Presentation of the Thirty-Fifth Annual Report1

International Monetary Fund. Secretary's Department
Published Date:
November 1980
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By the Chairman of the Executive Board and Managing Director of the International Monetary Fund—J. de Larosière

Let me begin by joining you in greeting all those assembled here for the Thirty-Fifth Annual Meetings. I should like to welcome the Governors for St. Lucia, St. Vincent and the Grenadines, and Zimbabwe, which have become members since the Annual Meetings last year.

I should also like to extend a special welcome to the Governors for the People’s Republic of China. The Fund is looking forward to the important contribution which this great country will be able to make to our work. The increase in the quota of the People’s Republic and its representation on the Executive Board by the addition of an Executive Director signal the importance that the International Monetary Fund attaches to its participation. This marks a significant date in the history of our institution.

I shall now review briefly the salient features of the present economic situation. I will then outline the main policy measures which need to be undertaken. In the last part of my speech, I will describe how the Fund is adapting its policies to help its member countries meet the difficult economic challenges they face.

1. Major Problems in the World Economic Situation

Three problems dominate the state of the world economy: inflation, energy, and the plight of the non-oil developing countries.

The present level of inflation is intolerable, not because of some theoretical preference but because it undermines the prospect for medium-term economic growth. In the industrial countries, the average rate of increase in consumer prices from 1979 to 1980 is estimated at 12 per cent. This is greater than the 1979 figure (9 per cent) and is close to the highest in recent history (13 per cent in 1974). The inflation record of the developing countries has been far worse—on average, consumer prices in those countries are expected to rise by 35 per cent from 1979 to 1980.

In time, inflation destroys the roots of savings and productive investment. Indexing mechanisms engendered by inflation become widespread and elaborate; they accelerate the phenomenon, anesthetize the body politic and the whole society, and postpone the essential policy actions. The primary aim of economic policy must be to bring about and maintain a reduction of inflation and inflationary expectations.

It must be recognized that many countries have noticeably tightened their economic policies since we met in Belgrade last year. These countries have given top priority to the fight against inflation, and elimination of negative real interest rates in most industrial countries is a sign of this awareness. But the member countries that have taken this firm stance against inflation now face a crucial test. Activity is weakening and unemployment is rising in most of the industrial countries; there is a danger that great pressure may now be exerted on national authorities to relax demand management policies.

I come now to the energy situation. If we do not address this problem, directly and comprehensively, we will be encouraging economic instability. No anti-inflation effort, no sustained policy of growth, no plan to organize the world’s monetary system could succeed if the present energy situation were to persist. The problem of energy has become all-pervasive; measures to deal with it must embrace the whole process of formulating and conducting policies at both the national and international levels.

The energy problem stems primarily from one fact: the present level of oil consumption greatly exceeds rates of production that appear sustainable in the long run. The implications of this for national policies are of great importance. Most of our countries must speed up the process of adjustment to an age of high-cost energy. They must recognize that oil has become an expensive product and is bound to remain so.

This message is underscored by the impact which the steep rise in oil prices during 1979 and 1980 has had on countries’ international payments. The combined current account surplus of the oil exporting countries has gone up from $5 billion in 1978 to about $110 billion in 1980; and, as we look ahead to the next few years, it seems likely that this surplus will prove to be longer lasting than in the 1974-78 period.

Unfortunately, it is certain—and I come now to the third problem—that many of the non-oil developing countries, in particular, will continue to be sharply affected by international economic developments. The rise in oil prices has reduced, in some cases massively, the foreign exchange available for their imports of other goods. The growth in their exports has been slowed by anti-inflation policies—albeit justified policies—in the industrial countries and by the depressive effects of higher prices of energy in those countries. We are projecting a current account deficit of $80 billion for the non-oil developing countries in 1981—higher than this year and more than twice as large as their combined deficit in 1978.

For developing countries where levels of per capita income are already close to the margin of human subsistence, these depressive forces could prove disastrous. Our estimates and projections for the non-oil developing countries distinguish a low-income subgroup whose current situation is already very serious. This subgroup comprises 39 countries2 whose per capita GDP in 1977 did not exceed the equivalent of $300; 38 per cent of the population of the Fund membership lives in those countries, but they account for only 3 per cent of its aggregate gross product. In the six years from 1974 to 1980, these countries suffered a decline of about 10 per cent in their “real” export earnings; the volume of their imports increased over this period by a mere 3 per cent. On a per capita basis, the real GDP of the low-income developing countries rose at an average annual rate of only 1½ per cent from 1974 to 1980; that of the “richer” countries increased during the same period by well over 2 per cent—and, of course, from a much higher base. Thus, the relative position of the low-income countries has worsened considerably during the last few years. How can one be surprised that calls for international solidarity and for reform of the system continually arise?

2. The Policies Needed to Reduce Inflation and to Encourage Sustainable Growth

a. Demand management

Having outlined the three major economic problems we face, I shall endeavor now to show how national economic policies can be adapted to deal with them and to encourage sustainable economic growth over the new decade.

We recently prepared a study in the Fund which set out a few broad “scenarios” for the world economy over the next five or six years. These scenarios reflected different general assumptions about the conduct of demand management policies in the industrial countries. Let me indicate, very briefly, the main points which emerged from this analysis.

—Assume first that industrial countries persist, in their fight against inflation. Given the present very high rates of inflation in quite a few of these countries, this implies that they accept for some time a reduction in the growth of their nominal demand. It may be expected, on this hypothesis, that inflation in the industrial world gradually decreases, that the average rate of growth of real GNP advances from a low level, and that the recycling problem proves manageable. This scenario is certainly not ideal, as it would entail an increase in economic slack. It would, however, restore by the mid-1980s an environment conducive to sustained long-run growth. To achieve this result, it would be essential for industrial and developing countries alike to take advantage of the next several years to adopt supply-side measures that would gradually relax the energy constraint and, more generally, remove the factors tending to hinder productive investment and labor mobility. This, in essence, was our first scenario.

—Our second scenario supposed that demand management policies make an early shift toward expansion. Growth rates might improve markedly for a year or two, but inflation would flare up again and upward pressures on the price of oil would intensify. A new shift toward severe restraint of demand would probably then occur, bringing about a fall in rates of economic growth. Those countries with weak external positions would see them deteriorate even further and, toward the middle of the decade, recycling problems would become very serious. Several years would have been lost in the fight against inflation, and inflationary expectations would become even more deeply entrenched. Moreover, if national authorities made a premature shift to an expansionary stance but did not quickly reverse course when inflation turned up again, the period 1985-86 would bring severe inflation and recession, together with the risk of unmanageable strains on the international financial system.

I see no course of policy that could make the economic situation truly satisfactory over the next several years. However, the tackling of inflation—provided it is coupled with effective policies on the supply side—holds out the promise of bringing substantial improvement to the international economic environment by 1985 or so. It will assist in resolving the energy problem and, in this and other ways, it will strengthen the position of the non-oil developing countries over the coming years. On the other hand, failure to give priority to the control and reduction of inflation would entail grave risks and waste precious time in achieving a sustainable growth pattern.

Because of their heavy weight in the world economy, the major industrial countries have a special role in combating inflation. But corresponding efforts are no less urgent in most other countries. Among these are many developing countries, where the prevalence of high rates of inflation has been a serious deterrent to domestic saving since the early 1970s, and where economic policies are in need of adjustment from the standpoint of both domestic and external considerations.

Successful handling of the inflation problem will require maintenance of firm restraint in the conduct of monetary policy. Fiscal policy should be pursued in harmony with that objective. In some countries this will call for renewed efforts toward greater fiscal discipline, involving primarily better control over government spending.

b. Complementary policies

Policies on the side of demand management, however, will not generally be sufficient in themselves. Complementary measures should be adopted to help contain the growth of nominal incomes within the limits set by anti-inflation objectives. Direct measures to influence the growth of incomes will vary from country to country according to their traditions, economic circumstances, and the political setting. But let me make two observations. First, the present situation of “stagflation” and increased cost pressures of external origin seem to make some form of incomes policy particularly justifiable. Second, even if used only in an informal way, incomes policies could make a contribution in present circumstances by impressing upon the general public the limitations on real income gains that are implied by the weak growth of productivity in many countries over recent years and by the rapid escalation of energy prices.

Demand management policies and supplementary measures to restrain the growth in incomes need to be accompanied by measures to improve productivity and efficiency. In many countries, growth has been affected by structural problems, including poor productivity records and rigidities arising from the widespread quasi-automatic adjustment of wages and social benefits to rising prices. In some countries, the adjustment of relative prices to changes in the world economy has been restrained or prevented. Subsidies have been directed to the maintenance of outdated production methods and of industries in decline. The legitimate demands of social policy have not been reconciled with the need for dynamic industrial growth. The problem is to devise policies which improve economic efficiency and raise the level of investment. Through adjustments of tax structures and government spending programs, it is important to shift resources from consumption to investment without sacrificing overall fiscal restraint.

One aspect of economic policy—the energy problem—demands special attention. Other policies cannot have their full impact unless, at the same time, conditions to improve the supply of energy are created by moderating consumption, by finding additional supplies of mineral fuel, and by exploring alternative sources of energy. All countries will need to work toward these objectives, but for them to be reached one crucial condition must be satisfied. The increased prices for oil imports must be passed on in their totality to the domestic consumer, thus motivating both the oil producer and the consumer. This necessary adjustment of oil prices will induce structural change, however, only if the authorities prevent increased energy prices from triggering a proportional rise in the general level of prices and wages. The fight against inflation is thus the cornerstone of any effective energy policy.

While every country has a responsibility in respect of energy policy, the remarks I have just made apply particularly to the industrial countries, which possess abundant financial and technological resources and which absorb almost three fifths of the energy consumed in the world. Here, interdependence is clearly fundamental. Any delay in adopting energy-saving policies—particularly on the part of the major oil consuming countries—affects the situation of the international oil market and tends to cancel out the results achieved by countries more conscientious about their responsibilities or more aware of the constraints upon them.

I said earlier that we face the prospect of continuing payments imbalances on current account over the next few years. These imbalances must be progressively reduced through a reorientation of energy production and consumption. It would be unrealistic to expect the payments imbalances to be eliminated in the short run through a rapid rise in imports by the oil exporting countries as a group. Such a rise in imports is highly improbable because of the desire of the oil exporting countries to avoid, and rightly so, an inflationary expansion of domestic demand, and also because of their need to pay regard to achieving development at a pace that does not cause the excessive strains that may result from too rapid social change.

Thus, both developed and developing countries need to ensure that the current account deficits they incur not only are financed but also are accompanied by adjustment of their economies in a way that improves their energy position and favors growth. More generally, where they are compelled to borrow, this borrowing should be accompanied by mobilization of a greater volume of domestic savings and by investment to enhance the productive base of their economies. Only if such adjustments are undertaken will the borrowing prove feasible and sustainable. While implementing judicious financial programs, deficit countries should, therefore, apply realistic pricing policies both in the domestic economy and in the foreign trade sector, so that their resources can be allocated in the most fitting way and the funds available for investment can be channeled into the most profitable sectors of activity.

c. Policies to assist the developing countries

It is true that all countries need to make adjustments in their economies, but the low-income developing countries are facing difficulties that demand international action in their favor. These countries, with their low capacity to save and to pay external debts, are heavily dependent on foreign official transfers and on aid dispensed to them on concessional terms by a number of international organizations. Their present plight signals a great and urgent need for more official development assistance from the industrial and oil exporting countries. An increase of only a few billion dollars in the level of annual assistance could play a decisive role in the survival of the lowest-income developing countries. Such assistance, of course, must be truly additional to that already being provided.

Greatly increased financial flows will be necessary for many of the developing countries over the coming years. But the level of external debt is already high in a number of these countries; to the extent possible, they should be enabled to pay for their imports through their own earnings of foreign exchange. Expansion of exports also provides the major vehicle for economic growth in many developing countries. The industrial countries, therefore, must resist the temptation to maintain or raise trade barriers, notwithstanding current account deficits, economic slack, and the decline of some of their industries.

Moreover, the industrial countries have a self-interest in avoiding protectionism. There is a real need for structural adjustment in these countries. This is required not only to augment the production of energy and conserve its use but also to allow the absorption of low-cost manufactured imports from the developing countries while providing new employment opportunities and income for their own peoples—especially in the manufacture of the most sophisticated products. Only in this way can a rational approach to a viable world economy be maintained. This global approach, based on a more efficient use of economic resources and on intensified competition, can underpin the fight against inflation in the industrial countries. Protectionist pressures must be resisted for the sake of maintaining the great gains we have come to enjoy from the liberalization of world trade, as well as for the sake of controlling inflation, promoting increased productivity, and contributing to the sustained growth of the developing countries. While this process of adjustment is being carried out, the major industrial countries should be prepared to accept weaker external current account positions so that the developing countries—whose position is very much the weaker—should not have to bear an excessive burden of current account disequilibria as a counterpart of the oil surpluses.

3. Role of the Fund in Financing and Adjustment

I now come to the role that the Fund can play in assisting its members.

At its meeting in April of this year, the Interim Committee endorsed three important guidelines for the life of our institution:

  • —It considered that the Fund should stand ready to play a growing role in the adjustment and financing of payments imbalances.

  • —It reaffirmed that the assistance provided by the Fund should be accompanied by the adoption of adjustment programs appropriate to the needs and problems of members in the present economic situation.

  • —It encouraged me to start discussions with potential lenders on the terms and conditions under which the Fund could borrow funds to increase its resources.

In compliance with these guidelines, a considerable amount of work has been accomplished by this institution, although the Executive Board will still have to work further on some aspects of their implementation.

I will outline the results of this work, the decisions adopted, and the future prospects.

(a) With respect to the financing of deficits, the Fund must not engage in financing if there is not a strong effort to adjust on the part of the member or if there is no scope for correcting the balance of payments over a reasonable period. The persistence and nature of the present imbalances make this adjustment effort more imperative than ever. But it is also necessary that the amounts of assistance provided by the Fund be adequate to the situation, so that they encourage members to solve their problems and, where possible, exert a catalytic effect on other sources of financing. In this spirit, the Fund has decided to enlarge its assistance significantly. Countries that are able to adopt adequate adjustment programs can now count on access to the Fund’s resources that may, in certain cases, be several times as large as the traditional amounts. This policy has already been translated into fact. This is reflected in the overall rise in the Fund’s new lending commitments; these amounted to SDR 4.3 billion during the calendar year 1979, while in the first nine months of 1980 they already came to SDR 5.9 billion.

(b) As regards the nature of the adjustment to be undertaken, I would like to describe the new thrust of our policy. First of all, because of the structural aspects of most of the problems, it must be recognized that correction of disequilibria will often need to be extended over a longer period than that considered normal in the past. Second, our programs need to address the structural aspects. This approach must endeavor to create conditions conducive to the improvement of supply. This will require, of course, supportive measures on the demand side so as to keep the claims on resources in a sustainable relationship with their availability. It is only through the pursuit of such a comprehensive macroeconomic approach that inflation can be reduced, the external situation strengthened, and domestic saving promoted in the context of a sensible plan of investment. The adjustment programs we support will thus be an integral part of a longer-term strategy for fostering investment and economic growth. To this end, we have made the necessary arrangements to collaborate closely with the World Bank and other agencies specializing in long-term investment assistance.

Thus, with flexibility and realism the Fund is endeavoring to make its assistance to members increasingly effective. I am fully aware of the claims by some critics that our policy advice has been too harsh. But this criticism, I believe, is largely misplaced. It is the condition of a country’s balance of payments—sometimes in conjunction with the low level of official assistance from abroad—that is the true cause of the harsh adjustment measures that sometimes must be adopted in the attempt to restore its payments equilibrium and to open up prospects of improved future growth.

We have learned from experience how difficult it is to reconcile conflicting claims when countries are forced to cut back on their use of resources. The Fund helps with finance and thereby moderates the severity of the adjustment. But it cannot determine the manner in which the pain of adjustment is distributed within the society. For this extends to the heart of the political process, and there we are vigilant to pay due regard to the domestic social and political objectives, to the economic priorities, and to the individual circumstances of members. There is little that the Fund—or, for that matter, any external agency—can do to help with decisions in this area.

The difficulties associated with many adjustment programs could be eased, or even avoided, if members came to the Fund earlier, before the external situation had become so severe as to require drastic action. It is my hope that the various changes now being introduced into our policies on the use of the Fund’s resources will induce members to come to the Fund for assistance whenever needed, and without delay.

(c) As to the means of financing this new assistance policy, let me first stress that quotas must remain the fundamental source of the financing provided by the Fund to its members. They are a manifestation of the cooperation among governments that constitutes the very essence of the Fund. At this point, implementation of the 50 per cent increase provided for by the Seventh General Review of Quotas is urgent. But even with this increase, the size of the deficits and the concentration of surpluses among a few members mean that the Fund’s liquidity would not enable us to implement the policy of enlarged access which I described a moment ago. By about the end of this year, the supplementary financing facility will be totally committed, and it will be necessary to have recourse to further borrowing as an interim method of financing. Preparatory work on the Eighth General Review of Quotas is to begin soon in the Executive Board, but completion of the whole process will take time. I have, therefore, begun examining the possibilities of direct borrowing by the Fund from members that are in a strong external position. The reaction I have had to date shows that these countries have a positive attitude to collaboration with the Fund. The discussion continues. Furthermore, with the strong encouragement of the Executive Board, I am proceeding to explore other sources of financing, including market financing. In the coming months it will be necessary to take decisions on these matters in order to assure the necessary continuity in the financing of our institution to meet the needs of its members.

I am conscious that the Fund’s borrowed resources are expensive for its members to use, and this affects particularly members with low per capita incomes. Therefore, the Fund has also undertaken to institute an interest subsidy account designed to decrease the cost of using the supplementary financing facility. Part of the resources of this account will be derived from the expected repayments of loans granted by the Trust Fund. I hope that another portion will come from voluntary contributions or loans, preferably on concessional terms, from countries which are in a position to participate in such operations. We have already initiated inquiries with a number of countries regarding their possible contributions. Some replies have been negative or are pending. We are, therefore, the more grateful to those countries which have given a positive reply, and I trust that decisive progress can be made in this matter before the next Interim Committee meeting.

In concluding these remarks on the Fund’s policies, I should like to draw attention to one proposal under study in the Executive Board that I believe deserves particular support. This is the suggestion that the Fund should establish a food import facility which could alleviate the problems of countries—especially low-income countries—suffering from crop failures or sharp rises in food import costs. The scheme that has been studied appears workable and fully compatible with the revolving character of the Fund’s assistance, and its demand on our resources can be limited. Because of the present serious situation of the developing countries, I consider that an early and positive decision on this matter would be an important manifestation of our concern for human issues.

My remarks so far have been directed to the most urgent problems faced by our member countries in the present economic situation. I have traced a consistent set of policies aimed at securing sustainable growth during this decade. I have explained how the Fund, while retaining its special role, is adapting its policies to the new realities. My concluding remarks concern, more broadly, the future of the international monetary system. This is a fundamental question from which even the most urgent day-to-day concerns must not distract us.

We live in a system that is under strain. There are, nevertheless, important and growing areas of stability and consensus in this system, and I will begin by speaking of these. First, the surge of inflation in the 1970s provoked, or hastened, an increasing awareness of the importance of monetary discipline. By this, I do not mean a naïve and mechanistic faith but a growing recognition that continuous monitoring and restraint of monetary expansion is a necessary, though not sufficient, condition for sustainable growth. Monetary targets and the monitoring of monetary aggregates are widespread in the industrial countries, and increasingly so in the developing world. Second, in close relation to this, there has been, over the last two years, a greater degree of stability in the foreign exchange market than most people would have dared to predict. This market has coped remarkably well with large shifts in deficits and surpluses and with other serious international tensions. The European Monetary System is one example of this stability; and, more generally, the principal world currencies have only in rare cases fluctuated beyond a range conducive to appropriate balance of payments adjustment. Third, despite the regrettable failure to decide on the establishment of a substitution account, the Fund’s members have reaffirmed their conviction that a strong SDR should be the centerpiece of the international monetary system. The recent decision to simplify the SDR to a five-currency basket will increase its use both by the private sector and by official holders. Furthermore, the Interim Committee has just requested the Executive Board to give early attention to the question of adjusting the SDR interest rate to the full market rate and of eliminating the remaining reconstitution requirement. Also, the importance of the SDR as a stable and attractive international reserve asset will continue to be enhanced through the Fund’s borrowing activities.

I will turn now, Mr. Chairman, to those aspects of the system on which a consensus among our members still needs to be built.

The recent special session of the UN General Assembly heard interventions on a wide range of subjects of direct concern to the Fund, including the creation and distribution of international liquidity and the decision-making process in international financial institutions. Indeed, over the past decade the Fund has been engaged in a process of self-examination. This has continued intensively in recent months during the preparation of reports for the Interim Committee on the Group of Twenty-Four’s Program of Immediate Action and for the Development Committee on the Brandt Commission’s recommendations. One of the most important areas of study has been the creation and distribution of international liquidity. The allocation of SDRs was resumed in 1979 after a hiatus of seven years. We will soon be actively discussing the question of new allocations in order to achieve a level of SDR holdings commensurate with the growth of world trade, the need for global liquidity, and the objective of reversing the falling share of SDRs in members’ reserves. Discussion of the “link” between SDR allocations and development assistance has been resumed in the Fund, and new approaches have been put forward which we are going to study again in greater detail after these Meetings.

The issue of decision making will be an important element underlying the impending Eighth General Review of Quotas. The elements of the formula used in the calculation of Fund quotas will be reviewed, and we shall have to work for selective increases in quotas that reflect the changing importance of countries and groups of countries in the world economy. In all our discussions, and throughout the range of activities we pursue in the Fund, we must ensure that all our members have a sense of real participation in the Fund’s affairs.

These issues are not easy to resolve. The interrelated problems of inflation, slow growth, and energy confront the world economy with profound challenges. They call for a quality of creativity and an intensity of cooperation on the part of the international community that is almost unprecedented. Solutions will need to be worked out in a spirit of patience and day-to-day cooperation. I would emphasize, Mr. Chairman, that we are determined to address these issues directly, and to arrive at solutions, within the framework of the Fund’s basic objectives.

The Fund is a financial institution which, to survive, must serve its members in a practical and businesslike way. Its operational response must be swift and its financial policies sound. But the Fund is also a collaborative institution, founded to promote cooperation among its member countries. If it is to play its full role at the center of the international monetary system, it must be capable of change; it must adapt itself to new realities; it must respond to the needs and aspirations of its membership. It is only in bringing together and blending these two strands in the Fund’s nature that we can successfully respond to the economic challenges of the difficult decade that we now face.

September 30, 1980.

Not including the People’s Republic of China, which is not yet covered in Fund statistics.

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