Jacques de Larosière
This is a vital moment in our economic history. It is the first time in recent years that the world finds itself facing the combination of three sources of disturbance whose persistence is both paradoxical and alarming:
a generalized surge in inflation;
a deep-rooted unemployment in most industrialized economies with the exception of the United States; and
a slackening of growth in the Third World.
How can the International Monetary Fund best contribute to the needs of the developing world? And how can it help find solutions to the present difficulties of the international monetary system? As an answer to these questions, I will first analyze the major monetary aspects of current difficulties: in particular the persistence of large balance of payments (BOP) deficits; the increase in the debt burden; and the uncertain conditions experienced from time to time in exchange markets.
This article is based on an address by the Managing Director of the International Monetary Fund before the Fifth Session of the UN Conference on Trade and Development in Manila, on May 11, 1979.
The existence of BOP deficits is not in itself a cause for concern. The fact that developing countries, in order to expand their investment and to raise their standard of living, draw on resources saved in the rest of the world has long been reflected in current account deficits. Several aspects of this phenomenon have, however, become alarming in the last five years, especially for the poorest countries.
There is first of all the prodigious increase in the size of current deficits. In 1973, the magnitude of such deficits was around US$11 billion; in 1978, this had grown to around US$31 billion. For 1979, the non-oil producing developing countries will doubtless face a combined deficit well over US$40 billion. This figure is worrying even when it is deflated by an index of prices of the non-oil exports of these countries. I will come later to the difficulties connected with financing deficits of this magnitude.
Second, of even greater concern than the size of these deficits are the factors which have caused their rise. It would be easier to accept this phenomenon if such deficits were financing the rapid growth of imports in developing countries, as we would know that these payments imbalances reflected greater real economic activity. But this is not the case. The real growth rate of Third World countries, which averaged 6 per cent per annum between 1967 and 1972, has since been reduced to a figure of the order of 5 per cent. We know that this rate of expansion is insufficient to cope, in a humanly acceptable manner, with the problems of absolute poverty and hunger as they exist today in many parts of the world under the prevailing demographic conditions.
If, then, an increase in the volume of developing countries’ imports associated with rapid growth is not the main cause of their growing deficit, it is because other factors have played a preponderant and pernicious part. Among these I shall highlight three, all of which bring us back to the most critical aspects of the current international economic situation.
Some causes of LDC deficits
The first of these factors results from the deterioration in the terms of trade suffered by Third World countries. This deterioration stems both from the sharp rise in the price of petroleum products since 1973, and also from the equally serious rise in the prices of manufactured—especially capital—goods. This dual trend has not been matched by the prices of non-oil raw materials, which still represent the bulk of exports from developing countries. The second source of current payments difficulties experienced by these countries is the stagnation in most industrial economies, which frustrates an increase in either the volume or the price of developing country exports, whether they be of primary products or manufactured goods. Finally, the increase in foreign debt contracted by these countries to finance their current deficits is associated with increasingly heavy interest payments which further worsen their payments position.
Thus, in the last few years, developing countries in general have had to find increased financial means—the growth rate remaining constant—to pay both the higher prices of imports and also the interest charges on debt assumed. They will have to do so to an even greater extent in 1979.
In the past, the developing countries have met these payments partly by increasing their debt burden. Even when one corrects the data for world inflation, the international debt figures have reached a high level. In relation to the gross domestic product of non-oil developing countries, total debt reached 21 per cent in 1978. As a ratio of their exports of goods and services, the burden of servicing their foreign debt has risen to over 13 per cent.
Finally, one must note that the bulk of indebtedness incurred by developing countries since 1974 has been through commercial and banking channels, that is to say at market rates and sometimes with relatively short maturities. These two characteristics do not meet the needs of the poorest countries. There is no doubt that, as far as maturities and interest charges are concerned, the debts contracted in the last five years by many low-growth developing countries represent a costly and ill-adapted way of transferring international savings.
Conditionality is a subject which is discussed frequently and sometimes misunderstood. Its application by the Fund is based on a simple premise: that it is not in the interest of any country—and ultimately not feasible—to incur payments deficits over a protracted period which cannot be sustained by capital inflows.
Non-oil developing countries: debt and debt service, 1970-781
(As a percentage of exports of goods and services)
Citation: 16, 3; 10.5089/9781616353384.022.A004
Sources: World Bank Debtor Reporting System and Fund staff estimates
1 The debt and debt service ratios plotted in this chart relate only to mediumterm and long-term external public, or publicly guaranteed, debt.
Not only have current account deficits become serious and the cost of meeting them a heavier burden, but unsettled conditions in the day-to-day functioning of the exchange markets have created serious difficulties for developing countries, as well, of course, as for others. We have seen very marked variations in the values of the major currencies. Such movements have at times been very large and have often not seemed to be consistent with the evolution of basic economic developments. These variations have the effect of complicating the financing of current trade, the management of foreign exchange reserves in developing countries, and of rendering more uncertain the cost of their debt servicing. The development of the terms of trade of the developing countries also becomes hard to predict, and in general the management of their domestic economies becomes much more difficult.
The Fund’s response
The Fund is well aware of these many difficulties. Within the scope of its powers and means, and with the support of its members, it is continually seeking to improve its response to the needs of the developing countries and to ease the difficult tasks they have in helping to meet the aspirations of their people. Our concern in these areas is not new. It has been reflected, in the past, in important changes in the Fund’s methods and policies and it will lead, in the period ahead, to continuing modifications.
Three principal areas deserve mention:
the provision of financing;
the requirement that appropriate policy undertakings (or so-called conditionality) accompany the use by members of the Fund’s resources; and
the exercise of surveillance over the entire international monetary system.
Over the years, in response to changing circumstances, the Fund has steadily enlarged both the scale of its lending capability and the range of financing programs with which to assist its membership, especially among the developing countries. As regards available resources, the Fund’s ability to assist its members has been considerably enhanced of late both by the 50 per cent increase in quotas decided by the Board of Governors last October, and by the recent entry into force of the supplementary financing facility, with initial resources of nearly SDR 8 billion. I am well aware, of course, that the adequacy and structure of existing quotas remain lively questions, particularly in view of the magnitude of BOP financing needs. Both these questions will need to be addressed in our next quota increase, on which work will probably begin in 1981.
As to the range of financing programs, attention has been given to the special needs of developing countries in a number of ways in recent years. These include the establishment of an extended—that is, longer-term—Fund facility; the creation of the Trust Fund, which provides practically non-interest-bearing loans to low-income developing countries out of profits from the sale of gold; and the liberalization of the terms and conditions of the compensatory financing facility. I would stress the special importance of the last facility to the developing countries. Between January 1976 and February this year, financing from this facility covered about 50 per cent of their export shortfalls and provided some SDR 2 billion in loans. What is more, the Fund’s Executive Board is currently studying ways of further improving the functioning of this facility and will be reporting on its work to the Development Committee at its next meeting. An additional fourth facility specifically oriented toward the needs of developing countries—namely, the buffer stock financing facility—has so far not been much used. An enlargement of its use will depend on the number and scope of commodity agreements signed and implemented under UNCTAD’s general program in this field.
Conditionality is a subject which is discussed frequently and sometimes misunderstood. Its application by the Fund is based on a simple premise: that it is not in the interest of any country—and ultimately not feasible—to incur payments deficits over a protracted period which cannot be sustained by capital inflows. By requiring corrective policy action, conditionality serves as a complement to the provision of financial assistance and helps ensure that credits are used to redress endangered situations.
There are, of course, circumstances in which the application of credit tranche conditionality would not be appropriate. The Fund’s policies, for example, on the compensatory financing facility, recognize this. There can, however, be no escaping the need for adjustment once an economy has become overextended. Only thus can the ground be restored for the resumption of balanced growth. And when adjustment is called for, the prime task must rest with the country concerned.
Adjustment is never likely to prove easy, especially for the poorest countries, and experience suggests that it becomes progressively more difficult the longer it is delayed. In its approach to requests for conditional assistance, the Fund recognizes that, to be evenhanded, conditionality must take into account the domestic political and social objectives of its members, as well as their economic priorities. This has been explicitly affirmed in a recent decision of the Fund’s Executive Board and it will not remain a dead letter.
By the same token, conditionality must, to be practicable, allow for varying speeds of adjustment. In this connection, I would note that the duration of programs supported by the Fund has been lengthening in recent years, in recognition of the difficulties of adjustment and the importance of policy shifts of a structural nature. I refer not only to the extended Fund facility, which covers programs lasting up to three years. Stand-by arrangements, too, now frequently extend beyond the traditional one-year period. And repayment periods—necessarily limited to three to five years under most facilities by the need to keep the Fund’s capital circulating—may, under certain important special facilities, now extend to seven or eight years in the cases of the supplementary financing and extended Fund facilities and, indeed, to ten years in the case of the Trust Fund.
I have already mentioned the extent to which movements in exchange rates can have a destabilizing effect in certain circumstances. Through its annual consultations and its continuing exercise of surveillance, the Fund must impartially monitor the exchange policies of its members so as to avoid disorder or competitive manipulation of rates.
As well as this action on exchange policies, the Fund must try to define a concerted growth strategy for industrialized countries. Such a strategy is necessary if the size of BOP surpluses and deficits in these countries is to be reduced and if the associated deflationary and inflationary chain reactions are to be broken.
Finally, the creation of international liquidity is such that we must seek more rational ways of achieving it than those we have at the moment. Here again, the Fund has extensive responsibilities. It is vital that the international community become more aware of the importance of this problem, and make the special drawing right what it has not yet become, namely, the principal reserve instrument of the system. The latest SDR allocation and the study of a substitution account are steps, albeit modest ones, in this direction.
As far as monetary matters are concerned, these are the lines to follow. Some are already solidly established, others have only been outlined. Monetary action, however, has its limits.
The efforts the Fund is trying to promote will have much greater impact if they are supported by two basic actions in the areas of capital movements and trade. The excessive indebtedness of developing countries is to a great extent due to:
insufficient concessional aid; and
the stagnation of activity and trade restrictions in industrial countries.
It is unfortunately obvious that aid commitments and objectives recommended by the United Nations ten years ago have not been observed. Far from attaining 0.7 per cent of gross national product (GNP) in industrialized countries, official assistance amounted in 1978 to 0.32 per cent. The percentage has decreased rather than increased. It is abundantly clear that increasing financial aid on concessional terms is more than ever a necessity. In certain circumstances and in the case of those countries that are deeply embedded in underdevelopment, domestic policy adjustments would not be sufficient—even if they are supported by considerable medium-term credits. In such cases, monetary mechanisms must not be used alone, as there is the risk of their breaking down or of their threatening members with intolerable levels of deflation. It is the transfer of greater real resources that is at issue. It is paradoxical that industrialized countries—most of which are not using their productive potential to the full—are hesitating to increase their financial aid to poor countries. This is despite the fact that such aid would result in increased global demand and thus contribute to a reactivation of world trade and a recovery of production. There is nothing in the present state of deflationary chain reactions in the industrialized world (stagnation feeding inflation) which would argue against such an increase in financial aid. In this regard, Bank and Fund staff are undertaking a comprehensive study of the world’s long-term capital requirements and the existing deficiencies in this field, particularly in the context of the requirements of international payments equilibrium.
It is from the same viewpoint that a liberalization of world trade becomes imperative. In most economic programs which we assist developing countries to draw up we include the advice: “Diversify and extend your production range so as to export more.” Some have followed this advice successfully and have imported from industrialized countries the equipment necessary to produce under competitive conditions. However, these new exporting countries must be able to sell their products. Demand in high-income countries must not be choked off. Furthermore, industrialized countries must not erect barriers to world competition and must take the necessary structural measures to adapt themselves to a new international division of labor. It will be all the easier to accept the necessary consequences of the free interplay of world trade, and adjustment measures will become all the more practicable, when potential demand in the developing countries has been allowed to materialize and world trade and production have attained a higher level in developed as well as in other countries.
The way to break the vicious circle of stagflation, protectionism, and poverty will thus be through a vigorous growth of development aid coupled with liberalization in world trade, though these must, of course, be supported by prudent domestic fiscal and monetary policies. It is in this context that the action the Fund takes will assume its full scope and meaning.
The institution that I head has the rare merit of practicing the art of international consensus daily and in a concrete manner. It is also inspired by the overwhelming desire to act along the lines I have mentioned. Inevitably, changes in policy tend to come about gradually, in an evolutionary manner. Such changes, however, are all the more real and enduring for being backed by so broad a consensus. It is my hope that a similar consensus will emerge in the international community at large on suitable measures to meet the challenge facing us all.