Biennial Review of the Implementation of the Fund’s Surveillance and of the 1977 Surveillance Decision—Content of Surveillance
Author:
International Monetary Fund
Search for other papers by International Monetary Fund in
Current site
Google Scholar
Close

Biennial Review of the Implementation of the Fund's Surveillance and of the 1977 Surveillance Decision - Overview, Modalities of Surveillance, and Content of Surveillance

Abstract

Biennial Review of the Implementation of the Fund's Surveillance and of the 1977 Surveillance Decision - Overview, Modalities of Surveillance, and Content of Surveillance

I. Introduction

1. This paper examines the content of surveillance over the past two years in light of the Board guidance that emanated from the 2002 biennial review of surveillance and subsequent policy discussions, and reflects on ways to improve the content of surveillance with a view to increase its effectiveness across the whole membership. The paper consists of two parts: the first takes stock of the broad evolution of the coverage and content of bilateral surveillance in the last two years; the second takes a closer look at the treatment of four specific issues, namely global and regional spillovers, exchange rate issues, balance sheet analysis, and institutional underpinnings of growth.

2. The paper focuses on characteristics of the content of surveillance, such as focus of coverage, aspects of the quality of the analysis, degree of substantiation of the policy advice, and candor of the policy dialogue. On one topic, namely exchange rate issues, the paper also considers general characteristics of the policy recommendations. However, the paper does not seek to assess whether, in individual country cases, the Fund’s policy advice was right or wrong.

II. Coverage and Content of Fund Surveillance1

A. Introduction

3. Following their discussions of the 2002 biennial review of surveillance, Executive Directors reached the following main conclusions on the coverage and content of surveillance:2

  • Over the years, the coverage of surveillance had expanded from a relatively narrow focus on fiscal, monetary and exchange rate policies to a broader purview encompassing external vulnerability assessments, external debt sustainability analyses, financial sector vulnerabilities, and structural and institutional policies that have an impact on macroeconomic conditions. This broader coverage constituted a necessary and positive adaptation of surveillance to a changing global environment.

  • Under the expanded reach of surveillance, it was important to keep individual Article IV consultations focused on key issues. The twin objectives of breadth and focus could only be achieved by ensuring that selectivity of coverage is molded to country-specific circumstances.

  • The selection of topics in individual consultations should be based on macroeconomic relevance and, within subjects meeting this criterion, matters at the apex of the Fund’s hierarchy of concerns, which were external sustainability, vulnerability to balance of payments or currency crises, sustainable growth and the policies to achieve it, and, for systemically important countries, conditions and policies affecting the global or regional economic outlook.

  • Fund surveillance had succeeded in embracing a wider coverage without losing focus. Issues covered in individual consultations had generally been chosen appropriately, based on country-specific circumstances.

  • Further scope remained for enhancing selectivity in individual cases and areas, with trade policy being one such area. Coverage of trade policy was critical where serious trade distortions hampered macroeconomic prospects, as well as in countries whose trade policies had global or regional implications.

  • A thorough discussion of exchange rate issues was essential to Fund surveillance. While welcoming the greater degree of candor in the evaluation of “soft” exchange rate pegs in countries with market access, Directors urged that exchange rate issues be treated candidly throughout the membership.

  • The coverage of financial sector issues needed to be brought up to par with coverage of other core areas of surveillance. Directors welcomed the expanded coverage of financial sector issues, but were concerned that, in the absence of an FSAP, the quality of financial sector surveillance had been uneven across countries.

  • Two issues related to external vulnerability assessments deserved greater attention, namely the private sector’s balance sheet exposure to interest and exchange rate shocks, and debt sustainability.

  • There remained scope for better integration of multilateral surveillance with bilateral surveillance. While Directors expressed support for the current modalities of multilateral surveillance, many Directors stressed that the spillover effects of policy changes in systemically important countries needed to be more carefully explored, and that the Fund should consistently bring a cross-country perspective to bear on bilateral surveillance.

  • In countries with Fund-supported programs, as in other countries, there was a need for periodic reassessment of economic conditions and policies, which required stepping back from the program framework. Many Directors noted that Article IV consultation discussions sometimes failed to do this, thereby limiting the potential effectiveness of surveillance.

4. In several subsequent Board discussions, Executive Directors addressed selected aspects of the content and coverage of Fund surveillance. In particular,

  • in March 2003, in the review of the Financial Sector Assessment Program (FSAP), Directors emphasized the need for continuous and effective financial sector surveillance, and called for use of a range of complementary modalities to full FSAP exercises;3

  • in March 2003, in response to the recommendations of the Independent Evaluation Office stemming from its evaluation of the prolonged use of Fund resources, Executive Directors introduced a systematic process of ex post assessment and forward planning linked to the Article IV consultation process;4 and

  • in July 2003, in the review of the application of the strengthened framework for assessing external and fiscal sustainability, Directors stressed the need to better integrate debt sustainability assessments with the rest of staff’s analysis and policy discussions.5

5. In light of the above policy conclusions, this section of the paper considers (i) how the Fund has coped with the competing demands of breadth and focus in its surveillance activities since the 2002 review of surveillance; (ii) how the coverage of surveillance in program countries has evolved; (iii) what has been the focus of surveillance in low-income countries; and (iv) how the treatment in Fund surveillance of some of the topics highlighted above, particularly financial sector issues, has evolved. The coverage of the remainder of these topics, namely exchange rate issues, balance sheet analysis, and policy spillovers, is analyzed in some detail in the next section of the paper.

6. The analysis presented in this section is primarily based on a review of the 140 Article IV consultation reports discussed by the Executive Board between January 1, 2003 and March 4, 2004. The sample consisted of 29 advanced, 25 emerging market, 23 small island, 10 oil-producing, and 53 other developing countries (see Appendix). The starting date of January 1, 2003 was chosen to include only those consultations that were initiated following issuance of the Operational Guidance Note to Staff following the 2002 Biennial Surveillance Review. The review was based on a detailed questionnaire addressing four main aspects of coverage: (i) rationale for focus and scope, (ii) short-term macroeconomic developments, outlook, risks and policy discussion, (ii) macroeconomic and structural policies, and (iv) assessment of vulnerability and medium-term sustainability. The questionnaire consisted of 25 questions (see Appendix), which can be divided into two groups. The first group sought to assess the adequacy of coverage in a particular area. These questions were posed in a way that defined the elements considered necessary for adequate coverage in a particular area, and allowed the assessor to identify which of these elements, if any, were not present in a particular report. The second type of question was designed to draw out more details on coverage of a particular issue, relevant background information or, for some areas of coverage, a qualitative summary assessment. This review of Article IV consultation reports was conducted internally by a team of PDR staff not involved in day-to- day review work. This section also contains selected information on the results of outreach activities, which are described in greater detail in a companion paper.6

7. Adequate coverage was defined as clear, focused, and well-substantiated treatment of relevant issues with a candid and balanced account of the discussion with national authorities. More specifically, the following elements were considered essential for adequacy of coverage in an Article IV staff report: a presentation of recent economic developments with a clear “story line”; discussion of authorities’ and staff’s views on the short-term economic outlook and risks to this outlook, taking into account global (or regional) economic and financial market developments; a crisp statement on the focus of the consultation; selection of issues guided by the criterion of macroeconomic relevance and the set of matters at the apex of the Fund’s hierarchy of concerns;7 identification of key policy challenges and crisis vulnerabilities; and a well-substantiated and balanced dialogue on policy recommendations.

B. Coverage

General considerations

8. The focus of Article IV consultation reports varied substantially across countries. Establishing or maintaining macroeconomic stability was a central issue in most consultations. A significant number of consultations, for both developing and advanced countries, also focused on medium-term growth prospects or structural reforms. For emerging market countries, the policy discussions often centered around reducing crisis vulnerabilities and making further progress on medium-term structural reform agendas. Consultations in oil-producing economies focused on appropriate management of oil revenues and development of the non-oil sector. Reports on most small island economies concentrated on the fiscal situation and public debt sustainability.

9. In the assessors’ views, in more than three quarters of the reports, the scope of coverage was broadly adequate—that is, it was neither too broad nor too narrow, and the focus of the consultation was clearly set out and well justified. Staff used a flexible approach in covering short- and medium-term issues, providing greater details on key matters, and generally devoted substantial attention to a fairly limited number of issues, thus bringing focus to Article IV consultation reports (Box 1). Discussion of macroeconomic policies typically provided a clear identification of key policy challenges and a comprehensive discussion of potential remedies. Inadequate coverage of macroeconomic policies in a small number of reports reflected insufficient discussion of one of the main policy areas, most often exchange rate issues, or a failure to provide a consistent and integrated discussion of all main policy areas. For several countries, coverage of fiscal issues was informed by Fiscal Strategy Briefs, which discuss priority areas for fiscal reform and, in some cases, broad sequencing of measures.8

Focused Reports, Flexible Approach—Positive Examples

Short-term versus medium-term outlook

The 2004 Article IV staff report for Canada mostly focuses on the short-term outlook, trying to identify policies needed to foster economic recovery after a sharp slowdown caused by negative shocks. While the report succinctly weaves in the discussion of medium-term issues, such as fiscal sustainability and productivity growth, short-term issues take up most of the report. Another well-focused report, the 2003 Article IV staff report for Morocco, concentrates on medium-term structural issues against the background of broad macroeconomic stability and a daunting unemployment problem in the country. The Switzerland 2003 Article IV staff report blends the discussion of medium- and short-term issues as the report makes policy suggestions on how to lift the country out of a recession caused by investment collapse from weak external demand.

Macroeconomic vs. structural issues

The 2003 Hungary Article IV staff report focuses almost entirely on monetary, exchange rate, fiscal, and wage policies that are relevant for short-term conditions as well as for the medium-term strategy to adopt the euro; yet it manages to flag key structural issues. In the context of broad macroeconomic stability, the 2003 staff report for Tunisia, on the other hand, devotes much of the discussion on how to strengthen the macroeconomic policy framework and implement accelerated broad-based reforms to make the economy more globally integrated and market-based. In the staff report for Angola, a country facing severe macroeconomic instability and a humanitarian crisis, the focus of the discussion is a split between medium-term issues, such as installing better governance, transparency and accountability, and how to address the entrenched three-digit inflation.

Level of detail

The 2003 Article IV staff report for India provides detailed analyses on a number of issues, particularly in the financial and fiscal sectors, and six boxes giving rich insights into the country’s economic outlook and vulnerabilities, while keeping the focus on enhancing medium-term growth and ensuring fiscal sustainability. The well-structured report on Chile, with a few boxes and key details, provides a comprehensive coverage of all relevant issues, including an-depth discussion of external and financial vulnerabilities. The 2003 Poland staff report provides a crisp, focused and balanced discussion of all main policy areas and vulnerabilities with a measured level of detail and no boxes.

10. In almost all cases where the scope of coverage was considered to be inadequate, it was perceived to be too narrow. Typically, in such cases, assessors were of the view that, given their importance for growth prospects, one or more structural issues (e.g., labor market policies, regional integration, conditions for private sector investment) had not received the necessary degree of attention. Interestingly, the outreach to national authorities brought to light a parallel view on the issue of focus, with a number of officials regretting that insufficient attention was given to country-specific issues that were high on the authorities’ agenda.

11. The presentation of the policy dialogue between the authorities and staff was considered candid in most reports for non-program countries, though with some variance across policy areas.9 For example, despite the Board’s call for candor but reflecting the obvious sensitivities, discussions of exchange rate issues were often very cautious, with important elements of analysis lightly covered—such as possible differences between de facto and de jure regimes, the degree of flexibility in a flexible regime, and the appropriateness of the exchange rate level—and any view other than full support to existing policies extremely carefully worded (see Section III.B). Similarly, while reports usually placed the discussion of fiscal adjustment in the context of the medium-term fiscal outlook, a lack of genuine dialogue in a number of reports hampered readers’ understanding of the authorities’ views on the pace and extent of adjustment recommended by staff or on the feasibility of measures needed to achieve such adjustment.

12. In those cases where the presentation of the policy dialogue was not considered candid, the coverage of the authorities’ views was quite limited. In these reports for non- program countries, the section on policy discussions tended to read like a monologue rather than a genuine policy dialogue. This is consistent with the conclusions of the survey of national authorities, which emphasized that the policy dialogue between staff and the authorities had become more balanced in recent years, but that there were still cases of limited interaction.

Coverage of surveillance in program countries

13. The 2002 review of surveillance revealed weaknesses in a number of areas regarding surveillance in program countries vis-à-vis non-program countries.10 Responding to these weaknesses, the Operational Guidance Note Following the 2002 Surveillance Review underscored the need for the following elements in surveillance in program countries (as in surveillance of non-program countries): a comprehensive assessment of recent economic developments; a candid analysis of the short- and medium- term outlook, including a thorough discussion of risks and vulnerabilities; a stock-taking of the policy strategy to date; and a candid account of the policy dialogue between staff and the authorities on key policy issues. To enhance effectiveness of surveillance in program countries, the Executive Board also endorsed flexibility in the Article IV consultation schedule to allow consultations to take place at a time when they are most beneficial in a program context, i.e., before a program is negotiated, when a program has clearly moved off- track, or in between programs.

14. As indicated above, the steps adopted at the conclusion of the 2002 review of surveillance to strengthen surveillance in program countries were complemented by the introduction of systematic ex post assessments (EPAs) for countries with a longer-term program engagement. EPAs are to be prepared by an interdepartmental team prior to the Article IV consultation mission; reflect input from the World Bank; and cover an analysis of the problems facing the country, a critical and frank review of progress during the period of Fund-supported programs, and a forward-looking assessment that takes into account lessons learned and presents a strategy for future Fund engagement.

15. The decision modifying consultation cycles for program countries adopted in July 2002 has helped time consultations better.11 Since then, most Article IV consultations with program countries have taken place either at the beginning of a program, in between two programs, or when the program moved off-track or expired; one-third of consultations in our sample were combined with a review.

16. The 37 Article IV staff reports for program countries discussed by the Executive Board between January 1, 2003 and March 4, 2004 were reviewed to assess the impact of the steps adopted in 2002.12 Implementation of EPAs is too recent to allow for a review at this time.

17. This review shows that there has been improvement with regard to the quality of coverage in the above-mentioned four areas since the last review of surveillance, albeit in different measures (see Table 1).13 The vast majority of these reports provided a substantial discussion of recent economic developments, which was not simply wrapped around the narrow set of program targets. In addition, these Article IV consultation reports, which were often combined with a program request or review, presented a broad discussion of macroeconomic and structural issues, which was not limited to provision of program-related technical details.

Table 1.

Coverage of Specific Topics in Article IV Staff Reports for Program Countries 1/

article image

See footnote 6 for definitions of “adequate,” “barely adequate” and “inadequate” in various categories.

18. The most striking improvement relates to taking stock of the policy strategy to date—i.e., the design and implementation of the authorities’ program of economic policies. Many of the reports had a separate section dedicated to this issue, and more than three quarters of program country reports in our sample included one or more paragraphs in the background section on effectiveness of the policy strategy to date. The discussions, at a minimum, addressed past policy implementation and the success of previous programs in broad terms. Most reports also went into substantial details, laying out the policy objectives under past programs, identifying areas of weak implementation, discussing what factors contributed to the success or failure of the program, and shedding light on the remaining policy agenda (Box 2). Reports tended to identify the following as areas where policy implementation has fallen short of expectations: public expenditure management, revenue forecasting, capacity building, public enterprise restructuring, lack of progress in diversification, improving the quality of institutions and governance. Shortcomings were generally reported to stem from one or more of the following reasons: program design, resource constraints, limited implementation capacity, lack of political will or consensus, entrenched governance problems, or uneven growth performance.

Taking Stock of Past Policy Developments in Program Countries— Positive Examples

The Article IV staff report for Mauritania, a country that has completed three PRGF/ESAF arrangements and is going into its fourth, provides an in-depth dialogue on performance under past programs that identifies areas of strong and weak performance, and lessons. The report recognizes that Fund-supported policies have helped the country in maintaining macroeconomic stability and promoting structural reforms in a number of areas, but has had little impact on diversifying the economy, attracting foreign direct investment, improving financial intermediation, and enhancing project implementation capacity. Looking forward, the report highlights the need for a deeper understanding of the political, social and economic structure of the country, more emphasis on governance issues, and a more focused structural conditionality. Given the assessment that Mauritania has not yet built a critical mass of institutional and technical capacity to implement, on a sustained basis, consistent macroeconomic policies, staff and the authorities see merit in continued Fund involvement with a new PRGF arrangement with small access.

The Article IV staff report for Bangladesh, a country where the Fund has recently resumed lending after several arrangements in the 1980s and 1990s, provides a discussion that identifies four key structural weaknesses that have constrained investment and kept growth below potential. These are a weak revenue base, bottlenecks in physical infrastructure and inadequate human capital investment, a weak banking system, and poor governance. Against the backdrop of broadly satisfactory macroeconomic performance, the report places priority on putting the public finances on a sound footing, strengthening the effectiveness of monetary policy, moving to a more market- oriented exchange system, strengthening the banking system and reducing the budgetary burden posed by the SOEs.

The Article IV staff report for Kyrgyz Republic, a country that has received continuous financial support from the Fund since 1993 under various arrangements, provides a rich discussion where the performance is marked by three distinct periods: the “euphoric” period following independence that lasted until 1994 with favorable policy climate and donor assistance, the period of “dismay and frustration” during 1995-2000 where reforms stalled, external debt arrears increased, fiscal discipline was lost and programs went off-track, and finally the period of “realism and pragmatism” starting in 2001 where constraints imposed by high external debt and poverty brought back the pursuit of macroeconomic stability on the agenda.

The Article IV staff report for Lithuania, a country where the Fund provided financial support in the mid-1990s and has more recently been involved in two successive stand-by arrangements, provides a retrospective on this long-term engagement that is drawn from broad consultations with the authorities and civil society. Fund-supported programs are viewed to have played a catalytic role in bringing about the turnaround of the economy in the midst of a political crisis and a recession. More specifically, Fund-supported programs are thought to have helped create consensus across a fragmented political spectrum on the economic policies needed to preserve the currency board arrangement and join the EU.

19. Progress is more muted regarding candid presentation of the short- and medium-term outlook and candid account of the policy dialogue in Article IV consultations for countries with Fund-supported programs. Several staff reports reflected efforts to improve discussions of risks to the short- and medium-term outlook, supported by public or external debt sustainability analysis or both, available indicators of vulnerability, and alternative scenarios or analysis of sensitivity to shocks. Nevertheless, for a significant number of program country reports, the discussion of the short-term outlook remained unsatisfactory, with either limited or no coverage, lack of discussion of risks to the outlook, or absence of information on the authorities’ views on the outlook. In some cases, the discussion of the medium-term outlook may be affected by the optimism of PRSPs on medium-term prospects. Similarly, regarding the policy dialogue, while it was relatively easy to sense or identify policy consensus among the authorities and the staff, areas of dissension or the path to consensus were often unclear.

20. Article IV consultations for program countries that were conducted on a stand- alone basis provided a somewhat richer account of the policy dialogue with the authorities.14 There were no noticeable differences in coverage in other areas (Table 1). The main explanation seems to lie in the nature of staff reports in a program context: policy consensus is reached through negotiations; and divulging the details of initial policy preferences may be avoided out of fears of undermining confidence in the program or the authorities’ capacity to implement it.15 Interestingly, according to the results of the outreach exercise, most authorities in program countries still failed to clearly differentiate Article IV consultations and program discussions.

Coverage of surveillance in low-income countries

21. With progress on macroeconomic stability, the dominant challenge in many low- income countries is to sustain high rates of growth and reduce poverty. A large number of low-income countries have produced a Poverty Reduction Strategy Paper (PRSP), which lays out a country’s medium-term development goals and strategy to tackle poverty, including a macroeconomic framework. In addition, the international community has adopted poverty reduction goals for low-income countries, known as Millennium Development Goals (MDGs).

22. A review of 53 Article IV staff reports for low-income countries shows that the discussion of the medium-term outlook typically contains broad references to the level of growth, links to poverty reduction, and the means to achieve such growth. When identifying sources of growth, reports placed emphasis on traditional sectors and envisaged a strengthened role for the private sector. In identifying the policies needed to reach these growth objectives beside macroeconomic stability, reports generally supported (i) reforms that improve the investment climate and competitiveness, such as simplifying the tax regime, implementing judicial reform, strengthening governance, improving physical infrastructure, and facilitating financial intermediation; and (ii) policies that reduce fiscal vulnerabilities, such as civil service reform, strengthened revenue collection, better monitoring of the budget, and privatization. In a few cases, preferential market access was viewed as a key ingredient to achieve higher medium-term growth. Most reports identified risks that can hamper the growth prospects and jeopardize poverty reduction goals. Among these risks prominently featured terms of trade shocks, high dependence on aid, political instability, weak political commitment to reforms, and poor implementation capacity. However, reports rarely contained an explicit discussion of how recommended policy adjustments and reforms could help increase resilience to shocks.

23. While Article IV staff reports for PRGF countries generally made references to PRSPs, the incorporation of PRSPs varied considerably across reports, and they very rarely played a central role in the medium-term discussions (Box 3). This may be because PRSPs have not yet evolved into fully functioning vehicles for medium-term growth strategies for low-income or PRGF countries, or because PRSPs are seen to be more closely related to the design of PRGF programs and are assessed in that context in Joint Staff Assessments. As pointed out in the review of experience with PRSPs, it is also an instrument charged with multiple objectives, many of which can be in conflict—long-term ambition versus budget constraints, comprehensiveness in addressing different dimensions of poverty versus focus and prioritization, meeting the expectations of the international community versus country ownership and implementation capacity.16 That review concludes that these tensions often result in documents that do not reflect proper coordination between ministries or an appropriate degree of realism. As they mature into documents that are more aligned and integrated with the country’s budget preparation and donor activities, a more integrated role for PRSPs can be envisaged in surveillance of these countries.

Examples of References to PRSPs in Article IV Reports

The staff report for Senegal makes a connection between goals set in the PRSP and the medium-term economic program. The report candidly acknowledges that the scenario set in the PRSP appears to be too optimistic and that medium-term financial planning would require more realistic assumptions about implementation ability, the economy’s absorptive capacity and the private sector’s response.

The discussion of poverty reduction strategy sets the stage for discussion of the medium- term outlook in the staff report for Burkina Faso, drawing on the goals and strategy set forth in the PRSP.

The staff report for Lesotho notes that the PRSP then still under preparation provides policy priorities for the current and upcoming budgets.

The Sri Lanka staff report refers to the PRSP (Regaining Sri Lanka) in discussing the poverty situation in the country, its roots and the necessary measures for its reduction.

The Cambodia report contains a paragraph that notes that macroeconomic and key structural policies in the PRGF-supported program have been consistent with the policy agenda specified in the PRSP.

The Bolivia staff report contains a separate section on PRSP-related issues which notes developments and challenges in the consultation process as well as analytical work to support the PRSP agenda.

The Honduras report makes reference to the PRSP regarding performance of poverty- related social spending, including a detailed box on implementation status of actions to strengthen tracking of poverty-related public spending.

The Yemen staff report notes that PRSP implementation has been mostly limited to setting an administrative framework and no poverty indicators were available. The report also acknowledges broad consistency between the medium-term baseline scenario and PRSP objectives without going into any details.

24. Some Article IV staff reports made references to MDGs. A few reports reflected briefly on the country’s prospects for meeting MDGs, but the discussion has remained very general so far.

C. Content

Financial sector issues

25. Financial sector issues constitute a main area of Fund surveillance. Article IV consultations are the Fund’s primary instrument of financial sector surveillance, and Financial System Stability Assessments, where available, feed into these consultations. At the multilateral level, the Global Financial Stability Report (GFSR) is the main vehicle for surveillance of financial markets and systems. Main issues include financial sector vulnerabilities that could trigger a liquidity or solvency crisis, amplify macroeconomic shocks or financial market volatility, or hamper policy responses to shocks; and structural weaknesses in the financial sector that impede the mobilization or efficient allocation of savings. Its coverage is expected tovary according to country-specific circumstances. For example, in countries with relatively developed financial systems and extensive links to international capital markets, risks arising from volatile cross-border capital flows may be a dominant issue; in countries with systemically important financial systems, market developments that can affect other Fund members will need to receive particular attention; and in countries with rudimentary financial systems, greater weight may need to be given to medium-term developmental issues.17

26. The review of Article IV staff reports shows that the coverage of financial sector issues had improved since the last biennial surveillance review but, in many country cases, was not yet at par with coverage in other main areas.

  • The scope of financial sector coverage varied substantially across countries. Many reports, particularly for industrial countries, provided a focused and selective discussion of financial sector issues. For systemically important countries, coverage of potential sources of volatility for other member countries, drawing on multilateral surveillance, had been limited. Coverage of the financial sector was generally broader for emerging market countries, with the discussion providing substantial insights into the macro-financial linkages. For developing countries, the coverage was uneven, varying from a thorough coverage of the health of the financial sector to a virtual absence of any discussion.

  • The provision of financial soundness indicators (FSIs) varied across country groups. For industrial countries, the coverage was often limited to a few key categories, such as earnings and profitability.18 For emerging market countries, the provision of FSIs tended to cover three or more key categories out of five. For developing countries, the provision of FSIs was mostly limited to one or two indicators or a qualitative assessment of non-performing loans. For all countries, including those with sophisticated capital markets, available FSIs are mostly limited to banking sector indicators. When provision of FSIs was limited, the reasons for this situation were typically not clarified, nor were the implications for effective surveillance.

  • Three-quarters of the reports indicated whether the financial system was considered to be sound or not. However, this summary assessment was not always demonstrably backed up by substantial data and analysis—such as relevant FSIs or stress tests or discussion of the views of supervisory and regulatory agencies—and it is questionable, in any case, whether such definite judgment can be justified.

27The unevenness in coverage of financial sector issues can be explained partly by the intensity of concerns about financial sector weaknesses. But it also reflects allocation of financial sector expertise, as can be seen from the additional quality and depth of coverage of financial sector issues in consultations benefiting from substantial input from expert staff (Table 2). Coverage is most extensive in cases where the country has completed an FSAP. Substantial coverage is also achieved in many cases by inclusion of one (or more) MFD or ICM experts in the Article IV consultation missions. The discussion of financial sector issues in these reports is typically longer, providing key diagnostics and recommendations. A number of consultations for countries where financial sector issues have been prominent for some time, and thus have been studied in detail, also provide substantive coverage of the financial sector without benefiting from an FSAP, MFD, or ICM participation in the Article IV mission.

Table 2.

Coverage of Financial Sector Issues 1/

article image

Analysis in this table is based on a sub-sample of 69 randomly selected Article IV consultation reports

Trade policy

28. The 2002 biennial review of surveillance identified trade policy as one area where further scope for selectivity existed. It concluded that coverage of trade policy is essential in countries where serious trade distortions hamper macroeconomic prospects, as well as in countries whose trade policies have global or regional implications. It was considered that selectivity would strengthen the coverage of trade issues.

29. The coverage of trade issues has improved significantly for systemically important countries. There has been a progressive strengthening of the depth and scope of trade policy coverage in the “Quad” countries, i.e. Canada, the European Union, Japan and the United States, which involved preparing selected issues papers on trade topics and including recommendations on trade policies in staff appraisals (See Section III.A. and Box 6).

30. For a number of other countries, the coverage of trade issues remained unfocused or insufficiently selective. In some cases, the discussion did not highlight important elements, such as significant changes in regional trade agreements or sizable foreign impediments to export performance. In some other cases, coverage was considered too lengthy given country-specific conditions—i.e., a largely open trade regime, no systemic impact, and no significant concern about market access.

Social sector developments and policies

31. In recent years, the Fund has increasingly focused on the coverage of social issues, particularly social spending and provision of poverty and social indicators. The linkage of PRSPs to the medium-term policy framework provides a natural basis for coverage of social sector issues in PRGF countries. More recently, Executive Directors welcomed the staff’s efforts to focus, in close collaboration with the World Bank, on protecting social spending and incorporating the costs of social safety nets into program design.19 The IEO has also recommended that, during Article IV consultations, staff invite country authorities to suggest what are the existing critical and social programs and social services they would like to see protected in the event of shocks.20

32. The review of Article IV consultation reports shows that more than half of the reports included some discussion of social issues. A majority of these concerned low- income countries, where coverage addressed poverty incidence and human development indicators. For other countries, the coverage was justified by consideration of the macroeconomic consequences of extreme income inequality, rising poverty, or entrenched unemployment problems. For a few countries, the discussion addressed social spending, pension reforms, or the social impact of price increase. In addition to discussion of social issues, a number of reports—particularly, for countries with repeated episodes of social instability—provided greater coverage of political developments than usual.21

33. While the coverage of social sector issues was often relevant to macroeconomic developments, it was not always substantive. Coverage was most meaningful in post- conflict countries and countries with endemic political and social instability. In these countries, the discussion provided a valuable context for policy discussions. For some other countries, the discussion was limited to a few passing references. Reports contained virtually no reference to information from outside experts.

Assessing vulnerabilities

34. In recent years, the Fund has undertaken substantial work to reinforce its capacity to identify vulnerabilities in member countries. A strengthened framework for assessing public and external debt sustainability was adopted in June 2002 with further enhancements introduced in June 2003. A range of instruments has been defined to enable more continuous and effective financial sector surveillance. A large volume of analytical work has been produced to deepen understanding of factors contributing to the emergence of balance sheet fragilities, and the transmission of these weaknesses across different sectors. The staff has also progressively refined the high-frequency vulnerability exercise that provides a platform for an independent assessment by departments of key risks in individual countries and feeds into staff’s analysis in Article IV consultations. However, more use could be made of this exercise in bilateral surveillance. In some cases, experts from ICM have joined Article IV missions or provided headquarter-based inputs to strengthen assessment of vulnerabilities arising from capital market developments.22

35. More than two-thirds of the 140 reports covered in this review provided views on elements of vulnerabilities to balance of payments, currency or financial crisis. In most cases, these assessments were supported by debt sustainability analyses, relevant discussions of domestic policy developments, financial and corporate sector vulnerabilities, or, occasionally, domestic political economy factors. The discussion of vulnerabilities was most substantive for emerging markets. For a large number of developing countries, the discussion revolved around fiscal vulnerabilities, exposure to potential commodity shocks, and possible shortfalls in donor support.

36. However, few reports provided an integrated assessment of crisis vulnerabilities or a clear view on the severity of these vulnerabilities. In most cases, the discussion of vulnerabilities was distributed throughout the report in relevant sections. Reports that included a separate section on vulnerabilities tying together various components discussed elsewhere in the report gave a much clearer sense of vulnerabilities than other reports (Box 4).

D. Conclusions and Recommendations

37. The review suggests the following conclusions on the coverage and content of surveillance:

  • The general guidance on coverage of surveillance set by the Executive Board at the conclusion of the 2002 review of surveillance (paragraph 3, first three bullets) remain valid. In particular, coverage of individual Article IV consultations should continue to be guided by the criterion of macroeconomic relevance and matters at the apex of the Fund’s hierarchy of concerns.

  • Fund surveillance has generally continued to succeed in embracing a broader purview without losing focus. Nevertheless, at the margin, in choices involving breadth and depth of coverage, it may be necessary to lean towards greater depth at the expense of less breadth—that is to say, to strive for still greater selectivity of topics. This may mean that some topics are examined in depth, but not every year.

  • As concerns surveillance in program countries, (i) greater flexibility in consultation cycles for program countries has resulted in better timing of consultations; (ii) considerable improvement has been made regarding assessments of recent economic developments and stock-taking of the policy strategy to date; and (iii) there is room for further improvement in the coverage of the short- and medium-term outlook and the policy dialogue between national authorities and staff.

  • Implementation of the policy on ex-post assessments is expected to help strengthen further surveillance in program countries and, in particular, to facilitate bringing a fresh perspective to the analysis of past developments and policy design. Progress in surveillance in program countries could be reviewed once substantial experience with EPAs has been gained.

  • Article IV reports for low-income countries typically provide a general discussion of medium-term growth prospects and sources of growth. The use of PRSPs in the discussion of the medium-term outlook in these reports has generally been limited, and references to MDGs have typically been brief.

  • Steps are being taken to reflect more fully the international community’s efforts to achieve the MDGs in Fund surveillance. To help track progress toward the MDGs and facilitate consideration of such progress in Board discussions, an MDG table in Article IV consultation reports for relevant countries is being introduced. Article IV consultations for PRGF countries could also be used to analyze alternative macroeconomic frameworks aimed at meeting the MDGs. The Fund is currently working with the World Bank on a pilot MDG study; this and other planned pilot studies should provide valuable insight on coverage of MDGs in Article IV consultation reports.23

  • For PRGF countries, integration and sequencing of the PRSP process, program discussions, Article IV consultations, and Ex Post Assessments pose a significant challenge. The different cycles applying to these exercises, uncertainties surrounding the timing of program reviews, and resource constraints make this issue particularly complex. Further consideration of this matter is needed.

  • Coverage of financial sector issues has improved. Nevertheless, its scope or depth has not yet consistently reached that of other main areas of surveillance. Most importantly, assessments of the overall health of the financial sector, which are frequently provided in Article IV consultation reports, need to be better supported by provision of relevant data—including financial sector soundness indicators—and analysis. While FSAPs significantly enhance the quality of surveillance in financial sector, this review indicates that when an FSAP cannot be accommodated, significant improvement in coverage can also be achieved by including MFD or ICM experts in Article IV missions. Thus, a variety of options—e.g., focused FSAP updates, MFD and ICM participation in Article IV consultation missions, separate MFD or ICM missions, monitoring of financial sector developments from Fund headquarters, training of area department staff by MFD—should continue to be used to bring necessary expertise to bear on analysis of financial sector issues. An operational guidance note on financial sector surveillance in Article IV consultations is under preparation, it should help further strengthen cooperation between area and functional departments in this area.

  • The coverage of social issues could be more selective. As discussed later in this paper, this conclusion also applies to other issues that are not in the Fund’s traditional areas of expertise. While social issues were typically discussed when macroeconomically relevant, coverage was not always substantive. Taking account of resource constraints, in the aggregate, it would be preferable to cover fewer issues in greater depth, perhaps every few years. Deeper treatment of relevant issues would likely require greater use of available information from outside experts.

  • In countries where shocks could have a sizeable and sudden impact on social conditions, Article IV consultation missions—and other contacts between staff and member countries—may offer a valuable opportunity to solicit members’ views on protection of social safety nets or other priority expenditures in times of economic stress. Such discussions would be conducted on a voluntary basis.24

  • The 2002 call for greater selectivity of coverage of trade issues deserves to be reiterated. An effort should also be made to link the discussion of trade policy issues (where covered) to that of other economic developments and policies. A more focused approach would involve, on the one hand, more substantial treatment of market access and important developments in regional trade arrangements and, on the other hand, no coverage when no major trade issues arose since the last consultation, the trade regime is largely open, and the country neither faces major obstacles in accessing international markets nor has systemic importance.

  • Recent initiatives designed to strengthen assessment of member countries’ vulnerabilities to a currency, balance of payments or financial sector crisis remain appropriate. Efforts should concentrate on providing an integrated assessment of crisis vulnerabilities. Use of multi-sectoral analytical frameworks, such as the Balance Sheet Approach (see Section III.C.), should prove helpful in this area.

III. Selected Issues in Fund Surveillance

38. This chapter focuses on the treatment in Fund surveillance of four issues that have received particular attention in recent policy discussions.

A. Global and Regional Spillovers25

39. This section reviews the coverage of global and regional spillovers, with a particular focus on the integration of the Fund’s bilateral, regional, and global surveillance. At the conclusion of the 2002 biennial surveillance review, Executive Directors stressed that conditions and policies in systemically important countries affecting the global or regional outlook were a matter at the apex of the Fund’s hierarchy of concerns. Directors also called for better integration of multilateral surveillance into bilateral surveillance.26 This section reviews to what extent bilateral consultations conducted since then have focused on developments and risks in the global economy and/or in their region, and discusses the scope for strengthening the integration of bilateral, regional, and multilateral surveillance.

Global spillovers

40. The Fund is in a good position to take advantage of synergies between bilateral and multilateral surveillance. Many public and private institutions monitor macroeconomic developments and prospects of Fund member countries on a regular basis. However, the Fund is unique in its combination of comprehensive multilateral surveillance (through the WEO and GFSR), regular multilateral policy dialogue (in particular the IMFC), and in-depth bilateral policy discussions concluded by the Executive Board. This allows the Fund to use a consistent surveillance framework for its member countries and the world economy.

41. The Fund’s quantitative macroeconomic analysis is already well integrated. The WEO’s global database draws on the results of bilateral surveillance, while country teams use centralized WEO data as inputs for their quantitative work. These inputs include global assumptions about oil and commodity prices; partner country data available through the internal Economic Data Sharing System; and real effective exchange rate data available through the INS database. The interplay of bilateral and multilateral surveillance was also noticeable in recent work on debt sustainability, when efforts to develop a consistent framework for bilateral consultations were complemented by an in-depth analysis of public debt in emerging markets in the September 2003 WEO report.

42. However, most Article IV staff reports contained little explicit discussion of linkages between, on the one hand, global economic conditions and risks and, on the other hand, domestic conditions and risks. About three-quarters of recent reports contained minimal if any references to global growth, inflation, non-oil commodity prices, interest rates, equity markets, emerging market financing trends, or geopolitical risks.27 The types of global linkages that were described most often related to the impact of global economic growth on advanced economies; the impact of geopolitical conditions on tourism- dependent economies; and the impact of oil prices on oil exporters. By contrast, only about 10 percent of reports mentioned the depreciation of the U.S. dollar against the euro as relevant for the specific country; there was hardly any mention of the implications of the low inflationary environment worldwide; and less than 20 percent of reports on developing countries referred to the impact of non-oil commodity prices. All these issues were discussed in detail in WEO reports or GFSRs (Box 5).

Themes of WEO Reports and GFSRs

The WEO and GFSR reports issued during September 2002 – September 2003 analyzed the ongoing global recovery. Global inflation was very subdued, but the risk of global deflation was considered remote. There was recurring uncertainty about oil prices, partly in connection with geopolitical conditions. The U.S. dollar continued to depreciate against the euro. Interest rates reached historical lows. Global equity valuations were gradually rebounding, but the reports noted vulnerabilities associated with weakened balance sheets and corporate governance concerns. After a period of decline, emerging market financing began rebounding in 2002 and interest rate spreads started narrowing significantly. In general, the reports were cautiously optimistic about global economic prospects, but stressed a number of key risks and uncertainties:

  • - Risks emanating from the large global imbalances were a key recurrent theme. The September 2002 WEO noted that the constellation of imbalances was unlikely to be viable over the medium term and stressed the potential for significant and disruptive changes in tradable sectors and real exchange rates. In this context, the September 2003 WEO discussed to what extent G-3 exchange rate volatility could adversely affect economic performance in other countries. The GFSR highlighted the potential risks arising from the magnitude and structure of portfolio flows into the United States.

  • - Uncertainties about the fallout from the bursting of the equity bubble were identified as a risk to the global recovery. The April 2003 WEO noted that the decline in output growth after the equity bubble burst was larger than in previous bust episodes, owing to sharper falls in private fixed investment, but that the timing of the recovery was broadly in line with historical experience. The WEO and GFSR stressed the risks of potential housing price bubbles and excessive corporate leverage in an environment of unusually low short-term interest rates.

  • - Risks to external financing conditions in emerging markets were another recurrent theme. The GFSR discussed the rebound in emerging market financing flows and the decline in interest rate spreads, but cautioned about a possible correction, given the likely rebound in world interest rates, possible volatility certain emerging markets, and high public debt ratios. The September 2003 WEO concluded that sustainable debt ratios were substantially lower in emerging markets than in industrial countries, given more volatile public finances. The GFSR highlighted the benefits of extending public debt maturities and developing the local securities market.

  • - The September 2002 WEO emphasized that trade openness was needed to underpin international financial liberalization in order to reduce the risk of financial crises. The report stressed the substantial gains for developing countries from industrial country agricultural liberalization.

43. The near absence of references to conditions in global capital markets in Article IV reports is particularly striking. There have been significant movements in capital markets in recent years, including the bursting of the equity bubble, the sharp decline in world interest rates, and the recent narrowing of spreads on emerging market debt. These events have had a profound impact on many economies, and the prospect of higher interest rates in advanced economies entails substantial risks for many countries, particularly those with high debt levels, as highlighted by the WEO and GFSR (Box 5). Nevertheless, less than 10 percent of all Article IV reports linked domestic financial conditions to movements in world interest rates; only about a quarter of emerging market reports referred to the impact of past or prospective capital market conditions for emerging markets; and less than 20 percent of advanced country reports mentioned the effects of movements on global equity markets.

44. In some countries or in particular circumstances, global economic conditions may be of secondary relevance, which would justify limited coverage. For instance, in countries that are experiencing a deep crisis, domestically-generated economic volatility may be so high as to marginalize the potential impact of global spillovers. Small countries with limited capital account openness and high dependence on one or two large trading partners may be only indirectly affected by global conditions. In these cases, explicit references to global economic conditions in reports would be expected to be limited, while global WEO assumptions would nevertheless be used for the underlying quantitative analysis.

45. However, in general, the review of Article IV reports points to scope for strengthening the treatment of the impact of global economic and financial developments on national economies. While global conditions and risks may be well known to many readers, they affect individual countries in different ways. Glossing over global linkages can distort the presentation of economic policies and fundamentals. For instance, reporting on a country’s narrowing Eurobond spreads without mentioning the general decline in emerging market spreads can give a misleading impression about country- specific fundamentals. Attention to global spillovers is also crucial for assessing the full spectrum of vulnerabilities and identifying appropriate policy responses.

Surveillance of the G-328

46. Economic policies and events in the G-3 have a major impact on the world economy. The near-term risk of a balance of payments crisis in the G-3 countries is very low, but their macroeconomic policies have important and sometimes immediate consequences for financial stability in many other countries. The G-3 countries account for about half of world output and trade, and global economic trends are highly dependent on business cycles in the G-3.29 International capital market developments often have their origin in events in the G-3. Volatility among the three major currencies has contributed to exchange rate misalignments in some countries and been identified in analyses of past financial crises as one contributing factor.

47. Economic and financial conditions in the G-3 and their impact on global developments have been at the top of economic policy agenda over the past two years. Key issues have included the uneven pattern of economic growth, current account imbalances, the decline in the U.S. dollar against the euro, the low interest rate environment, the bursting of the equity bubble, concerns about corporate governance, as well as trade and aid policies. Recently, movements in U.S. interest rates and their impact on world interest rates and emerging market financing have received considerable attention.

48. The WEO and the GFSR are appropriate tools for analyzing the global impact of economic and financial developments in the G-3. The WEO has provided in-depth analysis of spillovers from G-3 countries to the rest of the world. The risk of a disruptive adjustment to the large global imbalances has been a central theme of the WEO in recent years, highlighting the role of G-3 fiscal, monetary, and structural policies underlying the imbalances. The WEO has also analyzed the impact of G-3 exchange rate volatility on developing countries and emphasized the substantial gains for developing countries that would result from industrial country agricultural liberalization (Box 5). The GFSR has analyzed developments and risks in global capital markets, including the impact of mature markets on emerging markets. The channels considered in the GFSR have included the size and composition of portfolio flows into the United States; the impact of changing expectations about monetary policy actions in the major economies on global equity prices, credit spreads on bonds, and the availability of capital flows to emerging markets; and structural changes in mature markets, including the increasing role of non-bank financial institutions in the allocation of risk.

49. Bilateral surveillance with G-3 countries has included some discussion of global linkages, focusing primarily on trade. The discussion of trade policies has gained greater prominence in recent years, partly in connection with the Doha Round, and G-3 staff reports have focused increasingly on the global impact of G-3 trade policies in addition to analysis of their domestic effects (Box 6). Staff reports for leading industrial countries also routinely include a reference to the level of official development aid.

Global Impact of the Trade Policies of the “Quad”1

Canada, the European Union, Japan, and United States—the “Quad” in world trade parlance—are responsible for US$5.6 trillion in world trade and their imports amount to 39 percent of total world imports (excluding intra-EU trade). Their trade and trade-related policies therefore have a significant impact on other countries and the global economy. Apart from the structure of import tariffs, systemically important policies include non-tariff measures (such as anti-dumping action, textile quotas and technical standards), the regulation of services trade, agricultural support programs and export subsidies, preferential or reciprocal trade arrangements, and the Quad’s stance in multilateral trade negotiations.

A review of Article IV staff papers for the period 2000-2004 shows that the scope of trade policy coverage in consultations with Quad countries widened progressively, and there was a growing focus on the global impact of these policies in addition to analysis of their domestic effects. Coverage of trade issues in the 2000 staff reports tended to be brief, and the discussion of global implications limited. The depth and scope of trade policy coverage strengthened in 2001, when selected issues papers on trade topics were prepared for the United States, Canada, and Japan, and the Euro Area staff report contained a box on the EU’s agricultural trade regime. Staff appraisals in 2001 picked up trade issues in all the reports, highlighting the global impact of policies.

Following the initiation of the WTO’s Doha Round in late 2001, there was a further increase in both the detail and systemic perspective of trade policy coverage. The 2002 and 2003 staff reports for the United States and the Euro Area reviewed aspects of the U.S. and EU negotiating positions in the Doha Round and provided a critical assessment of the impact of their agricultural policies on developing countries. Other issues covered in some detail included trade disputes (especially steel), preferential access for LDCs, and regional trading arrangements. Selected issues papers for both the United States and the EU examined the impact of trade policies on third countries, discussing issues such as the 2002 U.S. Farm Act, lessons from NAFTA for economic integration in the Americas, U.S. regionalism/bilateralism, the impact of the European Union’s eastern enlargement, and EU CAP reform. While surveillance of EU policies was conducted primarily at the regional level, some recent staff appraisals for individual EU members stressed the importance of a commitment to trade and agricultural reform.

The 2003 Article IV staff report for Japan stepped up both the extent and frankness of the discussion of trade issues, reviewed Japan’s positions on key aspects of the Doha Round and pointed to the impact of its agricultural policies on third countries. The 2004 report for Canada had significant coverage of regional trading arrangements and their domestic and regional impact, while a selected issues paper examined developments and prospects for Canada-U.S. economic integration.

1/ The main author of this box is Nur Calika.

50. Staff reports on the G-3 countries also contain limited references to the systemic impact of their economic situation and policies. For instance, the staff report on euro area policies notes that the recent appreciation of the euro is welcome from a multilateral perspective and that more rapid demand growth in the euro area would facilitate the adjustment of international imbalances.30 The Article IV report on Japan notes the yen’s role in the global financial system and the need to consider the international repercussions of the staff’s proposal that the Bank of Japan purchase a wider set of foreign assets. The report on the United States is an example of a somewhat fuller discussion, noting the role of the United States in supporting global growth; the potential global costs of a disorderly adjustment to the U.S. current account deficit; the potential spillover of U.S. public debt on world real interest rates; and the critical role of the United States in multilateral trade talks.

Regional spillovers

51. Regional spillovers have had a substantial impact on economic performance in a number of recent cases. Dramatic examples of regional spillovers include the Asian and Russian crises, and more recently the regional transmission of shocks in successive crises in Brazil, Argentina, and Uruguay (Box 7). The correlation of business cycles is an important issue for economies that depend on import demand of large regional partner countries. Exchange rate policy and competitiveness issues are further potential channels for regional spillovers (Box 8).

Regional Spillovers in the Souther Cone

Recent experience from South America provides an illustration of some of the different channels of regional crisis transmission.

  • - Competitiveness: The sharp real depreciation of the Brazilian real in early 1999 was one of the factors affecting the sustainability of the Argentinean currency board.

  • - Demand spillovers: The severe recession in Argentina during 1999-2002 depressed demand for exports to Uruguay, contributing to Uruguay’s prolonged economic recession.

  • - Contagion on international capital markets: The Brazilian and subsequently the Argentinean crises contributed to a heightened perception of regional risk among international investors and thus to increased spreads on the external debt of other countries in the region.

  • - Financial sector spillovers: Following the imposition of a deposit freeze and capital controls in neighboring Argentina, cash-strapped Argentine depositors began to withdraw their funds from Uruguays banking system. The run on deposits rapidly spread to resident depositors, after problems developed in two large private banks with strong links to Argentina.

  • - Public confidence spillovers: The Brazilian and Argentinean crises also had an impact on public confidence in neighboring countries, leading in the case of Uruguay to increased dollarization.

A Case Study of Coverage of Regional Spillovers: China’s Changing Role1/

Spillover effects from China’s changing role in the world economy have many dimensions. Trade patterns in Southeast and East Asia have undergone major shifts, with intra-regional trade booming and China a key driving force behind this change. Industrial production in the region has become more vertically integrated, with China often the last step in the production chain and final demand residing primarily in the G-3 countries. Foreign direct investment flows have also been affected, as investors have been attracted by China’s large domestic market and its potential as a regional and global production base. China’s strong growth has also contributed to an increase in world commodity prices. More recently, attention has focused on the impact of China’s exchange rate policy on its trading partners.

Fund surveillance has repeatedly analyzed China’s role in international trade and investment flows. A September 2003 cross-country study examined the likely impact of WTO accession on global and regional trade patterns, and the April 2004 WEO analyzed the various channels through which China’s growth might affect the global economy. China’s accession to the WTO was deemed to have a mixed impact on the region, with some diversion of trade and investment offset against increased access to China’s large internal market and the benefits of greater regional integration. Looking ahead, the expiration of the Multi-Fiber Arrangement in 2005 has been the focus in analyzing export prospects for low- to middle-income garment producers in the region, with China expected to gain a large market share when the quota system is eliminated.

In the period reviewed, Article IV documents for Hong Kong SAR and Singapore discussed the medium-term challenges arising from intensified regional competition. Economic activity in Hong Kong SAR has been shifting towards high value-added services, as manufacturing and low-end services have been outsourced to the mainland as the two economies are becoming increasingly integrated. Singapore has been facing similar competitive challenges in both the services and manufacturing sectors, as well as in attracting foreign investment. In these and other economies in the region, the Fund has advocated meeting these challenges through structural reforms, such as financial sector reform, labor market reform, and the liberalization of trade and investment regimes, in order to enhance productivity and boost competitiveness.

China’s exchange rate policy also has important implications for the region. The decision to maintain the exchange rate of the renminbi stable during the Asian crisis was recognized as pivotal to warding off further repercussions from the crisis. The current debate on the future of China’s exchange rate regime has been closely monitored within the region. The Fund has long recommended increased exchange rate flexibility for China, as it would allow more room to pursue an independent monetary policy, help cushion China’s economy against adverse shocks, and facilitate adjustment to the major structural reforms that are underway. It has also been noted that increased flexibility of the renminbi could encourage similar moves by other countries in the region and thereby facilitate the adjustment of global external imbalances.

1 The main author of this box is Piyabha Kongsamut

52. Many Article IV reports refer to economic conditions in large regional trading partners. References to regional linkages were particularly frequent in European and South American countries, focusing primarily on trade links and, to a lesser extent, on confidence spillovers. In total, close to half of reports mentioned one or more regional linkages in their discussions of recent economic developments, and a similar share of reports referred to regional linkages in their discussion of economic prospects and risks.

53. However, reports where coverage of regional spillovers and related vulnerabilities is substantially developed are relatively rare. Examples include the Article IV report for Uruguay with an extensive coverage of regional spillovers; the staff report for New Zealand with a box on spillovers from Australia and the US; the report on the Czech Republic, which highlights the critical role of conditions in the EU for the economic outlook; and the report for Canada, which provides a detailed discussion of the business cycle and investor sentiment spillovers from the United States; and, reports for a number of Asian countries, which consider China’s changing role in the world economy (Box 8). Typically, while baseline projections take regional growth prospects into account, few reports spell out these underlying assumptions. References to regional risks are more frequent (in about a third of all reports), but the probability of shocks, the mechanism of shock transmission, and the potential magnitude of spillovers are rarely explicitly analyzed. Moreover, it is not clear whether vulnerability analyses are based on assessments of the nature and scale of spillovers that are consistent across countries within a given region.

54. Area departments have made very significant efforts to strengthen regional surveillance. Most area departments are preparing regional economic outlook papers on a regular basis, as well as occasional seminars and research papers. The Fund also holds annual discussions with regional authorities in four currency unions and participates in meetings of a number of regional economic groups (see Section IV of the companion paper on modalities of surveillance). These initiatives have been useful in highlighting common economic issues and facilitating cross-country analysis.

Conclusions and recommendations

55. The Fund’s bilateral and multilateral surveillance has become more integrated over time. Bilateral surveillance usually reflects WEO projections for the real sector, in particular commodity prices and economic growth, and generally takes into account developments in major regional trading partners. Bilateral surveillance in the G-3 countries takes into account the global importance of their trade policies. Multilateral surveillance, the WEO in particular, has been an effective tool for highlighting global risks and analyzing the global ramifications of economic policies in the G-3. Since 2002, there has been progress in developing the GFSR, expanding regional surveillance initiatives, and strengthening the analysis of trade policy spillovers from the G-3.

56. Enhanced focus on global and regional spillovers would strengthen the Fund’s surveillance. While key linkages are taken into account in baseline scenarios, discussions of the economic outlook and risks in many Article IV reports contain limited or vague references to the impact of global or regional economic developments, including potential shocks. More in-depth discussion of such spillovers would make vulnerability analysis more comprehensive and consistent across countries. Coverage of the global ramifications of economic policies and conditions in the G-3 countries in bilateral surveillance would provide opportunities to enhance the dialogue between the Fund and national (or regional) authorities on these issues.

57. The following areas deserve particular attention:

  • Fuller discussion of the systemic consequences of the policies G-3 countries in bilateral surveillance of these countries, expanding on the approach already adopted for coverage of trade policies. Article IV consultations could regularly discuss the impact of their fiscal, monetary, exchange rate, and key structural policies on global growth and capital market conditions, building on treatment of these issues in the WEO reports and the GFSR.

  • In bilateral surveillance of all countries, more explicit links of past and prospective economic performance to global economic and financial conditions. Depending on country circumstances, this might involve references to the impact of global growth trends, commodity/oil price trends, movements in G-3 exchange rates, or trends in global capital markets, such as the low level and expected increase in world interest rates.

  • Also in bilateral surveillance of all countries, enhanced identification and analysis of key country-specific vulnerabilities related to specific global economic and financial risks. The latest WEO, GFSR, and IMFC communiqué noted a number of global risks, including the large global imbalances; public debt sustainability; the transition to a higher interest rate environment; oil market developments; and geopolitical uncertainties. The vulnerability analysis in Article IV reports should highlight which global risks, if any, could translate into significant country-specific shocks. For countries where a specific global shock (or shocks) would have serious macroeconomic implications, reports could present a relevant alternative scenario (or scenarios) or stress test (or tests), similar in nature to the alternative scenarios or stress tests currently used in the internal vulnerability exercise. These scenarios and stress tests would help illustrate the potential magnitude of global shocks on the domestic economy.

  • More systematic use of existing regional surveillance initiatives to analyze regional spillovers and risks. This would strengthen vulnerability analyses in bilateral consultations, and provide for a more consistent treatment of risks across countries.

  • Fuller exploitation of multilateral surveillance exercises to ensure that capital account projections for individual countries consistently reflect current thinking about prospective conditions in global capital markets.

58. It may be desirable to boost specific mechanisms for encouraging greater integration of bilateral, regional, and global surveillance. Possibilities include (i) strengthening internal procedures to facilitate consideration of key risks identified in the WEO reports, GFSRs, and IMFC communiqués in bilateral surveillance activities, including broader dissemination within staff of high-frequency assessments of global conditions and risks currently done by RES and ICM and greater use of pre-brief meetings for this purpose; (ii) discussing regional developments at the Board, possibly annually, based on inputs prepared by area departments—inputs could include standardized indicators for all countries in the region; and (iii) strengthening elements pertaining to global capital market conditions, including in the WEO’s analytical apparatus, in cooperation with ICM (e.g., addition of medium-term projections of ten-year benchmark bond yields in mature markets, enhanced reviews of capital account projections for individual countries against global developments).

B. Exchange Rate Analysis31

59. This chapter considers three related issues: the extent of coverage of exchange rate issues in Fund surveillance over the last two years; advice on exchange rate regimes during that period; and conclusions of assessments of external competitiveness. It does so in light of research findings on exchange rate regimes and Board guidance on exchange rate issues.

Research findings

60. Over the past decade, new considerations for choosing an appropriate regime— and on its impact on economic performance—have emerged. While regime choice had previously been related mainly to the nature of shocks that a country faced and to its trade linkages, the role of exchange rate regimes as a mechanism of policy commitment became more prominent. For example, for countries with a history of inflation, a pegged exchange rate regime was viewed as a stronger and more visible anchor for prices and expectations than any alternative anchor. However, as the decade proceeded, pegs were increasingly seen to hinder countries’ ability to handle volatile capital flows and to invite speculative attacks.

61. The currency crises of the 1990s prompted advocacy by some of a bipolar view of exchange rate regimes, according to which only regimes at the polar ends of the flexibility spectrum—“hard” pegs and free floats—would prove sustainable over the longer term (Fischer, 2001). Proponents of this view argued that soft pegs reduced policymakers’ flexibility in responding to unexpected events but, at the same time, lacked sufficient resilience in the face of speculative attacks. In practice, evidence of a shift towards polarization of exchange rate regimes is not clear: MFD’s 2002 review of exchange rate arrangements and foreign exchange markets concluded that there had been such a shift during the previous decade, which had been more pronounced in countries that have gained access to international capital markets;32 by contrast, using a different classification of de facto regimes, Rogoff et al (2004) find no evidence of a generalized bipolar propensity.

62. A recent generation of papers offered more nuanced assessments of the relationship between regime choice and economic performance. Using data for the post- Bretton Woods era for over 100 countries and focusing on regimes as they are actually operated (de facto regimes) as distinct from the announced (or de jure) regimes, the analysis initiated by Ghosh, Gulde, Ostry, and Wolf (1997) and Ghosh, Gulde, and Wolf (2003), found that inflation under fixed exchange rate regimes is significantly lower than under intermediate or freely floating arrangements, due to greater confidence in the currency (a credibility effect) and lower money growth (a discipline effect). They did not, however, find evidence of a strong link between exchange rate regimes and economic growth, especially after controlling for country-specific effects and possible simultaneity bias. This result contrasts with Levy-Yeyati and Sturzenegger (2002) who used their own “de facto” classification of regimes and found that flexible exchange rates are associated with higher growth in developing countries. They did not find a similar association between exchange rate regime and growth among industrial countries.33

63. Fresh evidence presented by Rogoff et al (2004) suggests that the performance of alternative exchange rate regimes, and hence the choice of the appropriate regime, depends importantly on the maturity of member countries’ economies and their institutions. Developing economies that have limited interactions with international capital markets appear to benefit from policies that imply strong commitment to stable exchange rate and monetary policies. The harder end of the commitment in exchange rate regimes delivers lower inflation without sacrificing economic growth.34 For emerging market countries, policy commitment in the form of a pegged (or nearly pegged) regime may also deliver lower inflation on average, but those gains may unravel in periodic crises, as the likelihood of financial crises is high with these regimes. When countries graduate to the status of advanced economies, the evidence suggests they benefit from flexibility with higher growth and lower inflation. For these countries, the credibility of their economic policies derives from their institutional framework rather than from special instruments designed to severely limit the discretion of policymakers.

64. Account must also be taken of the literature on optimal currency areas, which points to conditions that may favor the hardest form of peg over exchange rate flexibility (see Mongelli 2002 for a recent survey). Broadly speaking, the literature on optimal currency areas seeks to identify conditions under which the gains from greater economic integration resulting from adoption of a common currency exceed the costs of reduced flexibility. It typically points to high mobility of factors of production, price/wage flexibility, economic openness, diversification in production and consumption, and fiscal and political integration.

65. Overall, the economic literature offers useful, but limited, guidance on exchange rate regimes. It indicates that, for countries that maintain their own currency, the degree of maturity of the economy is an important factor to consider in the choice of exchange rate regime. It also strongly suggests that the choice of exchange rate regime is complex; it cannot be reduced to a simple exercise of selecting “the” right regime on the basis of a limited set of country characteristics.

Board guidance

66. Executive Directors have repeatedly stressed that a thorough discussion of exchange rate issues is essential for Fund surveillance.35 At the conclusion of the 2002 biennial surveillance review, Directors urged that exchange rate issues be treated candidly throughout the membership. Directors had earlier emphasized that the Fund must take into account the provisions in the Articles of Agreement that it is for members to choose their exchange rate arrangements; and that the Fund should continue, in the context of Article IV consultations, to discuss with country authorities the requirements for making a chosen exchange rate regime function reasonably well in the particular circumstances of that country and to actively advise on the suitability of the exchange rate regime.36

67. In their 1999 discussion of exchange rate regimes, Directors reached a number of conclusions on regime choice, including the following:37

  • no single exchange rate arrangement was appropriate for all countries or in all circumstances;

  • the system of flexibility among the exchange rates of the dollar, the euro, and the yen was not expected to change;

  • for a significant number of countries, the widespread liberalization and expansion of capital movements has made it more difficult to sustain pegged rates; for these for many emerging market economies, a substantial degree of flexibility was desirable; however, freely flexible exchange rates were not a viable option for all emerging market countries, and, in practice, many would want to use intervention and domestic monetary policy to guide exchange rate movements; and

  • for smaller more open economies, and especially those with limited involvement in global capital markets, a peg would likely continue to be the preferred course.

68. These conclusions appear to be generally consistent with the recent research findings described above. One exception may be the tendency toward movement to the “extremes”, where evidence is unclear.

Review of Article IV consultation reports

69. The following paragraphs provide an analysis of the coverage of exchange rate issues in Article IV consultation documents discussed by the Executive Board between January 1, 2003 and March 4, 2004.38 These issues are among the most sensitive topics addressed in Fund surveillance. It is therefore possible, and indeed likely, that the treatment of exchange rate issues in Article IV consultation reports do not always fully reflect discussions between country authorities and staff. This caveat likely applies even if country authorities chose not to publish the Article IV consultation reports: experience during the period that preceded publication of staff reports suggests that staff exercises great caution regarding inclusion of highly sensitive material in staff reports. Thus, the following paragraphs may underreport treatment of exchange rate issues in bilateral contacts.

70. Discussions of exchange rate regimes typically focused on consistency of the given regime with underlying macroeconomic and structural policies, institutional conditions, and the external environment—rather than on the choice of exchange rate regime per se. An exception to this rule was provided by EU accession countries; in the perspective of an eventual adoption of the euro, the choice of the exchange rate (and monetary) regime was a key issue in these Article IV consultations.

71. A pegged exchange rate was the only regime whose sustainability was ever questioned. When this issue arose, discussions typically focused on the threat of a weak fiscal position or concerns about external competitiveness. In addition to policy consistency, discussions of exchange rate policies sometimes addressed management of the exchange rate regime. This was particularly common for emerging market countries whose regime was a managed float. For these countries, the focus of discussions typically was on the extent of exchange rate intervention.

72. Very seldom was the de facto regime identified as different from the de jure regime. This was done in 8 out of 140 cases. Hence, the difference between de facto and de jure classification stressed in research work was not found in Article IV consultation reports. This discrepancy may be due to the sensitivity of the matter or lack of clarity in existing guidelines on the importance of considering this issue.

73. When offered, policy advice leaned towards greater exchange rate flexibility, except when the current regime was a hard peg or movement toward a hard peg was considered. For hard pegs, advice was generally on seeking greater flexibility in other sectors of the economy (e.g., labor market flexibility) or fiscal tightening. Greater flexibility was generally recommended on the grounds that it would protect external competitiveness and facilitate diminution of external imbalances.

74. Assessments of external competitiveness were often limited to an analysis of movements of a real effective exchange rate indicator. Use of a broad range of competitiveness indicators (e.g., market shares, comparative cost measures) or of econometric methods (e.g., estimations of a long-run relationship between the exchange rate and fundamentals) was not common. In many cases, this may be the consequence of significant data constraints.

75. Real exchange rates were often found to be ‘about right’ or in line with fundamentals. However, when a misalignment was identified, reports typically concluded that the exchange rate was overvalued. Cases where the exchange rate was assessed to be undervalued were very rare. Furthermore, in these few cases, the degree of undervaluation was typically considered to be slight or insignificant. This suggests a bias in staff’s estimates since the prevalence of currency undervaluation—i.e., its frequency across countries (weighted by size) multiplied by its magnitude—should be commensurate with the prevalence of currency overvaluation. Alternately, it may indicate that staff is more sensitive to the risks of overvaluation than of undervaluation.

76. When advice on exchange rate adjustment was given, i.e. on the need for greater exchange rate flexibility or for an exchange rate depreciation, authorities tended to disagree. Authorities generally stressed the benefits of a stable exchange rate for price stability and the potential negative impact of exchange rate volatility on sectoral balance sheets and growth.

77. When staff and the authorities disagreed on exchange rate policies, Executive Directors usually held divergent views. In such cases, a number of Executive Directors typically shared the authorities’ views that the current exchange rate policy continued to be appropriate; while a number of other Directors saw merit in staff’s calls for an eventual policy change.

Conclusions and recommendations

78. The above review indicates that pointed discussions of exchange rate issues are rarer than may be warranted and, when they do take place, can be controversial. It suggests that candid treatment of exchange rate issues is, and will likely remain, a significant challenge.

79. Mindful of this challenge, a few practical steps are worth considering:

  • greater candor in the description of the de facto exchange rate regime;

  • more systematic use of a broad range of indicators, extending beyond real effective exchange rate series, and other analytical tools to assess external competitiveness;

  • deeper scrutiny of alternative monetary and exchange rate regimes, including institutional requirements for making different regimes work well, when the views of the authorities and of the staff differ; and

  • brief discussions of exchange rate issues within each region could be part of the proposed Board informal discussions of regional developments (paragraph 58).

80. The above review also suggests that it would be worth exploring further (i) whether the lessons of the past decade on the dangers of fixed exchange rates are being applied too broadly, as research findings suggest that pegged regimes may be worth considering for developing countries with limited exposure to private capital markets; (ii) whether, in the aggregate, there is some bias towards finding exchange rates overvalued; and (iii) what are the most promising paths to achieve a successful move towards greater flexibility, as economies mature.

C. Balance Sheet Analysis39

81. In recent years, balance sheet issues have featured prominently in debates on economic developments in both advanced and emerging market economies. In advanced economies, much attention was paid to the balance sheet effects of asset price movements (e.g., equity, real estate) and to the impact of population aging on public liabilities. In emerging market economies, debt sustainability (encompassing both debt level and structure), exposure to exchange rate shocks, vulnerability to shifts in market sentiment, and transmission of shocks from domestic balance sheets to the external sector have continued to be active issues.

82. At the Fund, policy and analytical work is supporting implementation of balance sheet analysis in surveillance. Over the past two years, these activities have covered the balance sheet approach (BSA), debt sustainability assessments (DSAs), financial soundness indicators (FSIs), FSAP exercises, and work on liquidity management.40 The WEO chapters on asset price booms and busts (April 2003), public debt sustainability (September 2003), and credit booms (April 2004) and the systematic focus in the GFSR on balance sheets in industrial countries (and the implications for financial markets) are examples of a focus on such issues in multilateral surveillance. A framework to promote balance sheet analysis in the Fund is being implemented, which cover data compilation issues, as described in the February 23, 2004 note on Integrating the Balance Sheet Approach into Fund Operations.

83. This section takes stock of the initial impact of these efforts on the depth of coverage of surveillance, and identifies the challenges ahead. While implementation of several of the individual initiatives mentioned above has been or will be considered separately by the Board, this chapter focuses primarily on their integration into the analysis and focus of bilateral surveillance. It is based on the review of Article IV staff reports described in Section II.A., as well as on closer scrutiny of a few surveillance cases. These cases help illustrate how comprehensive balance sheet analysis can be conducted, what it can bring to individual surveillance exercises, and what operational challenges are faced.

Review of recent Article IV staff reports

84. Article IV consultation reports provide an increasingly substantial coverage of sectoral balance sheets:

  • Reliance on a full balance sheet framework that cover assets and liabilities of the government, financial, nonfinancial, and external sectors is still exceptional.41 It remains limited to a few staff reports, including Peru and Thailand. Staff expects some additional full balance sheet matrices to be incorporated into forthcoming Article IV staff reports in the near future.

  • However, recent initiatives have helped strengthen substantially the coverage of balance sheet issues in key sectors. In particular:

    • Implementation of the strengthened framework for debt sustainability assessments (DSA) has helped sharpen attention to public and external balance sheets. A majority of 2002-03 staff reports provided a DSA (63 percent), especially reports for advanced and emerging market economies (72 and 88 percent, respectively).

    • Progress is also evident in financial sector surveillance based on FSIs and FSAPs. Overall, 44 percent of recent Article IV consultation reports either provide some FSIs or make use of analysis presented in FSSA reports. This proportion increases to 78 percent for reports on advanced and emerging market economies.

  • Overall, selective coverage of balance sheet issues is frequent. While coverage of external and public sectors is most frequent across the membership (in line with the use of DSA), balance sheet conditions in other key sectors are often addressed, particularly in advanced and emerging market economies. Financial sector balance sheets are covered in a majority of staff reports, and corporate sector balance sheets in about half of them. Household balance sheets are discussed in many staff reports on advanced economies. Overall, all staff reports on advanced and emerging market countries include at least some balance sheet analysis.42

85. Balance sheet analysis in a number of Article IV staff reports goes beyond consideration of individual sectoral balance sheets. Specifically:

  • Some coverage of channels of transmission of shocks across sectoral balance sheets is provided in a majority of staff reports on advanced and emerging market countries. Interestingly, the cross-sector balance sheet analysis in emerging market economies often focuses on a larger number of transmission channels than in advanced economies (see Box 9).

  • Most importantly, balance sheet analysis increasingly informs staff’s macroeconomic analysis and policy advice. This degree of integration is particularly evident in staff reports on emerging market economies where balance sheet analysis is almost systematically an explicit input into the macroeconomic analysis (e.g., macroeconomic conditions and outlook) and policy recommendations (e.g., monetary or fiscal policy stance) as well as, in a majority of cases, into assessments of the role of institutions (e.g., financial regulation and supervision). Such integration is more limited in advanced economies.43

Coverage of Balance Sheet Issues in Article IV Staff Reports— Positive Examples

United Kingdom – Staff report for the 2003 Article IV consultation

This staff report provides an example of close integration between the analysis of a particular sector’s balance sheet on the one hand, and the discussion of core macroeconomic and policy issues on the other. A quantitative and qualitative analysis of household balance sheets illustrates the risks posed by the combination of highly leveraged households, a possible house price bubble, and the traditional sensitivity of consumption to house price developments. Available information on the distribution of debt and liquid assets within the sector also points to the existence of more severely exposed segments. A key immediate policy challenge is to engineer a soft landing, i.e., to avoid an abrupt correction in housing and credit markets. Various channels through which monetary tightening could trigger a rapid weakening of household balance sheets (and consumption) are addressed, including: on the liability side, the increased difficulties for households to service their debt–possibly triggering a credit crunch; on the asset side, the negative impact of a drop in house prices; and, also, the impact of rising unemployment. Against this background, staff and the authorities agree that asset price considerations should be factored into the inflation targeting framework and, specifically, that the unusually high household debt level necessitates gradualism in monetary policy adjustments.

Peru – Staff report for the 2003 Article IV consultation

In this case, staff implemented the balance sheet approach based on the matrix provided in Allen et al. This allows for a systematic and quantified assessment of currency and maturity mismatches within and across the balance sheets of all sectors, and a good understanding the potential macroeconomic implications of such exposures. These findings are used in particular to: (i) put some of the vulnerabilities into perspective, e.g., by highlighting that the risks associated with substantial currency mismatches are mitigated by favorable maturity structures and, therefore, relatively high foreign currency liquidity; (ii) identify specific potential weak spots, e.g., significant foreign currency lending by banks to non- exporting firms; (iii) identify the most likely channels of transmission of crisis pressures, e.g., from the nonfinancial private sector to banks to the government; and (iv) recognize the key factors accounting for the economy’s resilience during past periods of regional turbulence, e.g. its high level of reserves that cover not only short-term external debt but also domestic dollar deposits. The main conclusions of the analysis are closely reflected in the discussions with the authorities, as they inform staff’s policy advice in the areas of bank supervision, exchange rate policy and reserve adequacy.

86. Balance sheet issues have received substantial attention in Fund surveillance of both advanced and emerging market economies. In advanced economies, the focus has been on private balance sheet vulnerabilities in connection with risks stemming from house prices and mortgage lending (e.g., Australia, Ireland, the Netherlands, Norway, Portugal, the U.K. and the U.S.). Corporate balance sheets have also received attention, particularly in the largest advanced economies. In emerging market economies, staff reports have focused on the potential transmission of shocks across sectors under crisis conditions (e.g. from corporate sector to banks to government), the key factors promoting resilience in such circumstances, and ensuing policy advice in the areas of banking supervision, exchange rate policy and reserve adequacy assessments (e.g., Peru). Box 9 provides some examples of staff reports where balance sheet analysis was particularly substantive or well integrated into macroeconomic analysis and policy advice.

87. While data availability is generally known to be an obstacle to detailed balance sheet analysis (especially corporate and household sector data), staff reports rarely identified specific data constraints. As noted above, the generalization of DSA has provided a greater focus on public and external sector data, and FSAP exercises and the FSI initiative has contributed to strengthen the reporting of financial sector data. However, efforts are still needed to make available more comprehensive balance sheet data, as evidenced by the difficulties in implementing the full balance sheet matrix or in obtaining key indicators essential for vulnerability analysis, such as indicators on maturity and currency mismatches.44 Staff reports rarely addressed these data issues explicitly.

Conclusions and recommendations

88. Efforts to strengthen balance sheet analysis in Fund surveillance are already making an important contribution to enhancing the quality of Fund surveillance. These efforts deserve to be pursued diligently and pragmatically, recognizing constraints stemming primarily from data weaknesses. Balance sheet analysis constitutes a useful complement to flow-based analysis, helps provide a fuller picture of countries’ vulnerabilities, and thus strengthens further the risk-orientation of surveillance.

89. In the short-term, significant progress is possible based on information already available in member countries. Staff increasingly use balance sheet concepts to focus surveillance on key vulnerabilities, especially in advanced and emerging market countries, and in the public and financial sectors. Implementation of other related initiatives (DSA, FSIs) is also well advanced. However, there is more room to systematically:

  • Cover key balance sheet issues, including cross-sectoral transmission channels, in countries where the required data exist. More systematic attention could be paid to these data, especially in advanced economies. At the same time, such a focus should remain selective, reflecting each country’s specific circumstances. For instance, one may expect household balance sheets to be more relevant to macroeconomic analysis in advanced countries than in emerging market countries; and, conversely, the external balance sheet to have more significant implications for vulnerability analysis for emerging market countries than for advanced economies.

  • Integrate the results of balance sheet analysis into macroeconomic analysis and policy advice, especially in advanced economies. While the review shows a high degree of integration in staff reports for emerging market countries, there is room for greater reflection of analysis of balance sheet vulnerabilities in policy discussions in surveillance of advanced economies.

90. Looking further ahead, increased data availability will allow for a more widespread and precise focus on balance sheet analysis across the membership. Analysis that can underpin the formulation of finely-calibrated, convincing policy advice requires a comprehensive coverage of sectoral balance sheets, which in practice is hampered by data limitations. For instance, the lack of detailed balance sheet data on the corporate sector is a frequent impediment to proper analysis of financial sector soundness—if not, by extension, of public debt and fiscal sustainability. Staff reports can contribute to identify priorities for data compilation to fill these gaps progressively, according to each country’s specific context.

91. In light of the above, it is recommended to continue with a selective implementation of balance sheet analysis in surveillance activities. Overall data and resources constraints that affect the implementation of balance sheet analysis in the Fund were discussed by the Board in the context of the latest review of the Data Provision policy. Priority for implementation should be for countries where risks are more prevalent, countries whose economic developments have systemic or regional implications, or countries where experimentation is facilitated by better availability of data.

D. Institutional Underpinnings of Growth45

Introduction

92. Over the past decade, the view that “institutions matter for growth” has gained considerable credence. Many factors in different regions of the world have contributed to this development. The experience of transition economies showed that sound institutions and legal framework were essential ingredients in the transformation to a market economy. The Asian crisis demonstrated that weaknesses in supervisory regimes, reserves management, corporate governance, and other institutional issues could threaten economic stability and hurt growth. The debate on globalization has brought renewed attention to the distribution and determinants of international private capital flows, including to institutional conditions that promote domestic and foreign investment. The international community’s focus on achievement of the Millennium Development Goals (MDGs) has strengthened attention to the conditions necessary to spur higher growth and reduce poverty and, among these, to sound economic institutions. Many activities carried out by the Fund, including FSAPs, ROSCs, offshore financial center assessment reports, and technical assistance (TA) reports, have extensive coverage of institutional issues and can inform surveillance in this area.

93. This section considers the treatment of the institutional underpinnings of growth in Fund surveillance, focusing on three distinct but inter-related and overlapping areas, namely institutions, the investment climate, and governanceBox 10 provides a selected definition of each of these three areas, whose characterization in the literature and in usage varies considerably. The chapter begins by a broad review of coverage of institutional reforms in Fund surveillance. It then pays closer attention to issues that relate specifically to the investment climate. It ends with a review of coverage of governance, in light of previous guidance from the Executive Board. The first two sections of this chapter focus on low and middle-income countries, while the third encompasses the whole membership as governance issues are of concern to all.

Selected Definitions of Institutions, Investment Climate, and Governance

Institutions: the organizations, markets, regulatory frameworks, and practices that governments, businesses, and individuals use when they carry out economic and financial activities.

Investment Climate: the macroeconomic conditions and policy, regulatory, and institutional frameworks that have a direct bearing on the ability of investors to assess risks and maximize risk-adjusted returns.

Governance: the practices and institutions through which power is exercised in the management of a country’s economic and social resources.

Institutions

Background

94. As stressed in the chapter on Growth and Institutions in the April 2003 WEO report and the World Bank’s 2002 World Development Report on Building Institutions for Markets, the importance of institutions for economic development and growth has long been understood.46 Thus, it is no surprise that, in the years following the adoption of the 1977 Surveillance Decision, institutional issues are one of the main areas that Fund surveillance came to cover, in addition to fiscal, monetary, and exchange rate policies.

95. The fact that “institutions” is such a wide-ranging concept raises several pointed questions for surveillance. Does surveillance manage to focus on the institutional issues of macroeconomic import and, more specifically, on issues that bear relation to the apex of the Fund’s hierarchy of concerns? Is it successful in linking this coverage to the overall assessment of economic conditions and policy recommendations made in Article IV consultations? In order to assess how institutional issues are being covered in Fund surveillance, the survey of Article IV reports done for this review included a set of questions on this area (see Appendix).

Review of Article IV staff reports

96. Institutional issues were covered in a high share of surveillance reports (over ninety percent). Reports with no coverage of institutional issues all pertained to small island economies.47

97. The balance between the coverage of short-term macroeconomic and longer institutional issues was deemed appropriate for most countries. Where macroeconomic instability was of immediate concern, institutional issues received relatively less attention, unless they were directly linked to relevant vulnerabilities. In contrast, in post-crisis, low- income countries, surveillance reports identified the main steps to achieve macroeconomic stability, but also gave great attention to priorities for building or rebuilding institutional capacity. However, in a small but non-negligible share of reports, there were suggestions that institutional issues had not received sufficient coverage.48

98. The coverage of institutional issues was greatest in three areas: financial supervision and regulation and corporate governance; fiscal policy and operations; and legal and judicial reforms. In the financial area, coverage most often related to the supervision and regulation of banks. It also addressed deposit insurance, anti money laundering and combating the financing of terrorism (AML/CFT), and corporate governance. This coverage often benefited from references to existing or forthcoming FSAPs. In the fiscal area, the most common issues were the transparency and operational efficiency of public enterprises and the management of public resources. Judicial and legal reforms were raised frequently across different types of member countries. Central bank institutional issues were mentioned about one-third as often as financial and fiscal institutional concerns; this likely reflects the relative strength of central banks across the membership, compared to other institutions in the financial and fiscal sectors. Even institutional issues in the social sector, such as the institutional capacity for pro-poor spending and social security institutions, received more coverage than central banks.

99. Institutional issues were regarded as having potential macroeconomic implications in most cases. For a number of countries, the link was through the impact of the poor management of public enterprises on growth. However, in about a quarter of cases, the macroeconomic import of an institutional issue could not be easily discerned from the overall content of the report. In some of these cases, the lack of clarity was because a specific institutional issue, such as the need for judicial reform, was mentioned early on in the Article IV report but never followed up; in some others, the institutional issues seemed important but their coverage was not well integrated with the overall assessment.

100. Surveillance reports were generally successful in linking the coverage of institutional issues to the impact of institutions on growth and stability. In some cases the link drawn by staff between institutional strengthening and growth was somewhat general. In others, institutional reforms were clearly identified as necessary for fostering private sector development, reducing high unemployment, or allowing the government to perform its most basic functions. For some low-income countries (e.g., the Republic of Congo, Namibia), institutional reforms were also explicitly linked to a country’s poverty reduction efforts, PRSP, and/or plans to achieve the MDGs, giving greater prominence to the importance of these issues and their link to the overall policy strategy. These cases were, however, relatively rare.

101. Reports on the Observance of Standards and Codes (ROSCs) are making a contribution to the frequency or depth of coverage of institutional issues. There is some correlation between discussion of institutional issues and the number of completed ROSCs for a given country. Substantial references to completed ROSCs occurred in about fifty percent of reports. Fund technical assistance studies were also cited frequently.

102. The coverage of institutional issues in areas outside the Fund’s core expertise (e.g., corporate governance, accounting and auditing, insolvency) continues to be generally weak. As noted in the last Biennial Surveillance Review, this probably reflects both that Fund staff may feel that they lack expertise in these areas; and that fewer ROSCs in these areas, in which the World Bank takes the lead, have been done. However, completed ROSCs in areas where the World Bank takes the lead were never mentioned in the reviewed reports.49

103. The staff’s use of the work of external bodies to inform the coverage of institutional issues in surveillance is moderate. External reports such as the EBRD’s Business Environment and Enterprise Performance Survey, the World Bank-IFC’s Foreign Investment Advisory Service, the private sector PRS Group’s International Country Risk Guide, and reports by multilateral banks (e.g., an Asian Development Bank study on tax reform) and the United Nations were sometimes cited. However, the breadth and quantity of available material suggests that there could be more use of external work on institutional issues, especially in areas outside the Fund’s traditional expertise.

104. Article IV reports generally provided little information on implementation of previous recommendations for institutional reforms. A few reports presented boxes that summarized the country’s implementation of the body of recent Fund recommendations on institutional reforms; this was done almost always in a program context.

Conclusions

105. Appreciation for the importance of institutional issues in surveillance is manifest. Institutional issues receive substantial attention in Fund surveillance.

106. Institutional issues are being selectively covered. Supporting this conclusion is the fact that in about 75 percent of cases, the macroeconomic implications of an institutional issue were made clear, and that coverage focused on areas at the top of the Fund’s hierarchy of concerns.

107. Nevertheless, greater selectivity in the coverage of institutional issues outside the Fund’s core areas of expertise appears desirable. Greater selectivity would allow deeper treatment of fewer issues even within a given resource envelope and, thus, help improve the quality of coverage of key issues outside the Fund’s traditional areas of expertise. It would also facilitate coverage of institutional issues in areas or countries where existing background information may be more limited (for instance, due to the absence of ROSCs).

108. There is a wide range of credible information available on institutional issues, and mission teams should be encouraged to draw on more of it. Information from ROSCs, FSAPS, and TA is informing Fund surveillance, but its integration in surveillance could be improved. Information from the World Bank, EBRD, UN, and multilateral development banks is drawn on in only a small share (about 20 percent) of surveillance reports.

109. Fund surveillance could do a better job of reporting on a country’s implementation of past Fund advice on institutional reforms. The relatively limited extent to which Article IV reports alluded to the authorities’ progress in this regard suggest that the Fund may be foregoing an opportunity to help keep a country focused on necessary institutional reforms and to acknowledge progress.

Investment climate50

Background

110. Private investment is an essential contributor to growth and poverty reduction. Thus, much attention has been paid to the investment climate, i.e., the macroeconomic conditions and policy, regulatory, and institutional frameworks that have a direct bearing on the ability of investors to assess risks and maximize risk-adjusted returns. Table 3 lists selected investment climate determinants.

Table 3.

Key Determinants of the Investment Climate

article image

111. Many different members of the international community work on understanding, measuring, and improving the investment climate in low- and middle- income countries. The World Bank plays a major role (through, for example, the World Bank-IFC Private Sector Development Vice-Presidency and the Foreign Investment Advisory Service), and has recognized the improvement of the investment climate as a key pillar of World Bank Group work.51 UNCTAD, the multilateral development banks, and many private organizations are also engaged in this work, as is the Fund.

112. A wide range of factors determine the investment climate. These determinants include macroeconomic, microeconomic, structural, and institutional factors. While the list of determinants of the investment climate vary somewhat across different studies, Table 3 is representative of the factors that are typically highlighted.

113. Treatment of the investment climate in Fund surveillance can be approached from the general principles on coverage of surveillance. Macroeconomic conditions and policies have obviously always been at the heart of Fund surveillance. In addition, structural and institutional issues are treated in Fund surveillance to the extent that they have a bearing on macroeconomic developments and, more precisely, to matters at the apex of the Fund’s hierarchy of concerns, which include sustainable growth and the policies to achieve it. Apart from its impact on growth, the investment climate is also a potential topic for Fund surveillance because of its relationship to foreign direct investment and, more broadly, the stability (or volatility) of capital account flows.

114. The importance of the investment climate for the work of the Fund is reflected in a variety of initiatives adopted over the past few years. Fund competencies in the financial and corporate sector have been strengthened with the creation of the Financial Sector Assessment Program (FSAP); Reports on the Observance of Standards and Codes (ROSCs); the International Capital Markets Department; and the Capital Markets Consultative Group (CMCG), to name just a few initiatives.52 The Executive Board has encouraged the staff to continue its efforts to improve the assessment of investor sentiment in a country context.53

115. This section takes stock of whether information on the investment climate is informing Fund surveillance and, if so, how. To this end, the survey of Article IV reports included a set of questions on the investment climate (see Appendix).

Review of Article IV staff reports

116. Coverage of determinants of the investment climate in Article IV staff reports on low- and middle-income members is common. While generally not treated as a discrete subject of analysis or evaluated exclusively from the perspective of private investment, key determinants of the investment climate—beyond macroeconomic policies and financial sector issues—were covered in about 70 percent of reports for such members.

117. The coverage of issues related to the investment climate was considered useful and relevant in most of these reports. There appeared to be some room, however, for a greater sense of the priority of investment climate-related reforms and more specific staff advice in this area.

118. There are variations in the coverage of the investment climate across regions. Coverage of the investment climate was especially strong in transition economies and low-income countries in Africa. In the former, extensive coverage was related to the focus of these reports on progress in market-oriented reforms. In the latter, it was linked to a clear recognition of the need for private sector-led investment to spur growth and poverty reduction. Coverage was lighter in Western Hemisphere countries and small island economies, which, for many countries and for the covered period, may reflect an appropriate focus on achievement and maintenance of macroeconomic stability.

119. Outside expertise or information was cited in about 25 percent of the surveillance reports that covered the investment climate. The main sources of internal or external information that staff cited as informing their analysis of the investment climate were ROSCs, PRSPs, Fund TA studies, Transparency International, and the EBRD Business Climate Indicators. For the nine countries for which World Bank Investment Climate Assessments exist (and for which an Article IV report has followed the issuance of the Assessment with a sufficient time lag for the Assessment to be incorporated), the assessments were not drawn on to any significant extent.

Conclusions

120. Coverage of determinants of the investment climate is quite common in Fund surveillance. This certainly reflects the fact that a number of institutional issues receive substantial attention in Fund surveillance and that some of these are considered to be institutional determinants of the investment climate.

121. Article IV consultation reports point to a number of cases where improving the investment climate is seen as important for growth and poverty reduction. For example, some reports pinpoint that a more supportive environment for investment is needed to address macroeconomic problems such as underemployment or inefficient and excessive government involvement in the economy.

122. The importance of the investment climate for growth might justify greater coverage in Fund surveillance. However, a selective and focused approach to coverage of this area will remain essential, given limits to staff’s expertise and resource constraints. In some country cases, conditions appeared to justify drawing attention to needed improvements in the investment climate, but coverage was limited or not informed by a clear set of priorities. Given resource constraints and limited expertise, meaningful coverage of determinants of the investment climate requires careful selection of its scope.

123. The Fund’s coverage of the investment climate could draw more on external sources, especially World Bank’s expertise in this area. Efforts are underway to compile information available from the World Bank, UNCTAD, and other providers; to step up discussions on investment climate issues through ongoing contacts with foreign investors; and to channel that information to Fund country teams on a more systemic basis.54

Governance

Background

124. The Guidance Note on governance adopted by the Executive Board in 1997 promoted greater attention to governance issues in the Fund’s policy advice and technical assistance. The note identified two main areas for the Fund’s attention:

  • improving the management of public resources through reforms covering public sector institutions (e.g., the treasury, central bank, public enterprises, civil service, and the official statistics function), including administrative procedures (e.g., expenditure control, budget management, and revenue collection); and

  • supporting the development and maintenance of a transparent and stable economic and regulatory environment conducive to efficient private sector activities (e.g., price systems, exchange and trade regimes, and banking systems and their related regulations).

125. The guidance note directed that the modalities for enhanced attention to governance issues would include:

  • a more comprehensive treatment in the context of both Article IV consultations and IMF-supported programs of those governance issues within the Fund’s mandate and expertise;

  • a more proactive approach in advocating policies and the development of institutions and administrative systems that embody good governance;

  • an evenhanded treatment of governance issues in all member countries; and

  • enhanced collaboration with other multilateral institutions, in particular the World Bank, to make better use of complementary areas of expertise.

126. The 2001 review of the Fund’s experience with governance issues covered all strands of that work—i.e., activities in the context of use of Fund resources, technical assistance, and surveillance. As regards the last of these, the review found that such issues were receiving greater prominence in Fund surveillance, which benefited from input from new initiatives such as standards and codes and safeguards assessments, and that coverage was largely in areas where the Fund had expertise, notably transparency and accountability in public resource management. More than half of Article IV consultation discussions in the period 1998–99 mentioned these issues, compared to around one-fifth in the pre-guidance-note period of 1994–95.

127. Executive Directors welcomed the Fund’s heightened attention to governance as a key factor influencing economic performance. They noted that coverage of governance issues had evolved in line with the Guidance Note. Directors agreed that governance issues with macroeconomic significance should continue to be raised in the context of surveillance and that there may be some instances where the Fund would have to be involved with specific remedial measures.55 They were generally of the view that the Fund should explore ways to pay more attention to the two-sided nature of corruption, including by following up in Article IV discussions on the status of implementation of OECD-led initiatives to combat the bribery of foreign public officials (i.e., the supply side of international corruption), and in similar such initiatives. Directors indicated that subsequent reviews of the IMF’s experience with governance should be integrated into future reviews of surveillance, technical assistance, and conditionality.

128. In order to assess how governance has been covered in Fund surveillance since the last Biennial Review of Surveillance, the survey of Article IV reports included a set of questions on governance, related to the scope of coverage and modalities specified by the guidance note (see Appendix). In addition, additional analysis was carried out on the latest Article IV reports for all members to shed more light on variations in coverage across regions; the correlation of governance coverage with perceived governance quality; and the content of policy recommendations on governance.

Review of Article IV staff reports

129. Governance issues continue to be raised in a significant share of surveillance reports. The results of the questionnaire-based review of the Article IV reports showed a further increase in the coverage of governance in surveillance since the 2001 Review, with governance issues raised in about 70 percent of Article IV consultation reports.

130. For all but advanced economies, the primary area of coverage of governance issues is the fiscal domain. Transparency and accountability of the budget and public enterprises were prominent topics. Fiscal governance of extractive or other key sectors (e.g., forest sector) was raised in almost all relevant cases (Box 11).56 Legal and judicial reforms, as well as broad-based anti-corruption strategies constituted another major area of coverage of governance issues. Other areas covered included nontransparent exchange rate systems, and financial institutional arrangements open to rent-seeking.

Governance in Natural Resource Exporting Countries

The special challenges faced by developing countries exporting substantial natural resources are being addressed by a number of international initiatives that pursue revenue transparency as an important part of the solution. In 2003, the UK government launched the Extractive Industries Transparency Initiative (EITI), building on the earlier NGO campaign Publish What You Pay (PWYP).

The EITI is broader than the PWYP. Unlike the PWYP, which strives for mandatory disclosure by oil and gas companies of their payments, the EITI aims for voluntary disclosure not just by companies but also by governments. Companies would disclose in the aggregate, but according to the same templates as governments, so that a reconciliation would be possible.58

Experiences from many countries show that transparency is the key to accountability and efficiency in the use of the government’s “rent” income from extractive industries. The transparent management of natural resource revenues establishes policy credibility and informs the domestic political debate. For these reasons, the IMF strongly promotes policy transparency, including through its transparency codes for fiscal and monetary and financial policies. Staff actively encourages transparency in revenue management in resource rich countries.

Fund staff is supporting the EITI in a way that fits within its existing or already planned activities. Fund staff advised on the reporting templates, a first version of which is now being tried out in a few pilot countries. A supplement to the fiscal transparency manual with good practices on resource revenue management is under preparation. Where appropriate, Fund staff has suggested to authorities to consider discussing participation in the EITI with their extractive industries. When information emerges from the EITI, staff expects to be able to use it for more comprehensive and accurate assessments of members’ budgetary outlooks. During Article IV discussions, the Board has welcomed the plans of several countries to participate in the EITI, e.g., Ghana, Sao Tome and Principe, and Trinidad and Tobago. In the case of Ghana, the Board also asked that the fiscal ROSC concentrate on resource revenue transparency.

131. Corporate governance was the issue most likely to be raised in surveillance of advanced economies.57 Further enhancements to fiscal transparency and governance issues related to EU accession were also raised.

132. Coverage of the supply side of corruption was frequent. The OECD Convention on Combating the Bribery of Foreign Public Officials in International Business Transactions is referred to in 29 surveillance reports, representing four-fifths of countries that have ratified this convention (Box 12). However, the reporting tends to be brief and descriptive. It does not appear to have received much attention in Board discussions of individual Article IV consultations.

Follow-up of Implementation of the OECD Anti-Foreign Bribery Convention59

At the February 2001 governance review, the Board asked that staff use Article IV consultation missions and reports as vehicles to follow up on members’ implementation of the OECD Convention on Combating the Bribery of Foreign Public Officials in International Business Transactions. Adopted in 1997, and effective as of 1999, this Convention was seen by many as a promising development in the fight against international corruption. It requires ratifying countries to criminalize the bribery of foreign officials, and to treat it with the same severity as the bribery of domestic public officials. The Convention emphasizes the responsibility of developed countries in stemming the supply of bribery to developing countries.

By now all thirty OECD members, and five non-members, have ratified the Convention. The OECD’s monitoring of the implementation of the Convention follows the peer-review model. A first phase focused on whether all signatories had brought their legislation up to the standards of the Convention. While quite a few recommendations coming out of that phase still need to be implemented, the monitoring has now entered a second phase. This phase focuses on enforcement, and includes on-site consultations with officials and a broad range of private sector and civil society representatives. External observers have concluded that there has been little enforcement of the new laws by national governments so far, other than by the United States.60 However, several investigations are ongoing and may lead to trials and possibly convictions.

In the period from March 2001-April 2003, 60 percent of staff reports made mention of the Convention. The references were typically short. All in all, the Convention has been referred to in an Article IV report at least once for 29 of the 35 countries that ratified it.

133. Overall, the focus of coverage was on the development of policies, institutions, and administrative systems that “embody good governance,” as the Guidance Note advocates, rather than on identifying cases of actual corruption. This focus recognizes that corruption, the abuse of public power for private gain, is a particular subset of governance concerns. While governance issues were raised in about 70 percent of staff reports, corruption is raised in about 10 percent of reports.

134. Differences in the extent of coverage of governance issues across individual Article IV can be largely explained by difference in country characteristics. For instance, the degree of coverage of governance issues is reasonably well correlated with a World Bank corruption indicator (see Box 13). Differences in coverage across regions is also partly correlated with participation in the standards and codes initiative.

Additional Analysis of the Coverage of Governance Issues in Surveillance

Analysis

A more extensive analysis of the treatment of governance issues in surveillance was carried out by assessing the most recent Article IV staff report for each of the Fund’s 184 member countries, starting in January 2004 and proceeding backwards in time.

The occurrence of governance references was assessed for: coverage by per capita income level; coverage by region; coverage in surveillance of program versus nonprogram members; and a comparison of Fund coverage with an outside indicator of corruption (e.g., one of the World Bank governance indicators)

The substance of the governance/corruption references was also assessed, in terms of: the economic policy categories in which they fall; whether they contain general or specific comments; whether they are descriptive or proscriptive (advise, recommendation); whether they have institutional dimensions (to address concern that Fund neglects institutions); whether they are linked to a Fund-supported program; whether the involvement of another institution is mentioned.

Results

  • - Coverage is broad: governance references occur in roughly 75 percent of Article IV staff reports and in 60 percent of those the issue is picked up in the staff appraisal.

  • - Coverage of governance is inversely related with a World Bank indicator of corruption. Only reports for one out of six countries in the lowest corruption control category did not raise governance as an issue.

  • - Governance was covered in reports for several OECD countries (i.e., Australia, Canada, France, Japan, The Netherlands, Spain, Switzerland, Turkey, UK and the US). In most of them, the references are to corporate governance.

  • - Using the World Bank indicator as a control variable, coverage appears to exhibit regional variations. For example, coverage for Middle East and Central Asia region is below the average in the lowest and highest corruption control groups. Coverage in Europe is low compared to Africa, Asia, and Western Hemisphere for the two highest corruption control categories of countries.

  • - Frequently the references to governance are of a general nature. Most references are descriptions of actions or intentions and staff endorsement is only implicit. Moreover, reports rarely evaluate past improvements in governance as a result of specific actions.

  • - Most governance references deal with the establishment or reinforcement of institutions.

135. The macroeconomic relevance of the governance issues raised was generally obvious. There may be cases where the import of governance issues would deserve a fuller treatment, since a number of reports mentioned governance as a main obstacle as growth in general terms but included few specific references to particular issues.

136. One aspect of the coverage of governance issues, namely treatment of past and current policy recommendations, appeared relatively weak. In many cases, references to governance tended to be limited to descriptions of what the authorities were planning to do, or had done; they stopped short of assessing whether these steps would be or have been sufficient and effective, or indicating what additional measures might be needed.

137. Staff’s reliance on the information and expertise available from external bodies appeared limited, except as regards cooperation with the World Bank in a program context. Explicit references to use of World Bank expertise or information in stand-alone surveillance reports were rare. This contrasts with evidence in combined Article IV-UFR reports that the Fund is coordinating well with the Bank in a program context on governance issues where the Bank takes the lead, such as civil service and public enterprise reforms. The staff appeared to draw on other outside information only occasionally. Some Article IV documents reported governance indicators compiled by other institutions or groups (e.g., the World Bank, Transparency International). The staff report for Azerbaijan provided a good example of the use of external information on governance, drawing on the governance- related work of the World Bank and reports from the EBRD, the IFC, and the Heritage Foundation. Other country reports cited the EBRD Business Indicators and TA-type reports by multilateral development banks. The discussion of governance issues also drew on fiscal ROSCs, but rarely on other types of ROSCs.61

Conclusions

138. The basic requirements of the Fund’s policy on governance are being well met in the context of surveillance. The treatment of governance in surveillance is generally fulfilling the objective of identifying issues of actual and potential macroeconomic significance in areas within the IMF’s mandate and expertise, when these exist.

139. Coverage of governance issues should remained selective, based on country- specific circumstances and the criterion of macroeconomic relevance, and focused on issues within the Fund’s expertise. To promote selective but evenhanded coverage, staff could be encouraged to take into consideration governance indicators published by other institutions (e.g., the World Bank, Transparency International) more systematically, when deciding upon coverage of governance issues in Article IV consultations.

140. The substance and consistency of the treatment of governance in staff reports could be strengthened, where relevant, with greater specificity and more focus on policy recommendations and actions. As noted, identification and description of governance issues in Article IV consultation reports seem generally satisfactory. To raise the impact of the Fund’s attention to governance issues in surveillance where warranted, improvements in coverage could focus on provision of more specific policy recommendations; better reflection in staff appraisals of discussions of governance issues; and more attention to the authorities’ responses to past advice on governance, in order to highlight achievements and implementation difficulties.

141. The supply-side of corruption could be covered more effectively through revised modalities. Reporting on the OECD Anti-Foreign Bribery Convention in Article IV consultation reports tends to be brief and purely descriptive, and has generated little discussion at the Board. Alternative approaches to the coverage of the supply side of corruption are worth considering. One possibility would be (i) to use Article IV consultations or alternative vehicles to collect information on implementation of the OECD Convention;62 and (ii) to disseminate information on such activities to the Board through periodic, cross- country reports. This approach could help give greater prominence to the Fund’s treatment of the supply side of corruption.

142. Staff should draw more systematically on ROSCs and on the wealth of other material on governance that is available externally, including from the World Bank. Drawing on credible external information would support many of the Guidance Note’s directives (increased attention to governance; even-handedness; proactiveness; a preventative approach; and enhanced collaboration with other multilateral institutions), while limiting further strains on staff resources. Fund staff would continue, per the Guidance Note, to be expected to make their own independent assessment of governance issues in a given country.

Conclusions and recommendations

143. Institutional reforms, the investment climate, and governance are receiving substantive, though selective, coverage in Fund surveillance. This coverage suggests that staff have taken on board the importance of institutional issues for stability, growth, and poverty reduction, when these issues are of macroeconomic importance.

144. However, there could be still greater selectivity in coverage of institutional issues, i.e., fewer issues treated in greater depth; more focus on progress in accomplishing institutional reforms; and greater use of external sources of information. More awareness of the wealth of information on institutional issues, governance, and the investment climate, including ROSCs, could help staff focus and strengthen the quality of surveillance in these areas within a given resource envelope.

Appendix Table 1:

Survey of Article IV Consultation Reports – Country Coverage

article image

These countries had two Article IV staff reports during the period covered (Jan. 1, 2003 – March 5, 2004) which were both reviewed.

Region or territory of member country for which separate Article IV consultations are conducted.

I. Questions for the Coverage Paper

A. Rationale for coverage of macroeconomic and structural issues

1. Does the report clearly sets out the focus of the consultation and the rationale for its coverage of core and non-core areas?

article image

2. In your views, is the scope of coverage appropriate?

article image

Please provide your assessment of the report's focus on a scale of 1 to 4 (1- highly satisfactory, 2- satisfactory, 3- somewhat satisfactory, 4- unsatisfactory)

B. Macroeconomic Developments and Policy Discussion

a. Recent Economic Developments and Policies

3. Is the coverage comprehensive and meaningful?

article image

b. Short-Term Economic Outlook

4. Are the authorities' and staff's views on the short-term economic outlook, including risks to this outlook, presented in a clear and substantiated way taking into account both global and regional economic and financial market developments?

article image

Please go to section II for questions on regional and global spillovers

c. Coverage of Macroeconomic Policy Areas

5. Is there an adequate coverage of all core macroeconomic policy areas (i.e., exchange rate, monetary and fiscal policies), including identification of key policy challenges, and a candid and balanced account of the report of policy discussions with the authorities?

article image

6. Does the report provide adequate rationale for the magnitude, composition and pace of proposed fiscal adjustment (if any) along with a discussion of political feasibility of such adjustment and authorities' reactions? Are fiscal policy recommendations for the short term put in the context of a clear medium-term fiscal road map?

article image

7. Does the report contain a substantial discussion of the composition of public expenditures, including spending on health, education, and social services? (Please describe)

8. Where relevant, does the staff report identify the causes of past failures in fiscal reforms and/or identify longer-term reform priorities?

Please rank the report's coverage of macroeconomic policies 1-4 (1- highly satisfactory, 2- satisfactory, 3- somewhat satisfactory, 4- unsatisfactory)

Please go to section III for questions on exchange rate analysis

C. Structural Issues

a. Financial Sector Issues

9. a. Has this country had an FSAP or FSAP update? If so, when?

9. b. Did MFD staff participate in the Article IV consultation mission?

9. c. Does the report provide a meaningful coverage of the findings of FSAP?

10a. Is there a description of the structure of the financial system that indicates the relative importance of the main segments of the financial sector?

10b. Does the discussion of financial sector issues permit conclusions as to whether the financial sector is a potential source of macroeconomic instability (i.e., by affecting the conduct of fiscal or monetary policy) and/or inefficiency (i.e., poor financial intermediation)?

article image

11. Does the report provide a set of financial soundness indicators and a discussion of the adequacy of the supervisory infrastructure in place?

article image

12. Does the report make recommendations and/or identify the need for technical assistance or other means to address existent financial sector vulnerabilities/inefficiencies, where applicable?

Please go to section IV for questions on Balance Sheet Analysis

b. Trade Policy Issues

13. Is there an adequate coverage of trade policies in the report that links the discussion to overall macroeconomic assessment and outlook?

article image

14. Does the report identify barriers to market access faced by the country (please specify if this is a non-issue for the country)?

c. Institutional Issues

15. Does the staff report draw attention to key institutional weaknesses relevant to growth and crisis vulnerability and identify potential sources of remedy?

article image

16. Which of the ROSC modules has this country completed?

17. Does the report make any reference to the findings of these modules? If so, in what way?

Please go to section V for questions on Growth and Institutional Issues

d. Social Sector Issues and Political Instability

18. Is there a discussion of social sector issues and/or political instability?

article image

19a. If the answer is yes, in your views, how substantive and meaningful is the coverage?

19b. If the answer is “no”, in your views is there a case for coverage of social sector issues? Why?

20. Does the report include a table on social sector indicators or provide some social indicators as part of another table in the text or in the appendix (please indicate)?

Please rank the report's coverage of this issue, 1-4 (1- highly satisfactory, 2- satisfactory, 3- somewhat satisfactory, 4- unsatisfactory)

D. Assessment of Vulnerability and Sustainability

21. Is there a candid and clear presentation of staff's and the authorities' assessment of vulnerabilities to a currency, balance of payments or financial sector crisis

article image

22. Does the above assessment takes into account (i) global economic and capital market developments, (ii) soundness of the financial and corporate sector, (iii) domestic policy developments and (iv) relevant political economy factors (please specify)?

23. Is there a clear, candid and adequate presentation of staff's and the authorities' assessment of the country's external and public debt sustainability?

article image
article image

24. Where unsustainability is detected, does the report discusses staff's recommended course of action to achieve sustainability anchored in a medium-term framework with an adequate discussion of political feasibility of the recommended course?

article image

Please rank the report’s coverage of this issue, 1-4 (1- highly satisfactory, 2- satisfactory, 3- somewhat satisfactory, 4- unsatisfactory)

25. Please identify areas of exceptional strengths and weaknesses of this report.

II. Questions for the Paper on Global and Regional Spillovers

A. Integration of multilateral and bilateral surveillance

1. Does the report's backward-looking section refer to the impact of global economic conditions (or conditions in economic groups of countries), in particular:

  1. the global economic recovery;

  2. subdued global inflation;

  3. the decline/low level of world interest rates;

  4. improved capital market conditions for emerging markets (reduction in interest rates/spreads, renewed capital inflows)

  5. change in country differentiation in emerging market spreads according to perceived risk;

  6. the bursting of the global equity bubble;

  7. the incipient recovery in global equity markets;

  8. the depreciation of the US$ against other major currencies;

  9. changes in oil/energy prices;

  10. changes in food/commodity prices;

  11. global geopolitical conditions, in particular the war in Iraq;

  12. other?

2. Do the report’s forward-looking sections refer to baseline global projections (or projections for economic groups of countries), in particular:

  1. the continuation of the global economic recovery;

  2. pick-up in growth in US, Japan, Asia, transition economies;

  3. the continuation of subdued global inflation;

  4. outlook for global interest rates;

  5. outlook for capital market conditions for emerging markets;

  6. outlook for global equity markets;

  7. outlook for the G3 exchange rates ($/euro, yen/$);

  8. changes in oil/energy prices;

  9. changes in food/commodity prices;

  10. a relatively quick resolution of geopolitical uncertainties, in particular a quick war in Iraq;

  11. other?

3. Do the report’s forward-looking sections refer to global risks (or risks for economic groups of countries) and their potential impact on the country, in particular:

  1. a lackluster or delayed global economic recovery;

  2. global deflation;

  3. an rebound in world interest rates;

  4. a deterioration in capital market conditions for emerging markets (increase in interest rates/spreads, decline in capital flows);

  5. significant emerging market volatility and/or financial crises (specifically South America, Turkey);

  6. reversals in the recovery of global equity markets and/or significant global stock market volatility;

  7. a disorderly unwinding of global imbalances, in particular a steep fall in the US$;

  8. a sharp change in oil/energy prices;

  9. a sharp change in food/commodity prices;

  10. a protracted phase of geopolitical uncertainty resulting from the war in Iraq

  11. other?

4. Does the staff appraisal mention global economic conditions/outlook (or conditions/outlook for economic groups of countries)? If so, is the potential impact on the country considered (a) significant, or (b) not very significant?

5. Overall, how would you characterize the degree of integration of multilateral surveillance issues into the report: (a) extensive (b) selective, or (c) minimal? In your view, would the report have benefited from a more extensive (or higher quality) discussion of multilateral surveillance issues? Please explain.

B. Integration of G3 issues into bilateral surveillance

6. Does the report’s backward-looking section refer to economic/financial conditions in the US, EU, and/or Japan (indicate which)?

  • If so, are these conditions considered to have a significant impact on the country’s economy (yes/no/not clear) and what are the main transmission channels:

    1. exchange rates;

    2. demand for the country’s exports;

    3. commodity prices;

    4. interest rates;

    5. equity valuations and corporate governance issues;

    6. availability/cost of external financing, either directly through G3 official/private financing or indirectly through the potential impact of G3 developments on international capital markets;

    7. other?

7. Do the report’s outlook or risk sections identify the economic outlook/risks in the US, EU, and/or Japan (indicate which)?

  • If so, is the US/EU/Japan outlook considered to have a potentially significant impact on the country (yes/no/not clear) and what are the main potential transmission channels:

    1. exchange rates;

    2. G3 demand for the country’s exports;

    3. commodity prices;

    4. interest rates;

    5. equity valuations and corporate governance issues;

    6. availability/cost of external financing, either directly through G3 official/private financing or indirectly through the potential impact of G3 developments on international capital markets;

    7. other?

8. Does the report mention the impact of current or prospective trade policies by the EU, US, and/or Japan (y/n)? If so,

  • Are EU/US/Japanese trade policies deemed to have a significant impact on the country’s economic performance/outlook (yes/no/not clear)?

  • What type of trade policies are mentioned: (a) the general trade regime in the EU/US/Japan (i.e. tariffs, quotas, subsidies, market access), (b) regional free trade agreements involving the EU/US/Japan, (c) preferential access agreements (e.g. EU Association, EU EBA, US AGOA, GSP)?

9. Does the staff appraisal refer to G3 (a) economic conditions/prospects/risks and/or (b) trade policies?

10. Overall, how would you characterize the degree of integration of G3 economic/financial issues: (a) extensive, (b) selective (c) minimal. In your view, would the report have benefited from more (or higher quality) discussion of G3 issues? Please explain.

C. Regional linkages

11. Please indicate the key regional partners mentioned in the paper.

12. Does the report’s backward-looking section refer to the impact of economic conditions in its region or in specific countries in its region?

  • If so, did regional economic conditions have a significant impact on the country’s performance (yes/no/not clear) and what were the main transmission channels:

    1. terms of trade;

    2. demand for the country’s exports;

    3. import competition;

    4. commodity prices;

    5. interest rates;

    6. risks perceived by investors;

    7. spillovers of public confidence or lack thereof;

    8. financial sector spillovers;

    9. other?

13. Do the report’s forward-looking sections refer to baseline projections for its region or for specific countries in its region?

  • If so, what are the main transmission channels:

    1. terms of trade;

    2. demand for the country’s exports;

    3. import competition;

    4. commodity prices;

    5. interest rates;

    6. risks perceived by investors;

    7. spillovers of public confidence or lack thereof;

    8. financial sector spillovers;

    9. other?

14. Do the report’s forward-looking sections refer to risks for its region or for specific countries in its region, and their potential impact on the country, in particular:

  • If so, do these risks have a potentially significant impact on the country’s prospects (yes/no/not clear) and what are the main potential transmission channels:

    1. terms of trade;

    2. demand for the country’s exports;

    3. import competition;

    4. commodity prices;

    5. interest rates;

    6. risks perceived by investors;

    7. spillovers of public confidence or lack thereof;

    8. financial sector spillovers;

    9. other?

15. Overall, how would you characterize the degree of integration of regional issues into the report: (a) extensive (b) selective, or (c) minimal? In your view, would the report have benefited from a more extensive (or higher quality) discussion of regional issues? Please explain.

III. Questions for the Paper on Exchange Rate Analysis

Type of regime

1a. What is the current “official” ER regime?

1b. What is the staff’s appraisal of the “de facto” ER regime? (i.e. does the staff state if they agree or disagree with the official classification of its regime)

Length of Regime

2. Has the ER regime been in place for short term (less than 3 months), medium term (between three months and 2 years), long term (2-5 years) or very long term (above 5 years)?

3. If there has been a change in regime since the last Article IV consultation, does the current report discuss events surrounding this development as well as implications (for example, was the change associated with a currency/banking/political crisis? was there a major devaluation associated with the change?)

Assessment of the Regime

4 In exchange rate regimes with some flexibility, which of the following best describes the country's monetary regime?

  1. full-fledged inflation targeting

  2. low inflation is the primary goal, although not a formal inflation targeting

  3. monetary regime is primarily used to counter business cycles

  4. monetary regime is geared toward a range of objectives (low inflation, creation of employment, keeping competitiveness etc.)

  5. monetary policy is subservient to fiscal policy

  6. other, please specify

5. Do the staff deem the current exchange rate regime as sustainable (i.e. compatible with other macroeconomic policies, policy objectives (e.g., growth), and structural conditions (e.g., capital account openness))

6. Does staff's assessment of the regime take due consideration of the country's fiscal stance, monetary policy objectives and other relevant structural factors (development of the financial market, extent of capital market openness, trade structure etc.?

Please indicate which factors have been given consideration

7. Does the report present an adequate assessment of competitiveness based on REER, unit labor costs and/or other indicators (please specify the tools)?

Assessment of the level of exchange rate

8. In less than free floating regimes, is there a discussion on the appropriate exchange rate level?

9a. If yes, what is the staff's conclusion (e.g., overvaluation, about right, undervaluation)? (please describe)

9b If yes, what are the main issues (i.e. competitiveness, reserves, current fiscal policy, trade and financial liberalization measures etc.)?

9c. How does staff measure over/undervaluation (i.e. cointegration analysis, discussion of trend levels, comparison with competitor countries, etc.)?

Policy Advice

10. Was there specific policy advice given to the authorities?

11a. What is the specific advice:

  1. a level/band adjustment

  2. an immediate movement to a free float

  3. a progressive transition to a float

  4. a move towards more flexibility in other markets (e.g. labor markets) keeping the peg untouched.

  5. keeping the rate fixed but tighten monetary/fiscal policies to better support the rate

  6. v. other (specify)

11b. How was the advice supported (main argument)?

11c. Is staff’s language/advice emphatic and compelling or mild and hesitant?

11d. If mild and hesitant, is it due to political sensitivity regarding the discussion of exchange rate issues?

14. Do the authorities agree with staff’s appraisal and advice of the exchange rate regime and level?

IV. Questions for the Paper on Balance Sheet Analysis

1. Does the staff report analyze the situation and risks within individual sectors’ balance sheets?

  1. Public sector (e.g., public debt management; implication for public debt sustainability and reserves adequacy; impact of population aging)

  2. Financial sector (e.g., asset/liability dollarization; exposures to rollover, interest rate, exchange rate or asset price shocks; capital structure mismatch)

  3. Non-financial corporate sector (e.g., liability dollarization; exposures to rollover, interest rate or exchange rate shocks; capital structure mismatch)

  4. Household sector (e.g., exposures to interest rate, housing and financial asset price shocks)

  5. External sector—i.e. country’s aggregate balance sheet position vis-à-vis non-residents (e.g., exposure to interest rate or exchange rate shocks)

2. Does the staff report analyze the (actual or potential) transmission of vulnerabilities across balance sheets of individual sectors?

  1. From non-financial corporate or household sectors to financial sector (credit risk)

  2. From financial sector to non-financial corporate or household sector (e.g., credit crunch)

  3. From corporate or financial sectors to external sector (e.g., depositor flight to foreign currency)

  4. From financial or non-financial corporate sectors to public sector (public contingent liabilities—e.g., SOEs, private banks)

  5. From public sector to financial sector (e.g., through banks’ holdings of public debt)

  6. From public sector to external sector (e.g., public external debt burden)

  7. (Other:___)

3. How is the above balance sheet analysis linked to the other key focuses of the staff report?

  1. Through impact on macroeconomic conditions or risks

  2. Through policy recommendations (e.g., on exchange rate policy, debt and reserve management, local capital market development to provide hedging instruments)

  3. Through role of institutions (e.g., role of transparency, prudential supervision or capital controls in reducing/exacerbating above risks)

  4. (Other:___)

4. Is the staff's analysis supported by provision of key data/indicators?

  1. Public sector data

  2. Financial sector data

  3. Non-financial corporate sector data

  4. Household sector data

  5. External sector data

5. If not, does the staff report provide recommendations for prioritizing data compilation in order to obtain the data required for balance sheet analysis?

6. Does the staff report include information related to other initiatives that are directly relevant to the balance sheet approach?

  1. DSA

  2. FSAP/FSSA

  3. FSIs

  4. Enhanced focus on reserve adequacy (e.g., augmented reserve ratios)?

  5. (Other:___)

7. Does the staff report include authorities' views on the balance sheet risks? If yes, are they different from the staff assessment?

8. In light of the country's economic circumstances, do you consider the coverage of balance sheet issues as adequate (qualitatively and/or quantitatively)?

V. Questions for the Paper on Institutional Underpinnings of Growth

Note: Questions in Sections 1 and 2 will be assessed against low- and middle-income members only; questions in Section 3 will be assessed for all members.

Section 1

1. How much coverage is there of institutional issues? (Low, medium, high)

2. What institutional issues are covered:

  1. Central bank

  2. Financial Supervisory and Regulatory institutions

  3. Other Financial Sector Issues

  4. Fiscal institutions/operations

  5. Governance (general)

  6. Judiciary

  7. Rule of law/private property rights/controls on the executive

  8. Social sector

  9. Other

3. Does the report indicate if the institutional issues it raises have potential macroeconomic implications? Does it seem links between institutional issues and the broader macro environment and policy challenges are sufficiently developed?

4. Assess the balance between short-term macroeconomic and medium-term institutional issues: given information in the rest of the report (economic indicators, staff's appraisal of main challenges to the economy), does it appear that institutional issues received sufficient attention for this country's case?

5. How are institutional issues/reforms linked to the Millennium Development Goals in particular, or to poverty reduction and growth in general?

6. What sources of information does the report draw on to assess institutional issues? Indicate if the report uses mainly the staff's analysis during the Article IV mission; if it draws on ROSCs; or if it draws on external information (World Bank, other).

7. In discussing institutional issues, to what extent does the report recommend that new ROSCs be undertaken; update existing ROSCs.

8. Please comment on how previous recommendations for institutional strengthening in Article IV or program documents have been implemented by the authorities?

Section 2

9. Is the investment climate covered? Even if the investment climate is not specifically mentioned, are the suitability of economic and institutional conditions for private sector investment addressed?

10. If so, is the level of coverage useful, and how is it integrated with the rest of the report?

11. If the investment climate is covered, what outside information/expertise did staff draw on?,

12. If the investment climate was not covered, does the report suggest if this was because of lack of expertise/information, because it was not judged a priority for the analysis, or other reason?

13. Does the rest of the report suggest that it would have been useful to cover the investment climate?

Section 3

14. Was governance and/or corruption covered? If so, in the context of which sectors were these issues raised:

(a) fiscal sector

(a) monetary sector

(a) financial sector

(a) external sector

(e) real sector, including oil, extractive, and other industries

(f) relations with the Fund (e.g., reporting to the Fund)

(g) OECD Convention on the Combating of Bribery of Foreign Public Officials in International Business Transactions

(h) Other

15. If so, did the report make it clear whether the governance/corruption issues had macroeconomic importance?

16. Were governance issues addressed in sufficiently clear and direct language, or were they treated obliquely, to an extent that their significance was difficult to interpret?

17. Did the staff mainly draw on its own analysis, or did it use external information, such as external governance indicators (e.g., Transparency International) and external assessments?

18. Did the staff cite ROSCs in relation to governance issues?

19. Was transparency in extractive industries or in other key industries raised? Please note if the issue was not raised, but seemed relevant for this country.

20. Did the staff make specific recommendations related to governance/corruption?

21. Did the report give a sense of whether governance issues were being addressed or ignored by the authorities? For example, were response of the authorities to earlier recommendations related to governance covered?

VI. Questions for the Paper on Modalities of Surveillance

A. Policy Dialogue

1. Reporting the authorities' views

1.1 Are the authorities' views on major policy issues presented in the staff report?

article image

1.2 Are the authorities' views on particularly sensitive issues, e.g., assessments of exchange rate and vulnerability, described?

article image

1.3 Are the authorities in agreement with staff on major policy issues?

article image

1.4 Are the differences between the authorities and staff policy preferences clearly explained?

article image

1.5 Is the authority’s plan of action clearly explained?

2. Reporting on the dialogue with the authorities itself

2.1 Did staff try to formulate a second-best approach that would take into account the authorities' main concerns?

2.2 Does the staff report point to ways to alleviate constraints on policy implementation (if applicable)?

article image

2.3 Did the staff use cross-country analysis in discussions with the authorities or present it in the staff report or the selected issues paper?

2.4 Did some of the staff 's arguments convince the authorities?

2.5 Did some of the authorities' arguments convince staff?

2.6 Does the staff report makes an assessment of the quality of the dialogue?

2.7 Did staff undertake special activity to foster the dialogue (internal conference, workshop)? Please specify.

2.8 Does staff identify follow up action to continue the dialogue (conference, TA, staff visit)? Please specify.

3. Is the consultation cycle tailored to the national timetables, e.g., budget cycle, medium-term economic plans?

4. Dialogue with non-governmental actors

4.1 Does the staff report identify the key themes of the domestic policy debate?

4.2 Are these themes the same as the key themes of the consultation?

article image

4.3 Are the views of non-governmental actors reported by staff?

article image

4.4 Do they occupy a meaningful place in the report?

article image

4.5 Is any external dissemination activity mentioned in the staff report?

5. General assessment of the quality of the policy dialogue

5.1 Overall, and beyond the necessary degree of ambiguity, do you believe the staff's policy advice during the consultation was candid, especially on sensitive issues concerning vulnerabilities and exchange rates?

If not, why?

5.2 Overall, and beyond the necessary degree of ambiguity, do you believe the authorities' response in discussions as presented in the staff report was candid and open?

If not, why?

6. Effectiveness of the past dialogue

6.1 Does the staff report clearly and meaningfully assess the authorities' response to the Fund's previous policy advice?

6.2 Does the assessment describe the authorities' policy actions in response to Fund's previous advice?

6.3 Does the assessment discuss the reasons for the authority’s actions?

6.4 Based on this backward-looking assessment, does the Fund surveillance appear to have been effective in this country?

6.5 Is there any evidence suggesting that staff has adjusted its mode of operation?

7. The authorities' views on the dialogue with the staff (as presented in the authorities' BUFF)?

7.1 Did the authorities view the dialogue as candid and open?

7.2 Did the authorities believe that discussions with the staff were useful?

7.3 How exactly?

article image

7.4 Did the authorities identify major areas of disagreement? If yes, in which areas?

7.5 What is the nature of the disagreement (the appropriateness of the policy action, its timing, or its feasibility given policy constraints, etc.)?

7.6 Did the authorities make any suggestions on how effectiveness of Fund consultations can be enhanced?

B. Surveillance in Program Countries

1. Was a program in place at the time of the consultation?

2. Are A4 issues clearly separated from UFR issues

article image

3. How is the PRSP/I-PRSP/PRSP Progress Report integrated in the Article IV Staff Report?

article image

4. How much space is given to the discussion of medium-term prospects and policies in the report?

article image

5. Qualify the section on medium-term prospects and policies

article image

C. Cross country experience/ Knowledge transfer

1. Does the report contain references to other countries?

if yes, specify which country

2. What is the context of such references?

article image
article image

3. How extensive is the reference?

article image

4. If cross-country analysis is used, please specify the issue/area covered

5. Does the report refer to or make use of analysis done by other individual/institutions/think tanks? if yes, specify which

article image

6. Please specify the structural/policy area where the above analysis is used

7. Did the report contain references to other Fund work?

article image

8. Does the report refer to/make use of/follow up the diagnosis made in the context of Fund TA missions?

9. If so, in what areas (fiscal, statistics, monetary policy instruments etc.)?

10. Does the report include an assessment of effectiveness of past Fund TA?

D. Format of report

1. What is its length in pages (without annexes)?

article image

2. Was there too much repetition?

if yes, what was the reason, in your view?

3. Did the report use proforma sentences (e.g., the exchange regime has served the authorities well)

if yes, give example

4. Did the introduction section add important information, or was the material repeated elsewhere?

5. Were “housekeeping issues” (date of last consultation, Article VIII status, etc):

article image

6. Were charts, text tables, boxes inserted in the main text of the report?

6.1 If yes: did they

article image

6.2 If text tables were included : was the amount of data included in these tables

article image

7. Were standard end tables and charts helpful to the reader?

article image

8. Was the amount of data included in the end tables

article image

9. Were appendices/annexes relevant to the report?

article image

10. Were boxes and appendices

article image

11. Were boxes and appendices

article image

References

  • Acemoglu, Daron, Simon Johnson, and James Robinson, 2004, “Institutions as the Fundamental Cause of Long-Run Growth,” NBER Working Paper No. 10481.

    • Search Google Scholar
    • Export Citation
  • Baxter, Marianne, and Alan Stockman, 1989, “Business Cycles and the Exchange-Rate Regime: Some International Evidence,” Journal of Monetary Economics, Vol. 23 (May), pp. 337400.

    • Search Google Scholar
    • Export Citation
  • Calomiris, Charles W., 1998, “The IMF’s Imprudent Role as Lender of Last Resort,” Cato Journal, Vol. 17 (Winter), pp. 27594.

  • Edison, Hali J., and Michael Melvin, 1990, “The Determinants and Implications of an Exchange Rate System,” in Monetary Policy for a Volatile Global Economy, edited by William S. Haraf, and Thomas D. Willet (Washington: The AEI Press).

    • Search Google Scholar
    • Export Citation
  • Fischer, Stanley, 2001, “Exchange Rate Regimes: Is the Bipolar View Correct?paper prepared for the meetings of the American Economic Association, New Orleans, January 6.

    • Search Google Scholar
    • Export Citation
  • Ghosh, Atish R., and others, 1997, “Does the Nominal Exchange Rate Regime Matter?NBER Working Paper No. 5874 (Cambridge, Massachusetts: National Bureau of Economic Research).

    • Search Google Scholar
    • Export Citation
  • Ghosh, Atish R., Anne-Marie Gulde, and Holger C. Wolf, 2003, “Exchange Rate Regimes: Choices and Consequences (Cambridge, Massachusetts: MIT Press).

    • Search Google Scholar
    • Export Citation
  • International Monetary Fund, Independent Evaluation Office, 2003c, IMF and Recent Capital Account Crises: Indonesia, Korea, Brazil: Evaluation Report (Washington: International Monetary Fund).

    • Search Google Scholar
    • Export Citation
  • Levy-Yeyati, Eduardo, and Federico Sturzenegger, 2002, “Classifying Exchange Rate Regimes: Deeds versus Words,” Universidad Torcuato Di Tella. Available via the Internet at: www.utdt.edu/~fsturzen.

    • Search Google Scholar
    • Export Citation
  • Levy-Yeyati, Eduardo, and Federico Sturzenegger, 2003, “To Float or to Fix: Evidence on the Impact of Exchange Rate Regimes on Growth,” American Economic Review, Vol. 93, No. 4 (September), pp. 117393.

    • Search Google Scholar
    • Export Citation
  • Mongelli, Paolo, 2002, “New Views on The Optimum Currency Area Theory: What is EMU Telling US?,” ECB Working Paper 138, April 2002.

  • Mussa, Michael, 1986, “Nominal Exchange Rate Regimes and the Behavior of Real Exchange Rates: Evidence and Implications,” Carnegie-Rochester Conference Series on Public Policy, Vol. 25 (Fall), pp. 117214.

    • Search Google Scholar
    • Export Citation
  • Mussa, Michael, and others, 2000, Exchange Rate Regimes in an Increasingly Integrated World Economy, IMF Occasional Paper No. 193 (Washington: International Monetary Fund).

    • Search Google Scholar
    • Export Citation
  • Mussa, Michael, 2002, “Argentina and the Fund: From Triumph to Tragedy” (Washington: Institute for International Economics).

  • Rogoff, Kenneth S., Aasim M. Husain, Ashoka Mody, Robin Brooks, and Nienke Oomes, 2004, Evolution and Performance of Exchange Rate Regimes, IMF Occasional Paper 229 (Washington: International Monetary Fund).

    • Search Google Scholar
    • Export Citation
  • Rose, Andrew, 2004, “A Meta-Analysis of the Effect of Common Currencies on International Trade,” NBER Working Paper No. 10373, (Cambridge, Massachusetts: National Bureau of Economic Research).

    • Search Google Scholar
    • Export Citation
  • Thom, Rodney, and Brendan Walsh, 2002, “The Effects of a Currency Union on Trade: Lessons from the Irish Experience,” European Economic Review, Vol. 46, pp. 11111123.

    • Search Google Scholar
    • Export Citation
1

The main author of this section is Jesmin Rahman.

2

IMF Executive Board Reviews the Fund's Surveillance—Biennial Review of the Implementation of the Fund’s Surveillance and of the 1977 Surveillance Decision (Public Information Notice No. 02/44, 4/18/2002), available at www.imf.org.

3

IMF Reviews Experience with the Financial Sector Assessment Program and Reaches Conclusions on Issues Going Forward (Public Information Notice No. 03/46, 4/4/2003), available at www.imf.org.

4

IMF Concludes Discussion on Prolonged Use of Fund Resources (Public Information Notice No. 03/49, 4/9/2003), available at www.imf.org.

5

IMF Discusses Applications of and Methodological Refinements to Assessments of Sustainability— (Public Information Notice No. 03/111, 9/5/2003), available at www.imf.org.

6

Biennial Review of the Implementation of the Fund’s Surveillance and of the 1977 Surveillance Decision— Modalities of Surveillance, available at www.imf.org.

7

When a particular structural or institutional issue is covered, it is relatively straightforward to assess whether it has macroeconomic relevance on the basis of information provided in the staff report. It is harder to detect where issues not presented in the report ought to have been covered due to their macroeconomic relevance.

8

At the conclusion of their discussion on the follow-up on the recommendations of the IEO report on fiscal adjustment in IMF-supported programs, Executive Directors encouraged wider use of Fiscal Strategy Briefs (Public Information Notice No. 04/19, 3/11/2004), available at www.imf.org. As of June 30, 2004, 48 such briefs have been prepared and posted on FAD's website. More recently, FAD has prepared a guidance note for staff on the presentation of fiscal policies in staff reports.

9

A report was deemed to show a reasonable level of candor if it articulated the authorities’ views in key areas well, and laid out areas of disagreement and the reasons for these differences of view.

10

Biennial Review of the Implementation of the Fund’s Surveillance and of the 1977 Surveillance Decision— Surveillance in a Program Environment (Supplement 2, 4/18/2002), available at www.imf.org.

11

See Biennial Review of the Implementation of the Fund’s Surveillance and of the 1977 Surveillance Decision—Follow-Up (7/15/2002).

12

This sample includes 27 countries that had a Fund-supported program, or were requesting use of Fund resources, at the time of the Board conclusion of the Article IV consultation. Among these, two countries had programs that were considered off-track. In addition, the sample includes 10 countries whose latest Fund- supported program had recently expired or that were in between programs at the time of the consultation.

13

In Table 1, “adequate coverage” of recent economic developments means a substantial discussion with a clear storyline, which is not wrapped around program developments. “Adequate coverage” in stock-taking includes a discussion of policy strategy to date, identification of areas of strength and weakness and a discussion of implications for future policies. A “barely adequate coverage” falls short of providing recommendations, while “inadequate coverage” entails either an absence of discussion or a discussion that is completely pro forma. For the short- and medium-term outlook, an “adequate coverage” means a “yes” answer to questions 4 and 21-24 of the questionnaire (see Appendix); “barely adequate coverage” applies to cases where coverage misses one or more of these areas, but where an assessment can be made from the rest of the report; “inadequate coverage” misses one or more key areas (for example, short-term outlook or a key vulnerability area). For policy dialogue, the definition of adequacy is less clear-cut where readers often rely on the perception of the policy dialogue they extract from the reports. Reports with clear presentation of the authorities’ views in key areas are judged to have “adequate dialogue,” reports; where authorities’ views are missing in some key areas but there is an implicit sense of agreement with the staff, dialogue is judged to be “barely adequate,” reports where authorities’ views are largely missing, the dialogue is considered “inadequate.”

14

As a result of greater flexibility in consultation cycles, about half of the Article IV reports for program countries were prepared on a stand-alone basis—a significantly higher proportion than in preceding years. Prior to the introduction of EPAs, a few Article IV consultations that were combined with discussions on use of Fund resources (UFR) were conducted using somewhat different procedures than usual: a senior staff member was added to the country team to lead the Article IV consultation (but not the UFR discussions); separate consultation and UFR reports were produced; or separate Board discussions on the Article IV consultation and UFR took place. For details, see Enhancing the Effectiveness of Surveillance—Operational Responses, the Agenda Ahead, and Next Steps (4/10/2003), available at www.imf.org.

15

In a few cases, the reports mentioned the authorities’ dependence on staff’s technical expertise, which might have contributed to a muted dialogue.

16

Poverty Reduction Strategy Papers (PRSPs)—Progress in Implementation (9/22/2003) available at www.imf.org.

17

An operational guidance note to staff on financial sector surveillance in Article IV consultations is under preparation. It will reflect past Board discussions of this question, and seek to deepen understanding of the objective, scope, focus, and modalities of treatment of financial sector issues in Fund surveillance.

18

There are five key categories of FSIs: capital adequacy, asset quality, earnings and profitability, liquidity and sensitivity to market risk.

19

Follow-Up on the Recommendations of the Independent Evaluation Office Report on Fiscal Adjustment in IMF-Supported Programs (Public Information Notice No. 04/19, 3/11/2004), available at www. imf.org.

20

Independent Evaluation Office—Evaluation of Fiscal Adjustment in IMF-Supported Programs (9/9/2003), available at www.imf.org. 21 Assessors identified 16 such cases.

21

In this review’s sample of 25 emerging market countries, one third of Article IV missions included an expert from ICM.

22

The main author of this section is Piyabha Kongsamut.

23

Under this pilot country study, the World Bank is costing different sectoral programs designed to achieve the MDGs. Once this is done, the Fund will consider how to integrate these programs and their accompanying external resource requirements in a coherent macroeconomic framework.

24

Article IV, Section 3(b) stipulate that the principles adopted by the Fund for guidance of all members with respect to exchange rate policies shall respect the domestic social and political policies of members.

25

The main author of this section is Christian Mumssen.

26

The operational guidelines for staff that emanated from the review noted that: “Article IV staff reports are expected to highlight the domestic consequences of global economic conditions and, where relevant, of developments in international capital markets. At the same time, surveillance in systemically important countries needs to pay close attention to the regional and global impact of economic developments and policies in these countries. Staff reports need to discuss these spillover effects.”

27

There are some notable exceptions to this observation, such as the substantial coverage of domestic risks related to global growth and potential oil price shocks in the 2002 Article IV consultation reports for Korea (3/19/2003) and the United Kingdom (3/3/2003), both available at www.imf.org.

28

The G-3 are defined here as the EU/euro area, Japan, and the United States. The review of the EU/euro area surveillance focused primarily on the staff report on Euro Area Policies (9/16/2003), available at www.imf.org.

29

For an analytical discussion of global spillovers, see, for example, Chapter II of the October 2001 World Economic Outlook. For a discussion of the impact of mature market interest rates on emerging market spreads, see Chapter II of the April 2004 GFSR. Both are available at www.imf.org.

30

By contrast, the systemic dimension of economic developments and policies of the largest euro area members is not mentioned in their respective Article IV consultation reports.

31

The main authors of this section are Ashoka Mody and Tania Reif.

32

Exchange Arrangements and Foreign Exchange Markets—Development and Issues, World Economic and Financial Surveys, March 2003, available at www.imf.org

33

How to classify exchange rate regimes remains a debated issue. Accordingly, several missing and inconclusive observations in the Levy-Yeyati and Sturzenegger (2003) classification have raised concerns about their conclusions.

34

This result is also consistent with the finding that relatively poor and small countries benefit from currency unions in the form of enhanced trade (Rose, 2004, and Thom and Walsh, 2002).

35

These appeals have been reinforced by calls for the Fund to intensify its surveillance over members’ exchange rate regime and supporting policies, underscoring the importance of an improved understanding of the macroeconomic performance of alternative regimes (Calomiris, 1998; International Financial Institution Advisory Commission, 2000; Mussa, 2002; and IMF, Independent Evaluation Office, 2002).

36

Exchange Regimes in an Increasingly Integrated World Economy (Occasional Paper No. 193, 8/10/2000), available at www.imf.org.

37

Ibidem. countries, a tendency toward either more flexible arrangements or more constraining exchange rate systems was perceived;

38

See Appendix for the questionnaire.

39

The main authors of this section are Nicolas Blancher and Ioannis Halikias.

40

See Box 1 in the report on the Review of Data Provision to the Fund for Surveillance Purposes (4/12/2004), available at www.imf.org, for a presentation of the coverage of, and articulation between, these initiatives.

41

For a full description of such a framework, see The Balance Sheet Approach and its Application at the Fund (6/30/2003) and A Balance Sheet Approach to Financial Crisis (Working Paper No. 02/210, 12/1/2002), available at www.imf.org.

42

For example, in advanced economies, the following topics have been a focus of surveillance: foreign exchange loans to households in Austria; household saving in Canada and the U.S.; bank international linkages and foreign exposures in Germany, Portugal and Spain; corporate sector vulnerabilities in Japan (including stress tests); and pension fund issues in the Netherlands and the U.S. In emerging market economies, corporate sector balance sheets have been a focus of staff reports on Malaysia, Mexico, and South Africa.

43

Mirroring this, integration of balance sheet analysis is absent in 24 and 44 percent of staff reports in advanced and developing economies—against 4 percent in emerging market economies.

44

See Review of Data Provision to the Fund for Surveillance Purposes (4/12/2004), available at www.imf.org.

45

The main authors of this section are Lynn Aylward, Anton Op de Beke, and Todd Schneider.

46

A growing body of economic literature stresses that economic institutions are not exogenous (or so-called state) variables. It puts emphasis on the distribution of political power, which shapes economic institutions, and on its determinants, namely political institutions and distribution of resources, as ultimate determinants of differences in economic development (see, for instance, Acemoglu, Johnson, and Robinson (2004).

47

This does not mean that all reports for small island economies had little or no coverage of structural issues. Institutional issues were covered extensively in reports for several small island economies (e.g., Antigua and Barbuda, Samoa, and Tonga).

48

For instance, it was noted in one Article IV consultation that the report had limited coverage of institutional issues while the Executive Director’s Buff Statement emphasized their importance in fostering growth.

49

The potential contribution of ROSCs (and FSAPs) to coverage of institutional issues in surveillance is also affected by the voluntary nature of these initiatives.

50

In addition to the review of Article IV consultation reports, this section draws heavily on the paper on the Investment Climate—Concept and Selected Issues for Fund Surveillance, available at www.imf.org.

51

“Investment climate issues are to be part of systematic and regular analysis in preparation of country strategies and will be considered routinely in the Bank Group’s assistance strategies.” Private Sector Development Strategy – Directions for the World Bank Group, (World Bank Group 4/9/02), available at www.worldbank.org.

52

See, for example, the CMCG report Foreign Direct Investment in Emerging Market Countries, September 2003, available at www.imf.org.

53

IMF Discusses Applications of and Methodological Refinements to Assessments of Sustainability (Public Information Notice No. 03/111, 9/5/2003), available at www.imf.org.

54

See the paper on the Investment Climate—Concept and Selected Issues for Fund Surveillance, available at www.imf.org.

55

The Fund has on several occasions interrupted or delayed financial support to member countries with Fund- supported programs because of the failure of the members to address specific governance concerns of the Fund and the international community.

56

Box 11 provides additional information on the Fund’s role in governance initiatives relating to extractive industries.

57

The GFSR has addressed the importance of corporate governance. This is another area where multilateral surveillance can inform bilateral surveillance.

58

For information on PWYP, see http://www.publishwhatyoupay.org/, and for information on the EITI, see http://www.dfid.gov.uk/.

59

For an analysis of the genesis and content of the Convention, see OECD Convention on Combating Bribery of Foreign Public Officials in International Business Transactions (9/18/2001), available at www.imf.org.

60

See Global Corruption Report 2004, Transparency International (page 128) which can be found at http://www.transparency.org/.

61

While monetary and financial policy transparency ROSCs were not frequently cited in the survey staff reports, governance generally receives prominent coverage in such ROSCs.

62

Information would be provided by members on a voluntary basis.

  • Collapse
  • Expand
Biennial Review of the Implementation of the Fund's Surveillance and of the 1977 Surveillance Decision - Overview, Modalities of Surveillance, and Content of Surveillance
Author:
International Monetary Fund