Abstract
Authors of Working Papers are normally staff members of the Fund or consultants, although on occasion outside authors may collaborate with a staff member in writing a paper. The views expressed in the Working Papers or their summaries are, however, those of the authors and should not necessarily be interpreted as representing the views of the Fund. Copies of individual Working Papers and information on subscriptions to the annual series of Working Papers may be obtained from IMF Publication Services, International Monetary Fund, 700 19th Street, Washington, D.C. 20431. Telephone: (202) 623-7430 Telefax: (202) 623-7201 This compilation of summaries of Working Papers released during July-December 1994 is being issued as a part of the Working Paper series. It is designed to provide the reader with an overview of the research work performed by the staff during the period.
This paper provides a review of the literature on both analytical issues and country experiences with respect to the sequencing of financial sector reforms. It discusses the choice between “big bang” and gradual reforms, the relationship of financial sector reforms to other economic reforms, the internal sequencing of financial sector measures, and the influence of initial conditions. The paper concludes that a pragmatic approach to the sequencing issue is necessary, as there are only a few general principles valid for all countries.
One important principle seemingly valid for all cases is the need to accompany financial sector liberalization with the introduction and/or the enforcement of an adequate degree of prudential regulation and supervision. This is not a panacea, however, and consideration must also be given--especially in backward and emerging financial markets--to establishing procedures for imposing discipline through the development of markets and associated institutions. A related finding derived from experience is that delays in addressing the problem of failing financial institutions and in eliminating the causes of this problem can be very costly in terms of both fiscal resources needed for the eventual rescue and the malfunctioning of the liberalized financial markets.
Macroeconomic stabilization--always a worthwhile objective in its own right--can also help substantially in alleviating the problems of transition to a liberal financial system, and in maintaining the efficiency of the system once the liberalization has been completed. The transition generally has the temporary effect of increasing the rate of credit expansion above that of deposit creation; this expansionary effect must be offset through the use of newly created indirect instruments, but in a manner that avoids the risk that real interest rates might rise to very high and unsustainable levels. In addition to this transitory increase in liquidity, financial sector reforms may involve significant budgetary and real sector adjustment costs. These costs, although transitory and smaller than the long-term benefits, will likely affect the political determination to carry out the reforms and, therefore, the speed and sequencing of the measures.
Some common sense rules on sequencing can also help to avoid major policy errors, including the implementation of mutually inconsistent measures, which hardly promote the financial sector objectives, and premature liberalization measures, which crucially harm objectives in sectors other than the financial sector. These types of inappropriate sequencing can increase the risk of a financial crisis. Finally, the paper suggests that structural linkages among specific reforms (for instance, monetary instruments and money market structure) could dictate a specific sequencing of measures to ensure efficient implementation.