Presentation of the Thirty-Ninth Annual Report1
- International Monetary Fund. Secretary's Department
- Published Date:
- November 1984
By the Chairman of the Executive Board and Managing Director of the International Monetary Fund—J. de Larosière
I would like to extend a particular welcome to the Governors of St. Christopher and Nevis who are present for the first time since their country became a member earlier this year. I understand, too, that delegates are present from the People’s Republic of Mozambique whose application for membership will be taken up later in our proceedings. I am glad that they are with us today.
Mr. Chairman, two years ago, our Annual Meetings took place in an atmosphere of gathering crisis in the world economy. The worldwide recession had brought economic activity to a low ebb, and the debt problems of several major developing countries threatened an unraveling of the international financial system.
Recalling this underlines how far we have come since Toronto. Since early 1983, economic expansion has proceeded at a rapid pace in the United States, and there is increasing evidence that growth is reviving in the rest of the industrial world. International trade has rebounded strongly. Inflation has been substantially reduced. And the balance of payments situation of heavily indebted developing countries has improved dramatically.
There are, however, important problems that continue to present difficult challenges to policymakers. Interest rates are still very high in real terms. Although they do not appear to have impeded recovery so far, high interest rates undermine its longer-term sustainability and compound the problems of heavily indebted developing countries. Many developing countries still have a long way to go before being able to combine balance of payments viability with their needs of domestic economic development. This is particularly true for many smaller developing countries and low-income countries. In the industrial world, unemployment remains at very high levels, especially in Western Europe.
In my remarks today, I will address these problems and how they must be tackled so as to consolidate the improvements that have recently taken place in the world environment. I will deal first with the issue of achieving stable expansion in industrial countries—a goal upon which so much ultimately depends. Next, I will assess the progress that has been made in strengthening the external position of developing countries, and moving toward a resumption in the momentum of their development. Lastly, I will turn to some issues of international cooperation that are crucial if full advantage is to be taken of the opportunities that now exist.
1. Sustaining Expansion in Industrial Countries
1984 is shaping up as the best year for economic growth in the industrial countries in at least eight years. The IMF staff expects output to be 5 percent higher than in 1983, with the majority of industrial countries recording an acceleration in their growth rate. Encouragingly, this strengthening in the economic situation has not been accompanied by an acceleration of inflation. Price increases in 1984 are expected to average about 4½ percent, a little less than in 1983, and the best performance in almost 15 years. Also encouraging has been the strength of fixed investment. Despite the high level of interest rates, business capital formation has been expanding more rapidly than in previous cyclical recoveries, even in some countries where recovery has been relatively subdued.
A variety of factors have contributed to this improved outlook. First and foremost, the success of policy in reducing inflation and inflationary expectations has transformed the climate in which business and consumer decisions are made. A more stable financial environment enhances the willingness of savers and investors to make long-term commitments. Consumers have more confidence to spend out of current incomes if their accumulated savings are not being eroded by inflation. Other factors have been adding to the improved economic performance of the United States; in particular, flexibility in the functioning of markets, especially labor markets, has facilitated structural change and job creation, while tax cuts have given a boost to business fixed investment.
There are, however, difficult challenges to be met in broadening the basis of the present expansion and making it more durable. A particular problem lies in the geographically unbalanced nature of the upswing. In Europe, growth has not yet made much of a dent in the unemployment problem. In the United States, on the other hand, policies have to ensure that the growth of nominal demand is made consistent with the avoidance of a resurgence of inflation. In particular, continued and determined action to reduce the budget deficit is essential. This would also assist in bringing down reliance on foreign savings to a more sustainable level and relieve pressures on interest rates. In Europe, although the fiscal balance in several of the larger countries is improving, public sector spending generally remains much too high relative to GNP. This and other structural rigidities are keeping output and employment levels below potential.
The economic strategy adopted several years ago to foster sustained growth remains valid. This strategy involves the restoration and maintenance of economic and financial balance, and an improvement in the functioning of markets. In this way, conditions would be created that are conducive to improved resource allocation and steadier growth of private sector investment and demand. What is needed in present circumstances is to preserve those aspects of the strategy that are bearing fruit while moving decisively to strengthen policy in areas where the strategy has been incompletely implemented.
This means that the stance of monetary policy should continue to guard against any resurgence of inflation and to contribute to a further easing of price pressures. The lesson of the 1970s is that focusing monetary policy too narrowly on interest rates is dangerous and ultimately abortive. A steady policy with a medium-term focus, aimed at a gradual reduction in the underlying rate of inflation, is the only one that can command credibility and succeed. The improved price performance which such a policy has achieved in the past two years is a major factor underpinning the present recovery. In this connection, let me say that present rates of price increase, though vastly more satisfactory than those of a few years ago, do not provide grounds for complacency. In almost every country, there are advantages to be gained from bringing inflation down still further. Let us not forget that the 4½ percent inflation projected for the industrial countries this year is still 1½ percentage points above the average annual rate recorded during the expansion of the early and middle 1960s.
The way to achieve lower interest rates is not through accommodative monetary policy—this would simply rekindle inflationary fears—but through a fiscal policy that reduces the share of savings absorbed by the public sector. This involves action both to bring down fiscal deficits and to curb the growth of public expenditures. If government deficits remain high, markets will remain fearful that the temptation to monetize debt will become difficult to resist. Even if this temptation is resisted, the pre-emption of savings to finance fiscal deficits will eventually squeeze out interest-sensitive expenditure, particularly business investment. Of course, private spending can also be crowded out by tax-financed government outlays; it is therefore of the utmost importance that adequate restraint be exercised over government expenditures.
Financial policies, however, are only part of the story. We need also to make sure that markets are flexible enough to adapt to the demands of rapidly changing technology, and to absorb the available labor force. This is an area in which the different institutional settings of countries will require different policy responses. Depending on circumstances, these may include action to encourage labor mobility and retraining; greater limitations or even elimination of indexation provisions in contracts; reduction of artificial supports for declining industries; reform of the regulatory structure; rationalization of investment incentives; reform of wage bargaining arrangements; and so on. The fact that universal solutions do not exist should not divert attention from the importance of making a determined attack on these structural problems.
Improving the efficiency with which the industrial economies function would help restrain the forces of protectionism. To the extent that these countries can exploit the opportunities of new industries and technologies, the pressure to cling to the false security of old ones will be reduced. The dynamic nature of comparative advantage means that it is to the ultimate benefit of all countries to preserve an open trading system. It is thus not just the industrial countries themselves that would benefit from a more efficient functioning of their economies. The rest of the world looks to growing markets in these countries to provide the kind of global environment that is so necessary to their efforts to regain the momentum of development.
2. Growth and Adjustment in Developing Countries
The improving situation in the industrial countries is having a beneficial effect in the Third World. A number of developing countries have taken advantage of these conditions by implementing courageous and determined adjustment programs. With better conditions and improved policies, exports of developing countries to the industrial world have grown rapidly over the past year (by 18 percent in dollar terms), imparting a badly needed stimulus to growth and contributing to a further improvement in balance of payments positions. The current account deficit of the non-oil developing countries in 1984 is likely to be less than $50 billion, well under half the figure of three years ago. This deficit is equivalent to about 9 percent of their exports of goods and services, the lowest proportion in at least twenty years.
The fact that the adjustment process in developing countries is now moving from the import-compression phase to the export-expansion phase is also making for faster output growth. For the first time in four years, output in these countries, as a group, is expected to grow appreciably faster than population, and a further acceleration to 4½ percent is in prospect for 1985.
These positive developments should not be allowed to obscure the many aspects of the present picture that give cause for concern. The present trends in growth follow several years in which living standards in many developing countries have been stagnant or declining. It must also be borne in mind that economic performance has been highly uneven across countries, with African and Latin American countries having been severely affected. The African countries have suffered particularly severely as recent setbacks have been compounded by adverse climatic conditions. What is more, the low growth rates now being experienced in Africa follow several years of economic stagnation against a background of already low per capita incomes. Though Asian countries have generally experienced satisfactory growth rates, we must not forget that this is still the region with the largest number of people in economic distress. Lastly, the debt situation of many developing countries the world over remains precarious and vulnerable to adverse developments, whether of a domestic or external character.
The key issue is how developing countries burdened with heavy indebtedness can regain the momentum of their economic advance. This is a question that concerns us greatly in the Fund. We have studied it closely, both in the context of our support for member countries’ programs of adjustment and of the Fund’s surveillance of world economic developments. Careful analysis of recent developments and future prospects yields several important conclusions.
—First, the prospects for an orderly and effective handling of the debt situation are much better now than they were a year ago.
—Second, with sensible policies, the situation of indebted countries appears manageable in the medium term. A resumption of growth can be combined with a gradual reduction in their external debt burden. The latest medium-term projections undertaken by the Fund staff suggest that by 1990 the ratio of external debt to exports of goods and services for the seven most heavily indebted developing countries, taken together, could fall by two fifths, while economic growth could increase to about 5 percent a year over the second half of the decade.
—Third, the differences among countries are such that a case-by-case approach offers the only realistic hope of continued progress. This case-by-case approach has already yielded positive results. Several major indebted countries have made significant progress toward restoring their creditworthiness while improving the basis for domestic growth. If the adjustment programs which these countries have adopted are continued, there is every prospect that further progress will be made in the period ahead.
Having said that, I must now underline the point that while a satisfactory outcome is possible what will actually happen depends, above all, on the policies that are pursued. It is in this respect that the challenge arises to all of us concerned with national and international economic policymaking.
The policies that I want to touch on involve three sets of decision makers: the authorities of the major industrial countries, whose economic performance will affect the global environment in which growth and adjustment in developing countries must be pursued; lenders, both in the private and public sectors, whose lending decisions determine the direct constraints facing the indebted countries; and finally, and most importantly, the authorities of the borrowing countries themselves, whose adjustment efforts are the touchstone for the maintenance of adequate financing.
The major countries have a vital role, in present circumstances, to create an environment conducive to export growth and smooth debt service. This means three key things: continued noninflationary economic growth to provide a steadily expanding market for developing country exports; the avoidance of protectionist measures; and the adoption of policies that permit a return to more moderate levels of real interest rates.
For lenders, both official and private, continued understanding of the dynamics of the adjustment process will be needed. This involves a continued willingness to provide adequate financing to countries that are making genuine attempts to solve their debt problems. It also involves a readiness to approach debt problems in a medium-term context and to take account of progress toward adjustment through adequate refinancing.
I come, now, to the indebted countries themselves who bear the main burden of adjustment. I want to emphasize that in an integrated yet rapidly changing world environment, adjustment is not a policy option: it is obligatory for a country’s economic survival. True, adjustment involves costs. But those costs can only be compounded if adjustment is resisted through controls and restrictions. The relevant distinction is between orderly adjustment that seeks to exploit the opportunities of a new situation and an adjustment that is ultimately thrust on a country when confidence has been lost in the currency, forcing drastic cuts in imports and living standards.
Key elements in an effective adjustment strategy include the following:
—More effective pursuit of greater domestic price stability to improve the climate for investment.
—Adequate control over budget deficits where they have been contributing to inflationary pressures or crowding out more productive resource use in the private sector.
—Realistic and flexible domestic prices (including especially the exchange rate, interest rates, and major administered prices) so as to improve the allocation of resources and promote growth.
—Continuous review of government expenditure, both current and capital, to ensure that the resources thus absorbed are productively employed.
These are the policies that are recommended by the Fund. It would be hard to exaggerate their importance. Only such policies can rebuild confidence, serve to bring back flight capital, and attract new flows of direct foreign investment. Without such policies the present imbalances and external payments difficulties cannot be surmounted and a return to satisfactory growth will simply not be possible. They are not short-sighted or anti-growth policies as is sometimes contended. Far from it: they are consistent with growth and, indeed, indispensable to it. It is in that context that the collaboration between the Fund and the World Bank is so important. Indeed, the Fund works very closely with the World Bank to ensure that the requirements of balance of payments adjustment are cast in the light of balanced and sustainable development over the longer term; this collaboration is being intensified.
We can already see that many of those countries that have been most successful in implementing adjustment programs and in restoring external viability are also those where domestic growth is recovering most vigorously. Though the road of economic adjustment will continue to be bumpy, the adjustment programs that many developing countries are implementing, if adhered to, promise significant further benefits to economic performance over the medium term. It would indeed be unfortunate if the recent and prospective surge in developing countries’ exports gave rise to complacency about the need for further policy adaptations. There is an important role here for political leadership in developing and sustaining support for the policies needed.
In spite of the remarkable progress achieved in a number of countries, adjustment programs have still to be agreed upon in some cases. Indeed, a lot remains to be done to improve economic performance in much of the developing world. Inflation remains extremely high in many developing countries. Major rigidities are still to be found in the mechanisms by which interest rates, exchange rates, and other key prices are adjusted. Government deficits are often high and public expenditures inefficiently allocated.
The success of adjustment efforts will require determination on the part of the borrowing countries and the support of lenders. The Fund can play a crucial role in this respect. The Fund is indeed uniquely placed to help member countries devise responses to adverse developments and provide assurances to lenders that the thrust of an adjustment effort is being maintained.
3. International Collaboration
Grasping the opportunities and meeting the challenges of the present situation will require not only domestic political commitment, but also a high degree of international collaboration. The world economy has become increasingly interdependent, and all countries need to recognize the ways in which their policies interact with those of their trading and financial partners. One of the main functions of the Fund is to foster such a recognition and to promote sound national policies that are internationally compatible.
The past year has seen several welcome manifestations of effective international collaboration. To begin with, the Fund’s finances have been substantially reinforced. Toward the end of 1983, the increase in Fund quotas under the Eighth General Review became effective. This was followed by an enlargement of the resources available to the Fund under the General Arrangements to Borrow, and through additional lending agreements with Saudi Arabia, the Bank for International Settlements (BIS), and certain industrial countries. These developments have significantly enhanced the ability of this institution to promote and finance orderly adjustment. In the 12 months to the end of August 1984, the Fund approved 27 new stand-by or extended arrangements for member countries. After the high commitment figures of 1983 (SDR 11 billion) in the wake of the debt crisis, Fund commitments are expected not to exceed SDR 5 billion in 1984. These amounts should not entail a need for additional borrowing by the Fund for the time being. They show the prudent way in which the Fund has utilized in individual cases the limits of the enlarged access policy. The agreement reached in the Interim Committee over the weekend to continue the enlarged access policy is very important. The agreement preserves the necessary flexibility for the Fund to be able to respond to individual situations and problems if and when they arise.
Collaboration on the part of international lenders, both public and private, has over the past year been crucial in underpinning adjustment efforts and in bringing about an orderly evolution of the debt situation. There are no miracle solutions, no global panaceas in this field. It is only by maintaining and improving collaboration between all the parties concerned on a case-by-case basis that continued progress can be realized. Remarkable cooperation has been shown in the Paris Club in handling official debt refinancing. And cooperation among commercial banks too has been close and effective. The recent multiyear rescheduling arrangement concluded between the Mexican authorities and the banks’ advisory group constitutes an extremely important step forward. That arrangement, by dealing with the entire “hump” of debt maturing between 1985 and 1990, will enhance Mexico’s capacity to manage its external debt and facilitate its return to normal market access. It also marks an improvement in the terms obtained by Mexico, thus strengthening the obvious linkage between performance and spreads. Lastly, the arrangement provides for a continuing collaboration between the Fund and the Mexican authorities through enhancement of the procedures of Article IV consultations. This agreement should therefore strengthen the incentives for other countries to pursue effective adjustment policies. Extension to other countries of multiyear rescheduling will depend on the circumstances of each case.
These are, indeed, welcome developments. At the same time, there remain aspects of the situation where the spirit of collaboration needs to be strengthened. I will refer to three: concessional financing, trade policies, and surveillance.
While many governments are finding it difficult to increase their official development assistance, it is clear that whatever the cooperation provided by the banks in international lending in the coming years, and whatever the level of direct investment—which should play an increasing role—there will be a need for increased official development assistance. The role of governments in providing adequate concessional lending, in particular through IDA, and in making available additional bilateral assistance, for instance, in the form of sustained access to export credit guarantees, cannot be overemphasized. It will also be essential that governments play an active role in backing financial packages in support of adjustment programs.
International collaboration in the field of balance of payments adjustment and financing cannot be fully effective if adjustment efforts are impeded by measures that restrict or distort trade. Yet, over the past few years, many governments have been yielding to protectionist pressures despite an almost universal commitment to resist them. Some recent actions to resist protectionist pressures are encouraging. The importance of firmer resistance to protectionism cannot be over-stated. Of course there are political pressures. But the hard lesson of the past is that protectionist measures, however temporary they are intended to be, have a tendency to become entrenched and to spread. They do not just poison the trading climate in certain industries, but weaken the fabric of international economic and political cooperation as a whole. They impede the satisfactory functioning of the international price mechanism, they undermine efficient allocation of resources, and they add to balance of payments and debt problems. Thus, there is an urgent need for high-level political decisions on a strategy to advance trade liberalization and strengthen the trade system based on the GATT.
It is sometimes suggested that pressure for protection has arisen largely as a consequence of shifts in exchange rates. This leads some observers to suggest that the focus of collaboration should be on redesigning the international monetary system so as to prevent or reduce the exchange rate movements which have characterized the floating period. While it is true that exchange rate variability gives rise to problems, it must be recognized that, in a world of integrated financial markets and free capital flows, such movements are not easy to check by means of exchange rate limits and intervention. They are more often the manifestation of economic instability than the cause of it. Exchange rate variability arises to a large extent from divergences in policies and performance among major countries, and it is on improving policies that the principal effort should, in my view, now focus. That is why it is so important to enhance the effectiveness of Fund surveillance of exchange rates and of the national economic policies and international developments that influence them.
To strengthen the Fund’s capacity to act as a forum for multilateral surveillance, we have built upon some of the initiatives introduced in the consultation process in recent years. The great majority of consultations are now on a regular 12-month basis; and there is a growing focus on assessments of trade policies and their impact on domestic and international adjustment. The procedures are now in place. But the effectiveness of multilateral surveillance will depend in the event on the willingness of member countries to submit their own economic policy choices to the constraints and the spirit of international collaboration. I look forward to an enhancement of evenhanded surveillance as is now being contemplated.
* * * * *
Mr. Chairman, the world economy has made considerable progress in the past two years. The industrial world is regaining the momentum of growth and the rapid deterioration of the debt situation has been reversed. These are solid achievements. Our goal now must be to ensure such sustained growth, for all countries, on a firm financial footing.
I believe this goal can be achieved. It cannot, however, be achieved without a continued commitment to sound noninflationary policies. The fight against inflation is not yet over. We still have to maintain the course and resist the pressures from whatever source to relax the commitment to financial discipline. The lesson of the 1970s is clear. It is that shortsighted inflationary policies exact a heavy price in terms of growth and jobs. There is also another lesson: those who have been predicting collapse since the onset of the debt crisis have been wrong. Action and cooperation are possible and if pursued with determination can lead to success. If these lessons have been well learned, we can be confident of a stronger and more sustainable economic performance as we face the second half of the 1980s.
September 24, 1984.