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2. Recommendations to International Financial Institutions (IFIs)

2. Recommendations to InternationalFinancial Institutions (IFIs)

As the central institution of the internationalmonetary system, the IMF plays a pivotal role in the managementof currency crises. On the other hand, the primary role of internationaldevelopment banks (MDBs) is to provide development financing forspecific projects in countries with poor access to the internationalcapital markets. In the process, MDBs become directly involvedin the structural issues of individual countries.

Crisis management of the Asian currency criseswas undertaken through the tripartite cooperation of the IMF,the World Bank and the Asian Development Bank (ADB). In respondingto the requests for by countries affected by crises, the IMF presentsa list of terms (IMF conditionality) which must be met in exchangefor financial support. Conditionality extends to a broad rangeof requirements concerning macroeconomic policies, exchange ratepolicies, and the reform of the financial markets and industrialstructure. In most cases, the international financial packageput together by the IMF contains contribution by the World Bank,the ADB, and individual countries. In order to promote medium-and long-term structural reform, MDBs such as the World Bank andthe ADB attach their own conditions concerning improvements infinancial market structures and governance. It is important thatfinancial support schemes involving several international financialinstitutions be closely coordinated and designed so that variousfunctions can be appropriately divided among participating institutions.For instance, the responsibilities of the three participatinginstitutions which participated in providing assistance to Thailandand monitoring the progress of the reform program were brokendown as follows: macroeconomic policies and the reform of thebanking sector were assigned to the IMF; the World Bank was placedin charge of the reform of the financial markets, excluding thebanking sector; and, the ADB was placed in charge of the reformof the capital markets.

In resolving a currency crisis, it is ofvital importance to avoid measures which give ad hoc preferenceto a specific group of creditors (including the advanced economiesand international organizations), and that solutions favoringcreditors in general not be sought. Solutions must strictly conformto economic principles and rationality and a careful balance mustbe sought between the interests of creditors and debtors. Furthermore,due attention must be paid to averting moral hazards for creditors,debtors and developing countries as such moral hazards are capableof triggering a fresh wave of crisis.

(1) Recommendations to the IMF

[1] Prediction and Prevention
The IMF has always played a central role in predicting and preventingcurrency crises. It has also spearheaded damage-control effortsby providing financial support and advice on fiscal and monetarypolicies to affected countries. No doubt, the IMF can be expectedto continue performing these vital functions in the future. Nevertheless,there are some issues which bear closer inspection. Specifically,the following issues should be examined with greater care.

A. Expansion of SDDS
Further efforts must be made to generate and to disclose in atimely fashion accurate data concerning macroeconomic conditionsand the flows of short-term foreign capital. It is hoped thatthe SDDS system introduced following the Mexican currency crisiswill now be upgraded and a system created through which the marketand other pertinent parties can gain timely access to accurateinformation. The April 1998 recommendation of the Interim Committeeto include in SDDS various data concerning net foreign reserves,outstanding external debts (particularly, short-term liabilities),and indicators of the stability of the financial sector constitutesa highly appropriate first step.

B. Maintaining the Transparency of IMF Surveillance
With regard to IMF surveillance, greater emphasis should be placedon structural issues, and the transparency of the results of surveillancemust be improved. At the present time, a majority of nations publisha summary of the IMF Article IV consultations in PIN form. Whilethis has improved the transparency of the IMF policy advice, itis hoped that efforts will be made for achieving yet greater transparency,as mentioned in the April recommendations of the Interim Committee.

Note: PIN stands for "Press InformationNotice." The IMF publishes in PIN form a summary of the paperpresented to the Board of Governors concerning Article IV consultationsand a summary of the deliberations of the board following eachmeeting of the board. (Publication is subject to the consent ofthe relevant member countries.)

C. Promoting the Development of an EarlyWarning System
It is hoped that the IMF will promote the development of an earlywarning system. However, questions remain as to what the IMF shoulddo when its routine surveillance or early warning systems detectevidence of heightened risk of a currency crisis. The announcementof such a finding may in itself precipitate a crisis. On the otherhand, failure to announce may promote unrealistic market expectationsleading to the continuation of unsustainable policies. This mattertherefore requires careful consideration.

[2] Crisis Management
Improvements can be made in how the IMF responds to currency criseswhen they occur.

A. IMF Conditionality
Before all else, the IMF financial support must function to restoreconfidence in the policies of the affected country. The eventsleading to a loss of confidence obviously differ from one countryto another. Hence, IMF conditionalities must reflect specificmacroeconomic conditions and the historical background of theeconomic policies which are in place.

For instance, the countries affected by theAsian currency crises have generally enjoyed a decade of soundfiscal management and differ significantly on this point withthe Latin American countries. In view of this fact, a thoroughempirical study must be undertaken to determine whether it wasindeed necessary to direct the Asian countries to adopt fiscalausterity when business conditions were already deterioratingin response to the introduction of tight monetary policies designedto cope with the currency crisis.

In particular, the conditions applied tothe Indonesian aid package bear re-examination. Because the sequenceand pace of structural reforms demanded was too rushed, the IMFconditions only served to complicate the problem. In decidingcontents of the conditionalities, the IMF should pay careful attentionto the historical background of existing economic policies andsocial constraints. In order to restore market confidence, sequenceand speed of implementing conditionalities should be carefullyconsidered. Furthermore, the IMF should take into considerationthe negative side effect of conditionalities on business conditionsand vulnerable groups. This would require prior access to sufficientinformation on the conditions of the affected country. For thispurpose, the IMF must strengthen its capabilities for collectingand analyzing local information through ongoing dialog, not onlywith the governments of the countries in question but also withorganizations of the non-government sector, including variousnon-governmental organizations (NGOs).

B. Strengthening the IMF's Financial Resources
In the "21st century-type" currency crisis, the short-termliabilities of the government and private sector tend to be verylarge in comparison to the overall scale of the domestic economyand the nation's foreign reserves. For an financial support programto gain effectively the confidence of the market under such conditions,the IMF must be able to muster very large amounts of financialsupport. The SRF which was first used to support South Korea inits crisis is a facility which is not limited by the IMF quotaof the affected country. As such, it suited to the needs of thecrises. On the other hand, these massive outlays bring the IMFup against the limits of its financing capabilities. In view ofthis fact, there is an urgent need to strengthen the IMF's financialresources. It is urged that prompt action should be taken bothon increasing the IMF quotas, on which the agreement was reachedat the IMF
's Hong Kong meeting (September1997), under the Eleventh General Review (the completion of thenecessary domestic procedures by member countries) and on establishingthe New Arrangements to Borrow (NAB). In addition to quota increase,thought should be given to the possibility of the IMF's directfunding from the markets in order to meet the new requirement.

C. IMF Role in Problems of Private-SectorDebt
External debts of the private sector surfaced as a critical problemin the Asian currency crises. Because of the massive scale ofprivate-sector liabilities, private-sector creditors will movevery quickly to recover their funds at the first hint of default.By the same token, foreign banks refused to roll over maturingliabilities. These behaviors combined engender a serious liquiditycrisis. For such cases, arrangements should be made to allow theIMF to intervene as a moderator in the adjustment of repaymentschedules. Further consideration should be given to the establishmentof a system for the orderly workout of private sector liabilities.The inclusion of this point in the Communiqu
éof the April Interim Committee is a very welcome development.

[3] Addressing Institutional Issues

A. Proper Sequencing of Capital Liberalization
For Asian countries whose domestic savings ratios exceed thatof the advanced industrialized countries, there is no overwhelmingadvantage in pressing on with capital liberalization. On the contrary,rapid liberalization has serious risks. While the IMF is now workingon the amendment of the Articles of Agreement to promote the liberalizationof capital movements, due attention must be paid to allow adequateflexibility in the implementation of capital liberalization. Specifically,liberalization should be allowed to advance with proper sequencingto match the strength and developmental stage of the domesticfinancial sector and the maturity of the supervisory systems.

B. Desirable Foreign Exchange Regimes andExit Policies
One of the underlying causes of the Asian currency crises wasthat capital liberalization had been pursued under a fixed exchangerate regime. Continued economic development and capital liberalizationcall for the implementation of appropriate exit policies and theadoption of more flexible regimes. The IMF should examine variousmodels for desirable foreign exchange regimes for developing countriesand also consider specific options for exiting from a fixed exchangerate regime.

(2) Recommendations to the World Bank,ADB and Other MDBs

Hitherto, MDBs have been playing a pivotalrole in promoting the structural reform in individual countries.However, a review of the causes of the Asian currency crises indicatesthat these past efforts at structural reform were not necessarilysuccessful. Indonesian structural issues which the IMF programattempted to address were the same ones that the World Bank andthe ADB had been working on over the years, but could not havesolved.

[1] Utilizing a Diverse Range of AssistanceMeasures
Currency crises, such as the Asian ones, require a swift and massiveinjection of financial support. It is the original mission ofMDBs to provide necessary assistance to prevent a deepening currencycrisis from derailing the economic development of a country andfrom exerting a major negative impact on problems of poverty.In this sense, it is appropriate that the World Bank and the ADBprovided unprecedented amounts of assistance in the Asian crises.To enable MDBs to provide swift and massive financial assistancewhen needed, the active utilization of guarantee facilities andother methods for promoting the flow of private funds and theefficient use of funds must be considered.

[2] Making a Greater Contribution to theFormulation of Conditionalities
MDBs can be expected to make an important contribution to theresolution of various structural issues which surfaced in theAsian currency crises, such as the reform of the financial sector.To implement the required reforms, it will be necessary to furtherexpand the World Bank's CAS and the ADB's COSS programs whichrepresent the medium-term assistance strategies of these organizations.We welcome the commitment of MDBs to review and revise their functionsalong these lines. Implementation of these programs should bebased on a full understanding of the prevalent conditions in thedeveloping countries. This information should be acquired throughan ongoing dialog which takes into its scope the governments ofthe affected countries, as well as organizations of the non-governmentsector including various NGOs. In addition, due considerationmust be given to clarifying policy objectives and determiningthe sequence of implementation. While cooperating with the IMF,it is desirable for the position of the MDBs on these mattersto be more clearly reflected in the financial support packagesoffered to affected countries.

Note: CAS and COSS stand for "CountryAssistance Strategies" and "Country Operational StrategyStudies," respectively. These are documents of the WorldBank and the ADB which define the medium-term assistance strategiesof these organizations toward individual developing countries.

[3] MDBs Manpower Development for the FinancialSector
None of the World Bank, the ADB or the IMF necessarily have asufficient number of specialists with the required expertise infinancial sector affairs. In this respect, the creation of theWorld Bank's SFOU (Special Financial Operations Unit) and themove by the World Bank and the ADB to use external human resourcesis appreciated. However, the specialists to be hired should notonly be experts in the market systems of advanced countries, butshould also have as much expert knowledge as possible of marketconditions in specific countries.

[4] Further Efforts for the Reform of Financialand Capital Markets
Assistance to the financial sector should not stop at restructuringthe banking sector and improving the supervisory system. Otherimportant objectives include the nurturing and development ofmature securities markets, in the process of which various measuresmust be taken to promote the inflow of foreign direct investmentsand long-term capital. Such measures should include the issuanceand rating of long-term bonds and greater activity in providingadvice and assistance concerning conditions in the stock exchangesand transaction rules. For the purpose of promoting the developmentof the securities markets, it would be worthwhile for the MDBsto consider the issuance of bonds in emerging market economies.

[5] Greater Contribution to Corporate Governance
Given the awareness that improved standards of corporate governancehave an important role to play in the maturation of the financialand capital markets needed to support the process of economicdevelopment, MDBs must play a more active part in this field.

Better accounting systems and a more fullydeveloped competitive environment are indispensable elements inimproving the standards of governance. The disclosure of accuratecorporate information is closely linked to proper tax execution.In the connection, it is also important to improve the overallenvironment for tax execution.

[6] Greater Contribution to InfrastructureDevelopment
The pursuit of the development of the social infrastructure, includingeducation, communication and transportation, is very importantas these provide the foundation for economic development. As such,MDBs should take a more active part in contributing to infrastructuredevelopment.

MDBs can play a pivotal role in the importanttask of mitigating country risks by providing reliable informationconcerning the implementation of private-sector participationpolicies and regulatory systems of individual countries. Furthermore,it is important for MDBs to provide advice to governments whichare formulating policies related to private infrastructure projectsand restructuring their regulatory framework. MDBs must also activelyassist the local governments of developing countries in the preparationof their infrastructure projects. From this perspective, it isvery important that the World Bank's "Action Program"to facilitate private involvement in infrastructure be steadilyimplemented. Similarly, from the perspective of averting foreignexchange risks, it is important that MDBs strengthen their supportfor the development of local financial and capital markets inorder to encourage local-currency borrowing.

Note: The "Action Program" to facilitateprivate involvement in infrastructure was formulated in September1997 to promote the involvement of the World Bank in this field.Japan is actively supporting this initiative through the JapanSpecial Fund.

[7] Local-Government and NGO Assistance
The World Bank is considering a "two channel approach"for financing the social-sector reform program for Thailand whichis currently under preparation. This approach combines conventionalgovernment assistance to social development projects with assistancethrough local-governments and NGOs in anti-poverty and socialdevelopment programs.

In addition to conventional central-governmentinitiatives, local-governments and NGOs can play an importantrole in promoting social-sector programs by directly providingassistance at levels that are closer to beneficiaries. The WorldBank's "two channel approach" is highly appreciated.It is hoped that other MDBs will adopt this method of assistancein the future.

[8] Crisis Management Systems
As part of the World Bank's strategic compact, efforts are beingmade to delegate greater authority to local offices. On the otherhand, in a crisis on the scale of the Asian currency crises whereaction is demanded on structural issues, the crisis managementcapabilities at the organizational headquarters must be upgradedto allow flexible and effective action by the entire organizationfor tasks including coordination with external organizations.In this scheme, local information gathered by regional officesmust be organically integrated into a unified action.

3. Recommendations on Regional Cooperation

(1) Strengthening the Manila Framework

One of the important issues highlighted bythe Asian currency crises is collective regional action. In particular,cooperative schemes for providing financial support from widerange of members in the region played an important role in thecases of Thailand, Indonesia, and South Korea. In addition, asthe entire region came under the influence of the contagion effect,a strong awareness emerged on the need to take common action.

From this perspective, it is hoped that theManila Framework, which was created with the purpose of conductingregular surveillance of the regional economies and the possibilityof undertaking cooperation in providing financial support, willbe strengthened. Specifically, due consideration should be givento the intensification of the discussion for regional surveillanceof the Manila Framework and its financial support schemes. Whereassurveillance meetings of the Manila Framework are currently conductedon the level of deputy finance ministers and deputy central bankgovernors, we recommend that consideration be given to organizinga meeting of finance ministers and central bank governors.

(2) Utilizing the Tokyo Offices ofIFIs for Regional Surveillance

The effectiveness of regional surveillancedepends to a large degree on the collection of data, its thoroughanalysis and proper evaluation. Tokyo is home to the offices ofthe IMF (the only one in Asia), the World Bank and the ADB, aswell as the ADB Institute. This confluence provides a ready frameworkfor possibly pursuing inter-organizational coordination. Thus,it is hoped that Tokyo will emerge as a center for regional surveillancein the future.

(3) Guidance to Countries of the Regionfrom the Tokyo Offices of IFIs

A review of the Asian currency crises indicatesthat some problems were common to the entire region while othershad developed out of factors which were specific to individualcountries. In light of this fact, it is important to utilize theTokyo offices of IFIs to provide more extensive advice, takinginto consideration the salient features of individual countries.


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