U.S. Department of the Treasury

(Archived Content)

Mr. Chairman, I welcome the opportunity to testify before your subcommittee today on reform of the International Monetary Fund.

We reached a strong, bipartisan consensus last year on a series of important objectives for change at the IMF. That consensus on reform, and the substantial replenishment of the IMF's resources it made possible, made a significant contribution to our efforts late last year to address the risks to U.S. interests presented by the global financial crisis.

I am pleased to report on the progress we have made in encouraging the IMF to implement the reforms called for in the legislation.

The Mission of the IMF

It is useful to start by reviewing the core mission of the IMF, and the broad objectives that have guided our efforts to improve its effectiveness.

When the IMF was created more than 50 years ago, its founders gave it two key roles:

• First, to conduct so-called surveillance of the economic policies and performance of its members' countries. This involves a process of consultation to promote appropriate policies that contribute to faster economic growth and that help make economies less vulnerable to shocks.
• Second, to provide financial assistance to countries in crisis in support of policies designed to help restore stability and growth as quickly as possible.

As the world economy and financial system have changed over this period, member countries have supported a wide range of changes to how the IMF carries out these two missions. The IMF's surveillance process has been expanded to promote a broader range of open, market-oriented economic reforms and institutional arrangements -- strong financial systems, for example -- that are important to how economies perform. The IMF's financial facilities have been expanded and adapted to meet the more complicated mix of challenges that its members face in today's world. The reforms outlined in the legislation support both these objectives.

In the past two years, the United States has strongly supported the IMF as the central institution in the effort to resolve the financial crises that began in Asia. The IMF is the right institution to be at the center of this effort for three important reasons. First, it has the expertise to shape effective reform programs. Second, it can obtain reforms in crisis countries that no assisting nation could obtain. Finally, the IMF internationalizes the burden.

But, it is important to recognize that there are limits to the IMF's mission and powers. The IMF does not have the power to compel its members to adopt and implement the policies necessary to avert crisis. And although the Fund can have considerable influence over the policies countries pursue as a condition for financial assistance, it cannot by its actions alone ensure that countries are able to restore confidence and growth. Furthermore, when countries experience crises, the IMF cannot fully insulate these countries from the disruption that necessarily accompanies economic adjustment.

The IMF can make an important contribution, often decisive in some respects, to how economies fare in our more integrated world economy and financial system. Ultimately, however, sovereign governments are responsible for the decisions that shape the performance of their economies.

IMF Reform

The 1998 IMF legislation, passed in October, outlined a number of important reforms to the IMF, and we have already begun to make some progress in advancing these reforms. Let me focus on our efforts in the following three broad areas:

• increasing transparency and accountability;
• sharpening the terms of the IMF's financial support to make it more market-based; and
• improving the design of IMF policies and programs.

1. Transparency and Accountability

When the IMF was founded in 1945, its operations were largely cloaked in secrecy. The basic approach which the Fund followed for most of the past 50 years is no longer tenable today. In recent years, largely at U.S. urging, significant changes have taken place that make the IMF a more transparent and accountable institution. Let me highlight the most important ones.

• The IMF now releases summaries of Board discussions, in a form called Public Information Notices, on its annual reviews of the policies in its member countries (so-called AArticle IV@ reviews) and on an increasingly broad range of policy issues as well. Just two years ago summaries of board discussions were rarely if ever released. Today, this is becoming the rule, with summaries now published on the annual reviews of nearly 100 countries.
• The IMF's members now release key documents on IMF programs, such as the ALetters of Intent@ detailing the policy conditions associated with borrowing from the IMF, much more systematically than in the past. Indeed, for all of the recent major IMF programs in Thailand, Indonesia, Korea, Russia, and Brazil the letters of intent were published and available to the public.
• The IMF now releases on a monthly and quarterly basis much more comprehensive information on its financial position in a form that is more accessible to the public, including a liquidity table and summary of countries' accounts with the Fund and all IMF loans.
• The IMF has now begun to release key policy papers, including the recent comprehensive review of the Fund's recent programs in Asia, and will be publishing summaries of Executive Board meetings on major policy issues.
• The IMF now is subject to more frequent external evaluations of its programs. The first such evaluation, assessing the IMF's Enhanced Structural Adjustment Facility, was published last year. External reviews of IMF surveillance of economic conditions in member countries, as well as the IMF's research program, are now in progress.

These changes are important because they will subject both the IMF and the policies of its member governments to much greater scrutiny by the citizens of its member countries, by the academic community, by the taxpayers of those countries which are the major creditors to the IMF, and by the financial markets. As these changes become policy in the institution, analysts everywhere will be able to assess the quality and effectiveness of the IMF's advice and the degree to which governments deliver on the commitments they make as a condition for IMF assistance. These changes will make Congressional oversight much easier than it has been in the past. And we believe they will make the IMF a stronger and more effective institution, with broader support and appreciation for its role in the international financial system.

2. More Market-Based Terms for IMF Financial Support

As the world economy has grown and the scale of the global financial markets has expanded, it was both necessary and appropriate for the IMF to develop the capacity to provide finance exceptionally on a larger scale than had been possible in the past.

To help reduce the risk that the availability of exceptional amounts of official finance could discourage governments from pursuing prudent economic policies, we believe it is important for the terms of such finance to be more expensive relative to the IMF's normal lending terms. The IMF legislation reinforced this objective, stating that in cases where exceptional amounts of IMF assistance are provided, the terms of that finance should be designed to limit recourse to that support and to encourage an early return to the private markets.

In the fall of 1997 the United States led an important innovation in this area with the creation of a new IMF facility -- the Supplemental Reserve Facility. This marked a fundamental change in the terms and conditions of IMF lending -- financing on shorter terms at premium rates of interest.

Since the creation of this new capacity, a substantial portion of all IMF lending in large programs has been provided on so-called ASRF terms@ -- interest rates that are at least 3 percentage points above short-term market interest rates, and maturities of 2« years or less. In the three large programs that came after this facility was established, for Korea, Russia, and Brazil, 62 percent of IMF assistance carried these terms. I expect that this will be the case in future large programs as well.

Looking ahead, any use of the new contingent credit line for combating financial market contagion, which the U.S. and the G-7 proposed last fall, will also carry premium rates of interest and short maturities.

3. Improving Design of IMF Policies and Programs.

The IMF funding legislation also set out a number of important objectives for changing the design of IMF programs. The committee's letter of invitation to this hearing asked me to address the extent to which IMF programs in a number of recent cases reflected these and a list of other objectives.

Trade Liberalization

The legislation included various provisions aimed at encouraging the liberalization of restrictions on trade in goods and services, consistent with international agreements.

In fact, the IMF has moved quite substantially on this front, both with respect to broad policies that encourage trade liberalization and in specific programs. Let me cite a few examples of how the IMF has supported trade and investment liberalization in the key countries cited by the Committee.

• Indonesia. Indonesia, pursuant to its Fund program, has removed restrictions on foreign investment in wholesale and resale trade; allowed foreign banks to buy domestic banks; terminated government support for Indonesia's national airplane project; discontinued special privileges for the national car project, which had given rise to serious WTO concerns; abolished import monopolies for such products as soybeans, sugar and wheat; cut tariffs on a range of products; agreed to phase out all quantitative import restrictions and other non-tariff barriers; and dissolved all cartels for plywood, cement and paper.
• Korea. As part of its IMF program, the Korean government has undertaken a wide-range of policy measures to liberalize its trade and investment regimes. Among these measures are substantial reductions in the number of items subject to adjustment tariffs, elimination of export subsidies, and simplification and harmonization of import certification procedures to WTO standards. In addition, restrictions on foreign investment in Korean equity, bond and money markets have been significantly reduced or eliminated, while restrictions on foreign direct investment have been substantially eased. As discussed below, two of Korea's major banks are now being privatized with foreign investor involvement. The Fund's efforts to restructure Korea's financial and corporate systems, along with the opening of the economy to foreign participation, should help create a stronger free market system that conducts transactions on the basis of arms-length practice.
• Thailand. Trade-related conditionality was a less important part of Thailand's IMF program given its relatively greater openness to foreign trade and capital. The Thai government has nonetheless moved to further liberalize foreign investment through a new draft foreign investment law, which opens up the brokerage, wholesale and retail trade, construction and hotel industries to foreign investment.
• Brazil. In recent years, Brazil has made critical progress in restructuring its economy through de-indexation, a major privatization program which was open to foreign investors, and beginning to liberalize import restrictions by joining Mercosur. But there is still more to be done. During discussions leading up to a program with Brazil, the U.S. Executive Director stressed to the Brazilian authorities and to the IMF Board and management that Brazil needed to meet its international trade obligations. The USED also ascertained, informally, that there were no intentions to raise tariffs as part of the government's fiscal adjustment program. At our urging, the text of Brazil's agreement with the IMF included a pledge to continue its policy of trade liberalization and integration. Further, the agreement just reached between Brazil and the IMF provides for major cuts in Brazilian export subsidies.

Notwithstanding this progress, the IMF continues to search for ways to go further. Many analysts have felt that the IMF at times was prone to accept trade restrictive actions, such as import duty hikes, as a means of protecting fiscal positions. On February 3, 1999 the Executive Board held a seminar to consider its approach to trade reform and its fiscal ramifications. The Board's discussion revealed a fairly strong consensus on the benefits of trade liberalization. Indeed, the Board noted that there was ample empirical evidence that trade liberalization was not correlated with lower trade tax revenues, that the presence of adverse revenue consequences from trade liberalization should not delay trade reform, that the actual revenue costs of trade reform have not proven overly burdensome, and that countries needed to act to complement trade reforms with growth supporting domestic tax reforms and macroeconomic policies.

Directed Lending

The IMF legislation called for policies aimed at eliminating the systemic practice of government-directed lending on noncommercial terms and of subsidies. Some examples of progress in this area include:

• The Korean authorities have expressed a commitment to desist from their practice of directing commercial bank lending decisions. This commitment was formally incorporated into the provisions of the standby arrangement by setting structural performance criteria intended to advance reform of the banking sector. During the most recent quarterly review in December, IMF staff confirmed that all but one of the structural performance criteria had been observed. This condition was subsequently met as scheduled by the end of January. We will continue to monitor this issue closely.
• In Indonesia, the focus is on the more prevalent practice of connected lending through the banking system and the inappropriate use of off-budget government accounts. The IMF, in cooperation with the World Bank, is addressing the problem in its financial sector restructuring program. This includes the issuance of new prudential regulations that tighten restrictions on connected lending and the requirement that former owners of banks that have been closed or taken over by the government repay losses arising from connected lending. Lending on noncommercial terms is also being addressed through the phased elimination of preferential access to bank credit. Also, off-budget accounts, such as the so-called Reforestation Fund, that were used to siphon off funds for pet projects or connected individuals are being audited by international firms and are now included in the Indonesian budget.

Bankruptcy Reform

The legislation included provisions aimed at promoting bankruptcy reform -- to be precise, a legal basis for nondiscriminatory treatment in insolvency proceedings between domestic and foreign creditors, and for debtors and other concerned persons. The IMF is sharpening its efforts in this area, focusing on the development of effective, nondiscriminatory bankruptcy laws and procedures. For example:

• In Indonesia, the IMF has been actively involved in helping to develop more effective national bankruptcy laws and procedures, as well as providing support for the training of judges.
• As part of its IMF program, Korea has amended its bankruptcy law to facilitate more rapid resolution of bankruptcy procedures and has increased staffing and resource levels to resolve bankruptcy claims more quickly.
• In Thailand, the Fund has been active in promoting legislation to facilitate bankruptcy proceedings, foreclosures and mergers, and faster disposal of assets. Progress in these areas will not only promote orderly, nondiscriminatory insolvency proceedings, but will also help encourage private sector resolution of debt problems before a crisis strikes.

It is important to recognize, however, that merely passing new laws is not enough to create an effective bankruptcy regime. This also requires institution building, a process which the IMF, the World Bank, and regional development banks are also working to support.

Reduction of Unproductive Spending

The so-called voice and vote provisions of the IMF legislation called for, among other objectives, the curtailing of excessive military spending, and the reduction of spending by governments on show-case projects. The United States has strongly urged the IMF to devote increased attention and effort in this area, and we are seeing some indications that our efforts are paying off:

• In countries with an IMF program, military spending has fallen from 5 « percent of GDP in 1990 to 2 1/4 percent presently.
• Recently, the Fund's membership endorsed a code of good practices on fiscal transparency, aimed at enhancing the transparency of fiscal policy, and reducing or eliminating off-budget transactions and accounts, which are often the source of unproductive government spending.

There are also specific examples of the USED using the voice, and the vote, of the United States to oppose unproductive spending. For example, on January 14 the United States abstained on a review of Pakistan's ESAF program in part because of concerns over the composition of government spending, including military spending.

Privatization of State-Owned Enterprises

The IMF legislation called for progress in a number of areas intended to enhance the establishment of market-based economies, for example through privatization of state-owned enterprises. Privatization figures prominently in many IMF programs as part of the Fund's efforts to help countries restore fiscal stability, rationalize the role of government in the economy, and expand the scope for private-sector led growth. A full accounting of the IMF's efforts in this area, strongly encouraged by the United States, would take much more time than we have today, therefore, I would like to cite just a few recent examples:

• In Indonesia, the IMF program, in cooperation with the World Bank, includes a major privatization effort aimed at divesting the vast bulk of state enterprises over the next decade. Between 1999-2001, the privatization effort will focus on hotels, trading, construction, mining and civil engineering firms and fertilizer producers. As part of the program to strengthen the financial sector, four state owned banks are being merged with a view to privatization in this period.
• In Korea, changes in the legal regime have facilitated a growing number of privatizations.
  • By January 1999, the government had completed the sale of stakes in four enterprises (Namhae Chemical Corporation, National Textbook Company, Pohang Iron & Steel Corporation, and Korea Technology Banking Corp.) for a total of 760 billion won ($620 million).
  • Memorandums of understanding have now been signed to sell two banks nationalized by the Korean government in December 1997 to foreign investors. A majority stake in Korea First Bank will be sold to an investor group led by two U.S. firms, Newbridge Capital and GE Capital, and HSBC, a U.K.-based bank recently reached an agreement with the Korean government on the purchase of a 70 percent stake in Seoul Bank, and subsequently announced its intention to increase its stake to 100 percent.
• Thailand has also sold its stakes in several companies in the energy sector, while the privatization of the Ratchaburi Power Plant is scheduled to occur this year. The privatization program will be expanded this year with the scheduled sales in the telecommunications, transportation and banking sectors.

The Social Dimension of IMF Programs

The IMF legislation recognized, appropriately, the importance of ensuring that IMF programs take into account, in ways consistent with the IMF's mandate, the social dimensions of economic adjustment. We have pushed hard, with some success, to encourage the Fund to pay greater attention to the composition of fiscal spending in countries and to the need to cut unproductive spending and shift resources toward the most vulnerable segments of society. We have also emphasized that the fiscal adjustments countries make as part of IMF programs should be structured in a way that does not undermine environmental protection, enforcement of labor laws, or come at the expense of the most vulnerable members of society. That means not only strengthening social safety nets for those in greatest need and promoting core labor standards around the world, but also increasing investment in education and health care, where there are high social rates of return, to provide all citizens with the requisites for economic success.

The IMF programs for Indonesia, Korea and Thailand reflect some success in these areas. As the severity of the crisis became apparent, fiscal deficit targets agreed to between these countries and the IMF were substantially eased in order to allow for greater government social spending on social safety net programs designed to alleviate poverty and protect the unemployed. The World Bank and Asian Development Bank have played a critical role in designing and helping to fund these programs. Indonesia is the best example of this. It had broadly maintained a balanced fiscal position for decades. As the depth of the crisis and its massive toll on poverty became evident growth may have contracted 15% in Indonesia last year with poverty shooting up by as many as 6 million people the Fund helped redesign Indonesia's fiscal strategy and mobilize international support to allow for a large fiscal deficit that accommodated basic social spending for the poor, including subsidies for basic goods such as rice, oil, and fuel. More recently Indonesia has developed a massive targeted program to provide rice to the truly needy.

Labor rights and environmental concerns have also been addressed in the IMF's discussions and programs with these Asian countries. For example, in response to the urging of the international community, particularly the United States and the IMF, the Indonesian government released a prominent independent union leader, Muchtar Pakpahan, from prison, ratified International Labor Organization (ILO) conventions on Freedom of Association, and announced its intention to ratify conventions on forced labor, employment discrimination and child labor. In coordination with the World Bank, the IMF program has also included a number of critical environmental policy measures, such as introducing special resource taxes, drafting of a new environmental law, and raising stumpage fees.

The IMF programs for Brazil have also reflected concerns over the environment and labor issues.

• With respect to the environment, the U.S. Executive Director emphasized to IMF staff and the Brazilian authorities the importance of protecting environmental expenditures from needed fiscal cuts. When evidence emerged that key pilot programs for environmental protection could suffer deep cuts, the U.S. government and the international financial institutions raised concerns with the Brazilian government and the funds were restored.
• Similarly, the United States vigorously used its voice to stress the importance of insulating from fiscal cuts programs to enforce labor laws B especially prohibitions against child labor and forced labor B and programs to enforce laws protecting the rights of Brazil's indigenous populations.

Assessment of IMF Programs in Asia

It should be clear from the forgoing review that the programs are broadly consistent with the objectives of the IMF reform legislation passed in October 1998, despite the fact that the programs for the Asian countries were initially drafted in 1997. While the IMF has recently completed and publicly released its own assessment of its programs in Asia, I would like to note several key issues as we reflect on the appropriateness and success of these programs.

• First, these programs were designed to address the specific underlying causes of the crisis that applied in each specific case. While the IMF has been accused of adopting a uniform orthodoxy to every country, these programs demonstrate that this is not the case. The heavy emphasis on structural reform measures in both Indonesia and Korea reflects the nature of the weaknesses that helped precipitate and intensify the crises in these countries. This is also true of the emphasis on restructuring and strengthening of the financial systems in all three Asian countries.
• The IMF has also demonstrated considerable flexibility in adjusting these programs as both domestic and external circumstances have changed. Although the IMF, along with almost everyone else, failed to anticipate the severity of the economic contraction that would accompany the crisis, the IMF has moved quickly to work with the governments in the region to adjust their reform programs to reflect these developments.
• IMF programs, when implemented fully and consistently by governments in the region, have been quite successful in achieving their objectives. In trying to overcome a financial crisis of the type that began in Asia in 1997, the critical first step must be to reestablish macroeconomic and financial stability. This is a necessary precondition for arresting high-or hyper-inflation -- the cruelest tax on people; for stabilizing exchange rates; and for bringing down interest rates to levels that will support sustained growth. Macroeconomic stability is also a prerequisite for the success of structural reforms and other measures to address the underlying causes of the crisis, as well as efforts to mitigate associated human suffering. Despite an extraordinarily difficult external environment, IMF-supported reform programs have helped countries such as Korea and Thailand to move forward on the path of recovery.
• Some private sector forecasters now expect the Korean economy to grow in excess of 2% this year, while the Thai government projects its economy will return to positive growth in the second half of this year. After peaking at the beginning of last year, short-term interest rates have fallen back to pre-crisis levels, or lower, in both Thailand and Korea. This does not mean that the cost of the crisis has not been high or that the governments and people of Korea and Thailand do not still face immense challenges. But it demonstrates that continued, forceful implementation of economic reforms continues to represent the surest and fastest road to recovery.
• The case of Indonesia, which has suffered the greatest deterioration in economic conditions in the region, also demonstrates the benefits of consistent implementation of strong policies. A significant relaxation of monetary policy in late 1997 helped produce a sharp plunge in the value of the rupiah, a rapid acceleration of inflation and a marked deterioration in the condition of many companies overburdened with foreign debt. Since June of 1998, Indonesia has been able to bring inflation under control and has strengthened the rupiah, allowing interest rates to fall sharply from their high levels. It has begun the difficult and painstaking processes of bank and corporate restructuring that are essential to any sustained recovery. While the challenges for Indonesia remain daunting, particularly in light of the political uncertainty surrounding elections this year, the need for, and benefits of, continued implementation of economic reforms are clear.

Looking Forward

Recent IMF programs have been broadly consistent with the key agenda items reflected in the IMF reform legislation, and they have been reasonably successful in helping countries take the difficult steps to recover from their economic crises. Nonetheless, the Treasury will continue to strengthen the process by which we identify opportunities to advance the agenda outlined in the IMF reform legislation, coordinate with other U.S. government agencies, and attempt to build consensus internationally for this agenda.

• Treasury Task Force. Within the Treasury, we have created a new task force composed of country specialists and officials knowledgeable in particular issue areas, such as banking, trade, labor, and the environment. Other U.S. government agencies, such as the U.S. Trade Representative, the Labor Department, the Commerce Department, and the State Department, will provide input into the work of the task force. The objective of this group is to promote a mechanism for early insight into the IMF's dialogue with its member countries and the design of its programs.

In terms of international cooperation, we are working hard to strengthen and, over time, expand the consensus exemplified by the October 30, 1998, statement by G-7 Executive Directors on reforms set out in section 601 of the IMF funding legislation. Our basic objective in this regard has two dimensions:

• at a general level, to continue to advance and refine our arguments in the IMF policy-making process with the goal of bringing appropriate proposals to the IMF Board and management for consideration; and
• an incremental case-by-case approach whereby we try to further our progress in specific programs to encourage a more systematic application of these reforms.

Concluding Remarks

We take the issues before us today seriously and will continue to work hard to advance the reforms set out in the legislation. We have made significant progress in a number of areas. The cumulative impact of the changes that are taking place is quite meaningful and probably more significant in scope and importance than anything that has happened in the IMF for some time.

In many ways, however, we are still at an early stage of the process. I think we can take encouragement from the fact that the IMF has shown a willingness and capacity to adapt. I also believe that current IMF management is making a good-faith effort to work with us, as are our G-7 partners and a number of other IMF members. We hope to build on that foundation.

Thank you. I would be happy to try to answer questions.