Global Policy Forum

US Treasury Secretary Lawrence H. Summers -
Remarks to London Business School

These are challenging times for the international community. That globalization offers enormous potential for raising global living standards and opportunities is not in question. What is, in many ways, the public challenge of our time is showing all of the world's citizens that international integration will work for them.

No part of that challenge will be more important for global prosperity than helping countries to develop the capacity to realise the benefits of a global flow of capital and to manage its risks. This is the goal at the heart of the global initiative that has come to be called the reform of the international financial architecture, which will take another step forward this week in Berlin as finance ministers and central bank governors from key industrial and emerging market economies gather for the first regular meeting of the G20.

There are many aspects of financial architecture. Today I would like to draw on recent experiences and the active debate that these have provoked to consider the future role of the IMF. This seems an appropriate occasion to focus on the IMF because, for the moment, the crisis of recent years has passed, and the prospect of new leadership at the IMF is drawing near.

Recent events have reaffirmed that the IMF is indispensable. We would all of us involved with global finance be breathing less easily this holiday season if the IMF had not taken the steps that it did in response to the crises in Asia and elsewhere. But as I have said many times, to say that the IMF is indispensable is not to say that we can be satisfied with the one we now have.

The founders of the Bretton Woods institutions more than half a century ago were right to recognise that there could be no successful global integration without financial stability within countries and a well-functioning system for the flow of capital between them. This was the painful lesson of the 1930s, when the absence of an effective international response to financial panics helped pave the way for deflation and depression - and ultimately, World War II. The same lesson has been taught again and again in the postwar period.

While that insight remains valid today - indeed, has been pointed up by recent events in Asia and elsewhere - a great deal in the global economy has changed since Bretton Woods. The framing new reality of the late 20th century global financial system is that the private sector is the overwhelming source of capital for growth.

This has been true domestically and increasingly in the flow of capital to emerging markets:

In the 1990s, nearly $1.3 trillion in private capital has flowed to the emerging market economies, compared to around $170 billion in the previous decade. In 1990, one emerging market economy issued a sovereign Eurobond. In 1998, nearly twenty did.

As we have seen in so many areas - ranging from mortgage finance in industrial countries to building bridges and roads in the developing world - as private capital markets develop, the role of the public sector increasingly shifts from providing finance to providing a framework for strong and sustainable private sector flows.

The IMF must reflect that change, with a focus on promoting financial stability within countries, a stable flow of capital between them, and rapid recoveries following any financial disruptions. Apart from the question of concessional finance for the poorest countries, an issue to which I will return, a reduced emphasis on the provision of finance is desirable. It is also inevitable. The IMF cannot expect its financial capacity to grow in parallel with the growth of private sector capital flows.

The best organisations are constantly reinventing themselves. The same should be true of international organisations. This is a matter of policies and procedures, but also and perhaps most crucially of culture and orientation. We believe that to maximise the IMF's effectiveness, consideration should be given to six critical areas:

A greater focus on promoting the flow of information from governments to markets and investors. Attention to financial vulnerability as well as macro-economic fundamentals. A more selective financing role that is focused on emergency situations. Greater emphasis on catalysing market-based solutions. A more limited role in the poorest countries focused on growth and poverty reduction. Modernisation of the IMF as an institution.

We will be outlining these proposals in more detail to the members of the IMF going forward and working with them to build the consensus necessary to bring about real change.

I. Promoting the Flow of Information to Markets

In a more integrated global capital market, IMF surveillance needs to shift from a focus on collecting and sharing information within the club of nations - to promoting the collection and dissemination of information for investors and markets.

If one were writing a history of the American capital market I would suggest to you that the single most important innovation shaping that capital market was the idea of generally accepted accounting principles. Countries all over the world need that kind of infrastructure, and the IMF needs to promote that goal in its dealings with member governments.

Notably:

The IMF needs to encourage more countries to adopt and comply with the Special Data Dissemination Standard, including its new provisions relating to the reporting of reserves. We also need to add to the SDDS both strengthened standards for reporting external debt and indicators of financial sector soundness. It needs to: encourage countries to implement the many international standards and codes for sound policies that are being developed; assess, with the World Bank and others, countries' compliance with these benchmarks going forward; and release these assessments publicly. It needs to pay more attention, not just to the quantity of information disclosed to markets, but also to its quality. In the context of countries receiving IMF finance we believe it is appropriate that independent external audits of central banks and other relevant government entities be required and published. This should be something that private capital markets come to expect - and look to the IMF to promote in other contexts.

More generally, we are learning that transparency and the closely related issues of governance and corruption are fundamental to maintaining financial stability - indeed, they may be as important as the details of the budget. Substantial deficiencies in the accuracy and quantity of data that a country discloses should be noted in the course of IMF surveillance, and highlighted in the way that more conventional macro-economic deficiencies are highlighted. It should no longer be tenable for countries to block the release by the IMF of key data that would help investors make better-informed decisions.

II. Not Just Macro-economic Fundamentals but Financial Vulnerability

Just as the goal of IMF surveillance needs to change, so too must its content. Every crisis teaches lessons of emphasis. Refining our understanding of what makes countries vulnerable to modern-style crises and helping countries to guard against those risks will be a central focus for the G20 as it carries forward its work. And here too, the IMF can play a critical role.

The series of crises that began with Thailand in the summer of 1997 - and the Mexican crisis of 1995 - each had a variety of elements. But looking back we can now see that central to all of them was a sudden loss of confidence and large-scale withdrawal of capital by domestic and foreign investors, initially out of a concern about the fundamentals, but increasingly out of a concern not to be the last out. A kind of bank run psychology took hold, and the opportunity to fix the problems that had triggered the crisis, without up-ending the economy, drained away.

In the wake of these events, the IMF needs to focus its attention on countries' vulnerability to this kind of dynamic. It should no longer be possible to joke, as I have done in the past, that IMF stands for It's Mostly Fiscal.

Two changes in IMF practices will be essential.

A greater focus on the strength of national balance sheets

While it has become fashionable to blame capital account crises on a voracious global capital market, a large part of the problem in these crises came from governments' own efforts to attract short-term inflows that could not reasonably be sustained. We saw this, for example, in Mexico, with the increasing resort to issuing dollar-indexed Tesobonos in the lead-up to crisis; we saw it in Thailand in tax breaks for offshore foreign borrowing; and we saw it in Russia, in the government's efforts to attract foreign capital to the domestic bond market.

In light of these experiences, the IMF should actively promote a more fully integrated assessment of a country's liquidity and balance sheet. Governments need to think long and hard about their approach to financial liberalisation - and, in particular, the dangers of opening up to short-term capital in the presence of too many domestic guarantees. And they need to manage the government's own debt in a way that best insures them against future risks. The most sophisticated debt managers are not those who achieve the lowest possible cost of borrowing.

What you count, counts. We believe that the IMF should work with member countries, including through the G20, to develop and publish a set of explicit quantitative indicators that provide more meaningful guides to the adequacy of country's reserves than simply their size relative to imports. For example: the maturity of the sovereign's debt and any worrisome deterioration in it; the scale of foreign currency related claims on the official sector; and the scale, maturity and composition of aggregate external claims on the financial and corporate sectors.

Highlighting more clearly the risks of unsustainable exchange rate regimes

These crises have reaffirmed the impossibility of maintaining both a fixed exchange rate and substantial discretion in domestic monetary policy. The IMF must increasingly bring to the fore in its discussions with countries the implications of this fact when it comes to the choice of an exchange rate regime.

Countries maintaining a fixed exchange rate should be expected to make explicit the extent to which monetary policy is to be subordinated to the exchange rate objective. And those using fixed exchange rates as a tool of disinflation should be expected to disclose the nature of their exit strategy. The presumption needs to be that countries that are involved with the world capital market should increasingly avoid the "middle ground" of pegged exchange rates with discretionary monetary policies, in favour of either more firmly institutionalized fixed rate regimes or floating.

III. Focusing Finance on Emergency Situations

International financial institutions, no less than private companies, need to focus on core competencies. Going forward the IMF needs to be more limited in its financial involvement with countries, lending selectively and on short maturities. It can and must be in the front line of the international response to financial crises. It should not be a source of low-cost financing for countries with ready access to private capital, or long-term welfare for countries that cannot break the habit of bad policies.

This suggests a number of core imperatives:

A more selective financial role

The IMF must be a last, not a first, resort - and its facilities and approaches should increasingly reflect that. We believe that the IMF's shareholders and management need to review carefully and comprehensively the myriad lending facilities that have been established over time. That review should be guided by the principles that official finance should be a backstop, not an alternative, to private sector finance.

In our view, a necessary result of this kind of streamlining would be that longer-term lending would be phased out as a normal part of IMF operations and that the IMF would come to rely on three core instruments for the bulk of its lending. These would be:

The new Contingent Credit Line, to help countries ward off external contagion. Short-term stand-by arrangements for countries with non-systemic balance of payments problems. The Supplementary Reserve Facility (SRF), for countries suffering systemic capital account crises, to be lent on a very short-term basis at prices to encourage rapid repayment.

The question of the pricing of these facilities needs careful consideration. The agreement on premium finance for the SRF in 1997 was an historic step. Going forward it would be appropriate to introduce significantly higher charges for normal standby loans to deter excessive recourse to the core IMF financing arrangements. We also believe that it makes sense to consider making the terms of the CCL more attractive than those of the SRF - so as to motivate countries to invest earlier in policy changes that will better protect them from contagion.

As we said many times in 1998, when the world faces a truly exceptional systemic threat, it is vital that the IMF continue to be in a position to provide very large scale financing to respond to that threat. But the overwhelming presumption must be that, in all but a fraction of cases, normal access limits will apply.

Effective conditionality

When crises come, there can be no hard and fast rules for an effective response. The sources of crises vary, and so must the solutions. But it bears emphasis that those who have carried out consistently their programs with the IMF - Mexico, Thailand, Korea, and more recently, Brazil - have all seen very strong results. By contrast, the more dramatic failures of this period have followed countries' unwillingness to follow through on commitments in their programs - as in Russia in 1998 and Indonesia the previous year.

In the wake of recent crises there has been and will doubtless continue to be great debate about the appropriate scope for IMF policy conditions. The basic principle is clear: programs must be focused on the necessary and sufficient conditions for restoring stability and growth. Intrusion in areas that are not related to that goal carries costs that exceed the benefits, and may undermine the legitimacy of the IMF's advice. But the stability of banking systems, issues of social cohesion and inclusion, and the capacity to enforce contractual arrangements - these will all, in many cases, be critical to restoring confidence, and they can and should be addressed as a condition for IMF support.

In thinking about conditionality, we should never forget that financial stability is only a means to the ultimate objective of restoring growth. Austerity can never be an objective for its own sake. But avoiding hyperinflation and maintaining confidence in a country's currency are essential to restoring growth. The IMF staff is to be commended for altering initial judgments about the need for contractionary fiscal policy in Asia as the depth of the recession became more evident.

We can never guarantee that the right balance will be struck in every case. But let us be clear: the success of a government in implementing its program with the IMF will and must be judged by the restoration of sustainable growth.

A clear path toward graduation

There is no economy too prosperous to benefit from the analysis and insights afforded by regular consultations with the IMF. But the IMF should not and need not be financially involved in countries forever. In 1976 people were not surprised when the UK turned to the IMF. Today it is inconceivable. The IMF's goal now must be to mark a path for the graduation of the emerging market economies, so that they too will reach the point when calling on the IMF for financial support is unthinkable.

Achieving this will involve a number of reforms. A reduced willingness on the part of the IMF to offer long-term finance is one. Higher pricing to deter prolonged use would be another. Going forward the IMF should also be insisting on stronger prior actions in countries with a record of missing targets and not completing programs - and considering other ways that repeated resort to the IMF might be discouraged.

IV. Supporting the Right Kind of Private Sector Involvement

In a world of private capital flows the IMF has not, cannot and should not aspire to having financial capacity that is proportionate to those flows. That goes to the need for rapid graduation of countries from IMF support. It goes to the need for constant vigilance about the scope for alternative private sources of finance. And in times of crises - it points up an important role for the IMF as a facilitator of more market-based solutions.

In order to play this role more effectively we believe that the IMF should establish a Market Conditions Advisory Group to help it have a deeper knowledge of the private sector systematic access to market trends and views. In the context of individual crises, the official sector should also stand ready to facilitate coordination among debtors and creditors, including through creditor committees, where these are appropriate.

We all need to recognise that a capital market depends on the idea that debtors must meet their obligations if they can, but that there will be times when debtors cannot meet their obligations. A global capital market in which dozens of issuers are issuing at spreads of hundreds of basis point can only function if there is the capacity for managing situations where debts cannot be serviced in full and on time.

In its response to crises, several basic presumptions should now be guiding the IMF's approach with respect to the private sector.

IMF lending should be a bridge to and from private sector lending not a long-term substitute. Official lending along with policy changes can be constructive in helping to restore confidence in situations where a country does have the capacity to repay. Where possible, the official sector through its conditionality should support approaches - as in Korea and, more recently, Brazil - that enable creditors to recognise their collective interest in maintaining positions, despite their individual interest in withdrawing funds. Such agreements should have the maximum feasible degree of voluntarism, but they should not fill short-term financing gaps in a way that promises renewed problems down the road.

As we have seen, for example in Pakistan and Ecuador, it will be necessary in some rare cases for countries to seek to change the profile and structure of their private sector debts. In exceptional cases, the IMF should be prepared to provide finance to countries that are in arrears to their private creditors: but only where the country has agreed to a credible adjustment program, is pursuing a cooperative and transparent approach with its creditors, and is focused on a realistic plan for addressing its external financing problems that will be viable over the medium and longer term.

We have become convinced that it is not appropriate for the official sector to mandate the terms of debt contracts between countries and their creditors. But lenders and borrowers alike must recognise that if they choose contractual arrangements that are costly and inefficient in the event of failures, the official sector will not be prepared to shoulder the consequences.

V. New Focus on Growth and Poverty Reduction in the Poorest Countries

The focus of my remarks has so far have been directed at the IMF's work in emerging markets. Different issues are posed by the poorest countries, which cannot attract significant private capital, and can borrow from the official sector only on concessional terms.

Helping these nations has rightly been high on the global agenda in recent months in our efforts to translate debt relief for the Heavily Indebted Poor Countries into concrete reductions in poverty. As part of this effort, we have worked closely with the UK and others to establish a fundamentally new framework for the international community's efforts to combat poverty, one that gives the World Bank the lead and the IMF a more tightly focused role.

The premise for this new approach is that macro-economic stability may be necessary, but it is far from being sufficient to creating lasting and inclusive growth. The approach looks to the IMF to continue to certify that a country's macro-economic policies are satisfactory before debt is relieved or new concessional lending is advanced. But much of the dialogue between countries and the official sector will centre on issues relating to poverty that have not traditionally received the attention they deserve.

As a result of recent agreements among the G7, I am confident that a number of countries - including Bolivia, Uganda, Mozambique and Mauritania - will be able to benefit from the Cologne initiative very early in the new year, with a number of others also benefiting before the Spring meetings of the World Bank and IMF in Washington. What will be critical will be effectively implementing the new framework for official support in these and other countries, so that the poorest will also see rapid results.

VI. Institutional Reform

Finally, if the work of the IMF is to change, its nature may need to change in the 21st century as well.

It should move over time toward a governing structure that is more representative and a relative allocation of member quotas that reflects the changes under way in the world economy - so that each country's standing and voice is more consistent with their relative economic and financial strength.

It should deepen the commitment to transparency that is built into the IMF's own operations, especially by making the IMF's own financial workings clearer and more comprehensible to the public. For example, there is no reason why there should not be regular publication of the IMF's operational budget. And it should become more attuned, not just to markets, but the broad range of interests and institutions with a stake in the IMF's work. Just as the institution need to be more permeable for information to flow out, so too must it be permeable enough to let in new thoughts - by maintaining a vigorous ongoing dialogue with civil society groups and others.

This seemed a propitious moment to focus on the IMF. But as our international discussions on these issues continue, it will be important for its shareholders to consider not just the role of the IMF, but the World Bank and other development institutions and also how these institutions relate to each other.

VII. Concluding Remarks

Let me re-emphasise the observation with which I began. As important as it is, the IMF is just one component of the international financial architecture. Indeed, if I have learned one thing in my seven years in government, it is that national policy shapes national outcomes. The international community cannot want reform and stability in a country more than its own government and people do.

But international institutions do matter, and so do the individuals who lead them. Michel Camdessus's imaginative leadership has made its mark in helping the IMF prepare itself for a 21st century global financial system. What is critical is that we maintain the spirit of change and adaptation in the months and years ahead.

Thank you.

FAIR USE NOTICE: This page contains copyrighted material the use of which has not been specifically authorized by the copyright owner. Global Policy Forum distributes this material without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes. We believe this constitutes a fair use of any such copyrighted material as provided for in 17 U.S.C íŸ 107. If you wish to use copyrighted material from this site for purposes of your own that go beyond fair use, you must obtain permission from the copyright owner.