The financial crises in East Asia in 1997–98, followed by those in Russia and Brazil in 1998–99, have underscored the need for changes in the global financial system that will reduce the risks posed by institutional weaknesses and volatile capital flows and extend the benefits of globalization to those countries that have not yet benefited from the new economic environment. Reforms that would strengthen the “architecture” of the international financial system were a major focus of the Executive Board’s attention in 1998/99.
Promoting transparency, accountability
Greater transparency fosters better decision making and economic performance by member countries and international institutions and is thus an important pillar in a strengthened international financial system. In the past two years, the Executive Board has taken steps to improve the transparency of the IMF’s activities and its members’ policies. In March and April 1999, the Board approved additional initiatives to enhance transparency, including establishing a presumption that member countries would release documents that describe the polices they intend to implement in connection with their requests for financial support from the IMF (Letters of Intent and Memorandums of Economic and Financial Policies) as well as their economic objectives and policies (Policy Framework Papers).
Standards and codes of good practice
The IMF is seeking to foster the development, dissemination, and adoption of internationally accepted standards, or codes of practice, for economic, financial, and business activities. During 1998/99, the IMF made considerable progress in this area, including in strengthening the Special Data Dissemination Standard (see box, page 8), and in drafting a Code of Good Practices on Transparency in Monetary and Financial Policies, in collaboration with other international financial institutions, a representative group of central banks, and academics. In discussing the role of the IMF in relation to standards in March 1999, the Board recognized that the IMF has expertise that would allow it to assess members’ observance of international standards in the four core areas of data dissemination, transparency of fiscal policy, transparency of monetary and financial policies, and—working with other organizations—banking supervision. It agreed to consider this issue further at a later date.
Strengthening financial systems
Strengthening financial systems, including through better financial market supervision and appropriate mechanisms for managing bank failures, is an essential element of the new architecture. To this end, the IMF, together with other international organizations, has stepped up its efforts to develop and disseminate international principles and good practices of sound financial systems. In September 1998, the IMF and the World Bank established the Financial Sector Liaison Committee to enhance their collaboration, which is seen as crucial in the effort to strengthen financial systems. The committee, whose objective is to ensure that the two institutions deliver high-quality, sound, and timely advice to countries, has developed guidelines and procedures for the IMF and the World Bank to share information and incorporate internationally recognized standards and sound practices in their work programs.
Capital account issues
Financial integration, including capital account liberalization, offers substantial benefits but also carries risks. In 1998/99, the Board discussed capital account liberalization on two occasions and in March 1999 reviewed members’ experiences with the use of capital controls in the context of the recent financial crises. Directors noted that, in the countries most seriously affected by crisis, liberalization had been poorly sequenced or inadequately supported by economic policies, financial regulation, and oversight and that monetary and exchange rate policies had been inconsistent, leading to an accumulation of imbalances. Subsequently, these countries were vulnerable to external shocks or a loss of confidence.
While supporting a further liberalization of capital flows, Directors discussed the use and effectiveness of capital controls over outflows and inflows. They broadly recognized that controls over inflows, particularly those designed to influence their composition, might be justifiable, but only in countries with appropriate policies. Most Directors concluded that controls on capital outflows were not an effective policy instrument in a crisis. The IMF would continue to review countries’ experiences with capital controls and with liberalizing different components of the capital account and draw conclusions for best practices.
Private sector involvement
Involving the private sector in crisis prevention and resolution is critical for bringing order to the adjustment process, limiting moral hazard, strengthening market discipline, and helping emerging market borrowers protect themselves against volatility and contagion. It is clear that measures to involve the private sector have to be in place to make it easier to resolve balance of payments pressures in an orderly way should a crisis occur.
In 1998/99, the Executive Board considered various proposals on private sector involvement and agreed that more had to be done to create market-based incentives and instruments to get the private sector involved. Possible approaches include modifying the terms of sovereign bond contracts to encourage collective action in addressing distressed debt, establishing forums for discussions between debtors and creditors, and formalizing contact with representatives of the private financial community to provide a forum to renegotiate debt, if needed.
Exchange rate issues
Since the establishment of the IMF, the international monetary and financial system has changed profoundly, raising broad systemic issues. In a preliminary discussion of IMF-supported programs in East Asia, one lesson that emerged was that the pegged exchange rates of the countries affected may have led borrowers and creditors to perceive that they were implicitly protected against losses stemming from currency risks. It was noted, however, that a more flexible exchange rate regime was not a panacea. Regardless of the regime, vulnerabilities would continue to exist, and standards for strengthened financial systems and improvements in transparency would continue to be necessary.
The Executive Board planned to discuss exchange rate issues before the 1999 Annual Meetings, focusing on the volatility of the exchange value of major currencies, the scope for measures to moderate such volatility, and the consequences for the exchange rate policies of emerging market economies.