The main job of the IMF is to promote economic and financial stability in member countries and financial stability in member countries and at the global level, as a basis for sustained economic growth, which is essential for raising living standards and reducing poverty.
Promoting macroeconomic and financial stability is partly a matter of avoiding economic and financial crisis, which can destroy jobs, slash incomes, and cause great human suffering. But it is also a matter of avoiding large swings in economic activity, high inflation, and excessive volatility in exchange rates and financial markets. Any of these types of instability can increase uncertainty and discourage investment, impede economic growth, and hurt living standards.
A dynamic market economy necessarily involves some degree of instability, as well as gradual structural change. The challenge for policymakers is to minimize instability without hampering the ability of the economic system to raise living standards through the higher productivity, efficiency, and employment that it generates.
Experience has shown that the countries with the strongest growth and employment rates and the least economic instability are those that
follow sound macroeconomic (fiscal, monetary, and exchange rate) policies;
allow markets to function, with appropriate regulatory, structural, and social safety net policies;
are open to international trade;
build strong economic policymaking and regulatory institutions;
foster the development of strong financial systems;
collect, monitor, and disseminate high-quality data; and
embrace good governance.
The IMF promotes the stability of the international financial system through its three primary functions:
Surveillance. The IMF tracks economic and financial conditions around the world and examines whether policies in member countries are appropriate from the international as well as the national point of view. It alerts member countries to impending dangers, enabling governments to take preventive action if necessary.
Lending. The IMF lends to countries with balance of payments difficulties. The primary objectives of its lending to low-income countries are economic growth and poverty reduction.
Technical assistance and training. The IMF helps member governments develop strong policymaking institutions and economic policy instruments.
Surveillance in action
With its nearly universal membership, the IMF serves as an international forum where members can monitor and discuss developments in their respective economies and also global economic developments. In recent decades, the major challenge to financial stability has come from the growth in the size and sophistication of international capital markets. A large number of countries have gained access to these markets. In many ways, financial globalization is a welcome development. It provides opportunities to channel private capital flows to finance investment and growth in these countries where the capital can be used most productively. Capital market integration also, in principle, enables countries to adjust to external shocks without having to rely on official funds.
But capital flows are also a potential source of volatility, as the past decade has shown, especially in many emerging market countries. A new breed of crisis—arising from sudden capital account outflows—has emerged and has proved harder to manage than the current account imbalances with which the IMF traditionally dealt in its lending activities. Arresting an outflow of capital requires measures that restore investor confidence, including, in some cases, financial help from international institutions.
Financial globalization has also increased the risk of contagion by introducing new channels—in addition to the traditional trade links—through which one country’s vulnerabilities can affect others and even spread through the global economic system.
Current trends imply that financial globalization will intensify. Emerging markets are likely to represent a growing share of the world economy in the coming decades. The future emerging market giants, India and China, may pose particular systemic challenges. And the aging of industrial country populations, by shifting saving-investment balances internationally, may also imply larger cross-border capital flows.
Types of surveillance
Country. The IMF holds consultations, normally once a year, with each member country about its economic policies. (These are referred to as “Article IV consultations” because they are required by Article IV of the IMF’s Articles of Agreement.) The consultations focus on the member’s exchange rate, fiscal, and monetary policies; developments in its balance of payments and external debt; the influence of the country’s policies on its external accounts; the international and regional implications of its policies; and the identification of potential vulnerabilities.
As financial markets around the world have become more integrated, IMF surveillance has become increasingly focused on capital account, financial, and banking sector issues. Institutional issues, such as central bank independence, financial sector regulation, corporate governance, and policy transparency and accountability, have also become increasingly important to IMF surveillance in the wake of financial crises in emerging market countries and in the context of member countries making the transition from planned to market economies.
Global. The Executive Board’s conduct of global surveillance relies heavily on two staff reports—the semiannual World Economic Outlook and the Global Financial Stability Report—as well as on more frequent discussions of world economic and market developments. The World Economic Outlook report offers a comprehensive analysis of prospects for the world economy, individual countries, and regions, and policy issues that arise. It also examines topical issues. The Global Financial Stability Report was introduced in 2002 (replacing the former International Capital Markets report) to provide timely and comprehensive analysis of developments in both mature and emerging financial markets and to identify potential fault lines in the global financial system that could lead to crisis.
Regional. To supplement country consultations, the IMF also examines policies pursued under regional arrangements. It holds regular discussions with such regional economic institutions as the European Union and the European Central Bank, the West African Economic and Monetary Union, the Central African Economic and Monetary Community, and the Eastern Caribbean Currency Union. The IMF also takes part in policy discussions among finance ministers, central bank governors, and other officials in such groups as the Group of Seven major industrial countries, the Asia-Pacific Economic Cooperation forum, and the Maghreb countries associated with the European Union.
How is surveillance conducted?
To conduct country surveillance in accordance with Article IV, an IMF staff team visits a member country to meet government and central bank officials and collect and analyze economic and financial information. The analysis covers recent economic developments, as well as the exchange rate, monetary, fiscal, and relevant structural policies the country is pursuing. The Executive Director for the country usually participates in the mission’s high-level meetings as an observer. The team also generally meets with other groups—such as trade unions, business associations, academics, financial market participants, and sometimes members of legislative bodies. The IMF staff team normally prepares a concluding statement, or memorandum, summarizing its findings and policy advice and leaves this statement with the national authorities, who have the option of publishing it.
On returning to headquarters, IMF staff members prepare a report that describes the economic situation in the country and their policy discussions with the national authorities and evaluates the country’s policies. The Executive Board then discusses the report. The views of the country’s authorities are conveyed to the Board by the country’s Executive Director, and a written summary of the Board’s discussion is produced and sent to the country’s authorities. Subject to the approval of the country concerned, the documents related to the consultation are posted on the IMF’s website.
Combating terrorist financing
The IMF and the World Bank are working together to help countries put in place strong regimes to counter money laundering and combat the financing of terrorism. Work in this area is linked to the joint drive to strengthen financial sectors through the Financial Sector Assessment Program (FSAP). Some governments, particularly in low-income countries, need help to put in place legislative and institutional frameworks to combat terrorist financing. The IMF and the World Bank are cooperating to provide technical expertise.
Taking early action
Early warning of an impending crisis is not enough to prevent the crisis; prompt preventive action is also necessary. Moreover, with increasing financial integration, surveillance must focus not just on crisis-prone countries but also on the system as a whole. Even if a country is not itself at risk, it may be contributing to global imbalances and placing the rest of the world at risk. The IMF, as the impartial voice of the international community, has a particularly important role to play here in highlighting major economic challenges that the world has to tackle. This is why, for example, the IMF has, during 2003-04, called on the United States, Europe, and Japan to contribute in particular ways to more balanced and sustained global growth. It has asked the United States to take steps to reduce its fiscal and external current account deficits, and the European Union and Japan to promote more vigorous growth through structural reforms. Surveillance of the major industrial countries is critical, and global surveillance, including of capital markets, needs to be constantly strengthened.
Lessons from the Mexican crisis of 1994-95 and the Asian crisis of 1997-98 prompted significant efforts to sharpen the focus of surveillance on crisis prevention. The IMF now monitors economic and financial developments more closely at the regional and global levels and advises its members to incorporate more “shock absorbers” into their policies—such as fiscal policies that leave room for larger deficits in difficult times, adequate reserve levels, efficient and diversified financial systems, exchange rate flexibility in many cases, and more effective social safety nets. And it has introduced several specific initiatives that seek to make countries less vulnerable to crisis:
In 1999, partly in response to the Asian crisis, the IMF and the World Bank introduced the Financial Sector Assessment Program (FSAP), through which they assess countries’ financial sectors in depth. FSAP reports help countries identify the strengths, risks, and vulnerabilities of their financial systems and formulate appropriate policy responses. The IMF is also involved in international efforts to combat money laundering and the financing of terrorism (see page 17).
The IMF has developed and actively promotes standards and codes of good practice in economic policymaking.
The IMF has been working to improve its ability to assess countries’ vulnerabilities to crisis, including by developing vulnerability indicators and early warning system models.
The IMF has improved its debt sustainability analysis to help countries judge whether they can service their external and public debts over time without an unrealistically large correction to the balance of income and expenditure.
The IMF has been increasing efforts to promote good governance, which is essential for strong economic performance. Particular areas of emphasis include improving the efficiency and accountability of public sectors and financial systems. The IMF has also focused on improving its own accountability (see section on Independent Evaluation Office, page 32) and transparency.
Transparency at the IMF
The IMF is now a lot more open with information while preserving its role as a confidential advisor to its members. The IMF’s Executive Board has adopted a series of measures to improve the transparency of members’ policies and data and enhance its own external communications.
The IMF now publishes most policy papers written for the Executive Board and posts financial and operational information on its website. It also makes available more information about its oversight of members’ policies and their IMF-supported programs. Although publication of country documents requires the consent of the relevant member country, there is a presumption by the Board in favor of publication.
The Executive Board decided in 2003 to give the public access to its documents in the IMF’s archives that are over 5 years old, minutes of Executive Board meetings that are over 10 years old, and other documentary materials that are over 20 years old, subject to certain restrictions.
(Details of changes in the IMF’s transparency policy can be found at www.imf.org/external/np/pdr/trans/2004/021204.htm)