United Nations


General Assembly

Distr. GENERAL  

16 September 1998


                                                     Original: English
General Assembly
Fifty-third session
Agenda item 91 (b)
Macroeconomic policy questions: 
  financing of development,
  including net transfer of resources 
  between developed and developing countries

         Global financial flows and their impact on developing
            countries: addressing the matter of volatility

                   Report of the Secretary-General


                                                     Paragraphs  Page

  I.  Introduction . . . . . . . . . . . . . . . . . .   1-6       2

 II.  Towards a new consensus  . . . . . . . . . . . .   7-47      2

      The political art of policy-making . . . . . . .  11-15      3

      Macroeconomic policy in capital-importing 
      countries  . . . . . . . . . . . . . . . . . . .  16-22      4

      Speed and sequencing of financial liberalization  23-29      5

      Quality of regulation in capital-importing 
      countries. . . . . . . . . . . . . . . . . . . .  30-32      6

      Policy in developed countries. . . . . . . . . .  33-38      6

      International reform . . . . . . . . . . . . . .  39-47      7

III.  Conclusion . . . . . . . . . . . . . . . . . . .    48       8

        I.     Introduction

1.   A number of developing countries, mainly in Asia and
Latin America, became increasingly successful in the early
1990s in accessing international financial markets. The
extent of Latin American access was especially noteworthy,
as the region had been largely bypassed by international
financial investors in the 1980s, owing to the debt crisis.
However, 1994 ended with a currency crisis in Mexico,
followed in early 1995 by a crisis in Argentina and
pressures on the financial and currency markets of several
countries. By the summer of 1995, Mexico and Argentina
were in deep adjustment recessions and the international
community began to formulate policy measures to deal with
a new class of crises, ones in which increasingly open
developing and transition economies suddenly found
themselves having to cope with large movements of
financial flows. 1/

2.   In the light of these experiences, the General
Assembly began a series of discussions on development and
global financial integration. These discussions led to the
adoption of Assembly resolutions 50/91, 51/166 and 52/180
in 1995, 1996 and 1997 respectively.

3.   As reflected in those resolutions, the international
community updated its strategy for dealing with economic
and financial crises in developing countries (for example,
through improved standards of information flow to the
public on emerging market economies and establishment of
an emergency financing mechanism at the International
Monetary Fund (IMF)). In addition, the Latin American
crisis countries entered into recovery paths. Concern
remained, however, about the degree of exposure to
potential financial volatility.

4.   Indeed, in July 1997 an economic crisis erupted in
South-East Asia when Thailand was no longer able to
maintain the fixed exchange rate of the baht. The updated
international strategy for dealing with such situations was
applied in assisting Thailand, the Philippines and then
Indonesia (Malaysia was also heavily affected, but did not
arrange an internationally supported adjustment
programme). Beginning in October 1997, moreover, the
nervousness spawned by the South-East Asian situation
spilled over into financial and currency market volatility in
Hong Kong, China; Brazil; South Africa; the Russian
Federation and elsewhere. Even the New York Stock
Exchange was affected for a time. The year ended with the
Republic of Korea engulfed in a major financial crisis and
a growing international chorus of questioning whether the
new strategy was working. 2/

5.   The General Assembly thus requested the Secretariat
to analyse current trends in global financial flows and the
effect of their volatility on growth and development, and to
recommend ways and means to address the volatility of
those flows (see Assembly resolution 52/180, para. 13). An
assessment of the financial and economic situation of the
affected countries as seen in April 1998 was presented in
World Economic and Social Survey, 1998, 3/ which, as
requested, also offered a set of observations on policy for
consideration by the Assembly. An updated assessment, as
requested, was presented in Trade and Development Report,
1998, 4/ with further policy considerations.

6.   In addition, the General Assembly requested the
Secretariat to prepare a report for the present session of the
Assembly covering matters raised in Assembly resolution
52/180 (see para. 14 of that resolution). As other
documentation prepared for this session of the Assembly
under agenda item 91 reviews trends and policy issues
concerning the financial flows and net transfers of resources
of developing countries (see A/53/228) and the external
debt situation of developing countries (see A/53/373), the
present report focuses on suggested policy measures for
national Governments and for strengthened international
cooperation in the context of increasingly volatile
international financial flows.

       II.     Towards a new consensus

7.   Almost a decade ago, John Williamson, a British
economist, coined the phrase "Washington consensus" to
describe a set of policies that IMF, the World Bank and the
Governments of various aid-giving countries had been
jointly advocating for economic management and growth
of developing countries, and for the effective insertion of
these countries into the globalizing world economy. 5/ Other
international institutions   notably several members of the
United Nations family   focused international attention
more explicitly on the "human" dimension, environmental
concerns and other aspects of the development of nations,
but the Washington consensus was never seriously
challenged in the realm of the "hard" policy concerns of
macroeconomic stabilization and adjustment, trade and
financial liberalization, until recently.

8.   The change came as a result of the severity and
duration of the Asian currency crisis of 1997 1998. Policy
advice that was guided by the Washington consensus was
unable to stem the economic decline in East Asia or protect
distant countries from contagion. The economies of
developing countries that had once been considered among
the most successful and worthy of emulation were brought
down low. The Asian miracle became the Asian crisis.
Crisis management by national officials and the Bretton
Woods institutions has thus been challenged in a chorus of
growing numbers and intensity, including legislators,
academic critics and the financial and business community
in major developed economies.

9.   Under this wave of criticism and the unrelenting
economic decline in the Asian crisis countries,
internationally advocated policies have slowly changed.
Fiscal and monetary policy conditions have been eased in
the more recent adjustment agreements that crisis countries
have struck with IMF, 6/ and the time-frame for reaching the
goal of complete capital account liberalization has been
repeatedly lengthened and now stretches to upward of 50
years, at least for some countries. 7/ Moreover, in April 1998,
the Institute of International Finance (IIF), which reflects
the views of the major international commercial banks that
are its members, sent a letter to the Interim Committee of
IMF, inter alia, expressing reservations about amending the
IMF's Articles of Agreement to make capital account
liberalization a main goal of the Fund. 8/

10.  One strength of the multilateral institutions over the
past 50 years has been their capacity to learn and adapt,
which this year has required a period of reflection and
study. 9/ Indeed, thinkers from all corners of the world have
been analysing and discussing recent developments for over
one year. It thus seemed timely to see if a new consensus
was emerging on policy for macroeconomic management
and growth and for effective integration into the global
financial system. A meeting to take stock was therefore held
in July comprising individuals from many parts of the
United Nations, IMF, the World Bank, other international
institutions, the private sector and academia, who have
grappled with these policy concerns. 10/ The coalescing of
views that seemed to emerge from this meeting was less a
break with the Washington consensus than a pragmatic
modification, in the light of recent experience, of some
aspects of it .

               The political art of policy-making 

11.  The first element of the new consensus may set the
tone for the discussion to follow. It entails the awareness
that policy-making is carried out in a political context, and
policy prescriptions must be politically viable. Thus, policy
formulas developed for one set of national institutions do
not automatically work well in others; institutions
developed for one period can become inappropriate in later
ones. The art of policy-making consists in recognizing when
change is necessary in policies and/or institutions, when
change is possible, and how change can be brought about

12.  The choice of policies and measures involves a wide
range of considerations and frequently will not be optimal
from a purely technical point of view, even in those
circumstances where there is agreement on what is optimal.
Moreover, there is a fine line between policies that are
suboptimal but tolerable and policies that are unsustainable.
To the degree that a country is open to international
financial movements -- and no country is completely
closed -- incomplete (or even erroneous) "news" about the
economy can move perceptions across the line and turn what
is seen as a policy flaw into a policy disaster.

13.  Therefore, institutions need to be sufficiently robust
to withstand the consequences of perceptions of policy
shortcomings; in particular, loss of confidence of short-term
investors should not threaten economic collapse. Institutions
must also be in place before they can be drawn upon; for
example, the time to weave a social safety net is before there
is a crisis. In addition, sometimes the appearance of
institutional change will exceed what is actually achieved;
for example, privatizing state enterprises need not by itself
produce the expected economic restructuring or
competition. Continued monitoring is essential, and this
requires provision and dissemination of reliable and
appropriate data, and vigorous public discussion of policy
and institutional concerns.

14.  The new consensus, moreover, is well aware that the
international institutions that stand behind their policy
advisers may offer "carrots" or "sticks" to prod policy
reform, but that in the end it is only the Government that
implements any policy decision. International observers
should not expect more from a policy dialogue between a
Government and an international institution than is realistic.

15.  This notwithstanding, there is widespread recognition
that international policy advisers can take on unusually
powerful roles during economic crises. At such times, they
need to be particularly sensitive to local conditions. For
example, in a country emerging from years of civil conflict,
priorities normally accorded to fiscal adjustment have to be
weighed against programmes to build confidence in
government and development. This could affect the
assessment of the government's debt-servicing capacity and
foreign assistance requirements. Or, to take another
example, potentially viable firms may easily be lost in the
middle of a financial crisis. As their reconstitution may be
far from automatic or quick, the economic and social
consequences can be long-lasting. Debt workouts in such
cases might be considered part of the policy dialogue. In
such situations in particular, international policy advisers
act on behalf of the broadest interests of the international
community and need to be particularly sensitive to social
and structural fragility.

       Macroeconomic policy in capital-importing countries

16.  Macroeconomic policy-making   always difficult  
is made even more complex when capital markets are open
and financial flows are volatile. As a practical matter,
macro-policy should thus aim to attain medium-term goals
and incorporate automatic stabilizers to help absorb 
short-term fluctuations (for example, stabilization funds can even
out the tax revenues from unstable earnings on commodity

17.  As a general rule, in order to smooth the growth of
aggregate demand, fiscal policy should tend to offset private
spending booms that may accompany strong financial
inflows, and vice versa during outflows. Medium-term
budgeting with built-in plans to accelerate or slow certain
outlays as needed might mitigate the political difficulty of
cutting discretionary spending during periods of strong
growth when there is no crisis to be seen. Operationally, the
budgetary policy target should be the "structural" balance,
which takes account of the impact of cyclical developments
on the budgetary outcome, rather than the nominal
balance. 11/

18.  The ability to use monetary policy for domestic
stabilization purposes is inseparable from the choice of
exchange-rate regime. Typically, monetary policy is one of
the policy tools for managing the balance of payments. For
example, increases in domestic interest rates may be called
upon to stem an unwanted financial outflow. This may be
effective, but it is a dangerous policy choice when the
domestic financial sector is weak and the level of debt in the
economy is high. An increase in domestic interest rates has
a psychological effect as well as a financial impact on firms
and financial institutions and so must be a credible signal
of government commitment to a tight policy stance. If the
economy cannot withstand the shock (as was the case in
certain Asian economies in 1997), the signal is unlikely to
have the desired impact and may even have the obverse one.

19.  Financial outflows from a country may reflect a loss
of confidence in the local economy. Sometimes they can be
triggered by unrelated developments elsewhere. Certain
macroeconomic indicators, such as an increasing difference
between domestic and foreign interest rates, a falling ratio
of official foreign reserves to the money supply, a high
share of short-term financing in external capital inflows, or
a rising ratio of current-account deficit to gross domestic
product (GDP), may be monitored for signs of an
approaching unsustainable situation. However, there are no
universally applicable rules or "standards" regarding the
critical level of such indicators. Confidence may be lost at
different values of the indicators for different countries or
at different times for a single country. Decisions of the
private sector to move money in or out of a currency are
matters of judgement in an uncertain situation subject to
dramatic changes.

20.  One such dramatic change occurs when a "pegged"
or fixed exchange rate becomes unsustainable and has to
undergo a discrete adjustment. An alternative is to allow
some flexibility in the exchange rate so that smaller, daily
changes prevent the build-up of pressure for a large change.
The problem is that the inherent volatility of financial flows
may make the daily changes excessively large. For such
reasons, some form of controlled flexibility can be
attractive. For example, a thoughtfully designed "crawling
peg" can stop the real exchange rate from appreciating, the
trade balance from widening and the expectation of a
significant devaluation from growing. 12/

21.  The crucial issue is to avoid creating a situation of
"one-way bets" for speculators in which a Government
endeavours to maintain an exchange rate that is widely
perceived to be overvalued. Under such circumstances,
currency traders will usually be able to mobilize more
financial resources than the Government and will force a
devaluation by selling more local currency than the
Government can buy. 13/ While controls on short-term capital
movements can limit such possibilities, controls become
harder to enforce as the profit expected from evading them
rises. The expected profits can be held down by allowing
exchange rates to be changed before speculative pressures
build. On the other hand, flexible exchange rates call for the
development of forward markets or markets in "futures"
securities that enable firms to reduce their exchange-rate
risks. 14/ In any event, the fact that forward and futures
markets for the currencies of most developing countries are
likely to be relatively thin reduces the attractiveness of
freely floating exchange rates.

22.  A common compromise is to allow flexibility within
a band around a given exchange-rate peg. For this to work,
however, the authorities must keep the exchange rate well
within the band; if the value of the currency approaches the
edge of the band, speculative pressures can build, as in the
case of a strictly fixed exchange rate. A more sophisticated
approach would be a combination of periodic changes in the
central rate to compensate for differences in inflation with
trading partners, combined with intermittent and irregular
central-bank intervention in the market to raise uncertainty
about the size and direction of short-term movements in the
exchange rate (that is to say, "vigorous dirty floating"). If
this strategy exceeds the resources and capabilities of the
central bank, the authorities may have to choose between
accepting vulnerability to potentially sharp fluctuations in
the exchange rate and using some controls on capital
movements to strengthen the hand of the central bank.

     Speed and sequencing of financial liberalization

23.  Relaxation of policy limitations on a domestic
financial sector should not be carried to the point of
complete laissez-faire. That financial institutions are
inherently prone to excess and vulnerable to crisis warrants
appropriate supervision and prudential regulation. By the
same token, liberalizing international capital flows opens
an economy not only to important opportunities, but also
to additional volatility which could present dangerous
challenges, especially for small economies in which the
external financial flows might grow to a significant share
of GDP.

24.  It thus seems generally preferable to develop and
locally deregulate the different elements of domestic
financial markets before opening them externally. 15/ The top
priority should be to build a robust banking system. The
development of stock exchanges has also been given priority
in many countries, but next to the banking system and the
potential benefits of domestic bond markets, stock markets
are of relatively marginal importance for development,
especially for the development of small and low-income
economies in the early stages of financial development.

25.  Foreign direct investment (FDI) can be an especially
fruitful form of financial inflow, which is why it is often
encouraged as one of the first components of capital inflow
to be liberalized. Although it is typical to think of the
benefits that can be brought by large multinational
corporations, small and medium-sized companies can also
offer important opportunities in transborder investing.

26.  However, FDI is not a panacea and total flows should
be monitored; for example, a surge in FDI inflows can
overvalue a currency's exchange rate as much as any other
type of international finance. Also given the physical
presence of direct investors from foreign countries, there
is a possibility of broad resentment and political backlash.
This could be the case, for example, if it were deemed that
substantial amounts of local corporate assets had been
acquired by foreign firms at distress-sale prices owing to
a crisis. More generally, as FDI is not an undifferentiated
financial flow but investment in a sector-specific activity,
policy makers have to ensure its consistency with national
development strategies and social and environmental

27.  The most difficult issue in financial liberalization is
choosing which flows to deregulate and which to control at
any point in time. Much of the blame for the Asian financial
crisis is commonly attributed to the untimely and poorly
sequenced liberalization of financial movements. In light
of the above discussion on exchange rate management, some
form of impediment to volatile financial flows seems
warranted in most developing countries. However, it is not
a simple matter to separate volatile flows from the long-run
investments that should be encouraged; as an example, even
funds brought into a country by a direct investor can be used
to take a speculative position in a currency.

28.  In this regard, there has been considerable interest in
policy experiments that use broad, market-based measures
rather than selective administrative restrictions to
discourage financial volatility. The Chilean effort to limit
vulnerability to speculative outflows by limiting speculative
inflows is the best known in this class of policy measures.
In the context of its highly open economy, Chile adopted
a combination of financial and quantitative controls on
external flows. Most attention has focused on the
requirement that financial investors sequester a fraction of
their capital inflow with the central bank at no interest for
one year (even if the funds are removed in less than one
year). 16/ While this technique appears to have limited
speculative inflows initially, it was increasingly evaded. In
1996, when international demand for Chilean investments
was especially strong, the sequestering requirement
appeared to serve in effect as the willingly paid price of
entry into the Chilean stock market. Moreover, in 1998,
with Chile's stock market and currency heavily impacted
by the economic fallout of the Asian crisis, the policy was
substantially eased so as to be less of a barrier to capital

29.  The lesson of the Chilean experience   like the lesson
of countries with stringent administrative controls   is that
controls can be evaded and are more likely to be evaded the
greater the financial incentives for such evasion. On the one
hand, this means that the exchange rate should not be
allowed to become clearly unsustainable because the
incentive to evade the controls is thereby increased. On the
other hand, it means that the instruments of control need to
be strengthened as weaknesses and loopholes appear. In
addition, the degree of restrictiveness of the controls needs
to be relaxed when conditions warrant, in other words,
controls should be a flexible instrument of policy.
Moreover, non-discretionary and semi-automatic
instruments will be less susceptible to corruption and
evasion. All in all, countries that seek to manage their
foreign exchange market should have a battery of policy
instruments available, rather than try to rely on a single
policy tool.

   Quality of regulation in capital-importing countries

30.  As a matter of accounting, external imbalances have
internal counterparts. However, to trace these adequately
requires more information, and on a more timely basis, on
aggregated domestic stocks as well as flows (for example,
levels of debt in corporate as well as banking sectors,
private liquidity ratios and debt/equity ratios, as well as
borrowing flows). It is essential for the authorities to
monitor the financial state of the domestic economy in order
to identify and address unsustainable situations as they
arise, and for this they may need new types of information. 17/

31.  In many cases, this also means that the government
should take measures to improve accounting and reporting
by domestic businesses; such a step is important especially
in countries seeking to develop domestic securities markets.
Regarding banking per se, a compendium of supervisory
documents has been produced by the Basle Committee on
Banking Supervision, particularly the 1997 core principles
for effective banking supervision. 18/ This is only a step,
however, as the integrated nature of finance requires a
comprehensive supervisory framework that can provide a
perspective on the financial sector as a whole, covering, in
particular, banks, non-bank financial institutions, securities
and insurance firms.

32.  While inadequate regulation is a concern, weak
enforcement of regulations is especially costly. One crucial
issue here is how to manage what are called
"non-performing assets", not only the overall level but also
the distribution by size of loan. In some cases -- most
dramatically, but not exclusively, in transition economies --
lending officers in financial institutions, supervisors and
regulators will need training to function adequately in a new
environment of enterprise-bank relations and accountability.
Local authorities must have the necessary resources and
autonomy to carry out their responsibilities in this regard.

               Policy in developed countries

33.  Developing-country policy makers have to cope as
best they can with the external economic environment as
they find it. However, that environment is very much
influenced by the policies and measures of developed
countries, particularly the major-currency countries, both
individual and collective. In mid-1998, for example, it was
generally considered essential for the Government of Japan
to address more effectively the problems besetting its
economy, particularly its banking situation and need for a
credible economic stimulus package, since this had been
adversely affecting other countries, particularly other
countries in crisis in the region.

34.  In general, however, macroeconomic policy
coordination among the world's major economies has
proved difficult, otherwise than in the occasional joint
intervention in foreign exchange markets when policy
makers together signal that they believe exchange-rate
changes have become excessive. One reason for limited
coordination is that different Governments have not always
shared the same view of the essential driving forces in their
economies or the same policy priorities.

35.  The difference of views has been especially sharp in
the case of the Japanese economy in recent years and can
be seen in the efforts of partner countries to encourage
policy changes in Japan. This experience suggests that a
useful instrument for international coordination is vigorous
international public debate on policy questions of global
importance as a means to build a consensus on policy.

36.  One area in which thinking in different official circles
has been along relatively similar lines is that of the
principles of financial market regulation and oversight. The
financial volatility seen in Asian and other emerging-market
economies in 1997 and 1998, however, suggests that some
regulatory gaps remain in developed economies. A number
of financial institutions in developed economies took
excessively risky positions by accumulating large holdings
of poor quality and poorly diversified foreign assets. Thus,
in these countries, as well as in the emerging-market
economies, regulatory systems and early warning
mechanisms need to be strengthened.

37.  The oversight begins at the level of the financial firm,
where it is in the nature of the industry for individual loan
officers and portfolio managers to have incentives to take
risky, albeit potentially profitable positions. Financial firms
thus need strong internal risk measurement and control
systems to ensure that the sum of the activities of their
managers individually does not expose the firm as a whole
to excessive risk. Equally, risk managers should have the
authority to override senior management if necessary in
order to cut excessive exposures.

38.  It might be assumed that financial enterprises would
act on such principles independently, but regulatory
authorities have instead found themselves pushing firms in
this direction. Indeed, at the urging of some of the banks
that developed sophisticated internal risk management
systems, this has become the broad thrust of new banking
regulation. 19/ Among the questions begging for answers,
however, is, How well or poorly did these systems work
during the Asian crisis? 20/ There is also a question whether
the established capital standards themselves are sufficiently
strict and comparable for bank and non-bank financial
institutions and for financial conglomerates that combine
various categories of activities and may operate in several
countries. 21/

               International reform

39.  The main avenues for international cooperation in the
financial arena are IMF and the Bank for International
Settlements (BIS). Forty-five central banks, several of
which are independent institutions, are members of BIS,
which is the locus of decision-making in the international
coordination of financial regulation. BIS services a group
of committees, including the Basle Committee, that are
concerned with different aspects of international banking
and that work increasingly closely with unaffiliated
international associations concerned with non-bank
components of the financial sector. These are ad hoc
arrangements that arose in response to perceived needs, but
they have been carried out at a high level of professional

40.  IMF undertakes a periodic review of global capital
markets, and principles adopted in the BIS committees may
be included by IMF in its surveillance of the financial
sectors of individual developed and developing countries.
This gives a degree of international oversight regarding
implementation of the BIS regulations. Nevertheless, there
are concerns whether this combination of technical work in
BIS committees and implementation oversight by IMF is an
adequate mechanism for global cooperation in financial
sector supervision. Bringing new regulatory questions under
international discussion, for example, depends on
acceptance of the issue by one of the existing committees
or establishment of a new ad hoc arrangement. Also, IMF
surveillance of implementation is necessarily less intense
than a peer review mechanism of regulators, such as might
be undertaken among BIS-member banking authorities. In
addition, the World Bank and regional development banks
provide financial support and technical cooperation for
financial sector reform (with capacity in the case of the
World Bank recently bolstered by the creation of its Special
Financial Operations Unit in February 1998).

41.  Proposals to pull these various threads together more
effectively range from establishing a new institution to
enhancing the responsibilities of one or more of the existing
institutions. 22/ While no new structure of institutional reform
commands wide support as yet, the Finance Ministers of the
Group of Seven (G-7), the major industrialized countries,
in their report to the G-7 Heads of State or Government in
Birmingham saw "an urgent need for a system of
multilateral surveillance of national financial, supervisory
and regulatory systems (which) could encompass
surveillance of such areas as banking and securities
supervision, corporate governance, accounting and
disclosure, and bankruptcy". The Ministers then asked "the
relevant institutions to develop proposals on ways in which
greater cooperation can be achieved, including options for
institutional reform". 23/

42.  There have also been proposals to supplement the
overall surveillance role of IMF in macroeconomic and
financial policy with surveillance at the regional level, most
actively in Asia. Although originally conceived in the
context of a proposed Asian Fund, a new cooperative
surveillance arrangement has been established by the
member countries of the Association of Southeast Asian
Nations (ASEAN). Modelled on "the G-7 format with a
distinct ASEAN character", the group envisages regular
informal meetings of central bank and finance officials at
deputy and ministerial level in which they would evaluate
"potential economic and financial risks of Member
Countries  ... (and encourage) early action to minimize such
risks". 24/ The initiative is being assisted by the Asian
Development Bank.

43.  Peer review and surveillance at the regional level are
likely to be more sensitive to local conditions and
requirements and, by bringing a plurality of views into
discussions of appropriate conditionality, enhance their
political effectiveness. There was also a financial dimension
to the ASEAN plan: a "cooperative financing arrangement"
of mutually supplied funds would potentially supplement
the resources of IMF and other international financial
institutions in the adjustment programme of a member
country. Quick disbursement of funds for financial crisis
situations was also made part of the arrangement, in this
case through the agreement to maintain an existing ASEAN
swap arrangement. However, the extremely difficult
situation into which most ASEAN nations have fallen since
adopting this plan has rendered the financial cooperation
dimensions almost moot for the moment. It has also meant
that the absence of the Asian Fund is felt more strongly.

44.  As a result, IMF remains the only institution with the
mandate to deal with international financial crises.
However, IMF resources have become strained by the
demands imposed on them by the recent crises. If the
international community wishes IMF to carry out the role
it has been assigned, the agreement to increase its resources
should be implemented without delay. 25/

45.  This notwithstanding, the resources that IMF needs
to deploy in any specific crisis depend in part on how the
claims of private foreign lenders are treated. In the case of
the Republic of Korea, it became most clear that a
considerable portion of the international official resources
channelled to the Republic of Korea at the end of 1997 was
helping to finance the retreat of foreign bank lenders. Even
though international commercial banks are the arteries for
monetary and payment systems and thus warrant special
treatment, it was widely felt that they should have been
required to roll over maturing loans and replace short-term
credits with longer-term maturities; indeed, by early 1998,
this was the approach adopted. 26/

46.  There is considerable sentiment, especially among
experts, in favour of international adoption of stronger
proposals in the same vein. Conditions would be established
under which debtor countries in balance-of-payments crisis
would not be penalized for undertaking a "debt standstill",
that is to say, a moratorium on debt servicing having at least
implicit approval of the creditors. 27/ The availability of such
a mechanism could be made manifest before a crisis struck
by writing into loan contracts that some potential event  
perhaps validated by an international assessment of need  
might trigger a warranted standstill. Knowledge that such
a standstill might be declared would increase the perception
of riskiness of bank lending to emerging-market economies,
and this in turn could discourage excessive inflows. It would
also probably slightly raise the cost of credit, as banks
would bear more risk. Above all, however it would perforce
"bail in" the private creditors that accepted being exposed
to such situations: they would have every incentive to accept
a "voluntary" debt restructuring should an emergency arise,
rather than write off their loans.

47.  A complementary proposal would further encourage
creditor cooperation in restructuring the debt due in such
circumstances. This proposal has come to be called "IMF
lending into arrears". It would entail an IMF policy decision
to permit agreement to a Fund-supported economic
adjustment programme with a member country under certain
circumstances even if arrears were continuing to accumulate
on outstanding debt. If the debt standstill and "lending into
arrears" were deployed together, these two options could
make the difference in terms of maintaining adequate
liquidity and avoiding the kind of credit crunch that seized
up the financial systems of the Asian crisis countries.

                  III.     Conclusion

48.  This report is being submitted while we are still in the
midst of the storm that has hit the global financial system.
Hence, the outlines of the consensus on national and
international policies for macroeconomic and financial
management presented above must be considered an interim
exercise. If the storm blows over soon, a widespread
recession is avoided and the most affected economies
resume the path of growth relatively quickly, then the new
consensus presented above may be sufficient to reduce the
risks of a similar episode in the future. If, however, the
storm worsens, then the changes suggested by the new
consensus may not be sufficient and the policy paradigm for
development in a globalized market economy may need to
be revised.


          1/   Developments were traced in two reports of the
               Secretary-General, one entitled "Global financial integration:
               challenges and opportunities" (A/51/388) and the other "Global
               financial integration: an update" (A/52/406).

          2/   For a variety of assessments presented to the General
               Assembly, see Barry Herman and Krishnan Sharma, eds.,
               International Finance and the Developing Countries in a Year
               in Crisis: 1997 Discussions at the United Nations (Tokyo,
               United Nations University Press, 1998).

          3/   United Nations publication, Sales No. E.98.II.C.1.

          4/   United Nations publication, Sales No. E.98.II.D.6.

          5/   The elements of the Washington consensus include fiscal
               discipline (as indicated by the overall budget position),
               redirecting fiscal expenditure to health, education and
               infrastructure, curtailing subsidies, broadening the tax base
               and lowering marginal tax rates, eliminating multiple
               exchange rates and making the unified exchange rate
               competitive, making property rights secure, deregulating the
               domestic economy, liberalizing foreign trade, privatizing State
               enterprises, eliminating barriers to foreign direct investment,
               and financial liberalization (see "What Washington means by
               policy reform", in Latin American Adjustment: How Much
               Has Happened?, John Williamson, ed. (Washington, D.C.,
               Institute for International Economics, 1990), pp. 7-20). In its
               original formulation, financial liberalization did not extend
               to international financial flows.

          6/   The sequence of policy programmes in Thailand, Indonesia
               and the Republic of Korea can be traced in "IMF's response to
               the Asian crisis", 30 July 1998, available on the Internet at

          7/   The Managing Director of IMF, in his remarks to the special
               high-level meeting of the Economic and Social Council of the
               United Nations with the Bretton Woods institutions held on
               18 April 1998, noted that IMF had been working towards full
               current-account liberalization for over 50 years and had not
               yet reached that goal for all countries and that presumably it
               would take a like period for capital account liberalization
               (see E/1998/SR.4).

          8/   The letter from Charles Dallara, Managing Director, IIF, to
               Philip Maystadt, Chairman of the Interim Committee of IMF,
               dated 8 April 1998, says that the "private financial community
               supports the prudent and progressive liberalization of capital
               account transactions, but it is clear now that liberalization
               should be approached with care and complemented by steps to
               strengthen domestic financial systems. The Fund has a central
               role in furthering capital account liberalization. However, the
               case has not been made that an amendment of the IMF Articles
               is necessary" (see www.iif.com/PublicPDF/icdc0498.pdf on
               the Internet).

          9/   In this regard, at the end of June 1998, the Executive Board of
               IMF initiated an external evaluation of its surveillance role,
               which will complement the external evaluation, completed in
               March 1998, of economic policy programmes under the
               Enhanced Structural Adjustment Facility (the Fund's
               concessional lending arm) (for text and discussion of the
               latter, see 

         10/   The meeting, organized by the Department of Economic and
               Social Affairs of the United Nations Secretariat, in
               cooperation with the regional commissions of the United
               Nations, asked, "What have we learned one year into the
               financial crisis in the emerging market economies?" (The
               agenda of the meeting and its main papers may be found on
               the Internet at www.un.org/esa/analysis/expert.htm.)

         11/   For a review of budgetary targets, see World Economic and
               Social Survey, 1997 (United Nations publication, Sales
               No. E.97.II.C.1 and corrigenda), chap. V; see also Economic
               Commission for Latin America and the Caribbean, The Fiscal
               Covenant: Strengths, Weaknesses, Challenges
               (LC/G.1997(SES.27/3)), of 23 April 1998.

         12/   Another option -- followed, for example, by countries
               employing "currency board" systems -- is to announce a
               permanent peg and commit to defending the peg no matter
               how great the disruption of the economy that is required. If
               confidence is maintained, the durability of the system need not
               be tested. Once confidence is lost, however, a deep economic
               contraction and high unemployment may have to be withstood
               before confidence in the peg is restored. The attraction of the
               peg, particularly in the currency board variant, is that it can
               be a potent tool for fighting high inflation, in which case it
               can be seen as an alternative to discredited central-bank
               currency management. Given the possibility of policy-induced
               economic contraction, however, it is a policy with some risk.

         13/   A currency speculator should be thought of not as belonging
               among the limited number of "hedge fund" managers who
               operate internationally, but as being potentially any financial
               or non-financial enterprise or individual with access to credit
               who perceives the low-risk, high expected return of a bet
               against a central bank with limited foreign exchange reserves
               that is trying to defend an overvalued exchange rate.

         14/   An importer having to make payment some weeks in the future
               could know precisely the local currency cost of the foreign
               currency obligation by making a forward foreign currency
               purchase, in which the price is set today for a transaction
               that is to take place at the agreed future time. "Futures"
               contracts are standardized securities that serve as a forward
               hedge. However, as they are securities, futures, like other
               derivatives, can be issued and traded in their own right and
               take on a life of their own which may become divorced from the
               underlying international trade and investment flows they were 
               initially established to serve.

         15/   The point here is not to prevent foreign direct investors from
               operating in a local financial sector, but to limit foreign
               financial inflows (for example, direct investment might be
               permitted in local brokerage houses, while foreign purchases
               on the local stock exchange might not be allowed).

         16/   See Manuel Agosin and Ricardo Ffrench-Davis, "Managing
               capital flows in Chile", paper presented to the United Nations
               Expert Group Meeting: What have we learned one year into
               the financial crisis in emerging-market economies?, United
               Nations, New York, 21 23 July 1998 (available on the
               Internet at www.un.org/esa/analysis/expert.htm).

         17/   Little national data on stocks (as opposed to flows) of
               financial assets and liabilities are collected even by
               countries with sophisticated statistical systems, although the
               conceptual framework for detailed balance-sheet data is already
               part of national income accounting (see Commission of the
               European Communities, IMF, Organisation for Economic
               Cooperation and Development, United Nations and World Bank,
               System of National Accounts, 1993 (United Nations publication,
               Sales No. E.94.XVII.4)).

         18/   See "Core principles for effective banking supervision", Basle
               Committee on Banking Supervision (available on the Web site
               of the Bank for International Settlements
               (www.bis.org/press/index.htm), release of 22 September
               1997). The Basle Committee has also formed liaison and
               consultation groups with a number of countries (joined by
               IMF, the World Bank and the European Commission in
               informal capacities) in order to assist in implementation.

         19/   The Basle Committee, in particular, adopted the approach in
               its 1996 amendment to the Basle Capital Accord. The Accord
               was the 1988 agreement that established common capital
               backing ratios for banks to protect against credit risk, which
               arises from the possibility of non-payment of principal or
               interest by borrowers. The 1996 amendment standardized
               protection against market risk (arising from possible changes
               in the prices of financial instruments in which a bank has an
               exposure) and in doing so allowed banks to use internal risk
               models to figure the required capital backing; it also put
               regulators in the position of assessing risk management

         20/   Indeed, in July 1998, the Institute of International Finance
               (IIF) established several working groups of private sector
               financial executives to learn from the Asian crisis, including
               by assessing the performance of risk management models and
               processes during the crisis (IIF press release, 7 July 1998).

         21/   These questions, inter alia, are being considered by the Joint
               Forum on Conglomerates, comprising the Basle Committee,
               the International Organization of Securities Commissions and
               the International Association of Insurance Supervisors, which
               in February 1998 released a set of consultative papers for
               discussion (see www.bis.org/press/index.htm, release of
               19 February 1998).

         22/   For an example of the former, see the report of the Committee
               for Development Planning on its thirty-second session
               (Official Records of the Economic and Social Council, 1998,
               Supplement No. 14 (E/1998/34)); for an example of the latter,
               see the proposal of the Minister of Finance of Canada at the
               meeting of the Interim Committee, 15 April 1998 (in a press
               release of the Department of Finance of Canada, 15 April

         23/   See "Strengthening the architecture of the global financial
               system", report of G-7 Finance Ministers to G-7 Heads of
               State or Government for their meeting in Birmingham, 15 May
               1998, para. 17.

         24/   Joint Ministerial Statement, Special ASEAN Finance
               Ministers Meeting, Kuala Lumpur, 1 December 1997,
               para. 12.

         25/   See report of the Secretary-General on financing of
               development, including net transfer of resources between
               developing countries and developed countries (A/53/228).

         26/   The debt agreements of the Republic of Korea are reviewed in
               the report of the Secretary-General on enhancing international
               cooperation towards a durable solution to the external debt
               problem of developing countries (A/53/373).

         27/   See Group of Ten, The Resolution of Sovereign Liquidity
               Crises, a report to the Ministers and Governors prepared under
               the auspices of the Deputies, Basle, Bank for International
               Settlements, May 1996, para. 84.


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Date last posted: 10 January 2000 10:05:30
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