CHAPTER VI Surveillance

International Monetary Fund
Published Date:
September 1998
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Central to the IMF’s purposes and operations is the mandate, under its Articles of Agreement, to “exercise firm surveillance over the exchange rate policies of members.” To earn’ out this mandate, the IMF exercises surveillance through both multilateral and bilateral means. Multilateral surveillance consists of Executive Board reviews of developments in the international monetary system based principally on the staff’s World Economic Outlook reports and through periodic discussions of developments, prospects, and key policy issues in international capital markets. Bilateral surveillance takes the form of consultations with individual member countries, conducted annually for most members, under Article IV of the IMF’s Articles of Agreement. The Board supplements this systematic monitoring of individual country and global developments with informal related discussions.

Traditionally, the IMF’s main focus in surveillance has been to encourage countries to correct macroeconomic imbalances, reduce inflation, and undertake key trade, exchange, and other market reforms. But increasingly, and depending on the situation in each country, a much broader range of institutional measures has been seen as necessary for countries to establish and maintain private sector confidence and lay the groundwork for sustained growth (see Box 2). In 1997/98, in addition to its discussions of regular Article IV consultations, the Board met a number of times to develop guidance in each of these areas.

Article IV Consultations in 1997/98

Consultations under Article IV of the IMF’s Articles of Agreement are held with each member country, for the most part, every year. An IMF staff team visits the country, collects economic and financial information, and discusses with the authorities the economic developments and the monetary, fiscal, and structural policies they are following. The staff generally prepares a concluding statement for discussion with the authorities at the end of the visit; in some instances, the concluding statement is released to the public. On its return to headquarters, the staff team prepares a report analyzing the economic situation and evaluating the stance of policies. This report is then discussed by the Executive Board. At the end of the discussion, the Chairman of the Board summarizes the views expressed by Directors during the meeting. This “summing up” is transmitted to the country’s authorities. It is then released to the public—at the option of the country—in the form of a Press (now “Public”) Information Notice (see Box 3). During 1997/98, the IMF concluded 136 Article IV consultations (Table 7).

Table 7Article IV Consultations Concluded in 1997/98
CountryBoard DatePIN IssuedCountryBoard DatePIN Issued
AlgeriaJune 27, 1997July 23, 1997IndiaJuly 2, 1997July 16, 1997
AngolaOctober 8, 1997IndonesiaJuly 9, 1997
Antigua and BarbudaDecember 3, 1997December 17, 1997Iran, Islamic
ArgentinaFebruary 4, 1998February 23, 1998Republic ofJanuary 30, 1998
ArmeniaFebruary 6, 1998March 12, 1998IrelandJuly 2, 1997July 25, 1997
ArubaMay 19, 1997May 27, 1997IsraelFebruary 11, 1998March 10, 1998
AustriaJune 13, 1997June 20, 1997ItalyMarch 13, 1998
Bahamas, theMarch 13, 1998March 31, 1998JamaicaSeptember 8, 1997October 2, 1997
BahrainMarch 4, 1998JapanJuly 25, 1997August 13, 1997
BangladeshAugust 18, 1997JordanApril 23, 1998
BarbadosJanuary 30, 1998February 25, 1998KazakhstanJune 20, 1997
BelarusAugust 21, 1997KiribatiJune 2, 1997
BelgiumFebruary 23, 1998March 3, 1998KuwaitOctober 15, 1997February 3, 1998
BelizeMay 12, 1997June 5, 1997’Kyrgyz RepublicDecember 12, 1997
BoliviaSeptember 10, 1997September 19, 1997LaosJune 16, 1997
BotswanaMarch 13, 1998April 10, 1998LatviaMarch 23, 1998April 14, 1998
BrazilFebruary 11, 1998March 13, 1998LebanonDecember 12, 1997
Brunei DarussalamOctober 6, 1997LesothoFebruary 4, 1998
BulgariaJuly 23, 1997July 29, 1997LithuaniaJune 25, 1997July 14, 1997
BurundiOctober 8, 1997MadagascarSeptember 10, 1997October 28, 1997
CambodiaApril 27, 1998MalawiSeptember 12, 1997
CameroonJanuary 7, 1998January 21, 1998MalaysiaSeptember 5, 1997
CanadaJanuary 30, 1998February 19, 1998Malaysia1April 20, 1998April 27, 1998
Cape VerdeFebruary 20, 1998March 10, 1998MaldivesJanuary 26, 1998
ChadJune 13, 1997July 15, 1997MaliDecember 22, 1997April 1, 1998
ChileFebruary 11, 1998February 20, 1998MaltaMay 23, 1997
China, People’sMauritaniaJuly 14, 1997August 27, 1997
Republic ofJune 30, 1997MexicoSeptember 2, 1997
ColombiaJune 6, 1997MoldovaApril 20, 1998May 27, 1998
ComorosOctober 8, 1997MongoliaJuly 30, 1997September 3, 1997
Costa RicaMarch 18, 1998May 14, 1998MoroccoMarch 6, 1998March 31, 1998
Côte D’ IvoireMarch 17, 1998MozambiqueApril 7, 1998April 30, 1998
Czech RepublicFebruary 13, 1998March 6, 1998NamibiaOctober 22, 1997
DjiboutiMay 21, 1997NepalMay 28, 1997June 13, 1997
DominicaMay 23, 1997June 27, 1997NetherlandsJune 12, 1997July 1, 1997
Dominican RepublicAugust 21, 1997September 17, 1997New ZealandNovember 7, 1997January 12, 1998
EcuadorSeptember 3, 1997NicaraguaMarch 18, 1998April 9, 1998
EgyptJanuary 7, 1998NigerJuly 28, 1997
El SalvadorFebruary 20, 1998April 6, 1998NorwayFebruary 23, 1998March 9, 1998
Equatorial GuineaFebruary 2, 1998PakistanOctober 20, 1997November 4, 1997
EritreaJuly 28, 1997PanamaDecember 10, 1997December 22, 1997
EstoniaDecember 17, 1997December 24, 1997Papua New GuineaJanuary 23, 1998
EthiopiaNovember 21, 1997ParaguayOctober 10, 1997October 22, 1997
FinlandJuly 14, 1997July 23, 1997PeruJune 25, 1997
FranceOctober 22, 1997November 4, 1997PhilippinesMarch 27, 1998
GabonMay 21, 1997PolandMarch 16, 1998March 30, 1998
Gambia, theOctober 6, 1997PortugalOctober 17, 1997November 7, 1997
GermanyAugust 25, 1997August 29, 1997QatarJune 23, 1997
GhanaOctober 31, 1997December 1, 1997Russian FederationMay 16, 1997
GreeceAugust 1, 1997São Tomé and PríncipeJuly 16, 1997
GrenadaOctober 6, 1997October 22, 1997SenegalJuly 28, 1997August 26, 1997
GuineaApril 3, 1998April 29, 1998Sierra LeoneMay 5, 1997
Guinea-BissauMarch 6, 1998March 26, 1998SingaporeFebruary 20, 1998March 16, 1998
GuyanaDecember 22, 1997Slovak RepublicFebruary 13, 1998
Hong Kong SARJanuary 26, 1998February 16, 1998SloveniaJanuary 9, 1998January 26, 1998
HungarySeptember 8, 1997South AfricaJuly 11, 1997August 25, 1997
SpainMarch 16, 1998April 6, 1998TurkeyJuly 9, 1997August 5, 1997
Sri LankaJuly 23, 1997August 5, 1997TurkmenistanMay 21, 1997
St. Kitts and NevisJune 18, 1997June 26, 1997United Arab EmiratesOctober 8, 1997
St. VincentDecember 3, 1997December 17, 1997UgandaApril 8, 1998June 11, 1998
SudanFebruary 27, 1998April 13, 1998UkraineAugust 25, 1997
SurinameJune 4, 1997United KingdomOctober 27, 1997November 6, 1997
SwedenAugust 22, 1997September 2, 1997United StatesJuly 28, 1997August 4, 1997
SwitzerlandFebruary 20, 1998March 6, 1998UruguayJune 20, 1997
TajikistanDecember 19, 1997UzbekistanJuly 30, 1997
TanzaniaDecember 3, 1997December 23, 1997VietnamFebruary 2, 1998
ThailandJune 13, 1997YemenOctober 29, 1997
TogoJanuary 21, 1998February 19, 1998ZambiaOctober 8, 1997
TunisiaMay 23, 1997June 5, 1997ZimbabweMay 21, 1997

Malaysia’s 1998/99 Article IV consultation was advanced to April 20, 1998.

Malaysia’s 1998/99 Article IV consultation was advanced to April 20, 1998.

To ensure more continuous and effective surveillance, the Board supplements this systematic monitoring of individual country developments with regular informal sessions—sometimes monthly, or even more frequently—on significant developments in selected countries and regions. It 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.

Other Means of Surveillance

Surveillance through Article IV consultations is the main channel for collaboration between the IMF and its members. In addition, for members facing balance of payments difficulties, formal financial arrangements for the immediate use of IMF resources provide a framework for more intensive collaboration (see Chapter VIII). In some cases, members collaborate with the IMF in other ways, such as precautionary financial arrangements, informal staff-monitored programs, and enhanced surveillance.

  • 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 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. IMF staff monitor the country’s economic program and regularly discuss progress under that program with the authorities; however, there is no formal IMF endorsement of the member’s policies.
  • Enhanced Surveillance. This also does not constitute formal IMF endorsement of a member’s economic policies. Rather, the emphasis is on close and formal monitoring by the IMF. The procedure was initially established to facilitate debt-rescheduling arrangements with commercial banks but has been used occasionally in other situations.

Box 2Second-Generation Reforms

Although macroeconomic stability, liberalization, and the basic institutional framework of a market economy are essential for strong growth, the IMF’s experience with its member countries has shown that deeper and broader-based reforms are necessary to achieve high-quality growth that is sustainable and more equitably shared. Such reforms—so-called second-generation reforms—cover a number of areas highlighted most recently by the Asian financial crisis.

The IMF, in collaboration with the World Bank, has been contributing to second-generation reforms in member countries through its surveillance (along with other international organizations as appropriate), technical assistance, and financing, on several fronts:

  • helping members strengthen the efficiency and robustness of their financial sectors, including through appropriate prudential oversight;
  • helping members enhance the transparency of fiscal policy and practices and the quality, timeliness, and dissemination of economic and financial data to reduce the risk of disruptive changes in investor confidence when economic or financial problems appear;
  • helping members improve governance by establishing a simple and transparent regulatory environment and a professional and independent judicial system that will uphold the rule of law, including property rights;
  • assisting members in redefining the role of the state in the economy as a positive force for private sector activity, including through the restructuring and privatization of state-owned enterprises and by generally reducing government intervention in areas where market forces provide greater efficiency;
  • helping improve the quality of public expenditure in member countries, for example, through greater attention to education and health spending; and
  • helping members promote greater flexibility of labor markets.

In a few cases, the intensified monitoring described above has been a prelude to an IMF-supported adjustment program. More often, monitoring provides the authorities with a framework to reassure interested third parties, such as donors, creditors, or financial markets.

Lessons for Surveillance from the Asian Crisis

In March 1998, the Executive Board undertook its regular review of members’ policies in the context of surveillance, this time focusing on the lessons for surveillance from the Asian crisis. In their review, Directors noted that the IMF’s performance in identifying emerging tensions in crisis-affected countries at an early stage had been mixed. In the case of Thailand, the IMF had expressed serious concerns about economic developments beginning in 1996—concerns conveyed to the authorities in several ways, including through confidential contacts at the highest level. Indeed, the IMF appeared to have been more aware of the risks in Thailand’s economic policy course than had most market observers. In other cases in Asia, however, the IMF—while having identified critical weaknesses, particularly in the financial sector—had been taken by surprise, owing in part to the lack of access to requisite information and also to an inability to see the full consequences of the combination of structural weaknesses in the economy and contagion effects. In particular, in the case of Korea, the IMF had not attached sufficient urgency to the financial tensions that had begun developing in early 1997.

With hindsight it was clear that the affected countries’ vulnerabilities had been underestimated, including by the markets. Directors also remarked that some other emerging market economies had taken timely and sustained policy measures in the face of market pressures and had been able to fend off spreading turmoil successfully. In those cases, close IMF surveillance had been helpful. Some Directors stressed that it was unrealistic to expect IMF surveillance to detect all problems early and prevent all crises, and that the contagion effects of the crisis in Thailand were, to a large extent, unpredictable. Nevertheless, they encouraged the staff, in exercising surveillance, to place increased emphasis on the risks of contagion effects.

Directors agreed that the experience of the past nine months had provided valuable lessons for the IMF and for the international financial community. Events were still unfolding, and many issues would need revisiting, including the design and implementation of IMF-supported programs; the role of the IMF and other official financing for these programs; collaboration between the IMF and other international institutions, especially the World Bank; the role of the private sector in crisis situations; and the IMF’s policy on public information. To this end, it was agreed early in the new financial year 1998/99 that a review of the experience with IMF programs in the Asian crisis countries should be undertaken before the October 1998 Annual Meetings to address questions of program orientation and design, implementation, and, to the extent possible, early program results. The experience with the Asian crisis countries would also be examined in 1998/99 as part of the world economic outlook exercise and in the context of the annual report on international capital markets. The lessons from the Asian experience would be reflected in several papers addressing various aspects of strengthening the architecture of the international monetary system, focusing on the availability and the dissemination of economic data, transparency in members’ policies and in IMF surveillance, and the role of international standards in assessing countries’ policies and practices. There would also be further Board discussion on establishing appropriate incentives for international financial flows by involving the private sector in forestalling or resolving financial crises. The IMF would be incorporating lessons from the Asian crisis in its continuing work on orderly and appropriately sequenced capital account liberalization. In addition, the experience with World Bank-IMF collaboration, notably in the area of financial sector reform, would be reviewed with the aim of identifying areas with scope for improvement.

In March 1998, looking at IMF surveillance, Directors identified five main lessons.

Lesson One

The effectiveness of surveillance depended critically on the timely availability of accurate information. Directors saw some improvement since 1995 in members’ provision of data, both to the IMF and to the markets, but felt that further progress was essential. The Asian crisis had revealed the critical importance of certain data that had not been available, either because the authorities had been reluctant to provide them, such as re serve-related liabilities of the central bank, or because systems did not exist to produce timely data, such as that on private short-term debt. The crisis had also demonstrated that adequate provision of data to the public was important for promoting transparency and strengthening market confidence. Directors emphasized that further efforts to strengthen members’ provision of data to the IMF and to the public could be realized through the Special Data Dissemination Standard; in both domains, the monitoring of compliance had to be strengthened. Several Directors cautioned that access to highly sensitive data or data for which appropriate standards were not yet universally adopted, such as prudential indicators, had to be handled carefully. Directors particularly stressed the importance of compiling timely and accurate data on short-term external debt, while recognizing that this would require substantial statistical efforts on the part of most countries concerned. It was agreed that, in cases where countries were unable to collect the required data, technical assistance—including from the IMF in its areas of competence—was important, In the meantime, more attention should be paid to using and improving existing data sources, including data from the Bank for International Settlements.

Box 3Enhancing Information on Article IV Consultations

Since May 1997, the Executive Board has been issuing Press (now “Public”) Information Notices (PINs) following the conclusion of Article IV consultations with members. PINs set out:

  • a background description of the country’s economic situation at the time of the consultation;
  • the Board’s assessment of that situation and the country’s policies as detailed in the Chairman’s summing up of the Board’s discussion; and
  • a table of selected economic indicators.

PINs are issued on a voluntary basis, at the request of countries seeking to make public the views of the IMF on their policies and prospects. Of the 136 consultations completed during 1997/98, 77 resulted in the issuance of PINs (see Table 7). The full text of PINs is available on the IMF’s website ( Collections of PINs are also being published three times a year in a new IMF publication, IMF Economic Reviews; the first issue was released in May 1998.

More generally, considering the changing architecture of the international financial system and the variety of data sources, some Directors felt that the IMF needed to begin work with other international organizations, including national regulatory authorities and market participants, toward developing a conceptual framework for data compilation and dissemination. Directors strongly urged the staff to bring to the Board’s attention cases where its inability to obtain the necessary data had hampered effective surveillance, and they suggested that ways to strengthen the IMF’s reaction to such cases be explored. Some Directors suggested that consideration be given to not concluding Article IV consultations where members’ willingness to provide the IMF with the data required for surveillance was in question. This view was endorsed by the Interim Committee, which in its April 1998 meeting recommended that if persistent deficiencies in disclosing relevant data to the IMF seriously impede surveillance, conclusion of Article IV consultations should be delayed.

Lesson Two

The focus of surveillance had to extend beyond short-term macroeconomic issues, while remaining appropriately selective. There had been increased coverage and analysis of key structural policies, especially financial sector policies, in emerging market economies since 1995. Problems in the financial sector were often complex and long in gestation, however, and many Directors felt that the IMF needed to develop more expertise in their analysis, including by expanding staff resources with the relevant experience. Noting that the IMF’s comparative advantage was in analyzing macroeconomic developments, some Directors felt that financial sector restructuring should be left to other institutions, especially the World Bank. Others considered that, in the context of the Asian crisis, such a distinction had not always been easy to draw, and that the initial intensive role of the IMF in all aspects of the financial sector reforms had been essential. Collaboration with other institutions, it was agreed, had to be close and aimed at avoiding duplication of efforts, especially those of the World Bank, as well as national supervisory authorities and the BIS. Several Directors emphasized the usefulness of developing standards in a variety of areas that could help in the conduct of surveillance and provide information to markets; they suggested that IMF surveillance could usefully encourage members to adapt their practices in line with international standards, such as those laid out in the Basle Committee on Banking Supervision’s Core Principles on Banking Supervision.

The vulnerability of many emerging market economies to large capital flows was seen as underlining the importance, also, of close IMF surveillance over capital account issues. Some Directors stressed the need to monitor carefully the sequencing and the pace of moves toward capital account liberalization. In particular, IMF surveillance should focus on the risks posed by the potential reversal of large capital flows, the rapid accumulation of short-term external debt, and the impact of selective capital account liberalization. In this area, too, Directors stressed the critical importance of accurate and timely data. A few speakers proposed that consultation reports systematically address progress toward capital account liberalization. Some other Directors thought that the experience of the previous nine months suggested that selective, well-targeted capital controls could play a useful role in reducing a country’s vulnerability. Most Directors, however, were skeptical that introducing controls in economies with already relatively open capital accounts could be helpful, beyond perhaps providing temporary breathing space to put in place more fundamental adjustment policies.

Lesson Three

In an environment of increased financial and trade flows between countries, IMF surveillance at the country level should pay greater attention to policy interdependence and to the risks of contagion. How policies in systemically or regionally important countries affect other countries should receive closer attention, Directors remarked. At the same time, the vulnerability of domestic conditions to external developments should be examined in bilateral consultations, with the objective of urging early, forceful action to mitigate the risks of contagion. Directors noted that multilateral surveillance could help in identifying potential spillover effects; they underlined the importance of more fully integrating the IMF’s multilateral surveillance exercises with its bilateral dialogue with members and ensuring that the available staff expertise in capital market and financial sector issues was fully used in bilateral surveillance. Many Directors also supported a more frequent and systematic exchange of views between staff and market participants as part of surveillance; they considered that, in relevant cases, staff reports should include a summary assessment of market sentiment. A few Directors cautioned that such contacts should take into account the confidentiality of the IMF’s dialogue with members.

Box 4IMF Regional Office for Asia and the Pacific

The establishment of a new Regional Office for Asia and the Pacific in Tokyo reflects the importance of the Asia-Pacific region in the global economy and for the work of the IMF. The Director of the Office, Kunio Saito, administers a staff of 10. The main functions of the Office include the following:

  • Regional Policy Forums. The Office is responsible for the IMF’s dialogue with Asian policymakers that is conducted through various regional policy forums, including the Manila Framework Group, Asia-Pacific Economic Cooperation (APEC), Association of South East Asian Nations (ASEAN), and the Executives’ Meeting of East Asian and Pacific Central Banks and Monetary Authorities (EMEAP), and for facilitating regional and mutual surveillance activities. The Manila Framework Group brings together deputies from ministries of finance and central banks of 14 economics across the region. It is the principal new grouping aimed at strengthening surveillance, enhancing cooperation, and promoting financial stability in the region. The Regional Office provides the Secretariat for this Group.
  • Financial Market Surveillance. The Office monitors and analyzes financial markets in the region with a view to ensuring that the IMF has timely and comprehensive knowledge of market developments and trends. This analysis deepens the IMF’s understanding of economic developments in the region and is an important element in strengthening surveillance.

The Office also undertakes a wide range of external relations activities, and facilitates the delivery of technical assistance and training in the region.

Lesson Four

The crucial role of credibility in restoring market confidence underscored the importance of transparency. In this regard, Directors welcomed the decision by the authorities in Indonesia, Korea, and Thailand to release the Letters of Intent to the IMF detailing their adjustment programs. Several Directors also welcomed the fact that an increasing number of countries were agreeing to the release of Press (now “Public”) Information Notices, summarizing the content of Article IV consultations in the Board, and felt that it would be desirable if as many countries as possible could agree to do so. Some Directors felt that the IMF could go further in disseminating its views on the economic policies of its members; they suggested revisiting the issue of publication of staff reports for Article IV consultations. Some other Directors, however, advocated a more cautious approach, noting that maintaining confidentiality was key to effective surveillance. A few Directors also supported the suggestion that if, after a period of time, a member continued to ignore IMF warnings expressed confidentially, the IMF should, as a last resort, make use of the provision of Article XII, Section 8, of its Articles of Agreement, to make its concerns known to the public. But most Directors doubted that more public warnings would increase the effectiveness of surveillance. They were particularly concerned that the threat of publicity would jeopardize the frank dialogue between the IMF and member countries and that public warnings could accelerate crises rather than prevent them.

Lesson Five

The effectiveness of IMF surveillance depended crucially on the willingness of members to take its advice. A candid dialogue and the ability of the IMF to focus on the issues of importance to individual members were vital for effective surveillance. In addition, Directors emphasized the opportunity for IMF staff to harness the opinions of the international community by engaging in regional forums more actively; they believed the IMF should work closely with such forums in Asia and elsewhere (Box 4). Some Directors noted the importance of peer pressure both in regional forums and through the Board. Directors welcomed the IMF’s involvement in the discussions of the Asia-Pacific Economic Cooperation Council and the Second Manila Framework Meeting in Tokyo.

Government Transparency and Accountability

The IMF has long provided advice and technical assistance to help foster good governance in member countries, including by promoting public sector transparency and accountability. In recent years, increased attention has been focused on issues associated with good governance. In particular, in its Declaration on Partnership for Sustainable Global Growth, adopted in September 1996, the IMF’s Interim Committee identified “promoting good governance in all its aspects, including ensuring the rule of law, improving the efficiency and accountability of the public sector, and tackling corruption” as essential for helping economies prosper. Similarly, at its April 1998 meeting, the Interim Committee, in an effort to enhance the accountability and credibility of fiscal policy as a key feature of good governance, adopted a Code of Good Practices on Fiscal Transparency: Declaration on Principles.

In 1997/98, the IMF’s Executive Board met a number of times to develop guidance for the institution regarding governance issues and a code of good practices for member countries in the area of fiscal transparency.

Good Governance

In a discussion of the IMF’s role in governance issues in May 1997, Executive Directors strongly endorsed the importance of good governance for economic efficiency and growth. It was observed that the IMF’s role in this area was evolving pragmatically as more was learned about the contribution that greater attention to governance issues could make to macroeconomic stability and sustainable growth in member countries. Directors strongly supported the role the IMF had been playing in this area in recent years through its policy advice and technical assistance and welcomed the aim of ensuring a more comprehensive treatment, in the context of both Article IV consultations and IMF-supported programs, of governance issues within the IMF’s mandate and expertise. Directors stressed the need for evenhanded-ness in the treatment of governance issues in all member countries. Directors also felt the IMF’s efforts to encourage good governance had to be supported by enhanced collaboration with other multilateral institutions—in particular, the World Bank—to make better use of complementary areas of expertise.

Governance issues were, first and foremost, the responsibility of national authorities, Directors stressed. Wherever possible, IMF staff should build on the willingness of those authorities to address such issues. The IMF’s mandate did not allow the institution to assume the role of an investigative agency or guardian of financial integrity in member countries.

Directors emphasized that the IMF’s involvement in governance should focus on its economic aspects. The IMF could contribute to good governance principally in two spheres: improving the management of public resources and supporting the development and maintenance of a transparent and stable regulatory environment conducive to efficient private sector activities. In this context. Directors emphasized the potential benefits of such reforms as enhancing the transparency and accountability of public sector activities and providing a level playing field for the private sector. In addressing governance issues, the IMF should be guided by an assessment of whether the issue in question would have significant current or potential impact on macroeconomic performance in the short and medium term. Directors cautioned that the IMF should remain apolitical in its dealings on issues relating to governance. At the same time, they acknowledged that a clear delineation between the economic and political dimensions of governance was often difficult in practice: what was important was that the IMF’s advice be based on solid economic considerations within its mandate.

Directors emphasized that weak governance that threatened macroeconomic performance should be tackled early on in reform efforts. Although the requirement to safeguard IMF resources was primarily addressed through the implementation of appropriate macroeconomic adjustment policies, Directors recognized that governance issues could influence macroeconomic performance and the effectiveness of those policies. Thus, conditionality could be attached to policy measures relating to governance if those measures were necessary for the achievement of the program’s objectives.

In the wake of the May discussion, on July 25, 1997, the Executive Board adopted guidelines addressing the IMF’s role in governance issues.8 The guidelines seek to promote greater attention by the IMF to governance issues, in particular through:

  • a more comprehensive treatment in the context of both Article IV consultations and IMF-supported adjustment programs of those governance issues within the IMF’s mandate and expertise;
  • a more proactive approach in advocating policies and the development of institutions and administrative systems that eliminate the opportunity for bribery, corruption, and fraudulent activity in the management of public resources;
  • an evenhanded treatment of governance issues in all member countries; and
  • enhanced collaboration with other multilateral institutions, in particular the World Bank, to make better use of complementary areas of expertise.

Transparency in Budgetary Operations

Fiscal transparency can be defined as openness toward the public at large about government structure and functions, fiscal policy intentions, public sector accounts, and projections. It means ready access to reliable, comprehensive, timely, understandable, and internationally comparable information on government activities—including those activities undertaken outside the government sector—so that the electorate and financial markets can accurately assess the government’s current and future financial position. Noting that fiscal policy is a key focus of IMF surveillance, and with the aim of strengthening the approach of governments to fiscal policy issues, the Executive Board took up the questions of transparency in government operations and fiscal policy rules in October 1997. And in April 1998, the Board agreed on a draft code of good practices in the area of fiscal transparency for submission to the Interim Committee.

In their October 1997 discussion, Directors agreed that transparency in government operations was conducive to fiscal discipline, sound public sector management, good governance, and improved macroeconomic performance. Moreover, in a globalized economy, where the costs of loss of market confidence had become increasingly clear, fiscal transparency helped instill confidence in a government’s economic policies. Fiscal transparency entailed setting out clear fiscal objectives, building clear institutional arrangements (including a proper budgetary process), using transparent and widely accepted accounting methods, and providing timely and reliable information.

The IMF should continue to help its members achieve greater fiscal transparency through surveillance, technical assistance, and program design, Directors agreed. Improving fiscal transparency was a multiyear endeavor, and the priorities for improving transparency could differ among countries. Therefore, the IMF should pay due regard to the specific circumstances of individual countries. Some Directors stressed that the IMF’s involvement in fiscal transparency should focus on issues of macroeconomic significance, and they noted the need for an evenhanded approach.

Directors supported greater emphasis in the staff’s surveillance work on promoting transparency in government operations. Many favored asking the staff to prepare a brief manual of good practices for fiscal transparency, while some Directors expressed reservations about establishing “best practices.” Some others considered that the staff could gradually accumulate an inventory of transparent practices in the context of Article IV consultations. Many Directors cautioned about the resource implications of any such initiative.

Timely and comprehensive reporting of public sector accounts was also important. To this end, Directors urged that the coverage of fiscal accounts be extended to the general government level and include information on off-budget operations and the cost of quasi-fiscal activities, Also, cash-based recording should be supplemented with accrual-based recording of transactions. Where possible, the authorities should publish information on guarantees and unfunded public sector liabilities. Noting that discretionary tax relief, tax exemptions, and arbitrary tax administration were among the most important problems affecting fiscal performance in many countries, Directors also stressed the need for transparent and stable tax systems and for estimates of tax expenditures as part of the budget process.

Fiscal Policy Rules. In October 1997, the Executive Board also discussed the strengths and weaknesses of fiscal policy rules. These included such permanent restraints on fiscal policy as balanced budget or deficit rules, borrowing rules, and debt or reserve rules. Many Directors commented favorably on the potential usefulness of such rules in strengthening or restoring policy credibility in specific circumstances. Some also noted the usefulness of fiscal rules and limits in the context of common currency areas, citing the benefits for fiscal convergence in the European Union that had accrued from the fiscal reference values under the Maastricht Treaty.

At the same time, Directors cautioned that fiscal rules were not a panacea. Good economic performance depended on the political will to implement sound policies; simply promulgating rules without building the political consensus to put in place the implied sound policies was unlikely to yield the desired results. The view was also expressed that it might be difficult in practice for fiscal policy rules to embody all the properties of the model rule outlined by the staff (i.e., that it be well-defined, transparent, adequate, consistent, simple, flexible enough to accommodate exogenous shocks and cyclical fluctuations in activity, enforceable, and efficient).9 Moreover, attempts at complying with a fiscal rule through excessive reliance on tax rate increases and unsustainable or cosmetic expenditure cuts, or one-off measures, might tend to be counterproductive. Directors indicated that there were circumstances in which fiscal rules could prove useful for countries to institutionalize better macroeconomic policies. Where members were interested in formulating fiscal rules, or incorporating them in the design of adjustment programs, Directors believed that the IMF should be prepared to provide policy advice and technical assistance.

Code of Good Practices on Fiscal Transparency. Following further work by the staff in light of the October 1997 discussion, a draft code of good practices on fiscal transparency was submitted for the Board’s consideration in April 1998. The underlying rationale was that fiscal transparency could lead to better-informed public debate about the design and results of fiscal policy, make governments more accountable for the implementation of fiscal policy, and thereby promote good governance, strengthen credibility, and mobilize popular support for sound macroeconomic policies. Because of the IMF’s fiscal management expertise, it was well placed to take the lead in promoting greater transparency in this area. The draft presented to the Board set out specific principles and practices that a government could implement to ensure that:

  • roles and responsibilities in the government are clear;
  • information on government activities is provided to the public;
  • budget preparation, execution, and reporting are undertaken in an open manner; and
  • fiscal information is subjected to independent assurances of integrity.

Directors generally welcomed the draft code. Most saw merit in reaching a consensus on the broad principles and essential elements of a transparent approach to fiscal management and stressed the importance of moving ahead with a proposed manual to address some of the practical issues that could arise. They also suggested that the code be subject to periodic review and revision.

Directors pointed out that implementation of the code should be tailored to individual country circumstances, with recognition of the legitimate differences in approach that countries might take to improving fiscal transparency. For countries with weaker institutions or binding legal constraints, progress toward achieving fiscal transparency consistent with the code might take time. The IMF had to be prepared to provide technical assistance, in cooperation with other international organizations, to those countries that requested it.

At its April 1998 meeting, the Interim Committee adopted the Code of Good Practices on Fiscal Transparency—Declaration on Principles (Box 5; the full text is reproduced in Appendix VI), recognizing that implementation would be affected by diversity in fiscal institutions, legal systems, and implementation capacity.

Data Issues

Economic policymakers and financial institutions and markets—public and private—rely on information. When underlying information about the true economic and financial situation of countries, banks, and enterprises is poor, when disclosure of available information is limited, and when potentially damaging information can be disguised or withheld, national and international financial systems work less efficiently. Thus, the international community encourages the development and promulgation of sound information practices, in accord with broadly accepted international norms.

For its part, the IMF has paid increasing attention in recent years to data issues—the comprehensiveness, quality, frequency, and timeliness of the data that members provide to it, and the data that members disseminate to the public. To guide members in the latter, the Board has endorsed a two-tiered approach; a Special Data Dissemination Standard (SDDS), established in March 1996, to guide member countries that have or might seek access to international financial markets, and a General Data Dissemination System (GDDS), approved by the Board in December 1997, to guide all member countries. In September 1996, the IMF opened an electronic bulletin board on the Internet that provides public access to information about the data dissemination practices of members that subscribe to the SDDS (Box 6).

Box 5Code of Good Practices on Fiscal Transparency: Declaration on Principles

The Code’s main provisions are as follows:

Clarity of Roles and Responsibilities

  • The government sector should be clearly distinguished from the rest of the economy, and policy and management roles within government should be well defined.
  • There should be a clear legal and administrative framework for fiscal management.

Public Availability of Information

  • The public should be provided with full information on the past, current, and projected fiscal activity of government.
  • A public commitment should be made to timely publication of fiscal information.

Open Budget Preparation, Execution, and Reporting

  • Budget documentation should specify fiscal policy objectives, the macro-economic framework, the policy basis for the budget, and identifiable major fiscal risks.
  • Budget estimates should be classified and presented in a way that facilitates policy analysis and promotes accountability.
  • Procedures for the execution and monitoring of approved expenditures should be clearly specified.
  • Fiscal reporting should be timely, comprehensive, and reliable and identity deviations from the budget.

Independent Assurances of Integrity

  • The integrity of fiscal information should be subject to public and independent scrutiny.

Members’ Provision of Information to the IMF

In December 1997, the Board conducted its third review of progress by members in providing data to the IMF for surveillance. Directors noted the provision of core indicators by member countries to the IMF had continued to improve modestly (this refers to data on exchange rates, international reserves, reserve or base money, broad money, interest rates, consumer prices, exports and imports, external current account balance, overall government balance, gross domestic product or gross national income, and external debt). But they expressed concern that some members did not provide these data regularly or in a timely way, and that, in a number of cases, lags in data provision had continued or even increased. Directors urged members to improve the timeliness and frequency of their data reporting.

Recent experience had also suggested that the core indicators needed to be complemented by other data in light of the circumstances of individual countries, so as to increase the effectiveness of surveillance in the period between Article IV consultations and to identify emerging financial market tensions. Directors identified reserve-related liabilities, central bank derivative transactions, private sector external debt, and prudential-type bank indicators as desirable supplementary data. Within these broad categories, Directors identified a number of specific data items—including forward transactions (outright or arising from swaps), the maturity structure of external debt, the composition of short-term external debt, information on foreign exchange reserves, and information on the financial sector. Some Directors suggested that the definition of core data should be expanded to include these additional data, given their critical importance in identifying emerging tensions at an early stage. And some Directors suggested consideration of a common standard for timeliness and frequency of data provided to the IMF.

Box 6Dissemination Standards Bulletin Board

The DSBB is a tool for market analysts and others who track economic growth, inflation, and other economic and financial developments in countries around the world. It describes the statistical practices—such as methodologies and data release calendars—of countries subscribing to the Special Data Dissemination Standard (SDDS) in key areas: the real, fiscal, financial, and external sectors. It also describes steps subscribers have taken to improve practices to move toward full observance of the SDDS by the end of the transition period.

Beginning in April 1997, electronic links (hyperlinks) between the bulletin board and actual data on national data sites have been established, enabling users to move directly from the bulletin board to current economic and financial data on an Internet site maintained by the subscriber, (The links do not indicate IMF endorsement of the data.) The bulletin board can be accessed on the Internet at, or through the IMF’s website,

Subscribers to the SDDS as of the end of April 1998 are listed below; those for which hyperlinks were in place are indicated by an asterisk:

AustraliaGermanyLatviaSlovak Republic
AustriaHong Kong SAR*LithuaniaSlovenia*
BelgiumHungaryMalaysiaSouth Africa*
Czech RepublicIsrael*PhilippinesTurkey*
DenmarkItalyPolandUnited Kingdom*
EcuadorJapan*PortugalUnited States

On the related issue of data quality, inadequate coverage and deficiencies in compilation methods had often compromised the usefulness of the reported data and posed problems for the design and monitoring of members’ programs, particularly with regard to national accounts, government finance, and balance of payments statistics. Directors therefore urged the staff to continue its work on the assessment of data quality. Several Directors stressed the high cost of technical assistance and suggested monitoring recipient countries’ implementation of recommendations. Directors agreed that efforts to improve data quality must be part of a broad effort to build solid statistical frameworks in member countries, consistent with efforts undertaken for the Special Standard and the General System. Some Directors suggested that staff papers indicate clearly data adjustments to help identify for the authorities the data deficiencies and required improvements.

Members’ Dissemination of Data to the Public

Review of Special Data Dissemination Standard. In their first review of the Special Data Dissemination Standard, in December 1997, Directors noted that the number of subscribers (43) had been about as expected and hoped that, over time, more members would subscribe. They welcomed the growing external use of the Dissemination Standards Bulletin Board, especially since the introduction of hyperlinks from the bulletin board to national data sites (see Box 6). Directors believed the SDDS provided incentives and a structure for improvements in data dissemination practices; subscribers’ views on their initial experience with the Special Standard had been generally positive.

Directors agreed that the proposals for updating the SDDS were timely, given the economic and financial developments in Southeast Asia and elsewhere. They endorsed the procedures for modifying the SDDS, which were in keeping with the consultative and transparent process underlying the Special Standard. These entailed the shifting of the data components for countries’ reserve-related liabilities from an “encouraged” to a “prescribed” component and adding a prescribed component for net commitments under derivative positions. Some Directors expressed reservations in this regard, pointing to definitional problems and issues of confidentiality.

Directors agreed that the procedure for modifying the SDDS to include indicators of financial soundness should await the development of standards for the disclosure of macroprudential data and should draw on the work of other organizations, including the BIS, They also agreed to consider in the next review of the SDDS the possibility of establishing a more precise timetable for the dissemination by subscribing countries of data on international investment positions, which would include data on the short-term external indebtedness of the private nonbank sector.

Directors considered that in the period ahead, the credibility of the IMF and of the SDDS subscribers would depend on ensuring that subscribers had implemented the necessary changes to their dissemination practices so that they would fully comply with the Special Standard by the end of 1998. Noting that a number of current subscribers had made limited progress in completing the outstanding actions, Directors urged members to implement rapidly their announced transition plans and asked staff to give priority to assisting subscribers in successfully concluding the transition period. Directors agreed it would be prudent for members intending to subscribe during 1998 to assess carefully the likelihood of fully observing the Special Standard by the end of the transition period. On the same point, in its April 1998 meeting, the Interim Committee emphasized the importance of subscribers being in full observance of the standards by the end of the transition period in December 1998.

In discussing how to deal with possible nonobservance by a subscriber after the end of the transition period, some Directors cited the need to differentiate between minor and serious breaches; Directors agreed to reconsider the issue of possible nonobservance during the next review of the SDDS. Although some Directors suggested exploring some form of cost recovery, the Board agreed that, for the present, the costs associated with the Special Standard and maintenance of the associated bulletin board should not be borne by users on the grounds that the wide reach of the bulletin board benefited the entire international community.

General Data Dissemination System. In contrast to the Special Data Dissemination Standard, whose focus is on dissemination in countries that generally already meet high standards of data quality, the General Data Dissemination System aims primarily to improve the quality of data for all members. It focuses on the development and dissemination of a full range of economic, financial, and sociodemographic data with objectives for comprehensive statistical frameworks—comprising national accounts for the real sector, central government accounts for the fiscal sector, a broad money survey for the financial sector, and balance of payments accounts for the external sector, as well as a set of sociodemographic indicators. In December 1997, in approving the proposal to establish the GDDS, Directors recognized that it was an important step for all IMF members—not only in guiding the provision of data to the public, but also in encouraging improvements in the quality and accessibility of data.

Directors recognized that for many countries improvements in data quality were a necessary precursor to enhanced dissemination of data to the public and that the GDDS was a useful framework for developing a broad range of statistics. Directors favored the General System’s focus on a set of core frameworks and indicators, supplemented by improved data systems and categories; this made the General System relevant to a broad range of countries and provided a clear set of links between the General System and the Special Standard. These links were particularly helpful to countries that wished to use participation in the GDDS as a step toward subscription to the SDDS. Most Directors supported including in the General System a set of sociodemographic indicators because of the importance of these data in assessing economic developments in many countries. Some Directors reiterated that the responsibility for developing social indicators should be left mainly to other international organizations, and some expressed doubts about the appropriateness of including these data in the GDDS. Directors agreed that the IMF should cooperate closely with regional and other international organizations in developing social indicators.

The Board acknowledged that, as aspects of openness and transparency, the issues of access and integrity were important dimensions of the GDDS. The principles embodied in these dimensions were not yet standard practice in many countries, and it was therefore appropriate that the General System focus on developing these dimensions in the practices of data compiling and disseminating agencies.

Most Directors supported a phased approach in implementing the GDDS, focusing first on education and training through appropriate documentation, seminars, and workshops (Box 7). The Board recognized that the General System was an ambitious project, both for the IMF and for countries that might wish to participate, and many Directors agreed that a longer-term approach to implementing the General System was appropriate, taking into account the substantial resource costs to the IMF and to countries, as well as the absorptive capacity of participating countries.

Strengthening IMF-Bank Collaboration on Financial Sector Reform

The IMF and World Bank have long collaborated on financial sector issues (see also Appendix IV). In August 1997, the Board discussed this collaboration, stressing that it was crucial to maximizing the effectiveness of both institutions in helping countries strengthen their financial systems and saw improving this cooperation as an urgent priority.

Although the 1989 agreement between the IMF and the World Bank on Bank-IMF collaboration in assisting member countries in their respective areas of expertise continued to provide an appropriate overall framework, Directors felt that the roles of the two institutions on financial sector issues needed to be clarified and collaboration procedures improved. They stressed the role of collaboration in ensuring that emerging financial sector problems in all countries are promptly identified, that each institution would take the lead in its own areas of primary responsibility, that duplication of activity in areas of mutual interest be avoided, and that the IMF’s macroeconomic analysis and the Bank’s sectoral policy recommendations be fully coordinated. In this context, the two institutions would also have to pay due regard to the responsibility of the Basic Committee in the area of banking supervision.

Box 7How the GDDS Will Work

Participation in the General Data Dissemination System (GDDS), which is voluntary, consists of three steps:

  • commitment to using the GDDS as a framework for statistical development;
  • designation of a country coordinator; and
  • preparation of descriptions of current statistical production and dissemination practices, and plans for short-and long-term improvements in these practices that could be disseminated by the IMF on the Internet.

The GDDS will be implemented in two phases. The first will focus on education and training, and the second on direct country work. The training phase will include eight regional seminars and workshops, beginning in mid-1998 and ending in the fall of 1999, for up to 120 member countries. Following the training phase, IMF staff will work directly with member countries to assist them in assessing their practice against those of the GDDS and developing plans for improvement.

As of April 1998, some 25 countries had indicated preliminary interest in the GDDS by appointing a country coordinator. Formal invitations to participate have been sent to all member countries that have not subscribed to the Special Data Dissemination Standard (SDDS) following completion of guidance materials on the GDDS.

Many Directors remarked that they would have liked a clearer delineation of the spheres of responsibility of the two institutions, while recognizing that overlap in some areas—especially banking supervision and regulation, and banking legislation—was probably unavoidable. Most Directors stressed that banking system restructuring was the primary responsibility of the World Bank. Nevertheless, many Directors felt that the IMF had to play a role in banking system restructuring in crisis situations, especially in countries where it had been more actively involved. They emphasized, however, that those instances were expected to be rare, that the IMF’s involvement in such cases should be temporary, and that the implementation of restructuring programs should be handled by the Bank. In light of the IMF’s mandate, some Directors expected the IMF to focus on the macroeconomic implications of such reforms. But Directors hoped that the Bank, by strengthening its financial sector activities—including the establishment of the Financial Sector Board—would be better able to respond quickly and flexibly to help design financial sector restructuring programs in crisis situations. Directors also emphasized the Bank’s role—and early involvement—in helping to identify specific benchmarks for banking system restructuring to be incorporated in IMF financial programs.

Exchange Rate Issues

The Board considered two surveillance-related exchange rate issues in 1997/98: the methodology for assessing exchange rates and strategies for moving from a fixed to a flexible exchange rate regime (“exit strategies”).

Exchange Rate Assessments and IMF Surveillance

In discussing the methodology of exchange rate assessments and its application in IMF surveillance over major industrial countries, the Board emphasized in October 1997 that the IMF, as the central institution of the international monetary system, must continuously seek to strengthen its analysis and surveillance over exchange rate policies. The IMF had the advantage of a global perspective and a blend of technical expertise and practical policy experience that enabled its staff to add value in advancing the analytical framework and making judgments on exchange rate issues. In this context. Directors also pointed to the need for cooperation with the academic community.

Directors concurred with the view that the macro-economic balance methodology used by IMF staff (Box 8) complemented rather than substituted for the various measures of international competitiveness and financial market conditions that had traditionally played a major role in IMF surveillance over members’ exchange rates and exchange rate policies. Directors generally agreed it was not possible to identify precisely “equilibrium” values for exchange rates and that point estimates of notional equilibrium rates should generally be avoided. Nevertheless, they agreed that a rigorous, systematic, and transparent methodology was important to underpin IMF surveillance. They considered the existing methodology to be a useful starting point.

Directors emphasized that it was essential to consider the appropriateness of exchange rates against the background of prevailing cyclical positions and the attainment of overall macroeconomic objectives. Deviations of exchange rates from their medium-term equilibrium levels might be warranted, and even helpful, in cases of divergence in the cyclical positions of the major industrial countries. For these reasons, Directors advocated a case-by-case approach in considering what actions, if any, should be taken when exchange rates appeared to deviate substantially from their medium-term equilibrium values.

Many Directors considered that the current methodology for assessing exchange rates could be applied more broadly, in particular to nonindustrial countries of regional importance with access to international capital markets. Some Directors recognized, however, that data deficiencies and the diversity of economic conditions might limit the applicability of the methodology in the case of emerging and developing economies.

Exit Strategies: Policy Options for Countries Seeking Greater Flexibility

In January 1998, in their discussion of a staff paper10 on strategies for exiting from relatively fixed exchange rare regimes to regimes of greater exchange rate flexibility, Directors acknowledged that the choice of exchange rate regime was a complex issue that depended on the specific circumstances of individual countries. Particularly relevant were the structural characteristics of the economy and its historical inflation performance, the degree of vulnerability to shocks and the nature of those shocks, the extent of export and import diversification, and the degree of capital account liberalization and exposure to global capital markets. More generally, whatever regime was chosen, macroeconomic and structural policies needed to be credibly consistent with the regime, and the authorities needed to be transparent about policy objectives and how they intended to achieve them.

Several Directors noted that currency pegs, currency unions, or currency boards have served countries well in a number of cases, including small, open economies and a number of developing and transition economies, at least at some stage of their development and stabilization efforts. In the case of transition economies, a few Directors noted that the balance of costs and benefits tended to shift in favor of greater exchange rate flexibility as inflation subsided and the transition proceeded.

Most Directors were of the view that the increasing globalization of financial markets had made pegged regimes more difficult to manage. Many Directors particularly cited the heightened risk posed by fixed rates in encouraging unhedged exposure by borrowers. While some countries, with the appropriate supportive policies, would continue to benefit from a fixed rate—it being emphasized that there was no presumption that all countries would be better off with flexible rates—Directors noted that some countries with fixed or relatively fixed exchange rate regimes might now wish to move to more flexible arrangements. It was therefore desirable to consider the best ways to engineer an exit.

Box 8A Methodology for Exchange Rate Assessments

Oversight of members’ exchange rate policies is at the core of the IMF’s surveillance mandate. The methodology used for assessing the appropriateness of current account positions and exchange rates for major industrial countries embodies four steps:

  • applying a trade-equation model to calculate the underlying current account positions that would emerge at prevailing market exchange rates if all countries were producing at their potential output levels;
  • using a separate model to estimate a normal or equilibrium level of the saving-investment balance consistent with medium-run fundamentals, including the assumption that countries were operating at potential output;
  • calculating the amount by which the exchange rate would have to change, other things being equal, to equilibrate the underlying current account position with the medium-term saving-investment norm; and
  • assessing whether the estimates of exchange rates consistent with medium-term fundamentals suggest that any currencies are badly misaligned.

Directors emphasized that careful attention needed to be given, when exiting a peg, to the design of the new macroeconomic policy framework. In light of the many, often complex, considerations in the decision to exit—even from a position of strength—Directors believed that the IMF could play an important role in providing timely and candid advice to member countries on the appropriate exit strategy and the timing of such action. Too rapid an abandonment of the peg could be as harmful to credibility as too protracted a defense of the peg was to the level of foreign exchange reserves. It was suggested that the IMF’s regular Article IV consultations with its member countries should, when appropriate, give greater priority to discussing these issues.

Most Directors agreed that if a case for moving to a flexible regime existed, the best time to do so was during a period of relative calm in exchange markets or when there were pressures for appreciation of the currency, rather than when the exchange rate was under downward pressure. They noted, however, that much judgment was involved and it was often difficult to make such a decision when times were good and there seemed no reason to tinker with an apparently successful regime.

There was no question, Directors agreed, that it was much more difficult to exit a peg during a crisis, when some degree of exchange rate volatility was likely. To minimize depreciation and bolster policy credibility in such circumstances, it was essential that a country implement a strong and credible package of policy measures, including macroeconomic policies and accelerated structural reforms, and ensure the complementarity of those measures. Directors also stressed the need for an alternative policy framework after the exit to provide an anchor for inflation expectations.

Directors differed on how much macroeconomic policy should be tightened in these circumstances. Some pointed to the recent situation in East Asia as one where early and concerted monetary policy actions had not been sufficiently strong to prevent a continuing slide in a number of currencies in the region. Some other Directors noted that very high interest rates could increase pressures on already fragile banking and corporate sectors in most of these countries and could risk accentuating the resulting economic contraction. For similar reasons, some Directors argued that a more flexible approach to fiscal policy might be desirable in some cases, especially in countries where fiscal policy had been on a sustainable footing before the crisis.

The difficulties posed by financial sector problems for the choice of exchange rate regime were discussed at some length. Directors noted that financial fragility made the defense of a pegged rate through higher interest rates more problematic, since higher rates would exacerbate debt-servicing problems and further weaken the financial sector. As East Asia illustrated, however, depreciation of the currency after a long period of exchange rate stability could also endanger the soundness of financial and nonfinancial institutions, to the extent that they had tended not to hedge foreign currency exposures. The ideal solution was clearly to strengthen prudential regulations and supervision, and limit unhedged exposure, before the exit. Directors were divided on whether the absence of such measures merited delaying a needed move to greater exchange rate flexibility. Some pointed mainly to the further weakening of the financial and corporate sectors associated with the defense of the peg, while others noted that in some cases it was essential to begin financial restructuring and reduce unhedged foreign currency exposure before any large exchange rate depreciation. Several Directors suggested that further analysis of second-best policies for countries with less than robust financial sectors would be helpful, including ways to strengthen banking and prudential standards and establish clear bankruptcy legislation as rapidly as possible.

A number of Directors saw merit in imposing selective capital controls to limit the severity of the currency depreciation in the aftermath of an exchange rate crisis, as well as to reduce the risks of crises in the first instance. Several other Directors, however, cautioned that such controls were likely to be ineffectual beyond the short run and could even prove counterproductive, by leading to a surge in capital outflows. A better approach, these speakers felt, was to strengthen prudential regulation and supervision of financial and non-financial institutions. Areas to be governed by such regulation could include short-term foreign currency borrowing by domestic corporations and reporting requirements for foreign financial institutions.

Monetary Policy in Dollarized Economies

“Dollarization,” the holding by residents of a large share of their assets in instruments denominated in foreign currency, is common in developing and transition countries. Among countries that have undertaken IMF-supported adjustment programs over the past 10 years, almost half could be regarded as dollarized and a significant number of the others as largely dollarized.

In a review of the economic effects of dollarization in January 1998, the Board agreed that in a globalized economy with increasingly free capital movements and deregulated financial markets, most countries experienced some degree of dollarization—whether in the form of currency substitution, asset substitution as part of currency diversification of asset holdings, or a combination of the two. Several Directors saw this as a benign feature of the modern economic environment, to which all countries should adapt. Others were less sure, citing such issues as the policy adaptations required to cope with the challenges posed by currency substitution. Although Directors agreed that dollarization was an important feature in the advanced countries as well—and would become even more so with the introduction of the euro—their discussion centered on the effects of dollarization in developing and transition economies. In many of these countries, dollarization indicated a lack of confidence in the ability of the domestic currency to perform its functions effectively.

Benefits and Risks of Dollarization

Dollarization was seen as presenting both benefits and risks for developing countries. In some circumstances, foreign currency deposits could promote the growth of the domestic financial sector, for example, by allowing domestic banks to compete with cross-border accounts. Dollarization was sometimes the only effective way to remonetize an economy in cases of extreme price instability and capital flight. But, especially in weak and immature financial systems, dollarization could increase risks in the financial sector. Such risks could stem from a deterioration in the quality of the foreign currency loan portfolio in the case of a sharp devaluation of the domestic currency, as well as from the limited ability of the central bank to act as the lender of last resort. Countries with large cash holdings of foreign money would also lose seigniorage revenues.

With regard to the implications of dollarization for exchange rate and monetary policy. Directors noted that the likely higher volatility of money demand in economies with high currency substitution would tend to make the exchange rate more unstable and limit the effectiveness of monetary policy. Several Directors favored the adoption of a fixed rate or a currency board arrangement supported by appropriate macroeconomic policies to handle these types of monetary shocks. A number of Directors, however, stressed that the degree of currency substitution was only one of many elements to be taken into account in choosing an exchange rate regime; also significant were such considerations as the importance of real shocks, the degree of capital mobility, the scope for fiscal adjustment, and the overall macroeconomic situation.

What of the effects of dollarization for inflation? Although this was essentially an empirical question without a unique answer, Directors felt that the relevance of foreign currency aggregates should not be discounted and despite measurement difficulties, these aggregates should be included among the broader set of indicators monitored by the monetary authorities. Some Directors thought that certain dollarized economies could suitably adopt an inflation-targeting framework for monetary policy.

Directors generally preferred that monetary operations be conducted in domestic currency. They recognized, however, that monetary instruments denominated in foreign currency could be useful in highly dollarized economies where the bulk of credits and interbank operations were already denominated in that currency. Similar qualifications applied to the provision of foreign currency interbank settlement on the books of the central bank. In this regard, however, Directors advised that such operations be backed by ample international reserves, as well as effective measures to limit settlement risk.

Special vigilance was needed to limit prudential risk in highly dollarized economies, Directors stressed. Because of the impact of dollarization on credit risk, as well as risks to the banking system, dollarization argued for banks in developing countries to exceed Basle guidelines for capital adequacy. Directors noted that a central bank had limited ability to act as a lender of last resort in foreign currency and that sizable currency reserves and contingent credit lines could usefully contribute to limiting systemic liquidity risk in these circumstances. While recognizing the difficulties in monitoring limits on foreign exchange positions given the sophistication of financial markets, Directors stressed the importance of closely monitoring off-balance-sheet operations, as well as the maturity and composition of foreign exchange exposures.

Most Directors agreed that the focus of monetary policy should be on macroeconomic stabilization. In their view, measures to improve the attractiveness of the domestic currency were generally preferable to those for discouraging the use of foreign currency. Thus, Directors broadly agreed that dollarization should not be tackled by restricting residents’ ability to maintain accounts in foreign currency or imposing punitive reserve requirements on foreign currency deposits. Such measures would be counterproductive, weakening financial intermediation or leading to capital outflows. Interest rate liberalization, measures to increase financial deepening, an effective domestic payments system, and an independent monetary authority were the best avenues for limiting dollarization over the medium term. Also important—particularly in countries with weak financial systems—was an appropriate sequence of financial liberalization measures, supported by strong macroeconomic policies. Although Directors recognized that indexed financial instruments could also limit dollarization, the risks of promoting inflationary inertia had to be carefully weighed when contemplating such instruments.

Dollarization and the Design of IMF-Supported Adjustment Programs

The Board stressed the need to consider the prevalence of dollarization in designing adjustment programs supported by the IMF. Although dollarization had not seriously hampered the attainment of growth and inflation objectives, Directors argued that velocity and the money multiplier appeared to be more variable in dollarized economies, pointing to potential problems in selecting intermediate monetary aggregates.

In the Board’s view, programs should continue to apply conditionality in a way that would take into account the presence of dollarization, rather than attacking it directly, and to address the more fundamental policies needed to restore confidence and the long-term credibility of the domestic currency. Programs should continue to focus on the underlying causes of dollarization, the development of domestic financial systems, and, where necessary, the adoption of prudential measures. Noting that the costs of dollarization might outweigh the benefits, a few Directors saw greater merit in pursuing an active de-dollarization strategy. In view of the uncertain duration of foreign currency deposits in the banking system, the Board generally agreed that domestic banks’ reserves with the central bank against foreign currency deposits be considered part of the central bank’s liabilities for purposes of measuring net international reserves.


Published as IMF, Good Governance: The IMF’s Role (1997); also available at


Published as IMF, Fiscal Policy Rules, IMF Occasional Paper 162 (1998).


Published as IMF, Exit Strategies: Policy Options for Countries Seeking Greater Flexibility, IMF Occasional Paper 168 (1998).

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