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Major Tasks for the Reform of the International Financial System


Provisional Translation
May 18, 1999


Major Tasks for the Reform of theInternational Financial System

1. Improvement of Transparency and Establishment of International Standards


Strengthening of the IMF' SDDS (Special Data Dissemination Standard), 2 codes relating to the transparency in fiscal policy, and the financial and monetary policies developed by the IMF, Transparency of the IMF itself, Efforts of the OECD, BIS, IASC (International Accounting Standards Committee), IAIS (International Association of Insurance Supervisors), IOSCO (International Organization of Securities Commissions), etc.

2. Strengthening of Financial Supervision


Strengthening of prudential regulation (for industrial countries/emerging market economies), Measures to deal with hedge funds, the Financial Stability Forum

3. Safeguards against International Capital Movements


Preconditions and a sequence of liberalization of capital movements, Strengthening of monitoring, Validity of the controls of capital flows

4. Establishment of Stable Exchange Rate Regimes


Stability of the exchange rates among major currencies, Appropriate exchange rate regimes for emerging market economies

5. Reform of the Interim and Development Committees


Deputy-level meetings of the Interim Committee, Possibility for setting up of the Council

6. Improvements in the IMF Surveillance, Programs and Procedures


Safeguards against international capital movements, Better grasp of the real economy, Appropriate fiscal and monetary policies and exchange rate regime for crisis prevention and resolution, Limited involvement of the IMF in structural issues, Improvements in the IMF procedures for the enhancement of the transparency and accountability

7. Enhancing the Function to Provide Liquidity


Implementation of the IMF Quota increase, Implementation of the New Arrangements to Borrow (NAB), IMF' Contingent Credit Line

8. Private Sector Involvement


Maintenance of exposure of private financial institutions, Collective action clauses, Temporary stay (temporary moratorium of the external debt of the public and private sectors)

9. Protection of Vulnerable Groups in Society


Principles of good practices in social policy (World Bank)


Provisional Translation
May 18, 1999

Specific Agendas on the InternationalFinancial System ("Architecture")


+ :

trends in international opinions
# :among the opinions above, particularly those that Japan has been proposing, and are reflected in the international consensus.
* :Japan's view

1. Improvement of Transparency and Establishment of International Standards

From the perspectives of helping investors make rational decisions, encouraging the government of each country to be fully responsible for the implementation of policy measures, and contributing to the strengthening of the surveillance of the IMF, etc., it is necessary to improve transparency in the government of each country, financial institutions, private corporations, and international financial institutions.

-For the purpose of improving transparency and governance, the establishment of international standards should be promoted.
+Each country has committed themselves to the establishment and observance of the standards on transparency including the corporate governance and accounting standards in the private sector.
#For improvement in the transparency of the IMF, consideration is being given to the publication of staff papers, etc.
#The importance of strengthening the Fund' contribution to transparency by more public information on, and evaluations of, the Fund' operations and policies was reaffirmed. In particular, the Fund was encouraged to continue undertaking systematic evaluation, both internal and external, of the effectiveness of selected operations, programs, policies and procedures. (At the G7 and Interim Committee meetings in April 1999)
+Strengthening of the Fund' SDDS (Special Data Dissemination Standard) has been realized. Particularly, dissemination of full information on foreign reserves has been agreed upon.
+Consensus has been reached on the code of good practices on fiscal transparency developed by the IMF, and the manual on its implementation is currently being reviewed.
+Consideration is being given to a code of best practices for monetary and financial policy transparency.
+Efforts of the related international organizations
-OECD will submit its code of principles of sound corporate governance to the May 1999 OECD Ministerial.
-IASC (International Accounting Standards Committee) practically finalized a full range of internationally agreed accounting standards in January 1999.
-Basle Committee on Banking Supervision is reviewing its standard on the capital adequacy ratio by April 1999.
-Other than the above, IOSCO (International Organization of Securities Commissions) and IAIS (International Association of Insurance Supervisors), etc. are also making efforts to strengthen their international standards.

2. Financial Supervision
-Industrial countries should strengthen their supervisory system on the lender financial institutions.
-Emerging market economies should strengthen and reform their supervisory system on the borrower financial institutions.
+Prudential regulations should be strengthened in industrial countries.
+Prudential regulations and financial systems should be further strengthened in emerging market economies.
#Consideration has been given to the method of strengthening the risk management system of financial institutions investing in and lending to hedge funds (indirect regulation). --> This was finalized in a report entitled "Bank's Interactions with Highly-Leveraged Institutions" of the Basle Committee on Banking Supervision in January 1999.
#Consideration has been given to the influence of the HLIs' and offshore centers' activities regarding the framework of financial supervision in a broader context, including whether or not it is necessary or feasible that hedge funds themselves provide further reporting and disclosure.
#G7 countries have taken the initiative in convening a Financial Stability Forum (participated in by representatives of the finance ministry, central bank, and financial supervisory authority of each country).
(Note)The Forum formed three working groups on highly leveraged institutions (HLIs), offshore financial centers, and short-term capital flows' effect on global financial stability.

3. Safeguards to International Capital Movements
Because financial crises in emerging market economies for the past two years were partly due to the rapid in/outflow of short-term capital, safeguards should be taken against short-term or speculative capital movements.
#Each country's experiences of liberalization and controls of capital movements should be analyzed and reflected in the future measures.
#The Communique of the October 1998 Interim Committee specified the need of the review at the Executive Board of the Fund at the strong request of Japan, etc. and the Board made comprehensive analysis and discussion in March 1999. It was also agreed in the Communique of the October 1998 Interim Committee that the Fund would continue its analysis and discussion.
#Capital account liberalization in emerging market economies should be carried out in an orderly and well-sequenced manner, on a case-by-case basis for each country. The orderly liberalization is necessary in a sense that the strengthening of the financial sector, liberalization of trade and other policies should be the preconditions for the liberalization as well as that capital flows should be liberalized on a category-by-category basis. (Prudence is particularly important for the liberalization of the inflows of short-term capital.)
#Monitoring of capital movements, particularly short-term capital, should be reinforced. Stricter monitoring of investors (hedge funds, etc) is also necessary.
+Controls on capital inflows, particularly short-term capital, may temporarily reduce the inflows and create breathing space for the implementation of more fundamental policy measures. However, these cannot serve as an alternative measure since they can decline in effectiveness over time.
+It is questionable that measures to prevent capital outflows are reintroduced in crises, because such restrictions are broad by their very nature, and may result in reducing the rollover rate or influx of new money after all.
#In order to prevent volatile capital movements, consistent monetary policy and exchange rate regime is important.
#Capital controls are more effective if they are market friendly and are imposed temporarily and broadly.
*In an extreme case in crises, capital controls may be the lesser of evils in order to restore stability.
*Any measure to prevent turbulent capital inflows can be justified insofar as it is market friendly. Reintroduction of measures to prevent capital outflows for residents in crises may be one option. Further objective analysis and discussion on these points is hoped for.

4. Exchange Rate Regime
-It should be necessary to ensure stability in the exchange rates among major currencies.
-It is essential for emerging market economies to adopt an appropriate exchange rate regime consistent with their macroeconomic policies, so as to prevent crisis.
#In order to make the exchange rates among major currencies in line with fundamentals G7 countries need to maintain their strong cooperation.
#It is important to consider the necessary factors for the maintenance of a sustainable exchange rate regime in emerging market economies.
#Desirable arrangements may vary across countries. Any exchange rate regime must be supported by disciplined policies and robust financial systems.
*Even in industrial countries, misalignment and volatility of exchange rate have a considerable influence on the real economy after shifting to the floating exchange regime, and it is necessary to consider how to achieve exchange rate stabilization.
*For emerging market economies, it might be one of options to peg their currency to a basket of currencies of the developed countries with which they have the closest interdependence, while adjusting the peg in accordance with the developments in relative real effective exchange rates or current and capital account balances. However, there is no simple set formula, and a case-by-case perusal of a country's specific situation is essential.

5. Reform of the Interim and Development Committees
It is necessary to improve the accountability of international financial institutions (IFIs) by further reflecting the political decision of shareholders in the business of IFIs.
#The IMF Interim Committee as well as the IMF-World Bank joint Development Committee should be strengthened. France claims that it would be best to transform the Interim Committee to the Council.
#The scope for institutional improvements, including of the Interim Committee, should be further explored. It is necessary to improve mutual information, while reducing overlap between the Interim and Developing Committees.
#Deputy-level meeting of the Interim Committee has been held.

6. Strengthening of the Fund Surveillance, and Improvements in its Programs and Procedures
Strengthening of the Fund surveillance and improvements in its programs and procedures are essential for the prevention and resolution of today's currency and financial crises.
#Consensus has been reached to support a wide range of reforms to improve the effectiveness of the IMF, including their transparency and accountability, changes in lending policies and conditions, and better conditionality.
#As concrete progress, the Executive Board of the Fund reviewed the Fund programs during the Asian currency crisis at the request of Japan and other Members in December 1998, and discussed lessens such as: (1) the failure in growth outlook led to more severe consequences, (2) fiscal policy was too much tightened at the outset, and (3) implementation of the structural policy measures needed more careful consideration. A paper was also published in January 1999. Besides, at the Manila Framework Meeting in Melbourne in March 1999, active discussion was made among participants from Asia-Pacific nations, IMF, etc.
#Following these considerations, actual programs for Asia have been improved.
#Moreover, building upon the useful review by the Executive Board of IMF-supported programs in the Asian financial crisis, the Interim Committee of May 1999, urged by Japan and other members, requested the Executive Board to discuss ways to further improve IMF surveillance and programs so that they better reflect the changes in the world economy, in particular potentially abrupt large-scale cross border capital movements.
*In order to ensure more accurate Fund surveillance (general review of economic policies) and programs (policy discussions for lending), the following three points should be focused on: (1) safeguards against international capital movements, (2) exchange rate policies, and (3) better grasp of the real economy, in addition to the macroeconomic fiscal and monetary policies. On the other hand, it is also necessary to limit the IMF’s involvement in structural issues.
*For the review of the Fund programs, it is necessary to consider (1) fiscal and monetary policies which may not only recover stability in crises, but also avoid excessive contraction of economy and any further erosion of confidence, and (2) measures to ensure private sector involvement for the prevention and resolution of crises.
*For the review of the IMF procedures, from the aspect of improving the IMF's accountability as well as the involvement of the Executive Board, it is important to: (1) with regard to the design of programs, allow the Board to be involved in the whole process of formulation of Fund programs, including the process before entering into negotiation with each country; (2) invite representatives of the country in question to participate in Board discussions on surveillance or programs; (3) promote voluntary publication of all staff papers on both surveillance and program; and (4) set up an evaluation unit reporting directly to the Interim Committee.
#As to the issue of publication of staff papers, a pilot project for the voluntary release of surveillance papers by the country in question has started.
(Note)At the IMF interim committee in April, Japan expressed its intention to become a pilot country for the project.

7. Enhancing the Function to Provide Liquidity
For the prevention and resolution of crises, it is also necessary to strengthen the international function to provide liquidity centered on the IMF.
#The 11th IMF Quota increase was implemented. (As of January 22, 1999, the IMF Quota was increased by 45%, up to 212 billion SDRs. Japan is the second largest shareholder on its own with 6.28% of the total Quota.)
#The NAB (New Arrangements to Borrow) was implemented. (As of November 18, 1998, a total of 34 billion SDRs, the amount of which is twice as large as that of the GAB. The number of participant countries and areas increased from 11 to 25.)
+The Executive Board of the Fund decided to establish a contingent credit line (CCL) in the Fund.
(Note)Japan has been proposing that the IMF should create a new facility that could provide a great amount of short-term lending to be disbursed at one time for the case where a country with good track records certified thorough regular Fund surveillance encounters a crisis due to the contagion of a currency crisis or the attack of speculative capital. The establishment of the CCL is along with this proposal.
*In order to augment the financial resources to be used in crises, it is also necessary to consider that the IMF borrow funds in the market.
*In order to augment member countries' foreign reserves, it could be considered that the IMF implement a general allocation of SDRs.
*Long-term consideration would be needed for the establishment of a regional currency support mechanism, in order to complement the role and function of the IMF.

8. Private Sector Involvement
For the prevention and resolution of crises, it is an urgent task to establish a system to require private creditors to take the appropriate responsibility in crises.
#Measures currently being considered to ensure the involvement of the private sector:
-Make Fund programs conditional on the maintenance of exposure and/or rollover loans of the private sector.
-Set up the Contingent Credit Line with private banks.
-Add the call option for extension of the repayment period for the inter-bank loan, and activate it in crises.
-For more organized debt workout, include the collective action clauses in the contract when issuing bonds.
-Introduce the temporary moratorium of external debt upon approval of the IMF.
-IMF promotes its policy of lending into arrears.
-Avoid excessive accumulation of short-term debt.
-Establish systems for high-frequency monitoring of private external liabilities.
-Maintain effective communication with private capital markets.

9. Protection of Vulnerable Groups in Society
It is necessary to minimize the impact of financial crises on vulnerable groups in society.
#For the adjustment programs in crises, it is necessary to promote measures to give more consideration to how the most vulnerable group in society are affected.
+The World Bank is developing principles of good practices in social policy.
+Collaboration between the World Bank and IMF on public expenditure work should be strengthened.