 1999March 7, 1999
KenyaMay 22, 1998United StatesAugust 3, 1998August 7, 1998
KoreaMay 29, 1998June 19, 1998UruguaySeptember 3, 1998September 18, 1998
KuwaitJanuary 29, 1999February 22, 1999UzbekistanSeptember 4, 1998
Kyrgyz RepublicMarch 3, 1999March 29, 1999VanuatuAugust 5, 1998September 16, 1998
Lao People’s Dem. Rep.June 15, 1998July 7, 1998VenezuelaJune 17, 1998
LibyaFebruary 25, 1999Yemen, Republic ofMarch 23, 1999April 15, 1999
LithuaniaJuly 13, 1998July 21, 1998ZambiaMarch 25, 1999April 29, 1999
LuxembourgMay 13, 1998June 1, 1998

Box 6External Evaluation of IMF Surveillance

Because surveillance is so central to the IMF’s activities, the Executive Board, in mid-1998, agreed to engage a group of three independent external experts to conduct an evaluation of IMF surveillance over members’ policies, to assess the effectiveness of such surveillance, and to make recommendations for improvements. The experts were requested to include in their evaluation all channels and instruments of IMF surveillance.

The external evaluation addresses four broad questions:

  • How effective is surveillance in identifying the macroeconomic, structural, and financial weaknesses and imbalances in member countries and in the world economy that obstruct sustainable noninflationary economic growth and external viability?
  • Are the policy recommendations of the Board and the IMF staff relevant, realistic, and timely?
  • What impact do these recommendations have on members’ policies?
  • How appropriate are the surveillance procedures, the resources and staff skills employed, the interactions with member country authorities, and the ways in which the Executive Board’s surveillance conclusions are disseminated?

The outside experts began their work in July 1998 and are expected to complete their report in the summer of 1999.

In addition to Article IV consultations, the Board carries out surveillance in its discussions of ongoing IMF financial arrangements in support of members’ economic programs and financial arrangements intended as precautionary. Other means of surveillance are informal staff-monitored programs and the enhanced surveillance procedure.

  • Precautionary Arrangements. Members agree with the IMF on a Stand-By or Extended Arrangement but do not intend to use resources committed under these arrangements unless circumstances warrant. The country has the right, however, to draw on the resources provided it has met the conditions agreed upon in the arrangement. Such arrangements help members by providing a framework for economic policy and highlighting the IMF’s endorsement of its policies, thereby boosting confidence in them. They also assure the country that IMF resources will be available if needed and provided the agreed conditions are met.
  • Informal Staff-Monitored Programs. Under these programs, the IMF staff monitors the country’s economic program and meets regularly with the country’s authorities to discuss the policies undertaken. The IMF does not, however, formally endorse the member’s policies or provide financial assistance under such programs (see also Chapter 7).
  • Enhanced Surveillance. This involves close and formal monitoring by the IMF, without constituting formal IMF endorsement of the member’s economic policies. The procedure was initially established to facilitate debt-rescheduling arrangements with commercial banks, but it has also been used in other situations.

Global and Regional Surveillance

During the financial year, the Executive Board met on three occasions to discuss the World Economic Outlook and twice to consider reports on developments in international capital markets (see Chapters 2 and 3). On regional surveillance, the Board considered a wide range of issues related to the European Economic and Monetary Union during the year, as well as developments in the West African Economic and Monetary Union.

European Economic and Monetary Union

In April 1998, the Interim Committee welcomed the creation of the European Economic and Monetary Union as one of the most important international monetary developments in the post-Bretton Woods period. EMU was expected to have powerful implications for the international monetary system, based on the promise of a dynamic and integrated economy of 300 million people. Its single currency, the euro, backed by strong macroeconomic policies and a European Central Bank committed to low inflation, held the promise of gaining importance second only to the U.S. dollar.

Box 7The Stability and Growth Pact

In June 1997, the European Council concluded negotiations on the Stability and Growth Pact to secure budgetary discipline in member states during the final stage of the European Economic and Monetary Union. The Pact covers both the implementation of the excessive deficit procedure specified in the Maastricht Treaty and the medium-term surveillance of fiscal policies.

Under the excessive-deficit procedure, EU countries that breach the 3 percent of GDP reference value for the general government deficit are deemed to be in excessive deficit, unless exceptional circumstances apply, and will receive advice from the Economic and Financial Council of Ministers of the European Union (ECOFIN) on correcting the excessive deficit. Failure to follow up effectively on this advice will result in fines for countries in the euro area.

Countries are also expected to submit medium-term stability programs, updated annually, that identify how governments plan to meet and maintain the Pact’s medium-term objective of general government positions that are near balance or in surplus.

Foreseeing wide-ranging changes, the Interim Committee requested the Executive Board to examine further the implications of EMU for IMF operations.

The Board met on several occasions during 1998/99 to discuss various EMU-related issues. It discussed the economic policy challenges facing the euro area; the operational and legal aspects of EMU for the IMF; euro-area monetary and exchange rate policies in the context of Article IV consultations with euro-area countries and discussions with the European Central Bank; and the impact of EMU on selected non-EU countries.

Policy Challenges Facing the Euro Area

At an August 1998 meeting, Directors discussed the policy challenges facing the euro area. In many ways, they noted, circumstances were favorable to the introduction of the euro on January 1, 1999, as the economic recovery in the euro area appeared to have gathered greater momentum and was increasingly driven by domestic demand. Moreover, low inflation and substantial reduction of fiscal imbalances would, if sustained, help Europe achieve the extended growth needed to make inroads into its chronic unemployment problem. But several Directors emphasized that to reduce unemployment to acceptable levels, and ensure the lasting success of EMU, much remained to be done to improve the flexibility of labor and product markets. Against this background, the Board considered how policies could best consolidate the achievements in economic convergence to date and capitalize on them.

The euro area was well equipped to deal with economic policy challenges, with three pillars for ensuring effective policy coordination: the ECB, with its mandate of price stability; the Stability and Growth Pact (see Box 7), which embodied a commitment to sound fiscal policies; and the multilateral scheme for surveillance over labor policies agreed to at meetings of the European Council in June 1997 in Amsterdam, and in Luxembourg in November and December 1997. In this regard, Directors recognized that the final responsibility for individual fiscal and structural policies would remain at the national level.

Establishing credibility was a key challenge facing the ECB, Directors agreed. While the impressive performance of the national central banks in recent years provided a basis for confidence in this regard, many Directors cited some initial challenges in setting up a workable framework to guide monetary policy. The ECB would need to adjust its policy instruments pragmatically and explain clearly, frequently, and transparently the factors influencing its policies so as to clarify to the markets and the broader public the consistency of its actions with its mandate to ensure price stability in the euro area. Several Directors considered that cyclical divergences should not pose a major problem for monetary policy; they would diminish over time as a common monetary policy was implemented and as economic integration proceeded.

The conduct of national fiscal and structural policies was critical, not only for economic prospects in individual economies, but also for the euro area as a whole, as national policies would have inevitable spillover effects on other countries via their implications for the single monetary policy and the exchange rate of the euro. Several Directors observed that a number of cyclically advanced economies were either pursuing expansionary fiscal policies in 1998 or not taking sufficient advantage of favorable cyclical conditions to strengthen their medium-term fiscal policies. Tighter fiscal policies in these countries would help prevent the emergence of appreciable inflation differentials and real exchange rate swings with the union.

Allowing fiscal policy to play an effective countercyclical role was important for moderating cyclical swings in demand at the national level, thereby helping keep cyclical divergences in check in the future. Against the background of past tendencies toward procyclical fiscal policies, Directors saw as critical a commitment to the Stability and Growth Pact’s goal of providing countries room to deal with normal cyclical divergences while keeping general government deficits below 3 percent of GDP.

Consistent with the Stability and Growth Pact, a medium-term fiscal position of near balance was appropriate at the time for most countries, although surpluses were warranted in a few countries. Although a less ambitious medium-term fiscal target might be sufficient to provide room for the automatic stabilizers in normal cyclical fluctuations, a number of considerations warranted going beyond this; these included adequate scope for discretionary countercyclical policies and of providing room for dealing with interest rate shocks, general uncertainty in the measurement of output gaps, and helping prepare public finances for the longer-term challenges associated with population aging.

Although there were some differences across countries, the convergence process in recent years had brought the euro area much closer to a satisfactory medium-term position. Nevertheless, the deterioration in the projected general government primary structural balances, especially for 1998, pointed to the still-significant risk that some countries would not achieve the medium-term goal of the Stability and Growth Pact and that some policymakers might focus too much on actual rather than cyclically adjusted deficits, leading them to introduce expansionary measures during economic upswings.

Against this background, Directors thought that governments needed to provide convincing evidence in their budgets for 1999 and in the stability programs to be presented to the EU’s Council of Economic and Finance Ministers by the end of 1998 that fiscal positions would be brought into line with the medium-term goal of near balance, or surplus, not later than 2001. This was particularly important for those countries with high levels of public debt. The objective would entail a relatively moderate pace of fiscal adjustment, providing the opportunity to focus also on reform of fiscal systems—including pension and welfare schemes—as part of a broad package of structural reforms addressing the root causes of Europe’s high unemployment and low labor participation rates. Directors noted that spending reforms could have a direct impact on incentives in the labor market, but they were also essential for creating scope for cuts in taxes and social security contributions. Initial reforms, the Board believed, should focus on reductions in primary expenditures.

At their August 1998 discussion, Directors underscored the importance of complementing fiscal reforms with other structural changes aimed at enhancing the flexibility of the real economy. Accelerated action was needed to achieve greater product and labor market flexibility to help reduce the high level of structural unemployment. Many Directors observed that countries had made progress in addressing structural rigidities, but it was not sufficient to have a noticeable impact on structural unemployment in most countries. It was essential, in the Board’s view, that institutional and market structures also allow sufficient flexibility to deal with asymmetric shocks.

In view of the key role of national economic policymaking in determining the overall policy mix in the euro area, and the associated potential for spillover effects, Directors emphasized the importance of effective coordination of national economic policies. Some Directors, however, thought that current practice in the European Union, bolstered by the Stability and Growth Pact, balanced appropriately the need to limit policy spillovers with the need to provide scope to adapt policies to national circumstances. Directors underlined the role that IMF regional surveillance could play in fostering a desirable overall stance of policies and an appropriate policy mix. Such efforts had to be complemented by IMF consultations with individual countries.

In reflecting on the course of interest rates in the future, Directors observed that, for the euro area as a whole, a slack-absorbing recovery (as of the end of August 1998) was still in its early stages and that considerable spare capacity remained. Moreover, price inflation was low; developments in wages and monetary aggregates gave little ground for concern about inflation prospects; and the historically low long-term interest rates indicated that fears of inflation were also absent from the markets. These considerations on their own warranted keeping short-term interest rates in the core countries of the exchange rate mechanism (ERM) stable, with rates in other euro-area countries converging toward this level. Directors pointed to downside risks associated with developments in Russia and Asia, as well as the weakening in several emerging markets, which argued against premature tightening of monetary policy; an increase in interest rates would, therefore, have to await a further maturing of the recovery and a clearer indication of the effects of external factors. The Board agreed to a wait-and-see approach to interest rate policy.

Operational and Legal Aspects for the IMF

In September 1998, the Board discussed the operational and legal aspects of EMU for the IMF. The transfer of monetary powers by members of the euro area to EMU institutions, Directors agreed, would not affect their countries’ legal relationship with the IMF under its Articles of Agreement, as the IMF is a country-based institution. Euro-area members would remain members of the IMF in their own individual capacity as countries. Nevertheless, the exercise of the individual rights and fulfillment of the obligations of members may be affected by the adoption of a common currency and the transfer of competencies to common institutions within the euro area.

With regard to operational aspects of EMU for IMF surveillance. Directors noted that EMU, and particularly the adoption of a single monetary policy under the responsibility of an independent European Central Bank, had important implications for IMF surveillance. As economic policies ofthe euro area would have important effects on other countries, Directors agreed that the IMF’s responsibility to conduct surveillance over members’ external and exchange rate policies required intensifying discussions with EU and euro-area institutions, especially the ECB.

Box 8IMF Grants Observer Status to European Central Bank

On December 22, 1998, the Executive Board granted observer status at the IMF to the European Central Bank (ECB), effective January 1, 1999. The ECB was invited to send a representative to attend Board discussions on the following topics:

  • IMF surveillance under Article IV over the common monetary and exchange rate policies of the euro area;
  • IMF surveillance under Article IV over the policies of individual euro-area member countries;
  • the role of the euro in the international monetary system;
  • the world economic outlook;
  • international capital markets reports; and
  • world economic and market developments.

The ECB was also invited to send a representative to Board meetings on the agenda items recognized by the ECB and the IMF to be of mutual interest in fulfilling their mandates.

Directors agreed that while Article IV consultations with euro-area members would proceed as usual, these could not be completed without discussion of such core policies as monetary and exchange rate policies that fall within the IMF’s mandate. It was decided, therefore, that discussions with the representatives of the relevant EU institutions—the ECB, and also the Council of Ministers and the Economic and Financial Committee, especially on matters related to the policy mix and the exchange rate—would need to take place as part of Article IV consultations with individual euroarea countries. The modalities envisaged included twice-yearly staff discussions with the EU institutions responsible for common policies in the euro area, and an annual IMF staff report and Board discussion on the monetary and exchange rate policies of the euro area in the context of Article IV consultations with these countries. To the extent possible, the discussions with individual euro-area countries would be clustered around the discussions with the EU institutions.

To provide transparency on the IMF’s surveillance of EMU, Directors agreed that, subject to the consent of the members concerned, Public Information Notices could be issued following the conclusion of the Board discussion on euro-area surveillance.

Directors agreed that effective communication of relevant EU institutions’ views in Board discussions would be important for enhancing IMF surveillance over the euro area, and they called for granting the ECB observer status at the IMF (see Box 8). Directors highlighted the implications for national and regional data and information provision to the IMF from the move to the euro and directed the staff to make the necessary arrangements, particularly with the ECB and the Statistical Office of the European Union (Euro-stat), for regular and timely transfer of data sets.

Euro-Area Monetary and Exchange Rate Policies

In March 1999, following the January 1 launch of the euro, Executive Directors discussed for the first time the monetary and exchange rate policies of the euro area in the context of Article IV consultations with euro-area countries. EMU offered participating countries and the world economy potential for greater economic stability and performance, and much had been done already by euro-area authorities to establish the foundation for realizing these benefits: a solid framework had been put in place to guide both monetary and fiscal policies; price stability had been achieved, and seemed secure for the foreseeable future; headway in fiscal consolidation had been made in satisfying the Maastricht convergence criteria; and the internal market program had substantially increased market integration in the European Union. Important challenges remained, however—in particular, the need for further fiscal adjustment and for national authorities to address urgently the structural rigidities impeding employment and economic growth.

The tasks facing euro-area policymakers had been complicated by the weakening of short-term growth prospects in the preceding six months. While policymakers’ sights should remain firmly fixed on medium-term requirements, policies also had to be adequately attuned to supporting domestic demand. The euro area required a sustained period of strong domestic demand to help close a sizable output gap and absorb the cyclical component of unemployment. Moreover, most Directors believed that the euro area should play a greater role in supporting global demand.

Board members thought that, with price stability well assured and room for the operation of automatic fiscal stabilizers limited in many euro-area countries by the need for further fiscal adjustment, any easing should come from monetary policy. Short-term interest rates in the euro area had declined significantly over the past year, providing welcome support for economic activity. The case for a further interest rate reduction had increased in recent months, given the continuing uncertainties regarding the strength of the expected economic recovery in the euro area, the further heightening of global economic risks, and the continued downward pressures on inflation in the euro area. Directors agreed the European Central Bank should act decisively if the slowdown appeared to be persisting. In particular, a reduction in interest rates would be warranted if the global environment deteriorated further, if consumer confidence weakened significantly, or if a recovery in industrial confidence did not materialize.

Directors felt that the depreciation of the euro since its introduction reflected the continuing strength of the U.S. economy and uncertainties about growth prospects in the euro area.

Directors underlined the importance, at the early stages of the ECB, that the public understand and have confidence in the monetary framework, given the uncertainties in the outlook for the euro area and the global economy. They generally commended the work done in elaborating the ECB’s approach to monetary policy, which was both sensible and pragmatic in light of the uncertainties of the change in regime. Several Directors felt that the ECB needed to specify an explicit lower bound for inflation to help improve policy discipline and accountability. The ECB had made important strides in communicating with the public, and Directors encouraged its efforts to develop further its communication strategy. In particular, many thought that the ECB had to provide greater detail of its assessment of inflation prospects and be more forthcoming in explaining how it would adapt monetary policy to changing economic conditions, including changes in inflation within the range that defines price stability. A few Directors indicated that there were limits to what could be conveyed by such statements of intent, given the complex considerations that went into monetary policy decisions, and that greater public understanding of the ECB’s monetary policy would come from seeing the ECB in action and listening to its explanations for its actions.

Many Directors felt that an understanding of how the ECB was likely to respond to macroeconomic developments was important for fiscal authorities in gauging the appropriate stance of fiscal policy. While the appropriate fiscal stance in specific countries depended on a range of economic considerations addressed in individual Article IV consultations, the need for further fiscal consolidation in a number of euro-area countries—especially those with relatively large deficits or debts—and the lack of underlying fiscal adjustments in 1998 and in budgets for 1999 constrained the extent to which automatic stabilizers could be allowed to operate in the face of weaker activity. At the same time, the appropriate use of stabilizers also depended on the pace of economic activity and on the degree of support provided by monetary policy. It was especially important in the prevailing uncertain macroeconomic environment, Directors generally emphasized, that the mix resulting from fiscal and monetary policies fosters an appropriate level of aggregate demand in the euro area.

Demand management alone, however, would not provide the antidote to the slow growth and high unemployment that had plagued the euro area. Determined Determined reforms of government spending and taxation systems and a forceful attack on structural rigidities were essential if unemployment was to be lowered substantially. Moreover, early action on these fronts would both boost confidence and ease the task of policymakers in tackling the current cyclical weakness.

Many Directors noted that countries’ medium-term stability programs generally relied on cyclical improvements and declining interest spending to reduce further fiscal deficits, and that they had not planned even the relatively modest annual adjustments in primary structural balances sufficient to realize balanced fiscal positions in 2001–02. Moreover, the modest curtailment of spending growth planned by most countries left insufficient room for tax cuts. These Directors stressed that more ambitious medium-term fiscal strategies would bolster the credibility of the Stability and Growth Pact, provide the monetary authorities with greater room for maneuver, and help prepare for the effects of population aging.

In the area of structural reform, some countries had made good headway in labor market reform and some further progress had been achieved in recent years in strengthening the European Union’s internal market, including through increased competition in telecommunications and liberalization in the utilities sector. Progress in attacking the root causes of high unemployment, however, had been disappointing. Countries had to train the large number of unskilled workers, many without recent job experience; address pervasive rigidities in labor and product markets; cut the heavy tax burden on labor; and reduce disincentives resulting from the interaction of generous unemployment and welfare benefits, their long duration, and inadequate tests of the availability for work of those receiving benefits. A number of Directors also emphasized that further trade liberalization, especially in agriculture, would contribute to a more efficient allocation of resources and help maintain price stability.

Directors were reassured that the ECB considered euro-area financial institutions in sound financial condition in the face of the recent global financial crisis, with no evidence of a credit crunch. Nevertheless, given the increasing integration of European financial markets and the mushrooming of complex operations, existing arrangements had to be reviewed to assess their capability to deal effectively with any rapidly emerging financial problems in European markets. It was especially important to ensure the efficient and rapid flow of information between the national supervisory authorities and the European central banking system.

On April 27, 1999, the Interim Committee welcomed the start of the European Economic and Monetary Union, which should contribute to financial stability and sustainable growth in the euro area and globally. It also welcomed the early April reduction by the European Central Bank of all three of its leading interest rates. The Committee emphasized the importance of open and competitive markets as a key component of efforts to sustain growth and stability in the global economy. Committee members urged the euro area to attack the root causes of high unemployment. An appropriate policy mix to support stronger domestic demand, accompanied by structural reforms in labor, capital, and product markets, was essential for enhancing growth and employment prospects, especially in the medium term, in order for the euro area to be a major source of growth in the world economy.

Impact of EMU on Selected Countries

In July 1998, the Board considered the impact of EMU on selected countries outside the European Union—Eastern and Central Europe, the Mediterranean Basin, and the CFA franc zone.15 While Directors noted the significant benefits of EMU for non-EU countries over the medium term, they stressed the need for these countries to pursue financial and structural policies that would minimize the risks and maximize the opportunities arising from the euro’s introduction. To mitigate possible trade- and investment-diversion effects that could result from reduced transaction costs within the euro area, non-euro countries had to strengthen structural reforms aimed at increasing the openness and competitiveness of their economies. Stronger competition from EU financial markets would also heighten the need for non-EMU partner countries to strengthen their financial sector reforms.

Several Directors considered capital account liberalization a high priority for potential members of the EU. In this connection, they underlined the need for orderly and well-sequenced liberalization, giving high priority to financial sector restructuring. The Board also emphasized the importance of EU countries, for their part, maintaining open trade regimes to broaden and deepen trade and investment relations with other countries. As to the possible risk of short-term exchange rate volatility that could adversely affect those countries with close trade linkages to the EMU or with large euro-denominated debt, Directors generally considered that the likely continuation of strong monetary policy credibility under the EMU meant that such a risk was not a major cause for concern.

Directors looked forward to further discussions of the implications of EMU for IMF surveillance. They saw the need to address the possible spillover effects more explicitly in the IMF’s surveillance over euro-area members, particularly with respect to addressing struc-tural rigidities and maintaining appropriately tight fiscal stances. They also saw the need for greater attention to the implications for non-EU countries of changes in economic and financial conditions in the euro area and to financial sector issues. In certain cases, increased integration in the world economy could mean that greater attention to the choice of exchange rate arrangements would be appropriate. Given that EMU and access to the EU would constrain the framework, design, and implications of macroeconomic policies for future EU members, Directors agreed that IMF surveillance should help these countries by offering them appropriate policy advice on complementary macroeconomic and structural reforms—including with regard to creating a legal and institutional framework and steps to increase the flexibility of markets.

West African Economic and Monetary Union

Executive Directors met in May 1998 to discuss strengthening IMF surveillance of regional developments in Africa by establishing a formal dialogue between the IMF and the regional institutions in the West African Economic and Monetary Union (WAEMU). The economic performance of WAEMU members had improved since the devaluation of the CFA franc in January 1994; nonetheless, Directors felt that the sustainability of the favorable performance hinged upon the pursuit of sound macroeconomic policies and the intensification of structural reforms. They emphasized the importance of continued progress in raising investment—particularly private investment—which remained low relative to GDP by the standards of other developing countries.

The overdue exchange rate realignment of 1994 had helped improve the competitive position of the region and had resulted in a strong increase in the growth of output and exports. Directors also noted that, although the real exchange rate had tended to appreciate since 1994, the competitive position of the WAEMU remained broadly adequate. However, the evolution of competitiveness indicators would need to be kept under close review. Moreover, several Directors recognized that trade liberalization reforms could adversely affect a country’s external position; such effects would be relevant in assessing the need for balance of payments assistance in the context of a comprehensive adjustment program.

The monetary policy of the Central Bank of West African States (BCEAO) had contributed to the macroeconomic stability of the region, including the stability of the exchange rate peg, which had been modified only once since 1948. There was general agreement on the constraints placed on regional monetary policy by the fixed exchange rate regime and on the absence of scope for monetary policy at the national level. While agreeing that the indirect monetary policy instruments introduced since 1993 seemed broadly adequate, Directors emphasized the importance of continued efforts to enhance their effectiveness. They also acknowledged the role of the ceilings on monetary financing of governments and pointed to the importance of strictly adhering to them in the context of fiscal consolidation.

The quality of financial intermediation in the WAEMU area would benefit from a stronger functioning of the regional interbank market, the introduction of a single zone-wide licensing agreement for banks in the WAEMU, and more competition between financial institutions. Directors also underscored the importance of improving the functioning of the judiciary system. While recognizing that the quality of bank supervision in the Union was on the whole adequate, Directors stressed the importance of promptly completing bank-restructuring programs under way in a number of WAEMU countries. They recommended that governments seek full privatization of the banking system and give prompt attention to raising capital ratios to international standards.

The Board supported steps by the WAEMU countries toward liberalizing the region’s trade regime through the adoption of a common external tariff, which would become fully effective by January 2000. They agreed that the tariff structure should contribute to raising potential output in the Union as a whole by improving productivity, enhancing competition, and promoting the integration of the region into the world economy. Directors considered that government revenue shortfalls stemming from trade liberalization efforts—in particular, the introduction of the new external tariff—should be addressed primarily through the elimination of tax and customs duty exemptions and further efforts to strengthen tax administration and collection.

Directors welcomed the efforts under way for harmonizing indirect taxation and adopting a common investment code aiming at eliminating, or at least reducing substantially, exemptions from customs duties or value-added tax. They also encouraged the authorities to pursue other ongoing efforts at improving the overall business environment.

The Executive Board encouraged the authorities to sustain efforts to promote regional convergence of economic performance, in line with the provisions of the WAEMU Treaty. While noting the progress made over the last two years toward observing convergence criteria on the fiscal balance, the domestic contribution to public investment, and payments arrears reduction, Directors encouraged strong efforts toward broadening convergence so as to promote stability and growth. They welcomed the efforts under way to create a common budgetary framework, and a set of comparable economic indicators, and emphasized that progress in the timely availability of reliable data on the national accounts, domestic debt, and the balance of payments was essential to enhance surveillance.

Experience of Transition Economies

In November 1998, the Executive Board discussed the experience with growth and disinflation in transition economies. Directors noted that economic recovery in the transition economies had been mixed and that countries were at different stages of transition (see Box 9). For a number of the Central European and the Baltic countries, the transition was far advanced, with their economic problems and issues progressively more similar to those faced by middle-income market economies; here, progress on structural reforms played a key role. On the other hand, for most of the countries of the Commonwealth of Independent States (CIS), and to some extent for those in southeast Europe, a long unfinished agenda of market-oriented reforms remained.

In some of the Central European and Baltic countries—such as Poland, Hungary, Estonia, and Latvia—economic recovery might be running ahead of itself, Directors observed, which was generating risks of overheating and reversals of capital flows. In the future, growth should depend more on the mobilization of savings and their efficient intermediation by the financial sector—which underlined the need to put the banking system on a sound footing. Much more effort was needed to rationalize, and perhaps reduce, still-expensive social programs, while ensuring the provision of adequate safety nets.

With regard to the CIS, and to some extent countries in southeast Europe, the task at hand varied from completing the large-scale privatization and a meaningful imposition of hard budget constraints in Bulgaria (and even more so in Romania) to making a serious start with reform in Belarus and Turkmenistan, and restarting the reform process in Uzbekistan. Persistence was essential, in particular with adequate follow-through in areas of fiscal and financial sector reform. Privatization was a key mechanism for achieving efficiency and new growth, but this could only be achieved if countries managed to impose hard budget constraints, while establishing a legal framework to ensure the protection of property rights and the application of the rule of law.

Directors agreed that rapid disinflation had been achieved by many transition economies during 1993–97, at minimal output cost. This had been possible because strong stabilization packages had been introduced at a relatively early stage, before inflation expectations had taken root. The small inflation inertia was due to the limited use of wage and price indexation and the rapidity of price liberalization. Disinflation from high inflation levels, as well as the reduced variation of inflation, had enhanced the medium-term growth prospects of the transition economies.

Box 9Conference on the Transition Experience

During February 1–3, 1999, the IMF held a conference, “A Decade of Transition: Achievements and Challenges,” on the transition in central and eastern Europe. Its purpose was to identify lessons from the 10-year transition experience and distill them into better policies and more effective reforms for an increasingly diverse group of transition economies.

IMF Managing Director Michel Camdessus opened the conference by discussing the legacy of the past decade of transition, looking at the future agenda, highlighting the importance of enforcing the rule of law, and focusing on key questions for the future.

The first session of the conference reviewed the experience with inflation and growth. Transition countries in Europe had seen a striking reduction in inflation in the early 1990s, which led to robust output growth. Most of these economies, especially in central Europe and the Baltics, had made good progress on growth and now faced issues similar to those of middle-income market economies, although a long agenda of unfinished reforms remained. The objective in all transition countries should be good economic governance; in many, the government had not pulled back far enough from intervention in economic activity, and yet was not involved enough in providing law and order. Growth rates in the Asian economies in transition (China, Mongolia, Lao People’s Democratic Republic, and Vietnam) were generally greater than those of countries in central and eastern Europe. Growth had generally been fastest in areas where reforms were most far-reaching, especially in agriculture, and these countries had the benefit of more favorable initial conditions than in Europe—specifically, a relatively large agricultural sector and rural labor surpluses.

Participants at a second session, on structural reforms, concluded that privatization had generally improved financial and operating performance, but its mixed record—especially in the countries of the former Soviet Union—had fueled questions about its method and outcomes. Speakers agreed there was no alternative to privatization and that the state should channel its energies into more effective privatizations, for example, by seeking ways to enlarge capital and ensure sales to strategic investors. On banking sector reform, three pillars to effective bank restructuring were identified: corporate governance, competition, and prudential regulation and supervision. The last was not optimal in any country in the region, but strong performers shared a number of features, such as having applied effective foreign and domestic bank entry and exit regulations during liberalization and new private commercial banking. Weak performers in banking sector reform also shared characteristics, for example, a lack of competition, poor asset quality, a lack of sector-specific expertise, significant state ownership, low levels of corporate lending, and an unstable macroeconomic environment.

The third session addressed the need for countries in transition to build institutions that support a market-oriented economy. Conference speakers noted that total capital inflows to transition countries had risen to significant levels, and early reliance on exceptional financing had given way to foreign investment and other flows, which are enhanced by a positive legal and political climate.

The role of government changes during a country’s transition, speakers noted; shock therapy was the first step in adjustment but the more difficult step was the slow process of developing new institutions, changing incentives, and completely rethinking the role of government.

Conferees also discussed the underground economy, which may account for more than 40 percent of total GDP in several countries of the former Soviet Union, and over 20 percent in many others. It is not high taxes that drive firms underground, speakers noted, but rather excessive regulatory discretion, weak rule of law, and corruption. To break the cycle whereby regulatory discretion leads to hidden firm activity, reduced public revenues, weakened legal institutions, and thus greater opportunities for corruption, governments need to reduce regulatory discretion, reform bureaucracies, simplify and enforce laws, create an independent judiciary, and enhance government transparency and public oversight.

The transition to market economies has been accompanied by a large increase in income inequality, since income from self-employment and property (which is traditionally unequal) now makes up a larger proportion of national income, while some former state employees remain unemployed and social transfers sometimes fail to reach the poor.

At the end of the three-day conference, it was clear that transition economies’ experience with privatization, income inequality, and institutional needs was becoming increasingly diverse (partly because of historical and geographical differences), and that the achievement of macroeconomic stabilization, while widely recognized as necessary, was only the first step in the transition process. The vital next stage for these countries was to strengthen or create the legal, fiscal, and regulatory infrastructures—and incentives—needed for the operation of a market economy.

IMF Deputy Managing Director Shigemitsu Sugisaki summarized the conference by noting some underlying themes:

  • Fiscal and monetary stability are essential for successful transition.
  • A sound financial sector is an indispensable component of macroeconomic stability.
  • Privatization is key to forming a viable market-oriented economy.
  • Measures to address income inequality are increasingly important.
  • At the heart of the transition process is the complex and time-consuming task of institution building that helps states support market-oriented economies.

Directors noted that the hardening of budget constraints, together with central bank independence and a tightening of limits on central bank credit to the government, had been at the core of the stabilization packages. Although the link between fiscal performance and further disinflation at moderate inflation levels was less clear, even here disinflation could be impeded by fiscal policies that led to overheating or put the long-term solvency of public finances at risk. In this respect, Directors encouraged the countries that had successfully disinflated to implement structural reforms to strengthen their long-term fiscal positions.

Some Directors believed that, while the lack of inflation anchors had not impeded fast disinflation, their continued absence might expose monetary policy to undue pressures at a later stage of the transition, while a few others questioned the relevance of inflation targeting in the context of transition. Directors agreed that the risk of a reacceleration of inflation could be minimized by institutional reforms aimed at enhancing the independence of the central bank and the transparency of monetary policy.

On the role of monetary anchors, Directors agreed that exchange rate pegs might have contributed significantly to prolonging the moderate inflation phase in some countries. A few also noted the possible drawbacks of exchange rate pegs—pointing in particular to the possible increase in the volatility of capital flows as these countries made progress on the road to market economies—and argued for imparting some flexibility in the exchange rate arrangements. In this regard, greater attention could be given to the costs and benefits of different exchange rate systems in the context of the overall macroeconomic situation and the stage of transition, including the issue of exit strategies.

Sustaining low inflation rates also required the establishment of a strong financial system. Indeed, financial instability rooted in weak banking systems was critical in explaining the few episodes of relapses into high inflation during 1993–97.

Directors were concerned about the fallout from the crisis in Russia, which came to a head in August 1998. The crisis in Russia had reinforced the lessons that could be derived from the experience with transition:

  • incomplete structural reforms to strengthen property rights and governance jeopardize the sustainability of financial stabilization; and
  • the cost of incomplete reform in terms of lost output and renewed inflation can be severe.

Directors suggested that these considerations be taken into account in the design of future IMF-supported programs.

In all countries, the vital task of securely establishing good economic governance still remained, in particular in the CIS and southeast European countries. While in many countries the government had not pulled back sufficiently from intervening in economic activity, the authorities had perhaps pulled back too far in such areas as enhancing a secure climate based on the rule of law. Poor economic governance had delayed structural reforms, which in turn inhibited the economic recovery and constrained the development of a new, more dynamic business sector. In the area of structural reforms, Directors stressed the need for close cooperation between the IMF and the World Bank to achieve the most efficient and consistent support for the stabilization efforts of the transition countries.


The PINs are also published three times a year as IMF Economic Reviews.


The staff paper was published as R. Feldman and others, Impact of EMU on Selected Non-European Union Countries, IMF Occasional Paper No. 174 (Washington: IMF, 1998).

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