The main job of the IMF is to promote international monetary cooperation, and economic 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 is responsible for overseeing the international monetary system and the compliance of each member country with its obligations to help ensure orderly exchange arrangements and a stable system of exchange rates. The Fund exercises this responsibility by tracking economic and financial conditions around the world and examining 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.
Technicalassistanceandtraining. 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 nascent 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.
To keep a close watch on these developments, the IMF is continuing to strengthen its analysis and advice through more tightly focused surveillance, deeper scrutiny of exchange rate issues, and better analysis of financial sectors, debt sustain-ability, and regional and global spillovers. The 2004 biennial surveillance review endorsed these steps and stressed that surveillance should evolve and adapt continuously to meet the needs of the IMF’s membership.
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.
Regional. To supplement country consultations, the IMF also examines policies pursued under regional arrangements, such as in the euro area, the West African Economic and Monetary Union, and the Eastern Caribbean Currency Union. In addition to stepping up its surveillance of currency unions, the Fund is paying more attention to issues of common interest to countries in given regions (for example, in Central America, sub-Saharan Africa, or Pacific Island countries). The discussions of staff reports on these topics allow not only consideration of policies decided at the regional level but also comparative analysis of developments and policies across a region, and analysis of the regional transmission of shocks.
How is surveillance conducted?
To conduct country surveillance in accordance with Article IV, an IMF staff team visits a member country, normally once a year, 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. The national authorities have the option of publishing the statement.
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 (www.imf.org).
Global. In addition to country and regional surveillance, the IMF monitors global economic conditions, countries’ economic policies in their global context, and developments in international capital markets. In this global surveillance work, the IMF also assesses the global effects of major economic and financial developments, including in such areas as oil markets and trade. Its main findings on global surveillance are published twice a year in the World Economic Outlook and the Global Financial Stability Report, which serve as documentation for the discussions of the IMFC. The September 2004 and April 2005 World Economic Outlook reports both found near-term global growth prospects to be quite healthy, but risks posed by global current account imbalances, an upturn in global interest rates, and further increases in oil prices. The Global Financial Stability Report, meanwhile, cited the increased resilience of the global financial system, but also noted that the risks of market corrections had increased, owing to overabundant liquidity and lower risk premiums. In addition, the Executive Board holds frequent discussions of world economic developments. IMF management and senior staff also take part in discussions on the economic outlook and policies among finance ministers, central bank governors, their deputies, and other officials in a variety of groups and forums, such as the Group of Seven (G7) major industrial countries, the Group of 24 (G24) developing countries, and the Financial Stability Forum.
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 2003-05, 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 also assesses offshore financial centers, which account for a sizable portion of the world’s financial flows and thus are potentially important for global financial stability. In addition, the IMF is involved in international efforts to combat money laundering and the financing of terrorism.
The IMF has developed and actively promotes standards and codes of good practice in economic policymaking. In the area of data standards, it has designed initiatives to enhance public availability of reliable, timely, and comprehensive statistics on member countries, helping market participants to make well-informed investment decisions and reducing the likelihood of shocks that can precipitate crises.
The IMF has introduced several types of assessments to enhance its ability to identify countries’ vulnerabilities to crisis, (for example, the balance sheet approach, liquidity management, and financial soundness indicators). These frameworks aim to strengthen the IMF’s policy advice to member countries on how to make their economies more resilient to shocks.
The IMF has also 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 stepped up its attention to trade-related vulnerabilities, which remain a pressing issue for the poorest countries with IMF-supported programs. To help developing countries address the short-term effects on their balance of payments of multilateral trade liberalization, the IMF’s new Trade Integration Mechanism makes resources more predictably available to qualifying member countries under existing IMF facilities.
Also under consideration is a request by some member countries and donors for new policy monitoring and signaling arrangements that do not involve IMF financing. Such arrangements would allow members to demonstrate their commitment to sound policies either for domestic purposes or as a signal to international creditors and donors.
Transparency at the IMF
The IMF has also focused on improving its own accountability by establishing in 2001 the Independent Evaluation Office (see page 32) and by increasing over the past decade the transparency of its operations and decision making. The IMF has become a more open and accountable institution and a major source of information for the general public and capital market participants, while preserving its role as confidential advisor to its member countries.
The IMF now publishes most policy papers written for the Executive Board, posts financial and operational information on its website, and makes available more information about its surveillance. Although member countries need to consent to the publication of documents related to their countries, in most cases, publication is presumed, and the large majority of staff reports are in fact published.