Background

Although much has changed in the international monetary system since the Bretton Woods agreement was formulated in 1944, the rationale for the IMF’s work, as embodied in its Articles of Agreement, still holds. Article I specifies, in the context of promoting an open and growth-oriented world economy through monetary cooperation, that the IMF should “give confidence to members by making the general resources of the IMF temporarily available to them under adequate safeguards, thus providing them with opportunity to correct maladjustments in their balance of payments without resorting to measures destructive of national or international prosperity.”

Confidence to members, Masson and Mussa explain, refers both to the actual financial support the IMF offers members in time of difficulty and the “reasonable expectation that appropriate support will be available for members that accept the inevitable (and generally desirable) risks when they adopt more open policies.” The temporary nature of this assistance and the assurance of safeguards protect the resources of the institution and those of the entire membership. The insistence on a balance of payments need likewise limits the scope of IMF support. In effect, the IMF’s conditional financial support for strong adjustment programs undertaken by member countries helps forestall otherwise harsher and more disruptive measures that might negatively affect not only the adjusting economy but also its trade and finance partners.

The IMF’s mandate to conduct surveillance is, in principle, distinct from its financing responsibilities. In practice, there is a symbiotic relationship between the two, with surveillance interacting with the purposes of, and need for, financing. In a perfect world, surveillance would identify problems early, and the policy response would be prompt and appropriate. The number and severity of economic disturbances would be reduced accordingly, and the need for financing would be minimal. But in the real world, Masson and Mussa observe, countries must cope with external disturbances that cannot be anticipated and deal with the consequences of human error. Financing strengthens the hand of surveillance, providing leverage to motivate adjustment and helping cushion possible adverse effects of adjustment.

The roles of IMF financing and surveillance have evolved with changes in the international monetary system. The authors cite four major developments that have reshaped the global economic landscape, with significant implications for the work of the IMF:

• Greater exchange rate flexibility. With the Second Amendment to the Articles of Agreement, IMF surveillance replaced its earlier responsibility for supervising exchange rates under the par value system. Since the monetary policies of the major industrial countries now provide the nominal anchor for the international monetary system, ensuring that these policies are not inflationary, deflationary, or a source of major disturbance has become a critical focus of surveillance.

• Massive changes in the size and agility of private capital flows. Industrial countries now generally have continuous access to international capital markets. As a result, IMF financial support is no longer directed to industrial countries but to developing countries and, more recently, centrally planned economies in transition to market oriented systems. Enhanced mobility of capital has both good and bad sides. Private capital flows give countries wider scope to finance current account deficits and increase domestic investment, but in some instances this has allowed countries to postpone needed adjustment. Moreover, it is now more difficult to maintain a pegged exchange rate if the market believes that rate is no longer viable.

• Increased economic integration. The sustained growth in trade and the dramatic expansion in capital flows have hastened and intensified economic integration. Increased integration, however, has also left countries increasingly vulnerable to external shocks through these same trade and capital flow linkages.

• Expanded IMF membership. Two historic trends—decolonization and the transformation of formerly centrally planned economies—have universalized the IMF and nearly quadrupled the number of its member countries, to 181 at present from 46 in 1945.

Rationale for Financing

In the original Articles of Agreement, the IMF’s creators assumed a central role for IMF financing. In fact, few industrial countries have drawn on these resources to address payments imbalances. In recent years, countries with secure access to international capital markets—most of the industrial countries and a few of the developing ones—have relied exclusively on private financing. Does the increasingly prominent role of international capital markets preclude a future role for the IMF as a supplier of balance of payments financing? Market imperfections and the otherwise inadequate availability of international public goods justify a continuing role for IMF financing, according to Masson and Mussa.

Market Imperfections. Unimpaired access to the world’s capital markets is still not available to many countries. If these countries face balance of payments difficulties yet are unable to secure access to private market financing and have no recourse to official financing, they may pursue, over the short term, policies destructive not only to their own but to others’ prosperity. Timely financing from the IMF, with appropriate conditionality, allows members to address payments imbalances effectively while limiting a spillover of these problems to other countries.

It is widely acknowledged that the discipline the private capital markets exercise hastens recognition of unsustainable policies and prompts remedial action, but the market has neither access to complete information nor the impetus to seek socially optimal solutions. Market imperfections derive from four key elements:

• Incomplete information. Inadequate or erroneous information can mislead the market, prompting a shift in sentiment unwarranted by economic fundamentals.

• Bandwagon effects and “free rider” behavior. The debt crisis of the 1980s, Masson and Mussa note, illustrates both dangers. Fierce competition to make loans and a lack of adequate appreciation of potential risks encouraged over-lending; then, when the crisis came, jockeying for position relative to other creditors to obtain reimbursement from the borrowing country greatly complicated debt-restructuring negotiations.

• Reluctance to lend to sovereign borrowers. Sovereign borrowers sometimes find it difficult to provide credible commitments to repay, because private creditors lack adequate means to enforce proper conditionality in circumstances of actual or potential default.

• Multiple equilibria. Faced with two or more conflicting scenarios, the market may focus on one that is worse for all concerned. Lack of confidence in a country’s policies on the part of financial markets can lead to a self-fulfilling failure to achieve needed adjustment by denying the country the financing needed to carry it out, whereas if financing had been available, a better outcome (involving repayment of the creditors) would have resulted.

IMF surveillance and financing can compensate for these market imperfections, maintain Masson and Mussa. Stronger surveillance encourages countries to make more data available on a timely basis and thus allows markets to make better informed judgments. It also helps member countries put their financial houses in order and improve their relations with commercial banks and official lenders. This, in turn, instills confidence in the member’s adjustment policies and facilitates debt-restructuring agreements.

But, according to Masson and Mussa, the IMF exercises its greatest impact in providing financing conditional on strong adjustment policies, supplemented by prudent policy advice. The IMF’s commitment of resources to a member’s adjustment program is a clear statement of confidence in those policies and is more likely than verbal assurances of support to convince private lenders and, thereby, to stimulate additional financing from other sources. The exercise of conditionality places the IMF in a better position than private lenders to work with sovereign borrowers. IMF lending, accompanied by conditionality, reassures other lenders, however, by signaling the country’s pursuit of sound policies and increased ability to repay loans. The IMF’s conditional financing reduces the potential for self-fulfilling confidence crises, which, by denying credit, might not permit the desirable policy reforms that would otherwise have taken place. Also, appropriate conditionality is essential for limiting the “moral hazard” that might otherwise arise from expectations of financial support.

Inadequate Access to International Public Goods. The IMF also encourages the provision of international public goods, most notably by standing ready to make resources available in times of crisis. The IMF, note Masson and Mussa, encourages economic openness by “supplying a form of insurance against adverse shocks for countries … that are liberalizing or have liberalized their economies.” This insurance takes the form of providing access to IMF credit, under appropriate conditionality, if balance of payments positions deteriorate. This is credit that private lenders either will not provide or will do so only upon payment of a risk premium, because private lenders do not fully account for the benefits to global welfare of their lending. The availability of IMF financing both encourages countries to pursue appropriate policies and enhances the ability of other organizations to do their work—such as the World Trade Organization, whose job is to facilitate reduction of trade barriers.

Another international public good is facilitating the smooth adjustment and stability of the exchange rate system, one of the primary purposes of the IMF. In an era of flexible exchange rates, IMF surveillance seeks to minimize volatility and misalignments, and in doing so benefits all countries.

Implications for IMF Resources

The speed and scope of the Mexican economic crisis of 1994-95 signaled that changes in the international monetary system—particularly the growing role of private capital flows—have significantly recast the nature of economic crises, with consequent implications for both IMF financing and surveillance. Masson and Mussa do not estimate the amount of IMF financing that might be needed in coming years, but they review the broad components of potential demand for resources from industrial, transition, and developing economies.

Industrial countries have not made use of IMF resources in two decades. If they were to draw on IMF resources in the future, it would presumably be in a period of generalized economic stress.

The authors believe that prudent longer-range planning necessitates a scale of liquidity adequate to accommodate possible drawings by IMF creditor countries, as well as an increase in the funds available under the General Arrangements to Borrow to supplement the IMF’s resources in times of crisis.

Some transition economies have successfully stabilized their economies, implemented structural reforms, and recently gained access to private capital markets. Without an established track record, however, they cannot be assured of continuing market access if a balance of payments financing need emerges. The more advanced transition economies may continue to need IMF financing on an occasional basis. Those less advanced in their stabilization efforts and still seeking to solidify their relationship with creditors and donors are likely to have greater and more prolonged need for IMF resources, but this should not override the fundamental principle that IMF financial support “should be temporary,” Masson and Mussa say.

For middle-income developing countries and their trade and financial partners, substantially greater openness has meant faster growth and improved welfare. At the same time, it has heightened countries’ vulnerability to external developments—particularly shifts in world capital market conditions and in investor sentiment toward emerging markets. Most of these countries will remain vulnerable to withdrawals of access to private financing. Accordingly, Masson and Mussa believe, the IMF will continue to play an important role in providing finance, when necessary to support strong adjustment programs.

The poorest developing countries, many of which struggle under heavy debt burdens and face enormous structural imbalances, often require concessional financing. In particular, they need access to the IMF’s enhanced structural adjustment facility (ESAF)—rather than lending from the IMF’s general resources at market rates. Despite the long-term and structural nature of these countries’ needs, the IMF’s involvement remains the same: macroeconomic policy advice and balance of payments financing.

As the IMF adapts its financing role to enhance its adequacy, timeliness, and effectiveness, surveillance will continue to play a key role in limiting the need for financing and in helping to reduce the severity of economic disruptions. IMF surveillance influences the organization’s financing requirements in three critical areas:

• Avoidance of generalized economic stress. Simultaneous requests for financing are likely to place the greatest potential strain on IMF resources and are most likely to arise from instances of widespread economic disruption. The IMF’s multilateral surveillance is well positioned to focus on the causes of such disturbances and to recommend appropriate policies to ameliorate or avoid them. To do so, it must focus not only on the likely users of IMF financing but also (and especially) on the countries whose policies are likely to have systemic implications. This increased attention to the broader impact of the policies of the major industrial and larger developing countries can help reduce pressures on the IMF’s financial resources.

• Early diagnosis. Early identification of member country payments problems facilitates timely adjustment and reduces the incidence and severity of imbalances. By serving as an effective early warning device, IMF surveillance can reduce the need for IMF financing and limit the severity of crises that might otherwise have widespread contagion effects.

• More attention to financial sector vulnerabilities. Identifying and helping members address systemic weaknesses in the crucial financial sector can, in turn, facilitate the correction of balance of payments imbalances and reduce the scale of financing needs.

Masson and Mussa conclude that recent IMF initiatives have begun to address these priorities. In response to the recommendations of an April 1995 meeting of the Interim Committee (of the Board of Governors on the International Monetary System), the IMF has moved in several areas to strengthen its surveillance. In particular, it is placing greater emphasis on the regular and timely provision of economic data by members to the IMF, and developing standards for the public dissemination by countries of comprehensive economic data on a timely basis; establishing a closer and more continuous policy dialogue with its members and furnishing more candid advice on appropriate policies; giving increased attention to members financing policies; and providing more rigorous surveillance over economies whose policies have potential systemic significance.

The Polish Example

Although Poland has made significant gains in fighting inflation over the past five years—consumer price inflation dropped to 27.8 percent in 1995 from 585.8 percent in 1990—further reductions are necessary if the economy is to enter a period of sustained low inflation. Inflation has proved considerably more resilient than anticipated for the following reasons:

• Polish inflation has been accompanied by marked changes in relative prices. Specifically, utility and rental price inflation has vastly exceeded overall inflation. To improve profitability, these sectors, and loss-making firms in general, must alter their relative prices to remain in business. In addition, prices in many sectors are still converging toward international levels.

• In a well-indexed economy, such as Poland’s, the effects of frequent sectoral price hikes are magnified. Employing a small wage-price model of the Polish economy, the IMF analysis demonstrates that after four years, the initial impact of an inflationary shock is quadrupled, even while the exchange rate has remained constant. Sectoral inflationary pressures, combined with high indexation, mean that very tight monetary policy would have been required to combat inflation. As a result, a reduction in the widespread indexation is needed to help achieve low inflation.

Inflation Trends in Poland

(In percent)

Citation: IMF Survey 25, 001; 10.5089/9781451937442.023.A003

Data: Polish authorities

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Inflation Trends in Poland

(In percent)

Citation: IMF Survey 25, 001; 10.5089/9781451937442.023.A003

Data: Polish authorities

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Inflation Trends in Poland

(In percent)

Citation: IMF Survey 25, 001; 10.5089/9781451937442.023.A003

Data: Polish authorities

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• Certain underlying problems, particularly involving the labor market, undermine the efficiency of monetary and fiscal policies. The political concerns associated with potentially large job losses in certain sectors, for example, continue to allow certain firms to avoid facing up to hard budget constraints. Indeed, the very threat of additional unemployment provides well-entrenched enterprises with formidable political influence, which can weaken government efforts to introduce hard budget constraints in the less competitive sectors of Poland’s economy.

The interaction of relative price adjustment and restructuring has been of particular importance for the Polish economy.

Relative Prices. The course of energy price inflation over the past five years illustrates the problem of relative price adjustment. One of the key reasons why price adjustment in this sector has been delayed can be traced to the legacy of central planning. Throughout Eastern Europe, including Poland, energy price subsidies constituted a vital part of the social safety net. Even while Poland is rapidly moving toward becoming a full-fledged market economy, the existing structure of price supports not only continues to encourage overconsumption of energy products, it actually benefits upper-income groups more than lower-income ones. Current subsidies to Poland’s steel and household heating sectors are such that these sectors’ patterns of energy consumption are comparable to those of Western countries before the oil shock of the early 1970s.

While Poland has undertaken a degree of energy price liberalization, it is in need of a good deal more price adjustment in this and other sectors. Since further energy price increases could trigger social tensions, such increases could be accompanied by cash or voucher distribution to compensate households.

Restructuring. Tighter monetary policy has an important role to play in moderating Polish inflation. Tight monetary policy, however, cannot substitute for structural reform. Indeed, without active restructuring and the imposition of hard budget constraints, the demands of tight monetary policy will impose too heavy a burden on Poland’s emerging private sector.

Given the political influence of traditional industries, and the employment consequences of rapid adaptation to market forces by many of Poland’s traditional firms, restructuring will not be easy. The current situation can best be described as a “fault line,” which pits two different groups of Polish firms against each other: those benefiting from the price shocks of the early 1990s, and those for which they proved detrimental, namely the old industrial sector. Many of these old firms have since been able to survive by adopting a “wait and see” approach to restructuring—effectively putting it off. As a result, relative wages have remained fairly stable, while labor shedding continues to fall short of restoring profits. Meanwhile, privatized or newly created firms have been less inclined to procrastinate; in certain cases, they have made significant strides toward reaching industrial country productivity standards.

The coal mining sector illustrates the problem facing firms that continue to delay restructuring. Sizable productivity gains by the coal industry indicate that some restructuring has already taken place, helping improve this sectors’ profitability. Despite this, the coal sector continues to run substantial losses while providing workers with wages considerably above those in Polish industry as a whole. These developments have resulted in high-priced coal, erosion in the value of coal sector assets, and further delays in restructuring.

There is also evidence that loss-making firms account for a substantial fraction of Polish banks’ assets, which contributes to the fragility of the financial sector. Banks appear to have limited leverage to push such firms to restructure. In fact, they are unlikely to force them into bankruptcy because banks have low priority as creditors. As a result, banks tend to roll over past loans to keep themselves and these distressed sectors afloat.

Use of STF as of December 31, 1995

(million SDRs)

¹Maximum access under the systemic transformation facility (STF) amounts to 50 percent of an eligible member’s quota. Access to resources under this facility expired on December 31, 1995. Figures show gross disbursement.

²Percent of Cambodia’s quota—SDR 25 million—effective at the time of the drawing.

Data: IMF Treasurer’s Department

Use of STF as of December 31, 1995

(million SDRs)

Member		Amount Drawn	Percent of Quota1	Date of Drawings
Armenia		33.75	50	Dec. 19, 1994, July 3,1995
Azerbaijan		58.50	50	April. 24, 1995, Nov. 22, 1995
Belarus		140.20	50	Aug. 2, 1993, Feb. 2,1995
Bulgaria		116.23	25	April. 14, 1994
Cambodia		6.25	102	Oct. 7, 1993
Croatia		130.80	50	Oct. 19, 1994, April 13, 1995
Estonia		23.25	50	Nov. 1,1993, Jan. 12, 1995
Georgia		55.50	50	Dec. 20, 1994, July 3,1995
Kazakstan		123.75	50	July 28, 1993. Jan. 31, 1994
Kyrgyz Republic		32.25	50	May 17, 1993, Sep. 23, 1993
Latvia		45.75	50	Dec. 20, 1993, July. 20, 1994
Lithuania		51.75	50	Oct. 27, 1993, April. 13, 1994
Macedonia,
	former Yugoslav Republic of	24.80	50	Feb 14, 1994, May 10, 1995
Moldova		45.00	50	Sep. 21, 1993, Dec. 22, 1993
Romania		188.53	25	May 16, 1994
Russia		2,156.55	50	July. 6, 1993, April. 25, 1994
Slovak Republic		128.70	50	July. 29, 1993, July, 27, 1994
Ukraine		498.65	50	Oct. 31, 1994, April 12, 1995
Uzbekistan		99.75	50	Jan. 30, 1995, Dec. 21, 1995
Vietnam		24.16	10	Oct. 6, 1993, June. 13, 1994
	Total	3,984.11

¹Maximum access under the systemic transformation facility (STF) amounts to 50 percent of an eligible member’s quota. Access to resources under this facility expired on December 31, 1995. Figures show gross disbursement.

²Percent of Cambodia’s quota—SDR 25 million—effective at the time of the drawing.

Data: IMF Treasurer’s Department

View Table

Use of STF as of December 31, 1995

(million SDRs)

Member		Amount Drawn	Percent of Quota1	Date of Drawings
Armenia		33.75	50	Dec. 19, 1994, July 3,1995
Azerbaijan		58.50	50	April. 24, 1995, Nov. 22, 1995
Belarus		140.20	50	Aug. 2, 1993, Feb. 2,1995
Bulgaria		116.23	25	April. 14, 1994
Cambodia		6.25	102	Oct. 7, 1993
Croatia		130.80	50	Oct. 19, 1994, April 13, 1995
Estonia		23.25	50	Nov. 1,1993, Jan. 12, 1995
Georgia		55.50	50	Dec. 20, 1994, July 3,1995
Kazakstan		123.75	50	July 28, 1993. Jan. 31, 1994
Kyrgyz Republic		32.25	50	May 17, 1993, Sep. 23, 1993
Latvia		45.75	50	Dec. 20, 1993, July. 20, 1994
Lithuania		51.75	50	Oct. 27, 1993, April. 13, 1994
Macedonia,
	former Yugoslav Republic of	24.80	50	Feb 14, 1994, May 10, 1995
Moldova		45.00	50	Sep. 21, 1993, Dec. 22, 1993
Romania		188.53	25	May 16, 1994
Russia		2,156.55	50	July. 6, 1993, April. 25, 1994
Slovak Republic		128.70	50	July. 29, 1993, July, 27, 1994
Ukraine		498.65	50	Oct. 31, 1994, April 12, 1995
Uzbekistan		99.75	50	Jan. 30, 1995, Dec. 21, 1995
Vietnam		24.16	10	Oct. 6, 1993, June. 13, 1994
	Total	3,984.11

¹Maximum access under the systemic transformation facility (STF) amounts to 50 percent of an eligible member’s quota. Access to resources under this facility expired on December 31, 1995. Figures show gross disbursement.

²Percent of Cambodia’s quota—SDR 25 million—effective at the time of the drawing.

Data: IMF Treasurer’s Department

Policy Implications

The first-best approach would have dealt with relative price adjustment simultaneously with the initial price liberalization and stabilization. With this approach, hyperinflation would have given way to low inflation, with the bulk of relative price adjustment already completed. However, Poland only succeeded in lowering inflation to moderate levels. As a result, it soon inherited the institutional constraints, inertia, and slow adjustment that are typical of countries with moderate inflation. In such an environment, the inflationary effects of relative price adjustment become magnified and continue to stand in the way of sustained inflation reduction.

How best to reduce moderate inflation in the face of pressures for relative price adjustment? The ideal approach to addressing Poland’s persistent inflation would complement tighter monetary policy with increased restructuring. Restructuring is not meant to imply a return to centralized industrial policies; rather, it involves adopting hard budget constraints at the microeconomic level to stimulate adjustment. Restructuring also entails increasing wage and price flexibility, including adopting measures to reduce backward-looking indexation.

Political or resource constraints may, in practice, complicate such restructuring. It also takes time. In such circumstances, relying on tighter monetary policy alone may still prove a useful means of reducing inflation. In particular, the threat of tighter monetary policy by an independent central bank could result in better control of public finances and, ultimately, enforce a tighter budget constraint on loss-making firms.

The risk is that without continued restructuring, tighter monetary policy will remain costly. Failure to impose hard budget constraints evenly means that the burden of tighter monetary policy will be borne disproportionately. Failure to check the extent of backward looking indexation will increase the output costs of tighter monetary policy. And failure to complete the process of relative price adjustment means that significant inflationary forces will remain in place.

Industrial Countries

The reversal between 1993 and 1994 from a surplus to a deficit in the industrial countries’ combined current account can be traced to “current transfers” and the “income” components of the balance of payments. Industrial countries as a group after 1990 consistently recorded surpluses in trade in goods and services, and the magnitude of these surpluses in 1994 remained around the level of 1993 (about $96 billion and $27 billion, respectively). Outflows of current transfers, however, continued to grow (to $106 billion from $95 billion in 1993), and the overall deficit in the income account widened (to almost $30 billion from $13 billion in 1993).

Several industrial countries recorded sizable increases in their current account deficits in 1994. The U.S. deficit expanded by 50 percent, to $151 billion; that of Australia, also by some 50 percent, to $15 billion; and that of Germany, by 40 percent, to nearly $22 billion. In contrast, Japan, Switzerland, Italy, Belgium, Luxembourg, the Netherlands, and France recorded current account surpluses, in aggregate amounting to about $195 billion.

The industrial countries experienced net financial inflows in 1994, owing largely to developments in portfolio and other investment flows. This contrasted with a net outflow in 1993. Patterns of inward and outward direct investment flows in industrial countries did not shift substantially in 1994, but portfolio and other investment flows changed significantly. Japan, for example, recorded a 60 percent increase in portfolio investment abroad (outflows), while registering a fourfold rise in foreigners’ portfolio investment in Japan (inflows). Similarly, while Germany experienced an increase of nearly 70 percent in portfolio investment flows abroad, foreign portfolio investment in Germany doubled. In addition, portfolio investment abroad by the United States was only about 35 percent its level in 1993, while foreign portfolio investment flows into the United States rose by about 20 percent. Financial liabilities incurred by several industrial countries in the form of other investment inflows to their countries exceeded their acquisitions of similar assets abroad.

Current Account Balance and Net Financial Flows

(billion U.S. dollars)

Citation: IMF Survey 25, 001; 10.5089/9781451937442.023.A003

Data: Balance of payments Statistics Yearbook. 1995

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Current Account Balance and Net Financial Flows

(billion U.S. dollars)

Citation: IMF Survey 25, 001; 10.5089/9781451937442.023.A003

Data: Balance of payments Statistics Yearbook. 1995

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Current Account Balance and Net Financial Flows

(billion U.S. dollars)

Citation: IMF Survey 25, 001; 10.5089/9781451937442.023.A003

Data: Balance of payments Statistics Yearbook. 1995

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Developing Countries

The combined current account deficit of developing countries improved in 1994. The deficit narrowed to $75.3 billion, from $109.8 billion in 1993, largely because of a fall of about $20 billion in the merchandise trade deficit. The merchandise trade balances of China and Singapore improved significantly, while Indonesia and Malaysia continued to record trade surpluses.

Overall financial movements in developing countries—including changes in international reserves—showed a net inflow of $68.2 billion in 1994, well below the inflow of $108.3 billion in 1993. The slowdown in net inflows in 1994 owed to a rise in financial outflows coupled with a decline in inflows.

Financial outflows rose by about 25 percent in Asia in 1994, with China and Korea accounting for about 70 percent of the total. Financial inflows rose in Asia—in particular, in China, Korea, Thailand, and Singapore; inflows remained virtually unchanged in Africa, while those for Eastern Europe and the Western Hemisphere (especially Mexico) declined.

International Organizations

The current account balance of international organizations—including the IMF, the Bank for International Settlements, the European Monetary Institute, and international development banks—posted a surplus of $10.2 billion in 1994, considerably larger than the 1993 surplus of $6.2 billion. Most of the increase resulted from a rise in net receipts of official unrequited transfers. The current account surpluses of international organizations largely reflect their operational surpluses. The surpluses—frequently lent to member countries—result mainly from a positive interest margin on these organizations’ lending operations; they also reflect the fact that (with a few exceptions) they do not pay dividends to their shareholders (member country governments).

Net financial outflows, including changes in international reserves, also increased to $9.9 billion in 1994 from $7.2 billion in 1993. This resulted largely from a reduction in portfolio investment inflows to international organizations.

Global Discrepancies

Conceptually, the combined surplus and combined deficit in the current accounts of all countries and international organizations should offset each other, leaving no net balance (or discrepancy) in the global current account. The same principle applies to the global capital and financial accounts. In practice, large global discrepancies are recorded each year, mainly because of incomplete coverage and inaccurate recording of transactions by countries and omission of countries for which data are unavailable.

The statistical discrepancy in the global current account for 1994 amounted to approximately -$80 billion, or about 0.7 percent of gross current account transactions. (A negative statistical discrepancy in the global current account indicates an excess of recorded debits, which may reflect an under-recording of credits, an overstatement of debits, or both.) This outcome was similar to that for 1993, but represented a decline from the 1990-92 level, when the discrepancy averaged -$110 billion (or about 1 percent of gross current account transactions). Among the different components of the global current account, the largest discrepancy continued to appear in the income flows, followed by that for trade in goods. The asymmetry shown for recorded trade flows in services was the smallest.

The statistical discrepancy in the global financial account grew to about $100 billion in 1994 from approximately $80 billion in 1993—but was less than the average discrepancy for 1991 and 1992, about $130 billion. (A positive statistical discrepancy in the global financial account indicates an understatement of capital outflows, an overstatement of recorded inflows, or both.) Among the various types of financial flows, the largest asymmetry was recorded for “other investment,” a broad category that includes loans and other financial assets and liabilities. For “other investment,” recorded flows in liabilities in 1994 exceeded those in assets by about $120 billion. In that year, the discrepancy for portfolio investment was about $60 billion, a sharp decline from about $215 billion in 1993. The discrepancy for direct investment flows remained the smallest, at about $10 billion.

Anne Y. Kester

IMF Statistics Department

Exchange Rate Research and Policy at the IMF

Over its 50-year life, the IMF, according to Jacques Polak, has been at the center of thought and action about exchange rates. But, he emphasizes, the link between research on exchange rates and policy outcomes was not simple or direct. “Policies were no doubt in part influenced by the outcome of this research,” says Polak, “but to a large extent they followed from the situation in which individual countries found themselves.” The only constant in the research activities of the IMF was the search for an understanding of how exchange rates and regimes worked. Polak identifies three “reasonably distinct” research themes that grew out of successive phases in the IMF’s 50-year history.

Learning About Exchange Rates. In the first decade of the IMF’s existence, the reigning regime for most of its members was the par value system. The IMF’s influence over the particular par value that a member adopted was “modest at best.” The chief research effort during this period was directed toward an improved understanding of how exchange rates worked: how could the theoretical concepts embodied in the IMF’s Articles of Agreement be given operational content; how do exchange rates affect the balance of payments and employment; and what other variables contribute to balance of payments outcomes.

Although in its early years the IMF was not “squeamish” about suggesting to its members that a change in par values might be appropriate, it did not attach a numerical value to its suggestions. “It recognized a wrong exchange rate,’ says Polak, “but was not yet ready to put forward its own views on the correct rate.”

Finding the Correct Exchange Rate. From the early 1960s until the mid-1980s, research activities in the IMF focused on finding the “correct” exchange rate and persuading member countries to adopt that rate. Up until the early 1970s, when the par value system fell apart, IMF staff, working within the restraints imposed by the system, gradually acquired the ability to determine the quantitative appropriateness of exchange rates. Despite the increasing reluctance of the major industrial countries to envisage any changes in the par values of their currencies, the staffs view was that changes in par values should remain a realistic option.

The reluctance of the major industrial countries to consider significant modifications to the par value system left the world ill-prepared for the onset of the 1971 crisis of the U.S. dollar that eventually led to the collapse of the par value system and the institution of floating rates. The introduction of flexibility did not, however, diminish the IMF’s interest in equilibrium rates. “The principle that members, whatever their exchange rate regime, should see to it that they had the right exchange rate,” says Polak, “remained the law of the Fund.” But the attempt to explain and predict the movement of exchange rates under a floating rate regime has been, according to Polak, “the most disappointing branch of modern economics,” and by 1984, grounds for calculating equilibrium exchange rates had eroded considerably.

Finding the Right Regime. In the 15 years since 1980, the attention of IMF research focused on the merits of alternative exchange rate regimes for industrial and developing countries. Concern about volatility of the rates among the major currencies and instances of extreme misalignment have sparked considerable discussion about the best regime for these currencies. The consensus IMF staff view, which, according to Polak, takes its cue from a 1984 IMF Occasional Paper by Morris Goldstein (The Exchange Rate System: Lessons of the Past and Options for the Future), is that no one system is ideal for all countries and that a floating regime can operate successfully if supported by disciplined and coordinated macroeconomic policies.

As developing countries have come to account for virtually all of the use of the IMF’s resources, the institution has exercised greater influence over their exchange rate policies. Over the years, the IMF has encouraged borrowing countries to adopt economically justifiable exchange rates. In the early 1980s, exchange rate policy in IMF-supported adjustment programs relied on the government to set rates rather than letting market forces do so. This thinking shifted in the late 1980s in the direction of free floating in conjunction with liberalization of trade and payments as a means of inducing countries to accept an economically correct exchange rate. Recently, the IMF has taken a more balanced approach, weighing the competitive benefits to be derived from a floating rate against the benefits of avoiding inflation through the adoption of an exchange rate anchor. Recent IMF studies by Susan Schadler, Mauro Mecagni, and others, conclude that a short-term trade-off between the two objectives of stability and competitiveness has to be considered, taking into account the country’s financial policies and the adequacy of its external reserves.

IMF Technical Assistance: May-October 1995

(In person years)

Citation: IMF Survey 25, 001; 10.5089/9781451937442.023.A003

Note: IMF technical assistance is conducted under the IMF’s own grant resources and through financing arrangements with the United Nations Development Program, the World Bank, the European Union, the Japanese Government, and other donors.¹Including legal and computer services.

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IMF Technical Assistance: May-October 1995

(In person years)

Citation: IMF Survey 25, 001; 10.5089/9781451937442.023.A003

Note: IMF technical assistance is conducted under the IMF’s own grant resources and through financing arrangements with the United Nations Development Program, the World Bank, the European Union, the Japanese Government, and other donors.¹Including legal and computer services.

• Download Figure
• Download figure as PowerPoint slide

IMF Technical Assistance: May-October 1995

(In person years)

Citation: IMF Survey 25, 001; 10.5089/9781451937442.023.A003

Note: IMF technical assistance is conducted under the IMF’s own grant resources and through financing arrangements with the United Nations Development Program, the World Bank, the European Union, the Japanese Government, and other donors.¹Including legal and computer services.

• Download Figure
• Download figure as PowerPoint slide

During May-October, 155 person years were spent on the delivery of technical assistance by IMF staff, long- and short-term experts, and on seminars and workshops (excluding IMF headquarters seminars provided by the IMF Institute).

Major new initiatives in May-October included:

• expansion and utilization of the IMF’s Framework Administered Account to allow greater flexibility for those donors wishing to contribute to the financing of technical assistance activities;

• establishment by the Japanese Government of a scholarship program for studies by Asian students, and a substantial increase in Japan’s contribution to IMF technical assistance activities through the Japan Administered Account;

• commencement of joint technical assistance programs with UNDP in Haiti, Malawi, and Yemen; and

• continued technical assistance country-level collaboration with the World Bank in Albania, Rwanda, Hungary, Lebanon, the former Yugoslav Republic of Macedonia, Mozambique, and Turkey.

Data: IMF Technical Assistance Committee

How the Principle of Surveillance Developed

The principle of IMF surveillance, although not explicitly mentioned in the original enabling Bretton Woods documents, is implied in the IMF’s Articles of Agreement. According to Harold James, in his historical review of the evolution of surveillance from the rules-based Bretton Woods regime to the multilateral surveillance undertaken by the IMF and the major industrial countries, the principle of surveillance developed out of two parallel considerations. As established in its charter, the IMF’s responsibility for the overall functioning of the international monetary system called for the institution to investigate national economic policies. The IMF’s Articles also committed the institution to act as a center for the exchange and transmission of information, while obligating member countries to provide data on national income, prices, and international financial transactions.

The second consideration evolved from the conditionality attached to a member’s use of IMF resources and the consequent need for monitoring; it is embodied in the stand-by arrangement, which, according to James, has become the most characteristic vehicle for IMF financial support.

The main focus of James’s article is on multilateral surveillance as a central element in the management of the international monetary system and as a means of reducing systemic disturbances caused by inappropriate national policies. IMF surveillance was explicitly recognized in Article IV of the Second Amendment to the Articles of Agreement, which emerged from the collapse of the par value system in the 1970s. The principle of surveillance was not new to the IMF: before 1958, it had been practiced through regular consultations under Article XIV for countries with nonconvertible currencies and also, after 1958, through consultations with member countries that had accepted convertibility. Under Article IV, however, the IMF would hold annual consultations with all its members. The new principle, says James, “was universal and all embracing,” including all countries whether they had IMF programs or not and recommending structural adjustment in all countries, developing or developed, with chronic balance of payments problems.

The weakness of the Bretton Woods System had been the absence of any mechanisms for encouraging members to adjust exchange rates promptly to changed circumstances. A major task of IMF surveillance, then, was to identify exchange rate policies leading to inappropriate rates at an early stage and to initiate discussions outside the framework of the regular Article IV consultations in the case of a member’s continuing to pursue such policies. As James demonstrates, however, exchange rate policy was a highly politicized topic, sensitive to leakages; as such, it was “more or less tacitly excluded from the formal part of the consultations procedure.”

Of more lasting value, says James, has been the development of the World Economic Outlook exercise. This exercise grew out of Article IV consultations, which provided the basis for statements about world economic developments and the role of national policies. The World Economic Outlook mechanism, says James, allows for a “continual interplay” between the ideas of the IMF, partially formed by the staff’s regular contact with member country officials, and the views of the countries as expressed through their representatives on the IMF’s Executive Board.

James also traces the development of multilateral surveillance among the major industrial countries outside the purview of the IMF. In the 1960s, attempts by the Group of Ten to coalesce into an effective provider of surveillance were frustrated by a combination of political and intellectual resistance to changes in national policy in support of international equilibrium. Although the Group of Seven major industrial countries began holding yearly summits in the 1970s, the absence of consensus about economic policy among them undermined the practice of global surveillance. Since 1982, the Group of Five finance ministers have held economic summits, with the Managing Director of the IMF attending in a personal capacity. Over the years, various summits have attempted to find a formula or mechanism that would provide for a more rigorous and structured discussion of international economic problems without too serious a derogation of national sovereignty.

Two recent events—the crises of the European Monetary System in 1992–93 and the Mexican financial crisis of December 1994—provided the major impetus for a reconsideration of the IMF’s surveillance role. There is now widespread recognition, says James, of the “centrality of information to economic management,” which is shared by the IMF and the Group of Seven. In the past, the practice and effectiveness of surveillance have been “stymied” by concerns about the confidentiality of data supplied by members to the IMF and the recommendations by the IMF to its members. But, concludes James, “the provision of better and more extensive information” on a regular basis and in a standardized form allows the international financial system as a whole, including market participants, to make judgments on policy and to supply funds—in other words, to “participate in the exercise of surveillance, which in the Bretton Woods framework was much more exclusively the preserve of the IMF.”

IMF Conditionality Practices

During its half-century relationship with its membership, the IMF has developed a “pragmatic and flexible body of policies and procedures” that govern the use of its resources by its member countries and have come to be known by the term conditionality. The actual implementation of conditionality has taken place in response to the evolving needs of the IMF’s members and those of the world economy.

In his overview of the past, present, and future of IMF conditionality practices, Manuel Guitián says that the basic aim of conditionality is to enable members with balance of payments problems to reconcile their adjustment efforts with their adjustment needs. But conditionality also serves a “multiplicity of interests.” On the domestic level, conditionality helps contain adjustment costs, thereby enhancing economic welfare. On the international level, it helps limit moral hazard risks, since access to and disbursement of the IMF’s resources are not automatic but are contingent on a member’s adoption and pursuit of economic adjustment measures to redress its external imbalance. Conditionality also protects IMF assets by encouraging early correction of imbalances when the costs of adjustment are smaller and more manageable. Finally, says Guitián, IMF conditionality safeguards the institution’s monetary identity by maintaining its resource portfolio liquid, as a norm, and ensuring that sufficient funds are potentially available to all its members as needed.

Guitián traces the practice of conditionality as it evolved and adapted to changing needs under the rules-based regime of the Bretton Woods period through the discretionary flexible regime now in operation. In the 1990s and beyond, he emphasizes, the continuing integration into the international monetary system of the economies in transition from central planning to market-based economic regimes and the globalization of capital markets will require further adaptation of conditionality practices.

Selected IMF Rates

Week Beginning	SDR Interest Rate	Rate of Remuneration	Rate of Charge
January 22	3.96	3.96	4.06
January 29	3.97	3.97	4.07

View Table

Week Beginning	SDR Interest Rate	Rate of Remuneration	Rate of Charge
January 22	3.96	3.96	4.06
January 29	3.97	3.97	4.07

The SDR interest rate, and the rate of remuneration, are equal to a weighted average of interest rates on specified short-term domestic obligations in the money markets of the five countries whose currencies constitute the SDR valuation basket (the U.S. dollar, weighted 39 percent: deutsche mark, 21 percent; Japanese yen. 18 percent; French franc, 11 percent; and U.K. pound, 11 percent). The rate of remuneration is the rate of return on members’ remunerated reserve tranche positions. The rate of charge, a proportion (currently 102.5 percent) of the SDR interest rate, is the cost of using the IMF’s financial resources. All three rates are computed each Friday for the following week. The basic rates of remuneration and charge are further adjusted to reflect burden-sharing arrangements, For the latest rates, call (202) 623-7171.

Data: IMF Treasurer’s Department

The increasing globalization of financial and capital markets, which increases the interdependence of individual member countries and their vulnerability to external developments, poses a major challenge to the IMF’s exercise of conditionality. A financially integrated world economic environment opens opportunities to increase welfare but also poses potential threats to the stability of the international monetary system. For governments, the challenge is to design and implement economic policies that support market forces when they act to correct imbalances, as well as policies that can contain these forces when they impel the economy toward creating or prolonging imbalances. The challenge for IMF conditionality, says Guitián, is to support policies in member countries that guide and favor corrective market forces and to promote policies that offset market failures.

One of the most interesting questions about IMF conditionality, says Guitián, is whether it has made a difference. Under the rule-based, par value system—which was largely self-en-forcing—conditionality made a difference by contributing to the rapid adjustment of external balances. Under the flexible exchange rate arrangements that followed the abandonment of the Bretton Woods system, IMF conditionality practices—by their “continuing adaptation to changing circumstances”—helped to correct imbalances owing to oil price increases in the 1970s and to resolve dangers posed by the debt crisis of the 1980s. Conditionality brought to the surface the link between macroeconomic and microeconomic conditions, stressed the importance of an appropriate balance between adjustment and financing, and exposed the limits of exchange rate management. The future effectiveness of IMF conditionality, says Guitián, will depend on its responsiveness to the growth in the role of global market forces, and its impact on national economic policies. A good test, he concludes, will be its ability to “underpin market discipline and prevent market forces from underwriting inappropriate policies.”