Presentation of the Twenty-First Annual Report1

International Monetary Fund. Secretary's Department
Published Date:
October 1966
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By the Chairman of the Executive Board and Managing Director of the International Monetary Fund. Pierre-Paul Schweitzer

Mr. Chairman, I should like to join with you in expressing our thanks to the Governor for the United States for his words of welcome. I should like also to associate myself with your greeting to the Governors, delegates, and friends of our organizations who have assembled here today. It is with pleasure that we are able to receive Singapore for the first time as a member, to welcome Guyana to membership today, and to note that the Ministers of Finance of the Gambia and Indonesia, which have applied for membership in the Bank and the Fund, are representing their respective countries.

I am pleased to present to you the 1966 Annual Report of the Executive Directors of the Fund. I am sure you will agree that the Report reflects the intensive and concentrated character of the work that the Fund has pursued in the past year.

The Report records that in terms of financial operations the latest fiscal year was the most active in the Fund’s history. Assistance was extended to more members than in any previous year. Sales of currencies reached a new record, exceeding the equivalent of $2,800 million, and stand-by arrangements approved during the year amounted to $575 million. Since the fiscal year ended, the Fund has actively continued its work of assisting members through financial transactions and through stand-by arrangements. In this connection, I should like to mention an important innovation in the Fund’s transactions with member countries. On August 18, the Fund borrowed the equivalent of $250 million in lire from the Italian Government. This loan made possible a corresponding drawing of lire by the U.S. Government, notwithstanding the low level of the Fund’s holdings of lire. The transaction enabled the United States to acquire dollars from Italy against lire—a transaction of the kind which was specifically provided for in the Articles of Agreement.

Governors will be aware of the progress which has been made in increasing members’ quotas in the Fund under the Resolutions which they approved in March of last year. As of today all but a few members have agreed to the increases in quotas provided for under those Resolutions, and total quotas now exceed $20.5 billion.

The Report also describes how the Fund has continued, and indeed expanded, the activities whereby, in a variety of ways, it seeks to be of assistance to its members. Programs of technical assistance have continued to help members in carrying out monetary, banking, exchange, and fiscal policies and in developing financial statistics. The Fund also has begun to provide, in Spanish as well as in French and English, its courses on monetary policy and analysis. Fundamental to all of these activities, there has been a continuation of that close consultation and cooperation with individual member countries which has always been the heart of the Fund’s endeavors.

In May of this year the Executive Directors marked the twentieth anniversary of their first meeting. As we reflect upon the past two decades of the Fund’s existence, we can point to the increase in its resources, the development of its policies and facilities, and the advances that have been made toward carrying out the basic principles and objectives of the Fund as set forth in the Articles of Agreement. In any comparison of the economic and financial record of the postwar period with that of the interwar period, we cannot fail to note the unprecedented advances in economic understanding and in international cooperation. Then, looking at the latest developments, we observe that economic growth in most of the industrial countries continues at a high rate, that international trade goes on expanding, and that the exports of the primary producing countries are being supported by high and rising levels of demand in the industrial countries.

All this gives much cause for satisfaction, and it is essential to keep it in mind as a matter of perspective. But I do not intend to dwell upon the more favorable side of things, historical or current. I will instead focus on certain problems in the world economy that require the attention and efforts of all of us—in the Fund, in other international organizations, and in national governments—now and in the coming months and years. Also, I shall have something to say about two matters that have been important preoccupations of the Executive Directors and staff of the Fund during the past year—compensatory financing and international liquidity.

Looking at the industrial countries, I would draw your attention to several developments during the past year. First, the further expansion of economic activity in the United States and Canada created a situation in which, for the first time in the postwar period, virtually all industrial countries are simultaneously enjoying high levels of employment and at the same time experiencing pressures on resources. Second, changes in economic activity and in underlying demand pressures have not served to reduce the imbalances in world payments. Third, the widespread strength of demand for credit and capital, along with other factors, has led to a dramatic rise of interest rates in most industrial countries. These features of the economic scene in the industrial world point up some clear problems and challenges in the field of national economic policy.

The problem of maintaining price stability in the world economy has become greatly accentuated by the strain on resources that is associated with the high levels of employment and activity currently prevailing in nearly all the industrial countries. These countries have shown perseverance and ingenuity in their pursuit of economic growth and full employment, but they have been notably less successful in reconciling this with a reasonable degree of price stability. In my view, the increases that have occurred in the domestic prices of many industrial countries in recent years should not be taken as a sign of overabundant international liquidity. Rather, they are attributable to the difficulties encountered by economic management when unemployment gets down to low levels and structural factors come into play. Such difficulties, experience shows, can afflict countries having deficits in their external transactions as well as those in surplus positions. Coping with inflationary forces in the leading industrial nations will not be easy, as it will require advances in our understanding of economic processes, more effective uses of a wide variety of policy instruments, and—in some cases—giving a higher priority to the maintenance of price stability among the objectives of policy.

The fact that containing cost and price pressures for domestic reasons has become a common problem in the industrial world also has relevance for the balance of payments adjustment process. It may be recalled that during recent years the marked advances of prices and costs that occurred in European countries—combined with essentially stable prices and costs in the United States—worked in the direction of reducing the U.S. payments deficit and moderating major surplus positions in Europe. However, with emergence of the problem of cost increases and incipient inflation in the United States, there would appear to be less assurance that price movements among industrial countries will continue, in general, to support the adjustment mechanism. The adjustment of balance of payments positions is dependent on an interaction between surplus and deficit countries, and the relative shares of the responsibility that they should assume for the adjustment will vary with the nature of the imbalances and with the underlying world economic situation. At this juncture, the assumption by the deficit countries of a major share of the responsibility for proper functioning of the adjustment process seems indicated, not only on the basis of current price trends among industrial countries but of other considerations as well.

Following reductions in their balance of payments deficits in 1965, both the United States and the United Kingdom experienced payments developments in 1966 which, though of a very different character, have been disappointing. As noted by the Executive Directors in their Annual Report, the continuance of deficits in the two reserve centers no longer necessarily produces a growth in world reserves and makes it more difficult to reach agreement on constructive solutions to the problem of ensuring an adequate growth of reserves for the future.

Notwithstanding a tightening of monetary conditions and a sharp upsurge of interest rates, aggregate demand in the United States expanded rapidly in the past year. This has led to a further shrinkage in the customary current account surplus of the balance of payments, offsetting the reductions in capital outflow. It is essential that policies in the period ahead be directed toward the achievement of an effective payments equilibrium, and one which safeguards the needs of other countries for capital and aid. The several measures of fiscal restraint proposed by the U.S. Administration earlier this month in order to diminish inflationary pressures would contribute to the desired equilibrium in external payments.

The balance of payments position of the United Kingdom, which showed gradual improvement after the crisis of 1964 but remained weak, has been made difficult by lack of confidence. The program adopted in July, together with the earlier measures, represents a substantial disinflationary effort. This should do much to relieve the pressure on British resources and so to correct the external imbalance. The various measures now in effect will entail some slowing down in investment and growth over the short term, but the efforts being made to improve the allocation of resources and to make incomes policy more effective should serve to strengthen the basic structure of the British economy and help to ensure adequate growth with internal and external stability in the longer run.

In both the United States and the United Kingdom, a rise in interest rates was appropriate in the prevailing situation of payments deficits combined with excess pressures of domestic demand. However, its contribution to the capital account of the balance of payments of the two reserve centers has been limited by a broadly parallel rise of interest rates in many countries on the continent of Europe.

In view of the strength of economic expansion throughout the industrial world, it is perhaps not surprising that interest rates in most leading countries have been high and rising over the past year or so. In part, the dramatic rise of interest rates has been a natural phenomenon reflecting the intensity of credit demands accompanying economic growth. However, there have been various other causes, the most important of which has been the way that industrial countries have managed their financial policies. Most of these countries have relied mainly on monetary policy to combat domestic inflation. However, it would have been more appropriate from the standpoint of international payments equilibrium if European countries in relatively strong payments and reserve positions had made greater use of fiscal policy for the purpose of checking inflation. Within the over-all degree of restraint obtained by the financial policies of such European countries in the recent period, a combination of greater restraint through fiscal policy and lesser restraint through monetary policy would have meant lower interest rates in those countries. This would have been helpful to the international adjustment process.

In short, interest rate developments in the industrial countries have not contributed significantly to a lessening of the disequilibrium in international payments. But, at least in some cases, these developments may also have disadvantages from a domestic viewpoint. There is room for concern that the later impact of a rapid advance in interest rates upon investment activity may be greater than desired. Moreover, in a few countries the upsurge of rates in the last year or so has been symptomatic of a somewhat disorderly scramble for funds. Also deserving of attention is the potential danger that further squeezes on liquidity, and further rises in interest rates, could have an adverse impact on particular categories of financial institutions or borrowers, with consequent repercussions on confidence and on real economic activity.

In any event, these -considerations regarding interest rate developments point clearly to the need for better fiscal policies in the industrial countries. Some improvement—perhaps not inconsiderable—could be realized through a greater willingness on the part of national authorities to face fiscal problems promptly, within the framework of existing arrangements. More fundamentally, every effort should be made to bring greater short-run flexibility into the instruments of fiscal policy in the industrial countries. This would contribute materially to the general effectiveness of demand management, enabling the authorities to cope more successfully with rapid changes in domestic conditions or in the balance of payments. If fiscal policies were better developed and could be adjusted more readily to changing circumstances, less reliance would need to be placed on monetary policies to influence domestic demand. This, in turn, would permit more attention to be paid to the effects of monetary policy on the international movement of capital. Given the convertibility of major currencies, an unduly heavy reliance on monetary policy may induce capital inflows or outflows which are disequilibrating to the balance of payments and also hamper the use of monetary policy for domestic purposes.

The industrial countries, by and large, have achieved some fundamental success in meeting their objectives of national economic policy in recent years. However, in one vital respect the record has riot been good. Preoccupied with their domestic problems of pursuing economic growth, combating inflationary pressures, and protecting payments or reserve positions, the industrial countries as a group have not expanded their various forms of assistance to developing countries. In view of the sheer immensity of the problems and needs facing the developing world, this situation is of the gravest concern.

High growth in the industrial countries, to be sure, has provided an expanding market for the developing countries’ exports during the 1960’s. However, the beneficial effects of this would have been greatly enhanced if the industrial countries, by continuing to lower trade barriers, had eased further the access to their markets. Only slight progress has been made along these lines in recent years.

High growth in industrial countries, moreover, might be expected to facilitate the flow of resources to the developing world. But, in spite of increased efforts by some countries, foreign aid in the aggregate has stagnated since the beginning of this decade. Its terms have hardened in the sense that the proportion of assistance in the form of grants has fallen and that of tied aid has risen. Furthermore, the volume of private long-term capital flowing to the less developed countries has increased relatively little over the past few years. Although the industrial countries that impose restrictions on capital outflows have attempted to insulate developing countries from the effects of such measures, the general economic environment in the industrial world has not been one of positive encouragement, by tax incentives or otherwise, to investment in less developed countries.

In view of this situation, the industrial countries should give a high priority to measures which ease the access to their markets and stimulate the flow of investment and development assistance. These countries should make all possible efforts to avoid having such measures become contingent on the state of their balances of payments or of their budgetary positions. If these principles, which appear to find broad acceptance, were to be put into practice, we could then look forward to a time in which the potential benefits of high growth in the industrial countries would be shared more fully with the developing world.

On the other hand, the developing countries themselves must play an important role in any such improvement. Financial prudence on their part is more than ever necessary, not only in the interests of internal balance but as a means of stimulating the inflow of foreign resources, both private and official. While the control of some of the more conspicuous inflationary situations in the developing world has met with a measure of success, there has been some deterioration in many of the milder cases, and the over-all outlook for internal price stability remains clouded. On the supply side, too, the developing countries must do more to marshal and redirect domestic resources if a higher level of exports to fill expanded markets is to be generated and if an increasing flow of foreign resources is to be used effectively. Particularly important, in view of the rapid growth in population, is the need in many countries for a strengthening of the agricultural sector.

The external position of many less developed countries remains precarious. The burden of servicing their accumulated foreign indebtedness has grown heavier, and the level of their reserves remains low. As a group, these countries have made sizable additions to their foreign exchange reserves over the last three years, but these reserves in many cases had fallen to very low levels and, besides, much of the over-all increase has been concentrated in only a few countries. Whatever strengthening of reserves has occurred is certainly to be welcomed; the less developed countries must have adequate reserves if they are to be able to deal with balance of payments uncertainties.

The Fund’s resources are available to the members, within the established policies governing their use, to supplement their own reserves at times of temporary balance of payments difficulty. A frequent cause of difficulty is a shortfall in export earnings, and ordinary drawings can be made on the Fund in such circumstances. However, in February 1963 the Fund extended its policies by making special provision for the compensatory financing of payments deficits arising out of export shortfalls. Taking account of suggestions made by Governors at the 1965 Annual Meeting and of a Resolution passed by the United Nations Conference on Trade and Development, the Fund in the past year undertook an intensive re-examination of its compensatory financing facility. This resulted in the improvement of the facility that is fully explained in a new report that has been made public today.

Here, I might note briefly that outstanding compensatory drawings under the special facility—previously limited to 25 per cent of a member’s quota—may in the future rise to 50 per cent of quota, with the provision that net drawings will ordinarily not exceed 25 per cent of quota in any one year. Henceforth these drawings will be outside the Fund’s tranche policies and therefore they will not affect the member’s ability to draw under those policies. The facility can now be said, in colloquial terms, to be a “floating” one. This is, of course, an important liberalization of policy for the benefit of countries eligible to use the facility. Countries making use of this facility will repurchase in accordance with the Fund’s established policies which, in general, call for repurchases within three to five years. At the same time, the Fund recommends that in these cases countries apply to repurchases approximately one half of the amounts by which their exports are above their calculated trend values in any year.

The compensatory financing facility provided by the Fund has been useful to some Fund members and in the future is likely to be useful to many more. It is for this reason that we have sought and achieved agreement on the expansion and liberalization of that facility. This has been done within the broad framework of the Fund’s policy on the use of its resources, especially the requirement that those resources are available to assist members in meeting temporary balance of payments difficulties. As a result of our latest decision on this subject, the Fund is better equipped to help countries which have encountered export difficulties not of their own making.

I turn now to the subject of international liquidity—a subject on which the Fund has done a great deal of constructive work over the past year. The main results of this work are discussed at considerable length in Chapter 2 of this year’s Annual Report of the Executive Directors. It is clear from this chapter that the work done during the past year, both in the Fund and elsewhere, has produced significant advances in understanding and agreement. I may mention as one example the issue of the distribution of any newly created reserves; very wide agreement has been gained on the principle that all members of the Fund should participate in any distribution of such reserves and that Fund quotas (or a closely related measure of the relative economic position of countries) should serve as the yardstick for their allocation among Fund members. On other major points, too, there is a growing convergence of views.

There still remain a number of unresolved issues, including some important ones of both technique and policy. I do not want to minimize the difficulties involved but I am convinced that, given the will to establish a mechanism for the creation of reserves, these difficulties can be resolved in a reasonably short time. On the basis of the experience we have had this far, I conclude that there are no technical reasons why concentrated work could not provide Governors with fully developed suggestions for arrangements for reserve creation in time for next year’s Annual Meeting. As an illustration of how certain aspects could be worked out, I put forward some specific ideas last February for the consideration of Executive Directors. These ideas, which are also covered in Chapter 2 of the Report, reflect the basic principle of universality and incorporate those safeguards that are indispensable whenever the creation of money is undertaken.

I may perhaps draw attention to the large increases, announced two weeks ago, in the bilateral credit facilities and swap arrangements of the U.S. Federal Reserve System and the Bank of England with each other and with a number of other central banks. These arrangements are designed to cope with the problem of heavy short-term movements of capital between financial centers and are not intended to be a substitute either for the conditional liquidity extended by the Fund or for the deliberate creation of new reserves, but I mention them here because they provide impressive evidence that decisive action can be taken quickly in the area of international liquidity.

I suggested in my address a year ago that it would be very useful if the efforts of the Fund and the Deputies of the Group of Ten could be directed toward a common view on desirable lines of action in the field of reserve creation. In my view, these efforts might now be helped by informal meetings between the Fund’s Executive Directors and the Deputies. I am discussing practical arrangements for this purpose, and I hope to be able to submit proposals to the Executive Directors in the near future. It may well be that informal discussions with other groups would also appear useful during the year, and if the Executive Directors wish these to be arranged I perceive no difficulties. The most important consideration is to leave no procedure and no channel untried which can advance the work in which we are engaged.

I have made it clear that I consider it important that concrete arrangements for the deliberate creation of additional reserves be agreed among member countries without undue delay. I do not hold this view because I believe that the international monetary system is in imminent danger without injections of additional liquidity. But I do believe that world confidence in this system will be greatly strengthened once it becomes established that the members of the Fund have agreed on a system of deliberate reserve creation intended to ensure that reserves increase by such amounts as are judged necessary for the full, free, and noninflationary growth of the world economy.

I do not harbor the illusion that reserve creation can serve as a panacea for the economic problems of the world. But many of these problems can more readily and more successfully be tackled if countries following prudent policies can expect their reserves on the average to increase—that is to say, if countries can acquire the reserve increases they need over the long run out of a growing total rather than at the expense of other countries. It is to assure such an economic environment that agreement should be reached on arrangements for deliberate reserve creation. For that reason the most determined efforts of all of us should be devoted to this problem in the coming year.

September 26, 1966.

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