After financial crises erupted in emerging markets during the 1990s and spilled over to other countries, the international community took steps to make the world less vulnerable to crises. Nonetheless, it is clear that its work is far from complete. Improving the prevention and management of crises means tackling sources of vulnerability, increasing transparency, and adhering to international standards of good economic citizenship. The IMF, the private sector, and governments all have a role to play.
Over the past decade, the IMF has made a number of changes in the way it operates. It has become increasingly open and candid about its policies and operations and has encouraged its member countries to publish information about their economic and financial polices and practices. This greater openness promotes the orderly and efficient functioning of financial markets, reduces the likelihood of shocks, and makes policymakers more accountable for their actions.
In addition to building on the reforms it has initiated over the past several years, the IMF has rationalized and reformed its lending to focus on crisis prevention and to ensure that its funds are used more effectively. It has made the terms of the Contingent Credit Lines (CCL) Facility (see section on financial facilities) more attractive to potential users. It has approved measures to discourage excessive use of IMF resources by charging higher interest rates on large use of resources, as well as to encourage members to repay their IMF financing ahead of schedule. The IMF is also planning to streamline and focus conditionality by attaching fewer conditions to its financing (see section on conditionality). Programs should take adequate account of national decision-making processses and be founded on strong country “ownership” of the economic strategies supported by the IMF. The objective would be to provide maximum scope for countries to make their own policy choices while ensuring that the IMF’s financing supports the necessary policy adjustments and while safeguarding IMF resources.
Focus on crisis prevention
The IMF has developed standards and codes in its main areas of responsibility (see section on standards and codes) and introduced a program of reports on countries’ observance of standards and codes (ROSCs) that evaluate their economic and financial practices relative to international standards. Meeting certain standards helps ensure that economies and financial systems function properly at the national level, which is necessary if the international system is to function smoothly.
Together, the IMF and the World Bank have stepped up and improved their assessments of countries’ financial systems through their Financial Sector Assessment Program, which identifies potential weaknesses in the financial system, covering banks, insurance companies, mutual funds, and financial markets. This program has now been made a regular activity of the IMF, with a goal of covering 24 countries every year, and will focus on those countries that are important to the health of the global financial system. The purpose of the program is to help countries resist crises and cross-border contagion and to increase the effectiveness of efforts to promote sound financial systems.
Much has been done to increase the focus of IMF surveillance on member countries’ vulnerability to crises, including efforts to identify principles of prudent external liability management and to develop analytical frameworks for assessing countries’ external vulnerability. The IMF is helping its members assess reserve adequacy, manage their reserves, and monitor and manage debt so as to prevent crises. The IMF and the World Bank jointly developed guidelines for public debt management to help countries improve their debt management practices and reduce financial vulnerability. Representatives from 122 countries and 19 institutions were consulted, and the guidelines were subsequently revised to reflect their comments. This exercise was intended to strengthen country ownership of the guidelines and to help ensure that the guidelines correspond with sound practices and are broadly understood and accepted. (The final version of the guidelines appears on the IMF’s website.) The IMF is also working on early warning systems to monitor risks that arise from problems in member countries and conditions in international markets.
Early this year, IMF Managing Director Horst Köhler stressed that the IMF must gain a deeper understanding of international capital markets and financial flows. The IMF has established the International Capital Markets Department (see box, page 8), which will enhance its ability to provide early warning of potential crises. In addition, it created the Capital Markets Consultative Group (CMCG) as a channel for regular dialogue between IMF management and senior staff and representatives of the private financial sector. The CMCG held its first meeting in September 2000.
Private sector involvement in the resolution of financial crises refers to the participation of private creditors in the financing of a stabilization program. The rationale for private sector involvement is two-pronged. First, given that movements of private capital can be abrupt and can dwarf resources available from the official sector, there is a need to ensure that economic programs are adequately financed. Second, private sector involvement helps eliminate possible moral hazard, so that official financing does not reduce the incentives for the private sector to evaluate and manage risk.
During the financial year, the IMF applied this framework in Argentina and Turkey, while work advanced on two aspects of the framework—restructuring international sovereign bonds and designing corporate sector workouts. The IMF will continue strengthening this framework in financial year 2002, including through further work on promoting constructive relations between countries and their creditors. Work also includes analyzing the prospects of return of market access for countries affected by crisis, and issues of comparabilities of treatment of private and Paris Club creditors.