Surveillance lies at the heart of the IMF’s efforts to help prevent economic and financial crises. The Fund has taken a variety of measures in recent years to strengthen its surveillance, reflecting the changing global environment, including the increased importance of international capital flows, and drawing on the lessons of international financial crises. These initiatives aim to encourage members to adopt policies and institutional reforms that make their economies more resilient to potentially harmful developments and financial stress, support sustained and balanced global growth, and contribute to a more stable international financial system.

Issues related to economic and financial globalization were the subject of two IMF conferences and an informal Board seminar in FY2003 (see Box 2.1).

During FY2003, the IMF reviewed several of these key measures and took a number of additional steps to enhance its surveillance and contribution to crisis prevention:

• The Board undertook reviews of the IMF’s strategy for enhancing the effectiveness of its surveillance, and determined ways to carry the agenda forward.

• Management and staff continued to develop a system for assessing crisis vulnerabilities in countries that are potentially exposed to capital account shocks. This system enables the staff to pull together, for internal use, information on global economic and market developments, analyses of vulnerabilities and financing scenarios, early warning indicators, financial soundness indicators, information on vulnerabilities in specific sectors, and market intelligence to judge the likelihood of incipient crises and consider policies to forestall them.

• The Board proposed several improvements to assessment exercises under the IMF’s standards and codes initiative and the joint IMF-World Bank Financial Sector Assessment Program (FSAP).

• Executive Directors broadly supported proposals to enhance data provision for surveillance purposes.

• A new analytical framework for debt sustainability assessments was adopted in June 2002 and by end-April 2003 was being used in surveillance reports for members with significant capital market access, as well as in reports on members’ requests for use of the IMF’s general resources.

• In April 2003, the Board endorsed further measures to strengthen surveillance in program countries, partly in response to the Independent Evaluation Office’s report on the prolonged use of IMF resources. (See Chapter 4 for more details on the IEO report.)

• The IMF took steps to clarify the signals it conveys to official and private creditors about the strength of a member’s policies.

• The IMF significantly advanced its contribution to combating money laundering and the financing of terrorism, including through the start of a 12-month pilot program in October 2002.

Follow-Up to 2002 Biennial Surveillance Review and Steps Forward

The financial year saw two follow-up discussions by the Executive Board of the 2002 Biennial Review of Surveillance. The first, in July 2002, led to several conclusions: endorsement of a new guidance note for staff on surveillance, agreement on a first step toward enhanced assessment of the impact of the IMF’s policy advice, and measures to strengthen surveillance in program countries. The second discussion, in March 2003, was a more comprehensive follow-up: the Board revisited the conclusions of earlier reviews, took stock of the range of initiatives already undertaken to strengthen surveillance, and discussed a number of areas where further work would be helpful.

Past reviews, Directors noted, pointed to five key ingredients of effective surveillance:

• timely, comprehensive, and accurate information;

• focused, high-quality analysis

• openness to different perspectives to minimize the risk of “tunnel vision”

• effective communication of assessments to the authorities and the public; and

• desired impact on members’ policy decisions

They observed that, building on the lessons learned from the Mexican and Asian crises of the 1990s, a range of steps has been taken in recent years to shape

IMF surveillance to better meet these criteria. Nevertheless, there is scope for further progress in these ongoing efforts, including the following:

• improving data provision to the IMF and data dissemination to the public;

• achieving more systematic financial sector surveillance—in particular, through the Financial Sector Assessment Program (FSAP); and

• strengthening assessments of policy frameworks and institutions against internationally recognized standards and codes.

In addition, vulnerability assessments have been significantly bolstered, with better analyses of debt sustainability and capital account developments, and more consideration of market participants’ perspectives. Surveillance in program countries is being strengthened by ensuring that economic conditions and policies are reassessed from a fresh perspective. Moreover, regional surveillance is being reinforced by the multilateral surveillance missions to major emerging market financial centers conducted by the International Capital Markets Department to gather market participants’ views on the vulnerabilities facing emerging market economies.

Building on the Success of the Standards and Codes Initiative and the FSAP

The Executive Board conducted reviews of both the Standards and Codes Initiative and the financial Sector Assessment Program in March 2003 (see Box 2.2). These initiatives were significantly enriching IMF surveillance, Directors found, and member countries indicated that they had benefited from participation in the initiatives.

For the standards and codes initiative, Directors agreed that going forward, coverage should be more selective, focusing on the countries and standards expected to have the highest payoff in improving domestic and international financial stability and strengthening institutional capacity. In addition, Reports on the Observance of Standards and Codes (ROSCs) will be expected to focus more sharply on main conclusions and recommendations, with greater attention to follow-up.

In the case of the FSAP, Directors observed that there is scope for streamlining the assessment exercises. In addition, priority should continue to be given to industrial countries and emerging market economies of systemic importance, while maintaining a balanced coverage of countries. The program remained the foundation for strengthened financial sector surveillance, Directors agreed, but it should be complemented with other tools—such as FSAP updates, more participation of specialized financial sector staff in Article IV missions, and off-site monitoring, including through financial soundness indicators—to achieve more continuous surveillance, especially of systemically important countries. To make resources available for these activities, Directors proposed a moderate reduction in the annual number of FSAP assessments and reassessments—while continuing to expect that the entire membership would participate in the program over time—coupled with greater variation in the scope of FSAP assessments according to country circumstances. The proposed greater focus on medium-term and structural issues in low-income countries with small financial systems was welcomed by Directors. It was also noted that for least developed countries with nascent diversified financial systems, the more immediate need might be technical assistance to develop the financial sector, rather than a resource-intensive detailed FSAP.

Data Provision for Surveillance Purposes

The IMF’s member countries supply the data that the Fund needs to oversee their economic policies. Members are required to provide such data under the IMF’s Articles of Agreement. Crises in emerging market economies since the mid-1990s have made clear the importance of comprehensive, timely, and accurate economic and financial data—including on international reserves, external debt, and capital flows—for assessing countries’ external vulnerabilities and as an essential element of surveillance.

To guide members in disseminating their economic and financial data to the public, the IMF created data standards, the Special Data Dissemination Standard (SDDS) and the General Data Dissemination System (GDDS); see Box 2.2. These standards contribute to the pursuit of sound macroeconomic policies and the smooth functioning of financial markets.

In May 2002, the Board met to discuss the provision of data to the IMF for surveillance purposes. Directors welcomed recent improvements in members’ data provision to the IMF for surveillance purposes. They reaffirmed the IMF’s policy on data provision whereby all members are required to provide a minimum set of core data, consistent with their capacity. Beyond this, member countries are expected to supply the data appropriate to their individual characteristics and circumstances.

Directors broadly supported IMF staff proposals to enhance the provision of data needed by the Fund for surveillance purposes. Highlights of the discussion included:

Issues regarding moving to weekly dissemination of data on international reserves under the SDDS, Frequent and timely disclosure of reserves data to the public is emerging as a best practice for many countries, Directors remarked. However, increasing frequency and timeliness in the data requirements of the SDDS is not now necessary, most Directors considered, noting also that moving to weekly data would raise technical and resource constraints for most subscribers and could deter new subscribers. Directors will have an opportunity to return to this issue later in 2003.

Improving provision of fiscal data. Directors stressed the critical importance of the IMF’s being provided with adequate fiscal data, and asked the staff to continue working on improving the provision of these data. They welcomed the recent completion of the Government Finance Statistics Manual, Manual, which represents a major advance in the development of an analytical framework for fiscal data, and they supported giving IMF technical assistance to countries to help them adopt the practices set out in the new manual.

Identifying gaps in data for vulnerability assessments and national policymaking. Recent improvements in Article IV report discussions of countries’ vulnerabilities, particularly for countries with access to international capital markets, were welcomed by the Board. Nevertheless, data deficiencies in many cases continued to hamper vulnerability analysis, and most Directors agreed that staff reports should more clearly identify gaps in data and technical assistance priorities during Article IV consultations and discuss progress in compiling data needed for vulnerability assessments, as relevant.

The Board noted that the cost implications of these enhancements for member countries as well as for the IMF will require careful prioritization and sequencing. They stressed that efforts to increase the frequency of data provision should not come at the expense of quality.

Signaling Assessments of Members’ Policies

The IMF’s interactions with member countries can have an important signaling function. Most of these interactions take place in the context of IMF surveillance and the IMF’s financial support of policy programs. However, on occasion the IMF has responded to requests from member countries for special monitoring that goes beyond surveillance but does not involve an IMF financial arrangement. Some of these monitoring mechanisms were specifically intended to provide signals to official or private creditors. In recent years, such monitoring has mainly taken the form of staff-monitored programs (SMPs), under which no funds are lent but IMF staff follow a member’s economic program and meet regularly with the country’s authorities to discuss economic developments and policies.

During the discussion of the 2002 Biennial Review of the IMF’s Surveillance, Directors expressed concerns about certain aspects of these programs. A follow-up discussion took place in January 2003 based on a paper entitled Signaling Assessments of Members’ Policies. Experience with another signaling mechanism—assessments of members’ policies provided in response to ad hoc requests from various official creditors or donors—was also discussed.

Concerns about SMPs relate mainly to SMPs that are used to convey signals on a member’s policies to official and/or private creditors, Directors agreed. Given the close formal resemblance to IMF-supported programs, these “signaling” SMPs risk being misinterpreted as carrying the IMF’s seal of approval. Moreover, relatively lax standards for reporting on performance have allowed members to use the positive signal of initiating an SMP without adequate follow-up on implementation.

In light of these concerns, Directors felt that the existing framework for SMPs is not well suited to situations where members see a need for monitoring by IMF staff to provide assessments of their economic policies to official and/or private creditors. Consequently, they supported a proposal to discontinue such “signaling” SMPs. However, Directors concluded that the SMP framework remains suitable for circumstances where members need to establish a policy track record based on strong ownership before moving to an IMF arrangement or after an arrangement has gone off track.

Views differed, however, on establishing a new mechanism for this purpose. Given their differences on the matter, Directors agreed that, for the time being, the IMF will use existing mechanisms, including the Article IV consultation process and precautionary arrangements, for signaling purposes. If later it becomes evident that there is a demand for a more specific signaling mechanism, the staff will come back to the Board with a new proposal.

On the future role of SMPs, Directors were of the view that, in cases where SMPs are used to build a policy track record toward an IMF arrangement, the risk of misinterpretation is relatively low. In these cases, Directors concluded, the SMP framework remains suitable.

IMF staff also provide assessments of members’ macroeconomic conditions and policies in response to various ad hoc requests from other international financial institutions, creditors, or donors. While recognizing the need for flexibility in meeting such demands, Directors nevertheless saw merit in general guidelines for the preparation of these assessments. They stressed that these assessments should be sufficiently nuanced to take account of different country circumstances, but written clearly so that the boards of other international financial institutions or other donors would be able to distinguish between countries with strong macroeconomic policies and those without. The assessments should also provide a brief history of the IMF’s relationship with the member country.

Review of the Contingent Credit Line

The IMF designed and introduced its Contingent Credit Line (CCL) in 1999 as a way to enhance incentives for sound policies and provide a better safety net for good performers. It offers precautionary short-term financing under a Stand-By Arrangement primarily to help a member overcome the balance of payments financing need arising from a sudden and disruptive loss of market confidence due to contagion, and largely generated by circumstances beyond the member’s con-control. At the end of FY2003, Directors were engaged in a review of the CCL, addressing reasons why it had not been used to date, especially:

• Concerns by members that a CCL request could be viewed as a sign of weak, rather than strong, policies;

• The possibility that a country’s withdrawal from the CCL (or a determination that it no longer met the requirements) might trigger adverse market reactions; and

• An impression that the CCL might not provide greater assurances of timely financing than other IMF facilities and policies.

Besides its consultations with members and Directors, the staff has engaged in extensive outreach with market participants on these and other issues related to the CCL. The Board expects to continue its discussions in the period prior to the scheduled expiration of the facility in November 2003. In the interim, it has asked the staff to explore ways in which it might be possible to use strengthened IMF surveillance and precautionary arrangements to achieve the goals of the CCL in helping member countries with sound policies to confront the challenges of globally integrated capital markets.

Improving Sustainability Analysis

Assessments of the sustainability of a country’s external and public debt are a key element in the IMF’s work with many member countries. Judgments about debt sustainability—whether the debt can be serviced without an unrealistically large correction to the balance of income and expenditure—underpin the IMF’s decisions in program contexts, in particular by helping to determine when financing is appropriate and, if so, the appropriate amount of financing to provide. These judgments become critical—and in many cases, particularly finely balanced—in cases of emerging market countries that are highly integrated into global capital markets and may have large financing needs.

In June 2002 the Board discussed and endorsed a new framework for judging debt sustainability. The new framework provides a reality check on the baseline projections on the basis of which sustainability is assessed, by clarifying the underlying assumptions regarding key variables including growth, real interest rates, exchange rates, and primary fiscal or external imbalances, and by highlighting their implications. It introduces a set of standardized parameters for stress-testing the program baseline, to identify the extent to which sustainability hinges on the assumption of a macroeconomic outcome more favorable than experienced in the past and to help ensure the robustness of the program in the face of plausible shocks.

In their discussion, Directors noted that assessments of sustainability are necessarily based on judgment, given that they depend upon a complex assessment of the interrelationships among several factors—including macroeconomic developments, political and social constraints on adjustment, and the availability and cost of private and official financing. The new framework helps strengthen the analytical basis for making these judgments. It does not provide a mechanistic approach, which would be inappropriate given the wide variation in the debt-bearing and adjustment capacities of different economies over time. Rather, it is a framework for informing these judgments and expressing them in a transparent manner. As greater experience is gained, efforts will continue on further refining the framework.

Combating Money Laundering and the Financing of Terrorism

In July 2002, the Board discussed proposals to advance the IMF’s contribution to international efforts to combat money laundering and the financing of terrorism (AML/CFT). The IMF had begun a new chapter in its work on this subject, Directors noted, by taking two key steps:

• conditionally adding the Financial Action Task Force (FATF) 40 Recommendations and the 8 Special Recommendations (FATF 40+8) to the list of areas and associated standards and codes useful to the operational work of the IMF (see Box 2.3); and

• endorsing a 12-month pilot program of AML/CFT assessments and accompanying ROSCs that would involve participation of the IMF and the World Bank, the FATF, and FATF-Style Regional Bodies (FSRBs).