Chapter

Chapter 2. IMF Surveillance in Action

Author(s):
International Monetary Fund
Published Date:
October 2002
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In today’s global economy, where economic developments and policies in one country affect other countries and financial market information is transmitted around the world instantaneously, the IMF’s role in monitoring economic and financial developments and policies in member countries is more vital than ever before. The IMF has the mandate under its Articles of Agreement to oversee the exchange rate policies of its member countries to ensure the effective operation of the international monetary system. It exercises this “surveillance” responsibility by holding regular discussions with its member countries about their economic and financial policies, and by continuously monitoring and assessing economic and financial developments at the country, regional, and global levels. In these ways, the IMF can help signal dangers on the horizon and enable members to take early corrective policy actions.

IMF surveillance has evolved over time to reflect changing global realities, and both the practice and the underlying principles of IMF surveillance are reviewed by the Executive Board every two years (see Box 2.1). A central task is to make surveillance a more effective vehicle for preventing crises and promoting a global economic environment conducive to sustainable growth. The goal is neither the unrealistic aim of eliminating all risks of future crises nor an impractical promise to deliver definitive warnings about all future crises. Rather, the IMF’s efforts focus on strengthening incentives for country authorities and market participants to assess risks appropriately and to base their policies and investment strategies on these assessments. A well-functioning market economy draws its strength and dynamism from a continuous search by producers, investors, and consumers for better results. This will always lead to some degree of overshooting and correction, particularly in asset markets. Thus the IMF encourages governments to adopt policies, including institutional reforms, to strengthen the resilience of members’ economies in the face of harmful developments and financial stress—notably through appropriate exchange rate regimes; sound fiscal policies; prudent borrowing and debt management strategies; deeper, stronger, and more diversified financial systems and domestic capital markets; and more effective social safety nets.

Equally important are policies that promote sustainable growth and an open trade environment because growth, trade, debt-servicing capacity, and external viability are inextricably linked. The IMF thus has a role to play in promoting trade liberalization and has been moving toward increased coverage of market access issues in its surveillance consultations with member countries. It also encourages countries to liberalize trade by providing technical assistance to member countries in its areas of expertise that lay the groundwork for increased trade and by providing financial support for countries developing more open trade regimes.

Effective surveillance and crisis prevention have two key ingredients: sound policy advice and incentives to ensure that this advice has an impact. The IMF is continuing to strengthen its analytical capacity to identify sources of vulnerability as they emerge and to develop strategies to reduce vulnerabilities, promote stability, and foster growth. At the same time, it is paying greater attention to the factors that determine the effectiveness of its policy advice.

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The IMF conducts surveillance in several ways—country (or bilateral) surveillance and global and regional (or multilateral) surveillance.

  • Country surveillance. As mandated in Article IV of its Articles of Agreement, the IMF holds “Article IV” consultations, normally once every year, with each member country about its economic policies. These consultations are complemented by regular analysis of economic and financial developments provided by IMF staff, informal contacts with staff and national authorities, and interim Board discussions as needed.
  • Global surveillance. The IMF’s Executive Board regularly reviews international economic and financial market developments. The reviews are based partly on the World Economic Outlook reports, prepared by IMF staff usually twice a year, and reports on international financial markets. In addition, the Board holds frequent, informal discussions about world economic and financial market developments.
  • Regional surveillance. To supplement country consultations, the IMF also examines policies pursued under regional arrangements. It holds regular discussions with such regional economic institutions as the European Union, the West African Economic and Monetary Union, the Central African Economic and Monetary Community, and the Eastern Caribbean Currency Union. IMF management and staff have also increased their participation in regional initiatives of member countries—including the Southern African Development Community, the Common Market of Eastern and Southern Africa, the Manila Framework Group, the Association of South East Asian Nations, the Meetings of Western Hemisphere Finance Ministers, and the Gulf Cooperation Council (see also Appendix IV).
  • IMF management and staff also take part in policy discussions of finance ministers, central bank governors, and other officials in such country groups as the Group of Seven major industrial countries, the Asia-Pacific Economic Cooperation forum, and the Mahgreb countries associated with the European Union (Algeria, Morocco, and Tunisia).

Box 2.1IMF Biennial Surveillance Review

The Executive Board reviews the principles and the implementation of the IMF’s surveillance approximately every two years. The latest biennial review of surveillance activities was completed in large part in April 2002. The review took stock of the evolution of surveillance—both the framework within which surveillance takes place and the actual conduct of surveillance.

Directors noted that further discussions on the review of surveillance and on various surveillance-related issues—including the IMF’s transparency policy—would continue, but the review so far had yielded a number of important conclusions. First, the coverage of surveillance had expanded over the years—from concentrating narrowly on monetary, fiscal, and exchange rate policies, to a broader purview encompassing external vulnerability assessments, external debt sustainability analyses, financial sector vulnerabilities, and structural and institutional policies (see Chapter 3)—and that broadened framework constituted a necessary and appropriate adaptation of surveillance to a changing global environment, most notably to the rapid expansion of international capital flows. Second, IMF surveillance had generally succeeded in embracing wider coverage without losing focus. The issues that were covered in individual Article IV consultations were generally determined by their macroeconomic relevance in countryspecific circumstances. The current system of multilateral (or global) surveillance was working well and multilateral surveillance of capital markets had been improved by the creation of the International Capital Markets Department (ICM).

Given this overall record of coverage and focus, a number of specific areas were identified where further efforts were needed to ensure that IMF policy advice was sound and persuasive.

  • More candid and comprehensive assessments of exchange arrangements and exchange rates within the framework of macroeconomic policies should become the normal practice throughout the membership.
  • Coverage of financial sector issues should be brought up to par with coverage of other areas of surveillance. Voluntary participation in Financial Sector Assessment Programs (FSAPs) had provided for in-depth coverage of financial sector issues. However, in the absence of a member’s participation in an FSAP, the quality of financial sector surveillance had been uneven across member countries, and mechanisms had to be found to improve that situation.
  • To strengthen vulnerability assessments, analysis of debt sustainability had to be improved, particularly through the use of meaningful stress tests and alternative scenarios. Also, greater attention had to be paid to the private sector’s balance-sheet exposure to interest rate, exchange rate, and general macroeconomic shocks, and to collecting the data required to assess that vulnerability.
  • Coverage of institutional issues, such as public sector and corporate governance in certain countries, had sometimes been hampered by a lack of expertise and should be strengthened. Reports on the Observance of Standards and Codes (ROSCs) and, generally speaking, the work on standards and codes were important inputs to meeting this objective.
  • Structural issues outside the IMF’s traditional areas of expertise were, at times, key to a country’s macroeconomic situation and, thus, had to be addressed by the IMF. To tackle such cases, the IMF should make effective use of the expertise of appropriate outside institutions, in particular the World Bank.
  • There was some scope for enhancing the focus of surveillance in individual cases and areas. In particular, coverage of trade policies should be strengthened by concentrating on countries whose trade policies either had appreciable global or regional influence or had significant deleterious effects on domestic macroeconomic prospects.
  • The results of multilateral (or global) surveillance exercises and the IMF’s comparative advantage in crosscountry analyses should be reflected in bilateral (or country) surveillance in a comprehensive and consistent manner. Particular attention should continue to be paid to the systemic impact of the policies of the largest economies in Article IV consultations with those countries.
  • Article IV consultations with countries with IMF-supported programs should provide an effective reassessment of economic conditions and policies; that required a freshness of perspective and appropriate distance from day-to-day program implementation.

Directors stressed that, in many instances, the IMF could usefully complement sound advice on economic policy objectives with discussions with country authorities of alternative ways to achieve those objectives. An important component of such discussions would be consideration of social, political, and institutional factors to enhance ownership of policy recommendations and increase the likelihood of successful policy implementation.

Box 2.2IMF Launches Quarterly Report on Global Financial Markets

On March 14, 2002, the IMF issued the inaugural Global Financial Stability Report—a new publication on the health of the world’s financial system. The report, which will be published quarterly, aims at providing timely and comprehensive coverage of both mature and emerging financial markets as part of the IMF’s stepped-up tracking of financial markets.

The rapid expansion of financial markets during the past decade underscores the role that private sector capital flows play as an engine of world economic growth. But these flows can also be at the heart of crisis developments. In an effort to head off future crises, the Global Financial Stability Report seeks to deepen policymakers’ understanding of the potential weaknesses in the system and to identify the fault lines that have the potential to lead to crises.

The March 2002 issue weighed the stability of the international financial system in light of an emerging global economic recovery, paying particular attention to risks posed by a slowerthan-expected economic recovery and by the recent surge in the use of complex credit risk transfer mechanisms, such as credit derivatives and debt swaps. The report also examined the accuracy of selected early warning systems—statistical models designed to predict financial crises—and reviewed some alternative debt instruments that emerging market borrowers could use to tap global capital markets.

The report is prepared by the IMF’s International Capital Markets Department, which was established in 2001 to enhance the IMF’s surveillance, crisis prevention, and crisis management activities. It replaces both the annual International Capital Markets report, which has been published since 1980, and the quarterly Emerging Market Financing report, published since 2000.

Country Surveillance

An IMF staff team meets with government and central bank officials of each member country, as well as other groups—such as trade unions, employer groups, academics, legislative bodies, and financial market participants—generally once every year (with interim discussions held as needed), to review economic developments and policies. These consultations touch on major aspects of macroeconomic and financial sector policies, but they also cover other policies affecting a country’s macroeconomic performance, including, where relevant, structural economic policies and governance.

To provide the basis for country surveillance, an IMF staff team visits the country, collects economic and financial information, and discusses with the national authorities recent economic developments and the monetary, fiscal, and relevant structural policies the country is pursuing. The Executive Director for the member country usually participates. The IMF staff team normally prepares a concluding statement, or memorandum, summarizing the discussions with the member country and the findings of the staff team, and leaves this statement with the national authorities, who have the option of publishing it. On their return to headquarters, IMF staff members prepare a report describing the economic situation in the country and the nature of the policy discussions with the national authorities, and evaluating the country’s policies. The Executive Board, where the entire membership is represented, then discusses the report. The country is represented at the Board meeting by its Executive Director. The views expressed by Executive Directors during the meeting are summarized by the Chairman of the Board (the Managing Director), or the Acting Chairman (a Deputy Managing Director), and a summing up is produced. If the Executive Director representing the member country agrees, the full Article IV consultation report is released to the public, together with the summary text of the Board discussion and background material in the form of a Public Information Notice (PIN). Otherwise, a PIN alone may be issued. In FY2002 the Board conducted 130 Article IV consultations with member countries (see Table 2.1). The PINs and Article IV reports are published on the IMF website.

Table 2.1Article IV Consultations Concluded in FY2002
Country NameBoard DatePIN IssuedStaff Report Published
AlbaniaJuly 13, 2001July 27, 2001July 27, 2001
AlgeriaAugust 29, 2001September 19, 2001September 19, 2001
AngolaMarch 29, 2002
Antigua and BarbudaMarch 15, 2002
ArmeniaMay 21, 2001April 2, 2002April 2, 2002
ArubaAugust 22, 2001September 7, 2001September 7, 2001
AustriaJune 11, 2001June 14, 2001June 14, 2001
AzerbaijanFebruary 20, 2002March 8, 2002March 8, 2002
BahamasAugust 1, 2001August 14, 2001August 27, 2001
BangladeshApril 29, 2002May 15, 2002June 7, 2002
BarbadosNovember 26, 2001
BelarusJanuary 23, 2002February 19, 2002February 19, 2002
BelgiumMarch 1, 2002March 13, 2002March 13, 2002
BelizeJuly 9, 2001August 2, 2001August 27, 2001
BhutanMay 7, 2001May 23, 2001
BoliviaJune 8, 2001June 25, 2001June 25, 2001
Bosnia & HerzegovinaFebruary 25, 2002March 22, 2002March 22, 2002
BrazilJanuary 23, 2002February 7, 2002
Brunei DarussalamMarch 4, 2002
Burkina FasoJuly 2, 2001July 16, 2001
Burkina FasoApril 9, 2002May 1, 2002May 1, 2002
CambodiaFebruary 6, 2002March 1, 2002March 1, 2002
CameroonJuly 16, 2001July 26, 2001August 6, 2001
CanadaFebruary 4, 2002March 12, 2002March 12, 2002
Cape VerdeJune 15, 2001October 3, 2001October 3, 2001
ChadJanuary 16, 2002February 25, 2002February 25, 2002
ChileJuly 16, 2001July 27, 2001July 27, 2001
China, P.R. ofJuly 23, 2001August 24, 2001
ComorosJuly 18, 2001July 31, 2001August 9, 2001
Congo, Democratic Rep. of theJuly 13, 2001July 20, 2001July 30, 2001
Congo, Rep. ofFebruary 6, 2002February 25, 2002
Costa RicaJuly 30, 2001April 24, 2002April 24, 2002
Côte d’lvoireAugust 31, 2001October 2, 2001October 2, 2001
Czech RepublicJuly 16, 2001July 25, 2001July 25, 2001
DjiboutiNovember 30, 2001
DominicaJune 15, 2001July 13, 2001July 20, 2001
EgyptOctober 31, 2001November 5, 2001
E.I SalvadorJuly 23, 2001
Equatorial GuineaAugust 31, 2001October 11, 2001
EritreaNovember 26, 2001
EstoniaJune 27, 2001July 9, 2001July 9, 2001
FinlandNovember 9, 2001November 21, 2001November 21, 2001
FranceOctober 26, 2001October 31, 2001November 5, 2001
GabonApril 1, 2002May 3, 2002May 3, 2002
Gambia, TheJuly 13, 2001July 26, 2001August 20, 2001
GeorgiaOctober 26, 2001October 31. 2001November 26, 2001
GermanyOctober 24, 2001November 7, 2001November 7, 2011
GhanaJune 27, 2001August 9, 2001August 9, 2001
GreeceFebruary 22, 2002March 1, 2002March 15, 2002
GrenadaJuly 11, 2001July 20, 2001August 1, 2001
GuatemalaMay 14, 2001May 25, 2001
HaitiJanuary 18, 2002Februarys, 2002February 8, 2002
HondurasOctober 5, 2001October 26, 2001
HungaryMay 4, 2001May 18, 2001
IcelandMay 2, 2001May 24, 2001June 12, 2001
IndiaJune 20, 2001August 14, 2001
IndonesiaApril 26, 2002
Iran, Islamic Rep. ofSeptember 6, 2001September 18, 2001
IrelandAugust 1, 2001August 13, 2001August 13, 2001
IsraelJury 30, 2001August 6, 2001August 3, 2001
ItalyNovember 5, 2001November 20, 2001November 20, 2001
JamaicaMay 30, 2001June 6, 2001June 14, 2001
JapanAugust 3, 2001August 10, 2001August 10, 2001
IonianApril 29, 2002May 3, 2002
KazakhstanJanuary 23, 2012February 5, 2002March 19, 2002
KenyaMarch 15, 2002April 19, 2002April 19, 2002
KiribatiJune 25, 2001September 21, 2001September 21, 2001
KoreaFebruary 11, 2002February 12, 2002
KuwaitJune 27, 2001June 29, 2001July 20, 2001
Kyrgyz RepublicNovember 30, 2001December 19, 2001December 19, 2001
LatviaJanuary 18, 2002January 25, 2002January 25, 2002
LebanonOctober 17, 2001October 29, 2001
LesothoMarch 18, 2002March 21, 2002May 3, 2002
LiberiaFebruary 25, 2002July 18, 2002July 18, 2002
LithuaniaJanuary’l6, 2002January 24, 2002January 24, 2002
Macedonia, FYRMarch 4, 2002March 8, 2002March 8, 2002
MadagascarDecember 5, 2001December 13, 2001
MalaysiaAugust 29, 2001November 2, 2001
MaldivesAugust 30, 2001
MaliDecember 17, 2001January 9, 2002January 9, 2002
MaltaJuly 30, 2001August 3, 2001August 3, 2001
Marshall Islands, Rep. of theJanuary 18, 2002February 22, 2002
MauritaniaMay 9, 2001
MauritiusMay 14, 2001May 22, 2001May 22, 2001
MexicoAugust 2, 2001September 27, 2001October 25, 2001
MoroccoJuly 11, 2001August 2, 2001November 13, 2001
NamibiaFebruary 11, 2002February 22, 2002
NepalAugust 31, 2001September 21, 2001October 3, 2001
NetherlandsJune 6, 2001July 6, 2001July 6, 2001
Netherlands AntillesMay 7, 2001May 17, 2001May 17, 2001
New ZealandMarch 22, 2002March 27, 2002March 27, 2002
NicaraguaSeptember 19, 2001October 2, 2001October 2, 2001
NigerFebruary 8, 2002March 1, 2002March 1, 2002
NigeriaJune 29, 2001August 6, 2001August 6, 2001
NorwayMarch 1, 2002March 7, 2002March 7, 2002
PalauJanuary 4, 2002March 28, 2002March 28, 2002
ParaguayMay 11, 2001May 18, 2001June 15, 2001
PortugalMarch 25, 2002April 26, 2002April 26, 2002
Russian FederationMarch 8, 2002April 4. 2002April 4, 2002
St. Vincent and the GrenadinesJanuary 28, 2002February 19, 2002February 19, 2002
SamoaMay 9, 2001July 11, 2001
San MarinoDecember 5, 2001December 21, 2001December 21, 2001
São Tomé & PríncipeJanuary 30, 2002February 28, 2002February 28, 2002
Saudi ArabiaOctober 10, 2001November 7, 2001
SenegalSeptember 28, 2001October 18, 2001October 24, 2001
Sierra LeoneMarch 11, 2002
SingaporeJune 25, 2001
Slovak RepublicJuly 27, 2001August 1, 2001August 6, 2001
SloveniaMay 11, 2001May 21, 2001May 21, 2001
SloveniaMarch 20, 2002April 4, 2002April 4, 2002
SpainFebruary 1, 2002February 28, 2002March 13, 2002
SudanNovember 14, 2001
SurinameMay 9, 2001May 24, 2001
SwazilandMarch 20, 2002
SwedenAugust 31, 2001September 25, 2001September 25, 2001
SwitzerlandMay 9, 2001May 21, 2001May 21, 2001
Syrian Arab RepublicDecember,?, 2001
TanzaniaSeptember 24, 2001
ThailandAugust 2, 2001August 16, 2001
TongaSeptember 4, 2001October 31, 2001
Trinidad & TobagoJuly 6, 2001July 17, 2001July 24, 2001
TurkeyApril 15, 2002April 19, 2002
UkraineApril 24, 2002May 8, 2002
United Arab EmiratesOctober 12, 2001
United KingdomMarch 4, 2002March 7, 2002March 7, 2002
United StatesJuly 27, 2001August 14, 2001August 14, 2001
UzbekistanMarch 11, 2002
VietnamNovember 21, 2001January 4, 2002January 9, 2012
ZambiaNovember 7, 2001December 6, 2001
ZimbabweDecember 14, 2001June 19, 2002June 25, 2002

(For more details of the IMF’s bilateral surveillance, such as Financial Sector Stability Assessments, see Chapter 3, under “Crisis Prevention.”) In addition, the Board assesses economic conditions and policies of member countries borrowing from the IMF through discussions of the lending arrangements that support the member countries’ economic programs (see Chapter 4).

Global Surveillance

The Executive Board’s conduct of global surveillance relies heavily on staff reports on the World Economic Outlook and international financial markets (see Box 2.2), as well as sessions on world economic and market developments.

World Economic Outlook

The World Economic Outlook reports feature comprehensive analyses of prospects for the world economy, individual countries, and regions, and also examine topical issues. These reports are prepared by the staff and discussed by the Executive Board usually twice a year (and later published), but they may be produced and discussed more frequently if rapid changes in world economic conditions warrant.

In FY2002 the Board discussed the World Economic Outlook on three occasions: two regular discussions were held in September 2001 and March 2002, and an additional discussion was held in December 2001 in the aftermath of the terrorist attacks in the United States of September 11, 2001. The two discussions during the 2001 calendar year focused on signs of a slowdown in world economic growth, sharply albeit temporarily exacerbated by the events of September 11. By March 2002, however, there were encouraging indications that the slowdown had bottomed out and that global economic growth was recovering.

At its September 2001 meeting on the World Economic Outlook, the Board agreed that prospects for global growth had weakened since the last World Economic Outlook report had been released the previous May. In particular, Directors noted the substantial decline in growth in the United States over the past year; the serious deterioration in economic prospects for Japan; the weaker conditions and outlook in Europe; and the reduction in the projections for growth for most developing country regions. Slower GDP growth in almost all regions had been accompanied by a sharp decline in trade growth, Directors noted. Financing conditions for emerging markets had also deteriorated, although Board members were encouraged that the effects of contagion had been more moderate than in preceding episodes.

Directors considered that a number of interrelated factors had contributed to the slowdown, including a reassessment of corporate profitability and an associated adjustment in equity prices, higher energy and food prices, and tightening of monetary policy to contain demand pressures in the United States and in Europe. More broadly, the faster-than-expected slowdown also reflected the strong cross-country trade and financial linkages that were increasingly evident across countries.

At their December 2001 meeting on revised projections for the World Economic Outlook, Directors discussed the impact of the September 11 attacks on the world economy. They observed that, before the attacks, there appeared to be a reasonable prospect for recovery in late 2001. However, more recent data, on which the interim World Economic Outlook revisions were based, indicated that the situation before the attacks was weaker than had earlier been projected in many areas, including in the United States, Europe, and Japan. Directors accordingly concluded that the tragic events of September 11 had exacerbated an already very difficult situation for the global economy.

In the aftermath of the September 11 attacks, consumer and business confidence had weakened further across the globe, Directors observed. There was a significant initial impact on demand and activity, particularly in the United States. In financial markets, there had been a generalized shift away from risky assets in both mature and emerging markets, including a substantial deterioration in financing conditions for emerging market economies. Between the end of September and early December 2001, however, financial markets strengthened, as equity markets recovered and the earlier flight to quality was reversed. Movements in major exchange rates had been moderate, while commodity prices had fallen back further, especially for oil, as the outlook for global growth had weakened.

The economic slowdown and worsening financing conditions had adversely affected many emerging market economies, Directors noted. Net capital flows, including foreign direct investment, were constrained. Those countries that required substantial external financing were vulnerable to reassessments of economic prospects and to further shocks in international capital markets.

Board members expressed concern that developing countries and, in particular, the poorest countries were being hurt by weaker external demand and falling commodity prices, with the oil exporters being particularly affected. Nonfuel commodity exporters would also be affected by further weakness in already depressed prices, although, for some, the benefits from lower oil prices would limit the increase in their requirement for external financing. Thus, while growth was projected to be relatively well sustained for the group as a whole, Directors were of the view that the prospects for individual countries varied widely.

Given the limitations of monetary policy in the then prevailing environment of weak confidence and excess capacity, most Directors agreed in their December discussion that fiscal policy should also play a role, particularly through the operation of the automatic stabilizers.

Directors also pointed out that the agreement reached at the World Trade Organization meetings in Doha, Qatar (see Box 2.3 below), in November 2001 to launch new trade negotiations was of particular importance, as they could be expected to contribute substantially to global economic growth over the medium term.

There had been a marked improvement in global economic prospects by the time of the Board’s March 2002 discussion. Directors welcomed the increasing signs that, since December 2001, the slowdown had bottomed out, and that a global recovery was under way. This recovery was evident in the United States and Canada, and, to a lesser extent, in Europe and in some countries in Asia. Financial markets had bounced back strongly after the September 11 shock, commodity prices had begun to pick up, and emerging market financing conditions had strengthened markedly. Nevertheless, different but serious concerns remained in a number of countries, notably Japan and Argentina.

Directors observed that several factors underpinned the recovery. Most important was the substantial easing of macroeconomic policies in advanced economies—particularly the United States—and also in a number of emerging economies, especially in Asia. The scope for such policy support owed much to earlier progress in lowering inflation, strengthening fiscal positions, and reducing other sources of vulnerability, which enabled the membership to respond promptly and effectively to the difficult situation that the world economy had faced the previous year. Directors also noted that the adjustment in inventories appeared to be well along in the United States and some other advanced economies, and that this would also help boost production in the period ahead. The recovery in the major currency areas had also been supported by lower oil prices, although this was less of a factor following the strong pickup in prices since late February 2002. Directors underscored the importance of stable oil prices for a durable world economic recovery.

Overall, Directors agreed that the risks to the outlook had become more evenly balanced since their December 2001 discussion. Indeed, recent indicators of confidence, employment, and activity in the United States had been surprisingly positive, suggesting that the recovery would be stronger than earlier projected.

At the same time, a number of potential downside risks in the outlook required continued attention, Directors noted. First, in part because of the synchronized slowdown, relatively little progress had been made in reducing persistent imbalances in the global economy—notably, the high U.S. current account deficit and surpluses elsewhere, the low U.S. personal saving rate, the apparent overvaluation of the dollar and undervaluation of the euro, and the relatively high household and corporate debts in a number of countries. With the United States leading the recovery, Directors considered that these imbalances could, at least in the short term, widen further.

In discussing the implications of this prospect for the global outlook, Directors observed that the continued favorable outlook for U.S. productivity growth and capital inflows might reduce the risk of a disorderly unwinding of the current account imbalances. Most agreed that in the major currency areas, policies—especially structural policies—should be formulated to ensure an orderly reduction of current account imbalances that would enhance the sustainability of the global recovery.

Directors noted a second source of risk to the outlook. Following the strong rebound in past months, global equity prices again appeared to be richly valued and might reflect an excessively optimistic outlook for corporate earnings. If earnings growth were to prove disappointing, there would be a renewed risk of a weakening in financial markets, confidence, and activity. The analysis of the impact of asset prices on consumption, provided in Chapter 2 of the April 2002 World Economic Outlook, indicated that asset prices, in particular equity prices, had become more important over time as a determinant of consumer spending. Given the aging of populations in industrial countries, as well as continued financial market development, this trend was likely to continue, suggesting that developments in asset prices might have become increasingly important in the formulation of macroeconomic policies.

Specific concerns highlighted by Directors included the adverse effects the continuing economic difficulties in Japan and Argentina—while different in nature—could have on other countries in their regions. Most Directors regretted the decision by the U.S. authorities in early 2002 to raise tariffs on steel imports and the prospect of retaliation by other countries. They reiterated the critical importance for all countries to resist protectionist pressures and to ensure that substantive progress is made with multilateral trade negotiations under the Doha round.

Directors concurred that macroeconomic policies in most industrial countries should remain generally supportive of the emerging recovery. However, they noted that, with the exception of Japan, there appeared little need for additional policy easing and that, in countries where the recovery was more advanced, attention should turn in time toward reversing earlier monetary policy easing. Over the medium term, policy should seek to support sustainable growth, while aiming for an orderly reduction in global imbalances. This would require continued structural reforms to encourage growth in the euro area and in some Asian emerging markets; decisive action in Japan to reinvigorate the economy; and for the United States to ensure that medium-term fiscal targets were met. Directors also underscored the importance of using the recovery to make further progress in reducing vulnerabilities, including through accelerated efforts to address looming problems created by the aging of the populations of industrial countries; a sustained effort to achieve balanced budgets in the euro area; development of a medium-term fiscal consolidation plan in Japan; reform of the corporate and financial sectors in Asia; and medium-term efforts to strengthen fiscal positions in China, India, and many Latin American countries.

Sustained broad-based economic growth would be crucial to achieve higher living standards and an enduring reduction in poverty in the developing countries, Directors agreed. They noted that, despite encouraging progress in a number of countries, GDP growth in sub-Saharan Africa remained well below what would be needed to reduce poverty significantly. National policies would have to play the lead in improving economic performance, especially those designed to improve the conditions for savings, investment, and private sector activity. Stronger international support of sound policies would also be essential. In this connection, Directors welcomed the progress made at the Monterrey, Mexico, Conference on Financing for Development in March 2002 (see Box 5.6), including the announcement of increased aid targets by the European Union and the United States. They stressed, in particular, the vital importance of phasing out tradedistorting subsidies and giving greater access in world markets to exports from developing countries.

Major Currency Areas. On the prospects for the major currency areas, Directors agreed that recent indicators increasingly pointed to recovery in the United States. Confidence and equity markets had picked up, household spending had remained strong, and manufacturing output had stabilized. Some Directors considered that activity could pick up even more rapidly than currently projected, especially given the size of the policy stimulus in the pipeline and the continued resilience of productivity growth. Some other Directors, however, pointed to the possibility of a less sustained or less resilient upturn, for example if low corporate profitability or excess capacity constrained investment growth, equity prices failed to sustain recent gains, or households rebuilt savings.

Given the balance of risks, Directors supported the U.S. Federal Reserve Board’s decision to keep interest rates on hold for the time being. While they noted that monetary policy should not be tightened prematurely, they agreed some tightening would be required if economic activity continued to strengthen. Directors agreed that no further fiscal stimulus was warranted at this stage. While recognizing that the deterioration in the fiscal position over the past year was the result of a combination of factors—including tax cuts, a stimulus package, and the emergency and security spending measures taken in the aftermath of September 11—Directors considered that the time had come to turn attention to the efforts needed over the medium term to preserve fiscal balance and address pressures stemming from the social security system.

Directors expressed serious concern about economic conditions and prospects in Japan. The economy was in its third recession in a decade, confidence and activity remained very weak, and the banking sector experienced severe strains. While welcoming initiatives and noting some signs of a possible bottoming out in the fall of activity, Directors urged the authorities to push ahead vigorously with measures directed at bank and corporate sector restructuring, which would remain the key to restoring confidence and reestablishing prospects for solid growth. Although there was little scope for further macroeconomic stimulus, they also agreed that monetary policy needed to remain focused on ending deflation. Given the high public debt and rising long-term interest rates, Directors stressed the need for a clear and credible commitment by the Japanese authorities to medium-term fiscal consolidation, backed by reforms to the tax system, public enterprises, and the health sector.

Directors were encouraged that recent business confidence surveys and a pickup in industrial production pointed to an emerging recovery in the euro area. While the recovery was likely to be somewhat slower and to come later than in the United States, a number of Board members pointed to the contribution that Europe’s strong fundamentals had made to global stability. Building on recent progress, further policy reforms to support a strong and sustained recovery should nevertheless have continued to receive the highest priority. Directors emphasized the need for euro area economies to move ahead with structural reforms, in particular in the financial sector, labor markets, and pension systems. They noted that the introduction of euro notes and coins in January 2002 meant that such structural reforms should be even more beneficial. Directors supported the European Central Bank’s monetary policy stance, which was to keep interest rates on hold while being ready to move in either direction as macroeconomic developments unfolded. On the fiscal side, they said that countries with sizable structural deficits would need to strengthen their fiscal positions as growth picked up, both to provide scope for the automatic stabilizers to function during subsequent slowdowns, and to help tackle rising fiscal pressures from aging populations.

Emerging Markets. Directors noted that the prospective recovery in industrial countries should play a central role in supporting activity in emerging markets, along with continued efforts to strengthen economic fundamentals to reduce vulnerability and enhance productivity growth. In Asia, which—with the exception of China and India—was particularly hard hit by the global slowdown, there were clear signs of a pickup in activity, aided by a nascent strengthening in the electronics sector and easier macroeconomic policies in a number of countries. The emerging recovery would need to be supported by ongoing reforms across the region, especially in financial and corporate sectors. In India, structural fiscal reforms were needed to back the substantial consolidation required, Directors considered, while China should move ahead with reforms to address the competitive challenges arising from WTO membership and, in particular, tackle difficulties in the state-owned enterprises, the banking sector, and the pension system.

Directors considered the diverse prospects facing Latin America. They noted with concern that the situation in Argentina remained very difficult, and that a significant contraction in output in 2002 appeared unavoidable. While Directors noted the steps the authorities had taken to address the difficult economic situation, they stressed the need to rein in the fiscal deficit and strengthen the banking system, and urged the authorities to move quickly to put in place a sustainable economic program that could receive financial support from the international community. Spillovers from Argentina on other regional economies initially appeared to have been generally limited (with the exception of Uruguay), although they remained a potential risk. Directors noted that the recovery was likely to be strongest in Mexico and Central America, two regions that are closely linked economically to the United States, as well as in some Andean countries. In other countries the pace of recovery was likely to be more subdued.

Directors welcomed the analysis in the World Economic Outlook of debt crises in Latin America. They cautioned against generalizations across countries and across different stages of their reform processes. Nevertheless, they noted the extent to which the region’s relative closure to external trade, higher macroeconomic volatility, relatively underdeveloped domestic financial markets, and low saving rates might help to explain the high incidence of debt crises in this region. Many countries had made progress in recent years in reducing vulnerability, mainly by adopting more flexible exchange rate regimes and developing domestic capital markets. The analysis had again underscored the benefits that countries in the region could reap from further progress in strengthening fiscal positions as well as from continuing reforms of their trade and financial systems.

Growth among most candidates in central and eastern Europe for membership in the European Union had been generally well sustained during the global slowdown. Robust domestic demand had offset weaker export performance, and growth was expected to pick up further as the global recovery took hold. While the high current account deficits in many of these countries had so far been readily financed by direct investment and other capital inflows, they nevertheless represented a source of vulnerability that, Directors agreed, underscored the importance of ongoing fiscal discipline and structural reforms to ensure a positive climate for investment and growth. Directors welcomed the recent improvements in economic indicators in Turkey. They expected that strengthening confidence and exports should underpin a sustained recovery in 2002, provided the strong implementation of sound macroeconomic and structural policies continued.

Growth in the countries of the Commonwealth of Independent States (CIS) had also remained remarkably resilient to the global slowdown, Directors observed, although they considered that the pace of activity in 2002 might weaken somewhat—mainly as a result of slowing demand in the region’s oil-exporting countries. Board members welcomed the accelerated structural reforms in Russia, while noting that efforts to improve the investment climate remained a key priority. For the region as a whole, the central challenge continued to be to accelerate progress in structural reforms, notably in the areas of institution-building and governance, enterprise and financial sector restructuring, and in reducing the role of the state. The high level of external debt in a number of the poorest CIS countries continued to be a serious concern and would require ongoing close monitoring.

Directors were encouraged that growth in Africa had held up well in 2001 and was expected to remain relatively strong in 2002. The outlook for much of the region continued to depend heavily on commodity market developments, and on further progress in eradicating armed conflict and other sources of civil tension. It would also be important to contain the rise of famine in the southern African regions. Directors highlighted the central role that sound economic policies had played in raising significantly per capita income growth in strongly performing African countries in recent years. Sustained economic growth and diversification would require faster structural reforms, including improvements in public service delivery and infrastructure, trade liberalization, and strengthened regulatory institutions and more secure and stable property rights. Directors welcomed the New Partnership for African Development, endorsed in July 2001 by the leaders of the Organization for African Unity (OAU), which emphasized African ownership, leadership, and accountability in improving the foundations for growth and eradicating poverty. They stressed that these efforts would need to be supported by external assistance, including the further reduction of trade barriers, increased development aid—especially for HIV/AIDS—and support for capacity-building efforts (see Box 5.5).

Directors observed that growth in the Middle East was projected to weaken in 2002, although much would depend on oil market developments and the impact of the regional security situation. They noted that the adverse impact of lower oil prices in 2001 on oil-exporting countries had been limited by the prudent macroeconomic policies of recent years. Over the medium term, a key policy priority in many countries was to continue efforts to diversify production into nonenergy sectors and hence to reduce dependence on oil revenues.

Background Analysis. Directors welcomed the analysis of previous recessions and recoveries in industrial countries (Chapter 3 of the April 2002 World Economic Outlook). They noted that the synchronicity of the recent global slowdown had much in common with past downturns, whereas the relatively unsynchronized recessions of the early 1990s were an exception that reflected different shocks in different countries. In the recent downturn, the collapse in investment spending associated with the bursting of the technology bubble was also consistent with sharp drops in business fixed investment, which occurred typically in the lead-up to recessions in recent decades.

The mildness of the recent global slowdown was in line with the historical trend toward shallower recessions. However, the short duration and mildness of the recent downturn did not imply that the recovery would be slow or weak. Increases in interest rates prior to the recent downturns were smaller than before, which reflected relatively low inflation during the previous expansion. This helped to explain why the subsequent downturns had been relatively mild.

Regarding monetary policies in a low-inflation environment, Directors agreed that a major reason for the remarkable decline in inflation among industrial countries over recent decades had been the change in emphasis of central banks toward price stability and associated beneficial changes in private sector behavior. In discussing some of the policy challenges facing central banks, many Directors cautioned against drawing policy conclusions prematurely, noting that in several countries the low-inflation environment had not significantly hampered the effectiveness of monetary policy. More generally, in their view, the credibility of antiinflationary monetary policy was an important asset that should be preserved.

International Capital Markets and Global Financial Stability

In June 2001, the Board held its last review of developments in the mature and emerging international capital markets in the context of an annual International Capital Markets report. Published since 1980, International Capital Markets has been combined with another report, Emerging Market Financing, in a new publication, the Global Financial Stability Report (see Box 2.2.). This report focuses on current conditions in global financial markets, and is intended to help the IMF look forward and draw policy implications to strengthen its role in promoting international financial stability and preventing crises. The frequency of the report—every quarter—and its focus on contemporary issues should enable the Board to keep up with fastchanging events in financial markets.

The new report is one element in a broad effort by the IMF to strengthen surveillance of international capital markets. Other elements include the World Economic Outlook reports, the Board’s regular reviews of world economic and market developments, the ongoing work on private sector involvement in preventing and resolving financial crises, work on standards and codes, the Financial Sector Assessment Program (FSAP), and Special Data Dissemination Standards (SDDS).

International Capital Markets Report, June 2001

In their June 2001 discussion, Directors noted that the preceding year had been dominated by periods of increased asset price volatility, slowing growth in the global economy, and crises in key emerging markets. Adjustments in capital markets were evident in a repricing of risks in a wide range of equity and highyield bond markets. Directors were of the view that the high correlation of asset price movements across countries reflected the globalization of finance and the increasing tendency of investors to invest on the basis of industrial sectors or credit ratings, rather than geographic location.

Slowing global economic growth had been both anticipated by, and reflected in, a sharp fall in global equity markets—particularly in technology stocks—and a dramatic rise in high-yield credit spreads, although financial markets had later recovered significantly after monetary policy was eased in the major countries. Directors noted that there had been a remarkable degree of co-movement in asset prices among the major advanced countries, particularly between European and U.S. stock markets. The key exception was Japan, which seemed somewhat delinked from global markets. This reflected the more important role of domestic than foreign investors and the remaining weakness in the country’s corporate and financial sectors.

In discussing the risks facing international financial markets in the period ahead, Directors considered that—although the declines in equity markets had corrected part of the imbalances of recent years—there was still a risk that market sentiment might remain vulnerable to U.S. economic developments. Other sources of vulnerability could be concerns about the ability of monetary policy to offset economic weakness and about the sustainability of high productivity growth. In addition, if the sustainability of the current high U.S. household, corporate, and external imbalances came into question, a significant and potentially disorderly rebalancing of domestic and international portfolios might occur, which could affect key exchange rate relationships. The assessment of risks was complicated by a number of structural developments, including increasing concentration in the major financial systems, a growing reliance on over-the-counter (OTC) derivatives, and structural changes in major government securities markets. Those structural changes appeared to have reduced transparency about the distribution of financial risks in the international financial system; greater disclosure could help to enhance market discipline and official oversight. Board members noted, nonetheless, that U.S. banks appeared to be more robust than in previous downturns and were sufficiently well capitalized to weather a possible credit deterioration.

Directors reviewed the risks in Europe and Japan. Regarding Europe, Directors cautioned that, while banks remained strong, capital markets might be more vulnerable to spillovers and contagion from volatility in U.S. capital markets as well as to common shocks that appeared to affect these large economies simultaneously. Directors also expressed concern that loan provisioning in the Japanese banking sector might be inadequate and that this sector also had significant exposures to bond and equity prices in the Japanese market. At the same time, the Japanese banking sector seemed vulnerable to continued poor domestic macroeconomic performance, large unanticipated external economic and financial shocks, and volatility in Japanese financial markets.

While noting that domestic developments remained the key drivers of capital flows to emerging markets, Directors considered that, in the past year, emerging markets’ access to international capital markets had been strongly affected both by events in the mature markets and by crises in emerging markets. As a result, many emerging markets had found it difficult to maintain continuous market access. While, in earlier periods, exchange rate and banking crises in emerging markets and the ensuing contagion had led to an abrupt loss of markets access, during the past year many emerging markets had lost market access mainly because of developments in mature markets, such as the collapse of equity prices on the Nasdaq exchange in the United States.

Directors agreed that a shift in the investor base for emerging market instruments had increased the vulnerability of capital-importing emerging market countries to shifts in investor sentiment or investment strategies. Because holdings of emerging market assets by “dedicated” investors remained limited, “crossover” investors—those who could place a small fraction of their assets in emerging market instruments, with large effects on these markets—had come to dominate the current investor base. Directors emphasized that those investors were likely to reduce or eliminate their holdings of emerging market assets if the outlook for emerging markets deteriorated, if more attractive investment opportunities in mature markets arose, or if managers became more risk averse. That could result in an abrupt loss of market access for emerging market borrowers that was not necessarily related to changes in emerging market fundamentals. Although Directors noted that emerging market borrowers had shown welcome adaptability—particularly through syndicated loans, prefunding of obligations, and the use of alternate currencies—to the “on-off” nature of market access, such adaptations could sharply increase the cost of access to international financial markets. It was difficult to assess whether that shift would be long lasting. In any event, emerging market economies should not be deterred from pursuing sound and transparent policies. Over time, that could help to restore the role of investors in providing financing for emerging markets and hence reducing volatility.

Against the background of data pointing to a further weakening of global economic prospects, Directors reviewed the outlook for capital flows to emerging markets. They acknowledged that, while those flows were influenced by developments in mature markets and prospects for the global economy, the domestic policies in capital-importing countries could also be a factor in their distribution. With lower interest rates and a relatively soft landing, the gross issuance of international bonds, equities, and syndicated loans could increase, and net flows to emerging markets—particularly non-oil-exporting emerging markets—recover in line with the global economic recovery. Nevertheless, Directors also recognized that if the global slowdown in economic growth were sharper than expected, the consequence could be a marked slowdown in capital flows to emerging markets, including in foreign direct investment (FDI). Directors were of the view that, since FDI flows remained the single largest source of capital in all regions, the staff should monitor them closely and assess the conditions and policies that would foster greater stability.

Major Government Securities Markets. Directors agreed that the structural changes under way in the major government securities markets had implications for financial markets and should be kept under review. They noted that the shrinking supply of U.S. treasury securities had already resulted in important changes in U.S. and international financial markets, as market participants had come increasingly to rely on other instruments, including swaps. Directors noted, however, that private financial instruments might not easily, or fully, substitute for treasury securities as domestic and international safe havens.

Some harmonization of regulation and convergence of issuance and trading practices had already occurred in government securities markets in the euro area. Over time, greater convergence and integration was likely to promote the emergence of a uniform euro-area benchmark yield curve and an increase in euro-area market liquidity. At the same time, the region’s corporate bond market had become more integrated and had grown rapidly.

Directors discussed the situation in Japan, where lingering economic uncertainty and financial imbalances had impaired corporate financial activity and fuelled a rise in the supply of government debt. The combination of a low-interest-rate environment and technically driven changes in the supply of and demand for Japanese government bonds (JGB), along with shortcomings in the market infrastructure that had adversely affected market liquidity, had led to JGB market volatility while spreads in the corporate bond market had been significantly compressed. That situation presented financial institutions with challenges in managing risk, and also highlighted the challenges to the Japanese authorities of managing the costs and risks of a large and growing supply of government debt. Directors noted the steps taken to improve the JGB market infrastructure to enhance the efficiency and attractiveness of the JGB market to domestic and international investors.

Financial Sector Consolidation in Emerging Markets. Many emerging markets had undergone financial sector consolidation, although its extent and pace had varied in different regions. Directors saw this process as one facet of the continuing globalization of international financial activities, and akin to a “quiet” opening of capital accounts. While the migration of financial activities to low-cost financial centers was profoundly altering the financial systems of many emerging markets, it also linked them to international financial markets.

Directors pointed out that a number of aspects of the consolidation process differed from the experience of mature markets, including the role of cross-border mergers and acquisitions, which had been rare in mature markets. Furthermore, consolidation in emerging markets had frequently been a vehicle for restructuring the financial system following major financial crises, whereas, in mature markets, consolidation had more often been designed to reduce excess capacity. Also, the authorities had played a major role in fostering consolidation in emerging markets, whereas market forces had been the predominant force for consolidation in mature markets.

The process of financial sector consolidation in emerging markets raised a number of complex policy issues, Directors observed, including how to create sufficient market discipline and official supervision for institutions that were “too-big-to-fail.” The experience of mature markets indicated that dealing with these problems would involve strengthening supervisory capacity to monitor the activities of large complex financial institutions, and establishing clear entry and exit rules and prompt corrective action for distressed institutions.

Directors noted that the emergence of financial conglomerates providing a wide range of products and services complicated prudential supervision and regulation. These conglomerates raised the issue of how the regulatory agencies overseeing banks, securities, and insurance companies should be structured. Directors considered that this would depend on the specific circumstances of each country or region.

On the topic of e-finance, Directors noted that, while its development was still at an early stage in most emerging markets, there had been steady growth in the application of the Internet to the production and delivery of financial services. This underscored the need for improved liquidity management at the level of financial institutions and better supervision.

Global Financial Stability Report, February-March 2002

In the Board’s February inaugural discussion of the Global Financial Stability Report (published in March), Directors welcomed the recovery in global markets and the reduction in global risk aversion since the fourth quarter of 2001. They noted the remarkable turnaround in market sentiment regarding the strength and speed of a U.S.-led global economic recovery. Overall, financial markets had responded well to the uncertainties that arose during the slowdown and following the events of September 11, and had recovered quickly once it became clear that economic prospects were improving.

Mature equity markets in early 2002 had shown lackluster performance. Directors noted that this reflected widespread concerns about accounting problems that, among other things, reduced transparency on the true extent of the leveraging undertaken by corporations and financial institutions during the boom years.

Turning to the emerging markets, Directors agreed that contagion from the default and devaluation in Argentina had been subdued. More careful discrimination by investors across emerging markets, a variety of technical factors, and the adoption of sound economic policies geared toward more flexible exchange rates, higher official reserves, lower short-term debt, and stronger current account positions had contributed to the resilience of emerging markets during the fourth quarter of 2001 and beyond. However, risks remained, as events in Argentina were still unfolding and there was still significant uncertainty. Evidence of contagion might take the form of slower capital flows, including foreign direct investment, to some emerging markets. Furthermore, Directors observed that any unexpected changes in the global risk environment or the global economic outlook could adversely affect emerging market borrowers.

Stability Implications of Global Financial Market Conditions. While the international financial system had remained resilient in the face of serious disruptions, global financial conditions had worsened during 2001 across a broad range of markets, institutions, and sectors, Directors observed. Deteriorating credit quality and corporate earnings were reflected in higher corporate bond spreads and lower stock prices. These price adjustments had adversely affected the balance sheets of corporations and households. The slowdown had also affected financial institutions, although the major institutions in the United States and Europe seemed to be well capitalized. Directors acknowledged the heightened strains in Japan’s financial system, and underscored the importance of decisive moves by the Japanese authorities to deal with long-standing weaknesses in the banking, insurance, and corporate sectors.

Turning to the outlook for global financial market conditions, Directors agreed that the main risks related to the potential for a subdued or delayed global recovery. With asset prices seemingly reflecting expectations of a near-term economic rebound, a subdued or delayed recovery could lead to market corrections. Directors noted that, under this scenario, Japan and emerging market borrowers could experience particularly adverse effects. The adjustment could also include a temporary and selective withdrawal from risk taking by financial institutions. At the same time, the resilience of the international financial system during financial disruptions in the 1990s was cause for optimism that the adjustments would be manageable.

Credit-Risk Transfer Market. Directors noted that credit-risk transfer markets had grown very rapidly, an indication of the useful role they played in spreading risk among economic agents and contributing to portfolio diversification, and in providing alternative sources of liquidity. Concerns about the activities of new and less-regulated participants in credit markets could be addressed by improved disclosure and transparency. Many Directors also called for strengthened oversight of nonbank and nonfinancial entities that were active in financial markets. They expressed concern that regulatory arbitrage might shift risks to institutions least capable of managing them, and that accounting and auditing standards and practices might be deficient in several major countries. These Directors suggested that a top priority in the period ahead should be to update the supervisory and regulatory frameworks to keep pace with the evolving credit-risk transfer markets.

Further Development of Early Warning System Models. Directors agreed that the development of models to provide advance warning of a country’s vulnerability to crisis and of the buildup of systemic risk in financial markets was important for effective market surveillance and crisis prevention. Although such early warnings could be useful in helping the IMF to provide timely advice to prevent crises, given their current limited predictive power, early warning system (EWS) models should be used carefully and together with qualitative and other methods of vulnerability assessment. With this caveat in mind, Directors supported efforts to refine the EWS models currently being used in the IMF’s work. Those efforts could also complement work at the national level on early warning systems. Noting that currency crises were not the only threat to financial stability, most Directors welcomed efforts to develop the basic building blocks of a more general early warning system able to predict other types of crises, including debt and banking crises.

Alternative Financing Instruments. Directors urged caution on the use of alternative debt instruments, other than “plain-vanilla” bonds and regular loan issues, to maintain access to global capital markets in times of financial difficulties. While acknowledging that some of those instruments might be useful under certain conditions, Directors stressed that they should not substitute for strong economic policies and sound debt management practices—the main foundation for sound and sustainable access by emerging market borrowers to international capital markets. They noted that where high bond yield spreads reflected investor concerns about a country’s solvency, the use of some of those alternative instruments could make the problems worse.

Regional Surveillance

Central African Economic and Monetary Community

In May 2001, Executive Directors discussed developments and policy issues in the Central African Economic and Monetary Community (CEMAC), whose members include Cameroon, the Central African Republic, Chad, the Republic of Congo, Equatorial Guinea, and Gabon. They commended the authorities of the CEMAC countries for the progress made during 2000 in strengthening economic integration. The policy dialogue with the CEMAC regional institutions had served as a useful complement to bilateral surveillance, given the broadening range of policy issues dealt with at the regional level. They encouraged the authorities to continue to carry forward the process of integration at the next meeting of the Council of Ministers.

Directors noted that the sharp increase in oilproducing CEMAC countries’ export earnings and government revenues in 2000 had led to a large reduction in the community’s overall fiscal and external imbalances and to a strong recovery in the international reserves of the Bank of Central African States (BEAC). They viewed the competitive position of CEMAC as broadly adequate but noted that the economic situation remained fragile. The region was vulnerable to external shocks, especially to a drop in the price of crude oil and a weakening of the U.S. dollar against the euro, to which the CFA franc is pegged. In that context, Directors stressed the need for sustained implementation of structural reforms and efforts to diversify the economic base and produce a stable macroeconomic environment. They expressed concern about the sharp increase in domestic demand in 2001, which was expected to lead to a widening of the external current account deficit. Consequently, Directors also stressed the importance of further fiscal consolidation with a focus on strict control of government expenditure and saving of the oil revenue windfalls.

Notwithstanding progress made in 2000, an acceleration of the pace of economic integration would enhance CEMAC’s credibility. Directors encouraged the authorities to strengthen regional institutions and establish a solid framework for close coordination of fiscal and structural policies, which would provide firm support to the common exchange rate regime. The success of efforts to strengthen integration would depend on the implementation of both coherent and comprehensive convergence programs by individual member countries and the implementation of an effective system of mutual regional surveillance of member countries’ policies. Such a system should include binding rules and quantitative criteria, periodic reviews, and mechanisms to compel individual countries to take corrective measures in case of slippages.

Directors encouraged the authorities to improve the conduct of monetary policy and to take steps to strengthen the functioning of the regional interbank money market, which was essential for an efficient distribution of bank liquidity. They welcomed the decision to phase out the automatic granting of central bank credit to governments but urged member countries to proceed very cautiously on a proposal to have the central bank guarantee government security issues.

While acknowledging the recent progress made in rehabilitating the banking sector, Directors expressed concern at its continuing fragility. There was ample scope for a further strengthening of banks’ management and supervision of the banking system. A large number of banks did not comply with the core prudential ratios. Directors stressed the importance of completing the programs of bank restructuring and privatizations. They also underscored the importance of strengthening the Central African Banking Commission (COBAC) and keeping it free of political interference, and of reforming judicial systems to ensure that they did not contribute to a weakening of national banking systems.

Directors welcomed the member countries’ decision to further liberalize trade through a simplification of the present structure of the common external tariff, a reduction of average tariff rates, and the elimination of remaining intraregional barriers. To enable them to reap the benefits of economies of scale and strengthen domestic enterprises’ competitiveness, Directors encouraged the authorities to work on common sectoral policies that are critical to regional integration, focusing on infrastructure, transportation, communication, and energy. They also stressed the importance of creating a favorable environment for private investment by implementing initiatives in business laws, investment charters, and competition policy.

Directors encouraged the authorities to seek technical assistance to enhance and harmonize the production of regional statistics, especially in national accounts, consumer price indices, trade, balance of payments, and government financial operations. They considered that the IMF should provide technical assistance for data improvement, as well as to promote macroeconomic convergence and enhance COBAC’s capacity to carry out regional surveillance.

West African Economic and Monetary Un

In October 2001, the Board discussed recent economic developments and the main policy issues in the West African Economic and Monetary Union (WAEMU), whose members include Benin, Burkina Faso, Côte d’Ivoire, Guinea-Bissau, Mali, Niger, Senegal, and Togo. The slowdown in the WAEMU region’s overall growth performance that began in 1999 had continued. The negative effects of adverse external developments on the macroeconomic performance of the region had been compounded by a deterioration of the economic and financial situation in Côte d’Ivoire. There was a possibility that this economic slowdown could be prolonged beyond 2001 if the global environment and commodity prices weakened further. Against this background, Directors underlined the necessity of strengthening macroeconomic policies, deepening structural reforms, and improving competitiveness in the WAEMU countries to achieve the ultimate goals of economic integration in terms of growth and poverty reduction.

Directors commended the authorities of the WAEMU for the progress on the integration process in 2000, with the entry into force of the customs union and the steps taken to implement the Convergence, Stability, Growth and Solidarity Pact, which was adopted in December 1999. While welcoming adoption of the medium-term convergence programs by all countries, Directors noted that owing to weaknesses in policy implementation and the economic slowdown in the region, compliance with the regional convergence criteria by member countries had proved difficult, as indicated by the situation at the end of 2000. They believed that observing the convergence criteria by the end of 2002 would imply a more forceful political commitment, the implementation of corrective measures by member countries’ governments, and a reinforcement of the institutional capacities at both the national level and on the part of the WAEMU Commission to oversee the convergence process. Directors attached particular importance to a stronger political commitment on the part of member governments to remove remaining obstacles to the creation of a single regional market and the establishment of a full-fledged customs union. They also emphasized the importance of external support in moving the integration process forward and, in particular, the role of technical assistance in strengthening the regional institutions and ensuring the effective implementation of the various regional policy initiatives.

A prudent monetary policy had resulted in a further accumulation of foreign assets of the Central Bank of West African States (BCEAO) and an inflation rate broadly in line with that of the euro zone, Directors noted. The BCEAO’s key policy rates had not been adjusted since mid-2000, and they considered that there could be scope for greater flexibility in monetary management in light of the slowdown in economic activity. However, Directors emphasized the critical importance of sound fiscal policies and the associated containment of the governments’ domestic financing needs in supporting an appropriate monetary policy. In this connection, they drew particular attention to the need to bring public debt down to sustainable levels and to avoid arrears.

Directors underscored the importance of deepening the regional interbank market and achieving greater integration of the WAEMU region’s financial markets in facilitating private economic growth and fostering financial stability. They welcomed the decision to eliminate outstanding central bank credits to governments and to establish a regional securities market for member countries’ governments, although they recommended a realistic implementation schedule. Directors encouraged the authorities to identify and eliminate the obstacles to the regional interbank market. Those reforms would facilitate the financing of fiscal deficits from nonbank sources, enhance the BCEAO’s ability to manage liquidity in the banking system through market mechanisms, and promote the development of an efficient and competitive financial sector.

Despite the progress over the past ten years in rehabilitating the banking sector and conducting an effective supervision of banks, compliance with the recently revised prudential arrangements and regulations on internal controls appeared inadequate. Steps to strengthen banks’ loan portfolios in the region should include measures to improve the observance of prudential ratios by banks, strengthen loan-recovery mechanisms, and improve the judicial environment. Directors noted that more effective banking supervision was essential for the successful development of a regional financial market.

Directors supported recent steps to harmonize indirect taxation in the WAEMU, formulate a draft common investment code, strengthen common sectoral policies, and establish structural funds, all of which should contribute to the reduction of regional disparities. They encouraged the authorities to move forcefully in addressing the remaining agenda, including harmonizing taxation of petroleum products, promoting common tax regulations and a concerted effort to control tax exemptions, and making necessary improvements in the taxation of small businesses.

The external competitiveness of the WAEMU economies was adequate on the basis of a number of traditional exchange rate indicators, Directors agreed. In view of the longer-term structural problems besetting the WAEMU economies, however, an overriding priority for the authorities should be to implement policies aimed at broadening the productive base, improving productivity, and enhancing cost efficiency in the provision of key public utilities and services. Directors encouraged the authorities to develop and monitor nontraditional competitiveness indicators, such as export market shares.

Directors noted the efforts under way to integrate the WAEMU into the regional arrangement of the Economic Community of West African States (ECOWAS)1 with a view to creating a larger regional market and extending the common monetary framework to cover a broader group of countries in the region. To achieve this goal, it would be essential to further harmonize macroeconomic policies and trade policies between the WAEMU and non-WAEMU members of ECOWAS and to establish a credible surveillance mechanism to promote convergence among member states. Notwithstanding the desirability of such increased convergence and despite the strong political support underpinning the integration process within ECOWAS, the goal of achieving a single monetary union in West Africa by 2004 appeared very ambitious, owing to a range of economic reasons and institutional capacity constraints.

Directors believed that a strategy for regional integration would need to include the production of timely and reliable regional statistics, especially on national accounts, domestic debt, foreign trade, balance of payments, and the adoption of new indices to measure movements in prices and factor costs.

Monetary and Exchange Policies of the Euro Area and Trade Policies of the European Union

In October 2001, Executive Directors discussed the monetary and exchange rate policies of the euro-area countries and developments in trade policies of the European Union.

Policies of the Euro Area. Directors noted that in the face of large and global disturbances—including the earlier rise in energy prices, the downward correction in equity markets, and the marked slowdown in world trade growth—the euro area’s economic expansion had proven less resilient than anticipated. Against this already sluggish background, the economic repercussions of the events of September 11 were likely to dampen near-term growth prospects further. Nonetheless, the area’s macroeconomic fundamentals were sound, with low underlying inflation and muchstrengthened fiscal positions, complemented by supportive policies that provide a base for a new cyclical upswing.

The area’s cyclical setback should not detract from the considerable macroeconomic achievements of the last few years that were rooted in price stability, employment-friendly wage setting, fiscal consolidation, and a measure of structural reform. Those elements had provided the basis for faster income growth and job creation, especially in those countries that had implemented labor market reforms and sustained wage moderation. Structural rigidities remain pronounced, however, and Directors urged that reform efforts be stepped up across the area, especially in countries where labor market reforms had been lagging in recent years. More broadly, they highlighted the positive impact that growth-supporting macroeconomic and structural policies by the euro-area countries would have on global economic prospects.

As for monetary policy, Directors noted that risks to price stability were receding and that the European Central Bank (ECB) had properly reversed a significant portion of the monetary tightening it undertook in 2000. They commended the swift action by the ECB, in concert with the U.S. Federal Reserve and other central banks, to shore up confidence and provide sufficient liquidity to the banking system in the aftermath of the events of September 11.

Looking ahead, Directors expected risks to price stability to diminish further, particularly as weaker growth prospects and abating price pressures had increased the likelihood of continued wage moderation in 2002. The recent growth in M3 in excess of the ECB’s reference value appeared to some extent to reflect temporary velocity shocks related, among other things, to portfolio shifts and should therefore not be given undue weight in policy assessments. Against this background, Directors saw room for further monetary policy easing, particularly if the euro appreciated. A number of Directors encouraged the authorities to continue their efforts to improve market understanding of the policy framework underlying the ECB’s monetary decisions.

In discussing the factors responsible for the weakness of the euro’s external value, many Directors noted the role played by the much steeper rise of stock market capitalization in the United States than in the euro area, the ongoing international diversification by euroarea investors, and the increased issuance by nonresidents of euro-denominated liabilities.

On fiscal policy, Directors strongly endorsed the objective, embedded in the Stability and Growth Pact (SGP),2 that member countries reach and maintain budgetary positions either close to balance or in surplus over the medium term. This objective provided an anchor for assuring fiscal discipline while allowing for budget outcomes to vary over the cycle and across countries, as required for a well-functioning monetary union with a high degree of fiscal decentralization.

In considering how this objective might best be achieved, Directors discussed the merits of a framework that would combine the free play of automatic stabilizers with adherence to preannounced expenditure paths. In the view of a number of Directors, a key advantage of this approach would be to safeguard the mediumterm orientation of the SGP while providing a stabilizing framework for monitoring each member state’s position relative to its medium-term deficit objective. In contrast, focusing on meeting annual nominal deficit targets would, in the face of the global slowdown, require offsetting the operation of the automatic stabilizers, thus delaying the projected recovery. Other Directors, however, considered that reference to expenditure paths could usefully support the achievement of medium-term SGP objectives but should not replace nominal deficit targets.

Directors welcomed recent indications that, albeit with variations across countries, fiscal developments for the area as a whole broadly appeared to strike an appropriate balance between cyclical considerations and medium-term consolidation objectives. Most Directors agreed that, especially in light of the current generalized slowdown, the automatic stabilizers should be allowed to work. They generally did not see the need for significant discretionary fiscal policy actions to counteract the growth slowdown at that point, in view of the likely temporary nature of the adverse shocks and the effects such actions would have on fiscal positions.

Resolute and broad-based structural reforms would play a key role in raising the area’s growth potential and rebuilding business and consumer confidence. Directors welcomed the recent progress made toward more competitive product markets. They looked forward to further steps being taken in areas such as public procurement, state aid, administrative reforms, and the reduction of the regulatory burden on business. They regretted that relatively little had been done to address the work disincentives associated with tax and social benefits systems in many euro-area countries or to free up labor markets, including through more flexible wage-formation processes. Referring to the progress made by some countries on the basis of partial steps, Directors urged the authorities to aim for the major improvements in economic performance that should accrue from a more vigorous implementation of labor market reforms. Some Directors considered that a renewed effort toward structural reforms, aimed at enhancing the area’s productivity growth rate, could also contribute to a stronger euro over time.

Directors expressed their appreciation for the intensive preparations that had been made to ensure a smooth changeover to euro banknotes and coins and welcomed assurances that the changeover would not lead to an increase in prices. They looked forward to a successful completion of this reform of unprecedented scope, which should result in greater price transparency and enhanced competition.

Referring to the integration of capital markets as one of the greatest potential benefits of European Economic and Monetary Union (EMU), Directors expressed the hope that the recommendations of the Lamfalussy Report3 for streamlining the legislative process would soon come into play and encouraged the authorities to speed up implementation of the Financial Services Action Plan. Integrated capital markets posed new challenges to financial crisis prevention and management, and there was a need for significant strengthening of information exchanges among supervisors and of their decision-making processes.

Directors considered that further improvements in the availability, timeliness, and quality of euro-area statistics would be highly desirable, particularly for short-term cyclical indicators and balance of payments statistics, and they urged the authorities to continue their efforts to make improvements in these areas.

Directors welcomed the completion of three Reports on Standards and Codes (ROSCs) for the euro area (covering payment systems issues and the transparency of monetary policy and payments system oversight) and expressed broad agreement with their findings.

Recent Development in EU Trade Policies. Regarding the trade policies of the European Union (EU) as a whole, Directors expressed their conviction that the new Doha trade round would provide a much-needed boost to global growth prospects and urged the EU to continue to accord high priority to reaching agreement on the scope of such a round and to show leadership and flexibility to further the negotiations. They welcomed the EU’s “Everything-but-Arms” initiative for the least-developed countries and the proposed steps to simplify the EU’s Generalized System of Preferences. Directors emphasized that while those initiatives would be helpful in improving market access for eligible countries, more rapid progress in opening highly protected sectors to all trading partners would not only benefit developing countries but also entail significant gains for the EU itself In this regard, they highlighted the essential contribution that a comprehensive reform of the EU’s Common Agricultural Policy would make to both supporting trade liberalization and preparing for the EU’s enlargement.

Trade and Market Access Issues

In September 2001, the Board discussed the role of the IMF in trade. Directors agreed that the IMF had a substantial role to play in supporting an open international trading system and trade liberalization. They saw four avenues through which the IMF could make an effective contribution. First, it should continue to highlight the need for the successful launch of the new Doha trade round (see Box 2.3) and the benefits it could bring, both by raising living standards in all countries and by ensuring a stable world trading system.

Second, Directors agreed, the IMF should continue to address trade issues and support trade liberalization in the context of surveillance and IMF-supported programs where appropriate. Some progress had been made in focusing on market access issues in Article IV consultations with industrial countries, but more needed to be done to identify practices that impeded the exports of developing countries. Developing countries should also be encouraged to continue trade liberalization efforts to improve efficiency and foster sustainable growth. Directors emphasized that trade reforms should be designed with appropriate sequencing and with due regard to their impact—particularly in the short term—on revenue and the current account. In the context of IMF-supported programs, any conditionality pertaining to trade measures should be consistent with the guidelines and evolving practice for streamlining conditionality.

Third, Directors considered that technical assistance from the IMF should continue to play a vital role in laying the groundwork for successful trade liberalization. Reforms by members in the areas of the IMF’s particular expertise—namely, revenue systems and tax and customs administration—had often been essential in facilitating a smooth transition to more liberal trade regimes, with minimal impact on fiscal revenue.

Fourth, the IMF should continue to cooperate closely with the World Trade Organization (WTO) and the World Bank to avoid duplication and to ensure that the work of the three institutions on trade was complementary. Noting the strategic importance of trade for sustainable growth and poverty reduction in the poorest countries, Directors welcomed the cooperative efforts of the IMF, the World Bank, the WTO, and others in revitalizing the Integrated Framework for Trade-Related Technical Assistance. They supported the efforts of the World Bank and the IMF to help poor countries “mainstream” trade into their overall development and poverty reduction strategies, and, within that framework, to better target and coordinate technical assistance to improve its effectiveness.

Directors agreed that the IMF’s financing facilities were generally adequate to support members’ efforts to liberalize trade. The IMF was well placed to assist members, given the importance of a stable macroeconomic environment, an appropriate exchange rate policy, and the overall incentive framework for the success of trade liberalization efforts. In addition to the revenue and balance of payments implications of trade reform, Directors identified other areas where they thought further work, in collaboration with the World Bank, was needed in the design of trade liberalization, including the appropriate sequencing of trade liberalization; the impact on the poor; the shortrun adjustment costs in terms of output and employment, and measures to mitigate these costs; and the potential for export diversification in relevant cases.

Box 2.3Doha Development Agenda

The November 9–14, 2001, Fourth Ministerial Conference of the World Trade Organization (WTO), held in Doha, Qatar, launched a new round of multilateral trade negotiations—the Doha Development Agenda. The new round is the ninth since the signing of the General Agreement on Tariffs and Trade (GATT) in 1947 and the first since the conclusion of the Uruguay Round in Marrakech in 1994, which led to the establishment of the WTO.

The new round is comprehensive and aims to liberalize trade across a wide range of tradable goods and services and to update and strengthen the rules of the multilateral trading system. It also extends the work of the WTO into essentially new areas, such as investment, competition policy, and the environment. Rule-making constitutes a significant portion of the work program and is aimed at clarifying and improving disciplines on trade remedies (for example, antidumping measures), regional trade agreements, trade-related intellectual property rights, and the dispute settlement mechanism.

The fuller integration of developing countries into the trading system is a common theme of the Doha agenda. The Ministerial Declaration adopted at the Doha conference seeks to place the needs and interests of the developing countries at the heart of the work program. This is manifested by the importance it attaches to including the objective of duty-and quota-free market access for least-developed-country (LDC) producers, rules that take account of the special circumstances and implementation constraints of developing countries, and traderelated technical assistance and capacity-building programs. The development provisions in the declaration include commitments to make special and differential treatment more precise, effective, and operational and for special work programs for LDCs and small economies to promote their integration into the world trading system.

The launch of the new round sent a clear signal rejecting inward-looking policies and protectionism and provides a boost to market confidence and global prospects. For the new round to succeed, however, the intentions set out in the Doha agenda will need to be translated into actions including the opening up of markets, particularly for goods and services of greatest importance to developing countries.

In the communiqué issued following its meeting on April 20, 2002, the International Monetary and Financial Committee of the IMF’s Board of Governors noted that enlarging market access for developing countries and phasing out trade-distorting subsidies would benefit both developed and developing countries. The Committee welcomed the commitment, reiterated at the United Nations Conference in Monterrey, Mexico in March 2002, to work toward the objective of duty - and quota-free market access for the exports of the least-developed countries. It also noted the potential for increased opportunities from lowering trade barriers among developing countries.

1

Comprising Benin, Burkina Faso, Cape Verde, Côte d’lvoire, The Gambia, Ghana, Guinea, Guinea-Bissau, Liberia, Mali, Niger, Nigeria, Senegal, Sierra Leone, and Togo.

2

The European Council’s June 1997 agreement to secure budgetary discipline in member states during the final stage of European Economic and Monetary Union; it also called for annually updated medium-term stability programs.

3

Alexandre Lamfalussy (Chairman) and others, 2001, Final Report of the Committee of Wise Men on the Regulation of European Securities Markets (Brussels: European Union, Council of Economic and Finance Ministers [ECOFIN], February 15); available on the Internet at http://europa.eu.int/comm/internal_market/en/finances/general/lamfalussyen.pdf.

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