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ArchiveSeptember 30 1999

Get the design right

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The new financial architecture for the international monetary system needs to be built on secure foundations. Above ground, towering monoliths cast long shadows. Anthony Rowley reports.

Like a high-rise building to which extra floors are constantly being added, the 'new architecture' for the international monetary system is becoming a towering monolith. It will cast a long shadow over this year's annual meetings of the IMF and the World Bank in Washington DC, eclipsing debate on other issues.

But it is still open to doubt whether the foundations of this towering edifice are really sound. The multi-purpose structure is designed, among other things, to shore up banking and financial systems in emerging markets and to make their workings more transparent to international lenders and investors. It is also designed to propagate codes of good practice, to which both developed and developing countries can adhere, on anything from fiscal and monetary policy to corporate governance and the management of capital flows.

According to Michel Camdessus, managing director of the IMF, the aim is to promote the 'successful integration of a larger number of developing countries into the global financial system'. Yet the system now seems to have little desire to embrace emerging markets. Capital flows to these economies are likely to be just $140bn this year, compared with $330bn in 1996.

Even where they have had market access restored in the wake of crises, emerging market borrowers still have to pay very high spreads. A key question that appears to have been ignored by the architects of the new structure: be it the IMF, the World Bank, the G33, the Financial Stability Forum, which has taken over implementing the architecture from the G33, or any of the other would-be system builders - is whether emerging markets have been interfaced too rapidly with global markets, and whether more attention should be paid to mobilising domestic savings in developing countries.

If so, the new architecture may be the wrong design. Offering an unusually candid view, one former senior IMF official suggests to The Banker that 'the architecture debate is going nowhere'.

The private sector is 'kicking against it, and issues such as problems in derivatives markets are not even being discussed', he adds. Neither, note other critics, are key questions, such as the need for greater stability among key currencies to which many emerging market currencies are linked, nor the need for a global lender of last resort. The trouble is that consideration of points such as these has been buried under an ever-growing mountain of official and private reports seeking to add their voice to the great debate on the new architecture.

The whole string of Group of Seven, Group of Thirty-Three (soon to become G-44) and so on : as well as the Basle Committee on Banking Standards, the International Organisation of Securities Commissions and countless other industry bodies are all swamped by building plans. One IMF official assures The Banker that 'in each of the areas of the architecture there has been progress since the spring [April] meeting of the [IMF's policy-making] Interim Committee'.

There will be 'more reports at the September and spring 2000 meetings', he says, adding: 'It is an extremely complex and multi-faceted process.' Those involved say it will be several years at least before the architecture is fully in place. Most progress has been made to date in the area of improved transparency and surveillance by the IMF of member countries' economies. The IMF's Special Data Dissemination Standard (SDDS), designed to give markets early warning of impending problems in emerging and advanced markets, has been strengthened in terms of reporting of reserves and country debt.

Countries subscribing to the SDDS will need to comply fully by next March. The IMF has also produced a fiscal transparency code, and is finalising a code of good practice on transparency in monetary and financial policies.

'This deals with transparency in the financial sector on the public sector side,' notes one official. 'These issues have been brought to the forefront by financial crises. Markets have become more developed and, in a market environment, people like to make informed decisions.'

Progress has also been made in other areas, including the reporting of country debt. Under the IMF's new monetary code, all member countries will follow a pattern after a transitional period in their reporting of government liabilities and private sector short-term debt. (The IMF, World Bank, Bank for International Settlements and the OECD are meanwhile collaborating in loading debt statistics on to the Internet for the benefit of markets.)

The codes are designed to provide standards from which all countries, advanced and developing, can eventually 'benchmark'. They should enable the IMF and other surveillance bodies to monitor more easily what progress is being made towards achieving well-regulated and transparent markets. The Fund and World Bank are also collaborating on assessments of individual countries' banking and financial markets within the framework of the IMF's regular consultations and reviews.

The IMF is also making assessments on how individual countries are adhering to the Basle Core Principles for banking. This is part of a pilot programme of 'transparency' reports that the Fund hopes eventually to be able to produce on a wide range of issues of interest to financial markets. Argentina, Australia and the UK have agreed to act as 'guinea pigs'.

But officials are warning that there are limits to how far the process of increased transparency can go. 'Some things will never be made public and no more should they be,' says one former IMF source, citing as examples 'intimations of future changes in exchange rates or in a country's tax regime.'

A serving Fund official adds: 'One danger is that if very confidential discussions [between the IMF and member governments] are to be made public, they will not take place at all." In the area of banking, a Basle Capital Accord consultative document is due by next March. It is expected to provide for banks' risk assets to be weighted according to country data supplied under the SDDS.

Weightings may also be based on credit ratings from private agencies. Although the IMF shies away from the idea of producing its own country credit ratings, it is providing what officials term 'nuanced information' nowadays (via public information notices and executive board assessments which may soon be made public) from which markets can draw their own conclusions.

While things have moved smoothly in these areas, it is a very different matter in controversial issues such as possible controls over capital flows into - and maybe out of - emerging markets and to the even more vexed question of whether private sector lenders and investors should be 'bailed-in' to any official action for securing an orderly resolution of future financial crises.

As a result of recent crises in Asia, Latin America and Russia, there is more sympathy now than there was at the height of the emerging markets boom several years ago for the idea of orderly liberalisation of emerging market countries' capital accounts. But whether it should be achieved by Chilean-style controls on capital inflows or by more drastic measures, such as in Malaysia, is a matter of great debate. So too is the question of how much jurisdiction the IMF should have in promoting capital account liberalisation among its member countries.

The Fund has been given a mandate by its governing body, the Interim Committee, to study an amendment to its articles giving it the same powers in the area of capital account liberalisation it already has in current account transactions. Gordon Brown, the UK Chancellor of the Exchequer, was confirmed on September 10 as the new chairman of the committee. Shigemitsu Sugisaki, second deputy managing director of the Fund, says: 'There seems to be a broad consensus among both emerging and industrial countries that one of the purposes of the Fund should be capital account liberalisation.

But there are questions about how much jurisdiction we should have and how to promote capital account liberalisation.' Financial markets and the IMF now appear to favour sequenced capital account liberalisation so that long-term flows, such as foreign direct investment and term loans, are favoured ahead of short-term debt and equity flows. 'Because they had closed regimes, China and India did not get into trouble in recent crises,' notes William Cline, deputy managing director of the Washington-based Institute of International Finance. 'This has provoked some thought that capital controls may be justified.'

While markets are happy with the idea of controls on capital inflows, they are opposed to the idea of controlling outflows. Technically, the IMF's Article 8 (2b) gives it the right to declare a moratorium in member countries having problems meeting their external obligations, but this is a power it is very wary of using without more explicit authority from members. Some argue that there should not be any retreat from current levels of capital account liberalisation and that, if there is, then the Fund should have authority to approve it in advance.

Others say that the IMF should set a goal for liberalisation but, at the same time, allow a transitional arrangement during which countries would be urged to take steps to strengthen their banking and financial systems. Mr Camdessus is keen for the IMF to have a more explicit role in this area, and is expected to present a report to the executive board for further discussion.

The Interim Committee will receive a progress report at the annual meetings. Linked to capital accounts, and equally contentious, is the question of 'bailing in' the private sector to help forestall and resolve debt crises. In South Korea, the process of involving the private sector in negotiations over debt restructuring was relatively simple, since it involved mainly rollovers of short-term debt and interbank loans. 'The creditor base was quite restricted, so it was easy,' says one IMF source.

It is not so easy, however, when bondholders are included among a debtor country's creditors. One idea favoured by the IMF is to include collective action clauses in new bond issues so as to facilitate negotiations and to prevent individual bond holders 'jumping the queue' by initiating legal actions against debtors. The problem is that no country seems to want to be first to issue such bonds for fear of losing favour with the market. One idea is to have a co-ordinated issue of new bonds by G-10 countries or by a trade association on behalf of a number of emerging markets.

'We are a little disappointed that there has not been more progress on this issue,' admits one IMF official. The private sector is, however, wary about this approach. 'Bonds are long-term instruments but the essence of the emerging markets problem has been a run-up in short-term debt,' says Mr Cline.

He notes that 'the big crises in recent years have not involved bonds and so these are more theoretical than real dangers'. The IIF view, adds Mr Cline, 'is that the government involved should figure out methods such as exchange of instruments, and not be forced to reschedule. We do not know of a case where a country has regained substantial market access after rescheduling. You should tackle crises on a case-by-case basis involving adjustment by the country, IMF support and private sector arrangements that should be voluntary.'

The emerging market access that has been restored would not have been had markets been forced to agree to rescheduling, he adds. Financial markets are not happy either about other aspects of the proposed new architecture. For example, banks that have earned fees for making contingent lines of credit available to emerging market and other economies are unhappy now that the IMF itself has been granted approval to put in place its own Contingency Credit Line.

Some lenders are also unhappy about the idea of the IMF being allowed to 'lend into arrears' for fear that new credit lines to countries behind with repayments will damage discipline and slow reform efforts. Another problem within the ambit of the new architecture is to the so-called HIPC (highly indebted poor countries) initiative by the World Bank and the IMF to relieve some of the world's poorest countries of their burden of existing debt.

Its cost has risen from $12bn to $27bn as a result of the agreed expansion to 36 in the number of countries that will benefit from it. This will involve additional cost for multilateral institutions, as well as for governments. The IMF and the World Bank are concerned this may take money away from funds normally set aside for their conditional lending facilities.

All these issues have produced a multi-layered and top-heavy structure for the new financial architecture without even beginning to consider more weighty issues, including the role of the Fund as a lender of last resort. Were the Fund to be given power to issue its special reserve currency - the SDR - at will, it could match the resources commanded by the private sector and act as a true lender of last resort.

But the private sector is against this because of fears of inflation and because it would once again tilt the balance of power in global capital markets back in favour of the official sector.

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