IEO Annual Report 2005-06

Appendix 6 Evaluation of the Role of the IMF in Recent Capital Account Crises: Recommendations, Board Response, and Subsequent Follow-Up

International Monetary Fund. Independent Evaluation Office
Published Date:
January 2007
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IEO RecommendationExecutive Board Response1Follow-Up2
Pre-crisis surveillance
Article IV consultations should take a stress-testing approach to exposure to a potential capital account crisis, extending and systematizing existing approaches. Staff should assess the potential impact of itemized risks. Staff should develop greater understanding of political constraints on policy, in part through wider dialogue. Market views and political economy analysis should be reflected in staff reports.Directors concurred with the overriding message of the report for surveillance: to strengthen the effectiveness of IMF surveillance by extending and systematizing current guidelines for assessing vulnerabilities. They supported the call to itemize major potential shocks. Directors emphasized that stress testing should not be overgeneralized and mechanical, but should focus on key risks facing a particular country. Most agreed that the IMF should develop greater understanding of political constraints on policy while cautioning that this should not lead to interference in domestic affairs. A number of Directors cautioned that this could be counterproductive if it causes staff to lose focus and press for policies and reforms that are not macro-critical. Most Directors saw great value in systematic discussions with the domestic and the international financial and business communities—but emphasized that the staff would need to assess private sector views critically.The Board paper for the August 2004 Biennial Review of Surveillance noted that the IMF had substantially strengthened its capacity to identify vulnerabilities in member countries. In particular, it noted that balance sheet issues had received substantial attention in surveillance of advanced and emerging market economies, although various components of vulnerability assessments were not well integrated when presented in staff reports.
Since then, the identification of balance sheet vulnerabilities has been highlighted as a key area in guidance to staff on surveillance, and methodological tools and training have been developed that will help gradually mainstream balance sheet analysis in IMF surveillance.
Management and the Executive Board should take additional steps to increase the impact of surveillance, including through making staff assessments more candid and more accessible to the public. In particular, there should be a presumption of publication for Article IV staff reports. A clear presumption of publication for country-related staff working papers should also be established. Biennial reviews of surveillance should focus on assessing the impact of surveillance on key systemic issues in major emerging market economies.Directors strongly supported greater candor in the assessment of country risks and vulnerabilities in staff reports, building on the increase in candor that has already occurred. Nevertheless, Directors expressed a range of views regarding the potential conflict between candor and transparency, and the implications of the proposed shift from voluntary to presumed publication of staff reports. Many Directors warned that greater candor could adversely affect both the IMF’s dialogue with countries and market confidence in the context of the publication of staff reports. Some of these Directors felt that what really matters is candor in face-to-face consultations with the key decision makers in a country, rather than in the staff report. Many other Directors strongly supported presumed publication. These Directors believed that concerns about candor are overstated, and that surveillance would be more effective in building ownership and influencing policy if IMF analyses and recommendations are made public. It was agreed that the Board would return to the issue of presumed publication of staff reports during the discussion on transparency.The May 2006 version of the Operational Guidance Note for Staff on Document Publication notes that staff reports should be drafted independently of the authorities’ publication intentions and should include the staff’s candid assessment of risks, its frank views on the authorities’ policy stance, and its policy advice on all areas deemed relevant.
Since July 1, 2004, publication of staff reports for Article IV consultations is now “voluntary but presumed.” Moreover, the member’s agreement to publish staff reports is now required for management to recommend a program with exceptional access to the Board. This policy was confirmed at the time of the June 2005 review of transparency policies. Rules regarding modifications of reports prior to publication (including deletions) were also tightened at that time. Moreover, publication of country-related staff working papers is not subject to the consent of the member countries concerned.
Many Directors were not in favor of shifting from voluntary to presumed publication of staff reports, but a number strongly supported presumed publication.Increasing the impact of surveillance is one of the key objectives of the IMF’s Medium-Term Strategy (MTS). Staff has been encouraged to develop regional and country-level outreach strategies for this purpose. A broader, institution-wide communications strategy will be brought to the Board in spring 2007.
The Executive Board should agree on a systematic plan to provide institutional incentives for greater candor in the assessment of country risks and vulnerabilities, possibly including measures to give greater independence to surveillance teams.Directors encouraged the provision of institutional incentives to the staff to facilitate candor.Some area departments have experimented with having a different mission chief for Article IV consultations with program countries or have a senior staff member not assigned to the country concerned participate in Article IV consultation missions.
Biennial reviews of surveillance will remain the main vehicle for assessing progress.
Escalated signaling should be used when key vulnerabilities identified over several rounds of surveillance are not addressed. Such a policy would help strike the necessary balance between the role of the IMF as confidential advisor and its role as a vehicle for transmitting peer reviews on members’ policies and for providing quality information to markets.Many Directors considered that escalated signaling might be an idea worth pursuing. A number of these Directors reserved judgment on the suggestion until they had more information about how it would work. A few Directors felt that escalated signaling would undermine the IMF’s role as confidential advisor, and doubted that it would help in preventing crises or designing more effective programs.There was no consensus in the Board on escalated signaling or second opinions.
Moreover, management and the Board should explore the possibility of seeking “second opinions” from outside the IMF as part of the surveillance process when the authorities disagree with the staff’s assessment on issues that are judged to be of systemic importance. This would also serve as a building block for the idea of escalated signaling.Many Directors were not in favor of inviting second opinions from outside the IMF. Whereassome Directors considered that a second opinion would bring a fresh perspective that could help resolve differences of opinions with the authorities, many were concerned that it could encroach on the role of the Board, and undermine the work of the staff. A few Directors also noted that this approach has been tried and has failed.
Program design
A comprehensive review of the IMF’s approach to program design in capital account crises should be undertaken. In particular (1) greater attention should be paid to balance sheet interactions and their consequences for aggregate demand; (2) program design should allow for a flexible response, in case unfavorable outcomes materialize; (3) conventional financial-programming-based conditionality should be reviewed, and possibly adapted for capital account crisis circumstances; (4) parsimony and focus should be basic principles of structural conditionality and crises should not be used for pushing reforms that are not critical to crisis resolution, however desirable they may be in the long run; and (5) there should be an agreed communications strategy, characterized by a high degree of transparency.Directors endorsed these recommendations and hoped forthcoming staff papers on program design and balance sheet effects would give due attention to them. They endorsed the report’s focus on the restoration of confidence, and the importance of balance sheet effects on key macroeconomic variables. The balance sheet approach should be closely linked to debt sustain-ability analysis. There should also be more work on twin (banking and capital account) crises. Directors agreed that design should allow for a flexible response to unfavorable developments; that the conventional financial programming conditionality should be reviewed; and that there should be an agreed communications strategy. Nevertheless, a few Directors cautioned against excessive emphasis on risks and alternative scenarios in program documents, since it would be difficult to know all risks up front and since such emphasis could erode the program’s effectiveness in building confidence in the chosen action plan.The December 2004 review of the design of IMF-supported programs examined the analytical toolkit for program design, including tools for balance sheet and debt sustain-ability analysis, and the performance of these tools for macroeconomic projections underlying program design. In April 2006, staff also completed a review of whether there were any systematic differences between precautionary and nonprecautionary programs in terms of policies, conditionality, and macroeconomic outcomes, and whether these differences were attributable to the nature of the arrangement or to the member’s economic problems. In the context of designing programs for crisis prevention, a recent staff study found that during periods of heightened vulnerability, IMF financing over the preceding year as a share of short-term debt can be effective in lowering the likelihood of a crisis.
The 2005 review of the conditionality guidelines found that substantial changes have been made in the direction of greater parsimony in structural conditionality, and made suggestions to enable further progress in this direction.
The IMF as crisis coordinator
The IMF should ensure that financing packages provided in response to capital account crises are sufficient to generate confidence and be of credible quality. In particular (1) packages should not rely on parallel official financing unless the terms of access are transparently linked to IMF-supported strategy; and (2) terms for the involvement of other institutions providing parallel financing should be specified at the outset.The Board agreed with the recommendation, while noting that there are limitations on the IMF’s influence on other sources of financing. The Board stressed that the recently revised access policy must be observed and emphasized the importance of program credibility, not large financing packages, as the heart of IMF involvement. Directors fully supported the idea of moving toward more explicit procedures for collaboration with regional development banks and others and clear delineation of responsibilities, while noting that such procedures do not by themselves guarantee effective coordination.
Internal governance issues
The IMF should be proactive in its role as crisis coordinator. In particular (1) management should provide a candid assessment of the probability of success to the Executive Board and shareholders; (2) management should ensure that the technical judgment of staff is protected from excessive political interference; and (3) the nature of private sector involvement will have to be determined on a case-by-case basis. The IMF should play a central role in identifying circumstances where concerted efforts can help overcome collective action problems, based on meaningful dialogue with the private sector.The Board endorsed the recommendations. While Directors were in favor of early involvement of the Board in program discussions, a number of them observed that the Board and major members should not seek to micro-manage the operational details of programs or influence IMF missions in the field. Many Directors attached particular importance to the early involvement of the private sector as an integral element of crisis resolution.The new framework for exceptional access decisions provides a mechanism for encouraging more systematic early consideration of circumstances in which the success of a program would be enhanced by voluntary efforts to address collective action problems among private creditors and where steps to address an unsustainable debt burden need to be part of a strategy to restore growth and financial viability.
Human resource management should be adapted to develop and better utilize country expertise, including political economy skills, and to establish “centers of expertise” on crisis management issues. In particular (1) the length of staff assignments should be monitored to ensure continuity of staff expertise, and a critical mass of country expertise in each systemically important emerging market economy should be developed; (2) resident representatives should play a more central role in surveillance and program design; and (3) internal procedures should protect those who raise uncomfortable issues through proper channels, but consequently attract complaints from the authorities.The Board generally agreed on the need for institutional change to ensure that the IMF is in a position to respond rapidly to member countries facing crises. Some Directors supported creation of centers of expertise in crisis management, whereas others put greater emphasis on mechanisms for drawing upon available expertise and experience in the event of a crisis. A number of Directors favored longer country desk assignments, while others noted the importance of staff mobility in broadening the experience and perspectives of the staff and maintaining its impartiality. Most Directors favored a greater role for resident representatives with a few noting that only relatively senior resident representatives would be sufficiently acceptable to the authorities to play such a role. Directors supported modification of internal guidelines and human resource procedures. They also noted that human resource issues are management’s responsibility.The Monetary and Financial Systems Department was reorganized, with steps taken to provide a center of expertise on banking crisis resolution issues.
An internal task force is reviewing broad strategic issues related to the IMF’s resident representative program.
The Board paper for the August 2004 Biennial Review of Surveillance called for a reassessment of mechanisms for staff rotation and mobility to achieve greater continuity in the policy dialogue, enhance mutual trust, and build up country-specific knowledge. Guidance issued to staff following the 2004 Biennial Review of Surveillance highlights a number of steps to foster good policy dialogue with the authorities. The internal review process has also been strengthened to provide greater continuity, for instance through the mainstreaming of pre-brief meetings. The introduction by the MTS of three-year surveillance agendas providing a medium-term framework to guide staff’s work should also go a long way in providing the needed continuity.

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