- Andrew Crockett, and Morris Goldstein
- Published Date:
- February 1987
Chapter I: Introduction
1. Following the invitation to Ministers of Finance recorded in the Declaration of the 1983 Williamsburg summit, the Ministers and Governors of the Group of Ten met in Washington on September 24, 1983 and had a preliminary exchange of views on the conditions necessary to improve the functioning of the international monetary system. They instructed their Deputies to met in the next few weeks “to identify the areas in which progressive improvements may be sought and to report to them at their next meeting to be held in early 1984.”
2. In compliance with those instructions, in November 1983 the Deputies outlined a work program, subsequently approved by the Ministers and Governors, which identified the following four areas for investigation:
a) The functioning of floating exchange rates.
b) Strengthening multilateral surveillance.
c) Management of international liquidity.
d) The role of the International Monetary Fund (IMF).
3. In the organization of their work, the Deputies decided to undertake the elaboration of policy papers themselves, and to request the preparation of background studies to the international institutions represented in the Group—namely the IMF, the Organization for Economic Cooperation and Development (OECD), the Bank for International Settlements (BIS), and the Commission of the European Communities. The Deputies had the benefit of hearing the views of a senior representative of the International Bank for Reconstruction and Development (IBRD) at one of their meetings.
4. The Chairman of the Deputies presented a progress report on the Deputies’ work to the Ministers and Governors at their Rome meeting on May 19, 1984. In the communique issued at the end of that meeting the Ministers and Governors “instructed their Deputies to continue their work, with a view to submitting a final report during the first half of 1985.”
5. Following this Introduction, Chapters II, III, IV, and V deal in turn with the four subjects of the work program. They present an analytical overview of the issues and of the Deputies’ discussions, including both the proposals on which a consensus was reached and those on which it was not. Chapter VI contains the Deputies’ conclusions and their recommendations to the Ministers and Governors.
Chapter II: The Functioning of Floating Exchange Rates
6. The Deputies have conducted a thorough examination of the working of the present system of floating exchange rates, taking stock of both the real experience acquired during the past decade and academic discussion. This chapter is devoted to a description and assessment of the system and to recommendations for improving its functioning, with a view to promoting greater exchange rate stability.
7. The present exchange rate system came into being against a background of unsound domestic policies and divergent economic performances resulting in wide inflation differentials and large and persistent payments imbalances which rendered the previous par value system unsustainable. The sharp rise in oil prices and the widely differing policy responses exacerbated these problems and placed added strains on the international financial system. Following a transitional period, a more flexible exchange rate system was agreed upon in the 1976 meeting of the Interim Committee in Jamaica, which recommended changes in the Articles of Agreement permitting countries to choose their exchange rate regime while imposing on them certain general obligations (see Article IV).
8. Inflation, external disturbances, and divergent economic performances continued to affect exchange market developments. The rapid expansion of international banking, the increasing sophistication and progressive deregulation of national financial markets, and the gradual removal of restrictions on capital flows have led to greater financial integration and capital mobility; while these developments may have contributed to short-term exchange rate movements, they have facilitated balance of payments financing and world economic growth.
9. Although most countries maintain some form of pegging, the main currencies all float separately or jointly against each other. These currencies are used to invoice and finance the bulk of world trade, are the basis for most of the Eurocurrency markets, and dominate foreign exchange trading. Over time, the system has evolved into a multicurrency reserve system in which the U.S. dollar is predominant while other main currencies have assumed secondary reserve roles. Since some three quarters of world trade and most invisible and capital transactions are conducted at floating rates, the present system can be described as a floating exchange rate system. In addition, regardless of their formal exchange rate arrangements, most countries have shown a greater willingness to let their exchange rates vary to prevent or to correct balance of payments disequilibria than under the par value system.
10. Since 1979 an arrangement which limits exchange rate fluctuations to narrow margins around agreed adjustable parities has been in operation within the context of the European Monetary System (EMS), involving a high degree of monetary cooperation and mutual surveillance. The arrangement is part of an effort to create an area of monetary stability and to achieve economic and monetary integration among countries closely linked by commercial flows as well as by institutional and political affinity.
11. The Deputies recognize that a country’s choice of exchange rate regime is influenced by a number of factors, including the scale, composition, and direction of its trade as well as its openness to capital flows. Consequently, the degree of exchange rate stability deemed appropriate differs from country to country.
12. While countries have freedom in their choice of exchange rate arrangements, they must meet certain obligations in connection with their exchange rate policies. These obligations are set out in Section I of Article IV of the IMF Articles of Agreement, which reads as follows: “Recognizing that the essential purpose of the international monetary system is to provide a framework that facilitates the exchange of goods, services, and capital among countries, and that sustains sound economic growth, and that a principal objective is the continuing development of the orderly underlying conditions that are necessary for financial and economic stability, each member undertakes to collaborate with the Fund and other members to assure orderly exchange arrangements and to promote a stable system of exchange rates. In particular, each member shall:
i) endeavor to direct its economic and financial policies toward the objective of fostering orderly economic growth with reasonable price stability, with due regard to its circumstances;
ii) seek to promote stability by fostering orderly underlying economic and financial conditions and a monetary system that does not tend to produce erratic disruptions;
iii) avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members; and
iv) follow exchange policies compatible with the undertakings under this Section.”
The Deputies reaffirm the overriding importance of these principles and policies and of ensuring their full implementation.
Assessment of Floating Exchange Rates
13. It would be misleading to draw definite conclusions on the merits and demerits of the present system merely by comparing economic performance in the period of floating with that recorded under the par value system. Conditions during the floating rate period have been different in too many respects to allow such a comparison to be meaningful.
14. The Deputies agree that the existing exchange rate regime has shown valuable strengths. Exchange rate flexibility has made a positive contribution to external payments adjustment and to the maintenance of an open trade and payments system in a period of massive external shocks. It can help countries, especially the larger ones, to insulate their domestic price levels from inflation abroad, and can facilitate the pursuit of sound monetary policies geared more directly to domestic conditions. Furthermore, it is questionable whether any less flexible system would have survived the strains of the past decade, while attempting to preserve it would probably have led to increased reliance on restrictions on trade and capital flows.
15. The Deputies agree, however, that the functioning of the present system has also shown weaknesses. In particular the system has not adequately promoted sound and consistent policies. It has not prevented inadequate policies and divergent economic performances which have contributed to a high degree of short-term volatility of nominal exchange rates and to large medium-term movements in real exchange rates.
16. The Deputies have noted that short-term exchange rate volatility has been substantial and has not shown any tendency to diminish over time. Although empirical studies conducted by the IMF have been unable to find a significant systematic link between short-term exchange rate volatility and the volume of international trade, concern has been expressed that volatility may discourage investment and trade by adding to uncertainty and to financial risks for investors and traders. However, foreign exchange markets appear to have developed effective hedging techniques available to most operators to reduce the risks associated with exchange rate volatility, generally at comparatively little cost.
17. Changes in real exchange rates are appropriate when they facilitate desirable adjustments by reflecting changes in underlying economic conditions and inducing corrections in policies. However, large movements in real exchange rates may lead to patterns of international transactions that are unlikely to be sustainable and that can pose difficult problems for domestic economies, involving a risk of protectionist pressures building up and resources being misallocated. If these exchange rate movements are subsequently reversed, a further disruption of trade and investment may result over the medium term.
18. The Deputies have noted that the influence on exchange rates of financial transactions not directly related to trade flows has steadily increased during the past decade. In turn, exchange rate variability may have contributed to greater capital movements. As a result, exchange rate determination has been increasingly influenced by conditions in capital markets, including relative interest rates and expectations regarding the impact of national policies and current and future economic performance.
19. The Deputies recognize that some variability is inherent in freely floating exchange rates. Since trade flows tend to adjust more slowly than financial flows, the impact of changes in current conditions is first reflected in financial and foreign exchange markets. Furthermore, in an uncertain environment the difficulty of assessing policy stances and underlying economic fundamentals may lead markets initially to overreact to unexpected developments. Finally, structural rigidities, including legal and regulatory constraints, may distort exchange rate relationships and retard adjustment.
20. While some events affecting exchange rates have been beyond the immediate control of national authorities, the Deputies are of the opinion that exchange rate instability has been fueled by inadequate and inconsistent policies that have led to divergent economic performance. Expectations in financial markets that inappropriate policies might not be quickly corrected have sometimes resulted in large exchange rate movements. Moreover, the perceived instability in current and future policy courses has made it difficult for market participants to find an anchor for exchange rate expectations.
21. While their study of the functioning of the exchange rate system has focused primarily on the objective of achieving greater stability among floating currencies, the Deputies are fully aware that attempts to maintain exchange rates at levels not in line with economic fundamentals and market forces can be very damaging, both to the countries concerned and to their trading partners. They have expressed their strong support for efforts regularly made by the IMF to persuade countries to adopt realistic exchange rate policies.
22. Given the high degree of interdependence and financial integration in the world economy, the Deputies recognize that no exchange rate system can provide full insulation from the effects of economic policies and performance in other countries. A stable international environment certainly requires sound and consistent policies that promote convergence of economic performance. But even if there were widespread and persistent application of non-inflationary policies, exchange rates and exchange rate expectations would be influenced by a number of factors, including the international configuration of fiscal policies, monetary policies, structural rigidities, domestic savings and investment patterns, and political uncertainties. More generally, different policy responses to exogenous disturbances can exert an impact on exchange rates.
Proposals to Improve Exchange Rate Stability
23. The Group of Ten Ministers and Governors have already concluded that a return to a generalized system of fixed parities is unrealistic at the present time. In the view of the large majority of the Deputies, the adoption of alternatives to a system based on the floating of key currencies is unrealistic under current and foreseeable circumstances. All Deputies agree, however, that improvements are needed in the functioning of the present system.
24. While useful lessons can be drawn from the experience of the EMS as regards the promotion of policy convergence and exchange rate stability, the Deputies recognize that that system cannot be dissociated from the particular political and economic environment in which it operates and therefore cannot be readily extended to a broader and more heterogeneous context characterized by the presence of a plurality of reserve currencies. Such a system would run a much greater risk of being exposed to pressures similar to those which arose during the final phase of the par value system.
25. The Deputies agree that controls on international capital flows do not offer a desirable or effective means of achieving greater exchange rate stability. Their economic costs would be substantial. Given the close interrelationship between current and capital transactions, free capital movements are beneficial to the expansion of trade and to efficient resource allocation. Barriers to capital movements tend to hamper the smooth financing of current payments, distort market signals, and transfer more of the burden of external adjustment to exchange rates. Moreover, there is a constant danger of escalation and retaliation, with further negative consequences for trade growth and resource allocation.
26. The Deputies have also reviewed the role that official intervention in foreign exchange markets can play in reducing exchange rate volatility. They recognize that intervention has a role to play, if only a limited one, and in the light of recent experience they continue to endorse the conclusions reached on the basis of the Report of the Working Group on Intervention (see Report of the Working Group on Exchange Market Intervention, chaired by P. Jurgensen, January 1983), namely that:
i) intervention can be useful to counter disorderly market conditions and to reduce short-term volatility;
ii) intervention may also on occasion express an attitude toward exchange markets;
iii) intervention will normally be useful only when complementing and supporting other policies;
iv) countries should be willing to undertake coordinated intervention in instances when it is agreed that such intervention would be helpful.
27. Neither capital controls nor intervention can be relied upon to attain lasting stability of exchange rates. The Deputies have therefore focused on other means of achieving this goal through improved international cooperation.
28. The Deputies agree that the adoption of sound, credible, and stable policies in all countries, especially the major ones, can contribute fundamentally to exchange rate stability. Sound, non-inflationary macroeconomic policies contribute to greater convergence of economic performance among countries. Credible commitment to and persistent pursuit of such policies can also play an essential role in providing the foreign exchange markets with a firmer anchor for exchange rate expectations. Liberalization of capital markets and, more broadly, removal of restrictions and structural rigidities which hamper adjustment can reduce the burden placed on foreign exchange markets in absorbing short-term disturbances.
29. In view of the present high degree of economic interdependence, mutually consistent policies would also promote greater convergence of economic performance and thereby enhance exchange rate stability. Recognizing that the importance of external repercussions of national policies has often been underestimated, the Deputies agree that, in setting national policies, the international implications and interactions of those policies should receive an appropriately high priority.
30. In this connection, the Deputies have made a detailed review of the contribution that exchange rate developments might make to the evaluation of performance and policies. They note that these developments provide information on private markets’ assessments of underlying economic conditions and of current and expected policies in the various countries. However, a wide range of factors beyond exchange rate developments should also be taken into account in assessing national policies and the need for consultation and policy discussion. These include, in addition to those mentioned in the IMF’s principles for surveillance, developments and performance in the areas of fiscal policy (including the level of government expenditure), monetary policy, structural rigidities, and the openness of the economies to international trade flows.
31. Some Deputies made the proposal to introduce target zones for the exchange rates of major currencies because they believe that convergence of economic performance, while necessary, may not always be sufficient to achieve lasting exchange rate stability. They further believe that credible commitments to target zones would contribute to stabilizing market expectations and would promote greater international policy consistency by reinforcing multilateral surveillance. According to this proposal, the authorities concerned would define wide margins around an adjustable set of exchange rates devised to be consistent with a sustainable pattern of balances of payments. Target zones would be phased in progressively. They could, however, trigger consultations that would induce, step by step, more direct links between domestic policies and exchange rate considerations. This would not necessarily involve rigid commitments to intervene in exchange markets. Although the Deputies supporting this proposal recognize the difficulties of identifying equilibrium exchange rates, they believe these to be exaggerated, maintaining that arriving at a judgment about the appropriateness of the exchange rate of a currency is part of the current practices of the IMF. Some other Deputies recognize that there could be merits in this proposal and suggest that the technical aspects of a target zone approach should be further explored at an appropriate time.
32. Most Deputies, however, are of the view that reaching a consensus on the range of desirable exchange rates would prove extremely difficult. Given our imperfect knowledge of the determinants of exchange rate movements, the target zones would have to be too wide to serve as an anchor for expectations. Furthermore, even if agreement on an acceptable exchange rate pattern could be reached, there would still be the difficult task of allocating the burden of policy adjustment among the countries involved. Markets would inevitably test the zones, thereby adding to instability, and efforts to maintain exchange rates at levels incompatible with market sentiment could prove costly and ultimately unsuccessful. Above all, the constraints imposed on domestic policies by target zones might undermine efforts to pursue sound and stable policies in a medium-term framework. The majority of the Deputies, therefore, agree that the adoption of target zones is undesirable and in any case impractical in current circumstances.
33. All Deputies agree on the fundamental conclusion that greater exchange market stability requires close and continuing cooperation among countries and a strengthening of international surveillance to improve the compatibility of policies among countries and the convergence of economic performance around sustainable, non-inflationary growth.
Chapter III: Strengthening International Surveillance
34. The IMF plays a central role in surveillance. As mentioned earlier (paragraph 12), the IMF Articles of Agreement contain important obligations regarding members’ policies. They also include specific principles and procedures for the conduct of international surveillance to assure that these obligations are fulfilled (Article IV, Section 3 and Executive Board Decision No. 5392-(77/63)).
35. Surveillance functions are also performed by other institutions and consultative groups which operate under different legal frameworks and procedures. The Deputies have noted in particular the functions performed by the OECD, the BIS, the General Agreement on Tariffs and Trade (GATT), the IBRD, and the European Communities, and by various international ministerial groups. The Deputies have concentrated their attention on IMF surveillance, with a view to improving its effectiveness and consistency with surveillance in other forums.
36. The Deputies agree that no major changes are required in the present institutional setting for exercising surveillance over national policies. Nevertheless, they agree that during the period of floating exchange rates surveillance has not been as effective as desirable in influencing national policies and in promoting underlying economic and financial conditions conducive to exchange rate stability. Surveillance has not been sufficiently effective in inducing policy changes in countries which have adequate access to external financing and do not require an IMF-supported adjustment program. These countries appear to have been able on occasion to sustain policy courses not fully compatible with the goals of international adjustment and financial stability. A number of improvements, therefore, are needed in order to make the process more effective.
37. The Deputies recognize that in the implementation of surveillance the focus has tended to be on a country-specific approach, with less attention being given to the interaction of national policies and economic structures. The effectiveness of surveillance has also been weakened in certain instances by lack of mutual understanding of the impact of particular policies and of an agreed analytical framework, which have some-times made international consensus on the appropriateness of policies more difficult to achieve.
Proposals to Strengthen Surveillance
38. The Deputies reaffirm that effective surveillance presupposes full cooperation by every country. Countries must therefore be ready to recognize the international implications of their policies and to give them more weight in their decision-making process. Surveillance, however, is a delicate matter, since it impinges on the conduct of national policies. The Deputies emphasize that strengthened surveillance requires enhanced dialogue and persuasion through peer pressure, rather than mechanically imposed external constraints. All Deputies believe that mutually agreed procedures would be helpful, but some Deputies think that an element of constraint will also be required if surveillance is to be made more effective. While stressing that the sensitivity of the issues involved in surveillance necessitates preserving confidentiality, some Deputies suggest that greater publicity for policy conclusions could be an instrument to further the adoption of appropriate policies.
39. The Deputies stress the need for symmetry and evenhandedness in the exercise of surveillance. Countries should be treated in the same manner irrespective of their size, exchange rate regime, or financial position. However, equal treatment cannot mean uniformity of prescriptions. Policy advice must take account not only of different situations, economic structures, and institutional settings but also of the impact of individual countries on the world economy.
40. The Deputies emphasize that to be effective surveillance over exchange rates must concern itself with the assessment of all the policies that affect trade, capital movements, external adjustment, and the effective functioning of the international monetary system. Such an assessment should cover not only macroeconomic policies but also the micro policies and structural features that could weaken performance and induce exchange rate instability. It should also include a more explicit analysis of domestic policies in the context of the world economy, so that interdependences and mutual repercussions are fully brought out and taken into account.
41. While the present institutional framework for surveillance is considered adequate, the Deputies agree that the existing channels need to be used more effectively and coordinated better. They also agree that the central role of the IMF in surveillance should be preserved. At the same time, they underline that other institutions, consultative bodies, and groups of more limited membership should continue to play their role in the surveillance process. In this regard, they have noted the important role played by the OECD in the surveillance of the economic policies of the industrial countries.
42. In considering ways of strengthening surveillance, a distinction has been made between surveillance in the form of country-specific consultations with an international institution (e.g., bilateral surveillance), and surveillance which focuses on the international adjustment process and the interaction of national policies (e.g., multilateral surveillance). The Deputies’ detailed proposals are grouped below under the headings of “Article IV Surveillance” and “Multilateral Surveillance.”
Article IV Surveillance
43. The Deputies agree that Article IV consultations should continue to be primarily concerned with the broad range of macroeconomic policies, including exchange rate policies, bearing on a country’s external position and on international adjustment. Within this overall framework, they propose that consultations should also give more emphasis to analysis of capital account development; government policies which hinder the efficient operation of exchange and capital markets; and, more generally, impediments to the international adjustment mechanism caused by trade restrictions and other protectionist measures, such as policies to provide special incentives to exports or discourage imports, other market-distorting policies, and structural rigidities. In order to achieve greater consistency and continuity of action, policy analyses and recommendations should be viewed in a medium-term framework.
44. The assessment of the current state of individual countries and the world economy and the formulation of policy recommendations would be facilitated by better data and stronger analytical foundations. The Deputies are of the view that IMF surveillance activities can play a major role in improving the information on and analysis of individual economies. In this connection they put forward the following suggestions: (i) consultation reports should be used to identify necessary improvements in the scope, quality, and timeliness of data provided to the IMF by national authorities; (ii) the empirical and analytical basis of policy judgments should be made as explicit as possible, whether by the IMF or by member governments; (iii) techniques for analyzing medium-term external debt and debt-servicing scenarios should be improved as part of the ongoing work to strengthen surveillance over external indebtedness. Where appropriate, closer cooperation with the IBRD in all these areas should be sought.
45. The Deputies agree that, in order to ensure that consultation conclusions have greater influence, the IMF should provide more candid assessments of national policies and their domestic and international impact as well as precise suggestions for policy changes. Differences of views between the IMF and national authorities should be spelled out and discussed. For industrial and developing countries whose policies and performance are of greatest concern for the world economy, a confidential exchange of views between the Managing Director and the Finance Minister should be envisaged at the end of the consultation process. In addition, to ensure an adequate follow-up to the consultation conclusions, countries should be requested to present a report outlining the measures introduced or considered to deal with the problems identified by the IMF and to respond to specific policy suggestions. The degree of implementation and effects of policy recommendations should in all cases be reviewed in ensuing consultations and consultation reports.
46. The Deputies consider that it could be helpful if the IMF made greater use of the supplemental surveillance procedures in the face of exchange rate and other developments that may be important or may have important effects on other members, or that have implications for the operation of the international monetary system; to this end they invite the IMF to review the arrangements set up in 1977 and 1979 for invoking these procedures.
47. The Deputies note that the IMF has played an essential role as coordinator of multilateral efforts to respond to external debt problems. In most cases this role has involved the development of adjustment programs supported by use of IMF resources, but recently some debtor countries have been working with the IMF and their major creditors to explore the possibility of “enhanced” surveillance with the aim of facilitating non-IMF financing in connection with multiyear debt reschedulings. The Deputies encourage the IMF to continue to develop such procedures on a case-by-case basis, reflecting general understandings that would be adopted by the Executive Board. Similar procedures might be considered for countries whose limited access to external finance could be improved with IMF assistance and advice.
48. The Deputies agree that the basic confidentiality of the exchange of information and discussions between the IMF and its members should be preserved. The view has been expressed, however, that giving some publicity to consultation conclusions could help make them more influential. In particular, it has been suggested that a public statement might be made by the Managing Director, on his own authority and without Executive Board approval, at the end of the consultation process; the statement, which could be based on his own summing-up of the Executive Board discussion, would give a brief assessment of a country’s policies and prospects and would indicate the broad direction of suggested policy changes. It has also been suggested that the Executive Board consider authorizing the release of consultation documents, in whole or in part, at the request of the member country concerned.
49. The Deputies agree that multilateral surveillance should be strengthened. It should concentrate on countries which have a large impact on the world economy. Effective multilateral surveillance may require a reinforcement of existing procedures as well as consideration of the introduction of new arrangements.
50. The specific content of multilateral surveillance should be the examination of the external repercussions of national policies and their interaction in the determination of the global environment. The Deputies agree that the approach to these issues should be mainly judgmental in nature. In this respect, the regular monitoring of key economic developments can help to assess the consistency and mutual compatibility of national policies in the light of the objectives of international adjustment and financial stability, and hence to identify situations that warrant policy reviews and consultations. Special attention should be devoted to developments in exchange rates, trade, and capital flows, which are the principal elements of international interaction, as well as to the broad range of economic policies underlying them.
51. The Deputies propose that the IMF should periodically prepare documents analyzing the international repercussions of national policies of Group of Ten countries and of their interaction in the determination of exchange rate developments and international adjustment. More specifically, they consider it appropriate that the World Economic Outlook (WEO) paper should devote a separate chapter to these issues, setting out the principal quantitative aspects and providing an analytical framework for policy discussions.
52. The Deputies propose that the Group of Ten Ministers and Governors should review the main conclusions emerging from the chapter of the WEO on the international repercussions and interaction of their policies, as appropriate. Some Deputies propose that the conclusions of these reviews should be summarized in the form of a statement by the Chairman, containing the views of the Group on the appropriateness of its members’ policies.
53. The Deputies agree that Working Party No. 3 of the OECD should continue its regular review of major countries’ fiscal and monetary policies and the way these interact internationally, with particular reference to the evolution of external positions and exchange rates. While these interactions are in many respects of a short-term nature, it has become increasing appropriate for the Working Party’s deliberations to have a medium-term perspective, and to pay greater attention to structural features, such as rigidities in goods, labor, and financial markets, that have a bearing on the international adjustment process. In the latter connection, it is to be welcomed that the annual examinations of national economies in the Economic and Development Review Committee of the OECD now cover selected structural issues in depth.
54. The key role in fostering trade liberalization and the removal of barriers which restrict or hamper free trade pertains to the GATT. The Deputies believe that the GATT should have broad powers to exercise surveillance over all forms of trade restriction including bilateral restraint agreements and other national trade-restricting practices and policies. Close cooperation between the IMF and the GATT should be maintained. The IMF should place emphasis in its policy analyses and recommendations, whether within a bilateral or a multilateral framework, on the removal of trade-restricting practices and on the implementation of GATT recommendations and policies.
Chapter IV: The Management of International Liquidity
55. The Deputies have in the main confined their discussions to two aspects of the management of international liquidity. The first and more general issue related to the changes in the international financial system since the transition to floating exchange rates, and the implications of these changes for the creation and distribution of international liquidity. The second and more specific issue was the present and future role of the SDR in the international monetary system.
56. Under the gold-exchange standard, international liquidity was virtually equated with monetary authorities’ holdings of reserve assets, comprising gold, foreign currencies, and reserve claims on the IMF. Reserves were generally “owned,” since international liquidity acquired through credit arrangements played only a minor role. The demand for reserves was generally seen as a fairly stable and predictable function of the value of world trade and payments imbalances.
57. The ending of the obligation to defend fixed exchange rates has substantially changed the rationale for holding international reserves. It does not appear, however, to have led to any appreciable decline in the overall demand for reserves. There appear to be several reasons for this. Most floating countries have continued to intervene in foreign exchange markets to varying extents. Other countries have also continued to manage their exchange rate or to peg it [their currency] to another currency or to a currency basket. Thus reserve balances have been maintained for intervention purposes. In addition, many countries have held precautionary reserve balances in an attempt to protect themselves from the uncertainties arising from larger payments disequilibria and exchange rate fluctuations. Finally, reserves have been acquired as a means of demonstrating creditworthiness and preserving access to financial markets.
58. On the supply side, the international credit markets have provided new channels for meeting the rapid growth in external financing requirements and the demand for reserves quickly and efficiently. However, those countries that do not have access to international capital markets or that have lost creditworthiness have continued to rely primarily on official channels and conditional credit to finance current account imbalances and acquire reserves.
59. As a result of these changes, international liquidity has come to embrace not only monetary authorities’ actual holdings of reserve assets but also credit arrangements which permit the acquisition of reserves from private and official sources. Thus, the adequacy of international liquidity can no longer be assessed primarily on the basis of recorded reserve holdings, but must also take account of countries’ creditworthiness and the availability of official sources of financing.
60. Countries can obtain reserves from financial markets provided they maintain their creditworthiness, which is mainly a function of their own domestic policies and performance. However, conditions in international markets are affected by the financial policies of reserve-currency countries. Therefore, the terms on which reserves are supplied by the markets are likely to reflect not only the borrowers’ own policies and performance but also those of the major industrial countries.
61. The preponderance of market-supplied international liquidity has reduced the scope for influencing the process of reserve creation directly. Only a small share of total liquidity, arising from IMF-related reserve assets and credit provided under bilateral and multilateral official credit arrangement, is amenable to some form of direct control. These developments have increased the importance of pursuing sound domestic policies in order to safeguard creditworthiness. The strictness of the resulting discipline inevitably varies with countries’ economic structures and states of development.
62. As a result of the evolution of the international monetary system in the post-Bretton Woods era, financial markets have thus acquired a crucial role in the provision of liquidity in the world economy. In the process, the concept of international liquidity has widened and become more complex, and the smooth functioning of the system has come to depend more on countries’ national policies and creditworthiness and on the working of market mechanisms.
63. The Deputies agree that, while the process of liquidity creation has been made more flexible and the scope for countries to manage their international reserve position has generally increased, the working of the system has not been entirely satisfactory. The strong inflationary pressures of the seventies and the major external debt problems of the eighties suggest that during most of this period the supply of international liquidity has been ample, if not excessive. Instances of sharp contraction in the availability of international credit have also occurred. In the view of some of the Deputies this suggests that present arrangements for the provision of liquidity have not been optimal and that, while ultimately producing very powerful effects, they have not always been conducive to a gradual adjustment toward steady non-inflationary growth of the world economy. They believe that sudden and marked shifts in the terms and conditions on which international liquidity has been made available, late recognition of and abrupt response to changes in creditworthiness, and the very limited access certain groups of countries have to market borrowing, are factors that cannot be ignored. Other Deputies emphasize that sharp shifts in liquidity have generally reflected inadequate underlying policies that the stability of the system depends primarily on all countries pursuing sound policies to achieve sustainable non-inflationary growth.
Proposals Concerning International Liquidity
64. The Deputies agree that improvements in the provision of international liquidity need not be sought through fundamental changes in the system. They also recognize that for the foreseeable future financial markets must be expected to continue to supply the bulk of international liquidity and that official channels will have a significant supplementary role. The Deputies have considered a number of measures designed to strengthen the working of the system by enhancing the efficiency of market processes and by fostering the pursuit of appropriate policies in all countries. The Deputies have also considered various proposals relating to the IMF’s ability to meet systemic liquidity needs.
65. Three sets of measures have been proposed by the Deputies in order to improve the operation of financial markets in the provision of international liquidity. First, international institutions should be encouraged to continue to improve the collection and dissemination of all the data relevant to the markets’ assessment of individual countries’ creditworthiness, and banks should seek to improve their methods of risk evaluation. Second, countries should press forward steadily with the deregulation of capital markets and the liberalization of capital movements. Third, monetary authorities should continue to place emphasis on strengthening the supervision of banks operating in the international markets, especially with a view to establishing adequate capital requirements, applying consolidated balance-sheet reporting, and encouraging greater convergence of regulatory practices. The BIS has an important role to play in this respect. The Deputies stress that in monitoring international banking activities, the authorities should pay due regard to possible macroeconomic consequences of prudential measures.
66. The Deputies emphasize that a smooth provision of liquidity through financial markets is possible only in an environment of sound, non-inflationary policies in all countries. An appropriate evolution of international liquidity also depends on the willingness of countries to take account of the international implications of their domestic policies. The Deputies therefore agree that multilateral surveillance has a key function to play in this area as well, to foster policies consistent with a more stable evolution of international liquidity. Indeed, the IMF Articles of Agreement call on members to collaborate with the IMF and with other members in pursuit of the objective of “better international surveillance of international liquidity” (Article VIII, Section 7). In particular, surveillance should guide countries in their choice between financing and adjustment of external payments imbalances; facilitate the maintenance or, where necessary, the restoration of creditworthiness; and foster closer cooperation among countries whose policies exert an important influence on conditions in world financial markets.
67. The above considerations indicate that surveillance of exchange rate policies and surveillance of international liquidity cover a great deal of common ground. The Deputies therefore stress the need for their implementation to be closely integrated.
68. The Deputies are aware that some countries have not had significant access to international financial markets and are therefore largely dependent on other sources of financing for the acquisition of reserves until they can restore or gain creditworthiness. They recognize that the provision of concessional financing is necessary for many of these countries, and that officially supported financing can help maintain and strengthen their external positions. The Deputies therefore suggest that these countries be provided official financing on appropriate terms in support of sound policies which can help promote creditworthiness.
Present and Future Role of the SDR
69. The First Amendment of the Articles of Agreement enabled the IMF to allocate SDRs “to meet the need, as and when it arises, for a supplement to existing reserve assets” (Article XV, Section 1 [of the Articles currently in force]). The main purpose of creating the SDR was to make the supply of reserves less dependent on the official settlements balance of the United States and to provide an instrument to counteract reserve shortages. Moreover, by offering non-reserve countries the possibility of acquiring reserves without having to obtain balance of payments surpluses, the SDR could alleviate somewhat the asymmetry of external constraints on national policies. The Second Amendment of the Articles of Agreement called on members to collaborate, with the objective of “making the special drawing right the principal reserve asset in the international monetary system” (Article VIII, Section 7).
70. Despite the objectives stated in the Articles, the SDR has not assumed a major role in the system, its share in total foreign exchange reserves having actually declined during the last decade. The use of the SDR as a unit of account in private transactions remains limited and the market for SDR-denominated assets and liabilities, after an initial spurt, has not shown any tendency to develop further.
71. The limited success of the SDR as an international reserve asset can be attributed in part to its features and restricted usability. Developments in the monetary system have also lessened official interest in an internationally issued and administered reserve asset. The expansion of international financial markets has provided a flexible and efficient source of reserves for many countries, and the emerging multicurrency reserve system has reduced dependence on a single currency in international settlements and reserve holdings.
72. The Deputies recognize that these developments have affected the rationale for the SDR, including the objective of placing the SDR at the center of the system as the main reserve asset. Nevertheless, the Deputies, noting the SDR’s owned-reserve nature, believe that the instrument may still have a useful role to play in meeting the long-term global need for supplementing reserves in a system largely based on borrowed reserves. In this context, the Deputies have considered various ways of making the SDR available as a safety net for future contingencies, including the possibility of private markets being unable to respond adequately to a legitimate long-term global need for international liquidity. They have not agreed, however, that any of these approaches would be desirable or appropriate at this stage.
73. The Deputies have not reached a consensus on the question of whether the present situation calls for new allocations of SDRs. A number of Deputies consider that there is at present no clear evidence of a long-term global need to supplement international reserves, given the present state of total reserves and lending from international markets. Other Deputies, however, favor resumption of SDR allocations on the basis of the arguments described below.
74. According to some of the Deputies, severe strains in liquidity conditions have built up in the system and are reflected in the decline of reserves in relation to imports and foreign debt, the lopsided distribution of reserves, and the rise of barter trade. While an SDR allocation on a reasonable scale would not eliminate these strains entirely, these Deputies would see it as a means of assisting countries in their search for international liquidity and of facilitating the international adjustment process. Other Deputies, however, have expressed reservations about this analysis. In their view, the difficulties encountered by a number of countries are primarily an indication of their lack of creditworthiness and are not related to a general shortage of liquidity. Even in the recent period of debt problems, reserves have increased significantly, particularly for non-oil developing countries in aggregate. Moreover, the decline in reserves which occurred in 1981-82 followed a period of excessive inflation and rapid reserve gains. These Deputies stress that SDR allocations are not the appropriate tool for providing finance to countries whose access to international credit markets has been jeopardized and suggest that they might result in delaying necessary adjustment. Furthermore, even a substantial allocation would provide no more than a minimal benefit to debtor nations’ reserves.
75. Some Deputies have proposed that existing rules governing the conditions, the amount, and the distribution of allocations should be supplemented by an arrangement whereby SDRs would be used to finance IMF adjustment programs. To this end, participants in the SDR Department would place all or part of their allocations at the disposal of the IMF. These SDRs could then be channeled to countries in need of reserves in support of appropriate adjustment programs. This proposal has been criticized on various grounds. Some Deputies doubted whether the allocation of SDRs for these purposes would be consistent with the Articles of Agreement. The proposal could also blur the distinction between the SDR and conditional IMF credit, and the lending or transfer of SDR allocations to the IMF could raise legislative difficulties within countries. Finally, the use of SDRs to expand the IMF’s resources for conditional lending is viewed by these Deputies as unnecessary, since the IMF has adequate resources to fulfill its responsibilities for the foreseeable future.
76. In view of some of the Deputies, quite apart from short-term considerations relating to the state of liquidity, a resumption of SDR allocations is justified by longer-term, systemic considerations. These Deputies point to the fact that the long-term growth of trade must be supported by an expansion of international reserves, and that an increased share of the SDR in official reserves would increase the stability of the system. These Deputies advocate that SDRs should be injected into the system in accordance with a steady quantitative rule so designed that their relative weight in official reserves would expand gradually over time without endangering discipline. Other Deputies, however, believe that international financial markets and official channels provide adequate means of meeting the global demand for reserves, and are concerned that regular SDR allocations would result in unnecessary and excessive liquidity creation.
77. A further proposal examined by the Deputies is the establishment of an SDR-based IMF. Under this scheme, which would involve merging the General Department and the SDR Department, IMF lending would result in the creation of SDRs and reimbursement in their cancellation. In the view of its proponents this proposal, while not entailing any basic change in members’ rights and obligations, would equalize the characteristics of claims on the IMF, streamline the IMF’s operations, and render them more neutral with respect to exchange rates and monetary aggregates. Moreover, quota increases under the proposed scheme would not entail the provision of national currencies, thus obviating the need for national budgetary appropriations. Most Deputies consider this proposal too far-reaching and not realizable at the present time. In their view, such a major change would not enhance the IMF’s ability to fulfill its responsibilities and could undermine its mutual assistance character. Moreover, the abolition of subscription payments in convertible currencies could jeopardize confidence in the institution.
78. In conclusion, the Deputies have not reached agreement on any of the specific proposals described above. However, they recognize that the SDR may still have a useful role in meeting the long-term global need for reserves and in this context in providing a safety net for future contingencies. In these circumstances, the Deputies support the intention of the IMF Executive Directors to carry out a comprehensive review of the future role of the SDR in the system.
Chapter V: The Role of the IMF
79. The IMF plays a key role in the international monetary system. It oversees and guides the operation and the evolution of the system, providing a legal framework for consultation and cooperation. It promotes the adoption of domestic policies consistent with balance of payments adjustment and financial stability, the maintenance of a trade and payments system free from restrictions, and exchange rate stability. It supplements the stock of official reserves through SDR allocations and its credit activity, which results in the creation of reserve positions. The main instruments available to the IMF to further its objectives are the exercise of surveillance over countries’ policies, the extension of financial assistance conditional on the adoption of adjustment policies, and the authority to allocate SDRs. The IMF’s surveillance functions have been examined in Chapter III of this Report, and issues concerning the SDR in Chapter IV.
This chapter concentrates on the functions of the IMF in providing temporary balance of payments assistance and promoting adjustment.
80. The policies governing the use of IMF resources, embodied in the Articles of Agreement (notably Article V) and in Executive Board Decisions, stipulate that IMF financing is to be provided (i) on a temporary basis; (ii) in amounts related to members’ quotas; (iii) conditionally upon the adoption of policies to correct payments problems over the short-to-medium term. These policies are designed to ensure that the revolving nature of IMF resources is preserved and that claims on the IMF can be mobilized quickly in cases of balance of payments need. The Deputies wish to stress that IMF resources through the years have been used and provided by all categories of members, a factor which has reinforced the universal character of the institution and helped maintain the broad support of its membership.
81. An unprecedented conjunction of large and persistent external imbalances in many countries over the last 12 years has led the IMF to expand considerably its financial assistance in support of external adjustment programs. Lending policies have been modified, leading to a lengthening of program periods and to the introduction of a temporary policy of enlarged access which allows members to obtain credit up to a multiple of quotas in support of comprehensive adjustment programs. As a result the IMF has borrowed substantially from official sources to supplement its quota resources. In addition, the IMF has come to play a role as a catalyst and coordinator of external finance from other sources for countries facing severe problems in servicing their external debt. The Deputies note that in recent years requests for IMF credit and assistance have come almost entirely from developing countries.
82. The Deputies consider that the IMF has responded flexibly and effectively in the face of disturbances which were threatening world financial stability and that its adjustment programs have been most valuable in the process of restoring confidence and viable external positions. They encourage the IMF to continue its efforts in this area. They stress, however, that as more normal payments and credit worthiness situations in debtor countries return, the IMF should revert to its traditional role.
83. The Deputies recognize that the IMF has managed its operations prudently and that its liquidity position is currently strong. Nonetheless, they are concerned that, if they persist, the lengthening of program and repayment periods and the prolonged use of IMF resources may adversely affect the revolving nature of its financing and the liquidity of members’ claims on the IMF. This in turn would weaken the IMF’s ability to grant financial assistance and members’ willingness to provide resources.
84. The Deputies recognize that the correction of payments imbalances requires complementary measures in the areas of demand management and structural adjustment, including realistic exchange rates. However, they are concerned that in some cases countries with balance of payments difficulties have not adopted adequate adjustment policies early enough, or have adopted programs that were not sufficiently rigorous and comprehensive. This has been a factor in the lengthening of adjustment periods and the more extended use of IMF credit, and hence in the requests for the injection of additional resources. Recourse to frequent increases in resources, including borrowing, on the one side, and less effective adjustment on the other, tend to confuse the IMF’s functions with those of a development finance institution.
Strengthening the Role of the IMF
85. The Deputies emphasize the importance of preserving the monetary character of the institution and the revolving nature of its resources. The ability of the IMF to continue to play its role in promoting adjustment and providing conditional financing when the need arises depends on these fundamental features being preserved. In turn this requires that four conditions be met: (i) that the IMF be able to command adequate resources; (ii) that it normally finances its lending from quota resources; (iii) that the conditionality in IMF programs continues to place emphasis on the need to restore a sustainable balance of payments and external debt position in the short-to-medium term; (iv) that the universal character of the IMF be maintained.
86. The Deputies reiterate that quotas should represent the basic source of IMF financing and that recourse to borrowing to supplement these resources should be made only in exceptional circumstances. They recognize, in this connection, that the ability of the IMF to perform its functions effectively depends on the adequacy of its resources relative to the legitimate needs of its members. While the bulk of balance of payments financing should continue to be met through other private and official sources, IMF credit should be available on a sufficient scale to provide meaningful support to members and to serve as an important catalyst for other lending by providing confidence that the borrower is pursuing sound policies.
87. The IMF’s resources are intended to deal both with balance of payments financing needs that arise in normal conditions and with exceptional situations involving a threat to the stability of the system. The Deputies agree that, barring unforeseen circumstances, the recent increase in IMF quotas and the enlargement and expansion of the GAB [General Arrangements to Borrow] provide the IMF with an adequate basis to fulfill its responsibilities over the next few years. However, they recognize that negotiations on quotas and borrowing arrangements are complex and time consuming. They therefore suggest that the IMF undertake a study of alternative techniques that would provide resources to deal with exceptional circumstances without involving an immediate increase in members’ subscriptions, thus adding to the operational flexibility of the IMF.
88. The Deputies consider that the IMF should continue to implement the policies on the use of its resources in a prudent manner, and that a return to normal access policies is desirable. In this respect, they reaffirm that the policy of enlarged access is temporary, should continue to be phased down, and should be terminated as soon as the situation of external payments permits.
89. The Deputies reiterate the importance of effective conditionality in the implementation of IMF programs. They stress the need for high-quality and sufficiently comprehensive adjustment programs, including measures tackling structural problems, to be undertaken promptly in order to allow balance of payments difficulties to be dealt with quickly and effectively. The Deputies also see a need for a systematic examination by the IMF of the issues of prolonged use of its resources by some members and of the arrears it is owed. They consider that steps should be taken to deal with these problems.
90. The Deputies note that, while the IMF and the IBRD share certain broad objectives and while their activities are closely interconnected, their functions differ. The Bank’s responsibilities relate primarily to the provision of long-term finance to developing countries and the promotion of development, while those of the IMF are concerned with exchange stability, international payments, and balance of payments adjustment of industrial and developing countries. In the case of developing countries these functions are complementary, since macroeconomic balance is a precondition for growth and development, and over the longer run, project and sectoral efficiency and realistic investment priorities can be crucial to sustained balance of payments adjustment. Coordination between the two institutions is therefore essential to ensure the effective achievement of their common objectives, but it needs to be based on their separate responsibilities for implementing the several tasks entrusted to each.
91. The Deputies agree that there is considerable scope for closer cooperation between the two institutions. The main purpose of such cooperation should be to ensure that their financing programs provide a comprehensive and mutually supporting approach to countries’ adjustment problems and that they provide consistent policy advice. This would increase the effectiveness of both institutions and enhance the prospects for increasing private investment flows to developing countries.
92. The Deputies emphasize that the two institutions have different mandates, functions, financial structures, and expertises, and that these should be preserved. In particular, the strengthening of cooperation should not be in the direction of transforming the IMF into a channel for long-term finance or of shifting the IBRD away from its primary focus on development financing. The Deputies agree that improved cooperation between the two institutions does not require institutional changes, formal rules, or rigid procedures. Several operational proposals were examined by the Deputies in this connection. They recommend that the implementation of these proposals should be considered by the Executive Boards of the two institutions.
93. A first group of proposals concerns ways to achieve closer contacts and exchanges between the two institutions at both management and staff levels. In particular, representatives of one institution could attend board meetings of the other when the discussion concerns countries where both institutions have programs; staff of one institution could participate in the missions of the other; and, more generally, the two institutions could maintain a continuous exchange of information on country analysis and their activities. On occasion, joint meetings of the two Boards or joint seminars or working groups on topics of common interest could be held. Finally, the pooling of some facilities, notably training activities, research programs, and data bases, as well as local representation, could be considered.
94. A second group of proposals addresses the need to ensure greater consistency in program objectives and instruments. In this regard, the Deputies stress that it is important for the two institutions to contribute, each from its own standpoint, to a consistent assessment of medium-term projections of external financial positions and economic developments and policies. In this context, greater coordination of the financial support provided by the two institutions should also be sought, particularly where a reduction in access to IMF credit might be accompanied by appropriate forms of increased IBRD lending.
95. Finally, as regards the IBRD’s activities, the Deputies note that while program lending will continue to increase, primary emphasis must remain on project lending. They stress that the conditionality of IBRD lending should not be weakened. At the same time, they believe that the IBRD should be more active in encouraging external finance for investment, supporting medium-term structural adjustment, and enhancing its role as aid coordinator in developing countries.
Chapter VI: Summary and Conclusions
96. The Deputies have conducted a thorough review of the international monetary system, with the aim of identifying the areas for progressive improvements in its functioning. Their review has focused in particular on the exchange rate system, international surveillance, international liquidity, and the role of the IMF.
97. The Deputies have concluded that the basic structure of the present system, as reflected in the Articles of Agreement of the IMF, has provided the essential flexibility for individual nations and the international community as a whole to respond constructively to a period of major adjustment to global change. They agree that the fundamental approach of the Articles remains valid and that the key elements of the current international monetary system require no major institutional change.
98. The Deputies recognize, however, that the international monetary system has also shown weaknesses and that there is a need to improve its functioning in order to foster greater stability by promoting convergence of economic performances through the adoption of sound and compatible policies in IMF member countries. The conclusions of the Deputies are based on this approach and call for enhanced cooperation and a stronger role for the IMF.
The Exchange Rate System
99. The Deputies agree that the present exchange rate system based on the floating of key currencies has shown strengths but also weaknesses. Flexible exchange rates among the major currencies have made a positive contribution to the adjustment process and to the maintenance and growth of international trade and payments in a difficult global environment. However, there have been both a high degree of short-term volatility of nominal exchange rates and large medium-term swings in real exchange rates due mainly to unsound policies and divergent performance, as well as to adverse external developments. The Deputies agree that such conditions are a potential threat to the open trading and payments system, and that greater exchange rate stability is desirable.
100. The Group of Ten Ministers and Governors have already concluded that a return to a generalized system of fixed parities is unrealistic at the present time. In the view of the large majority of the Deputies, the adoption of alternatives to a system based on the floating of key currencies is unrealistic under current and foreseeable circumstances. All Deputies agree, however, that improvements are needed in the functioning of the present system.
101. While their study of the functioning of the exchange rate system has focused primarily on the objective of achieving greater stability among the floating currencies, the Deputies are fully aware that attempts to maintain exchange rates at levels not in line with economic fundamentals and market forces can be very damaging, both to the countries concerned and to their trading partners. They have expressed their strong support for efforts regularly made by the IMF to persuade countries to adopt realistic exchange rate policies.
102. The Deputies agree that the achievement of greater exchange rate stability would require close and continuing cooperation among major countries. In particular, they emphasize the following:
i) an essential condition of exchange rate stability is convergence of economic performance in the direction of sustainable non-inflationary growth;
ii) this in turn requires not only sound, consistent policies but also the removal of artificial barriers and structural rigidities which inhibit market flexibility;
iii) the international implications and interactions of domestic economic policies should be given close attention in the domestic policymaking process and in international consultations;
iv) a wide range of factors, including developments in exchange rates, fiscal and monetary policies, structural rigidities, and barriers to international trade and capital flows should be taken into account in determining the need for consultations and policy discussion;
v) the role of exchange market intervention can only be a limited one, as intervention will normally be useful only when complementing and supporting other appropriate policies. However, intervention can be useful to counter disorderly market conditions and reduce short-term volatility. Countries should be willing to undertake coordinated intervention on occasions when it is agreed that it would be helpful.
103. Some Deputies have proposed the introduction of target zones for exchange rates as more formal and binding indicators for the conduct of macroeconomic policies, maintaining that convergence of economic performance, while necessary, may not always be sufficient to achieve lasting exchange rate stability. Some other Deputies recognize there could be merits in this proposal and suggest that the technical aspects of a target zone approach should be further explored at an appropriate time. The majority of the Deputies, however, consider that such a move would be undesirable and in any case impractical in current circumstances.
104. In considering ways to promote the convergence of economic performances toward sustainable non-inflationary growth through the adoption of sound, compatible policies, the Deputies have agreed that surveillance, especially by the IMF, is the basic tool for moving toward these objectives. They recall that the amended Article IV of the Articles of Agreement gives the IMF increased responsibility to exercise firm surveillance over the exchange rate policies in order to ensure that members fulfill their obligations inter alia to:
i) pursue economic and financial policies aimed at orderly economic growth with reasonable price stability;
ii) foster underlying economic and financial conditions that do not tend to produce erratic disruptions; iii) avoid manipulating exchange rates or the international monetary system to prevent effective balance of payments adjustment or to gain an unfair competitive advantage.
105. For this purpose, the IMF has developed principles and procedures for surveillance which have been implemented and evolved over time. The Deputies recognize, however, that it would be necessary to strengthen the substance and procedures of surveillance to maximize its potential usefulness. To this end they suggest that:
i) the surveillance process should involve the senior level in governments in order to have an impact on policymaking;
ii) possibilities for public scrutiny playing an increased role in the surveillance process should be explored;
iii) governments should be more ready to take other countries’ advice into account, and the policy discussions of the surveillance process should allow greater emphasis on the international interaction and repercussions of policies, the working of the international adjustment process, and the progress of convergence of economic performances of major countries.
106. The Deputies recommend that the IMF consider the following steps to strengthen surveillance:
i) increasing the ability of the Managing Director and the staff to bring international concerns to the attention of members by the following measures:
(a) a confidential exchange of views between the Managing Director and the Finance Minister should be envisaged at the end of the consultation process in the case of industrial and developing countries whose policies and performance are of greatest concern for the world economy;
(b) participation in Article IV consultation should be at an appropriately high level, and the IMF report and summing-up should be brought to the attention of key economic policymakers;
ii) making more candid assessments and proposals for policy changes and, when necessary, follow-up reports to the Executive Board on actions taken by the member to respond to IMF suggestions;
iii) broadening the scope of Article IV documents to provide certain additional information and analysis;
iv) making greater use of the supplemental surveillance procedures in the face of exchange rate and other developments that may be important or may have important effects on other members, or that have implications for the operation of the international monetary system. The Deputies invite the IMF to review the relevant decisions for invoking these procedures;
v) continuing to develop “enhanced” surveillance procedures to be applied on a case-by-case basis at the request of members, with the aim of facilitating non-IMF financing in connection with multiyear debt rescheduling or in cases where IMF assistance and advice would improve the member’s limited access to external finance.
107. The Deputies have agreed that new arrangements for multilateral surveillance should be introduced to promote greater consistency of policies among countries in order to provide the basis for greater exchange market stability. They recommend that:
i) the IMF periodically prepare as a special chapter of the World Economic Outlook (WEO) an expanded analysis of the international repercussions of national policies of Group of Ten countries and of their interaction in influencing exchange rate developments and international adjustment;
ii) the Group of Ten Ministers and Governors contribute to the process of multilateral surveillance by cooperating with the IMF in reviewing, under appropriate procedures, the policies and performances of Group of Ten countries as well as the policy recommendations of the special chapter of the WEO.
108. The Deputies have concentrated their attention on the supply and distribution of international liquidity by international capital markets and official channels. They have agreed that the liberalization and integration of national capital markets have permitted a significant increase in international capital flows and enhanced the ability of creditworthy countries to meet their financing needs, although some countries continue to have little or no access to capital markets. While creditworthiness of borrowers will continue to be the principal factor in determining access to financial markets, the Deputies recognize that the availability and cost of liquidity are also affected by factors such as interest rates and credit policies in major countries. The combination of these factors does not necessarily ensure that the requirements of the international monetary and financial system are met.
109. In order to improve the stability of the international monetary system, the Deputies have agreed that it would be desirable to avoid excessive swings in the availability of liquidity. To this end they have reached a consensus on the need:
i) to improve the creditworthiness of debtor countries by encouraging economic adjustment;
ii) to improve IMF surveillance over the policies of countries which affect the availability and terms of credit in international financial markets; such surveillance is an integral part of the broad surveillance process on exchange rate policies and should be implemented in a closely integrated manner with other aspects of surveillance;
iii) to deregulate further capital markets and liberalize capital movements;
iv) for monetary authorities to pay due regard in the monitoring process of international banking activities to possible macroeconomic consequences of prudential measures;
v) to maintain the ability of the IMF to respond to systemic liquidity problems;
vi) to provide official finance on appropriate terms to developing countries which, despite adjustment efforts, lack sufficient access to capital markets.
110. The Deputies have reviewed the role of the SDR. They recognize that the international monetary system has changed considerably since the original creation of the SDR scheme and that this has affected the rationale for the SDR, including the objective of placing the SDR at the center of the system as the main reserve asset.
111. The Deputies have discussed both normal SDR allocations and other ideas for developing the SDR, but found no consensus within the Group on any specific proposal. However, they recognize that the SDR may still have a useful role in meeting the long-term global need for reserves and in this context in providing a safety net for future contingencies. In these circumstances, the Deputies support the intention of the IMF Executive Directors to carry out a comprehensive review of the future role of the SDR in the system.
The Role of the IMF
112. The Deputies recognize that the IMF has played a vital role in promoting international financial stability and external adjustment. They stress the need to safeguard its monetary character and the revolving nature of its financing, as well as the importance of keeping it as a quota-based financial institution and its lending normally in line with quota resources. They also stress the need to continue to phase down the policy of enlarged access and to terminate it as soon as the situation of external payments permits, and to deal with the problem of prolonged use and arrears.
113. The Deputies underline that IMF conditionality plays an essential role in encouraging adjustment and the restoration of creditworthiness. They stress the importance of maintaining the effectiveness of conditionality in order for the IMF to promote sound conditions in the world economic and financial system. They also stress that IMF credit should be available on a sufficient scale to provide meaningful support to members and to serve as an important catalyst for other lending by providing confidence that the borrower is pursuing sound policies.
114. The Deputies agree that, barring unforeseen circumstances, the recent increase in IMF quotas and the enlargement and expansion of the GAB provide the institution with an adequate basis to fulfill its responsibilities over the next few years. However, they recognize that negotiations on quotas and borrowing arrangements are complex and time consuming. They therefore suggest that the IMF undertake a study of alternative techniques that would provide resources to deal with exceptional circumstances without involving an immediate increase in members’ subscriptions, thus adding to the operational flexibility of the institution.
115. Finally, the Deputies recognize that a number of countries are facing both macroeconomic and structural difficulties which result in balance of payments problems, and that cooperation between the IMF and the IBRD should therefore be strengthened to address these problems in a coordinated manner, without jeopardizing the unique purposes of each institution. They recommend that the Executive Boards of the IMF and the IBRD continue their efforts to ensure that policy advice and the provision of financial resources by the two institutions be coordinated more than in the past, particularly where a reduction in access to IMF credit might be accompanied by appropriate forms of increased IBRD lending. The Deputies have also reviewed a number of specific proposals and recommend that they be submitted to the Executive Boards for consideration.
Chapter I: Summary of Recommendations
1. This Report has made a number of recommendations in the major areas of concern for the international monetary system which are summarized in paragraphs below.
The Functioning of the Present Exchange Rate System
2. The experience with the present exchange rate system has not been satisfactory. Exchange rates of major currencies were characterized by a high degree of short-term volatility as well as persistent misalignment which brought about uncertainty regarding future exchange rates, discouraged investment and trade, and resulted in misallocation of resources.
3. Volatility and misalignment of exchange rates have especially hurt the developing countries. They severely affected trade and raised reserve needs of these countries.
4. Exchange rate stability should be an important objective of policy, instead of being a residual of other policy actions of individual countries, as is the case at present. It is necessary to devise an exchange rate system to overcome the recognized rigidities of the par value system and the destabilizing uncertainties of floating rates.
5. The principle behind the concept of “target zones” for exchange rates of major industrial countries, commitment to which would promote greater international policy consistency, is in line with the approach of the 1984 Group of Twenty-Four Revised Program. Adoption of target zones for the exchange rates of major currencies could help achieve the objective of exchange rate stability and sustainable levels of payments balances. The proposal needs to be further studied and pursued in order to gain general acceptance. In the meantime, a mechanism has to be devised to enforce policy coordination among the major industrial countries.
6. Policy coordination among major industrial countries would imply complementary use of monetary, fiscal, and other policy instruments consistent with exchange rate stability and growth without inflation. Intervention may have to be used as a supplementary device for stabilizing exchange rates.
7. A framework for policy coordination already exists under the IMF Articles. In addition to that, a mechanism to trigger consultations among the concerned countries and the Fund is necessary whenever the indicators available suggest excessive short-term movements or misalignments of major currencies. In determining misalignment, the focal point of concern should not be just the attainment of balance in international payments but achieving the objectives of expansion and balanced growth of international trade with high levels of employment and real income and a durable payments equilibrium. The Fund should concentrate more than in the past on issues of a systemic character, and all coordination of policies should take account of the needs of developing countries.
8. Exchange rates of individual developing countries do not have any systemic impact on international alignment of exchange rates. Assessment of the appropriateness of a developing country’s exchange rate is not comparable with considerations that are applicable to the exchange rate of a major industrial country.
9. The surveillance function of the IMF is crucial for an orderly international monetary and financial system. It has so far been largely ineffective on major industrial countries, resulting in asymmetry in the international adjustment process, the burden of which has fallen disproportionately on developing countries. The main objectives of Fund surveillance should be to bring about symmetric international adjustment and facilitate expansion and balanced growth of international trade, high economic growth, and orderly financial conditions. To achieve these objectives, Fund surveillance should effectively influence the policies of industrial countries in a manner that would be supportive of growth, particularly of developing countries.
10. Multilateral surveillance and bilateral (Article IV) consultations should form two separate stages of the surveillance process. The first stage would involve multilateral negotiations about a mutually consistent set of objectives and policies among the major industrial countries. These multilateral negotiations should be conducted on a regular basis within the framework of the IMF. The World Economic Outlook exercise should provide the background for multilateral consultations, spelling out the international repercussions of national policies of major industrial countries. The second stage would involve a comparison between the actual outcomes and the targets of policy, setting off discussions of appropriate measures when the two deviate. The Fund should follow up with reports on recommended policies and performance indicators and deviations from them. These reports should be discussed by the Fund Board.
11. For improving effectiveness of surveillance over industrial countries, it is necessary to continuously monitor key developments pertaining to these countries and exercise pressure on them during both multilateral surveillance and Article IV consultations.
12. Bilateral consultations with major industrial countries should evaluate their policies against this multilateral framework of international adjustment. If the Board is not convinced of a country’s explanations for the deviations from the recommended policies, it could request the Managing Director of the Fund to discuss the matter further with the country concerned and to report back to the Board the outcome of these discussions for appropriate action.
13. For major industrial countries, Article IV consultations should concentrate on a thorough assessment of their national policies and their international impact. For developing countries, recommendations of policies should be made with a view to promoting adjustment consistent with economic development, bringing out the underlying needs of finance and the part that exogenous factors play on the adjustment efforts of these countries.
14. In prescribing exchange rate policies for developing countries, it is essential to consider that changes in resource allocation are time consuming and would need adequate financing. In many developing countries, controls to limit capital outflows may become necessary for the stability of exchange and interest rates. Flexibility in regard to use of multiple currency practices is also necessary in certain cases.
15. In view of the underlying confidentiality of the exchange of information and discussion between the members and the Fund, no publicity should be given to the conclusions of the consultations in any form.
16. The Fund should continue to play its role in easing the debt burden of developing countries through arrangements for use of Fund resources and also in a catalytic manner for facilitating the flow of resources from banks and other creditors. Deputies expressed concern over the implications of IMF involvement in “enhanced surveillance.” It is viewed by the Deputies as yet another evidence of creditor unwillingness to restore normal access to external financing despite significant adjustment efforts. The catalytic role of the IMF should, in principle, be exercised without “enhanced surveillance.” However, in cases where it proves necessary “enhanced surveillance” should be considered exceptional and undertaken only at the request of a member country. It is justified only if it secures financing from non-Fund sources in the context of a multiyear debt rescheduling. It is important that in “enhanced surveillance,” priority is given to policies aimed at promoting self-sustained growth. However, the Fund’s continued analysis and policy advice under “enhanced surveillance” arrangements should be clearly differentiated from the programs under Fund arrangements. The main objective of “enhanced surveillance” should be the early normalization of market relations between the member country and the international financial system. To this end, the period under which the country is under “enhanced surveillance” should be limited to the debt consolidation period or the grace period.
Management of International Liquidity and the SDR
17. The record of creation and management of international liquidity in the past decade has been unsatisfactory. During this period the supply of international liquidity was uneven and grossly inadequate, especially for developing countries. The recent contraction in commercial bank lending shows its unreliability as a source of liquidity.
18. Even if certain improvements in the functioning of capital markets such as deregulation are brought about, they may not result in increased availability of credit to developing countries. The recent improvement in the balance of payments of many of these countries has not reversed the decline in commercial lending to them, despite strenuous adjustment efforts.
19. If reserves are to be built to acquire “creditworthiness,” many developing countries will be required to generate current account surpluses for the next several years, at a time when many of them are facing a severe problem of reverse flows of real resources. For low-income countries, the official assistance fell in real terms in recent years, and they face a severe shortage of liquidity. As a result, many of these countries have accumulated payments arrears. They have to approach the Fund for support but often have to face reduced access limits and tightened conditionality without the provision of adequate liquidity.
20. The conditions of supply of international liquidity and its distribution are more important than the world aggregate reserve holdings. The scope for international liquidity policy is now limited by the willingness of major countries to consider the international impact of their policies. In addition to surveillance over exchange rate and other macroeconomic policies of major industrial countries, the Fund should be enabled to influence the liquidity of the world economy through adequate SDR creation and its more efficient distribution.
21. There is at present a long-term global need for a substantial allocation of SDRs in relation to expected growth of world trade, financial transactions, and output. An allocation at this time would relieve the stringency in the reserve position of a large number of developing countries; promote economic recovery and not be inflationary; improve balance between conditional and unconditional liquidity; reduce dependence on costly borrowed resources; and help orderly adjustment. For this purpose, an annual allocation of no less than SDR 15 billion as recommended by the 1984 Group of Twenty-Four Revised Program is warranted.
22. To make the SDR the principal reserve asset, as required under the Articles, SDRs should be issued on a regular annual basis with a view to ensuring that their proportion in reserves rises progressively.
23. Since the unsatisfied liquidity needs of developing countries are more than those of industrial countries, distribution of supply of liquidity in favor of developing countries would benefit all countries without creating any additional inflationary pressures. It will be desirable to link the allocation of SDRs to the development needs of developing countries.
Role of the IMF
24. The purposes of the International Monetary Fund were set out in Article I of the Articles of Agreement. During the past forty years, the Fund has certainly played an important role, but it was not very successful in fulfilling the aspirations of a large number of developing countries, which form a substantial part of the Fund membership.
25. The Fund has a role to play both in financing transitory payments problems and in financing and promoting adjustment of persistent imbalances.
26. Transitory payments problems are met by international reserves, borrowing from capital markets, or drawing on Fund resources. The compensatory financing facility (CFF) was created to provide low conditionality finance to meet transitory payments deficits produced by events outside the control of the borrowing country. The effectiveness of this facility has been in the recent past very much diluted. The tighter conditionality attached to the CFF and the reduction of access limits are retrograde steps and should be reversed immediately. The CFF should be extended to cover not only export shortfalls but also deterioration in terms of trade that is quantifiable. CFF drawings should be related to calculated shortfalls rather than to quotas, and should be provided automatically. The repayment period of the CFF should be extended as recessions have tended to become deeper and the cycles longer in the recent past, giving rise to prolonged stress on the balances of payments of most developing countries.
27. In view of the large variability in interest rates, a new facility to provide financing for interest rate increases needs to be introduced. This facility could also be a part of a facility which may cover deficit resulting from any exogenous factor that is reversible.
28. In contrast to transitory imbalances, persistent payment deficits require both large-scale finance and adjustment. The Fund is enjoined to promote adjustment with due regard to the requirements of growth and prosperity. Therefore, adjustment measures should not lead to contraction in activities and reduction of growth and development in the deficit countries.
29. Policies to correct persistent imbalances should be devised according to the nature of the underlying disequilibrium. Persistent disequilibria in developing countries are often structural in nature, requiring measures to raise the economy’s productive capacity and expand the supply of goods and services.
30. Reorientation of conditionality criteria from demand deflation to growth-oriented structural adjustment requires lengthened program periods and increased levels of financing. Instead of underplaying the EFF (extended Fund facility) as in the past two years, it should be used extensively.
31. It is recognized that the balance of payments problems of most low-income countries are structural in nature, caused mainly by persistent deterioration in their terms of trade, disproportionately large debt-service burden, decline in the flow of ODA (official development assistance), and very limited capability to attract external resources from non-official sources. These problems have been seriously compounded by devastating droughts of unprecedented proportions that have hit many African countries. Of late, many low-income countries have experienced net outflows of resources, including to the multilateral financial institutions. In view of the particularly difficult structural problems of these countries, it is essential that the Fund provide substantially larger and longer-term financing in support of their structural adjustment programs than has been done so far.
32. Some Fund programs have broken down in recent years because of excessively rigid performance criteria, which were not revised in the light of unforeseen developments beyond the control of the borrowing country. There is a need for greater flexibility in the application of such criteria. It is necessary that repayment obligations to the Fund are settled on time. However, where the balance of payments situation, made adverse by exogenous factors, makes it practically impossible for a country to repay according to a fixed schedule, mechanical application of sanctions would not be appropriate. To help such countries become current in their obligations to the Fund, new mechanisms should be evolved, in collaboration with the World Bank and regional development institutions, to provide longer-term assistance for orderly adjustment of these countries.
33. In recent years, the burden of increase in costs of Fund activities has fallen disproportionately on developing countries. Increasing rates of charge and the declining grant element impaired the process of adjustment, especially in low-income countries. To alleviate this, facilities and mechanisms should be established in the Fund, such as an Interest Subsidy Account on a stable basis. The Trust Fund should be revived to make concessional loans to eligible countries.
34. Quotas must remain the primary source of finance for the Fund. The Eighth Review of Quotas has fallen far short of the current requirements, which underlines the need to advance the Ninth Review. It would be desirable to relate quotas to a measure of the size of the world economy. In the absence of such a link, the interval of quota reviews should be reduced to three years. Until the size of quotas is increased adequately the option of borrowing by the Fund from any other official source should be kept open.
35. Enlarged Access Policy should be continued until the size of quotas bears an appropriate relationship to the size of the world economy. The present limits of access are too meager and should be enhanced to be useful for orderly adjustment in developing countries.
36. Any coordination between the Fund and the World Bank should not lead to cross conditionality, but should help further their mutual objective of providing resources to developing countries. While closer contacts between the management and staff of both institutions and sharing of relevant information could be useful, steps to seek uniformity of advice should not become a means of exerting a concerted pressure on the borrowing countries.
37. The role of developing countries in the decision-making process in the international financial institutions needs to be substantially increased. The system of weighted voting has led to a situation where, after the Eight Quota Review, developing countries as a group have no more than 38 percent of total votes. While the principle of weighted voting may be unavoidable in financial institutions, a better balance in the voting pattern is needed for a more equitable and effective functioning of these institutions. The share of developing countries in the total votes in the multilateral financial institutions should be increased to 50 percent. For this purpose, consideration might be given to, inter alia, an increase in basic votes. The present geographical representation of developing country regions in the Boards of the Bank and the Fund should be preserved.
The Debt Problem and Transfer of Resources
38. The debtor countries have been undertaking strenuous adjustment efforts in response to the external environment and the consequential adjustment process is having serious social and political consequences. The debt crisis is a result of excessive lending by commercial banks, abrupt policy changes, and, in some cases, an unbalanced policy mix by industrial countries and other factors leading to historically high interest rates, excessive borrowing with inadequate policies by many debtor countries, and the failure of Fund programs in the case of many low-income countries. Thus, finding realistic formulae and viable mechanisms for the solution of the crisis would require cooperative actions of debtor and creditor countries, commercial banks, and multilateral financial institutions. It is important to reiterate the view of the Group of Twenty-Four Ministers, as expressed in their April 1985 communique: “Also required is a co-responsibility of debtors and creditors, symmetry of adjustment, and cooperative efforts aimed at a durable solution to the debt problem in a global framework.”
39. The debt situation requires imaginative solutions involving debt restructuring and relief in order to bring the debt burden within the effective ability of the debtor countries to pay. There is an urgent need to move toward a “positive” type of adjustment, consistent with sustained growth of output in the medium and the long run. To support the efforts by developing countries to prevent the capital flight from the debtor countries, developed countries should, through their regulatory agencies, discourage capital outflows from those developing countries which are facing acute capital flight problems. Multiyear restructuring of debts has prevented the bunching of maturities in the near future and has been a helpful development. Co-responsibility of debtors and creditors also requires that interest rates should more closely reflect the real cost of funds for the creditors.
40. The lesson learned from the recent experience with the debt crisis is that heavy reliance on medium-and short-term borrowing for development financing is bound to give rise to liquidity problems even if such financing were to be directed to sound and viable projects. Therefore, there is an imperative need to expand sufficiently the resource base of international institutions.
41. In recognition of the interdependence of money, finance, and trade in the global economy, it is important to emphasize the close relationship between an expanding world trade and the solution of balance of payments problems, including the indebtedness of developing countries. Developed countries should therefore roll back protectionist measures, refrain from introducing new restrictions, and improve access for exports of developing countries to their markets.
42. Adequate flows of long-term resources are of paramount importance to the orderly and speedy adjustment of developing countries. The official flows in recent years have not even made up for the losses incurred by the developing countries on account of adverse movements of terms of trade and high interest rates. The quality and composition of aid also deteriorated.
43. The IDA (International Development Association) has played an important role in promoting development and increasing productivity, thus helping to raise the standard of living and to alleviate poverty in the low-income countries. There has been a steep decline in IDA resources in the Seventh Replenishment, and additional commitments are necessary. During the midterm review to be conducted shortly by the IDA, additional resources should be made available to restore the IDA VII Replenishment to US$12 billion. It is essential that funding for IDA VIII should be substantially larger than that for IDA VI, and efforts should be made to restore the historical rates of growth in IDA. The Special Assistance Facility established for sub-Saharan Africa is inadequate and it will be necessary to substantially increase the level and quality of funding in this respect. Developed countries should redouble their efforts to reach the internationally agreed target of 0.7 percent of GNP (gross national product) as official development assistance as quickly as possible and at any rate not later than the end of this decade. Each developed country should make binding commitments for annual growth rate of assistance. In respect of low-income countries, the Resolution of the Trade and Development Board 165 (SIX) should be implemented expeditiously and fully.
44. The role of the World Bank should continue to be one of commitment to development, growth, and poverty alleviation. The recent reduction in the lending program of the Bank is regrettable and it is essential to adopt lending policies to enable it to provide effective support. It is also urgently necessary to increase the general capital of the World Bank to resume significant increases in flows to developing countries. In this context it is disturbing to note that there is a possibility of negative net transfers from the World Bank, and this should be reversed effectively. The Bank’s lending policies including those of structural adjustment should conform to the national policy requirements of the borrowing countries. There should not be undue emphasis on so-called policy-based lending or on linking the quantum of Bank assistance to increasing conditionality.
45. The recommendations of the Deputies of the Group of Twenty-Four embodied in this Report, together with those of the Group of Ten, should receive consideration by the Interim Committee in October 1985. But, as the assessment of the situation in the world economy by developing countries differs from that by industrial countries, with different policy implications, a suitable institutional mechanism should be evolved for an in-depth and joint examination of the two Reports. A representative committee of Ministers from developing and industrial countries, which could perhaps take the form of a joint subcommittee of both the Interim and Development Committees, should be formed for this purpose. It should conduct its business on the basis of consensus.
Chapter II: Introduction
46. The Ministers of the Group of Twenty-Four adopted, in September 1984, the Revised Program of Action Towards Reform of the International Monetary and Financial System (hereafter referred to as 1984 Group of Twenty-Four Revised Program), which examined the various shortcomings of the international monetary and financial system and made several recommendations to improve its functioning.
47. The continued malfunctioning of the international monetary and financial system has also led to repeated calls from the nonaligned countries, the Group of 77, and several important industrial countries for the examination, in a broad-based international forum, of the defects of the existing system. They underlined the need for action for improvement and reform of the system.
48. The Interim Committee, at its meeting on April 17-19, 1985, noted that improvements in the international monetary system were currently under study and agreed to review this matter at its next meeting in Seoul. The Ministers representing the Group of Ten have recently forwarded a Report of their Deputies on the Functioning of the International Monetary System for the consideration of the Interim Committee. That Report covers mainly four areas, namely, the exchange rate system, surveillance, international liquidity, and the role of the Fund.
49. In May 1985, the Chairman of the Group of Twenty-Four appointed a Working Group to examine these and some other related issues in the light of recent developments. The report of the Working Group was examined by the Deputies of the Group of Twenty-Four and it forms the basis of this Report.
50. The Deputies wish to emphasize that the 1984 Group of Twenty-Four Revised Program . . . sets out the basic position of the Group on various issues of the international monetary and financial system. This Report is essentially an elaboration of the Revised Program on the areas covered in the Group of Ten Report and also the problems of debt and transfer of resources, as no meaningful improvement of the international monetary system is possible without their solution.
51. The recommendations of the Deputies of the Group of Twenty-Four embodied in this Report, together with those of the Group of Ten, should receive consideration by the Interim Committee in October 1985. But, as the assessment of the situation in the world economy by developing countries differs from that by industrial countries, with different policy implications, a suitable institutional mechanism should be evolved for an in-depth and joint examination of the two Reports. A representative committee of Ministers from developing and industrial countries, which could perhaps take the form of a joint subcommittee of both the Interim and Development Committees, should be formed for this purpose. It should conduct its business on the basis of consensus.
52. The Group of Twenty-Four Deputies considered that an effective reform of the international monetary and financial system requires a convening of an international conference. The joint examination of the recommendations of these Reports by the proposed representative committee of Ministers will be an effective step in preparing for such a conference.
Chapter III: An Overview of the International Economic Situation
53. The low growth rates and severe recessionary conditions in the international economy that prevailed in the early 1980s continue to have debilitating effects on many developing countries. The recovery in industrial countries, which showed its first signs in 1983 and peaked in 1984, has been fragile, partial, and unbalanced. Unemployment has remained high. And there has been intensification of current account imbalances of a number of industrial countries. Disparities in their fiscal stance, too, have continued. There has also been a deceleration in the growth of trade in recent months. In 1985 so far, the rate of expansion in these countries has slowed down considerably and the growth rate in the current year will perhaps be one half of the 4.9 percent rate recorded in 1984. The medium-term scenarios until the end of the decade, as set out in the World Economic Outlook for 1985, envisage that the average rate of growth in industrial countries will be slightly over 3 percent.
54. Per capita real incomes of many developing countries continue to be lower than in the 1970s. Most of them have large current account deficits, and large debts to be serviced. Their capacity to repay by generating export surpluses is limited not only by their own low growth performance but also by declines in the terms of trade, an increase in protectionism, and the low growth in industrial countries. Prices of oil, primary commodities, and manufactures of developing countries have either declined or been falling. The index for non-oil commodity prices in June 1985 is about 30 percent below the 1980 average and is lower than the bottom level recorded in 1982. High real interest rates have increased the debt service burden further. Interest rates ruled high during a good part of the 1980s. There has, however, been a welcome decline in interest rates in recent months, but with the spreads for “country risks” and with falling export prices, the real interest rate payable on bank loans by debtor countries would be unsustainable in the long run as it may exceed the likely rate of growth in real income and the real value of exports.
55. Official assistance and Fund financial support have both declined. Commercial bank lending to developing countries has been virtually withdrawn since the middle of 1982. The value of “spontaneous” syndicated credits raised by developing countries at $10.9 billion in 1984 was lower than $14.2 billion in 1983. In the first five months of 1985, no more than $2.9 billion was raised, indicating a continuation of the downward trend.
56. The net effect of these developments is that there has been a substantial outflow of resources from many developing economies. If this situation continues, the stability of the international financial system would be seriously impaired, unless the international community takes immediate steps to correct it in a manner that promotes adjustment and growth in developing countries. In the case of low-income countries, viability in external accounts and future development could be brought about only by substantial concessional financing.
57. Correction of the present malady requires a concerted action on the part of the policymakers in the industrial countries and in the major international institutions. The functioning of the exchange rate system should be improved to reflect fundamental underlying economic conditions. To ensure consistent policies among industrial countries aimed at sustained growth and financial and exchange rate stability, Fund surveillance of major industrial countries should be strengthened. The IMF should promote an international monetary system in which payments adjustment fosters international prosperity. Adjustment by strong demand management policies has in the past led to contractionary situations in many developing countries. Further adjustment of this kind in the present circumstances would sap their growth potential, reduce their imports, and ultimately bring about a fall in the volume of trade. Adjustment without large-scale financing would not, in the current circumstances, lead to correction of persistent payments imbalances. And inadequate financing with high conditionality would correct neither transitory nor persistent payments imbalances.
58. Developing countries suffer from a shortage of resources for productive investment activities. They have large reserve requirements. Their liquidity needs will have to be met by substantial SDR allocations, which will promote trade expansion without endangering price stability. Their development programs will have to be supported by large international financing. Even their balance of payments adjustment programs should be supported with substantial medium-term financing by the international institutions. But, in order to enable countries to approach these institutions, conditionality in lending should be modified by bringing forward development as a major objective. In turn, to enable these international institutions to play their part, their resources should be strengthened by increasing their quotas/general capital, and access of borrowers to these resources should be enhanced. The absence of adequate financing, in fact, could take the world economy back to the recessionary conditions.
Chapter IV: The Functioning of the Present Exchange Rate System
59. Floating exchange rates were adopted by major industrial countries in the early seventies, as the par value system established at Bretton Woods could not cope with the stresses generated by divergent national macroeconomic policies in an environment of increasing capital mobility. It had been anticipated at that time that market forces, aided by stabilizing capital flows, would keep exchange rates close to the levels required to achieve current account equilibrium and free other macroeconomic instruments to deal with domestic economic priorities. It was also hoped that floating exchange rates would assist the adjustment process and growth of world trade and output.
The Experience with Floating Rates
60. The experience with floating exchange rates has not been up to the original expectations. Both in terms of short-term volatility and long-term misalignment, exchange rate variability has increased since the abandonment of the Bretton Woods system. The increase in volatility, referring to short-term fluctuations, since the adoption of floating rates is well documented. Exchange rate volatility has not declined as markets became used to dealing with the flexible exchange rate system, as was anticipated when floating was first adopted.
61. Wide fluctuations in exchange rates have tended to bring about greater uncertainty about future exchange rates. Evidence from forward markets indicates that most exchange rate fluctuations are unanticipated. Volatility has contributed to expansion of financial transactions and greater capital movements not directly related to trade flows. It has discouraged investment and trade by adding to financial risks for investors and traders.
62. Misalignment, referring to a persistent deviation of the exchange rate from the equilibrium level, has been severe and, according to some studies, it has also become larger in the recent period than under the Bretton Woods system. Much of the medium-term movement in real exchange rates in recent years reflects not the changing pattern of competitiveness but rather the result of differences in fiscal and monetary policies, in which industrial countries have chosen macroeconomic policies independently, without serious consideration of their impact on the world economy. Misalignment inevitably produces either idle resources or wasteful shifts of resources back and forth between tradables and nontradables. It becomes a potent source of pressures for protectionism.
63. Exchange rate variability has, as the 1984 Group of Twenty-Four Revised Program had put it, “especially hurt the developing countries.” Exporters and importers in these countries are exposed to high exchange risks in the absence of well-developed financial markets, especially forward cover arrangements. The destabilizing uncertainties of floating rates have increased the reserve and capital needs of developing countries from the levels which would otherwise exist.
64. The functioning of the present floating-rate system has thus not been able to provide, as Article IV, Section 1 of the Articles of Agreement of the IMF puts it, “a framework that facilitates the exchange of goods, services, and capital among countries,” which sustains sound economic growth and helps develop orderly underlying conditions necessary for financial and economic stability.
Proposals for Improving Exchange Rate Stability
65. The 1984 Group of Twenty-Four Revised Program stated that an exchange rate system should be devised to overcome the recognized rigidities of a par value system and the destabilizing uncertainties of floating rates. Besides, the improved functioning of the exchange rate system requires the recognition by major countries that both the floating-rate and the fixed-rate systems need rules of the game relating to domestic macroeconomic policies. The Revised Program categorically stated that “this implies greater effort on the part of the developed countries to achieve a substantial degree of discipline and coordination in the conduct of their national policies.” Exchange rate stability should be an important objective of policy instead of being a residual of other policy actions of individual countries, as is the case at present.
66. The principle behind the concept of “target zones” for exchange rates of major countries, commitment to which would promote greater international policy consistency, is in line with the approach of the 1984 Group of Twenty-Four Revised Program. Adoption of target zones for the exchange rates of major currencies could help achieve the objective of exchange rate stability and a sustainable pattern of payments balances. The proposal needs to be further studied and pursued to gain general acceptance. In the meantime, a mechanism has to be devised to enforce policy coordination among the developed, especially the key currency, countries. Although the role of the developing countries in influencing such an exchange rate system is necessarily limited—and therefore the related mechanism of coordination and surveillance will be essentially concerned with the developed countries—it is important, as the 1984 Group of Twenty-Four Revised Program states, “that this coordination should take account of the needs of developing countries.”
67. Policy coordination in this context implies that monetary policy for exchange rate stability should complement the use of fiscal policy to counter inflationary and deflationary pressures as well as the use of other policy instruments. Intervention, for instance, could be used on a meaningful scale, without confining it to “leaning against the wind,” toward the end of exchange rate stability, as a complementary measure to other policies, and sometimes in coordination with other countries.
68. A framework for such a policy coordination already exists under Article IV of the IMF, according to which “each member undertakes to collaborate with the Fund and other members to assure orderly exchange arrangements and to promote a stable system of exchange rates” (Section 1) and “the Fund shall exercise firm surveillance over the exchange rate policies of members, and shall adopt specific principles for the guidance of all members with respect to those policies” (Section 3(b)). Over and above the regular multilateral consultations, a mechanism or procedure that would trigger consultations among the concerned countries and between them and the Fund is necessary whenever the indicators available suggest that excessive short-term movements of one or more major currencies are taking place, or that any major currency is already, or is in the process of becoming, seriously misaligned.
69. Since the concept of misalignment is central in this process of surveillance, it should be clearly spelled out in operational terms. Although the term misalignment was not used in 1970, the IMF’s report on the “Role of Exchange Rates in the Adjustment of International Payments” of that year provided an authoritative definition of the concept of fundamental disequilibrium, which was the Bretton Woods term for the same thing:
A basic feature of the concept of fundamental disequilibrium is that although its ultimate focus is on the balance of payments it is related to a general condition of the member’s economy and does not require that an imbalance must have developed in the balance of payments. This, in turn, reflects the underlying philosophy of the Bretton Woods system that, while attainment of balance in international payments must be a focal point of concern for the international financial community, it is not to be regarded as an objective in isolation from other objectives of the international monetary system. These objectives include the expansion and balanced growth of international trade on the basis of a liberal and nondiscriminatory regime of trade and payments, to contribute to the promotion of high levels of employment and real income and to the development of the productive resources of all the Fund’s members as primary objectives of economic policy. In this conception, attainment of payments balance through the use of measures destructive of national or international prosperity would clearly not comprise a durable payments equilibrium.
70. The alignment or misalignment of an exchange rate thus has to be judged in the light of a country’s overall economic performance and its impact on the international economy and not merely its balance of payments performance. For example, in many developing countries with relatively undiversified economies, protection of infant industries, judiciously applied, may be an indispensable element in the process of diversification and development, as recognized by GATT. On the other hand, for countries with diversified economies and relatively high mobility of factors of production, substantial or increasing restrictions on trade could well be a major symptom of exchange rate misalignment.
71. Exchange rates of developing countries are not of any great significance in relation to the international alignments of exchange rates, and assessment of the appropriateness of a developing country’s exchange rate does not generally involve systemic considerations comparable to those applicable to the exchange rate of a major industrial country.
Chapter V: Surveillance
72. In their 1984 Revised Program, the Group of Twenty-Four Ministers had noted that in view of “the high degree of interdependence of the world economy, the success of economic policy followed by one country often depends on actions by others.” It is equally true that cooperative macroeconomic policy formulation on the part of the major industrial countries can achieve a superior outcome for each country, than would be achieved by each acting independently. In the recent past, their uncoordinated attempts to disinflate led to an excessive emphasis being given to monetary restriction relative to other instruments. The result was a halting process of recovery with high real interest rates and low commodity prices having particularly adverse effects on the developing countries.
73. The IMF has a key role in the conduct of international surveillance. However, Fund surveillance has to date been largely ineffective over the major industrial countries whose actions have substantial spillover effects on the world economy. These countries have been able to pursue domestic policies without taking into account their impact on the international economy. In some cases, the subordination of international responsibilities to domestic priorities has been quite explicit, and notwithstanding the urgings of the Fund, the mix of monetary and fiscal policies remains inappropriate.
74. On the other hand, the influence of the Fund has been effectively felt by the users of its resources, mostly developing countries. Even if a formal distinction is made between Article IV consultations and adjustment programs associated with the use of Fund resources, the effect of Fund surveillance on inducing policy changes is much larger on developing countries than on major industrial countries, which have adequate access to external financing and do not require an IMF-supported adjustment program.
75. As a result of this basic asymmetry in the Fund’s surveillance function, the international adjustment process has been seriously biased. The deficit developing countries have been faced with harsher adjustment, and the world economy with a lower level of activity, than would otherwise be necessary. Any program for strengthening international surveillance has to reduce this asymmetry and devise methods for coordination of policies of major industrial countries for promoting world economic activity and trade expansion in a manner supportive of growth in developing countries.
The Objectives of Surveillance
76. The objectives of surveillance of the Fund to date are limited to surveillance over members’ exchange rate policies. Article IV, Section 3 and Executive Board Decision No. 5392-77/63 (of April 29, 1977) spell out that the Fund shall exercise firm surveillance over the exchange rate policies of members, and that a member shall avoid manipulating exchange rates to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members, that it should intervene in the exchange market if necessary to counter disorderly conditions characterized by disruptive short-term movements in the exchange rates, and that it should take into account in its intervention policies the interests of other members.
77. Surveillance, to be effective, should be explicitly recognized as surveillance of the international adjustment process. “The adjustment process,” stated the 1984 Group of Twenty-Four Revised Program, “must be adapted to the present global economic environment and the need for promoting development.” The design of such international adjustment process, based on coordinated national economic policies, must aim at sustained growth of output, employment and trade of all countries and ensure adequate real resource transfers to developing countries. This follows from the primary purpose of the International Monetary Fund as enshrined in Article I(ii): “To facilitate the expansion and balanced growth of international trade, and to contribute thereby to the promotion and maintenance of high levels of employment and real income and to the development of the productive resources of all members as primary objectives of economic policy.”
The Analytical Basis of Surveillance
78. The process of surveillance for international adjustment should focus on international policy interactions and economic linkages among the major industrial countries which are mainly responsible for the course of the world economy. Multilateral surveillance and bilateral (Article IV) consultations should form two stages of the surveillance process, rather than two parallel operations. The first stage would involve multilateral discussions and negotiations to be conducted on a regular basis within the framework of the IMF about a mutually consistent set of objectives, and a set of policies to collectively achieve these objectives. The aim might be to search for a set of outcomes or “objective indicators” or “targets,” that appear to be sustainable in the medium term and desirable to all parties. This should be quite feasible when the multilateral surveillance exercise is limited to a few major industrial countries, such as the key currency countries. The second stage would involve a comparison between the actual outcomes and the recommended targets or indicators, and a discussion of what measures would be appropriate when the two differ. This stage might most efficiently be conducted on a bilateral basis as part of Article IV consultations.
79. The form in which multilateral surveillance has so far been conducted is through the annual World Economic Outlook (WEO) type of exercise. Such exercises could serve a useful purpose if they provide a background for multilateral consultations about the mutually consistent set of objectives and policies as mentioned above. The WEO should clearly spell out the international repercussions and interactions of national policies of the major industrial countries and contain fairly specific proposals of policies for these countries. These analyses should be considered by the Fund Board to recommend a set of policies and the likely outcomes or performance indicators. The Fund should prepare follow-up reports on the implementation of the recommended policies, deviations from them, and the actual outcomes. These reports should be thoroughly discussed by the Fund Board.
Pressures to Make Surveillance Effective
80. It is generally accepted that while the Fund’s leverage over developing economies has been very large, there is virtually no effective pressure on industrial countries to comply with the Fund’s policy advice. For improving effectiveness in surveillance over industrial countries, it will be necessary for the Fund to continuously watch and monitor key economic developments pertaining to these countries and to devise procedures for exercising pressure both during multilateral surveillance and in Article IV consultations.
81. Bilateral consultations with the major industrial countries would have to focus on policy evaluation against this multilateral framework of international adjustment. Once an agreement is reached on the policy changes, deviations in implementing the suggested policy changes should give rise to information notices. The country concerned could raise the matter in the Fund’s Executive Board for a full discussion as to how and why the suggested policies could not be put into effect.
82. If the Board is not convinced of the country’s explanations, it could request the Managing Director of the Fund to discuss the matter with the country concerned and report back to the Board the outcome of the discussions for further appropriate action.
83. The suggested framework for multilateral surveillance of major industrial countries, and taking it up in detail during the bilateral Article IV consultations, would go a long way toward correcting the current asymmetry in the exercise of the Fund’s surveillance function.
84. In this context, it is useful and in fact necessary to distinguish the content of Article IV consultations that the Fund should conduct with major industrial countries from that of the consultations that should be had with developing countries. In the case of major industrial countries, the consultations should concentrate on a thorough assessment of their national economic policies, including the exchange rate policies, their domestic and international impact, and also their effect on the adjustment efforts of other countries of the world. The consultations should continue to give, as at present, details of current account developments. Emphasis should also be placed on the developments in the capital account in view of the large mobility of capital in recent years. They should also cover the restrictions placed on the international adjustment mechanism such as trade restrictions and other protectionist measures, market-distorting policies, and structural rigidities.
85. The consultation reports of the major industrial countries may contain references to the policy recommendations made by the Fund during the previous consultation and the measures undertaken by the member since then in this regard. For effective surveillance, the Fund may be allowed to make greater use of the supplemental surveillance procedures whenever exchange rate developments or other key developments having an impact on other members or on the functioning of the international monetary system warrant. The procedures outlined in the Executive Board decision in 1979 in this regard could be of guidance in invoking supplemental consultations in between the Article IV consultations.
86. Recommendations of policies for developing country members should be made with a view to promoting adjustment as a part of economic development. The underlying needs of finance for such adjustment should be assessed and methods for providing such finance should be indicated. While making the policy suggestions, the part that exogenous factors play in the adjustment efforts of these countries and also the effects of the actions of other countries, in particular the major industrial countries, should be clearly brought out.
87. In prescribing exchange rate policies for developing countries, it is essential to consider that changes in resource allocation are time consuming and would need adequate financing. Often changes in exchange rates of developing countries would have to be supported by complementary policies. While exchange rate devaluation may be useful for improving competitiveness and external viability in developing countries, it could also, as the experience has shown, stimulate cost inflation, causing economic disruption and negating the intended effects of lowering export prices in terms of foreign currency. It is much less useful in countries that have to rely on exports of traditional agricultural and mineral commodities; and simultaneous efforts by a number of countries to undercut the export prices of competitors have often resulted in losses for all. In many developing countries, controls to limit capital outflows may become necessary for the stability of exchange and interest rates. Flexibility in regard to use of multiple currency practices is also necessary in certain cases.
88. The underlying confidentiality of the exchange of information and discussions between the members and the Fund should be preserved. As such, no publicity should be given to the conclusions of the consultations either through release of a statement or through release of reports.
89. The Fund should continue to play its role in easing the debt burden of developing countries through arrangements for use of Fund resources and also in a catalytic manner for facilitating the flow of resources from banks and other creditors. Deputies expressed concern over the implications of IMF involvement in “enhanced surveillance.” It is viewed by the Deputies as yet another piece of evidence of creditor unwillingness to restore normal access to external financing despite significant adjustment efforts. The catalytic role of the IMF should, in principle, be exercised without “enhanced surveillance.” However, in cases where it proves necessary “enhanced surveillance” should be considered exceptional and undertaken only at the request of a member country. It is justified only if it secures financing from non-Fund sources in the context of a multiyear debt rescheduling. It is important that in “enhanced surveillance,” priority is given to policies aimed at promoting self-sustained growth. However, the Fund’s continued analysis and policy advice under “enhanced surveillance” arrangements should be clearly differentiated from the programs under Fund arrangements. The main objective of “enhanced surveillance” should be the early normalization of market relations between the member country and the international financial system. To this end, the period under which the country is under “enhanced surveillance” should be limited to the debt consolidation period or the grace period.
Chapter VI: Management of International Liquidity and the SDR
Management of International Liquidity
90. The changeover to a flexible exchange rate system did not bring about any perceptible decline in the world demand for reserves. The reasons for this are well known. Countries, whether they floated or pegged their currencies, continued to need adequate reserves for intervention purposes. The experience with the floating exchange rate system has also not been satisfactory, especially due to large, and at times, violent swings; this, together with large payments disequilibria and high interest rates, contributed to countries’ holding substantial reserves to protect themselves against uncertainties. In addition, larger reserves were needed especially by developing countries to insulate themselves against frequent exogenous “shocks,” deterioration of terms of trade, protracted recession, and increasing protectionism in industrial countries. Adequate reserves were also needed to prove “creditworthiness” and for access to international markets.
91. The supply of international liquidity was in recent years markedly influenced by credit made available by international commercial banks. For some developing countries, they provided a fairly substantial source of liquidity. But there was also a large number of developing countries which could not afford the high cost of commercial credit and which continued to rely on the supply of official finance, SDR allocations, and conditional credit for financing their balance of payments needs.
92. Dependency on commercial banks as a source of liquidity brought with it substantial debt-service requirements often too large in relation to receipts from trade. Floating interest rates, together with their volatility in the last four years, increased the variability of interest payments. Bunching of maturities also made it difficult to refinance their debt. And borrowed reserves were in fact withdrawn when they were most needed. Since mid-1982, bank lending sharply declined.
93. Developing countries are now facing a severe shortage of external real resources. A number of countries had to run large trade surpluses to service their debt and to build up minimum reserves required for normal transaction and precautionary purposes. This situation has been exacerbated by the falling commodity prices, which are at the lowest level since 1980. Oil prices as well as prices of certain manufactures exported by developing countries are also on the decline. Low-income countries which have only limited access to commercial borrowing are experiencing an equally severe liquidity problem. Official assistance to them fell in real terms in recent years. Many of these countries had accumulated arrears. They have to approach the Fund for support, but often have to face reduced access limits and tightened conditionality without the provision of adequate liquidity.
94. The conditions of supply of international reserve assets and the availability of liquidity relative to need, including the manner in which their supply is distributed among countries, are more important than the size of world aggregate reserve holdings. The present inadequacy as well as unevenness in international liquidity cannot be corrected or even controlled through market processes. It is often held that access to commercial credit would depend on “creditworthiness,” which in turn is dependent upon adjustment. But despite vigorous adjustment policies pursued by developing countries leading to a sizable improvement in their current account position, “creditworthiness” was not restored; nor was there a reversal of the decline in bank lending. Reserves have to be built up first to earn “creditworthiness” and, for obtaining such a position, developing countries will have to either generate current account surpluses or depend upon other nonmarket sources.
95. Improvements in the operation of capital markets, whether through risk evaluation by banks or by increased deregulation, will not automatically improve the liquidity position of developing countries. In fact, the conditions that determine the availability of reserves through the capital markets are similar to the conditions that influence the performance of the borrowing countries or their “creditworthiness.” Improvement in reserves on which “creditworthiness” hinges, would take place only when the balance of payments position is strengthened. It is necessary to recognize that movements of exchange rates, inflation rates, and growth of output and trade that affect the balance of payments of these countries are themselves subject to the influence of the domestic policies pursued by major industrial countries. These policies have not been internationally consistent and coordinated and have therefore not promoted international adjustment.
96. The scope for international liquidity policy is, therefore, limited by the willingness of major countries to consider the international impact of their policies and to respond to the urgings made in the representative international fora. The Fund is given the tasks of overseeing the international monetary system and ensuring that members collaborate with the Fund and with other members in pursuit of the objective of “better international surveillance of international liquidity” (Article VIII, Section 7). Therefore, in addition to stricter surveillance over exchange rate and other macroeconomic policies of the major industrial countries, the Fund should be enabled to influence the liquidity needs of the world economy through a more efficient SDR creation and distribution than it has so far been able to do.
97. The Articles of Agreement of the Fund provide for creation of additional liquidity through the allocation of SDRs. The Second Amendment of the Articles of Agreement, which became effective as late as 1978, provides that the members of the Fund should collaborate with the objective of making the SDR “the principal reserve asset” in the international monetary system. The main purposes of the allocation of SDRs are: to meet the growing liquidity needs of the world, to make the supply of international liquidity less dependent on the settlement of balances of a few countries, and to enable nonreserve countries to acquire reserves without having to generate balance of payments surpluses.
98. The SDR has not yet assumed a major role in the international system mainly because of its meager allocation. So far only SDR 21.4 billion has been allocated. This constitutes 5.3 percent of the total non-gold reserves. There have been sporadic allocations in two basic periods but since 1981, in spite of a substantial liquidity shortage, there have been none.
99. There is also the need to improve the quality of the SDR as a reserve asset and as an increasingly acceptable unit of account in private transactions. The evolution of a multicurrency reserve system has not reduced the need for an internationally controlled reserve asset such as the SDR. On the contrary, SDRs would provide stability to the international system more effectively than the multicurrency reserves by reducing the effects of volatility of exchange rates. By assuring adequate supplies, the SDR system would obviate the necessity of depending on one or two countries for supply of international liquidity. Besides, the SDR has an important role to play in a system where borrowed reserves are not available for most countries facing severe balance of payments adjustment.
100. The ratio of non-gold reserves to imports, which constitutes one of the important indicators for the measurement of demand for reserves, continues to be around 21 percent, much lower than the 28 percent in 1982 and 23 percent in 1978, when the previous allocation in the third basic period was agreed. The modest rise in the non-gold reserves, evidenced recently, was from an extremely low level of 1982, and it occurred basically on account of a substantial accrual of such reserves to a handful of countries; in the case of nearly 30 out of 64 non-oil developing countries for which data are available up to 1984, the level of non-gold reserves was lower than that at the end of 1979. Many of them had reductions in their reserves ranging between 50 and 90 percent. In addition, curtailment of access to financial markets has seriously affected the availability of borrowed resources to many countries. This has compelled developing countries to carry larger reserves. Even among those countries which had increased their reserves, many had accomplished it not by large increases in export earnings, but by a substantial curtailment of imports. Currently, the ratio of non-gold reserves to aggregate trade imbalances is more or less at the same level as in 1980, which was the lowest since 1974. If total reserves including gold valued at market prices are reckoned, their proportions to imports and aggregate trade imbalances would still show declines since 1979. Total reserves of all countries had declined by about 19 percent over this period.
101. The recent World Economic Outlook exercise implied a continuing expansion of world trade in SDR terms throughout the remainder of the 1980s. Even if the non-gold reserve holdings were to rise to a level that establishes the average reserve ratio for the period 1973-83 (21.5 percent), they would have to grow at an annual rate of about 10 percent per annum until 1990 (or in six years), implying an increase of about SDR 300 billion. According to this calculation, the proposal contained in the 1984 Group of Twenty-Four Revised Program of an annual allocation of SDR 15 billion would be much lower than what is warranted by the long-term global need of liquidity.
102. One fear that has often been expressed is that SDR allocations would increase the stock of world reserves and fuel inflation. This fear, however, is not well founded. The supply of reserves is demand determined and the SDR is a substitute for other forms of reserves. The total reserve stocks do not rise in the long run as a result of additional allocations. The first round effect of an allocation may be increased spending by liquidity-constrained countries. But considering their magnitudes, it is far fetched to suppose that SDR allocations, even on a scale sufficient to satisfy the reserve accumulation needs of developing countries, would create excess demand and stimulate inflation in industrial countries. On the contrary, industrial countries should welcome a consequential increase in export demand from the developing countries, which would reduce the pressures created by their need to accommodate the improvement in the current account balance of the developing countries. The spillover effects of an SDR allocation on industrial countries would thus be positive.
103. The objective of making the SDR the principal reserve asset in the international monetary system, as expressed in Article VIII, Section 7, has not been promoted. On the contrary, SDRs constitute a smaller proportion of total reserves now than they did in 1976. Private use of the SDR too has languished. The motive for the original commitment to make the SDR the principal reserve asset was a desire to construct as symmetrical a system as possible, so as to avoid the tensions, instability, and inequity of arrangements in which one or a few countries supply reserve currencies and all other countries have to earn or borrow their reserves. There is no good reason for abandoning this objective, especially when the multiple currency reserve system has contributed to serious volatility and misalignment of exchange rates of major currencies.
104. To make the SDR the principal reserve asset as required under the Articles, SDRs should be issued on a regular annual basis with a view to ensuring that their proportion in reserves rises progressively. Such allocations would permit pursuit of adjustment policies without too much additional austerity in a number of developing countries and help stimulate demand for exports of developed countries.
105. Countries which do not have access to international financial markets are dependent on other sources of finance for acquisition of reserves in the absence of SDR allocations. Concessional financing could be a substitute for additional SDR allocation. But only limited sums of mildly concessional financing are at present available and that, too, on highly conditional terms. This source of financing is too inadequate to meet the reserve needs of these countries or even to promote “creditworthiness” to increase their access to capital markets. Only an unconditional SDR allocation could provide the required reserves strength for most of these countries. As the 1984 Group of Twenty-Four Revised Program has stressed, the unconditional use of SDRs must remain inviolate.
106. The circumstances governing the supply of liquidity differ sharply as between different groups of Fund members. Industrial countries have an interest in acquiring adequate reserves and their liquidity needs have been largely met by capital flows. With the withdrawal of commercial bank lending to developing countries, and if official finance is not raised substantially, the only way to meet the liquidity requirements of developing countries is by an adequate allocation of SDRs. In this context, a link between allocation of SDRs and development would not only meet the unfulfilled absorptive capacity of developing countries but also reduce the pressures on the industrial countries to accommodate an improvement in the current account balances of developing countries. While allocations to industrial countries do not augment their liquidity, those to developing countries would offer benefits to all members of the world community. It is, therefore, difficult to see any reason for not adopting the link.
Chapter VII: Role of the IMF
107. The purposes of the International Monetary Fund were set out in Article I of the Articles of Agreement, which remained much the same even after the two amendments to the Articles. The role of the Fund was to change depending on the changes in the international monetary and financial system so as to achieve those purposes.
108. During the past forty years, the Fund certainly played an important role in the pursuit of some of these purposes. But it was not very successful in fulfilling the aspirations of a large number of developing countries, which today hold over a third of the Fund’s voting power and an overwhelming majority of the Fund’s membership. Developments in the international economy in the late seventies and early eighties affected most countries adversely, and developing countries found to their cost that they were more vulnerable than others. As pointed out in the 1984 Group of Twenty-Four Revised Program, “the conventional response to the international monetary disarray has been to find ad hoc solutions. The result has been that we have lived from one crisis to another.”
109. The International Monetary Fund is expected to play a central role in the operation of the international monetary system. It provides a forum for consultation and cooperation in international monetary relations, but in many respects it falls far short of needs. Its surveillance so far has not ensured that the policies of major members are consistent with the requirements of international economic growth and financial stability; it has not been able to supplement adequately the stock of international reserves through SDR allocations and promote the SDR as the principal reserve asset as required under the Articles; while it tried to smooth the process of adjustment of international payments, with some success, its concept of adjustment has not always been found appropriate.
110. The previous chapters dealt with the Fund’s role in surveillance over member governments’ policies, and in the provision of international liquidity. This chapter discusses the Fund’s role in promoting balance of payments adjustments, the provision of required finance, its resource base, and related issues.
111. When discussing payments imbalances, it is conventional to distinguish between transitory imbalances, which should be financed, and persistent imbalances, which require both finance and adjustment. The Fund has a role to play in both of them.
Transitory Balance of Payments Problems
112. Transitory payments problems are met by international reserves, borrowing from capital markets, or drawing on Fund facilities. Because of the liquidity squeeze to which developing countries have been subjected, and their difficulty in borrowing from international capital markets, the Fund’s facilities have for some years been used much more by developing than by industrial countries.
113. The compensatory financing facility (CFF) was the Fund’s first attempt to relate the provision of its low-conditionality finance to the events outside the control of the borrowing country that produce export fluctuations and, thereby, a payments deficit which could be assumed to be transitory. It has been extensively used by developing countries, especially since the liberalization of access in 1976.
114. In 1981, compensatory finance was extended to cover increased costs of cereal imports as well as shortfalls in the value of export receipts. Instead of extending the principle of low-conditionality finance for deficits due to factors beyond the control of the members, the Fund has since 1983 proceeded to emasculate one of its most successful operations, by making access under the CFF highly conditional. The access limits were also reduced from 100 percent to 83 percent of quota. These were retrograde steps imposed at a time when developing countries were exceptionally short of liquidity.
115. The high conditionality in the CFF should be reversed and the access should be restored to 100 percent of quota, in order to diminish the vulnerability of developing countries to exogenous shocks. The CFF should be extended to cover not only the export shortfalls but also a deterioration in terms of trade that is quantifiable. Further, CFF drawings should be related to calculated shortfalls rather than to quotas. The CFF should compensate the full amount of the calculated shortfall, and should be offered on a virtually automatic basis. As recessions have tended to become deeper and the cycles longer in the recent past, the balance of payments stress on most developing countries has increased and therefore the repayment period of the CFF should be extended.
116. Large variability in interest rates in recent years had a severe impact on indebted developing countries. Therefore, a new facility to provide financing for interest rate increases needs to be introduced. Moreover, there is a strong case for creating a comprehensive CFF to provide low-conditionality finance to cover deficits resulting from any exogenous factor that can be presumed to be temporary. It would help countries to manage their economies rationally and to provide a countercyclical influence on the world economy. Different facilities, such as those relating to export earnings, cost of cereal imports, increase in interest rates, commodity specific export shortfalls as proposed by UNCTAD (United Nations Conference on Trade Development) or practiced by STABEX, could all be components of such a comprehensive facility.
Persistent Imbalances Requiring Adjustment
117. In contrast to transitory payments imbalances, deficits that threaten to be persistent require both large scale finance and adjustment. The Fund is enjoined by its Articles to promote adjustment without members resorting to measures destructive of national or international prosperity (Article I(v)). This requires that adjustment measures not invariably lead to lowering of economic growth and development in the deficit countries. Correction of deficits through deflationary measures should be considered only as a last resort.
118. Clearly, policies should be devised according to the nature of the underlying disequilibrium. If payments disequilibria arise from excess domestic demand, more restrained fiscal and monetary policies will be in order. If they arise from exchange rate misalignment, the appropriate remedy lies in correcting the exchange rate. In either case, the policies should try to minimize their adverse impact on the growth of real output and income distribution. However, in most cases, persistent payments disequilibria in developing countries are structural. Because of low short-run elasticities of substitution, a country producing raw materials will not be able to switch resources quickly into alternatives needed to restore equilibrium. External balance can then be achieved by lowering domestic demand, implying idle resources; but the preferred course would be structural adjustment which raises the economy’s capacity to produce tradables. When improvement of the trade balance requires a supply response, either through increasing productivity or provision of specific inputs and technology or expansion of capacity, demand restraint is rarely sufficient, and often not even a part of the appropriate response to a balance of payments disequilibrium.
119. Recognition of the need in many cases for supply response or structural adjustment contributed to the development of multiyear adjustment programs, and specifically to the creation of the EFF. However, the design of some of these programs has not always focused on promoting the necessary shifts of productive resources within the context of policies for investment and economic growth. Nor do they take into account the adverse consequences for income distribution or inflation in the short run.
120. Reorientation of conditionality criteria from demand deflation to growth-oriented structural adjustment implies a need to lengthen program periods and to increase the level of financing. In fact, it may at times be appropriate to finance a transitory deterioration in the payments balance, if imported raw materials and investment goods are needed to reactivate or expand capacity in the tradables sector. Moreover, longer programs provide an opportunity to ensure that the needed structural reforms are undertaken. There is the danger in a short-term stabilization effort that a transitory recovery of the balance of payments will be achieved through demand deflation, while necessary structural adjustments are neglected.
121. In the past two years there has been a considerable underplaying of the EFF, with more and more of the programs supported by the Fund being standby arrangements. This development could contribute to unnecessary economic destabilization in many developing countries. In fact, excepting in cases where imbalances to be corrected are of a comparatively mild nature, the EFF should be used extensively.
122. It is recognized that the balance of payments problems of most low-income countries are structural in nature, caused mainly by persistent deterioration in their terms of trade, their disproportionately large debt service burden, their decline in the flow of ODA, and their very limited capability to attract external resources from nonofficial sources. These problems have been seriously compounded by devastating droughts of unprecedented proportions that have hit many African countries. Of late, the majority of low-income countries have experienced net outflows of resources, including to the multilateral financial institutions. In view of the particularly difficult structural problems of these countries, it is essential that the Fund provide larger and longer-term financing in support of their structural adjustment programs than has been provided so far.
123. Some Fund programs have broken down in recent years because of excessively rigid performance criteria, which were not revised in the light of unforeseen developments beyond the control of the borrowing country. There is a need for greater flexibility in the application of such criteria. The Fund’s operations are dependent on the revolving character of its resources, and it is necessary that repayment obligations to the Fund are settled on time. In cases where the balance of payments situation, made adverse by exogenous factors, makes it practically impossible for a country to repay according to a fixed schedule, mechanical application of sanctions available under the Articles of Agreement would be self-defeating and would not serve the purpose for which the loan to the country concerned was made. It may be necessary for the Fund to be more flexible in the application of Article V, Section 7(g), which provides for postponement of obligations “because discharge on the due date would result in exceptional hardship for the member.” However, to help these countries become current in their obligations to the Fund, new mechanisms should be evolved, in collaboration with the World Bank and regional development institutions, to provide longer-term assistance for orderly adjustment of these countries.
Need for Concessionality in IMF Lending
124. It is recognized internationally that there is a need to provide finance at concessional rates to developing countries, especially the low-income countries. However, the burden of costs of Fund resources has fallen disproportionately on the borrowing countries in recent years. On account of inadequacy of Fund quotas, the Fund resorted to borrowing to supplement its own resources and, increasingly, to provide financing to borrowing members by using a mix of borrowed and quota resources, and passed on the cost of borrowed resources fully to borrowing members. Besides, due to the steep increases in the rate of charge to borrowers, the borrowing costs of developing countries have greatly increased in the recent years. The grant element in the rate of charge fell steeply from about 30 percent during 1980-82 to negligible levels currently.
125. While interest rates in international markets have been declining, Fund charges on the use of quota resources have been raised during the last two years. By discouraging low-income members from borrowing from the Fund at reasonable cost, the Fund’s capacity to promote orderly adjustment has been undermined. It is therefore important to establish facilities and mechanisms within the Fund, such as an interest subsidy account, on a stable basis to ameliorate the situation. Moreover, in view of the extremely difficult situation in which many developing countries are placed, it is necessary to revive the Trust Fund and to make concessional loans to eligible countries.
The Volume of IMF Resources
126. Because of the special role that the IMF is expected to play in the international adjustment process, quotas must remain the primary source of the Fund’s financial resources. However, the IMF quotas had, in the aggregate, formed only about 5 percent of total imports at the end of 1984, as against 12 percent in the sixties.
127. The ratios of Fund quotas to world trade and to current account deficits are useful indicators of the shortage of Fund resources. Both these ratios have been declining sharply. While non-gold reserves and international bank lending rose some six- or sevenfold between 1970 and 1982, the size of the IMF, as measured by the sum of the quotas, the borrowing arrangements, and the SDR allocations, increased only threefold and the quotas barely doubled. However measured, the quantitative contribution of the IMF to balance of payments financing and to world reserves has declined sharply both in relation to need and in relation to other sources.
128. During the Eighth General Review of Quotas, the majority of the Fund membership favored a doubling of the Fund quotas as being essential to enable the Fund to discharge its responsibilities. This recommendation did not take into account the increase needed due to the impact of the pressures on the balance of payments of the debtor countries from mid-1982 onwards and the withdrawal of new lending by commercial banks. The increase in quotas that was eventually adopted amounted to only 47.5 percent. Despite the inadequacy of the quota increase, normal annual access limits were reduced in stages from 150 percent to 95-102 percent of quota, from 450 percent to 280-395 percent, over three-year periods, and from 600 percent to 408 percent cumulatively. Higher limits were to be considered only in exceptional circumstances. Access limits were also reduced for the CFF from 100 percent to 83 percent of quota.
129. As a result, the adjustment programs undertaken by developing countries could not be financed adequately and had more stringent conditionality than was appropriate for the structural changes that their situations warranted. The inadequacy of resources stood in the way of the Fund playing its due role in financing and adjustment.
130. There is, therefore, the need for a substantial increase of quotas under the Ninth General Review, which should be advanced. In order to avoid the political and procedural difficulties of negotiating quota increases, it may be desirable to tie quotas to some appropriate measure of the size of the world economy. In the absence of such an automatic link, the normal interval between quota reviews should be reduced to three years.
131. Pending the Ninth General Review, it will be necessary for the Fund to supplement its resources adequately by resorting to borrowing, preferably from official sources, so that real access to Fund resources is not reduced in these difficult times. Until such time as the size of quotas bears an appropriate relationship to some appropriate measure of the size of the world economy, it is imperative to maintain the policy of enlarged access without dilution.
Enlarged Access Policy and Access Limits
132. The enlarged access policy of the Fund, introduced in 1981, has been a useful instrument in making finances available to a number of countries that were affected by large payments imbalances. Developing countries consider that despite some improvement in the world economy in the last two years, recovery has been weak, fragile, and uneven. The outlook for 1985 at present is, in fact, bleak. A large number of developing countries continue to experience serious balance of payments difficulties. There is no reason to believe that their requirements of financing will fall to permit a reversal of the policy of enlarged access. Indeed, they consider that the present access limits, are, as a result of the recent reductions, too meager and should be enhanced.
133. Developing countries consider that the policy of enlarged access cannot be dealt with appropriately except in conjunction with the question of adequacy of quotas. Until an appropriate relationship is reestablished between Fund quotas and size of the world economy, access limits should be enhanced.
134. The fact that the drawings on the Fund in 1984 were lower than in 1983 by no means implies that there was any reduction in the size of the members’ needs. One of the main reasons for the shortfall is the increasing difficulties faced by the member countries in meeting high conditionality and performance criteria of growing complexity, leading to suspension of many programs. In addition, the semiautomaticity of the CFF was replaced by reduced access and high conditionality. There was also a noticeable shift towards reduction in actual access in determining the amount of finance provided under Fund programs. Given the severe compression of imports in many countries in the past few years, output growth rates, imports, and the aggregate current account deficits would have been higher had there been additional external financing consistent with the countries’ longer-term debt-servicing capacity on suitable terms.
135. The external account prospects of developing countries will be subject to great uncertainties in the coming years. For many of the countries that have had adjustment programs with the Fund, continued Fund support will remain essential for their progress towards balance of payments viability. In addition to large interest repayments, the highly indebted countries face a large hump in debt servicing over the coming years which would require substantial financing. Even to mobilize funds from commercial banks, Fund financing may have to play a catalytic role.
136. Considering the continuing and serious strain on the international monetary system, heavy debt-service burdens on developing countries that are expected to become accentuated in the next few years, and the inadequacy of Fund resources to meet the requirements of members facing balance of payments difficulties, it is important that the criteria for activating the GAB be relaxed. The GAB and other similar arrangements, however, are not a substitute for adequate growth in quota resources.
137. Developing countries consider that coordination between the IMF and the World Bank should not lead to cross conditionality but should help further their mutual objectives of providing resources to developing countries. Closer contacts between the managements and staffs of the two institutions could help foster understanding of each other’s points of view. However, it would not be advisable to seek some kind of uniformity of advice. Such a step would be counter-productive, could lead to cross conditionality, would dilute the respective responsibilities of the two institutions, and could become a means of exerting a concerted pressure on borrowing developing countries. Any policy advice by these institutions would therefore have to be in keeping with their respective roles. If there were to be a coordination of policy advice on a country, it would be essential to obtain the country’s consent in this process.
138. As far as the World Bank is concerned, its primary role should continue to be one of commitment to development, growth, and poverty alleviation, as enshrined in its Articles of Agreement. Developing countries consider that there should not be an undue emphasis on conditional lending or increasing conditionality linked to the quantum of lending. The World Bank should play a role in supporting debtor countries so that adjustment in these countries takes place in an environment of growth. The Bank should take effective steps quickly to negotiate a General Capital Increase so as to enable its lending to be expanded sufficiently to fully meet the needs of developing countries. In this context, developing countries are concerned that the net transfers from the World Bank to them are projected to decline over the medium term and to turn negative by the end of the decade, a development which needs to be avoided by an institution whose main purpose is to transfer resources to developing countries to promote economic growth.
The Decision-Making Process
139. The 1984 Group of Twenty-Four Revised Program has made the following recommendations on the decision-making process in the international financial institutions, which the Deputies wish to reiterate:
The role of developing countries in the decision-making process in the international financial institutions needs to be substantially increased. The system of weighted voting has led to a situation where, after the Eighth Quota Review, developing countries as a group have no more than 38 percent of total votes. While the principle of weighted voting may be unavoidable in financial institutions, a better balance in the voting pattern is needed for a more equitable and effective functioning of these institutions.
The share of developing countries in the total votes in the multilateral financial institutions should be increased to 50 percent. For this purpose, consideration might be given to, inter alia, an increase in basic votes. The present geographical representation of developing country regions in the Boards of the Bank and the Fund should be preserved.
Chapter VIII: The Debt Problem and Transfer of Resources
Problems Relating to External Debt
140. External indebtedness of developing countries increased substantially during the seventies. This increase had four characteristics: first, private bank lending became the single most important channel for the transfer of resources from surplus to deficit countries; second, the conditions on which these credits were provided were harder and the maturities shorter than development financing provided by international development finance institutions; third, the bulk of debt was largely accounted for by a relatively small number of countries; and finally, bank financing flows and the conditions on which these were provided showed a procyclical pattern, tending to increase on softer terms when export commodity prices were favorable and to retrench and harden when export earnings declined.
141. As a result of these factors, by the beginning of the eighties the external debt situation of the developing countries had registered an overall deterioration in its average term structure, adding a huge servicing burden and a significant element of instability to the international monetary system. By the middle of 1982 a number of exogenous factors, which were described in the earlier chapters, combined to produce the debt crisis. Their effect was compounded by significant shortcomings in the policies of many debtor countries. Tightening of regulations by bank supervisory authorities may also have had an impact on the availability of bank finance. A crisis of confidence had developed regarding the ability of some major borrowers to meet their external commitments. It affected not only these countries but also other borrowers as well as the commercial lending institutions.
142. The combination of a decline in capital inflows with continuing high interest rates has resulted in massive negative resource transfers from the developing countries. For Latin America as a whole, debt-service payments to banks are estimated to have amounted to $30 billion in 1983 and $27 billion in 1984, requiring large trade surpluses to be generated.
143. Debtor countries have undertaken strenuous adjustment efforts in response to the external environment. The consequential adjustment process is having strong social and political consequences for many debtor countries, including a serious decline in their standards of living and a deterioration in their social fabric. In spite of their harsh adjustment efforts, external debt servicing continues to impose a very heavy burden. The situation requires imaginative solutions involving debt restructuring over the long term, and there is an urgent need to move towards a “positive” type of adjustment, consistent with sustained growth of output in the medium and the long run.
144. Capital flight has been an especially acute problem for several of these countries in recent years, accounting for a sizable proportion of their accumulated debt. It is recognized that unstable conditions in debtor countries have on occasion triggered such capital flows. But in order to ensure financial stability, developed countries should, through their regulatory agencies, support the efforts of the authorities of developing countries to discourage capital outflows from those developing countries which are facing acute capital flight problems.
145. Multiyear restructuring of bank debts has been a helpful development since it prevented a bunching of maturities. However, it does not by itself solve the debt problem, since, after restructuring, debtor developing countries are left with a major resource transfer problem due to debt-servicing requirements, a result with severe adverse effects on their economies. Moreover, this outcome also poses serious questions on the stability of the international monetary system. In this connection, urgent consideration may have to be given to evolving mechanisms that would roll over or refinance a certain proportion of interest payments, i.e., those above the long-term trend real rate of interest.
146. A question arises whether in the event of continuing or increasing reverse transfers (and they will increase as long as the rate of growth of net lending is less than the rate of interest), sufficient resources for expanding investment in export capacity will be available to these countries. If exports do not increase sufficiently, debt-service difficulties could increase over time. More broadly, the issue is whether heavily indebted countries can combine the attainment of satisfactory rates of growth with meeting debt-service payments in full. Several elements will have a bearing on the solution of this issue in a satisfactory manner. Among these are (a) the future rate of growth of the major industrial countries; (b) the international level of interest rates and the dollar rates; (c) the access of developing countries’ exports to industrial country markets and the expansion of world trade; (d) the flow of resources to developing countries from financial intermediaries, including international financial institutions; and (e) sustained adjustment efforts on the part of debtor countries over the medium term, coupled with reallocation of resources in favor of exports.
147. There are, however, considerable uncertainties regarding the manner in which each of these elements would develop. In fact, it would be easy to envisage circumstances in which the unfavorable evolution of one or more of these factors would have a cumulative adverse impact on the others. Thus, a slowdown in the world economy, higher rates of interest, and growing protectionism could add considerably to the heavy debt-service burden, posing the risk that for at least some debtors the situation would become unsustainable. Without clear signs of economic progress the governments of debtor countries would be faced with political and social pressures making it difficult for them to reconcile the objectives of restoring growth in their countries with the prospective payments of debt service.
148. Since the debt crisis may be seen as a result of excessive lending by the commercial banks, abrupt policy changes, and, in some cases, an unbalanced policy mix by industrial countries leading to historically high interest rates, and inadequate policies by many debtor countries, as well as realistic formulae and viable mechanisms for its solution need to be found. The problem requires the cooperation of debtor and industrial countries, commercial banks, and international financial institutions in the discharge of their respective responsibilities; also required is the co-responsibility of debtors and creditors, symmetry of adjustment, and cooperative efforts aimed at a durable solution to the debt problem in a global framework.
149. Present problems have arisen to a considerable extent due to the absence of adequate sources of development finance, which led many developing countries to resort to short- and medium-term financing from international capital markets. The sources of finance from capital markets are bound to be greatly reduced in the future. Besides, the earlier pattern of recycling, which had a destabilizing influence on the international monetary system, has generated serious doubts as to the adequacy of the role of commercial lending in the system. The lesson learned from recent experience is that heavy reliance on medium- and short-term borrowing for development financing is bound to give rise to liquidity problems in the medium term, even if such financing were directed to sound and viable projects. Consequently, there is a need to design new financing mechanisms for orderly resource transfer to developing countries, and, in this context, the need to expand the resource base of existing financial institutions such as the World Bank, the regional development banks, and the IMF becomes all the more imperative to enable them to play a much larger role in the recycling process in the years to come.
Trade and Finance
150. In recognition of the interdependence of money, finance, and trade in the global economy, it is important to emphasize the close relationship between expanding world trade and the solution of balance of payments problems, including the indebtedness of developing countries. Developed countries should therefore roll back protectionist measures, refrain from introducing new restrictions, and improve access for exports of developing countries to their markets.
Transfer of Resources to Developing Countries
151. The recent record regarding the transfer of real resources to developing countries has been disappointing. The transfer of resources from official sources has not even made up, in recent years, for the unprecedented losses incurred by developing countries on account of the adverse movements in their terms of trade and high interest rates. The quality and composition of aid have also witnessed a considerable deterioration.
152. In the low-income countries, slow growth does most to perpetuate and accentuate poverty. Most human development and poverty alleviation programs have long gestation lags and their output is not directly tradable and often is not even marketable. Commercial financing of such investment is unrealistic. The decline in official aid to low-income countries has resulted in underutilization of capacities, a slowdown of priority investments, and disruption of development projects.
153. Within the framework of official development assistance, the International Development Association (IDA) constitutes a major source of concessional assistance to developing countries, and has played a crucial role in the development of low-income countries through high net transfers, proven effective utilization of resources, alleviation of poverty, and provision of technical assistance. Resources made available to IDA through successive replenishments should represent a substantial increase in real terms. It is of vital importance to maintain the integrity of IDA and avoid the repetition of the regrettable experience of IDA VI and IDA VII. During the mid-term review to be conducted shortly by IDA, additional resources should be made available to restore the IDA VII Replenishment to US$12 billion. It is essential that funding for IDA VIII be substantially larger than that for IDA VI, and efforts should be made to restore the historical rates of growth in IDA. The negotiations for IDA VIII should be started at an early date.
154. There is an urgent need to accelerate the flow of concessional aid to developing countries. Developed countries which have not yet reached the internationally agreed target of 0.7 percent of GNP as official development assistance should, as agreed at UNCTAD VI, redouble their efforts to achieve that target as early as possible and in any case not later than in the second half of the decade. Each developed donor country should establish its program and make a binding commitment for the annual growth rate of official development assistance disbursements. This should result in a general increase in real terms and an improvement in the quality of official development assistance flows to developing countries. It should include program and quick-disbursing aid tailored to development and short-term requirements at macro and sectoral levels, respectively. It should increasingly cover local and recurrent costs; be untied to the maximum extent possible; and be provided on an assured, continuous, and predictable basis. In respect of low-income countries, Resolution 165 (S-IX) of the Trade and Development Board of UNCTAD, relating to the adjustment of terms of past bilateral official assistance so as to improve the net flows in appropriate forms and on highly concessional terms, should be implemented fully and expeditiously.
155. There is an equally urgent need to augment the flow of resources from multilateral development institutions. It is disquieting that at currently projected commitment levels of multilateral development institutions, and particularly the IBRD, both net disbursements and net transfers show a significant decline even in nominal terms. It is estimated that IBRD commitment levels would have to increase at an annual rate of at least 6.2 percent in real terms over the levels reached in FY 1983 if net disbursements and net transfers are to remain relatively steady. This would call for an increase of the capital base of the IBRD. It is essential to take immediate steps to negotiate a General Capital Increase of adequate size to permit the IBRD to expand its lending. Similarly, there is need to increase the capital base of the regional development institutions to ensure that their commitments increase at a satisfactory rate. In this context, it is imperative that donor countries channel a greater proportion of their development assistance through multilateral institutions and reaffirm their commitments to multilateralism.
156. Structural adjustment lending which is quick disbursing should be made less conditional to improve its usefulness to borrowing countries. There is need for an increase in program lending of multilateral financial institutions to at least 25 percent of total loans. The lending programs of these institutions should also become increasingly responsive to the overall priorities, and in particular to sectoral priorities, of the recipient developing countries.
157. The early implementation of the recommendations of the United Nations Conference on the Least Developed Countries held in Paris in September 1981 would go a long way towards relieving the plight of these countries. In particular, donor countries should attain, by 1985 or as soon as possible thereafter, the objective of 0.15 percent of their GNP as ODA for these countries within the overall target of 0.7 percent.
158. Sub-Saharan African countries have been facing particularly acute and persistent problems. The Special Assistance Facility established for sub-Saharan Africa is inadequate, and it is necessary to substantially increase the level and quality of its funding. And the program to tackle the problems of these countries must be urgently implemented.
1977 Decision and Document
1. The Executive Board has discussed the implementation of Article IV of the proposed Second Amendment of the Articles of Agreement and has approved the attached document entitled “Surveillance Over Exchange Rate Policies.” The Fund shall act in accordance with this document when the Second Amendment becomes effective. In the period before that date the Fund shall continue to conduct consultations in accordance with present procedures and decisions.
2. The Fund shall review the document entitled “Surveillance Over Exchange Rate Policies” at intervals of two years and at such other times as consideration of it is placed on the agenda of the Executive Board.
Decision No. 5392-(77/63)
April 29, 1977
Surveillance Over Exchange Rate Policies
Article IV, Section 3(a) provides that “The Fund shall oversee the international monetary system in order to ensure its effective operation, and shall oversee the compliance of each member with its obligations under Section 1 of this Article.”Article IV, Section 3(b) provides that in order to fulfill its functions under 3(a), “the Fund shall exercise firm surveillance over the exchange rate policies of members, and shall adopt specific principles for the guidance of all members with respect to those policies.” Article IV, Section 3(b) also provides that “The principles adopted by the Fund shall be consistent with cooperative arrangements by which members maintain the value of their currencies in relation to the value of the currency or currencies of other members, as well as with other exchange arrangements of a member’s choice consistent with the purposes of the Fund and Section 1 of this Article. These principles shall respect the domestic social and political policies of members, and in applying these principles the Fund shall pay due regard to the circumstances of members.” In addition, Article IV, Section 3(b) requires that “Each member shall provide the Fund with the information necessary for such surveillance, and when requested by the Fund, shall consult with it on the member’s exchange rate policies.”
The principles and procedures set out below, which apply to all members whatever their exchange arrangements and whatever their balance of payments position, are adopted by the Fund in order to perform its functions under Section 3(b). They are not necessarily comprehensive and are subject to reconsideration in the light of experience. They do not deal directly with the Fund’s responsibilities referred to in Section 3(a), although it is recognized that there is a close relationship between domestic and international economic policies. This relationship is emphasized in Article IV which includes the following provision: “Recognizing . . . that a principal objective [of the international monetary system] is the continuing development of the orderly underlying conditions that are necessary for financial and economic stability, each member undertakes to collaborate with the Fund and other members to assure orderly exchange arrangements and to promote a stable system of exchange rates.”
Principles for the Guidance of Member’s Exchange Rate Policies
A. A member shall avoid manipulating exchange rates or the international monetary system in order to prevent effective balance of payments adjustment or to gain an unfair competitive advantage over other members.
B. A member should intervene in the exchange market if necessary to counter disorderly conditions which may be characterized inter alia by disruptive short-term movements in the exchange value of its currency.
C. Members should take into account in their intervention policies the interests of other members including those of the countries in whose currencies they intervene.
Principles of Fund Surveillance over Exchange Rate Policies
1. The surveillance of exchange rate policies shall be adapted to the needs of international adjustment as they develop. The functioning of the international adjustment process shall be kept under review by the Executive Board and Interim Committee and the assessment of its operation shall be taken into account in the implementation of the principles set forth below.
2. In its surveillance of the observance by members of the principles set forth above, the Fund shall consider the following developments as among those which might indicate the need for discussion with a member:
(i) protracted large-scale intervention in one direction in the exchange market;
(ii) an unsustainable level of official or quasi-official borrowing, or excessive and prolonged short-term official or quasi-official lending, for balance of payments purposes;
(a) the introduction, substantial intensification, or prolonged maintenance, for balance of payments purposes, of restrictions on, or incentives for, current transactions or payments, or
(b) the introduction or substantial modification for balance of payments purposes of restrictions on, or incentives for, the inflow or outflow of capital;
(iv) the pursuit, for balance of payments purposes, of monetary and other domestic financial policies that provide abnormal encouragement or discouragement to capital flows; and
(v) behavior of the exchange rate that appears to be unrelated to underlying economic and financial conditions including factors affecting competitiveness and long-term capital movements.
3. The Fund’s appraisal of a member’s exchange rate policies shall be based on an evaluation of the developments in the member’s balance of payments against the background of its reserve position and its external indebtedness. This appraisal shall be made within the framework of a comprehensive analysis of the general economic situation and economic policy strategy of the member, and shall recognize that domestic as well as external policies can contribute to timely adjustment of the balance of payments. The appraisal shall take into account the extent to which the policies of the member, including its exchange rate policies, serve the objectives of the continuing development of the orderly underlying conditions that are necessary for financial stability, the promotion of sustained sound economic growth and reasonable levels of employment.
Procedures for Surveillance
I. Each member shall notify the Fund in appropriate detail within thirty days after the Second Amendment becomes effective of the exchange arrangements it intends to apply in fulfillment of its obligations under Article IV, Section 1. Each member shall also notify the Fund promptly of any changes in exchange arrangements.
II. Members shall consult with the Fund regularly under Article IV. The consultations under Article IV shall comprehend the regular consultations under Articles VIII and XIV. In principle such consultations shall take place annually, and shall include consideration of the observance by members of the principles set forth above as well as of a member’s obligations under Article IV, Section 1. Not later than three months after the termination of discussions between the member and the staff, the Executive Board shall reach conclusions and thereby complete the consultation under Article IV.
III. Broad developments in exchange rates will be reviewed periodically by the Executive Board, inter alia in discussions of the international adjustment process within the framework of the World Economic Outlook. The Fund will continue to conduct special consultations in preparing for these discussions.
IV. The Managing Director shall maintain close contact with members in connection with their exchange arrangements and exchange policies, and will be prepared to discuss on the initiative of a member important changes that it contemplates in its exchange arrangements or its exchange rate policies.
V. If, in the interval between Article IV consultations, the Managing Director, taking into account any views that may have been expressed by other members, considers that a member’s exchange rate policies may not be in accord with the exchange rate principles, he shall raise the matter informally and confidentially with the member, and shall conclude promptly whether there is a question of the observance of the principles. If he concludes that there is such a question, he shall initiate and conduct on a confidential basis a discussion with the member under Article IV, Section 3(b). As soon as possible after the completion of such a discussion, and in any event not later than four months after its initiation, the Managing Director shall report to the Executive Board on the results of the discussion. If, however, the Managing Director is satisfied that the principles are being observed, he shall informally advise all Executive Directors, and the staff shall report on the discussion in the context of the next Article IV consultation; but the Managing Director shall not place the matter on the agenda of the Executive Board unless the member requests that this procedure be followed.
VI. The Executive Directors shall review annually the general implementation of the Fund’s surveillance over members’ exchange rate policies.
. . . .
3. Supplemental surveillance procedure. . . . Whenever the Managing Director considers that a modification in a member’s exchange arrangements or exchange rate policies or the behavior of the exchange rate of its currency may be important or may have important effects on other members, whatever the member’s exchange arrangement may be, he shall initiate informally and confidentially a discussion with the member before the next regular discussion under Article IV. If he considers after this prior discussion that the matter is of importance, he shall initiate and conduct an ad hoc consultation with the member and shall report to the Executive Board, or informally advise the Executive Directors, on the consultation as promptly as the circumstances permit after conclusion of the consultation. This procedure will supplement the proceedings in Executive Board Decision No. 5392-(77/63), adopted April 29, 1977.
Decision No. 6026-(79/13)
January 22, 1979
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Occasional Papers of the International Monetary Fund
2. Economic Stabilization and Growth in Portugal, by Hans O. Schmitt. 1981.
5. Trade Policy Developments in Industrial Countries, by S.J. Anjaria, Z. Iqbal, L.L. Perez, and W.S. Tseng. 1981.
6. The Multilateral System of Payments: Keynes, Convertibility, and the International Monetary Fund’s Articles of Agreement, by Joseph Gold. 1981.
7. International Capital Markets: Recent Developments and Short-Term Prospects, 1981, by a Staff Team Headed by Richard C. Williams, with G.G. Johnson. 1981.
8. Taxation in Sub-Saharan Africa. Part I: Tax Policy and Administration in Sub-Saharan Africa, by Carlos A. Aguirre, Peter S. Griffith, and M. Zühtü Yücelik. Part II: A Statistical Evaluation of Taxation in Sub-Saharan Africa, by Vito Tanzi. 1981.
9. World Economic Outlook: A Survey by the Staff of the International Monetary Fund. 1982.
10. International Comparisons of Government Expenditure, by Alan A. Tait and Peter S. Heller. 1982.
11. Payments Arrangements and the Expansion of Trade in Eastern and Southern Africa, by Shailendra J. Anjaria, Sena Eken, and John F. Laker. 1982.
12. Effects of Slowdown in Industrial Countries on Growth in Non-Oil Developing Countries, by Morris Goldstein and Mohsin S. Khan. 1982.
13. Currency Convertibility in the Economic Community of West African States, by John B. McLenaghan, Saleh M. Nsouli, and Klaus-Walter Riechel. 1982.
14. International Capital Markets: Developments and Prospects, 1982, by a Staff Team Headed by Richard C. Williams, with G.G. Johnson. 1982.
15. Hungary: An Economic Survey, by a Staff Team Headed by Patrick de Fontenay. 1982.
16. Developments in International Trade Policy, by S.J. Anjaria, Z. Iqbal, N. Kirmani, and L.L. Perez. 1982.
17. Aspects of the International Banking Safety Net, by G.G. Johnson, with Richard K. Abrams. 1983.
18. Oil Exporters’ Economic Development in an Interdependent World, by Jahangir Amuzegar. 1983.
19. The European Monetary System: The Experience, 1979–82, by Horst Ungerer, with Owen Evans and Peter Nyberg. 1983.
20. Alternatives to the Central Bank in the Developing World, by Charles Collyns. 1983.
22. Interest Rate Policies in Developing Countries: A Study by the Research Department of the International Monetary Fund. 1983.
23. International Capital Markets: Developments and Prospects, 1983, by Richard Williams, Peter Keller, John Lipsky, and Donald Mathieson. 1983.
24. Government Employment and Pay: Some International Comparisons, by Peter S. Heller and Alan A. Tait. 1983. Revised 1984.
25. Recent Multilateral Debt Restructurings with Official and Bank Creditors, by a Staff Team Headed by E. Brau and R.C. Williams, with P.M. Keller and M. Nowak. 1983.
26. The Fund, Commercial Banks, and Member Countries, by Paul Mentre. 1984.
27. World Economic Outlook: A Survey by the Staff of the International Monetary Fund. 1984.
28. Exchange Rate Volatility and World Trade: A Study by the Research Department of the International Monetary Fund. 1984.
29. Issues in the Assessment of the Exchange Rates of Industrial Countries: A Study by the Research Department of the International Monetary Fund. 1984
30. The Exchange Rate System—Lessons of the Past and Options for the Future: A Study by the Research Department of the International Monetary Fund. 1984
31. International Capital Markets: Developments and Prospects, 1984, by Maxwell Watson, Peter Keller, and Donald Mathieson. 1984.
32. World Economic Outlook, September 1984: Revised Projections by the Staff of the International Monetary Fund. 1984.
33. Foreign Private Investment in Developing Countries: A Study by the Research Department of the International Monetary Fund. 1985.
34. Adjustment Programs in Africa: The Recent Experience, by Justin B. Zulu and Saleh M. Nsouli. 1985.
35. The West African Monetary Union: An Analytical Review, by Rattan J. Bhatia. 1985.
36. Formulation of Exchange Rate Policies in Adjustment Programs, by a Staff Team Headed by G.G. Johnson. 1985.
37. Export Credit Cover Policies and Payments Difficulties, by Eduard H. Brau and Chanpen Puckahtikom. 1985.
38. Trade Policy Issues and Developments, by Shailendra J. Anjaria, Naheed Kirmani, and Arne B, Petersen. 1985.
39. A Case of Successful Adjustment: Korea’s Experience During 1980-84, by Bijan B. Aghevli and Jorge Marquez-Ruarte. 1985.
40. Recent Developments in External Debt Restructuring, by K. Burke Dillon, C. Maxwell Watson, G. Russell Kincaid, and Chanpen Puckahtikom. 1985.
41. Fund-Supported Adjustment Programs and Economic Growth, by Mohsin S. Khan and Malcolm D. Knight. 1985.
42. Global Effects of Fund-Supported Adjustment Programs, by Morris Goldstein. 1986.
43. International Capital Markets: Developments and Prospects, by Maxwell Watson, Donald Mathieson, Russell Kincaid, and Eliot Kalter. 1986.
44. A Review of the Fiscal Impulse Measure, by Peter S. Heller, Richard D. Haas, and Ahsan H. Mansur. 1986.
45. Switzerland’s Role as an International Financial Center, by Benedicte Vibe Christensen. 1986.
46. Fund-Supported Programs, Fiscal Policy, and Income Distribution: A Study by the Fiscal Affairs Department of the International Monetary Fund. 1986.
47. Aging and Social Expenditure in the Major Industrial Countries, 1980-2025, by Peter S. Heller, Richard Hemming, Peter W. Kohnert, and a Staff Team from the Fiscal Affairs Department. 1986.
48. The European Monetary System: Recent Developments, by Horst Ungerer, Owen Evans. Thomas Mayer, and Philip Young. 1986.
49. Islamic Banking, by Zubair Iqbal and Abbas Mirakhor. 1987.
50. Strengthening the International Monetary System: Exchange Rates, Surveillance, and Objective Indicators, by Andrew Crockett and Morris Goldstein. 1987.
International Monetary Fund, Washington. DC, 20431, U.S.A.
Telephone number 202 623-7430
Cable address: Interfund
“Communique of the Interim Committee of the Board of Governors of the International Monetary Fund,” paragraph 10, International Monetary Fund, Press Release No. 85/33, October 7, 1985.
“The Functioning of the International Monetary System: A Report to the Ministers and Governors by the Deputies of the Group of Ten,” June 1985, published in IMF Survey, Supplement on the Fund (Washington), Vol. 14 (July 1985). “The Functioning and Improvement of the International Monetary System: Report of the Deputies of the Group of Twenty-Four,” August 1985, published in the IMF Survey, Supplement on the Fund (Washington), Vol. 14 (September 1985). The reports are reproduced in the Appendix and are referred to in this paper as the Group of Ten Report and the Group of Twenty-Four Report.
Group of Ten Report, paragraph 97.
Group of Ten Report, paragraph 14.
Group of Ten Report, paragraph 97.
Group of Twenty-Four Report, paragraph 2.
Group of Twenty-Four Report, paragraph 3.
Group of Twenty-Four Report, paragraph 5.
Group of Ten Report, paragraph 32.
Group of Twenty-Four Report, paragraph 5.
Group of Twenty-Four Report, paragraph 78.
Group of Ten Report, paragraph 38.
Another potential area of interconnection is that between the exchange rate system and international liquidity. For example, proposals for liberalization of capital markets or for greater use of official intervention in exchange markets cannot be divorced from questions concerning the quantity and composition of international reserves. Still, the present study makes the assumption that many issues in the evaluation of the exchange rate system can be better discussed within the bounds of existing reserve and liquidity arrangements.
“It [volatility of exchange rates] has discouraged investment and trade by adding to financial risks for investors and traders,” Group of Twenty-Four Report, paragraph 61.
“Exporters and importers in these countries [developing countries] are exposed to high exchange risks in the absence of well-developed financial markets, especially forward cover arrangements. The destabilizing uncertainties of floating rates have increased the reserve and capital needs of developing countries from the levels which would otherwise exist,” Group of Twenty-Four Report, paragraph 63.
“. . . Foreign exchange markets appear to have developed effective hedging techniques available to most operators to reduce the risks associated with exchange rate volatility, generally at comparatively little cost,” Group of Ten Report, paragraph 16.
This definition is similar to those found in Nurkse (1945), International Monetary Fund (1970), and the Group of Twenty-Four Report, paragraph 69.
The real effective exchange rate used for these calculations is the relative normalized unit labor cost in manufacturing.
“. . . exchange rate determination has been increasingly influenced by conditions in capital markets, including relative interest rates and expectations regarding the impact of national policies and current and future economic performance,” Group of Ten Report, paragraph 18. “Much of the medium-term movement in real exchange rates reflects not the changing pattern of competitiveness but rather the result of differences in fiscal and monetary policies. . .,” Group of Twenty-Four Report, paragraph 62.
“Misalignment inevitably produces either idle resources or wasteful shifts back and forth between tradables and nontradables. It becomes a potent source of pressures for protectionism,” Group of Twenty-Four Report, paragraph 62.
See, for example, Bond and Knobl (1982).
All these figures on manufacturing employment are drawn from Obstfeld (1985).
“It [the present exchange rate system] has not prevented inadequate policies and divergent economic performance which have contributed to a high degree of short-term volatility of nominal exchange rates and to large medium-term movements in real exchange rates,” Group of Ten Report, paragraph 5. “This [improved functioning of the exchange rate system] implies greater effort on the part of the developed countries to achieve a substantial degree of discipline and coordination in the conduct of their national policies,” Group of Twenty-Four Report, paragraph 65.
“In the recent past, their [industrial countries] uncoordinated attempts to disinflate led to excessive emphasis being given to monetary restriction relative to other instruments. The result was a halting process of recovery with high real interest rates and low commodity prices having particularly adverse effects on the developing countries,” Group of Twenty-Four Report, paragraph 72.
An alternative point of view, inspired by the recent experience of the United States, is that strains in the traded goods sector tend to lead to protectionist pressures more than to fiscal restraint.
See, for example, Obstfeld (1985).
See Polak (1981) for an expansion of both these points.
“It would be misleading to draw definite conclusions on the merits and demerits of the present system merely by comparing economic performance in the period of floating with that recorded under the par value system. Conditions during the floating rate period have been different in too many respects to allow such a comparison to be meaningful,” Group of Ten Report, paragraph 13.
Group of Ten Report, paragraph 14.
An implicit assumption in this argument is that it is more difficult to alter the relative price of tradables in the presence of a relatively rigid nominal exchange rate.
International Monetary Fund (1984a) and Goldstein and Khan (1985).
See International Monetary Fund (1984c) and Shafer and Loopesko (1983).
See International Monetary Fund (1984b), (1984c), and Williamson (1985).
“It [the surveillance function of the IMF] has so far been largely ineffective on major industrial countries, resulting in asymmetry in the international adjustment process, the burden of which has fallen disproportionately on developing countries,” Group of Twenty-Four Report, paragraph 9.
“It [exchange rate depreciation] . . . could also . . . stimulate cost inflation. . . . It is much less useful in countries that have to rely on exports of traditional agricultural and mineral commodities. . . .” Group of Twenty-Four Report, paragraph 87. “. . . the degree of exchange rate stability deemed appropriate differs from country to country,” Group of Ten Report, paragraph 11.
“. . . the Deputies recognize that no exchange rate system can provide full insulation from the effects of economic policies and performance in other countries,” Group of Ten Report, paragraph 22.
Fiscal disturbances would be described as real disturbances in the classification presented above.
“It [exchange rate flexibility] can help countries, especially the larger ones, to insulate their domestic price levels from inflation abroad. . .,” Group of Ten Report, paragraph 14.
A counter-argument of the supporters of the Bretton Woods system is that the collapse of that system reflected not any intrinsic design flaws but rather faulty implementation. In particular, the system was undermined by “excessive” fixity in nominal exchange rates that produced large misalignments in key-currency real exchange rates.
See Swoboda (1983) and International Monetary Fund (1984c).
“Intervention . . . could be used on a meaningful scale, without confining it to ‘leaning against the wind,’ towards the end of exchange rate stability, as a complementary measure to other policies, and sometimes in coordination with other countries,” Group of Twenty-Four Report, paragraph 67.
Group of Ten Report, paragraph 14.
See Black (1980) and International Monetary Fund (1984c).
“Exchange rate stability should be an important objective of policy instead of being a residual of other policy actions of individual countries, as is the case at present,” Group of Twenty-Four Report, paragraph 65.
Group of Ten Report, paragraph 14.
“The functioning of the present floating rate system has thus not been able to provide . . . a framework that facilitates the exchange of goods, services, and capital among countries, which sustains sound economic growth and helps develop orderly underlying conditions necessary for financial and economic stability,” Group of Twenty-Four Report, paragraph 64.
International Monetary Fund (1984c).
Group of Twenty-Four Report, paragraph 66.
Group of Ten Report, paragraph 32. A more thorough treatment of the target zone proposal, particularly of its technical and operational aspects, can be found in Frenkel and Goldstein (1986).
Group of Ten Report, paragraph 31.
Group of Twenty-Four Report, paragraph 67.
Existing procedures do not rely on the assessment of appropriate zones but rather use as a starting point the last occasion on which exchange rate developments were brought to the attention of the Executive Board. In addition, this reporting and monitoring procedure has not led to any Board discussions.
“. . . commitment to [target zones for exchange rates of major countries]. . . would promote greater international policy consistency,” Group of Twenty-Four Report, paragraph 66.
“They [target zones] could . . . trigger consultations that would induce step by step, more direct links between domestic policies and exchange rate considerations,” Group of Ten Report, paragraph 31.
“They [some Deputies] further believe that credible commitments to target zones would contribute to stabilizing market expectations. . .,” Group of Ten Report, paragraph 31.
Group of Ten Report, paragraph 31.
Group of Ten Report, paragraph 31.
“Most Deputies, however, are of the view that reaching a consensus on the range of desirable exchange rates [for target zones] would prove extremely difficult,” Group of Ten Report, paragraph 32.
“Given our imperfect knowledge of the determinants of exchange rate movements, the target zones would have to be too wide to serve as an anchor for expectations,” Group of Ten Report, paragraph 32.
“Above all, the constraints imposed on domestic policies by target zones might undermine efforts to pursue sound and stable policies in a medium-term framework,” Group of Ten Report, paragraph 32.
Group of Ten Report, paragraph 30.
Supporters of target zones deny that an intelligent application of target zones would produce such perverse policy prescriptions. In their view, the political pressures that would emanate from repeated breaches of the zones would yield the appropriate corrective policies, both as regards the stance and mix of policies.
Group of Ten Report, paragraph 24.
Proponents of target zones might reply that successful policy coordination, whatever the exchange rate regime, requires precisely such “unusual” political commitment.
See particularly “The Report of the Technical Group on Indicators,” International Monetary Fund (1974).
Kenen (1985, p. 11), for example, in weighing options for reforming the international monetary system concludes: “. . . it should be much easier, technically and politically, for governments to collaborate in managing exchange rates than to coordinate their monetary and fiscal policies in a timely manner.”
Group of Ten Report, paragraph 97.
Group of Ten Report, paragraph 36.
Group of Ten Report, paragraph 28.
Group of Ten Report, paragraph 28.
Group of Ten Report, paragraph 29.
Group of Ten Report, paragraph 33.
Group of Ten Report, paragraph 38.
Group of Ten Report, paragraph 51.
Group of Ten Report, paragraph 27.
Group of Ten Report, paragraph 25.
“In the meantime, a mechanism has to be devised to enforce policy coordination among the major industrial countries,” Group of Twenty-Four Report, paragraph 5.
Group of Twenty-Four Report, paragraph 70.
Group of Twenty-Four Report, paragraph 87.
The Executive Board Decision adopting the document (No. 5392-77/63) was taken on April 29, 1977 and took effect when the Second Amendment to the Articles entered into force on April 1, 1978. See Selected Decisions of the International Monetary Fund and Selected Documents (Washington: IMF, twelfth issue, 1986), p. 10. The document is given in full in Appendix III.
It is also provided that there should be annual reviews of the manner in which the surveillance decision is implemented.
Executive Board Decision No. 4232-(74/67), in Selected Decisions of the International Monetary Fund.
See IMF Survey (Washington), Vol. 15 (January 19, 1976).
Decision No. 6026-(79/13), Selected Decisions of the International Monetary Fund, p. 15.
See International Monetary Fund, Exchange Rate Volatility and World Trade, Occasional Paper No. 28 (Washington, July 1986); M.A. Akhtar and R.S. Hilton, “Exchange Rate Uncertainties and International Trade,” Research Paper No. 8403 (New York, Federal Reserve Bank of New York, May 1984); and Padma Gotur, “Effects of Exchange Rate Volatility on Trade: Some Further Evidence,” Staff Papers, International Monetary Fund (Washington), Vol. 32 (September 1985), pp. 475-512.
See “Report of the Working Group on Exchange Market Intervention” (chaired by P. Jurgensen), January 1983.
For a discussion of these issues, see “Review and Assessment of the System of Floating Exchange Rates,” chapter I of this Occasional Paper.
A report prepared for the Committee of Twenty by the Technical Group on Indicators discussed a number of technical problems concerning indicators in the adjustment process. (See “Documents of the Committee of Twenty” (Washington: International Monetary Fund, 1974), pp. 51-77.)
See “Issues in the Assessment of the Exchange Rates of Industrial Countries,” International Monetary Fund Occasional Paper No. 29 (Washington: IMF, July 1984).
The projections published by the Fund staff in its World Economic Outlook series are based on the working assumption that there will be no change in competitiveness from some base date. It is nevertheless of considerable importance to estimate how the lagged effects of changes in competitiveness that occurred prior to that date will affect balance of payments patterns.
This means that the “statistical discrepancy” in world balance payments statistics would have to be appropriately allowed for.
The trade balance is another indicator of external developments that often attracts attention, particularly in the context of the need for trade liberalization and market access. The trade balance is also useful as a leading indicator of developments in the overall current account, since data related to trade are usually available on a more timely basis. In general, however, there seems little economic reason for drawing a distinction between trade in goods and trade in services.
For a review of the staff methodology for making cyclical adjustments to changes in the fiscal position, see “A Review of the Fiscal Impulse Measure,” by Peter S. Heller, Richard D. Haas, and Ahsan S. Mansur, International Monetary Fund Occasional Paper No. 44 (Washington: IMF, May 1986).
See Artus, J.R. and A.K. McGuirk, “A Revised Version of the Multilateral Exchange Rate Model,” Staff Papers, International Monetary Fund (Washington), Vol. 28 (June 1981), pp. 275-309.