My speech at the Financial Club on Globalisation and the IMF in the decade after the Asian Crisis, 14th September 2006
- It is a great honour to be invited to speak here today at this seminar supported by ICWA and Standard Chartered Bank in the run-up to the 2006 annual meetings of the IMF and World Bank in Singapore – the first annual meeting to be held here in Asia since the Hong Kong meetings in 1997. And it is a privilege to be here in Indonesia today, and to celebrate the close and deepening ties between our two countries.
2. The last time I visited was in March 1998. At that time we were seeing the playing out of the Asian crisis as it spread seemingly unstoppably from Thailand to the Philippines to Korea and finally to Indonesia. For the first time we saw the tremendous disruption that massive movements of footloose capital can bring to the global financial system.
3. I remember well the shockwaves these events sent through the finance ministries of the world and saw first hand the disruption and deprivation that citizens of this country endured as a result. Here were new and stronger global forces threatening not just regional stability but the world’s financial system as the crisis spread beyond Asia and into other emerging markets: Russia later in 1998, to Wall Street and then to Latin America and Turkey.
4. This unfolding crisis brought home to us all the interconnectedness of the global economy. In many ways what we now know as the Asian crisis was the first truly global crisis: the first crisis of globalisation.
5. Today, I want:
6. To look back and assess the lessons that the international community and emerging market countries have learned from this experience;
7. To take stock of the new challenges in the global economy and the new steps we must now take to ensure that today’s pressures of globalisation are managed multilaterally and its full benefits realised;
8. And to set out the practical responses finance ministers will need to take forward in the reform of the international financial institutions in Singapore in the coming days.
The experience of Asia and Indonesia
- The countries affected by the East Asian crisis showed many similarities. Following a highly successful period of growth across the region, a similar combination of factors led to a contagious loss of confidence. One after the other fixed exchange rate regimes came under intolerable pressure with inevitable devaluations. In turn this put pressure on firms and governments which had often borrowed excessively in foreign currency, reinforced by many lenders being carried away with the optimism of the times and underestimating the risks they faced. The result was an inevitable cycle of default, bankruptcy and poverty.
10. Here in Indonesia real GDP fell by 13 per cent in 1998, after growing at over 5 per cent per annum for the previous 15 years. The number of people living in poverty more than doubled from 22.5 million to almost 50 million. The weaknesses in the political system were exposed with the result that political and institutional change proceeded rapidly. The effect was disorienting and disruptive.
11. And the initial response of the international community did not help. Rather than restoring confidence, the involvement of the IMF in Indonesia exacerbated the uncertainty and added to the economic dislocation. There was a widespread sense that the IMF in the region was not sensitive enough to countries’ needs and wishes, prescriptions were not always correct, and particularly with regard to Indonesia: fiscal targets under the IMF programmes were too tight; the structural reforms too extensive; the degree of country ownership of the programmes too little. In retrospect, we would agree with much of that analysis – although Fund Staff – like the rest of us – were operating in a context that was completely unfamiliar.
12. And just as market sentiment led to massive inflows of “hot money” into the East Asian economies before the crisis, so it led to massive outflows of capital as the crisis began. Foreign creditors sometimes had limited knowledge – often hampered by insufficient data – about the individual corporations, financial sectors, and countries in which they had invested, with the result that the crisis spread to countries in the region whose fundamentals were very different from those in Thailand where the crisis had begun. Even South Africa was affected, despite its relatively healthy banking system – during the summer of 1998 foreign investors sought to withdraw from South African bonds, forcing the central bank to move to a more restrictive monetary policy stance at odds with the needs of their economy.
The lessons for countries
- There were three broad lessons for national policy that the Asian crisis taught us:
14. First, transparency matters. The root of many of the difficulties in many Asian economies lay in the complex and opaque ownership structures of companies. As a result, the true financial position of companies and individuals was obscured. And in the public sector, there was a lack of clarity in fiscal obligations and, for example, the reserve position of the Thai government.
15. Second, institutions matter. The effective and predictable operation of the key economic institutions: central banks, governments and judicial systems are central to economic performance. The fact was that in many countries these institutions were not operating effectively.
16. Third, sound policy matters. Most emerging market crises have had as their trigger the failure to abandon in time an inappropriate exchange rate regime. This, of course, is not a lesson exclusive to emerging markets – as previous UK governments have found – but the importance of flexible, credible macroeconomic policy underpinned by clear economic frameworks has been one of the most universal lessons of the Asian crisis. Equally, there are policy lessons for the international financial institutions as well. The over-zealous promotion of capital account liberalisation in the 1990s is a clear illustration of such a policy error.
17. These lessons are being absorbed. Asian economies have used this period of high liquidity and stability as an opportunity to rebuild macroeconomic stability. Vulnerabilities have been reduced with greater emphasis on domestic rather than international debt markets which has reduced the extent of any potential mismatch between liabilities and assets in the national balance sheet. As a result the region has enjoyed a period of broadly stable growth.
18. Here in Indonesia you have enacted a series of painful and sometimes controversial reforms: ending the Rupiah peg with the dollar; dismantling many monopolies and subsidies; breaking the tight ownership links between banks and corporations; better banking regulation and supervision; improving corporate governance by increasing transparency of financial reporting; and the government’s ongoing anti-corruption drive.
19. As a result Indonesia is once again seeing growth at over 5 per cent. Public debt as a proportion of GDP halved between 2000 and 2005 and is now at pre-crisis levels. Investment and net exports are both strong, corporate profitability has improved, and the banking sector is much stronger now than at the time of the crisis. Gross foreign reserves have reached record levels. In recognition of this, both Moody’s and Standard & Poor’s credit rating agencies increased Indonesia’s sovereign debt ratings in the first half of 2006. Furthermore, Indonesia is now able to repay the IMF ahead of schedule. In short, Indonesia today is combining macroeconomic stability with strengthening economic growth.
20. But there is more to do. Reforms take time to work and it is important to be patient. But with your continuing reform programme to make your economy more flexible, to boost investment, and to establish a business-friendly investment environment, there is a real prospect that growth will continue to strengthen further in the coming months and accelerate poverty reduction.
Lessons for the International Community
- But the lessons of the Asian crisis for the international community and international institutions were equally important. They are lessons to which we are also still responding.
22. The fact was that the international community did not have the right systems or techniques in place to understand the increasing complexity of the global economy and open, fast-moving capital markets and to support countries in identifying the risks that they faced in their economies and, especially, in their financial systems.
23. And in the resolution of these crises – more strongly in Indonesia than elsewhere – there were specific lessons for the IMF. The Fund learned, principally, that it did not always have all the answers.
24. The result has been an effort unprecedented in recent times to reform and galvanise the international system. This comprehensive effort was given impulse by the UK Presidency of the G7 in 1998 and was set out in full at the Cologne Summit in 1999. As a result we saw:
- new institutions to meet new challenges: the Financial Stability Forum and the G20 group of systemically important countries, with Indonesia a member from the outset;
- an agenda for change in the IMF. Promoted by the UK, the Board of the IMF has established the Independent Evaluation Office and the IEO has provided important insights to improve the operation of the IMF.
- It is the IMF reform agenda which I will concentrate on.
- The core purpose of the IMF is to preserve economic stability and open trade. The Asian crisis showed conclusively that the best way to meet this goal is not by resolving crises after they happen, but to prevent them from occurring in the first place.
27. In responding to the lessons of the Asian crisis there have been three building blocks of reform.
28. First, codes and standards. The 13 internationally agreed codes and standards aim to improve policy making, covering the full range of policies and the financial sector, provide a key part of the new financial architecture. They signal a move away from a concentration on high level macroeconomic aggregates to the underpinnings and frameworks needed to improve economic and financial performance.
29. We have seen 132 of the 184 members of the Fund undertake at least one element of this programme and be assessed through a report on standards and codes (RoSC). The G20 – of which both the UK and Indonesia are members – has been one of the driving forces of this process and I know that Indonesia is currently undergoing its assessment in the fiscal RoSC. These reports are becoming increasingly embedded in the international system. A rising proportion are published. There is evidence that important investors pay close attention to the willingness of countries to undertake RoSC assessments – and all ratings agencies integrate their findings into their analysis of countries.
30. Second, transparency for both countries and institutions. There is a well-established connection between the publication of IMF country reports and lower costs of borrowing for countries. Publication also acts as a discipline on the Staff of International Financial Institutions who recognise that their judgements will be the subject of external scrutiny. There has been important progress in the publication of country reports and the openness of the institutions in the past decade – now 77% of country reports are published.
31. Third, surveillance. Following the Asian crisis, the IMF has improved its surveillance of emerging and developing countries, with greater focus on crisis prevention and financial sector vulnerabilities.
32. Progress in this latter area is slow, because the data requirements which more sophisticated analysis requires are difficult to meet. But the Fund in particular has made considerable progress in bringing itself to the forefront of economic analysis. This has been seen particularly in the development of its debt sustainability framework for both low and middle income countries. But there is more to do.
33. The historic structure of the IMF means that surveillance and lending are directly intertwined. Staff are often responsible for both devising and monitoring lending programmes and for policy advice through surveillance reports – which may need to reflect critically on policies under a lending programme.
34. This potential conflict of interest risks undermining the credibility of the Fund in both its lending decisions and surveillance advice. Therefore, a long standing objective for the UK has been to make surveillance more independent and objective, to ensure that a “fresh pair of eyes” provides critical scrutiny of policies undertaken through Fund programmes. We have made progress on this issue in recent years but continue to believe that further institutional reform at the IMF may be needed to more clearly delineate surveillance and lending activities.
Eight years on – where do we stand?
- The Asian crisis showed that all countries matter in the globalised economy. It showed also that both the individual countries and the international community had a key role in learning the lessons of the crisis and seeking to ensure that future crises were prevented.
36. The fruits of all these efforts have been seen in recent years. Markets have become more discriminating and are learning to treat individual countries on their merits.
37. There is no doubt that current low spreads reflect the relatively high levels of global liquidity but it is also the case that the market has become more discriminating. It is worth remembering that the Argentinian default in 2001 – the biggest in history, accounting for nearly a quarter of the entire emerging market debt market at the time – registered scarcely at all in the spreads of other emerging markets at the time. It would be foolhardy to forecast a new paradigm; or to believe that there will never be a further emerging market crisis. However, economic policy making in emerging markets has improved significantly: to illustrate: CPI inflation for Fitch-rated emerging market sovereigns declined from 11.2% to 6.4% between 2001 and 2004; as a group, emerging market countries have moved from a current account deficit of $115 billion in 1998 to a $435 billion surplus in 2005 and fiscal deficits in emerging markets and developing countries have fallen from 4.7 per cent of GDP in 1998 to just 1.2 per cent in 2005, with greater appreciation of sound policy making and the techniques of macroeconomic management (for example, the development of local currency debt markets). All this has made emerging markets less vulnerable to crises in recent years.
Key emerging market issues going forward
- But it is also true that such a benign environment will not last. The global interest cycle has clearly turned and there are more testing times ahead.
39. The financial market instability of May-June 2006 illustrates why there is a need for continued vigilance. During this volatility, emerging markets with strong fiscal positions, stable governments and stronger domestic capital markets fared better than those with a weaker fiscal record and political instability.
40. Indonesia, for example, demonstrated that it had reduced its vulnerability to external shocks. Yet the sell-off in emerging markets in May/June illustrated a continued susceptibility to shifts in investor sentiment.
41. And while the risk premia for emerging market bond spreads remains at much lower levels than 5 years ago, it is by no means assured that these conditions will continue, and we must ensure that should these circumstances change, emerging markets can withstand the resulting pressures. I believe the international community and today’s IMF must be ready to do more to support countries like Indonesia in the face of global instability.
42. A number of IMF members, including the UK, have called for consideration of a new financing instrument specifically designed to support crisis prevention by emerging market members active in international capital markets. The Contingency Credit Line was approved in 1999 in response to global financial market volatility during the Asian crisis. We continue to support the original objectives of the CCL, to prevent liquidity crises, to incentivise countries to adopt strong policies and to provide a positive signal of good policy and give increased assurances of the availability of Fund resources.
43. We continue to look for development of the Fund’s instruments, both to reinforce country ownership and also to respond effectively to the needs of emerging market economies. That is why we welcome the Fund’s recent exploration of a Reserve Augmentation Line to provide signals of countries’ policy strength, not their policy weakness. I believe we should put in place such a facility to support crisis prevention and help emerging market economies cope with external challenges to their domestic stability.
- Because the Asian crisis was the first crisis of globalisation, we now need to move to anticipate and avoid the second.
45. Today’s challenges to global prosperity are of two kinds:
46. Threats to globalisation and open trade itself.
47. And Macroeconomic risks which – in contrast to the past twenty years – lie less in the emerging market economies and more in the policy mix and vulnerabilities in the largest, systemically important, and often highly developed economies which neither currently borrow, nor are likely to borrow, financial resources from the Fund.
48. The world is seeing historically high levels of external imbalances – current account surpluses and deficits. Both the sources of these imbalances – low levels of saving in some countries; high saving in Asia; surpluses in oil exporting countries and insufficient domestic demand in Europe – and the collective policy prescriptions for tackling them have been widely debated. But the risk remains that these imbalances correct in an uncontrolled way – and it is a risk that would have consequences for us all.
49. In addition, we are seeing the emergence of some old pressures as well as new ones. Inflation risks seem to be rising and a renewed era of global low inflation and global high growth cannot be guaranteed when the effect of sustained high energy prices has not yet fully fed through.
50. At the same time there are clear risks to open trade with the suspension of the Doha development round.
51. The task for Finance Ministers as they meet in Singapore this weekend is to set in place a shared response to these risks and to renew and redefine the IMF to ensure that it is fit to discharge its role in the 21st century.
52. If the IMF is to fulfil a modern role at the heart of ensuring international economic stability, it must continue to shift its focus from crisis resolution to crisis prevention. And with the source of global imbalances lying primarily with the Fund’s creditors rather than debtors, we must now strengthen and reform the IMF’s surveillance of all countries matched by reforms to enhance the accountability and transparency of the Fund itself. I know that IMF managing director Rodrigo de Rato is determined that the agenda will succeed.
- A reform programme for surveillance was set out by Ministers at the Spring Meetings in Washington this April. There are four elements:-
- First, because the global economy is more integrated and the linkages between individual economies stronger, the focus of Fund surveillance should be on the linkages and spillover effects of each country’s policies on others in the global economy. The Fund’s unique quality amongst international economic organisations is its universal membership and multilateral quality, yet only 5% of the Executive Board’s time is devoted to multilateral surveillance;
- Second, we need a reinforcement of the commitments that members have to each other and to the IMF. The Fund’s Articles of Agreement say in the key Article IV that `…each member undertakes to collaborate with the Fund and other members to assure orderly exchange arrangements…’. In the past this has focussed exclusively on exchange rate policy. Exchange rates are important – and the Fund does need to strengthen its work in this area. But now is the time to set those commitments in the modern context and recognise that it is frameworks across the whole of the range of policy areas – fiscal, monetary and financial – that influence global stability. In practical terms this means a comprehensive updating and strengthening of the 30 year old guidance which underpins IMF surveillance.
- Third, to support the Fund in influencing the membership a new procedure for multilateral consultation procedure is bringing together key players concerned with a particular issue to deepen understanding and develop policy responses. The results of these consultations need to be discussed with and informed by the whole membership; and these procedures would time limited and ad hoc bringing together different groups of countries depending on the subject involved. The first – on global imbalances – is already underway; a future consultation on financial stability may follow soon; and
- Finally, there is a need for an annual remit setting out the parameters and priorities for surveillance. This would bring together all these elements, setting out the objectives for surveillance, the responsibilities of the membership with respect to surveillance and the responsibilities of Fund management and Staff in the delivery of high quality and accurate surveillance. This annually renewed remit would become a practical charter for multilateralism as countries recognise their mutual dependency, as well – crucially – as the instrument for ensuring both the Fund’s independence and its accountability to the membership.
- I believe that implementing this framework will both address the new challenges we face and complete the work begun after the Asian crisis: each country recognising its obligation to support global economic stability; the Fund becoming accountable for its actions and – decisively – putting crisis prevention at the heart of the work of the international economic community.
55. In Singapore Ministers will review progress and set a timetable for the framework to become fully operational.
- This surveillance framework can only be effective if the IMF has legitimacy and credibility with its membership, as the shape of the global economy changes.
57. First, the Fund’s governance structure must give more weight to the fastest growing economies. Secondly, as the Fund’s financial relationship with emerging markets has declined in relative terms and a consensus for global action to meet the millennium development goals has been forged, low income countries have become an increasingly important part of the Fund’s client base. By the middle of this year, there were only 9 middle income countries with programmes, compared with 30 low income countries. So, with the close relationship that the Fund has with low income countries it is essential that measures – including increasing voting share – are taken to give them a greater say in the decision making of the fund. Basic votes – which are most important to small and poor countries – have declined from 11% of total votes in 1944 to 2% today. This decline must be reversed through a substantial increase in basic votes.
58. The UK welcomes the recent resolution put forward by the Board to meet these two objectives. There is much work to do over the next two years to define the details of this decision in practice and we look forward to working constructively with our international partners across the world to ensure that at the end of the process the Fund’s governance structure is more fully representative and legitimate in the eyes of all the membership.
Trade and Protectionism
- And at Singapore we also should re-energise the spirit of multilateralism which informed the foundation of the Bretton Woods organisations and make the case for open trade, while recognising that countries and individuals will need support to take advantage of the opportunities that the opening of markets offers.
60. That is why – to show that open trade and economic stability are two sides of increasing prosperity for all – Pascal Lamy, head of the WTO, will address Ministers at the IMFC. It is also why the Managing Director and the Chancellor of the Exchequer, as chair of the IMFC, are promoting a dialogue between business people and Ministers in the IMF. This will strengthen the focus on the discussion of what can be done by all parties, business, institutions and government to maximise the benefits and minimise the risks from globalisation. And practically, it is why the UK will be looking to push forward the agenda on `aid for trade’ to ensure that countries are equipped to take advantage of the opportunities to trade in the new global economy.
61. This weekend’s meetings provide an opportunity for the world’s leaders to put us on a path to restart the Doha round negotiations.
62. This will require leadership from developed countries because developed country agriculture remains the main barrier to reaching a deal. All countries, including the EU, will need to demonstrate their willingness to go further.
- In conclusion, a decade on from the start of the Asian crisis, Indonesia has taken decisive steps to learn lessons and implement reforms. So have many other emerging market economies. Now the IMF must also reform and demonstrate its continuing relevance to the countries of Asia and respond to the needs of all the membership.
64. With strong leadership and greater cooperation from all member countries, the Annual Meetings at Singapore can put us on the road to reform of the IMF to meet the challenges of the 21st century – promoting open markets, stable growth and poverty reduction, and preventing crises before they take hold. That is the test for the weekend ahead.