G-7 Plan for Financial Reform:


By Barry Herman

UN Development Update
January -February 1999

Late in 1998, finance ministers and central bank governors of the Group of 7 leading industrialized countries issued a major policy declaration, one of several recent steps designed to bolster confidence in world financial markets. The policy agreement among the G-7 countries [Canada, France, Germany, Italy, Japan, the United Kingdom and the United States] aims, on the one hand, to reduce uncertainty about countries and financial markets through greater transparency and, on the other hand, to redistribute the risk of foreign lending to emerging market economies (the "moral hazard" issue). In addition, the G-7 addresses governance of the International Monetary Fund (IMF).

Transparency is to be fostered by adoption of agreed "codes of good practices" for fiscal and monetary policy, principles of sound corporate governance and accounting, and new standards of disclosure for internationally active financial institutions. The G-7 calls on the IMF to monitor compliance and to publish regular "transparency reports" on individual countries.

The G-7 addresses the "moral hazard" problem (wherein foreign private creditors are said to take excessive risk in lending to emerging market economies, assuming that they will be bailed out in the event of financial crisis) by supporting the IMF's tactic of "lending into arrears", i.e., lending funds to a government during a currency crisis even if the government and its private creditors do not yet have an agreed plan for servicing the outstanding foreign debt. The idea is to signal to creditors that the IMF is backing the debtor country's adjustment efforts, and to pressure them to complete debt rescheduling and relief negotiations with the government, i.e., to keep their money invested in the country. In addition, the G-7 calls on the private sector to accept use of collective action clauses in government bonds, which make it easier to arrange rescheduling of payments to bondholders in the event of a crisis.

These measures speak to serious concerns expressed in the General Assembly of the United Nations, as well as by the financial markets, about the recent fragility of the international financial situation. In developing their response, the G-7 have made a point of consulting widely. The Group of 22 countries, convoked by the United States for a period in 1998, was the result of efforts to consult with emerging market as well as industrialized countries.

Consultation, however, is not power sharing, and the issues at stake transcend narrow financial questions. As the G-7 is considering decisions on international economic policy that may affect development trajectories, there are broader constituencies that may want to contribute to the deliberative process. This is not to say that the policies advanced by the G-7 are wanting. Overall, they embody sound and flexible advice. For instance, the G-7 agrees on "the importance of an orderly and progressive approach to capital account liberalization"--implicitly accepting the need for national controls on capital flows for possibly lengthy periods of time, which in recent years had become an anathema.

Their prescriptions, however, could be strengthened by discussion with other interested parties and in a broader forum. For example, the G-7 Executive Directors are seeking a requirement that borrowers from the IMF would eliminate the policy of government-directed lending on non-commercial terms or other market-distorting subsidies. Such a blanket condemnation of market interventions would deny developing countries policy tools that industrialized countries utilized for their own economic take-offs, and that all G-7 member countries still employ in one form or another. It can be argued that such a requirement would exceed the limits of appropriate conditionality lending by the IMF.

Importantly, the G-7 declaration acknowledges policy failures. It says, for instance, that "more attention must be given in times of crisis to the effect of economic adjustment on the most vulnerable groups in society".

The declaration calls for improved transparency and accountability in the IMF and for a formal mechanism for taking into account outside advice. It also reiterates an agreement, issued in Washington, D.C., in the October 1998 communiqués of both Bretton Woods committees, to "assess proposals for strengthening the Interim and Development Committees".

A suggestion by the Group of 77 developing countries in mid-1998 that governance of the international monetary, financial and trade systems be on the agenda of an upcoming United Nations meeting on "finance for development" was considered controversial. (Formal preparatory work on the meeting begins in January 1999.) Now, it is the developed countries themselves who have placed institutional reform on the agenda in Washington.

Former US Ambassador Bill Richardson, in a statement to the General Assembly last March, said the UN could usefully serve as a parallel forum to the Bretton Woods institutions, where ideas on finance for development are developed and discussed.

It was a good challenge. There are deep concerns at this time about sources and uses of finance, about declining public and uncertain private international flows, about financial fragility and volatility, about international governance of an integrated, global system in which there are few clear boundaries between domestic and international finance. The time is ripe to begin the discussion in New York.

Barry Herman is the chief author of the UN World Economic and Social Survey

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