Presentation of the Twenty-Ninth Annual Report 1. By the Chairman of the Executive Board and Managing Director of the International Monetary Fund

International Monetary Fund. Secretary's Department
Published Date:
November 1974
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H. Johannes Witteveen

Mr. Chairman, I should like to join with you in expressing our deep appreciation to the President of the United States for his cordial welcome. In greeting all those who have assembled for these twenty-ninth Annual Meetings, I extend a special welcome to the observers from Papua New Guinea, for which Governors will be asked to approve a membership resolution later this week.

The year that has elapsed since our meeting in Nairobi has been a turbulent one for the world economy. The rate of price inflation has soared. There has been a sharp slowdown in economic growth. An enormous disequilibrium has occurred in international payments. Financial markets have come under severe strains. Apprehension about the economic situation has been mirrored in stock markets the world over. These events have created a combination of economic problems that is both unprecedented and serious. Governments everywhere must deal simultaneously with severe problems across the whole spectrum of economic policy and with the complex interactions among them.

Inflation is a dominant economic issue throughout the world, and it is not necessary, before this audience, to dwell on the inequities and difficulties that it causes. Unless inflation is now brought under control, it could get further out of hand and produce serious distortions and disruptions in the world economy.

Efforts to deal with inflation encounter the dilemma of making significant progress on the price front without having an unduly severe effect on growth and employment. This problem is unusually acute at the present time, for the major industrial countries are experiencing low or negative growth rates even as prices continue their steep advance. Further, checking inflation has also been made more difficult by the need for large price increases in some sectors of the economy in order to adjust the distribution of demand and encourage structural changes—changes that have become necessary because of the sharply higher level of energy costs and the emergence of shortages and bottlenecks.

A few months ago national and international forecasters were generally expecting a pronounced economic upturn in the major industrial countries during the second half of this year, with a return to normal growth rates by the first part of 1975. It is now evident that these forecasts were too optimistic and that short-term growth trends in the industrial world will prove to be weaker than expected at midyear.

The painful dilemma of fighting inflation at a time of slow growth is already somewhat familiar from the past experience of individual countries. Now, however, it has become much more serious. Inflation has accelerated while the economic situation has become more unstable because of the unprecedented large deficits in the current account positions of oil importing countries. This development has accentuated trends in the world economy that already were veering toward “stagflation,” or even “slumpflation.” For the increase in oil prices has given added impetus to the inflationary spiral already under way, while also bringing about potentially deflationary effects.

To a certain extent, these deflationary effects have to be accepted, as some reduction in demand is required to fight inflation. But the necessary elimination of excess demand must not be allowed to generate international repercussions resulting in severe and prolonged recession. The emergence of severely recessionary conditions not only would be harmful in itself but also could be expected to have a counterproductive effect in the fight against inflation. For such conditions would inevitably lead to widespread pressures for a shift to sharply expansionary policies, and this could easily revive or exacerbate inflationary pressures and psychology. In the uncertain international environment that prevails, it will be of crucial importance for national authorities to conduct their demand policies with a close eye on changes in the underlying economic situation and, in this process, to take into account both the time lags in the effects of policy instruments and the interdependence of developments in different countries.

Anti-inflation policies should employ a combination of instruments so as to satisfy a number of different requirements. The first requirement is to achieve an effective policy of demand management. It is essential that anti-inflation efforts of the main industrial countries be directed toward the control of aggregate demand, with the objective of maintaining, for a prolonged period, a somewhat lower pressure of demand on resources than has been customary. But there is also a clear-cut need for complementary measures of a more specific character. Such measures could serve to improve supply conditions, strengthen the forces of competition, exert a direct influence on wages and prices in the public interest, and otherwise deal with particular problems or imbalances. Provided that measures of this type are not allowed to divert attention from the central task of using fiscal and monetary policies to control aggregate demand, they could play a significant role in combating inflation and, moreover, could lessen the adverse impact of demand restraint on the level of employment.

Of course, the scope for direct wage and price measures, which have come to be known as incomes policy, will vary among member countries because of differences in political conditions and institutional arrangements. But I wish to stress that, in general, the economic situation in the industrial world is now becoming more suitable for the use of incomes policy. Attempts to control wages and prices are generally not very effective at times of excess demand pressure. The present situation, however, is one in which the pressure of demand on resources is easing while the increase in wages and prices remains high. Therefore, the use of incomes policy at this juncture could prove to be relatively effective and considerably helpful; without it, I must emphasize, it may be very difficult to restrain cost pressures and achieve price moderation except at the expense of more slack and unemployment over a longer period.

The political will of the national authorities is apt to be severely tested if the industrial economies are operated at subnormal growth rates over an extended cooling-off period, but there would seem to be no real choice other than to persevere in such a course of policy. This is necessary in order to abate the upward pressures on prices and costs and to reverse the widespread and deeply embedded inflationary psychology. At the same time, it will be important from a social point of view to introduce various specific measures for the purpose of alleviating the distress to some sectors that this economic adjustment will inevitably entail.

The key issues of domestic economic policy—for developing countries, as well as for the industrial countries—have been treated comprehensively in the Executive Directors’ Annual Report, which I have the privilege of presenting to you. Apart from the general comments I have just offered on the subjects of inflation and growth, I wish to focus my statement this morning on the problems that loom ahead in the international monetary sphere and on their implications for the work of the Fund. Unless handled well, these problems could spell serious danger to the world economy.

The dominant aspect of the international monetary picture is the sudden and massive shift in current account positions that occurred primarily as a result of the increase in petroleum prices late last year. The major oil exporting countries will realize an aggregate current account surplus of something like $65 billion in 1974, and this will be matched by deficits on the part of oil importing countries throughout the world. The situation is new and different for almost all member countries, and it poses extremely difficult problems of balance of payments adjustment and financing—problems which appear likely to extend over a period of years and which could intensify if not handled cooperatively within an international framework.

With respect to adjustment, it is well understood that the oil exporting countries as a group can do comparatively little to adjust their current account position in the short term if present levels of oil prices and production are sustained. It is also well understood that, in such circumstances, the oil importing countries as a group cannot eliminate their overall current account deficit in the short run, and that attempts to do so would only reallocate the deficit among the oil importing countries and might have seriously constrictive effects on world trade and economic activity.

What is perhaps not so well understood is that oil importing countries, while having to accept a huge current account deficit as a group, should continuously press ahead with appropriate adjustments, on current and capital accounts, in relation to each other. Prior to the increase in oil prices, international payments had not yet returned to equilibrium and many countries still had sizable imbalances that needed to be eliminated. Moreover, the oil price increase itself had a widely varying impact among oil importing countries, and this created further imbalances in addition to those prevailing at the end of 1973. As a result, the collective payments disequilibrium of the oil importing countries in 1974 has been distributed quite unevenly among them.

The prevalence of large payments imbalances and the uncertainties surrounding payments prospects made it inevitable that the generalized floating that came into existence early in 1973 would be continued. However, it has become clear that, in practice, floating may have reduced, but has not solved, balance of payments problems; it has not removed the need for member countries to pursue internal adjustments. Most members have apparently taken the view that market-induced movements in their exchange rates beyond a certain range would be undesirable, either because of their implications for external competitiveness or because of their effects on domestic costs and prices. Floating downward has proved to be a difficult experience for countries that have tried it, mainly because the price effects have come through much more quickly than the trade effects and have threatened to set off a spiral.

The types of response to a situation in which par values are no longer observed have varied according to the particular situation of individual members. Few currency relationships have been allowed to fluctuate in a manner approaching free floating. By far the most important of these has been the relationship between the U.S. dollar and the European “snake.” This relationship has fluctuated widely in the course of the past year. For example, the U.S. dollar appreciated by about 20 per cent in terms of the snake currencies in the short period from late October 1973 to late January 1974 and then depreciated against those currencies by about the same amount over the succeeding four months; since then, the changes have been on a much smaller scale. To some extent, the large fluctuations that occurred were unavoidable, but they were a source of considerable risk and uncertainty in international transactions.

It seems clear that exchange rate changes can offer only a partial contribution to relative adjustment among oil importing countries in their balance of payments positions. In the present situation, it is uncommonly difficult for oil importing countries—both those in relatively strong positions and those in relatively weak positions—to judge their respective responsibilities in the adjustment process, and it is not apparent that they see eye to eye on this matter.

Let us consider briefly some of the main issues of adjustment and financing that confront the oil importing countries in the period ahead. These countries should do what they can to reduce their current account deficits through measures relating to the price, supply, and conservation of oil and other sources of energy, but such measures will take time to yield substantial results. Meanwhile, the responsibility of individual countries to adjust their current account deficits depends importantly on their ability to attract capital. In current and projected circumstances, a key question concerns the extent to which the huge volume of capital flowing directly or indirectly from the oil exporting countries will mesh with the current account deficits of individual oil importing countries.

Under present conditions, one important element of a solution to the international payments disequilibrium would consist of a large volume of long-term capital outflows from the oil exporting countries. But this takes time to develop. The oil exporting countries have so far been investing mainly at short term; and, in any case, the long-term capital markets have not been functioning well because of inflation and such other factors as exchange rate uncertainty. The Euro-currency market and other short-term money markets have therefore had to play a very important role in transforming short-term deposits from the oil surplus countries into medium-term or long-term loans to the oil importing countries. Until now, this task of recycling has been performed reasonably well. It has already become clear, however, that the market would encounter serious limitations if it were required to continue to perform such a function on a large scale over an extended period.

As we look ahead to 1975, the recycling problem is likely to remain very big. Oil exporting countries, however, might well be faced with certain problems and risks in channeling their growing volume of funds through private money markets. On the other hand, oil importing countries could find it increasingly difficult to finance their current account deficits by borrowing in these markets. Consequently, there is an urgent need to develop other channels of finance.

Mr. Chairman, the difficulties in the world economic situation that I have just outlined—rapid inflation, stagnant production, and unprecedented payments imbalances—place a heavy responsibility on member governments. They also present to the Fund two important challenges—first, to assist its members in devising, on a collaborative basis, the policies that are required to meet these difficulties and to bring about the necessary adjustments; and, second, to provide many members with financial resources, perhaps coming to large totals, so as to avoid the risk of disruptive adjustment.

It is fortunate that, as a result of the work of the Committee of Twenty over the last two years, the Fund will be better equipped to perform the functions assigned to it by the Articles and to meet the challenges of the current situation. I want to use this occasion to pay tribute to the distinguished Chairman of the Committee of Twenty, Minister Ali Wardhana of Indonesia, and to the admirable manner in which Mr. Morse and his colleagues steered the difficult work of the Deputies. Although the appearance of grave uncertainties on the world economic and financial scene precluded development of proposals for a full-scale reform of the international monetary system, the Committee of Twenty was able to achieve a substantial measure of agreement on the broad objectives of a reformed system. Furthermore, the program of immediate action endorsed last June should be very helpful in dealing with current international payments problems and could prove a significant step in the evolution of the system.

It is gratifying that this Annual Meeting will see the establishment of the Interim Committee, which is to be the forerunner of a Council with decision-making powers under an amendment of the Articles of Agreement. The tasks assigned to the Committee—namely, “to supervise the management and adaptation of the monetary system, to oversee the continuing operation of the adjustment process, and to deal with sudden disturbances which might threaten the system”—are clearly of the greatest importance in present circumstances. These tasks deserve the urgent attention of those in member governments who are responsible for economic policy making at the highest levels.

The Interim Committee will be concerned with a number of major issues relating to the immediate situation and to the interim period pending establishment of a reformed system. I will single out four of these issues.

First and foremost, I want to note the Fund’s concern with balance of payments adjustment. Here, the Executive Directors have already been putting into practice the basic principles outlined by the Committee of Twenty for the review of the adjustment process, with periodic discussions of the world economic outlook and of the positions of selected individual countries on the basis of the procedure of special consultations inaugurated toward the end of 1973. We are moving forward with these activities, and plan to integrate into them our work on the application of guidelines for floating.

It is essential that the Fund, working through the Interim Committee and the Executive Directors, give close attention to the adjustment process in the period ahead. As I have pointed out, the issues in this area are now unusually complex and varied, and much of the terrain is unfamiliar. But the stakes are exceptionally high.

It would, for example, be a matter of serious concern if countries in weaker payments positions resorted to measures restricting current transactions. In this regard, I urge Fund members to subscribe to the voluntary declaration on trade measures contained in the Committee of Twenty’s communiqué of June 13, 1974, and I hope that the pledge may soon receive the necessary vote to become operative.

Amendment of the Articles of Agreement is a second important area of current work in the Fund. The Committee of Twenty requested the Executive Directors to prepare draft amendments, for consideration by the Interim Committee, on a broad range of topics. The Committee of Twenty had in mind that many members may want to combine legislative action on the amendments with such action on increases of their quotas pursuant to the Sixth General Review of Quotas.

The topics mentioned by the Committee of Twenty as possible subjects for amendment have been inspired by a number of objectives. For example, some of the possible amendments would promote adjustment, particularly in present circumstances when members are unable to observe the provisions of the par value system. Other amendments would help to give special drawing rights the status of the principal reserve asset by improving their characteristics, extending their use, and freeing them from present restraints. At the same time, appropriate roles would be assigned to other reserve assets—gold and currencies. Another general objective of the Committee was that the functioning of the General Account should be simplified and improved by amendments that would take into account the experience of the Fund and current developments. Lastly, amendments could be adopted that would strengthen the Fund as an international organization, increase its ability to deal effectively with current problems, and assist in expanding the flow of real resources to developing countries.

The work of the Executive Directors so far has not gone beyond an initial and exploratory stage, but it has already been valuable in clarifying issues and in suggesting approaches. I am confident that Governors will encourage the Executive Directors and the Interim Committee to take advantage of the opportunity that now exists for important improvements in the Articles and will urge them to complete this arduous but necessary assignment.

Another main task for the Fund concerns the Sixth General Review of Quotas. This raises a basic issue as to the magnitude of the role that the Fund is to play, as well as the difficult question of the relative participation of different members and groups of members in the financing of the Fund’s activities, in the access to its resources, and in the taking of decisions. The purpose of the sixth review is to ensure that the quotas of member countries adequately reflect the rapid changes in the world economy that have taken place in recent years. In view of the expanded needs of member countries for balance of payments financing, I hope that the current review of quotas will result in a substantial expansion in the size of the Fund.

Finally, in reviewing the main issues that confront the Fund, I want to discuss the question of the role which our institution should play in 1975 with respect to the recycling of funds from surplus to deficit countries. It is to be expected, as I indicated earlier, that the role of official recycling will have to be larger in 1975 than in 1974, mainly because of the increasing difficulties that have become evident with respect to financing through the short-term money markets. A number of developed countries, and some of the better placed developing countries, that could attract adequate funds through market borrowing in 1974 are likely to be in need of official financing in 1975.

At the same time, as recycling enters its second year, it will be even more important than in the first year to ensure that this activity is organized in such a manner as to encourage the necessary adjustment in individual countries and in the world payments situation as a whole.

Official recycling may take many forms, from bilateral arrangements to multilateral arrangements of varying scope and from highly concessionary financing to transactions closely reflecting market interest rates. In the planning for 1975, such recycling will have to be arranged in light of the likely and acceptable magnitudes of current account imbalances and flows of private capital. This matter will require considerable thought and coordination on the part of many governments and institutions. It is essential that it be handled in such manner as to help both the oil exporting and the oil importing groups of countries. In the case of the oil exporters, the main general problem they face at present is how to invest the counterpart of huge current account surpluses in ways that are prudent in a very uncertain situation. On the other hand, the oil importing countries need to be given confidence that reasonable solutions will be found to their financing problems, and thus to be supported in pursuing policies that are appropriate in an international context.

The nature of the problems to be met and the experience gained by the Fund so far would suggest a substantial role, in the total structure of arrangements, for recycling operations through the Fund. We have to prepare for the possibility that the need for Fund transactions under an oil facility in 1975 will be substantially larger than the amount of SDR 2.8 billion which is now assured for 1974, and which will probably be able to cover a large part of the increase in oil import costs for most members that need and desire to use the facility.

Nevertheless, the oil facility cannot be a sufficient answer to the needs of the weaker developing countries, which are not in a position to continue paying market-related interest charges or to assume a significantly greater burden of debt. Many developing countries have been severely affected by recent international economic developments, notably those relating to food and energy. Moreover, these countries now face the further adverse effects of continuing rapid inflation and sluggish growth in the industrial countries. I strongly hope that the UN Emergency Program and other sources of official finance will be able to provide developing countries the grants or concessional loans which they need so urgently. The oil exporting countries themselves have made a hopeful beginning in providing such assistance on both a bilateral and a collective basis.

Many of the developing countries need to make structural adjustments in production, trade, and prices. Such adjustments can be assisted through the extended facility just established in the Fund. This facility will enable the Fund to give special assistance to members to meet balance of payments deficits for longer periods, and in amounts larger in relation to quotas, than has been the practice under existing tranche policies. The extended facility is a further demonstration of the Fund’s flexibility in adjusting to the changing needs and circumstances of its members.

Let me also say that I greatly welcome the recommendation of the Committee of Twenty to establish a Joint Ministerial Committee of the Fund and the Bank to deal with the broad question of the transfer of real resources to developing countries, and to give urgent attention to the problems of those developing countries which have been most seriously affected by recent events. The proposed new committee will provide a timely strengthening in the capacity of our two institutions, and of other organizations in this field, to serve in a coordinated way a large group of members in greatest need of assistance.

Mr. Chairman, the problems and uncertainties that now confront the world economy call for international cooperation of rare quality. The Fund will do everything it can to be of service in this troubled situation, and I call upon member countries to work with the Fund and to help improve its effectiveness. I am confident that our common commitment to the process of international collaboration will guide us in the difficult tasks that lie ahead and enable us to steer the right course.

September 30, 1974.

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