As the IMF looks ahead in this new century, one of its most pressing challenges, Timothy Geithner said, will be helping emerging market economies reduce their vulnerability to financial crises. Over the past decade, emerging market economies have made progress toward this goal, reflecting the increased sophistication and skill of their economic policymakers. Many of them have, on average, increased international reserves (providing a larger financial cushion); improved fiscal performance; reduced external balances; shifted from fixed but adjustable pegs to more flexible exchange rate regimes; and lowered inflation.
Still, the emerging market countries are not out of the woods yet, according to Geithner. “These aggregate improvements,” he said, “mask substantial differences across countries and … areas of lingering vulnerability.” For example, a number of countries face very high and, often, still growing public sector debts. The challenge of managing such large debt burdens is exacerbated by the structure of this debt. With a substantial share of the debt denominated in foreign currencies and carrying short maturities, these countries are vulnerable to foreign currency, liquidity, and interest rate risk. In some countries, Geithner added, large public sector debts have left banking systems highly exposed to the state, constraining governments’ room for maneuver. Recent improvements in external positions could also be reversed as domestic demand strengthens. In addition to the risk of crises, he said, large debts could depress domestic investment and long-term growth.
The IMF can help these countries become more stable financially, Geithner said, “by promoting an unwinding of these large balance sheet risks and, at the same time, providing a credible form of contingent insurance for those hopefully rare circumstances when its members face extraordinary financing needs.” But the IMF would be better able to help, he said, if it took steps to strengthen its own policy advice, surveillance, framework for sovereign debt restructuring, and financing instruments.
Geithner noted that studies by IMF staff and the Independent Evaluation Office, among others, have criticized the IMF’s reform prescriptions as insufficiently ambitious and as deferring too much to members’ domestic political constraints on adjustment and reform. One result, he said, is that members have run exchange rate regimes incompatible with the rest of the policy framework. Another criticism is that the IMF has not been effective in addressing increases in debt that have created balance sheet problems and made emerging market country crises so damaging and difficult to resolve. The studies also found the IMF overly accommodative of members’ unrealistic policy decisions.
Although Geithner characterized the criticisms as unfair in the degree of influence they expect the IMF to exert over a member country, he acknowledged that they have substantial merit. Thus, he said, the IMF “probably needs to raise the bar to increase the level of ambition of its policy recommendations.” It should not acquiesce to and validate policies that fall substantially short of what is required in the prevailing environment. As a remedy, Geithner proposed a risk-based framework for determining the hierarchy of policy priorities. Under such a framework, there would be a sharper focus on unwinding balance sheet problems, reducing sovereign debt to more sustainable levels, increasing buffers against liquidity problems, and preserving appropriate exchange rate arrangements. Addressing these issues, he said, would help reduce the risk of future capital account crises and improve the conditions for private sector growth.
Another area that could stand strengthening is the IMF’s existing surveillance framework, through which it delivers policy advice to its members. In its current form, Geithner observed, it is not well suited to small open emerging market economies with fragile credibility, limited buffers against shocks, and considerable exposure to a rapidly changing economic and financial environment. He also argued for more frequent and candid assessments of member economies. Now, they occur only every 12–24 months and are published only with the members’ agreement. This arrangement “tends to take the edge off the diagnoses and the prescriptions.” Furthermore, the assessments represent the judgments of the IMF’s Executive Board and not the staff, so that risks are not clearly and candidly identified and explored. Finally, he noted, there are no consequences for members because critical evaluations can be withheld from the public.
The IMF has considered a number of ways of strengthening surveillance, Geithner noted. One of the most promising entails more frequent publication of staff assessments of members’ performance against a medium-term framework that each member country would design. These assessments would then measure the progress countries are making in reducing vulnerabilities, improving resilience, and strengthening the structural underpinnings of growth. Geithner also argued that such a framework should be combined with contingent access to IMF resources. Currently, surveillance does not provide a meaningful check on members’ policies before they are adopted, even though good policies are a country’s best defense against crises. Moreover, the IMF makes resources available only when the financing need is acute.
Providing access to supplemental resources on a precautionary or contingent basis could help prevent short-term liquidity crises from becoming full-blown solvency problems that lead to default. “With an enhanced surveillance framework designed to help keep policy on a stronger path that does reduce risk over time, and with contingent finance that could be mobilized quickly,” Geithner argued, “the IMF would be better positioned to contain the risk of deeper financial crisis.”
Framework for sovereign restructuring
In the past few years, some progress has been made in improving the framework for restructuring sovereign debt. Geithner noted, in particular, that collective action clauses have become the market standard for emerging market governments issuing debt under foreign law.
Geithner laid out his view of how the international community could credibly approach situations in which a country must restructure its obligations to private creditors. He proposed two conditions for the IMF to lend to a country in default.
First, the country should commit to a credible medium-term adjustment program that offers the prospect of a successful restructuring and a reasonably early return to the capital markets. The country must determine its own adjustment path, which must be endorsed by the IMF.
And, second, the country should develop, in consultation with its advisors, a credible and monitorable framework for a viable debt restructuring that leaves it with a sustainable debt burden. This framework should be outlined to the IMF and accepted by the country’s creditors. It would also need to be consistent with the country’s macroeconomic framework and repayment prospects.
Reaffirming these conditions as the foundation for IMF support in restructuring countries’ arrears, Geithner said, would improve the system and better prepare the IMF to contribute to the favorable resolution of future crises that involve restructurings.
Finally, Geithner suggested some changes that would make the IMF’s financing instruments more effective in dealing with the challenges inherent in an increasingly integrated global economy. The reforms of the 1990s (including the increase in the financial size of the IMF, new facilities, and greater flexibility in the phasing of resources) were important, he said, as have been more recent IMF reforms designed to prevent the institution from making large-scale disbursements available without assurances that they would contribute to the resolution of a crisis.
Geithner proposed building on this recent progress by adding elements of a credible insurance mechanism to the IMF’s facilities. What would be needed? First, before receiving IMF resources, a country’s policy framework should be strong enough to restore confidence. Second, to help catalyze other resources, the IMF must calibrate the scale of the resources it provides to the country’s need. Third, the IMF must build in the flexibility to structure programs appropriate to a country’s circumstances and policy efforts. (For example, the IMF should be able to front-load financial packages when that would be warranted.) Fourth, the IMF should be prepared to support countries in pursuing reasonable restructuring proposals when circumstances warrant. And, fifth, the IMF should take steps to avoid either the reality or the perception that it can be induced to accept weak programs to allow a country to refinance its exposure.
These are modest proposals, Geithner said, and would not fundamentally alter the balance established by the IMF’s Articles of Agreement between the rights and the obligations of its member countries. These changes would, however, help the IMF deal with future financial pressure in emerging market countries. “And, given the scale of the economic costs imposed by recent crises, that is an important goal.”
View from the private sector
Speaking from the perspective of a large international banking concern, William Rhodes noted the IMF’s evolution over the past 60 years and exhorted it to keep two things constant: its support of meaningful reforms that meet the organization’s high standards and its role as a catalyst for private sector finance, which ensures that countries have access to the resources they need to grow. Experience has proved, he said, that the right mix of policy and official financing can restore investor confidence and catalyze private finance even in the most severe crises.
What should the IMF keep in mind as it looks to the future? Rhodes outlined five points that he would like to see the IMF take into account as it positions itself to uphold its key role as guardian of the international monetary system:
• Focus more on crisis prevention, including taking steps to strengthen Article IV consultations.
• Increase transparency. The IMF has made great progress but can do more.
• Work more closely with the private sector to have an informed market perspective. Rhodes pointed to the Capital Markets Consultative Group as a step in the right direction, adding that this initiative should be continued and even strengthened.
• Enhance credibility, which requires that the IMF carefully balance its roles of creditor and arbiter.
• Uphold its stated principles on a consistent basis.
For more information on the Bretton Woods Committee event on June 10—which also honored Paul Volcker, former U.S. Federal Reserve Board Chair, with its first Global Leadership Award—see www.brettonwoods.org.