Central to the IMF’s mandate of improving the operation of the international monetary system is its oversight (or “surveillance”) of the economic and financial policies of its member countries. IMF surveillance has taken on even more importance in the wake of the Mexican crisis of 1994 and the later financial crises in Asia and other emerging market economies, and the IMF has adapted its oversight to its members’ changing needs in an increasingly integrated global economy. As a result, IMF surveillance is also the mechanism through which most of the initiatives being pursued—or planned—as part of the international community’s efforts to strengthen the architecture of the international monetary and financial system will come together (see Chapter 4). The IMF has also acted to ensure that the process of surveillance is a continuous one through the process of surveillance is a continuous one through informal and supplemental discussions and mechanisms.

Central to the IMF’s mandate of improving the operation of the international monetary system is its oversight (or “surveillance”) of the economic and financial policies of its member countries. IMF surveillance has taken on even more importance in the wake of the Mexican crisis of 1994 and the later financial crises in Asia and other emerging market economies, and the IMF has adapted its oversight to its members’ changing needs in an increasingly integrated global economy. As a result, IMF surveillance is also the mechanism through which most of the initiatives being pursued—or planned—as part of the international community’s efforts to strengthen the architecture of the international monetary and financial system will come together (see Chapter 4). The IMF has also acted to ensure that the process of surveillance is a continuous one through the process of surveillance is a continuous one through informal and supplemental discussions and mechanisms.

The IMF carries out surveillance in several ways:

  • Country surveillance takes the form of regular (usually annual) consultations with member countries over their policies. (The consultations are referred to as “Article IV consultations” as they are mandated in Article IV of the IMF’s Articles of Agreement, or charter.)

  • Global surveillance entails periodic reviews by the IMF’s Executive Board of global economic developments, based on World Economic Outlook reports prepared by IMF staff, and periodic discussion of developments, prospects, and policy issues in international capital markets.

  • Regional surveillance over monetary unions has recently intensified—for example, in FY2000, the Board discussed developments in the European Economic and Monetary Union and in the Central African Economic and Monetary Community.1 Stepped-up discussions between staff and regional authorities serve to supplement country consultations with member countries.

To achieve more continuous and effective surveillance, the Board supplements its scheduled, systematic monitoring with regular informal sessions—sometimes monthly, or more frequently—on significant developments in selected countries and regions. The Board also meets regularly to discuss world economic and financial market developments. These continuing assessments by the Board inform and guide the work of IMF staff on member countries and are communicated to national authorities by Executive Directors.

In all these ways, the IMF seeks to signal dangers on the horizon and anticipate the need for policy action among its members.

The critical importance of effective and timely IMF surveillance has crystallized in recent years, owing to the rapid growth of private capital markets, increased economic and financial integration, higher risks of domestic policy errors spilling over to other countries, and the implications of current account convertibility and market-oriented reforms in most member countries.

Effective IMF surveillance increasingly depends on the following:

  • Provision of Information. The IMF encourages countries to introduce greater transparency and fuller disclosure of timely, reliable, and comprehensive data. Surveillance activities have thus paid more attention to the gaps or deficiencies in data that could hamper analysis and have emphasized the importance of candid information on the quality of the data available.

  • Continuity of Surveillance. The IMF has supplemented annual consultations with interim staff visits to member countries, and with frequent, informal Board meetings to review major developments in selected member countries.

  • Focus of Surveillance. Surveillance at the country level focuses on the core areas of surveillance over exchange rate, macroeconomic, and related structural policies. It examines whether, in the light of the country’s situation, these policies are conducive to achieving reasonable price stability, sustainable external positions, and economic growth. With the rapid integration of international financial markets, capital account developments, financial sector issues, and the assessment of external vulnerability—in particular for emerging market countries—have been added to the set of core surveillance issues in recent years. The set of core issues is likely to keep evolving given continuing changes in the global economy, although issues related to external sustainability and vulnerability to balance of payments or currency crises will continue to remain central. Surveillance also covers, albeit on a selective basis, such noncore issues as poverty, health and education, the environment, governance, and military spending when these have a direct and sizable influence on macroeconomic developments.

  • Vulnerability Assessment. Vulnerability analysis in country surveillance has been deepened, particularly for emerging market economies. Such analysis is supported by the collection of more comprehensive and timely data relevant for the assessment of vulnerabilities—including debt- and reserve-related indicators of vulnerability, and capital account development. Related work is under way on structural and institutional elements in foreign exchange reserve management, high—frequency monitoring of external liabilities of domestic banking systems, macroprudential indicators of financial sector vulnerability, and early warning systems.

  • Transparency. Efforts to increase the transparency of members’ policies and IMF policy advice have progressed considerably. About a third of member countries participate in a pilot program for the voluntary release of Article IV staff reports, and the vast majority of members now release Public Information Notices (PINs)2 after Article IV consultation discussions.

  • Surveillance and Standards. Adherence to international standards and codes of good practice, which is voluntary, is increasingly seen as important for improving the policy environment and for reducing countries’ macroeconomic and financial vulnerability. Progress has been made in developing and strengthening standards, including the Special Data Dissemination Standard (SDDS), the Code of Good Practices on Transparency in Monetary and Financial Policies, and the Basel Core Principles (BCP) of banking. Progress has also been made in preparing assessments of members’ observance of standards through the experimental Financial Sector Assessment Program (FSAP) and Reports on the Observance of Standards and Codes (ROSCs). IMF surveillance provides a framework within which to organize and discuss with national authorities the implications of assessments of adherence to standards and codes.

Country Surveillance

The IMF holds consultations with its member countries generally every year to review each member’s economic developments and policies. Consultations are not limited to macroeconomic policies, but touch on other policies affecting the macroeconomic performance of a country, including, for example, where relevant those relating to the labor market, governance, and the environment. With the intensified global integration of financial markets, the IMF is also taking into account more explicitly capital account and financial and banking sector issues (see Chapter 4 for discussion of mechanisms for strengthened surveillance of members’ financial sectors).

To conduct country surveillance, an IMF staff team visits the country, collects economic and financial information, and discusses with the authorities the economic developments that have occurred since the last such visit, and the monetary, fiscal, and relevant structural policies that the country is pursuing. The Executive Director for the member country usually participates. The IMF staff normally prepares a concluding statement, or memorandum, summarizing the discussions with the member country and leaves this statement with the government. If a country decides to release the staff’s concluding statement to the public, the IMF publishes the statement on its website. Back at IMF headquarters, the staff prepares a written report describing the economic situation in the country and the substance of the policy discussions with the government, and evaluating the country’s policy stance. The Executive Board then discusses this report. The country is represented at the Board meeting by its Executive Director. The views expressed by the Board members during the meeting are summarized by the Chairman of the Board (the Managing Director), or the Acting Chairman, and a summary text (“summing up”) is produced. If the Executive Director representing the member agrees, the summary text is released to the public, together with introductory background material, as a Public Information Notice. In FY2000, the Board conducted 127 Article IV consultations with member countries, 106 of which resulted in the issuance of a PIN (see Table 2.1); PINs also appear on the IMF website.

In addition to Article IV consultations, the Board carries out surveillance in its discussions of ongoing IMF financial arrangements in support of members’ economic programs, of financial arrangements intended as precautionary, and through staff-monitored programs.

Table 2.1

Article IV Consultations Concluded in FY2000

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  • Precautionary Arrangements. Member countries agree with the IMF on a Stand-By or Extended Arrangement but do not intend to use the financial resources committed unless circumstances warrant. The country has the right, however, to draw on the resources provided it has met the conditions agreed upon in the arrangement. Such arrangements help members by providing a framework for economic policy and highlighting the IMF’s endorsement of its policies, which boosts confidence in them. They also assure the country that IMF financing will be available if needed and if the agreed conditions are met.

  • Staff-Monitored Programs. The IMF staff monitors a country’s economic program and meets regularly with the country’s government to discuss the policies undertaken. Staff monitoring does not constitute formal IMF endorsement of the member’s policies, nor is financing provided.

Global Surveillance

World Economic Outlook

The Executive Board’s conduct of global surveillance is based on staff reports on the World Economic Outlook, which feature a comprehensive analysis of prospects for the world economy, individual countries, and regions, and an examination of topical issues. Although these reports are usually prepared (and published) twice a year, they may be produced more frequently if rapid changes in world economic conditions warrant.

During FY2000, the Board met on two occasions to discuss the World Economic Outlook: in September 1999 and in March 2000. These discussions focused on the strengthening global economic recovery.

At their World Economic Outlook discussion in September 1999, Directors welcomed the strengthening of the global economy during 1999 to date, led by rapid recoveries in most of the crisis-hit Asian economies and, to a lesser extent, in Russia; preliminary indications of a long-awaited turnaround in Japan; a better-than-expected outcome in Brazil; a firming of activity in much of western Europe; and ongoing growth in the U.S. economy. Reduced tension in financial markets was supporting growth in many emerging market economies, a number of which were also helped by increases in some key commodities prices, including oil. Economic activity in the industrial world was being underpinned by generally benign inflation, low interest rates, and improved fiscal positions in most cases. Directors also concurred with the staff’s projections of a further pickup in growth in 2000, with expected mild slowdowns in the United States and Canada more than offset by stronger activity in other industrial countries and in most emerging market economies.

While Directors agreed that the risks surrounding these projections appeared reasonably well balanced, several emphasized the uncertainties in the outlook. Of particular concern was the potential impact of a slowdown in the United States. Most Directors agreed that such a slowdown was inevitable and necessary given the rising domestic and external imbalances in the U.S. economy. Several noted, however, that a smooth transition to a somewhat slower and more sustainable growth rate could not be taken for granted. Moreover, they and other Directors questioned whether growth in Japan and Europe would be sufficiently robust to compensate for slower expansion in the United States.

At their March 2000 meeting on the World Economic Outlook, Directors noted with satisfaction the rapid recovery in the world economy in 1999, and the prospect of even stronger growth in 2000. Global economic and financial conditions had improved dramatically during the past year, with growth picking up in almost all regions of the world. Directors noted that the remarkable strength of the U.S. economy and the robust growth apparent in western Europe had provided key support for faster-than-expected recoveries in Asia, Latin America, and other emerging market regions. Determined actions to deepen adjustment and reform efforts by policymakers in the crisis-affected countries, together with support from the international community, were also important. Directors considered that, at least in the near term, staff projections for global growth might well require adjustment on the upside.

At the same time, Directors expressed some concern about the potential for a correction of highly valued stock prices around the world (especially in the technology and information sectors), the mixed signals regarding economic recovery in Japan, the vulnerabilities in emerging market regions, and the possibility that growing global economic and financial imbalances could, if unchecked, disrupt world growth. A sustained pickup in domestic demand in western Europe and Japan, together with some slowing of U.S. growth, would help achieve a more balanced pattern of growth among the major industrial countries. Several Directors cited added uncertainties arising from the increases in world oil prices. In view of these concerns, and notwithstanding the overall improvement in the global economy, policymakers worldwide faced important, but widely varying, challenges. In some countries, macroeconomic policies had to be directed toward providing ongoing support for recovery while, elsewhere, further firming in the macroeconomic stance was probably needed to reduce risks of overheating. More broadly, prospects for sustained growth in almost all developing countries, and in many advanced economies, would be enhanced by more vigorous and wide-ranging structural reforms.

Developments in the Major Currency Areas

In considering developments in the United States, Directors saw few signs of slowing economic activity despite several interest rate increases by the U.S. Federal Reserve; indeed, growth accelerated toward the end of 1999. They suggested that the combination of strong investment and productivity growth, subdued wage pressures, and ongoing low inflation—resulting from fundamental changes in the economy—had raised the U.S. potential growth rate. Nevertheless, many Directors were concerned about rising internal and external imbalances in the economy that had accompanied the prolonged expansion, including a record-high current account deficit, strongly negative net private saving, and high stock market valuations. Directors recognized the central role that U.S. demand had played in supporting recovery worldwide, as well as the importance of the strong domestic investment climate and increases in national saving in the evolution of the current account. Many Directors agreed, however, that some further firming in U.S. interest rates would probably be unavoidable, absent clearer signs of a moderation in demand. Such a strategy would improve the prospects for a “soft landing” in the economy, whereas a delayed response could increase the risk of a further buildup of the imbalances and of a subsequent “hard landing.” A more balanced pattern of global growth would help reduce the U.S. external deficit.

Some Directors noted, however, that further increases in U.S. interest rates could set back the prospects for sustained recovery in some key emerging market economies, notably among the Latin American countries requiring significant external financing in the coming years. These Directors advocated a cautious approach to further monetary tightening and considered that, alternatively, reliance on further fiscal consolidation to slow domestic demand growth would avoid the risk of spillover effects on world capital markets. They recognized, however, that implementing further fiscal tightening with a budget already in surplus could prove politically difficult. More generally, Directors agreed that further fiscal stimulus, whether through substantial tax cuts or spending increases, would be dangerous under the circumstances. Instead, they argued that the welcome increases in public saving should be assigned largely to reducing debt and meeting the longer-term fiscal requirements associated with an aging population.

Turning to Japan, Directors agreed that economic indicators provided unclear signals regarding prospects for recovery. The data on fourth-quarter 1999 GDP, along with trends in household spending, confirmed that real activity had again weakened following the short-lived upturn in the first half of 1999, while the index of leading indicators provided scope for more optimism about the economic outlook.

Most Directors considered that a strong, self sustaining recovery in Japan led by private domestic demand still appeared some distance away, and that supportive macroeconomic policies should therefore be maintained. Directors agreed that Japan’s zero interest policy remained appropriate for monetary policy, with several suggesting a further easing of monetary conditions, especially if the yen were to appreciate again. Some Directors also considered that the introduction of an inflation-targeting framework could help improve the monetary framework. Most Directors believed that fiscal policy also should continue to support recovery, although a number of them suggested that the focus should soon start moving toward fiscal consolidation, given the rapid rise in public debt, pressures on longer-term interest rates, and the need to deal with the approaching fiscal pressure from public pension arrangements. In this connection, several Directors were concerned about the efficacy of successive fiscal packages to put the economy on a self—sustained growth path. Directors underscored the crucial role of structural reforms in boosting confidence and thus enhancing the efficacy of Japanese macroeconomic policies, noting also that with zero interest rates and high levels of public debt, the scope for continued expansionary macroeconomic policies might be reaching its limits. Against this background, Directors were concerned about delays in implementing some important structural reforms, and what they perceived as a weakening of other initiatives. They believed that, while structural adjustment could have a downside impact on some sectors, this would be more than offset over time by the broader-based improvements in confidence and activity that would follow from measures to liberalize domestic markets, strengthen the financial system, and address other structural weaknesses.

Directors welcomed the pickup in confidence and activity in the euro area. They noted the improvements in economic performance of the largest economies in the region, but observed that growth remained substantially more dynamic in several of the smaller countries. Fiscal policy had to play a central role in moderating risks of overheating among the fast—growing economies, even though fiscal adjustments might be politically difficult given the emerging budget surpluses in some of these countries. A broad program of fiscal reform was also required in most euro-area economies to reduce current and longer-term expenditure pressures and provide greater scope for tax relief. Directors argued that the recovery under way provided an important opportunity to push ahead with these fiscal reforms, and with complementary structural adjustment—especially in labor and product markets—to help sustain the recovery. While all Directors agreed that monetary policy should continue to focus on maintaining low inflation, some thought that monetary conditions should continue to support recovery in view of the slack still evident in the region. Some other Directors, however, suggested that firming monetary conditions could be expected in the year ahead, given the risk of price pressures—including in asset markets–developing in some countries.

Asset Prices

In considering developments in the advanced countries, Directors gave particular attention to trends in asset prices. They noted that asset price inflation was a general concern, encompassing the United States and much of western Europe. High asset prices posed a formidable challenge for macroeconomic policy in the prevailing environment of low inflation in goods and services markets. On the one hand, given the practical difficulties in determining the equilibrium value of asset prices and the fact that they are traded in relatively efficient markets, Directors felt it was unsuitable for macroeconomic policy to try to target those prices. On the other hand, as rapid and prolonged buildups in asset prices might worsen inflationary pressures and threaten financial stability through their impact on aggregate demand and domestic credit, asset price developments could well be a serious concern for central banks. Directors agreed that, to the extent asset prices provided valuable information about future developments in economic activity and inflation, such information should be taken into account in inflation and monetary targeting frameworks—but that prices of goods and services should remain the policy target. While agreeing that targeting asset prices should not become a permanent policy goal, some Directors considered that there may be instances in which macroeconomic policy should “lean against the wind” and try to stem financial market excesses, even though inflation in goods and service markets remained quiescent–although they recognized the practical difficulties in determining when and to what extent such a policy should be implemented.

In the United States, Directors noted that, despite some uncertainty, many valuation analyses pointed to some degree of overvaluation in key broad indices. In light of evidence that wealth effects stemming from the stock market might contribute to fueling growth of domestic demand well in excess of increases in potential output, Directors felt that the U.S. steps to tighten monetary conditions had been appropriate—and that the need for further tightening would have to be kept under close review.

As for the euro area, Directors agreed that the main challenge for macroeconomic policy arising from asset price movements remained the magnitude of regional divergences, with property prices, in particular, rising far more rapidly in some fast-growing euro-area countries on the periphery than in the region as a whole. While faster growth on the periphery was at least in part justified by regional convergence in incomes associated with economic integration and the introduction of the euro, the potentially significant impact of asset price corrections on financial conditions in some small European countries posed a problem for the conduct of monetary policy.

Prospects for Emerging Markets

Turning to economic developments in Asia, Directors welcomed the rapid recovery in the crisis-affected countries and the projections of continued strong growth. Rising exports had played a key role in this recovery, adding to the support from public spending and, more recently, from private domestic demand. Directors agreed that fiscal stimulus should be steadily withdrawn as growth became self-sustaining. Indeed, several Directors suggested that in the countries with recoveries most advanced, macroeconomic policies should focus on reducing risks of overheating and containing the growth in public debt. Directors urged the crisis-affected countries to maintain the momentum of structural reforms—especially in the financial and corporate sectors and in the institutional and prudential framework—and cautioned that the recoveries could prove short-lived if these reform efforts were relaxed. And to maintain the prevailing robust growth rates in China and India, further structural reforms were needed.

In Latin America as a whole, the downturn in 1999 had proved to be milder than expected because of the sustained pursuit of prudent macroeconomic and structural policies, although several countries experienced severe recessions. Directors agreed with staff projections that a broader-based recovery should emerge in 2000 and continue into 2001. Several elements were contributing to the improvement in regional economic conditions; these included strong growth in the United States, rising commodity prices, and declining inflation and interest rates. Nevertheless, several Directors cited remaining vulnerabilities—especially the high external financing needs of the largest countries and persistent weaknesses in some smaller economies. Directors urged these countries to continue to take steps to reduce risks and maintain the confidence of international investors. Key measures would include reducing fiscal deficits, where further progress was expected in 2000; implementing monetary policy frameworks designed to achieve or maintain low inflation; and, to support these objectives, enacting further structural and institutional reforms, including greater trade liberalization. Directors also emphasized the importance of increasing public and private domestic saving to help reduce reliance on foreign financing.

Russia’s economy experienced a rapid turnaround in 1999, but prospects for a sustained recovery remained uncertain. The reductions in Russia’s fiscal and external imbalances in 1999 largely resulted from higher oil prices, with import compression and substitution also contributing to growth. Directors agreed that a firm and wide-ranging reform effort was needed to improve the investment climate and medium-term growth prospects. Priority had to be given to strengthening the institutions and processes that underpinned market economies—including the legal framework, competition policy, transparency, and governance. Such reforms would reinforce efforts to tackle key structural weaknesses in the economy, particularly in the tax regime, in the banking system, and in many parts of the corporate sector.

Economic conditions were strong among the central and eastern European transition economies seeking accession to the European Union (EU). Growth was expected to pick up in all these countries in 2000, helped in most cases by growing exports to western Europe and stronger investor confidence. But further progress with structural adjustment would be needed for sustained improvements in economic prospects and to prepare for eventual EU membership. In some countries, more rapid progress with fiscal consolidation was also desirable as growth strengthened, to reduce pressures on inflation and interest rates.

For many countries in the Middle East and several in Africa, the rise in international oil prices had contributed to improvements in fiscal positions, current account balances, and other dimensions of economic performance. Increases in some nonoil commodity prices (such as metals) also supported external earnings growth in several African countries, although low prices for other products (such as tea, coffee, and cotton), combined with unfavorable weather (particularly in Mozambique), had slowed growth prospects elsewhere. In this regard, Directors agreed on the importance of continued economic diversification to reduce these countries’ vulnerability to swings in the prices and volumes of commodity exports. They were encouraged that substantial progress had been made in these regions, including among many of the smaller countries in Africa, in laying the groundwork for broader-based growth. In view of the remaining economic and social challenges, these reform efforts had to be expanded to make substantial inroads on poverty and provide a better environment for economic development.

Strengthening Growth in the Poorest Countries

At their March 2000 discussion of the World Economic Outlook, Directors also reiterated their commitment to policies aimed at raising the living standards of the least well-off. Although economic performance in most developing countries had on average been unsatisfactory over the past 30 years, Directors were generally encouraged by gains in real per capita income in many poor countries in Asia—notably in China and India–and, more recently, in several countries in Africa, where programs directed at achieving reasonable price stability, prudent fiscal balances, and sustainable exchange rate regimes had been successfully implemented.

Directors emphasized the critical relevance for economic development of market-friendly institutions and an environment in which individuals and businesses could save and invest, and expect to enjoy the future benefits of their endeavors. Political instability, war, and the absence of the rule of law were critical impediments to such a setting and to development more generally. Directors called for continued progress in removing distortions in domestic markets by eliminating price controls and subsidies, liberalizing external trade, and combating corruption through effective and transparent government. Many developing countries also had to establish sounder financial markets to allocate efficiently savings to profitable investments. Many of these countries, especially the poorest, would also benefit from giving higher priority to health and education programs to help break the poverty cycle by increasing productivity. Directors cautioned, however, that there was no unique formula for starting and sustaining economic growth; each country would have to decide how best to provide the necessary fundamentals for economic prosperity through the combined efforts of government and representatives of civil society. In this respect, Directors emphasized that local “ownership” of the reform process was crucial to its success.

Unsustainable levels of external debt are a critical impediment to economic growth and poverty alleviation, especially in some of the poorest countries. Without significant debt relief, incentives for government reform and private investment are dulled, and countries can be caught in a vicious debt and poverty trap. Directors emphasized the opportunity provided by the recently enhanced Initiative for Heavily Indebted Poor Countries (HIPCs), under which debt would be lowered to sustainable levels through concerted efforts by the international community (see Chapter 5).

Directors recognized the important contributions to debt relief being made by the membership, and in particular the advanced economies, both directly and through international organizations. Several Directors called for a reversal in the downward trend in official development assistance, and cautioned that debt relief associated with the HIPC Initiative should not be seen as a substitute for future development assistance.

These Directors drew attention to the more effective use of development assistance, for example, through strengthened incentives for reform in the recipient countries and through better targeting of aid to address these countries’ needs. Many Directors also called on advanced economies to enhance the effectiveness of the HIPC Initiative by reforming their trade policies, especially in such areas as agricultural products and textiles, where current policies had particularly damaging effects on trade opportunities and growth prospects for developing countries.

International Capital Markets

At the end of July 1999, Executive Directors conducted their annual review of developments in, and prospects for, international capital markets. Directors also discussed the lessons learned from the 1998 global financial market turbulence and the emerging market crises. Although financial market conditions had improved in the past year, Directors underscored some risks and uncertainties in the outlook. They differed about the lessons of the turbulence of 1997-98 and the initiatives being considered to address shortcomings in the global financial architecture. Although Board members broadly supported efforts to enhance market discipline, prudential supervision, and regulation, they achieved less consensus on the specific measures to be taken and whether the problem of ensuring appropriate incentives was being adequately addressed. The risks of globalization and how to address them, Directors agreed, should remain at the center of the IMF’s research activities.

Issues and Risks

As of July 1999, the Board noted that the operation of international capital markets was considerably more favorable than in 1998, but cited several remaining risks and uncertainties, and sentiment was still unusually fragile. Even though financial market activity had in many respects returned to normal in the advanced countries, external financing remained unusually tight for many emerging markets. Spreads on these countries’ external debt instruments remained in several cases very high, and internationally active banks continued retreating from the emerging markets. As a result, volatility continued to be high and significant vulnerabilities remained.

The continued strong macroeconomic performance of the U.S. economy, signs of a broader pickup in continental Europe, and Japan’s progress in addressing its financial sector and macroeconomic problems augured well. The main risks related to the sustainability of the current combination of exceptionally high U.S. equity prices and U.S. dollar strength and the possibility that either a spontaneous reassessment or further moves by the Federal Reserve to tighten monetary policy could trigger a significant correction in equity prices. While many Board members were confident that the advanced countries could withstand a modest U.S. equity correction, a number of Directors felt uncertainty about the extent and distribution of leverage in advanced financial systems that risked a more severe fallout—one with adverse implications for the emerging markets, especially countries whose markets were already weak.

While welcoming the rally in emerging market asset prices since the start of 1999, a number of Directors pointed to the risks resulting from continued tight external financing conditions and the ongoing pullback of international investors. This reduced access to capital markets had put severe pressures on several emerging market banking systems; this, in turn, contributed to cutbacks in local funding for domestic corporate securities, making debt service more difficult. A number of Directors noted that a vicious cycle had been evident since Russia’s August 1998 unilateral debt restructuring, as pullbacks of international investors from emerging markets contributed to low liquidity and relatively high volatility, which in turn discouraged participation by other investors. While expressing some confidence about the near-term outlook, some Directors remained concerned about the degree of effective financial and corporate restructuring in several of the Asian-crisis countries.

Turbulence in Mature Markets and Highly Leveraged Institutions and Activities

Executive Directors discussed the systemic and other issues related to highly leveraged institutions and activities in 1998 and the reforms being considered to contain excessive leverage. The buildup of financial risks that preceded the 1998 turbulence had raised important questions about the current lines of defense against systemic risk—especially weaknesses in market discipline, prudential supervision and regulation, and macroprudential surveillance. Directors differed somewhat, however, on the importance of different lines of defense and what could be done to strengthen them. While a few Directors argued for direct controls over hedge funds, most saw major difficulties in seeking to regulate these institutions directly; they supported ongoing efforts—including by the Basel Committee on Banking Supervision—to influence hedge funds indirectly by significantly strengthening oversight by counterparty banks and through improved market discipline.

Many Directors believed insufficient market discipline by creditors, counterparties, and shareholders was a key element allowing the buildup in vulnerabilities and leverage that preceded the 1998 turbulence. These Directors believed that the lack of adequate market discipline may have reflected other, more fundamental, deficiencies that pointed to the need for improving financial disclosure and transparency and better aligning internal, market, and regulatory incentive structures. In this connection, several Directors saw a key challenge for private financial institutions and for public policy in maintaining the efficiency enhancing aspects of modern finance while reducing the system’s tendency toward financial excesses and virulent market dynamics. Several Directors noted that more proactive prudential supervision and market surveillance could help detect and avoid a buildup in vulnerabilities. They suggested that the presence of the public safety net for financial institutions created countervailing incentives that may work against market discipline. Some Directors felt that the staff’s analysis could have given further consideration to the issue of moral hazard and to the analysis of options to reduce it; some others, however, were not convinced that safety nets had given rise to moral hazard or had been excessive. Directors agreed that the ability to supervise and monitor modern financial systems would remain critical.

Directors unanimously welcomed the reform proposals on improved transparency and disclosure by both private sector groups and officials. Such proposals would likely require all financial institutions—including highly leveraged institutions—to provide more information. An important next step was to agree on a core set of data on firms’ risk exposures, and on the frequency with which it should be disclosed to market investors, counterparties, and, where relevant, supervisors.

Many Directors observed that greater disclosure and improved transparency may not in themselves be sufficient to improve credit and counterparty risk assessment; rather, internal incentive structures were required to encourage firms to obtain information and act upon it. Several Directors felt that current reform proposals did not generally address the need for such changes in incentives. In this connection, a number of Directors pointed to the proposed revisions to the Basel Capital Accord as a first step toward correcting possible regulatory distortions.

Several Directors expressed concern that the ongoing rapid pace of financial liberalization, innovation, and globalization was contributing to changes in the nature and sources of systemic risk that were not fully understood. They thus suggested the need for additional consideration of how regulators who supervise internationally active financial institutions could stay abreast in an increasingly dynamic and interrelated global economy.

As to market dynamics, Board members noted that there was no unambiguous answer to the question of optimal design of risk control mechanisms that would strike a balance between the slow adjustment to shocks that has traditionally characterized relationship banking and the rapid adjustment that takes place in modern capital markets. Some Directors felt the key to avoiding the turbulence seen in the fall of 1998 was strengthening risk management and control procedures to avoid a buildup in excessive leverage. Others suggested that the mechanical and rigid use of risk management practices–together with frequent marking to market–might unnecessarily worsen financial market strains once a crisis had erupted, because of the speed with which they call for portfolio rebalancing and deleveraging.

Regarding macroprudential oversight, several Directors cited the need to better understand and monitor the complex nexus between monetary and financial policies—in particular, the role that abundant liquidity conditions might have played in the 1998 buildup of leverage. Several Directors called for greater attention to how the growth of global liquidity might be monitored and, more broadly, to its possible role in foreshadowing a buildup of leverage and imbalances–although a few Directors underscored the difficulty in defining and measuring such a concept. A number of Directors also wondered whether national authorities were adequately exploiting the synergies between macroprudential surveillance and the supervision of individual financial institutions. Several Directors suggested that more proactive and countercyclical prudential supervision and market surveillance could play a key role in helping avoid excessive leverage. Some Directors were concerned, however, noting the difficulty in appropriately timing any changes in capital adequacy ratios relative to the business cycle, as well as to divergences in business cycles around the world.

A number of Directors observed that, while improvements in the lines of defense (private sector risk management, banking supervision, and market surveillance) should help address the systemic issues associated with the highly leveraged institutions, they would not address concerns about the impact of such institutions on small and medium-sized markets. Several Directors therefore suggested that further work was needed to better understand the conditions under which the activities of highly leveraged institutions could destabilize small and medium-sized markets.

"Nonstandard" Policy Responses

A number of national authorities had resorted to relatively “nonstandard” responses to deal with extraordinary external pressures, including official intervention in bond and equity markets and the imposition or intensification of capital and foreign exchange controls. A number of Directors defended using such tools in the face of pressures seen as out of proportion to underlying fundamentals and given the aggressive tactics adopted by some investors. These Directors considered that such measures should not be ruled out in exceptional situations, to complement other policy adjustments. They recognized, however, that over the longer term, nonstandard official responses could negatively affect the risk-reward profile of various financial market investments. Other Directors suggested that the evidence on the efficacy and desirability of these interventions was at best inconclusive.

A number of Directors considered the capital controls that Malaysia adopted useful insurance against future speculative activity and believed that, in that sense, the controls had served their purpose. These Directors also argued that Malaysia had effectively used the protection provided by controls to continue restructuring its banking and corporate sectors. Some other Directors, however, noted that the use of controls might prove damaging to Malaysia’s longer-term interests and could deter future capital inflows. They thus urged other countries to use caution in adopting similar measures.

Credit Rating Agencies

The major credit rating agencies had become important providers of independent assessments of sovereign and private credit risks, Directors noted. The credit ratings issued by these agencies could have a strong impact on both the borrowers’ cost of funding and the willingness of major institutional investors to hold certain types of securities. Also, since the Basel Committee on Banking Supervision had proposed to make credit ratings a key determinant of the risk weights attached to bank exposures, many Directors believed that the influence of the credit rating agencies was likely to expand.

In view of the potential impact of rating changes on capital flows to emerging markets, a number of Directors were concerned about the performance of the major rating agencies before and during the recent emerging market crises. These agencies had introduced a procyclical element into global capital flows, contributing to the excessive capital flows into emerging markets, as well as to their abrupt reversals. Moreover, some Directors observed that the rating agencies failed either to give a warning of the crisis or accurately reflect economic fundamentals. Some Directors noted, however, that the lessons drawn by the credit rating agencies from their experiences were similar to those reached by the IMF staff for improving surveillance.

Several Directors expressed reservations about reliance on credit ratings, especially for sovereigns, in determining risk weights for bank lending. They noted that there was no clear track record regarding the accuracy of sovereign ratings and saw a clear need for the rating agencies to improve significantly the quality of their analysis—including by taking into account increased international interdependence and greater market complexities.

Regional Surveillance

Central African Economic and Monetary Community

At a February 2000 meeting, Executive Directors discussed recent developments and regional policy issues in the Central African Economic and Monetary Community (CEMAC). They commended the efforts of CEMAC member countries (Cameroon, the Central African Republic, Chad, the Republic of Congo, Equitorial Guinea, and Gabon) to strengthen economic integration and to pave the way toward the creation of a single domestic market. The growing range of economic policies formulated and implemented at the regional level meant that a policy dialogue by the IMF with regional institutions could usefully complement bilateral surveillance, and should facilitate the monitoring of IMF-supported programs in the CEMAC area.

Directors noted that, in contrast to the impressive economic improvements of the community members after the devaluation of the CFA franc in early 1994, the economic and financial situation of the region deteriorated sharply in 1998 and in the first part of 1999. The substantial decline in the terms of trade had been aggravated by a loss of fiscal control in one of the major countries and the accommodating monetary policy of the regional central bank, as well as domestic conflicts in two other countries.

In this context, Directors welcomed the adoption by the CEMAC, in September 1999, of a regional policy package prepared by the central bank to promote macroeconomic policy convergence, fiscal discipline, and economic cooperation. This package, together with the recovery in the international price of oil, an improved security situation in the region, and the adjustment under way in member countries, should help improve the economic outlook of the region in 2000 and beyond. Directors urged the member governments and the regional institutions to seize the opportunity of CEMAC’s creation to establish a solid framework for close coordination of fiscal and structural policies, so as to provide firm support to the common pegged exchange rate regime.

Directors noted that the exchange rate realignment of January 1994 had helped improve the competitive position of the region and led to a strong increase in the growth of nonoil output and of exports. While the available indicators suggested that the competitive position of the CEMAC remained broadly adequate, Directors stressed that those indicators should be monitored closely, in view of the demonstrated high vulnerability of the external current account. Sound macroeconomic policies and decisive progress in structural reforms—including improved governance—were essential in all member countries to boost productivity growth, maintain the region’s competitiveness, and promote economic diversification.

The envisaged system of mutual regional surveillance of member countries’ fiscal policies will contribute to the financial stability of the CEMAC. Firm fiscal discipline should remain a priority for all the member countries. Directors saw merit in the proposal to introduce oil stabilization funds to gear central bank lending more appropriately to broader macroeconomic objectives. They welcomed the intention to phase out the current mechanism that grants automatic credit to the government (subject to ceilings) in the context of the development of a regional government securities market as a vehicle for nonbank financing of the treasury’s domestic borrowing requirements.

Board members cited the progress made by the COBAC, the regional banking commission, in conducting bank supervision in the region but stressed the importance of completing promptly the bank restructuring programs in the two remaining countries of the region and achieving the full privatization of banks. They also encouraged the authorities to strengthen further their prudential arrangements along the lines of the core principles for effective banking supervision recommended by the Basel Committee, and to expand COBAC’s technical capacity.

The quality of financial intermediation in the region would benefit from a better functioning of the regional interbank market, the introduction of a single zonewide licensing agreement for banks, and more competition among financial institutions. Directors urged the CEMAC to move quickly to establish a functioning regional financial market.

The Board welcomed the major trade policy reforms initiated in 1994 by the CEMAC countries, particularly the adoption of a common external tariff and the liberalization of intraregional trade. Directors encouraged the authorities to further liberalize trade by simplifying the tariff structure, reducing average tariff rates, and eliminating remaining intraregional barriers.

Any strategy for regional integration and economic growth would have to include the establishment of a common legal and regulatory environment conducive to development of the private sector and investment, and efficient resource allocation, Directors emphasized. They underscored the need to implement the recent initiatives in the areas of business laws, investment charter, and competition policy. Directors also stressed the need to enhance the production of timely and reliable regional statistics to strengthen regional surveillance, and encouraged the authorities to seek technical assistance in this area.

Some Directors hoped that eligible CEMAC countries would obtain debt relief under the enhanced Initiative for Heavily Indebted Poor Countries.

Monetary and Exchange Rate Policy in the Euro Area

In March 2000, discussing the monetary and exchange rate policies of the euro area, Directors noted that the near-term outlook had brightened with the deepening and broadening of the recovery, but that the key policy challenge remained to create conditions for sustained rapid growth. To this end, Directors urged a monetary strategy firmly focused on price stability, national fiscal policies aimed at promoting public saving and favorable supply-side responses, and intensification of structural reform efforts.

Directors commended the European Central Bank (ECB) for a policy stance that had been supportive of the euro-area economy throughout 1999, without endangering medium-term price stability. While acknowledging the need for a gradual return to a more neutral position as the cycle matured, many Directors thought this supportive orientation should be maintained in 2000. In particular, they saw no pressing need for an increase in interest rates in the near future, in light of the remaining slack in labor and product markets, the gradual pace at which it had been taken up, the prevailing moderation in wage claims, and downward price pressures stemming from deregulation in key sectors. These Directors also argued that monetary policy should be mindful of the need to probe cautiously the margins of untapped resources, taking into account some signs of an improved inflation-output trade-off in the euro area, as had occurred in the United States. Some Directors, on the other hand, saw risks to price stability on the upside—owing to, among other things, generous liquidity conditions in 1999 and rising oil and commodity prices; they felt it remained necessary to react quickly to threats of inflation. Directors generally agreed that the steadfast pursuit of structural reforms offered the best chance for noninflationary growth in the euro area and maintenance of market confidence, while allowing monetary policy to focus on continued price stability.

The ECB had made important strides in providing information to the public on its strategy and its assessment of economic conditions, but Directors felt that greater transparency could make monetary management more effective. They welcomed the ECB’s intention to publish macroeconomic projections—including projections of inflation—which, without implying a departure from the accepted monetary policy strategy, would promote a better understanding of how the ECB forms its view of the inflation outlook and enhance the credibility and predictability of policy.

Against the backdrop of stronger activity in the euro area and of the current and capital account imbalances among the major currency zones, Directors agreed that the prevailing weakness of the euro was undesirable. Lagged exchange rate responses of trade flows, they emphasized, could worsen existing patterns of trade imbalances and heighten the risks of abrupt exchange rate reversals and of protectionist pressures.

Nonetheless, Directors observed, a monetary policy reaction was appropriate only in the face of a threat to medium-term price stability. To the extent that a weak euro reflected the relative cyclical positions of the United States and the euro area, as well as markets’ concerns about the structural rigidities that could undermine the sustainability of the expansion, a monetary response in the absence of clear risks to price stability would do little to strengthen the currency. In the Board’s view, a recovery of the euro would come from markets becoming better attuned to the fundamental strength of the euro-area economy, greater cyclical convergence between the United States and the euro area, and greater progress on structural and fiscal reform in many euro-area countries.

Directors acknowledged the progress toward fiscal sustainability in the run-up to Stage 3 of the European Economic and Monetary Union, which occurred on January 1, 1999. Most Directors pointed out, however, that the adjustment effort had slackened in 1998–99 and needed to be reinvigorated. Such improvements were necessary to create the scope for discretionary fiscal policy, which is particularly important in the framework of a uniform monetary policy. These Directors indicated that, although the updated stability programs for 2002–03 were, in some cases, more ambitious than the previous ones in proposing tax cuts, the programs did not go far enough in providing the area as a whole with the necessary improvements in structural primary balances and reductions in tax burdens.

In the improved cyclical setting, Directors emphasized that manageable targets for 2003 should include the achievement of fiscal balances or surpluses in all euro-area countries, and reductions in the euro-area revenue-to-GDP ratio. They also stressed the need to ensure durable improvements in the fiscal positions of most countries by further reforming health care and modifying pension systems to guarantee lasting reductions in public spending. Such spending restraint was essential for allowing tax rates to be reduced significantly from current levels, while maintaining fiscal prudence and achieving the approximate fiscal balances or surpluses envisaged under the Stability and Growth Pact.3

While the euro-area countries had made considerable progress in reforming the product, services, and capital markets, the euro-area reform strategy was still too limited in scope. To continue cutting area-wide unemployment, Directors urged the governments to accelerate labor market reform.

In the labor market, most Directors felt that many countries needed to reassess the eligibility conditions for unemployment compensation and welfare assistance, promote a less rigid and more differentiated wage structure, and broaden the scope of the most effective vocational and apprenticeship programs. In the product and service markets, Directors welcomed the ongoing progress in privatization and deregulation but called for stepped-up efforts to lock in the beneficial effects of competition. They cited ample scope for further opening up access to still-sheltered sectors, as well as for removing administrative barriers to business formation, and to job creation in the service sectors and commercial activities.

Finally, some Directors noted that trade liberalization offered important benefits not only for augmenting world growth potential, but for the euro countries themselves, in terms of the implications for domestic prices, resource allocation, and the external position. They encouraged the euro countries to allow increased market access to exports from low- and middle-income countries, noting that trade protection, especially in agriculture, remained high.


One of the two monetary unions in the CFA franc zone (the other being the West African Economic and Monetary Union).


Public Information Notices (PINs) are issued, at the option of a member country, following the conclusion of its Article IV consultation. Such releases are aimed at strengthening IMF surveillance over the economic policies of members by increasing the transparency of the IMF’s assessment of these policies.


The Stability and Growth Pact, approved by the European Council in June 1997, sought to secure budgetary discipline in member states during the final stage of European Economic and Monetary Union.