CHAPTER 2 IMF Surveillance in Action

International Monetary Fund
Published Date:
September 2001
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The IMF’s charter—or Articles of Agreement—directs it to oversee the exchange rate policies of its member countries in order to ensure the effective operation of the international monetary system. To this end, the IMF assesses whether members’ economic developments and policies are consistent with the achievement of sustainable growth and macroeconomic stability. It does this by holding regular discussions with its member countries about their economic and financial policies, and by continuously monitoring and assessing economic and financial developments at the country, regional, and global levels. In these ways, the IMF can help signal dangers on the horizon and enable members to take early corrective policy actions.

IMF oversight, or surveillance, has evolved continuously to reflect changing global economic realities. In recent years, economic globalization and the increasing international integration of financial markets—and the 1994 Mexican and 1997–98 Asian and Russian financial crises—have underscored the importance of effective surveillance for crisis prevention. The IMF’s surveillance now devotes more attention to factors that make countries vulnerable to financial crises, including financial systems, capital account developments, poor governance, and public and external debt management. The IMF has continued to develop better analytical tools, such as those for assessing reserve adequacy and vulnerability to crises, and has strengthened efforts to incorporate the views of and developments in international financial markets into its surveillance activities. It has also underscored the importance of reporting accurate, timely, and comprehensive statistics and has encouraged members to publish country reports with a view to facilitating more informed decisions in the public and private sectors. As a result of these efforts, surveillance has become more focused and candid.

The IMF conducts its surveillance in several ways:

  • Country surveillance. As mandated in Article IV of its Articles of Agreement, the IMF holds “Article IV” consultations, normally every year, with each member country about its economic policies.
  • Global surveillance. The IMF’s Executive Board regularly reviews international economic and financial market developments. The reviews are based partly on the World Economic Outlook reports, prepared by IMF staff twice a year, and the annual International Capital Markets report. In addition, the Board holds frequent, informal discussions about world economic and financial market developments.
  • Regional surveillance. To supplement country consultations, the IMF also examines policies pursued under regional arrangements. It holds regular discussions with such regional economic institutions as the European Union, the West African Economic and Monetary Union, the Central African Economic and Monetary Community, and the Eastern Caribbean Currency Union. IMF management and staff have increased their participation in regional initiatives of member countries—including the Southern African Development Community, the Common Market of Eastern and South Africa, the Manila Framework Group, the Association of South East Asian Nations, the Meetings of Western Hemisphere Finance Ministers, and the Gulf Cooperation Council.

IMF management and staff also take part in policy discussions of such country groups as the Group of Seven industrial countries and the Asia-Pacific Economic Cooperation forum.

Recent developments have made clear that effective IMF surveillance depends on the following:

Provision of timely, reliable, and comprehensive data. Each member country is required to provide the IMF with the information necessary for surveillance. The IMF also encourages countries to be transparent about their policies and about economic developments, for example, by publishing data on external reserves, related liabilities, and short-term external debt. IMF technical assistance is playing an important role in improving many countries’ data systems and institutional arrangements so that they meet the requirements of transparency.

Continuous surveillance. To ensure more continuous surveillance, the IMF supplements yearly consultations with member countries with, for example, interim staff visits and frequent informal Executive Board meetings to review major developments in selected member countries.

A sharper focus for surveillance. Particularly in view of the globalization of financial markets, surveillance now involves a closer examination of financial sector issues, capital account developments, and public and external debt management. It also includes evaluations of a country’s financial health—including explicit attention to policy interdependence and the risks of “contagion” (that is, the spread of crises from one country to others).

Observance of standards and codes. The IMF and other international organizations and regulatory bodies have developed internationally recognized standards and codes of good practice, which can be used to help countries improve their economic and financial policies and systems and thereby strengthen the international financial system. Countries’ adherence to such standards and codes is voluntary, but they can play an important role in helping prevent financial crises and in enhancing economic performance. Standards and codes in place include the IMF’s Special Data Dissemination Standard, which covers key economic data, and codes for transparency in monetary, fiscal, and financial sector policy. The IMF and the World Bank are preparing Reports on the Observance of Standards and Codes (ROSCs) by member countries.

Transparency. The importance of credibility in maintaining and restoring market confidence underscores the value of transparency. The IMF has taken steps to encourage its members to increase the transparency of their policies, as well as to increase the transparency of its own policy advice. In FY2001, for example, it adopted a policy whereby Article IV staff reports are published when the country concerned agrees.

See Chapter 3 for more details on the IMF’s work in the above areas.

Country Surveillance

An IMF staff team meets with government and central bank officials of each member country, generally every year (with interim discussions held as needed), to review economic developments and policies. These consultations touch on major aspects of macroeconomic and financial sector policies, but they also cover other policies affecting a country’s macroeconomic performance, including, where relevant, those relating to structural policies and governance.

To conduct country surveillance, an IMF staff team visits the country, collects economic and financial information, and discusses with the national authorities recent economic developments and the monetary, fiscal, and relevant structural policies the country is pursuing. The Executive Director for the member country usually participates. The IMF staff team normally prepares a concluding statement, or memorandum, summarizing the discussions with the member country and leaves this statement with the national authorities, who have the option of publishing it. On their return to headquarters, IMF staff members prepare a report describing the economic situation in the country and the nature of the policy discussions with the national authorities, and evaluating the country’s policy stance. The Executive Board then discusses the report. The country is represented at the Board meeting by its Executive Director. The views expressed by Executive Directors during the meeting are summarized by the Chairman of the Board (the Managing Director), or the Acting Chairman, and a summing up is produced. If the Executive Director representing the member country agrees, the full Article IV consultation report is released to the public, together with the summary text of the Board discussion and background material in the form of a Public Information Notice (PIN), or only a PIN could be issued. In FY2001 the Board conducted 130 Article IV consultations with member countries (see Table 2.1). The PINs and Article IV reports are published on the IMF website.

Table 2.1Article IV Consultations Concluded in FY2001
Country NameBoard DatePIN IssuedStaff Report Published
AlbaniaJune 9, 2000June 23, 2000June 23, 2000
AlgeriaJuly 7, 2000August 4, 2000August 4, 2000
AngolaJuly 19, 2000August 10, 2000
Antigua and BarbudaMarch 7, 2001March 22, 2001
ArgentinaSeptember 15, 2000October 3, 2000December 19, 2000
AustraliaMarch 2, 2001March 21, 2001March 21, 2001
AustriaAugust 3, 2000August 8, 2000August 8, 2000
AzerbaijanAugust 1, 2000
BahrainJune 21, 2000
BarbadosNovember 1, 2000December 4, 2000December 4, 2000
BelarusOctober 13, 2000October 20, 2000
BelgiumFebruary 21, 2001March 7, 2001March 7, 2001
BelizeMay 19, 2000May 25, 2000
BeninJanuary 8, 2001February 2, 2001
BotswanaMarch 12, 2001April 13, 2001
BrazilNovember 27, 2000December 22, 2000
Brunei DarussalamFebruary 21, 2001
BulgariaMarch 23, 2001April 3, 2001April 3, 2001
Burkina FasoJuly 10, 2000August 8, 2000August 8, 2000
Central African RepublicJuly 12, 2000October 27, 2000
CambodiaSeptember 15, 2000October 13, 2000October 13, 2000
CameroonJune 7, 2000June 21, 2000
CanadaMarch 23, 2001April 23, 2001April 23, 2001
ChadJuly 25, 2000
ChileJuly 7, 2000August 9, 2000August 9, 2000
China, P.R. ofJuly 26, 2000September 1, 2000
ColombiaMarch 28, 2001April 12, 2001April 23, 2001
ComorosJuly 12, 2000September 5, 2000
Congo, Rep. ofNovember 17, 2000December 7, 2000
Côte d’IvoireJuly 12, 2000September 8, 2000
CroatiaMarch 19, 2001March 23, 2001March 23, 2001
CyprusAugust 3, 2000August 24, 2000August 24, 2000
Czech RepublicJuly 26, 2000August 9, 2000August 9, 2000
Dominican RepublicFebruary 23, 2001March 14, 2001
EcuadorAugust 28, 2000September 7, 2000
EgyptJuly 27, 2000
EstoniaJune 30, 2000July 11, 2000July 11, 2000
EthiopiaMarch 19, 2001
FinlandAugust 22, 2000August 31, 2000August 31, 2000
FranceOctober 27, 2000November 13, 2000November 13, 2000
GabonOctober 23, 2000November 22, 2000
Gambia, TheJuly 19, 2000August 15, 2000
GermanyOctober 23, 2000November 2, 2000November 2, 2000
GreeceFebruary 23, 2001March 16, 2001March 28, 2001
GrenadaJuly 5, 2000July 20, 2000July 20, 2000
GuineaDecember 20, 2000
Guinea-BissauDecember 15, 2000
GuyanaNovember 13, 2000November 30, 2000
HaitiNovember 22, 2000January 5, 2001January 5, 2001
Hong Kong SARFebruary 16, 2001March 2, 2001March 2, 2001
IndiaJune 19, 2000June 30, 2000
IndonesiaSeptember 14, 2000September 25, 2000
Iran, Islamic Republic ofAugust 3, 2000
IrelandAugust 2, 2000August 10, 2000August 10, 2000
ItalyJune 5, 2000June 13, 2000June 13, 2000
JapanAugust 4, 2000August 11, 2000August 11, 2000
JordanJuly 25, 2000
KazakhstanDecember 11, 2000December 18, 2000
KoreaJanuary 31, 2001February 1, 2001
Kyrgyz RepublicSeptember 13, 2000October 13, 2000
Lao People’s Dem. Rep.April 23, 2001April 26, 2001
LatviaJune 30, 2000July 11, 2000July 11, 2000
LesothoMarch 9, 2001May 21, 2001June 12, 2001
LibyaMarch 12, 2001
LithuaniaJanuary 10, 2001January 22, 2001January 22, 2001
LuxembourgMay 8, 2000May 16, 2000May 16, 2000
Macedonia, FYRMay 10, 2000June 23, 2000June 23, 2000
MadagascarJune 23, 2000August 30, 2000
MalawiDecember 21, 2000January 23, 2001February 20, 2001
MalaysiaJuly 25, 2000August 10, 2000
MaldivesNovember 3, 2000
MaliSeptember 6, 2000October 10, 2000October 10, 2000
Marshall IslandsJanuary 5, 2001
MauritaniaJune 19, 2000June 27, 2000
MicronesiaJanuary 5, 2001
MoldovaDecember 15, 2000March 13, 2001
MoroccoJune 7, 2000September 1, 2000
MozambiqueDecember 18, 2000January 17, 2001January 17, 2001
MyanmarDecember 4, 2000
NamibiaOctober 18, 2000
NetherlandsJune 12, 2000June 16, 2000June 16, 2000
New ZealandOctober 13, 2000October 27, 2000October 27, 2000
NigerDecember 14, 2000January 12, 2001January 12, 2001
NorwayJanuary 26, 2001February 5, 2001February 5, 2001
OmanMarch 26, 2001April 11, 2001
PakistanNovember 29, 2000December 14, 2000January 26, 2001
PanamaJanuary 22, 2001February 16, 2001February 20, 2001
Papua New GuineaOctober 13, 2000October 26, 2000October 26, 2000
PeruMarch 12, 2001March 19, 2001March 19, 2001
PhilippinesMarch 1, 2001March 13, 2001
PolandMarch 9, 2001April 10, 2001April 10, 2001
PortugalOctober 20, 2000November 20, 2000November 20, 2000
RomaniaNovember 29, 2000December 12, 2000December 12, 2000
Russian FederationSeptember 15, 2000November 9, 2000November 9, 2000
RwandaDecember 20, 2000March 27, 2001
Saudi ArabiaOctober 6, 2000
SenegalJune 21, 2000August 16, 2000
SeychellesNovember 1, 2000December 26, 2000
Sierra LeoneJanuary 22, 2001February 12, 2001
SingaporeJune 5, 2000June 30, 2000
Slovak RepublicJuly 21, 2000July 28, 2000
Solomon IslandsJanuary 19, 2001
South AfricaMarch 19, 2001May 9, 2001
SpainOctober 20, 2000November 16, 2000November 16, 2000
Sri LankaApril 20, 2001May 14, 2001May 16, 2001
St. Kitts and NevisOctober 23, 2000December 4, 2000January 8, 2001
St. LuciaMarch 7, 2001March 29, 2001
St. Vincent and the GrenadinesOctober 27, 2000November 13, 2000November 13, 2000
SudanMay 22, 2000June 9, 2000June 9, 2000
SwazilandJuly 19, 2000September 13, 2000
SwedenAugust 22, 2000September 8, 2000September 8, 2000
Syrian Arab Rep.November 1, 2000
TajikistanApril 12, 2001April 24, 2001April 24, 2001
TanzaniaAugust 1, 2000September 15, 2000
TogoApril 20, 2001May 3, 2001
TongaNovember 20, 2000
TunisiaFebruary 7, 2001February 13, 2001February 14, 2001
United Arab EmiratesJune 9, 2000
UgandaMarch 26, 2001
UkraineDecember 19, 2000January 19, 2001
United KingdomFebruary 23, 2001February 28, 2001February 28, 2001
United StatesJuly 21, 2000July 28, 2000July 28, 2000
UruguayFebruary 26, 2001March 14, 2001March 15, 2001
UzbekistanFebruary 7, 2001
VanuatuAugust 1, 2000September 5, 2000
VenezuelaFebruary 26, 2001
VietnamJuly 21, 2000August 4, 2000
YemenFebruary 28, 2001March 8, 2001
ZambiaJuly 26, 2000
ZimbabweDecember 6, 2000December 13, 2000January 8, 2001

In addition to Article IV consultations, the Board also carries out country surveillance through discussions of ongoing IMF lending in support of member countries’ economic programs, including precautionary financing (see Chapter 4), and through monitoring.

Staff-Monitored Programs. The IMF staff monitors a country’s economic program and meets regularly with the country’s authorities to discuss economic developments and policies. Staff monitoring does not constitute formal IMF endorsement of the member’s policies, nor is IMF financing provided.

Post-Program Monitoring. The IMF also now monitors countries’ economic policies after the conclusion of IMF-supported programs, particularly where there is substantial credit outstanding to the IMF, to help safeguard IMF funds and preserve the achievements of IMF-supported programs (see also Chapter 4).

Global Surveillance

World Economic Outlook

The Executive Board carries out its surveillance of global economic conditions based on the staff’s World Economic Outlook reports, which feature a comprehensive analysis of prospects for the world economy, individual countries, and regions, and examine topical issues. These reports are usually prepared and published twice a year, but they may be produced more frequently if rapid changes in world economic conditions warrant.

During FY2001, the Board discussed the World Economic Outlook in September 2000 and in April 2001. At its September 2000 meeting, the Board welcomed the strength of the world economy. The high global growth rate was attributable in large part to the remarkable strength of the U.S. economy, supported by a robust expansion in Europe and the countries in transition. Also contributing to world growth were a consolidation of the recovery in Asia, improved growth in Africa, and rebounds from year-earlier slowdowns in Latin America and the Middle East. While economic activity in Japan was also improving, the incipient recovery remained fragile.

Although the overall outlook as of September 2000 was encouraging, Directors cited continuing risks and uncertainties and saw no room for complacency. In particular, a number of serious economic and financial imbalances persisted in the world economy: the lopsided pattern of output and demand growth among industrial countries and the associated imbalances in the external current accounts, the misalignments among the major currencies, and the generous level of asset market valuations in the United States and several other countries. The possibility that these imbalances might unwind in a disorderly fashion remained a risk to the global expansion. The recent increase in oil prices, if sustained, would also hamper global growth and increase inflationary pressures in advanced economies and hurt oil-importing developing countries, including many poor countries in sub-Saharan Africa.

Against this background, Directors observed that policymakers continued to face important, if widely varying, challenges. The advanced economies had to continue efforts to facilitate an orderly rebalancing of growth and demand across the three main currency areas. In some advanced economies, a further tightening of macroeconomic policies might be needed to reduce the risks of overheating, particularly if higher energy prices fed through to underlying inflation; in others, where there were margins of slack, macroeconomic policies had to continue to support recovery. More broadly, Directors stressed that progress with structural reforms had to continue in most advanced, and in almost all developing, countries so as to strengthen prospects for sustained economic growth.

At the September 2000 meeting, Directors also expressed concern that, despite the strength of the global recovery, poverty remained unacceptably high, and many poor countries continued to face serious economic problems—compounded in some cases by natural disasters and adverse movements in non-oil commodity prices. Directors agreed that sustained efforts by the poorest countries were essential, notably in promoting macroeconomic and political stability, good governance, and domestic ownership of the reform agenda. Stronger support from the international community was also important, including through debt relief targeted at poverty reduction—which required funding in full the enhanced Initiative for Heavily Indebted Poor Countries (HIPC Initiative); a reversal of the declining trend in some advanced countries’ official development aid; and reform of protectionist trade policies in advanced economies that particularly affected poor countries. More international assistance was also needed to help address the HIV/AIDS pandemic, which posed a severe human as well as economic threat, especially in sub-Saharan Africa and parts of Asia.

At their April 2001 discussion on the World Economic Outlook, Directors agreed that prospects for global growth had weakened significantly, led by a marked slowdown in the United States, a stalling of the recovery in Japan, and a slowing of growth in Europe and in a number of emerging market countries. Some slowdown from the rapid rates of global growth of late 1999 and early 2000 had been both desirable and expected—especially in those countries most advanced in the cycle—but the deceleration was proving to be steeper than previously thought. At the same time, while headline inflation in most advanced economies had begun to stabilize—with moderate wage increases and declining oil prices—underlying inflation remained generally subdued, except perhaps in a number of faster-growing European and emerging market economies.

Given the rapid policy response by several central banks in both advanced and emerging market economies, Directors thought that prospects were reasonable that the global slowdown would be relatively short lived, although the pace of recovery might be slowed by continuing declines in global equity markets. Declining short- and long-term interest rates were expected to support economic activity in the second half of 2001, and, with inflation risks receding, policymakers in most advanced economies—except for Japan—had substantial room for further easing. Moreover, given the remarkable strengthening in fiscal positions in recent years, most advanced economies also had room for fiscal easing as a second line of defense—which the United States in particular was expected to use. In addition, while a number of emerging market countries continued to face serious difficulties, external and financial vulnerabilities had generally been reduced since the 1997–98 crises as a result of wide-ranging structural reforms; moreover, the shift away from soft exchange rate pegs to flexible exchange rate systems had improved countries’ ability to cope with external shocks.

Most Directors agreed, however, that the outlook remained subject to considerable uncertainty and that a deeper and more prolonged downturn was possible. The U.S. adjustment process could be complicated by the substantial imbalances that developed during the expansion—including the large current account deficit, the apparent overvaluation of the U.S. dollar, and the negative household savings rate—as well as by the risk of possible further declines in equity markets.

Directors emphasized that the extent of the slowdown would be affected by policy decisions by all countries. In the advanced economies, Directors agreed that a more proactive approach to macroeconomic policies—particularly on the monetary side—might well be required, and should be pursued consistently with these countries’ respective cyclical positions and without compromising medium-term stabilization goals. Where needed, these policies should be complemented by the determined pursuit of structural reforms. In view of the prevailing fragility of external financing conditions, prospects in emerging markets depended critically on maintaining investor confidence. For these countries, Directors underscored the need to maintain prudent macroeconomic policies and to press ahead with corporate, financial, and—especially in the transition economies—institutional reforms.

Directors were concerned that the slowdown in global growth would hurt the low-income countries, both directly and through lower commodity prices. The need for such countries to sustain strong policies was even greater, both in those countries receiving debt relief under the enhanced HIPC Initiative and in others. To help the low-income countries, Directors stressed that the advanced economies had a special responsibility to increase aid flows, to support initiatives promoting peace and domestic stability, and to provide further assistance to fight the spread of the HIV/AIDS pandemic. They especially emphasized the importance of reducing further barriers to the exports of the developing countries, and of the poorest countries in particular. In this connection, the Board welcomed the European Union’s recent initiative to eliminate tariffs on almost all exports of the least-developed countries.

Given the change in the global economic outlook, Directors felt it was particularly important for the IMF—in its dialogue with member countries, and through its multilateral surveillance—to continue to support actively the implementation of policies that promote economic stability and prosperity.

Major Currency Areas

For the United States, the outlook was subject to more than the usual amount of uncertainty. While growth was likely to remain weak in the first half of 2001, reflecting rapid inventory adjustment, most Directors believed that it would pick up in the second half, supported by lower short- and long-term interest rates, although the rate of pickup might be slowed by the lagged effect of the fall in equity prices. Directors also acknowledged the significant risk that the imbalances built up during the long expansion could unwind in a less orderly fashion, accompanied by further declines in confidence and increases in risk aversion in financial markets. With the balance of risks shifting increasingly toward weaker aggregate demand, Directors strongly welcomed the timely and significant easing of U.S. monetary policy in the first quarter. If economic and financial conditions remained weak, they felt that some further easing would be appropriate. While monetary policy remained the preferred instrument for responding actively to cyclical developments, Directors believed that—given the sustained fiscal surpluses in prospect in coming years—moderate and front-loaded tax cuts would also be appropriate from a cyclical perspective. These tax cuts should preferably be enacted in phases, with each phase put in place only when it was clear that sufficient budgetary resources would be available to finance it. At the same time, they recommended that the surpluses of the Social Security and Medicare Health Insurance trust funds be preserved to help meet future pension and health care costs.

Board members expressed considerable concern about the renewed setback to recovery in Japan, which could worsen the global slowdown and have a particularly serious impact on a number of Asian countries. While this setback partly reflected economic slowdown elsewhere—especially the weakening of global demand for electronics equipment—it was also due to continued weak consumer confidence and underlying structural weaknesses, especially in the Japanese corporate and financial sectors. Given the deteriorating outlook and continued deflation, Directors welcomed Japan’s introduction of a new monetary policy framework, which effectively returned to the zero-interest-rate policy and included a commitment to maintain the new framework until consumer prices had stopped declining, and (if needed) would step up outright purchases of long-term government bonds. Directors urged that the framework be forcefully implemented. Given the high level of public debt, Directors believed that the very gradual fiscal consolidation under way remained appropriate, and that further fiscal easing should be considered only as a last resort. Directors stressed, however, that the prospects for a return to sustained growth in the medium term depended most critically on determined action to address weaknesses in banks and life insurance companies—including through the vigorous application of the regulatory and supervisory framework—along with measures to further encourage corporate restructuring.

Turning to the euro area, Directors observed that while growth remained relatively well sustained, signs of slowing had intensified and confidence had weakened. While headline inflation remained above the target of the European Central Bank, underlying price pressures were muted, with little evidence of pass-through effects of higher energy prices and the weaker euro on wages. Against this background, many Directors believed that a moderate cut in interest rates was appropriate, with a further cut if the euro were to appreciate sharply or if indications of slowing growth were to mount. While recent tax cuts in some countries would provide a helpful stimulus, Directors saw no further need to use fiscal policy actively to support output, although fiscal execution should allow the full play of automatic stabilizers. While welcoming the important progress made in some areas of structural reform, Directors underscored that further deepening and acceleration of market-oriented reforms—especially of pension systems, labor markets, and product markets—was necessary both to raise potential output growth over the medium term and to address the challenges posed by aging populations. They also underscored the need, over the medium term, to further reduce tax burdens, which remained very high in a number of euro-area countries. Such reductions would need to be accompanied by spending restraint to help meet medium-term budget targets.

Emerging Market Economies

Following a rapid recovery from the regional crisis, growth in the Asian emerging market economies had weakened as a result of higher oil prices, slowing growth in the United States and Japan, the downturn in the global electronics cycle, and—in some countries—the lagging pace of corporate and financial restructuring. Directors noted that growth was expected to slow most in the newly industrialized economies and in member countries of the Association of South East Asian Nations (ASEAN), particularly those more advanced in the recovery and where corporate and financial restructuring had lagged. In these countries, it was crucial to restore the momentum of structural reforms. For countries with low inflation and sustainable fiscal positions, Directors recommended moderate interest rate reductions, coupled in some cases with an easier pace of fiscal consolidation. Growth was expected to be relatively well maintained in China and India. In China, a gradual shift to a more neutral fiscal policy stance was seen as appropriate given considerations of medium-term sustainability. In India, Directors agreed that the monetary policy easing should be supported by continued improvements in the environment for private investment and a substantial reduction, over the medium term, in the overall public sector deficit.

In Latin America, growth had rebounded in 2000, following the sharp slowdown in 1999, in part reflecting strong adjustment measures put in place in many countries. In 2001, the direct impact of weakening external demand on activity was likely to be largest in Mexico and in several countries in the Andean region and Central America, but more moderate in those countries—such as Brazil and Argentina—that were less exposed to the global trade slowdown and where trade links with the United States in particular were less important. Given Latin America’s large external financing requirements, however, the impact of the U.S. slowdown on financial markets would be critical. While a number of countries had been able to cover a substantial part of their annual public sector financing needs in early 2001, Directors were concerned that, despite the easing of U.S. monetary policy, financing conditions had deteriorated following the crisis in Turkey and significant difficulties in Argentina—which reflected a rise in investor risk aversion and possible concerns about a slowdown in inward foreign direct investment. With intensifying scrutiny from global financial markets, it was important to maintain prudent fiscal policies, along with structural reforms—particularly in financial and corporate sectors and labor markets. Directors generally welcomed the initiatives to strengthen the policy framework in Argentina, while stressing the need for continued fiscal restraint and strict adherence to the economic program at all levels of government.

In some countries in Africa, growth had been constrained by war and civil conflict, weak commodity prices, and, for oil-importing countries, by higher oil prices. While countries that implemented sound macroeconomic and structural policies and maintained political stability had been able to achieve relatively strong rates of growth, Directors were concerned that the outlook for the region could be adversely affected by the global slowdown, particularly through a further weakening of commodity prices. Directors welcomed the strengthening of economic policies in many countries, which were being supported by debt relief through the enhanced HIPC Initiative and the Poverty Reduction and Growth Facility. It was important to sustain the momentum for reform in the years ahead, particularly by improving the environment for private investment, strengthening public service delivery, improving tax administration and infrastructure, and enhancing governance. Directors generally endorsed trade integration in sub-Saharan Africa, noting in particular the scope for further reductions in trade barriers by African countries. They agreed that a lasting improvement in Africa’s trade performance would depend on a broader mix of macroeconomic policies and structural reforms critical to improved efficiency and external competitiveness, as well as on increased access to industrial country markets. Directors also welcomed the staff’s suggestions for rationalizing current regional trade arrangements to allow them to reach their intended objectives.

In the Middle East, higher oil prices combined with increased oil production had generally boosted activity and improved fiscal and external balances in 2000. With the windfall gains from higher oil prices having been used prudently, the projected decline in oil prices in 2001 and 2002 appeared generally manageable. Nonetheless, a prudent approach to fiscal policy remained desirable, especially in countries where government debt had to be reduced. More generally, Directors underscored the need for continued reforms to promote economic diversification and growth, including the removal of remaining impediments to trade and foreign direct investment. Growth in most of the non-oil-producing countries in the region was expected to remain stable, although it could be affected by a steeper-than-anticipated global slowdown. Reform of trade and foreign direct investment regimes was also a priority for many of these countries, which had yet to share fully in the benefits of globalization.

Directors observed that the situation in Turkey remained very difficult. They welcomed the steps taken to reform the financial system—particularly with regard to state banks—but noted that further decisive policy measures were needed to resolve the problems in the banking sector, strengthen the fiscal accounts, and achieve broad-based structural reforms. In central and eastern Europe, growth was expected to remain reasonably well sustained in 2001, although activity would be vulnerable to a greater-than-expected slowdown in western Europe. Against the background of weakening external demand and large current account deficits, Directors favored a rebalancing of the policy mix toward relatively tighter fiscal policy, which would help restrain domestic demand while limiting upward pressure on interest rates and exchange rates. They also cited the need for further structural and institutional reforms—especially with respect to privatization, enterprise restructuring, and financial regulation and supervision—to promote sustainable growth in the medium term and facilitate accession to the European Union.

Directors welcomed the improvement in growth performance and external positions in the countries of the Commonwealth of Independent States (CIS), which reflected mainly higher world energy prices and buoyant growth in Russia. In Russia, growth was expected to moderate from the very rapid pace in 2000, partly the result of lower oil prices and some real appreciation of the ruble, as well as the global slowdown. The government’s long-term reform plan was an important step forward, but it had to be both firmly implemented and significantly developed in a number of key areas, including banking reform, nonpayment problems, and the restructuring of infrastructural monopolies. Accelerating structural and institutional reform also remained the central challenge in most other CIS countries.

Maintaining Improved Fiscal and Monetary Policies

Directors noted that the durability of recent fiscal consolidation in the advanced economies was likely to be improved by the associated reductions in public spending (as a share of GDP) and the strengthening of fiscal frameworks over the past decade. They emphasized that fiscal discipline would be vital in the years ahead, given the substantial increases expected in public spending on pensions and health care as populations aged. To meet pension liabilities and enhance output growth as dependency ratios rose, Directors agreed that the policy response should be broad-based, encompassing both pension reform and structural reforms, including labor market improvements. Consideration should be given to directing a part of recent and projected fiscal improvements to increased prefunding of future pension liabilities. Taking a global perspective on population aging, Directors noted that as dependency ratios decline in many developing countries, increased saving by countries with aging populations could support growth in the developing world and future consumption in advanced economies.

With respect to the decline in inflation in emerging market economies in recent years, Directors noted that improved monetary stability in advanced economies and substantial progress in institutional reform in emerging market economies—including more independent central banks and improved knowledge about monetary policy transmission—had played an important role in achieving this outcome. Prudent fiscal policies had also been key in achieving lower inflation and allowing the conduct of a stable monetary policy over the long run. While observing that experience with the more frequent use of inflation targeting to accompany flexible exchange rates had been generally encouraging to date, Directors considered that a more definitive verdict on inflation targeting would need to await further experience, particularly with the maintenance of price stability during sustained periods that included episodes of financial stress and exchange rate instability.

Finally, Executive Directors took the opportunity to express their deep appreciation to Michael Mussa for his outstanding contribution as Economic Counsellor and Director of the Research Department to the IMF’s multilateral surveillance over the past 10 years, especially through his oversight and direction of the World Economic Outlook, and his regular informal briefings on World Economic and Market Developments, which were a highlight of the Executive Board agenda.

International Capital Markets

Executive Directors held their annual discussion of developments in the mature and emerging capital markets in early August 2000. While they noted that global financial conditions had improved over the previous 12 months, and the global financial system had proven to be adaptable and resilient, Directors saw several risks and vulnerabilities ahead, particularly relating to the major economies and financial systems. Directors also discussed three key systemic issues: the risks to financial stability from over-the-counter (OTC) derivatives markets, efforts to involve the private sector in the prevention and resolution of crises, and the implications of the expansion of foreign-owned banks in many emerging market countries.

The strong performance of the U.S. economy had bolstered global financial markets and investor sentiment, Directors observed. U.S. investment trends were increasingly reflected internationally, notably in the worldwide allocation of funds to the technology, telecommunications, and media sectors and, until March 2000, in the buoyancy of stock prices in these sectors. In Europe, financial market integration had progressed against the background of a depreciating euro and the buoyancy of equity and private bond markets. In Japan, problems in the financial system had stabilized considerably, and the authorities had put in place a potentially effective framework for financial and corporate restructuring. Some Directors, however, felt that the private sector had not made enough progress in implementing the new framework and that further progress was needed to sustain the Japanese recovery.

Directors discussed several risks for the mature financial markets. Some cautioned that a sharper-than-expected pickup in U.S. inflation, or an unanticipated drop in productivity, might give rise to a broadly based deterioration in investor sentiment, further corrections in equity and corporate bond markets, a general repricing of risk, portfolio rebalancing, and exchange rate adjustments. Sharp movements in the major currencies was another risk, which Directors related to mounting external imbalances.

Directors also saw risks for Japan and Europe. Some observed that, in Japan, expansionary policies—while appropriate from a macroeconomic perspective—might be affecting asset pricing and financial flows in Japan’s fixed income and money markets, and could be encouraging position-taking that might not be profitably sustained should interest rates adjust more sharply than expected. It was observed that it was critically important for Japan to manage the transition to less stimulative monetary and fiscal policies carefully and transparently.

As to the emerging markets, Directors noted that the terms and conditions of market access had gradually improved over the previous 12 months and that the prices of emerging market assets had strengthened. They attributed much of this improvement to stronger fundamentals in most emerging markets, reflected in stronger economic growth, stable exchange rates, and upgrades in credit ratings by the major international agencies. Directors welcomed the ongoing development of domestic financial markets in many emerging markets and the reduced reliance on external financing that this would entail. They saw as positive developments the continued strength in direct investment, reduced reliance on international bank financing, and lengthening of the average maturities of external financing. They also noted the improved sentiment toward emerging markets on the part of investors in mature markets and the reduced volatility in emerging market asset prices from the high levels seen during the crises.

At the same time, Directors recognized that flows to emerging markets remained substantially below precrisis levels and that borrowing costs remained high, relative to precrisis levels. Furthermore, market access by the poorest emerging markets was still extremely limited. The sharp cutbacks in financing flows associated with the turmoil in mature markets in April and May 2000 had highlighted the dependence of emerging markets on conditions in mature markets. Directors were nonetheless encouraged by the subsequent recovery in prices and financing flows, and considered that, as long as there were no major disturbances from the mature markets, the outlook for emerging markets was generally positive. Several key emerging market countries, however, had to continue strengthening macroeconomic policies and renew structural reform of their corporate and financial sectors. Directors also stressed the potential risks to financial and economic conditions in several key emerging market countries from the spillover effects of either a sharp unanticipated upturn in global interest rates or a large downward correction in mature equity markets.

(As part of its increased study and monitoring of international capital markets, the IMF began publishing on its website quarterly reports on emerging market financing; see Box 2.1.)

OTC Derivatives Market

Derivatives instruments had yielded substantial benefits to international financial markets and the global economy, Directors acknowledged. They noted the central role that derivatives instruments and markets play in the effectiveness of the global financial system, and their role in supporting pricing, trading, and risk management in all the major bond, equity, and foreign exchange markets. The use of derivatives to unbundle financial risks had created more complete, flexible, and efficient financial markets and improved the pricing and allocation of financial risks.

Box 2.1IMF Publishes Quarterly Reports on Emerging Market Financing

Beginning in the second quarter of 2000, the IMF began publishing on its website quarterly reports, entitled Emerging Market Financing. The reports provide in-depth analyses of the risks and opportunities facing emerging market countries in accessing international capital markets, focusing on developments in equity, loan, and bond markets. Prepared in the IMF’s Research Department, the reports are an integral element of the IMF’s surveillance over developments in international capital markets. They draw, in part, on a series of regular informal discussions with a broad set of private financial market participants.

While some Directors argued against overstating the risks associated with OTC derivatives activities, many believed that they could pose considerable risks to financial stability. They observed that OTC derivatives portfolios expose financial institutions to risks that can be more difficult to assess and manage than the risks in traditional lending and deposit taking. These Directors noted that OTC derivatives activities are ruled mainly by market discipline, rather than official regulation or oversight. Some also noted that, while the private, decentralized, market-disciplining mechanisms seemed, so far, to have safeguarded the soundness of individual, internationally active, financial institutions—in part because the institutions had been well capitalized—these mechanisms might not adequately protect market stability. Certain markets and countries, only remotely related to derivatives activities, had experienced instability because of spillovers and contagion. Some Directors recalled the experience in the period leading up to the near collapse of Long-Term Capital Management (LTCM) in the autumn of 1998 and noted that, while no major financial institution failed, private-market-disciplining mechanisms did not prevent the buildup and concentration of large counterparty risk exposures.

In that regard, Directors noted several features of OTC derivatives markets that could raise concerns about financial instability:

  • Gross credit exposures in OTC derivatives transactions are sensitive to changes in information about counterparties and asset prices.
  • Information asymmetries, because of limited disclosure and transparency, complicate the assessment of counterparty risk.
  • OTC derivatives activities affect the aggregate credit and liquidity available in asset markets.
  • Aggregate OTC derivatives activities and counterparty credit exposures are both sizable and highly concentrated in the internationally active financial institutions. This could make these institutions vulnerable to abrupt changes in market conditions.
  • OTC derivatives activities closely link institutions, markets, and financial centers, and therefore are possible vehicles for spillovers and contagion.

These features could raise the risk of a rapid unwinding of positions in response to new information or to changes in risk tolerance.

Those Directors who cautioned against overstating the systemic risks associated with OTC derivatives also noted that, while OTC derivatives combine market and credit risks in ways that would never happen in traditional risks, they also generate significant benefits.

Measures in three areas could address imperfections in the infrastructure of OTC derivatives markets and strengthen market stability: First, market discipline might be made more effective, particularly through private efforts to improve transparency and disclosure, supported by official coordination and oversight. Second, legal and regulatory uncertainties might be reduced, particularly those associated with closeout and netting arrangements and with the regulatory status of derivatives instruments in various jurisdictions. Finally, micro- and macroprudential monitoring of OTC derivatives activities could be significantly improved. Banking supervision and market surveillance could pay closer attention to the effects of OTC derivatives activities on risks in financial institutions and markets. Directors agreed that private and public efforts in these three areas, by enhancing market discipline, could strengthen private risk management and thereby reduce systemic risk.

Private Sector Involvement in Crisis Resolution

Directors agreed that efforts at crisis prevention and resolution, which serve to reduce inefficiencies and instability in the international financial system, were in the interests of both the public and private sectors. Because of the relative absence of clearly established rules of the game in the international context, the reaction of the private sector to new information and initiatives concerning the official community’s approach to crisis resolution could have potentially profound implications for the nature and structure of international capital flows. Market participants’ responses to the array of crisis prevention and resolution proposals had, in many cases, reflected an incomplete awareness of official sector initiatives. Many Directors therefore stressed the importance of publicizing and clarifying the official community’s objectives and initiatives, particularly the work on standards and codes of good practice. The level of communication and understanding between the public and private sectors also needed improvement. In that connection, Directors stressed the need for more active and effective dialogue between the IMF and the private sector. Directors also welcomed the Managing Director’s proposal to set up a Capital Markets Consultative Group, to complement and strengthen efforts for a faster and closer involvement of the private sector in crisis prevention and resolution (see Chapter 3 for an expanded discussion of these issues).

Directors recalled that private sector involvement in crisis resolution was not new. The extent of involvement, however, had been related to the nature of capital flows. Most Directors agreed that it was useful to distinguish between potential outflows in a crisis that are generated by direct or portfolio equity instruments and more inflexible outflows generated by instruments that have a predetermined, fixed contractual claim.

A key lesson from the 1980s was that, when particular lending instruments are involved in restructurings, the private sector would seek out new instruments it viewed as having a higher likelihood of repayment and as being insulated from restructurings. Directors noted that the large-scale restructuring of syndicated bank loans, in the aftermath of the 1980s debt crisis, while leaving Eurobonds untouched, had provided impetus for channeling flows to emerging markets through the interbank and international bond markets. The more recent experience with concerted interbank rollovers suggested that such rollovers were more likely to be expected as part of future crisis resolution packages. However, expectations that this would occur might lead some international banks to cut their credit lines and run early in the face of an imminent crisis. Alternatively, the possibility of an imminent crisis could prompt international banks to hedge or offset their exposures in other markets, such as the bond market. Most Directors concluded that undue emphasis could not be placed on interbank rollovers alone, and for them to be effective, they had to be part of comprehensive crisis resolution packages.

Directors welcomed the fact that the most recent string of crises had tarnished the halo surrounding the status of international bonds. The experience with bond restructurings and private sector involvement was continuing to evolve rapidly. Some Directors cautioned, however, that if bond restructurings became more common, private sector creditors would, over time, increasingly seek ways of structuring debt so that it was harder to restructure. Most Directors stressed the importance of involving the private sector in a cooperative and voluntary fashion to discourage the creation of ever more short-term or inflexible debt structures. This would contribute to a more efficient and stable international financial system.

Role of Foreign Banks in Emerging Markets

One of the major structural changes in the banking systems in many emerging markets in recent years was the sharp increase in the degree of foreign ownership, especially in Eastern Europe and Latin America. This change reflected the desire of both large international and regional banks to enter profitable markets and of the local authorities to improve the efficiency and stability of their financial systems, as well as to help reduce the cost of recapitalizing weak domestic banks.

The entry of foreign banks in the emerging market banking systems presented both benefits and challenges to the host country, in terms of efficiency and stability considerations. With regard to efficiency, the entry of foreign banks could improve the efficiency of emerging market banking systems by increasing competition and by introducing a variety of new financial products and better risk management techniques. On the other hand, some Directors noted, foreign banks were less likely to contribute to overall efficiency if they serviced only the most creditworthy corporate and household customers.

With regard to the role of foreign banks as a means of helping stabilize banking systems in emerging markets, Directors offered a range of views. Many argued that foreign banks could play an important role in stabilizing these systems, owing to their more advanced risk management systems, their better access to international capital markets, and the likelihood that the local foreign banks would be supervised on a consolidated basis with their parent. Other Directors, however, noted that the potential contribution of foreign banks would hinge on the circumstances, and might vary. They suggested that recent experience indicated that foreign banks may simply “cut and run” during crisis periods and are thus not a stable source of domestic funding. These Directors saw international banks as managing their exposures to emerging markets on a consolidated basis; a decision by them to cut exposures to an individual country could involve reductions in both cross-border lending and local operations. Moreover, these Directors argued that the presence of foreign banks opened a new channel for transmitting disturbances in mature market banking systems to emerging markets. Directors agreed that the entry of foreign banks into emerging markets would benefit efficiency and stability most if accompanied by both stronger prudential supervision in emerging markets and enhanced cross-border sharing of information between supervisors in mature and emerging markets. In particular, supervisory authorities would have to upgrade their capacity to acquire information on, and to analyze the implications of, their use of OTC derivatives products.

Some Directors were concerned about the potential banking system concentration that could arise either as foreign banks acquired local banks or as local banks merged to remain competitive. Such concentration could create banks that were too big to fail locally and thus would lead to an extension of the scope and cost of the official safety net. Other Directors argued that any potential problems could be limited by enhanced prudential supervision and suitable antitrust policies.

Regional Surveillance

West African Economic and Monetary Union

In June 2000, Executive Directors discussed developments and regional policy issues in the West African Economic and Monetary Union (WAEMU). They noted that, following an impressive performance after the 1994 realignment of the CFA franc, the economic and financial situation in the WAEMU had weakened somewhat since 1998. This was due largely to a sharp deterioration in the region’s terms of trade, as well as the weakening of policy implementation and political uncertainties in some countries. At the same time, economic integration had progressed during the previous year. To preserve the gains of economic and monetary union, strong political commitment and appropriate policy improvements were essential to reduce financial imbalances, and the structural reform agenda had to be advanced.

Directors welcomed member countries’ decisive steps toward closer economic integration and the establishment of a framework for coordinating macroeconomic policies, which could enhance the economic and regulatory environment and speed up growth and poverty reduction. They also welcomed the adoption of a regional convergence pact, which provided a framework for promoting good governance and macroeconomic convergence and strengthening mutual surveillance through periodic reviews and possible sanctions. To be effective, such a system should be accompanied by the introduction of harmonized accounting, reporting, and disclosure standards to enhance transparency and accountability in public finance management. Directors urged national authorities to introduce the necessary legislation.

Most of the elements of a customs union and single market were in place, including a common external tariff with relatively low average rates, which set the stage for eliminating intraregional barriers for eligible originating products. Directors urged the authorities to press ahead with removing the remaining barriers to reap the full benefits of economic integration. Directors stressed that the establishment of a full-fledged customs union and an effective single market would require removing special import surcharges and other safeguard measures, reducing duty exemptions, and abolishing nontariff impediments to free movement of goods and factors.

Despite a less favorable internal and external environment, the monetary policy of the Central Bank of West African States (the BCEAO) had been broadly appropriate in 1998 and in 1999. Directors underscored the need for monetary policy to remain prudent, particularly given the uncertainty about the resumption of adjustment programs in some countries. They welcomed the decision by the Council of Ministers to gradually eliminate central bank statutory advances to governments by 2002; such action would foster the development of a regional market for government securities and thereby increase the effectiveness of monetary policy in WAEMU.

Despite the progress made over the past decade in rehabilitating the banking sector and effectively supervising banks, a number of banks in the region still did not comply with the core prudential ratios. Directors welcomed the introduction of new prudential arrangements similar to the core principles recommended by the Basel Committee. They also welcomed efforts to improve compliance with prudential regulations, and plans to complete the privatization of major banks in several countries. There was still scope, however, to strengthen management of banks and the supervision of the financial system. While welcoming the introduction of a single, zone-wide licensing agreement for banks in the WAEMU, Directors noted that the quality of financial intermediation in the region would benefit from greater competition among financial institutions and from improvements in the judiciary and law enforcement system that would reduce the problems associated with loan recovery.

The authorities had taken important steps in 1998 to encourage the development of a regional financial market and the creation of a more diversified range of financial institutions and instruments to attract available saving and provide the longer-term credit needed to finance business expansion. The new regional stock exchange in Abidjan, together with the supporting regulatory framework placed under the supervision of a Regional Securities Commission, offered an excellent vehicle for mobilizing long-term saving to boost investment and growth in the region. Directors, however, stressed the need to further develop the operational and regulatory framework of the market to make it more efficient.

Directors supported recent steps to harmonize indirect taxation in the WAEMU, formulate a common investment code, and strengthen business laws in the context of the Treaty on the Harmonization of Business Laws in Africa (OHADA). They encouraged the authorities to move forcefully in addressing the remaining agenda items in that area, including harmonizing the taxation of petroleum products and promoting common tax procedures and methods to control exemptions and improve the taxation of small business.

The external competitiveness of the WAEMU economies appeared to be broadly adequate on the basis of a number of traditional exchange indicators. Directors suggested that those indicators be broadened and closely monitored, given the external current account’s demonstrated vulnerability to terms-of-trade fluctuations and to domestic price rigidities and economic inefficiencies. Apart from sound macroeconomic policies, decisive progress in structural reforms was essential in all member countries to boost labor productivity, cut excessive domestic costs, and maintain the region’s competitiveness in export markets. In that vein, Directors welcomed efforts to address, at the regional level, the most critical structural barriers to growth in agriculture, industry, transportation, and territorial development. While noting the merit of elaborating common sectoral policies, Executive Board members called for setting priorities in the pursuit of economic integration. Over the longer term, the rate of domestic savings would need to rise, to maintain the recovery in the rate of investment.

Directors welcomed and encouraged the renewed efforts to integrate the WAEMU into the larger regional arrangement of the Economic Community of West African States (ECOWAS)—with a view to creating a large, single regional market and a common monetary framework. They highlighted the need to harmonize trade policies by removing all internal tariffs and introducing a harmonized common external tariff. Directors stressed the importance of setting up an appropriate framework for credible regional surveillance to promote macroeconomic policy convergence in the region. The success of those initiatives would depend critically on strong progress in carrying out sound macroeconomic and structural policies in all ECOWAS countries.

Directors indicated that a strategy for regional integration required timely and reliable regional statistics, especially in the areas of national accounts, domestic debt, trade, and balance of payments, and the adoption of new indices to measure price and factor cost movements.

Monetary and Exchange Policies of the Euro Area and Trade Policies of the European Union

Executive Directors met in October 2000 to discuss the monetary and exchange rate policies of the euro area, and recent developments in trade policies of the European Union.

Policies of the Euro Area

While noting that favorable external developments and strong macroeconomic fundamentals had produced robust growth in the euro area, Executive Directors cautioned that the persistence of high and volatile oil prices had heightened downside risks and might affect the otherwise favorable prospects for growth in the short run.

Directors were more uncertain about medium- and longer-term prospects and emphasized that lasting reductions in unemployment in the euro area would be possible only if the ongoing expansion were sustained. They saw risks both in a sharp reversal of the favorable external shocks that had helped propel the euro-area upturn and in the area’s structural rigidities, which in the past had often interacted with insufficiently countercyclical fiscal policies to undercut upswings and worsen downturns.

The monetary union had strengthened the euro area’s macroeconomic structure, including by bringing about euro-area-wide monetary policy, better coordination of fiscal and structural policies, and greater awareness at the national level of the implications of wage developments for competitiveness. They stressed, nonetheless, that those changes had not yet been tested by adversity, and that the prevailing favorable economic circumstances provided an important opportunity to forge ahead with needed reforms.

The most pressing challenge, from a regional as well as a global standpoint, was to implement policies that both sustained the expansion and made it more resilient. In particular, Directors urged euro-area policymakers to adhere closely to the key requirements of safeguarding price stability; establishing structurally balanced fiscal positions and avoiding procyclical fiscal policies thereafter; and strengthening the supply side through a balanced and proactive strategy of tax, spending, and structural reforms.

Monetary management in the euro area had been suitably cautious; the rise in interest rates had helped preserve medium-term price stability during a period of unexpectedly large and protracted oil price increases and euro weakness. As the effects of the external influences that had contributed to the firming of the recovery and the buildup of cost pressures dissipated or were reversed, and if inflation showed signs of declining, the symmetric approach that had to date shaped policy would call for interest rates to be adjusted appropriately. In that context, the monetary authorities should focus on core inflation and be rather cautious in interpreting headline inflation.

As to the level of the euro, Directors noted that the misalignment of the euro, both vis-à-vis the U.S. dollar and in effective terms, remained large. The misalignment should eventually correct itself, in part as cyclical divergences narrowed and as underlying portfolio adjustments ran their course, but Directors’ views differed over the significance and nature of those portfolio adjustments. They agreed that the concerted intervention in support of the euro in September 2000 had helped stabilize the exchange rate by sending a signal that market participants would have to bear in mind in the future. They also considered that monetary decision making should take into account movements in the exchange rate to the extent that they posed a threat to medium-term price stability.

Directors agreed that the key fiscal challenge was to implement supply-enhancing tax cuts while avoiding procyclical fiscal policies. In that connection, they regretted that the prevailing stance was somewhat procyclical in the aggregate and risked becoming increasingly so if the pace of consolidation did not keep up with the expansion. In future, closely integrated tax and spending policies should ensure that tax reductions did not run ahead of offsetting permanent cuts in public spending.

More broadly, Directors stressed that the pursuit of at least neutral fiscal policies required evaluating fiscal positions relative to the cycle, thus targeting budgetary surpluses when activity was above potential. This would enhance the effectiveness of the monetary union by strengthening the policy mix and meeting the Stability and Growth Pact’s1 objective of close to balance or surplus in the medium term—which would also afford scope for countercyclical policies when growth weakened.

National fiscal strategies should also encompass tax and spending objectives that effectively bolstered the growth potential of the euro area. In that context, tax cuts had to be carefully targeted to achieve the most beneficial supply-enhancing effects, and spending policies should focus on increasing the efficiency of public services. Progress on this front had been mixed, especially with regard to spending reforms.

While acknowledging that structural reforms had advanced, Directors stressed that further efforts were essential to create scope for growth and to avoid capacity constraints from again choking off the expansion prematurely. In that connection, they welcomed the Lisbon summit decision to put structural reforms at the top of the European Union’s policy agenda.

In labor markets, Directors stressed the importance of strengthening effective labor supply, including by tightening eligibility for benefits and sharpening the incentives for job search, as well as by fostering in many cases more flexibility in wage determination.

In product markets, there was room to promote competition in key sectors and remove administrative barriers to business formation as well as to some cross-border activities. On the financial sector, Directors welcomed the intention of the euro-area authorities to keep the prevailing supervisory arrangements under review in order to ensure they continued to work effectively, particularly as the interbank market became more closely integrated and pan-European institutions resulted from ongoing consolidation. Directors also discussed whether some consolidation or strengthened coordination of the existing institutional arrangements would be desirable and expressed a variety of views on that matter. It was also noted that further steps were needed to increase the integration of capital markets and the transparency of banking institutions in the euro area, for example, by addressing the relatively weak disclosure rules and by instituting more uniformity in the provision of accounting information, including better reporting of nonperforming loans.

European Union (EU) internal surveillance over structural reforms had proven to be helpful, but Directors argued that its effectiveness depended on its candor. As for EU surveillance over fiscal policies, they agreed the annual appraisals of stability programs by the Commission and the Economic and Finance Council of Ministers of the European Union (ECOFIN) had proved beneficial and should continue. In that connection, Directors also noted the increasing role of the Euro Group as a forum for peer review, policy coordination, and harmonization.

Directors acknowledged the adequacy of existing statistical data for surveillance purposes, but called for strengthening the euro area’s statistical base in the dimensions most critical for monetary policy decision making.

Recent Developments in EU Trade Policies

Directors welcomed the EU’s commitment to an early launch of a new round of multilateral trade negotiations, and the EU Commission’s initiative in promoting free access for the exports of the world’s poorest countries. They urged the EU to put in place quickly its latest proposal in favor of these countries. Directors recognized, however, that support for new multilateral negotiations would be strengthened if the EU also addressed the most restrictive and complex aspects of its own trade regime—including through a faster liberalization of agricultural, textile, and clothing markets, a reduction of subsidies, and a review of antidumping policy.

Looking ahead, the impact of the EU’s policies on trade also had to be kept in mind as the EU was enlarged. Directors welcomed the EU’s reliance on the procedures of the World Trade Organization’s Dispute Settlement Body to resolve its bilateral trade disputes and encouraged it to abide by the Dispute Settlement Body’s rulings. Directors also called on the EU to minimize the potential for regional and bilateral trade agreements to lead to trade diversion by pursuing multilateral trade liberalization at a similar pace.


The European Council’s June 1997 agreement to secure budgetary discipline in member states during the final stage of European Economic and Monetary Union; it also called for annually updated, medium-term stability programs.

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