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The quest for successful adjustment in the world economy: A report on the Fund’s Annual Meeting

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
December 1981
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Avinash Bhagwat

The Annual Report of the Fund’s Executive Directors before the Governors this year called the world economic situation disappointing and difficult in important respects but also noted some signs of progress. The problems were many and interrelated: in industrial countries, continuing inflation accompanied by high, and in some countries rising, unemployment; for most countries, stagnant or sluggish economic growth and a slowdown in international trade; continuing external imbalances on current account—and those for the non-oil developing countries not only large but still rising; exceptionally high nominal as well as real interest rates in the principal financial centers, creating domestic policy dilemmas for many industrial countries and adding greatly to the already onerous external debt service of many developing countries; and on top of all the uncertainties, unusually wide fluctuations in exchange rates among major currencies. While a variety of perceptions, concerns, and proposed solutions for the world’s economic ills were offered, the striking aspect of the meetings perhaps was that on the essential issues there was a common ground shared by so many of the attending Governors. In retrospect, the central theme of this year’s meeting was the emphasis on the urgency of promoting adjustment in the world economy.

Some reassurance can be found in the already discernible indications of progress toward successful adjustment. First, there is clear evidence that the close link between energy consumption and economic growth has been loosened—total energy consumption of industrial countries was the same in 1980 as it had been in 1973, though their economies had grown by 19 per cent in real terms during this period. Second, the inflationary flare-up of 1979-80 seems finally to be getting under control, thanks mainly to the steadfast firmness of monetary policy in the larger countries. Thus, by June 1981, the consumer price inflation in the industrial countries had eased for the seventh consecutive month. Third, the combined external current account balance of the major industrial countries was expected to shift from a significant deficit in 1980 to a moderate surplus in 1981.

Turning to the non-oil developing countries, however, such a silver lining was difficult to find. The combined current account deficit of these countries had more than doubled in two years to US$84 billion in 1980 and was expected to approach $100 billion in 1981. In spite of the capability, so far, of private markets to provide much of the financing of this deficit, and even though many countries had adopted comprehensive adjustment programs—a number of them supported by the use of Fund resources—the question that had to be confronted was whether deficits of this magnitude could be financed on a sustainable basis.

Economic priorities

In his opening remarks, the Fund’s Managing Director, Mr. Jacques de Larosiére, stated that the effort to combat inflation and eliminate inflationary expectations must continue to be the cornerstone of a strategy for successful global adjustment. There was also a consensus among governors that resolute anti-inflationary policies remained crucial, especially now when there were some signs that the problem was abating. Despite unprecedentedly high levels of unemployment in the industrial countries, the prevailing judgment was that if expansionary policies were adopted prematurely, inflation would revive and inflationary expectations would be rekindled.

There was some divergence of viewpoints regarding the high prevailing rates of interest in the major financial centers. The effect on many countries with freedom of capital movements was to force them to maintain interest rates at levels inconsistent with those required for the revival of domestic investment and of economic activity in general. For many developing countries that had, during the last decade, contracted substantial external debt at floating interest rates, the high interest rates meant not only that financing was now costly but also that the cost of servicing the outstanding debt was placing an additional burden on external positions already under pressure from other quarters.

But these criticisms of prevailing high interest rates did not, on the whole, translate themselves into pleas for relaxing aggregate demand management. Many Governors considered the rates to be a result of excessive reliance on monetary policy to combat inflation and of inadequate supporting fiscal measures. In this connection it had been pointed out by the Managing Director that in industrial countries budget deficits in relation to national income had nearly doubled since 1973. The plea of these Governors was for a more restrictive fiscal policy and pruning of budget deficits, particularly in the larger countries. It was felt that the resulting reduced claims on financial markets would help to ease interest rates and to revive private investment. However, in the final analysis, the prevailing view was that a lasting reduction in interest rates basically depended upon success in controlling inflation and the consequent dissolution of inflationary expectations—an essential precondition for the resumption of real economic growth on a steady and sustainable basis and at a satisfactory pace.

For detailed reports on the Annual Meetings as well as the meetings of the Development and Interim Committees and the Group of Ten and the Group of Twenty-Four see the IMF Survey for October 12 and October 26, 1981.

A number of Governors stressed that, to achieve steady growth in productive employment opportunities as well as steadily improving living standards, firm control of aggregate demand must be supplemented by suitable measures to stimulate supply. A variety of policies were mentioned for this purpose: the eradication of long-embedded rigidities and inefficiences hampering the free operation of markets; the elimination of government regulations bolstering such inefficiencies; policies aimed at encouraging savings, productive investment and innovative entrepreneurship; programs to promote labor mobility and retraining; and comprehensive strategies for energy designed to conserve its use and to develop new sources. There was, in addition, a unanimous call to resist growing protectionist pressures on the grounds that resort to protectionism was not only self-defeating but also inimical to any coordinated international adjustment strategy.

External strains on LDCs

The most difficult problem was seen to be the current predicament of the non-oil developing countries. Their large external deficits on current account were caused mainly by external factors beyond their control—in particular, sharply deteriorating terms of trade, diminishing export markets because of the economic slack in industrial countries, and a heavier debt service burden due to high international interest rates. The amelioration of these adverse conditions depended on steady progress in controlling inflation in the industrial world, followed by economic recovery and sustained growth, which would both expand export markets and strengthen prices for goods from developing countries. The prospective easing of interest rates in the international financial markets should also lighten the burden of debt service. Meanwhile, however, the question was how long prevailing external deficits on current account could be sustained. In the face of the harsh external environment, it was important that adjustment efforts in these countries be reinforced so as to reduce the payments deficits to manageable levels.

In this connection, some Governors from developing countries raised the question of the appropriate sharing of the burden of adjustment between industrial countries and the non-oil developing countries. Briefly, the underlying argument was that after each of the two episodes of sharp increases in oil prices, massive payments imbalances had arisen between the oil exporting countries and oil importing countries as groups. It had been generally accepted (as reflected, for instance, in the Rome Communique of spring 1974) that the combined external surplus of the oil exporting countries could only be reduced gradually and that, during this interim adjustment period, it was unavoidable that the oil importing countries as a whole would experience a combined deficit equivalent to the surplus of the oil exporting countries. An attempt by any subgroup to eliminate its deficit would primarily result in passing it on to other countries within the oil importing group. Yet what seemed to be happening between 1980 and 1981 was that the share borne by the non-oil developing countries had increased, while that of the larger industrial countries had decreased. As the non-oil developing countries were the least able to finance whatever deficit had to be carried, these Governors pleaded for a cooperative international adjustment strategy that would also aim at a more equitable sharing of the global adjustment burden.

SDR allocations

In the area of Fund operations, an important issue before Governors was the question of a possible further allocation of special drawing rights (SDRs) in the immediate future. Under the Fund’s Articles, decisions regarding allocations must be based on a proposal by the Managing Director, to be made after ascertaining that it had broad support among members. Moreover, a decision on allocations of SDRs requires an 85 per cent majority of the total voting power in the Fund. In accordance with a decision taken in 1978, the Fund allocated to its members SDR 4 billion at the beginning of each of the following three years. In the absence of a new decision, no allocations would be made, effective January 1, 1982.

Some Governors felt that a convincing case for making allocations in 1982, to meet a demonstrated long-term global need for reserve assets, had not yet been made. By contrast, Governors who favored further allocations pointed out that, while the total supply of international liquidity might be adequate, many countries did not have access to it, and their need for international reserves remained acute. In the Interim Committee, it became clear that there was no consensus upon which a decision could be based. Accordingly, the Committee urged the Executive Board to continue its deliberations on whether there should be further allocations of SDRs at the present time and recommended that the scope of such deliberations should include the proposal for continuing allocations at the rate established in 1978—that is, at approximately SDR 4 billion a year.

Fund liquidity

A second important operational topic concerned the Fund’s liquidity, its potential needs for borrowing, and the Eighth General Review of Quotas. Governors were unanimous in affirming that quotas must continue to be the basic source of finance for the Fund. Hence the Eighth Review of Quotas was of paramount importance. At the same time, they welcomed the arrangements under which the Saudi Arabian Monetary Agency (SAMA) made a commitment to lend to the Fund SDR 4 billion annually for two years, with possibly an additional amount in the third year. The successful conclusion of these and shorter-term arrangements with other monetary authorities had made it possible to put into effect the Fund’s policy of enlarged access to its resources. The prevailing view was that the Fund should continue its efforts to arrange financing from official entities broadly along the lines of the agreements concluded earlier in 1981, but the use of borrowed resources by the Fund should be seen primarily as a bridging operation during the period when total quotas were not adequate to enable the Fund to carry out fully its responsibilities under the Articles in this regard.

In the Fund, quotas play a critical role. The size of a member’s quota is intended to reflect broadly its relative importance in the international monetary system—it determines its contribution to the Fund, its voting power, the limits on its access to Fund resources, and its share in any allocation of SDRs. The Articles provide for a general review of quotas at intervals of not more than five years. Accordingly, the Eighth General Review now in progress should be concluded, at the latest, by November 1983. Regarding this Review, there was general agreement on a number of points. First, that the total quotas of the Fund need to be increased substantially; over the years they had failed to keep pace with the growth in aggregate world imports and had also shrunk sharply as a proportion of total international liquidity. Second, that at present the quotas of many members are out of line with their relative positions in the world economy and that the Eighth General Review of Quotas should remedy the situation. The Interim Committee also agreed that the completion of the Review should be expedited as much as possible.

Surveillance; BOP financing

Governors also addressed interrelated aspects of Fund policies such as the Fund’s responsibility to exercise surveillance over the exchange rate policies of members and to provide temporary balance of payments (BOP) financing to members. The recent unusually large fluctuations in the exchange rates among major currencies were instrumental in focusing particular attention on the Fund’s surveillance function. The consensus on this matter was reflected in the communique of the Interim Committee, which emphasized “the need for effective implementation by the Fund, in a uniform and symmetrical manner for all members, of its surveillance role in connection with balance of payments and exchange rate policies.” Particularly worthy of note was the renewed emphasis on the need for uniformity and symmetry in the implementation of surveillance.

Avinash Bhagwat

a national of India, is an Advisor in the Secretary’s Department of the Fund. After graduating in economics from the University of Bombay (India) and Yak University (U.S.A.), he taught at the University of Pennsylvania (U.S.A.) before joining the Fund in 1967.

The Fund has in the past year begun to play a larger role in the financing and adjustment of payments imbalances, as the Executive Board has evolved what has come to be termed the policy of enlarged access to the Fund’s resources. Under this policy, subject to the existence of a BOP need and the adoption of strong national adjustment programs, members can borrow from the Fund up to 150 per cent of quota per annum and up to 450 per cent in three years. As regards conditionality, in view of the structural features of the payments problems of many countries, adjustment programs are designed to spread the adjustment process over longer periods than before. While prudent demand management continues to be an essential element, greater attention is given to supply-oriented policies, including measures aimed at eliminating bottlenecks in strategic sectors such as energy.

Strong support for these policies linking increased Fund financing to effective BOP adjustment was expressed by Governors from many countries. For instance, Secretary of the Treasury Donald T. Regan, Governor for the United States, characterized it as a “prudent response” in circumstances in which “most countries were confronted with the need to obtain additional financing and undertake balance of payments adjustments.” In practice, there has been a sharp increase during the last year in the number of stand-by or extended arrangements with upper credit tranche conditionality that have been requested by members and approved by the Fund. In his concluding remarks, the Managing Director noted that the Annual Meetings had indicated the conviction of member countries—industrial and developing—that effective adjustment was imperative for all countries with serious imbalances, whether or not they were using Fund resources.

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