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UNITED NATIONS CONFERENCE ON TRADE AND DEVELOPMENTGENEVA

TRADE AND DEVELOPMENTREPORT, 2001

Report by the secretariat of theUnited Nations Conference on Trade and Development

UNITED NATIONSNew York and Geneva, 2001

• Symbols of United Nations documents arecomposed of capital letters combined with fig-ures. Mention of such a symbol indicates areference to a United Nations document.

• The designations employed and the presenta-tion of the material in this publication do notimply the expression of any opinion whatso-ever on the part of the Secretariat of the UnitedNations concerning the legal status of anycountry, territory, city or area, or of its authori-ties, or concerning the delimitation of its fron-tiers or boundaries.

• Material in this publication may be freelyquoted or reprinted, but acknowledgement isrequested, together with a reference to thedocument number. A copy of the publicationcontaining the quotation or reprint should besent to the UNCTAD secretariat.

Sales No. E.01.II.D.10

ISBN 92-1-112520-0

ISSN 0255-4607

Note

UNITED NATIONS PUBLICATION

Copyright © United Nations, 2001All rights reserved

UNCTAD/TDR/(2001)

FOREWORD

Kofi A. AnnanSecretary-General of the United Nations

International economic issues touch the lives of people everywhere. Whether grapplingwith the challenges posed by new information technologies, seeking to draw policy lessonsfrom financial crises in emerging markets, or assessing the possible impact of China’sentry into the World Trade Organization, we look to economics as a guide in our rapidlychanging world. The poorest nations especially require a clear economic road map if theyare to make progress against the persistent problems of hunger, ill health and socialinsecurity.

Over the past 20 years, UNCTAD’s Trade and Development Report has establisheditself as an authoritative voice on key international economic issues. This year’s Reportoffers an assessment of recent trends and prospects in the world economy, with particularfocus on the impact that developments and policies in the industrial economies are likelyto have on prospects in the developing world. With policy makers everywhere concernedabout the effect of the economic slowdown in the United States, the Report’s call forgreater coordination and cooperation on economic issues deserves careful consideration.

In the past decade, there has been growing concern about the ability of multilateralrules and regulations to meet the challenges posed by global financial markets. This year’sReport examines in depth the ongoing discussions about reforming the multilateral financialsystem. It looks at key areas such as codes and standards, the contributions of privateinstitutions in managing financial crises, and the workings of the exchange rate system.On each subject, it offers challenging recommendations on how to move the reform processforward. Many of these issues are expected to be discussed at next year’s high-level eventon financing for development. I hope this Report will make a useful contribution to thosediscussions.

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Contents

FOREWORD ............................................................................................................................................... iii

Explanatory notes ........................................................................................................................................ xi

Abbreviations .............................................................................................................................................. xii

OVERVIEW ............................................................................................................................................... I-X

Page

Trade and Development Report, 2001

Part One

GLOBAL TRENDS AND PROSPECTS

Chapter I

THE WORLD ECONOMY: PERFORMANCE AND PROSPECTS ............................................... 3

A. Global outlook ...................................................................................................................................... 3

B. Developed economies ........................................................................................................................... 7

1. The slowdown in the United States economy ................................................................................ 72. European Union .............................................................................................................................. 103. Japan ................................................................................................................................................ 14

C. Developing countries ......................................................................................................................... 16

1. Latin America ................................................................................................................................. 162. Asia .................................................................................................................................................. 183. Africa ............................................................................................................................................... 21

D. Transition economies ......................................................................................................................... 23

Notes .......................................................................................................................................................... 25

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Page

Chapter II

INTERNATIONAL TRADE AND FINANCE .................................................................................... 29

A. Recent developments in international trade ................................................................................. 29

B. Non-oil commodity markets ............................................................................................................. 33

C. Recent developments and emerging trends in oil markets ......................................................... 35

1. Prices, supply and demand ............................................................................................................. 352. Impact of the increase in oil prices ............................................................................................... 363. Prospects .......................................................................................................................................... 38

D. Currency markets and selected financial indicators in emerging markets ............................. 39

E. Private capital flows to emerging-market economies .................................................................. 48

1. Developments in 2000 .................................................................................................................... 482. Outlook ............................................................................................................................................ 52

F. External financing and debt of the least developed countries ................................................... 54

Notes .......................................................................................................................................................... 56

Part Two

REFORM OF THE INTERNATIONAL FINANCIAL ARCHITECTURE

Chapter III

TOWARDS REFORM OF THE INTERNATIONAL FINANCIALARCHITECTURE: WHICH WAY FORWARD? .............................................................................. 61

A. Introduction ........................................................................................................................................ 61

B. The governance of international capital flows .............................................................................. 63

C. The exchange rate system ................................................................................................................. 65

D. Orderly workout mechanisms for international debt ................................................................. 68

E. Reform of the IMF ............................................................................................................................. 70

1. Surveillance and conditionality ..................................................................................................... 702. Liquidity provision and lender-of-last-resort financing .............................................................. 71

F. Governance of international finance .............................................................................................. 74

Notes .......................................................................................................................................................... 76

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Page

Chapter IV

STANDARDS AND REGULATION .................................................................................................... 79

A. Introduction ........................................................................................................................................ 79

B. Themes of the key standards ............................................................................................................ 81

1. Macroeconomic policy and data transparency ............................................................................. 812. Banking supervision ....................................................................................................................... 833. Payments and settlement ................................................................................................................ 854. Accounting and auditing ................................................................................................................ 865. Corporate governance ..................................................................................................................... 886. Insolvency ....................................................................................................................................... 897. Securities regulation ....................................................................................................................... 898. Insurance .......................................................................................................................................... 909. Market integrity and money laundering ....................................................................................... 91

C. Influence and participation in the formulation and implementation of standards ............... 92

D. Implementation, sanctions and incentives ..................................................................................... 96

E. Standards, financial regimes and financial stability ................................................................. 101

Notes ........................................................................................................................................................ 103

Chapter V

EXCHANGE RATE REGIMES AND THE SCOPEFOR REGIONAL COOPERATION .................................................................................................. 109

A. Introduction ...................................................................................................................................... 109

B. Exchange rate regimes ..................................................................................................................... 111

1. Soft pegs ......................................................................................................................................... 1112. Floating .......................................................................................................................................... 1133. Hard pegs ....................................................................................................................................... 116

C. Regional arrangements: the European experience .................................................................... 118

D. Options for developing countries: dollarization or regionalization? ...................................... 121

Notes ........................................................................................................................................................ 128

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Page

Chapter VI

CRISIS MANAGEMENT AND BURDEN SHARING ................................................................... 131

A. Introduction ...................................................................................................................................... 131

B. Private sector involvement and orderly debt workouts ............................................................ 132

C. Recent debate within the IMF ....................................................................................................... 136

D. Official assistance, moral hazard and burden sharing ............................................................. 138

E. Voluntary and contractual arrangements .................................................................................... 142

1. Bond restructuring and collective action clauses ....................................................................... 1432. Restructuring bank loans .............................................................................................................. 146

F. Conclusions ....................................................................................................................................... 149

Notes ........................................................................................................................................................ 152

REFERENCES ...................................................................................................................................... 155

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List of text tables and charts

Table Page

1.1 World output, 1990–2000............................................................................................................... 51.2 Growth in developing countries by region, 1990–2000 ............................................................ 171.3 Transition economies: selected economic indicators, 1998–2000 ........................................... 242.1 Exports and imports by region and economic grouping, 1997–1999 ...................................... 302.2 Exports and imports by region and economic grouping, 2000:

estimates by various institutions ................................................................................................. 312.3 World primary commodity prices, 1996–2000 ........................................................................... 342.4 G-7 countries: average pump prices of gasoline and revenues from

taxes on oil products ..................................................................................................................... 372.5 Oil import bills of oil-importing countries, 1998–2000 ............................................................ 382.6 Net capital flows to developing and transition economies, 1997–2000:

estimates of the Institute for International Finance and the IMF ............................................. 492.7 External assets of banks in the BIS reporting area vis-à-vis developing and

transition economies, 1997–2000 ................................................................................................ 502.8 International issuance of debt securities by developing and transition economies,

1997–2000 ..................................................................................................................................... 512.9 Capital inflow of LDCs by type of flow, and net transfer, 1990–1999 ................................... 554.1 Key standards for financial systems ........................................................................................... 80

1.1 Investment cycles in major industrial countries, 1981–2000 ..................................................... 81.2 United States: private investment and savings, 1990–2000 ........................................................ 91.3 United States: personal savings and government savings, 1990–2000 .................................... 102.1 Monthly average spot prices of OPEC crude oils, 1998–2000 ................................................. 352.2 Real oil prices, 1974–2000 .......................................................................................................... 362.3 Equity price indices of selected emerging-market economies,

January 1999 to January 2001 ..................................................................................................... 452.4 Exchange rates and money-market rates in selected emerging-market economies,

July 1999 to January 2001 ........................................................................................................... 462.5 Yield spread of selected internationally issued emerging-market bonds,

July 1999 to January 2001 ........................................................................................................... 535.1 Unit labour costs in selected European countries after a negative supply shock,

1972–1976 ................................................................................................................................... 1205.2 Unit labour costs after a positive demand shock, 1987–1991 ................................................ 120

Chart Page

x

List of boxes

1.1 Dissecting the United States downturn ....................................................................................... 122.1 External shocks, adjustment and crisis in Argentina ................................................................. 402.2 Stabilization and crisis in Turkey ................................................................................................ 424.1 Basel Capital Standards................................................................................................................ 985.1 Regional monetary and financial cooperation among developing countries ......................... 1225.2 The Chiang Mai Initiative .......................................................................................................... 1256.1 GATT and GATS balance-of-payments provisions and exchange restrictions ..................... 1356.2 Recent bond restructuring agreements ...................................................................................... 1396.3 Recent initiatives in IMF crisis lending .................................................................................... 141

Box Page

xi

Explanatory notes

Classification by country or commodity group

The classification of countries in this Report has been adopted solely for the purposes of statistical oranalytical convenience and does not necessarily imply any judgement concerning the stage of devel-opment of a particular country or area.

The major country groupings distinguished are:

» Developed or industrial(ized) countries: in general the countries members of OECD (other thanthe Czech Republic, Hungary, Mexico, the Republic of Korea and Turkey).

» Transition economies: the countries of Central and Eastern Europe (including the States formerlyconstituent republics of Yugoslavia), the Commonwealth of Independent States (CIS) and the BalticStates.

» Developing countries: all countries, territories or areas not specified above.

The term “country” refers, as appropriate, also to territories or areas.

References to “Latin America” in the text or tables include the Caribbean countries unless otherwiseindicated.

Unless otherwise stated, the classification by commodity group used in this Report follows generallythat employed in the UNCTAD Handbook of Statistics 2000 (United Nations publication, sales no.E/F.00.II.D.30).

Other notes

References in the text to TDR are to the Trade and Development Report (of a particular year). Forexample, TDR 2000 refers to Trade and Development Report, 2000 (United Nations publication, salesno. E.00.II.D.19).

The term “dollar” ($) refers to United States dollars, unless otherwise stated.

The term “billion” signifies 1,000 million.

The term “tons” refers to metric tons.

Annual rates of growth and change refer to compound rates.

Exports are valued FOB and imports CIF, unless otherwise specified.

Use of a dash (–) between dates representing years, e.g. 1988–1990, signifies the full periodinvolved, including the initial and final years.

An oblique stroke (/) between two years, e.g. 1990/91, signifies a fiscal or crop year.

Two dots (..) indicate that the data are not available, or are not separately reported.

A dash (-) or a zero (0) indicates that the amount is nil or negligible.

A dot (.) indicates that the item is not applicable.

A plus sign (+) before a figure indicates an increase; a minus sign (-) before a figure indicates adecrease.

Details and percentages do not necessarily add to totals because of rounding.

xii

Abbreviations

APG Asia/Pacific Group on Money LaunderingASA ASEAN Swap ArrangementASEAN Association of South-East Asian NationsBCBS Basel Committee on Banking SupervisionBIS Bank for International Settlementsbpd barrels per dayCAC collective action clauseCCL Contingency Credit Line (IMF)CFA Communauté financière africaineCFATF Caribbean Financial Action Task ForceCFR (United States) Council on Foreign RelationsCFRTF (United States) Council on Foreign Relations Task ForceCIS Commonwealth of Independent StatesCPLG Core Principles Liaison Group (of BCBS)CPSS Committee on Payment Settlement Systems (of BIS)DAC Development Assistance Committee (of OECD)EC European CommissionECB European Central BankECE Economic Commission for EuropeECLAC Economic Commission for Latin America and the CaribbeanEMI European Monetary InstituteEMS European Monetary SystemEMU European Monetary UnionERM Exchange Rate MechanismEU European UnionFASB Financial Accounting Standards Board (United States)FATF Financial Action Task Force on Money LaunderingFDI foreign direct investmentFLAR Fondo Latinoamericano de ReservasFSAP Financial Sector Assessment Programme (IMF-World Bank)FSF Financial Stability ForumGATS General Agreement on Trade in ServicesGATT General Agreement on Tariffs and TradeGDDS General Data Dissemination SystemGDP gross domestic productHIPC heavily indebted poor countryHLI highly leveraged institutionIAIS International Association of Insurance SupervisorsIASC International Accounting Standards CommitteeICT information and communication technologyIDB Inter-American Development BankIFAC International Federation of AccountantsIFAD International Fund for Agricultural Development

xiii

IFI international financial institutionIFIC International Financial Institutions CommissionIIF Institute for International FinanceIMF International Monetary FundIMFC International Monetary and Financial CommitteeIOSCO International Organization of Securities CommissionsIPO initial public offeringM&A merger and acquisitionNCVA National Venture Capital AssociationNIE newly industrializing economyODA official development assistanceOECD Organisation for Economic Co-operation and DevelopmentOFC offshore financial centreOPEC Organization of the Petroleum Exporting CountriesSDDS Special Data Dissemination StandardSDR special drawing rightSRF Supplemental Reserve Facility (of IMF)SWIFT Society for Worldwide Inter-Bank Financial TelecommunicationsUDROP universal debt rollover option with a penaltyUNCITRAL United Nations Commission on International Trade LawUNCTAD United Nations Conference on Trade and DevelopmentUNCTC United Nations Centre on Transnational CorporationsUN/DESA United Nations Department of Economic and Social AffairsWTO World Trade Organization

A quarter is a long time in economics. At the annual meetings of the Fund and Bankin Prague last September the mood was upbeat. The world economy had shruggedoff a series of financial shocks in emerging markets, the United States economy wascontinuing to forge ahead, driven by the “new economy”, Europe was at last show-ing signs of a robust recovery and Japan was beginning to emerge from a prolongedrecession. Growth figures were being marked upwards. The only cloud on the hori-zon was rising oil prices.

The mood is different today. There are concerns about just how far and how fast theUnited States economy will slow down and whether traditional macroeconomic in-struments can manage a rapid recovery; how vulnerable the dollar is; whether thenascent recovery in Japan will once again be nipped in the bud; whether the Euro-pean locomotive can pick up sufficient speed to keep the world economy on track,and if not what a global downturn might mean for the still fragile recovery in Asia.On a more optimistic note, the oil cloud on the horizon has dissipated; prices hadalready peaked at the time of the Prague meetings. Conventional economic analysisis not, it seems, adapting very well to the gyrations of a globalizing world.

The UNCTAD secretariat has for some time been warning that excessive financialliberalization is creating a world of systemic instability and recurrent crises. A com-mon response has been to blame such crises on misguided policies and cronyinvestment practices in emerging markets. Whether similar accusations will sur-face as financial excesses and wasteful investments are exposed in the United Statesby economic slowdown remains to be seen, but they would be no more helpful thanthey were in the aftermath of the Asian crisis. Markets can and do get it wrong, andfor developing and developed countries alike. The onus is still on policy makers tofind preventive measures and appropriate remedies.

Certainly that task is difficult in a highly integrated world economy. But multilat-eral financial rules and institutions were established precisely to prevent a repetitionof the inter-war economic chaos linked to persistent payments and currency disor-ders and excessive reliance on short-term capital flows. Sadly, since the break-upof the Bretton Woods system the world has been ill-prepared to deal with the re-emergence of such problems. Talk of far-reaching reform of the international financialarchitecture after the Asian crisis has proved to be no more than that. However, if astrong wind does pick up from the North, the consequences for the world economywill be much more chilling than those of the wind that blew in from the South. It isto be hoped that this threat will suffice to breathe new life into the reform efforts.

OVERVIEW

II

The performance of the world economy in 2000 was the best in over a decade. In every regiongrowth edged upwards, with recoveries in Latin America and the transition economies that were strongerthan expected. Moreover, this performance was achieved against the backdrop of sharply rising oilprices. While positive impulses from the previous year, notably the large liquidity injection to staveoff the Y2K bug and to support the introduction of the euro, helped maintain the momentum, it was thecontinued strength of the United States economy that underpinned the 4 per cent growth in globaloutput. To some observers, the combination of deregulated markets and new information technologieswas putting pay to old-fashioned ideas about how economies worked, and many were looking forwardeagerly to an unprecedented era of global prosperity.

Things changed dramatically over the last quarter of 2000 and into the new year. The UnitedStates economy began to slow sharply and the landing could well be harder than optimists had ex-pected. The unwinding of its high-tech boom has produced a drop in investment spending, which hasbeen aggravated by weaker consumer confidence and the threat of sizeable job losses in new and oldeconomic sectors alike. The Federal Reserve reacted swiftly by cutting interest rates twice in January,with further cuts expected. The question that remains is whether the United States economy is experi-encing the kind of cyclical downturn which will respond positively to such moves, and so ensure aquick rebound from two or three quarters of flat or negative growth back to a potential growth rateabove 3 per cent. If the answer is in the negative, is the United States in for a longer period of disin-vestment and debt restructuring with resemblances to those which occurred in Japan and parts ofEurope in the early 1990s?

Expectations remain quite high that a short Keynesian downturn in the United States can becorrected by appropriate monetary and fiscal action. Some indicators at the beginning of the yearprovided grounds for guarded optimism: oil prices had dropped from their earlier peak; equity pricesappeared to be stabilizing; and the trade balance had started to improve. The quick and decisive actiontaken by the Federal Reserve is also encouraging. The tax cuts that are under consideration, if appro-priately timed and targeted, could further stabilize the situation.

But, even if the steady policy hand of recent years is maintained, there are doubts that traditionalmacroeconomic policies will carry the day, given the high level of private indebtedness, the surfeit ofinvestment during the technology boom, and uncertainties surrounding the dollar. While the publicsector prepares to pay off its outstanding debt, the private sector has attained record debt levels. Ashouseholds see their income growth decline, they will have to borrow more in order to maintain cur-rent spending, at precisely the time when it is becoming more difficult for them to keep up withpayments on their outstanding debt. At the same time, much of the high-tech Schumpeterian invest-ment sustained by the venture capital boom and the stock market bubble may be destroyed with areturn to normal financing conditions. If households and the business sector were to simultaneouslylimit their spending to current earnings, there could be a significant decline in GDP.

Global economic downturn and prospects

III

The fact that such a long period of expansion has no recent precedent should make for cautiousassessment of the current slowdown. However, on balance, the various conflicting pressures point toan uncertain future; any abrupt shifts in sentiment or policy could still make for a deeper downturnthan many are expecting and prejudice a swift recovery.

In view of its pivotal role in bolstering global demand in recent years, the prospects for theUnited States economy are a matter of worldwide concern. The increasing integration of the globaleconomy certainly means that both real and financial shocks are transmitted much more rapidly acrossregions, countries and sectors. At the same time, because of the intertwining of finance and produc-tion, such shocks can have unexpected consequences, as has been demonstrated by the financial criseswhich began in Asia in 1997.

Whatever the immediate future holds in store for the United States, the long-term fate of theglobal economy cannot be left to be determined by policies and events in a single country. In thecontext of growing interdependence, all the major industrial economies need to harmonize their forces,if the gains from globalization are to be widely distributed and, in particular, to reach down to devel-oping countries. Accordingly, “business as usual” is not the right mantra for policy makers anywhere.

Growth in Europe in 2000 broke through the 3 per cent barrier for the first time in over a decade,but leading indicators point to a slowdown in 2001. Now that budget deficits have been brought undercontrol, the current account is healthy and there are few signs of inflationary pressure, the way is clearfor a shift to expansionary macroeconomic policy. With interest rates falling in the United States andthe prospect of a recovery of the euro which should further ease the pressure on monetary policy,Europe seems well placed to take on global economic responsibilities and boost global demand, thusoffsetting the effects of slowdown in the United States. However, the EU appears reluctant to test thelimits of its potential growth, as the United States did in the second half of the 1990s. Yet such actionis also necessary in order to overcome its persistent and high unemployment. The European CentralBank maintains that it sees no signs of the potential growth rate in the euro area rising above a modest2.0–2.5 per cent, implying that it sees no immediate scope for relaxing monetary policy without infla-tionary consequences. This stance may need to be reconsidered if, as seems likely, the EU is hit harderby a slowdown in the United States than might be suggested by its limited trade ties with that country.

Japan is unlikely to fill the breach, given its fragile recovery and the importance to it of theUnited States market. Its nascent expansion, which looked healthy in the first half of 2000, was builton rising net exports, but negative growth was resumed in the third quarter of the year. A lower dollarand weaker demand in the United States market place the burden of recovery on strong domesticdemand. But since domestic investment is still closely tied to exports, and unemployment is againedging upwards, it is not at all clear from where the impulse will come.

Governments in Japan have repeatedly responded to sluggish growth with more active fiscalmeasures, but now that public debt is at an unprecedently high level pressure for fiscal consolidationis starting to impact on macroeconomic policy. Considerable uncertainty also surrounds the future di-rection of monetary policy; the Central Bank no longer seems willing to hold itself to a zero interest-ratepolicy, which it views as an impediment to financial structuring. With liquidity and fiscal traps snappingshut and export prospects darkening, recovery may once more be cut off just as it gathers momentum.

* * *

Much still depends on the readings and actions of policy makers in Washington and it is prema-ture to give the global economy a clean bill of health. Even if Europe in 2001 were to match the earlierUnited States growth performance, that would not have the same effect on the developing world, since

IV

it has a lower propensity to import from those countries. The downside risks for developing countriesare thus considerable.

Trade flows are one channel for contagion from a United States slowdown. The danger is appar-ent from the Asian experience, when slower growth in high-tech exports played an important role inthe build-up of external fragility and the impact of the subsequent financial shock was amplifiedthrough intraregional trade. Just as significantly, strong export growth has played a key role in theAsian recovery. In 2000 the growth of United States imports reached double-digit figures for the thirdyear running. The benefits to developing countries and transition economies were particularly marked,their total export volumes being estimated to have risen by over 10 and 15 per cent, respectively. Afurther factor in their favour was an improvement in their terms of trade on account of sustained oilprice rises. The prospects for this year are much less favourable.

Financial and currency markets are another channel for contagion. Falling United States interestrates will certainly benefit countries with large stocks of dollar debt. Capital flows could also beredirected to emerging markets as smaller profits in the United States discourage inflows of capitalseeking to join in the high-tech revolution and falling interest rates dampen short-term arbitrage inflows.However, it is equally possible that the United States slowdown will accentuate the bearish sentiment inglobal financial markets, raising the liquidity premium on dollar assets and the risk spread on emerg-ing-market borrowing, thereby wiping out the benefits of lower United States interest rates. In thatevent, capital flows to developing countries would scarcely exceed their disappointing levels of 2000.

The presence of different channels of transmission suggests that the United States slowdown willbe felt very differently in different regions of the developing world. East Asia was the fastest-growingregion last year. After strong recoveries in 1999 in most of the economies damaged by the financialturmoil of 1997–1998, growth accelerated further in 2000. Exports to the United States, which amountto more than 20 per cent of GDP in Malaysia, 10 per cent in Thailand, and 7 per cent in the Republicof Korea, played a key role, especially exports from high-tech sectors. The current combination ofdeclining sales in the United States and falling semiconductor prices has resulted in terms-of-tradelosses and declining export earnings for all these countries. Growth is consequently expected to fallthroughout the region this year. Intraregional trade linkages could once again amplify the negativeimpact of these shocks, triggering a further round of destabilizing exchange rate swings across theregion. Moreover, the economies are slowing down at a time when financial and corporate restructur-ing is running into difficulties in a number of countries.

The economy of China is also sensitive to developments in the United States, which absorbs over20 per cent of its exports. While robust growth last year gives grounds for hope that China can weatherthe downturn in the United States as well as it did the Asian crisis, the task of striking the right policybalance is being complicated by protracted, and as yet unfinished, negotiations over accession toWTO. The prospect of Chinese accession in the near future is also a matter of concern among some ofthe smaller labour-intensive exporters in Asia, who fear losing competitiveness at the very time whentheir export prospects are blackened by weakening import demand in the United States.

The impact of a United States slowdown on Latin America is more difficult to gauge. Recoveryin that region was stronger than expected in 2000, when growth reached close to 4 per cent, afterstagnation in the previous year. However, the aggregate picture hides much variation among coun-tries. Mexico, which accounts for one fifth of regional output, witnessed growth of around 7 per cent,reflecting its close economic ties to the United States (which takes some 85–90 per cent of Mexicanexports), as well as the rise in the export prices of its oil. It seems unlikely that the Mexican economywill be able to escape the consequences of the slowdown in the United States, although lower interestrates could be helpful. In addition, there is concern, shared with some other Central American andCaribbean countries, over the prospect of greater competition from China after its accession to WTO.

V

The impact on the rest of Latin America is likely to be different. In view of the weaker trade linkswith the United States and the heavy dependence on capital inflows, improved external financial con-ditions may more than offset the effect on their exports of reduced demand in the United States. In theabsence of a significant increase in risk spreads, lower interest rates in that country should meanreduced borrowing costs and debt servicing, easing the pressure on balances of payments and budgets.Furthermore, for countries which have opted for a currency board or outright dollarization a weakerdollar improves competitiveness vis-à-vis third parties. Argentina may turn out to be a big winner on bothcounts, emerging from the vicious circle of stagnation and deflationary adjustment to the external shocksof 1998–1999. Brazil should also benefit from improved financial conditions, though to a lesser extent.

Despite some grounds for optimism, the real danger facing Latin America is one of diminishedexpectations. Policy makers throughout the region appear content to target growth in the 3–4 per centrange, well below what is required to promote graduation to the next level of development. Moreover,with more countries choosing dollarization, dependence on conditions and policy decisions in the UnitedStates is increasing. A deeper downturn there, bringing with it a new round of financial uncertainty andreassessment of risks, could well wipe out the potential benefits of a weaker dollar and lower interestrates and, together with a slowdown in exports, could produce a further setback to growth prospects.

As regards Africa, there is a certain degree of asymmetry in the impact of fluctuations in globaleconomic activity. Because of supply-side rigidities, African LDCs that rely on exports of only one ortwo primary commodities cannot take full advantage of global expansion by increasing their exportvolumes, while they often bear the full brunt of commodity price declines. Prices of many of thecommodities exported from Africa were falling in the 1990s. The rise in oil prices benefited somecountries in 1999, and again in 2000, but for others, particularly the many that depend on oil imports,the consequence was a further widening of the resource gap.

Thus, despite the strong growth in the world economy in 2000, Africa’s growth rate rose onlymodestly, to 3.5 per cent, which is below the rate reached before the Asian financial crisis and wellbelow what is needed to tackle the problems of rising poverty and declining health. Even before theslowdown in the United States, growth forecasts were being revised downwards because of the con-tinued sluggishness of some of the larger economies, severe weather conditions and disruptions causedby civil and political unrest.

In these circumstances, any global shock could be particularly damaging for African countries.Not surprisingly, aid and debt relief remain high on their political agendas. The region should benefitfrom bilateral debt reduction accorded by some industrialized countries to the poorest economies, aswell as from recent European and United States initiatives to open up their markets to the pooresteconomies in Africa. However, with progress on the HIPC Initiative still much too slow, and a growingacknowledgement that the financial benefits are much smaller than expected, there is an urgent need fora bolder approach to multilateral debt relief.

The transition economies benefited considerably from favourable trading conditions in 2000. Forthe first time since the Berlin Wall fell, GDP increased in all countries. Growth in the Russian Federa-tion rose sharply, thanks to strong demand for its primary exports, particularly oil. Elsewhere, it wasthe industrial sector that underpinned improvements, notably those of Eastern European countries,which benefited from strong export growth of manufactures to the EU. Even so, the fact that therecovery is from a low base, and occurred in favourable global demand conditions, means that aslowdown in the world economy will be felt by many of the transition economies and that any furtherrecovery will have to come largely from a stimulus originating in domestic demand.

* * *

VI

The downturn in the United States, unresolved structural difficulties and sluggish growth in Ja-pan, and undue emphasis that monetary policy continues to place on inflation in Europe have theconsequence that the major industrial countries will be converging towards a slower pace of economicactivity. Despite decisive policy action, rapid recovery in the United States economy is jeopardized bythe financial excesses associated with its unprecedented period of expansion. Furthermore, an orderlytransition to a world where all the leading economies are pulling in the same direction is furthercomplicated by the uncertainty surrounding exchange rate adjustments to the trade imbalances whichhave built up over the past few years. A rapid weakening of the dollar would not only compromise theability of monetary policy in the United States to respond vigorously to a deepening of the downturn,but could also expose financial fragilities elsewhere. For all these reasons the downturn and instabilityin the world economy could be more pronounced than under normal cyclical conditions. Consequently,cooperation among, and responsible action by, all major players in the world economy becomes all themore necessary.

Reforming the international financial architecture

Between the myopia of global markets and the myth of global government, multilateral rules andinstitutions can help reduce market volatility and prevent mutually incompatible policy responses toeconomic shocks. For the architects of the post-war multilateral system who gathered at Bretton Woods,history had taught that financial markets were a particularly fecund source of instability and shocks,and that control over international capital flows was a precondition for currency stability, the revivalof trade and economic growth and the achievement of full employment.

The breakdown of the Bretton Woods system in the early 1970s initiated a period of financial andeconomic uncertainty and instability that shares at least some of the characteristics of the inter-warperiod. Various initiatives have been pursued in different forums in the hope of finding a system ofgovernance compatible with flexible exchange rates and large-scale private capital flows. The historyof these initiatives can point to some successes but has, by and large, proved unsatisfactory, in partbecause they have been premised on keeping separate the problems facing developed and developingcountries within the multilateral financial arrangements.

When the Asian financial crisis erupted, it seemed that all that would change. The virulence ofthe economic forces unleashed after the collapse of the Thai baht in July 1997, and among countrieswith track records of good governance and macroeconomic discipline, seemed to confirm the sys-temic nature and global reach of currency and financial crises. But despite the initial emphasis ofsome policy makers in the leading industrial economies on the need for systemic reform, moves in thatdirection have subsequently stalled. Instead of establishing institutions and mechanisms at the inter-national level to reduce the likelihood of such crises and better manage them when they do occur,there has been a very one-sided emphasis on reforming domestic institutions and policies in develop-ing countries.

VII

Efforts in the past few years have focused on measures designed to discipline debtors and providecostly self-defence mechanisms. Countries have been urged to better manage risk by adopting strictfinancial standards, improving transparency, adopting appropriate exchange rate regimes, carryinglarge amounts of reserves, and making voluntary arrangements with private creditors to involve themin crisis resolution. While some of these reforms undoubtedly have their merits, they presume that thecause of crises rests primarily with policy and institutional weaknesses in the debtor countries andaccordingly place the onus of responsibility for reform firmly on their shoulders. By contrast, littleattention is given to the role played by institutions and policies in creditor countries in triggeringinternational financial crises.

* * *

Proposals for new international institutions explicitly designed to regulate and stabilize interna-tional capital flows have been summarily dismissed by critics as the work of mavericks lacking inpolitical sense and technical judgement. The preferred line of reform has sought to establish variouscodes and standards to help strengthen domestic financial systems in debtor countries, enhance theirmacroeconomic and financial policy formulation, and improve the collection and disclosure of infor-mation. The Bretton Woods institutions, the Basel-based bodies and the Financial Stability Forumhave already made a series of proposals along these lines.

Such measures can bring self-evident benefits, but they can be properly assessed only as part ofan evolutionary process of stabilizing global financial markets. Of more immediate concern to devel-oping countries is the fact that what has been proposed so far under the heading of codes and standardsembodies the view that the main problems lie in countries receiving capital flows, but entails neithera fundamental change in policies and practices in the source countries nor improvement in the trans-parency and regulation of currently unregulated cross-border financial operations. And despite theemphasis on their voluntary adoption, there is the danger that incentives and sanctions linked to stand-ard-setting will become features of IMF surveillance and conditionality, compliance with which wouldplace a further heavy burden on the administrative capacities of many countries.

Because much of the impetus to improve codes and standards assumes their introduction into astable and predictable global financial system, such measures offer little in the way of immediateprotection for developing countries against supply-driven fluctuations in international capital flows,which are strongly influenced by policies and monetary conditions in the major industrial countries.Almost all major crises in emerging markets have been connected with shifts in exchange rates andmonetary policy in those countries. The root of this problem lies, in large part, in the failure to estab-lish a stable system of exchange rates after the breakdown of the Bretton Woods arrangements. Theexpectation then was that floating among the main reserve currencies would automatically bring aboutorderly balance-of-payments adjustments, increased exchange-rate stability and greater macroeco-nomic policy autonomy. This has not happened. But while the damage inflicted by disorderlyexchange-rate behaviour has been limited for the G-3 economies this has not been the case for debtordeveloping countries, which depend more heavily on trade and whose borrowing profile exposes themto greater currency risk.

Despite the broad consensus that the Bretton Woods institutions should get back to what they dobest, the discussion on reforming the international financial and monetary system has so far avoidedserious mention of how the Fund might help rebuild a stable exchange rate system among the G-3currencies. Proposals for securing greater stability through coordinated intervention and macroeco-nomic policy action, including formally established target zones, have been brushed aside, anddiscussions have concentrated on the pros and cons for developing countries of fixed or floatingexchange-rate regimes and the macroeconomic policies consistent with one or other of these “corner

VIII

solutions”. This ignores the mounting evidence that developing countries cannot unilaterally ensureappropriate alignment and stability of their exchange rates as long as major reserve currencies aresubject to frequent gyrations and misalignments and international capital flows to large swings be-yond the control of recipient countries.

* * *

With little progress on how best to prevent financial crises, attention has increasingly turned tohow best to limit their damage through faster and more effective responses once they do occur. So far,large bailout packages have been the preferred option, in most creditor and debtor countries alike, butthey are becoming increasingly problematic. Not only do they create moral hazard for lenders but alsothey shift the burden of the crisis firmly onto taxpayers in debtor countries. Moreover, the approach isrunning into political opposition in creditor countries as crises become more frequent and extensiveand the funds required get larger.

Thus, ways and means have been sought to redress the balance of burden-sharing between offi-cial and private creditors, as well as between debtors and creditors, by involving private creditors incrisis management and resolution. The issue is a contentious one. While the international communityhas come to recognize that market discipline will only work if creditors bear the consequences of therisks they take, it has been unable to reach agreement on how to bring this about.

For some time now the UNCTAD secretariat has been advocating a temporary standstill on debtpayments during crisis situations to prevent asset grabbing by creditors, combined with lending intoarrears to ensure that debtors have access to working capital. Although such procedures do not needfull-fledged international bankruptcy procedures, they do need effective mandatory backing at theinternational level. Such backing has met with strong opposition from some of the major economicpowers and market participants, who favour voluntary arrangements between debtors and creditors.Governments in some debtor countries have also been reluctant to back this proposal for fear of im-pairing their access to international capital markets. However, voluntary arrangements, while potentiallyhelpful in debt restructuring, are unlikely to halt asset grab races. Again, the evidence from recentsettlements suggests that without statutory protection for debtors the balance of power will continueto weigh heavily in favour of creditors.

A credible strategy for involving the private sector in crisis management and resolution shouldcombine mandatory temporary standstills with strict limits on access to Fund resources. A first step inthis direction would be the design of explicit guidelines under the IMF’s Articles of Agreement allow-ing a stay on creditor litigation in order to provide statutory protection for debtors imposing temporarystandstills. On the other hand, since the main objective of large-scale crisis or contingency lendingwould be to keep debtors current on their obligations to creditors, it would be difficult to ensureprivate sector involvement without limiting access to IMF financing. There is indeed growing agree-ment on the need to limit crisis lending. In setting such limits, it must be recognized that current IMFquotas have lagged far behind the growth of global output, trade and financial flows, and may notprovide appropriate yardsticks to evaluate the desirable limits to normal access. However, the currentapproach still appears to favour large-scale packages for countries considered to present systemicrisks, while other countries would face access limits and be encouraged to default in order to involvetheir private lenders in the resolution of their financial difficulties.

* * *

IX

The above are not the only changes needed in the mandates and policies of the Bretton Woodsinstitutions. Over the past two decades, the unwillingness of the advanced countries to defer to IMF oncontentious monetary and financial matters which directly affect their own interests has meant that theFund’s surveillance of the policies of the most important players in the global system has lost any realpurpose. Instead, there has been an intensification of surveillance of developing countries, which hasnow been extended to include financial sector issues, consistent with the diagnosis that the main flawsare to be found in debtor countries.

One result has been the expansion of conditionalities attached to IMF lending to countries facingactual or potential crisis. This has given rise to serious concerns about undermining sovereign respon-sibility, even as the effectiveness of IMF surveillance is increasingly questioned. These concernsincreased in the aftermath of the East Asian crisis, when excessive conditionalities led to policy re-sponses which intensified the crisis. As a result, there have been calls, including within the InternationalMonetary and Financial Committee, for the streamlining and refocusing of surveillance in line withthe Fund’s core competence in macroeconomic policy and related reforms. However, the recent finan-cial difficulties in Turkey and Argentina illustrate the reluctance to break with the past practice ofattaching wide-ranging policy recommendations to any IMF-negotiated loan package.

With swings in exchange rates and monetary policies in the major industrial economies acting asa catalyst for crises elsewhere in the world economy, a priority of the reform process must be strength-ening surveillance mechanisms to achieve a minimum degree of coherence among the macroeconomicpolicies of those countries. In view of the asymmetries in existing practices, one way forward mightbe to link surveillance procedures to a mechanism analogous to that used for settling disputes ininternational trade, where disagreements over the impact of macroeconomic and financial policiescould be taken up and their resolution sought.

More radical reform proposals put forward so far have sought to build on the consensus that theFund should provide international liquidity not only to countries facing current-account difficultiesbut also to those facing capital-account crises. According to the Meltzer Commission, the time hascome to make the Fund an international lender of last resort for any economy able to meet a series ofex ante conditions for solvency. This proposal raises two major concerns. On the one hand, it is likelyto result in much larger packages than existing crisis lending, with attendant moral hazard problemsfor lenders and no incentive for bailing in the private sector. On the other hand, a radical shift in IMFlending to short-term capital-account financing would deny access to multilateral financing to allthose developing countries considered systemically unimportant. These proposals place inordinatefaith in market forces both to resolve financial crises and to provide finance for development.

One of the original objectives of IMF was to provide short-term financing to countries facingcurrent-account problems due to temporary shocks and disturbances so as to ensure an orderly adjust-ment process. Experience continues to show that financial markets often fail to meet such needs, asthey tend to be pro-cyclical. Given the increased instability of the external trading and financial envi-ronment of developing countries, an effective reform of the Bretton Woods institutions should seek toimprove, not eliminate, counter-cyclical and emergency financing for trade and other current transac-tions.

* * *

There are certainly a number of conceptual and technical difficulties in designing reasonablyeffective global mechanisms for achieving currency and financial stability. Such difficulties are famil-iar from the design of national systems. At the international level, there are additional political problemsassociated with striking the right balance between multilateral disciplines and national sovereignty.

X

Indeed, political constraints and conflicts appear to be the main reason why the international commu-nity has not been able to achieve significant progress in setting up effective global arrangements forthe prevention and management of financial crises. In particular, the process has been driven by theinterests of the major creditor countries, which hold most of the power in the multilateral financialinstitutions, as well as in bodies set up more recently with the explicit intention of reforming theinternational financial architecture. As a result, many of the issues of crucial importance to develop-ing countries have been excluded from the reform agenda.

If reforms to the existing financial structures are to be credible, they must provide for muchgreater collective influence from developing countries and embody a genuine spirit of cooperationamong all countries. This will require a major reformulation of the reform agenda. It will also requirecareful examination of the representation in the existing multilateral financial institutions and of theirdecision-making practices.

But it is equally important that developing countries themselves reach a consensus on how theywant the reform process to move forward. While this consensus is lacking on several issues of thereform agenda, there are many commonly shared objectives, including: more balanced and symmetri-cal treatment of debtors and creditors regarding standards, codes, transparency and regulation; morestable exchange rates; more symmetrical surveillance; less intrusive conditionality; and above all,multilateral institutions and processes that are more democratic and participatory. Effective reform ofthe international monetary and financial system will ultimately depend on the willingness of develop-ing countries to organize their efforts around such common objectives, and on acceptance by developedcountries that accommodating these objectives will be an essential part of building a more inclusivesystem of global economic governance.

In the absence of collective arrangements for a stable international financial system, developingcountries should avoid commitments which restrict their policy autonomy with respect to dealing withfinancial instability. Interest is now growing in regional arrangements to provide collective defencemechanisms against systemic failures and instability, and regional currencies are increasingly seen asviable alternatives to dollarization. The European experience has also been held up as a model forregional arrangements, including in areas such as intraregional currency bands, intervention mecha-nisms, regimes for capital movements, payments support and regional lender-of-last-resort facilities.Such arrangements among developing countries probably require the inclusion of a major reserve-currency country willing and able to assume a key role for this purpose. In this respect, recent initiativesin Asia, involving developing countries and Japan, could constitute an important step towards closerregional monetary integration.

Rubens RicuperoSecretary-General of UNCTAD

Part One

GLOBAL TRENDS AND PROSPECTS

3The World Economy: Performance and Prospects

Prospects for the world economy dimmedtowards the end of 2000. After an unprecedentedperiod of expansion, growth in the United Statesdecelerated sharply in the third and fourth quar-ters of the year in response, inter alia, to a seriesof interest rate hikes, falling equity prices and ris-ing oil prices. Lower investment spending in thelast quarter snuffed out growth altogether at thebeginning of 2001, raising concerns that a harderlanding than expected might send recessionaryshockwaves throughout the world economy. Thefact that the slowdown, with its potential conse-quences, has caught many observers by surpriseis a further confirmation that policy makers eve-rywhere are ill-prepared to cope with the changesbrought about by the increasing integration of theworld economy.1

As a result of growing global interdepend-ence both real and financial shocks are transmittedmuch more rapidly across regions, countries andsectors. At the same time, given the intertwiningof the real and financial sides of the economy, suchshocks have unexpected consequences. The Asianfinancial crisis was initially expected to plunge

the global economy into recession; instead, it pro-vided a stimulus to the United States economy,prolonging growth there, which in turn supporteda rapid recovery in Asia through higher exports(TDR 1999 and TDR 2000). On the other hand,the adverse impact of the Asian crisis on com-modity and petroleum prices, which helped keepprices in the United States under control, createdbalance-of-payments and fiscal difficulties for anumber of developing countries. These eventuallyproduced another series of financial shocks, ig-nited by bond default in the Russian Federation,which triggered a global rush for liquidity thatthreatened even United States financial marketsduring the late summer of 1998. The reduction inUnited States interest rates in response to thatthreat, followed by substantial injections of liquid-ity to counter the Y2K computer problem and tosupport the introduction of the euro, steadied con-fidence, particularly in the United States, andbrought about a global recovery of growth in 1999and at the beginning of 2000.

However, the global recovery also aggravateddomestic and global imbalances in a manner simi-

Chapter I

THE WORLD ECONOMY: PERFORMANCEAND PROSPECTS

A. Global outlook

4 Trade and Development Report, 2001

lar to that of previous major cyclical disruptionsand periods of financial instability. As was sug-gested in TDR 2000, an end to the expansion inthe United States economy was unavoidable andimminent. Monetary tightening by the FederalReserve, which began in mid-1999 and had pushedinterest rates to 6.5 per cent by May 2000, tooklonger than expected to affect business and house-hold expenditures, but thesqueeze was clearly visible inthe last quarter of the year. Thecurrent slowdown is expectedto reduce the burgeoningcurrent-account deficit, whichstands at over 4 per cent ofGDP, thereby helping to cor-rect a major global imbalance,but without faster growth else-where it will lead to a signifi-cant decline in global demand.

A broad body of opinion expects the slow-down to be brief, although more pronounced thanhad earlier been predicted; once equity prices,excess capacity and inventories return to normallevels, the economy is expected to see robustgrowth consistent with the spread and further de-velopment of new telecommunications and infor-mation technologies. On this view, therefore, glo-bal growth should be little affected by what, atworst, would amount to a short recession, followedby recovery in the second half of 2001.

However, the current United States slowdowncannot be described simply in terms of previousexperience, when booms were ended by a combi-nation of monetary tightening in response to wageand price pressures and fiscal tightening to reignin public debt. Critics of the view that the intro-duction of new telecommunications and informa-tion technology has produced a structural changein the productive potential of the economy and inits cyclical behaviour point to the large increasein debt and the reduction in savings ratios that havebeen incurred by households and the business sec-tor in the presence of large fiscal surpluses(Godley, 2000). If the private sector were to at-tempt to repay its excessive debt and restore itssavings rates to historical levels, the shortfall indemand could produce a prolonged recession,since it would far exceed any fiscal stimulus thatcould be expected from planned tax cuts.2 In this

scenario, no region of the world could expect toescape the effects of a United States downturn.

The crucial question is consequently whethera new locomotive of global growth will emergeto compensate for the at least temporary abandon-ment of this role by the United States. Unlike theAsian crisis, this downturn is not expected to gen-

erate significant expansion-ary impulses elsewhere in theworld economy. Japan’s nas-cent expansion, based on ris-ing net exports and higher cor-porate profits leading to a re-covery in investment, is vul-nerable to a slowdown in theUnited States. Moreover, out-put growth was already nega-tive in the third quarter of 2000,after a strong performance inthe first half. In addition, with

interest rates close to zero and a large public-sector deficit, there appears to be little room for apolicy stimulus without the help of a major ad-justment in exchange rates. Most analysts are look-ing instead to the EU to help sustain global growthand offset declining import demand in the UnitedStates.

Growth in EU last year broke through the3 per cent barrier for the first time in over a dec-ade (table 1.1), and there is confidence that it willoutperform the United States in 2001, given thatexports to that country amount to less than 3 percent of regional output. However, despite the factthat the EU countries have successfully reducedtheir budget deficits, have kept their current ac-counts in balance and are showing little sign ofinflationary pressures, last year’s growth recov-ery continued to rely on net exports, accountingfor as much as half of the increase in output, evenin larger economies such as Germany. As net ex-ports are expected to make a smaller contributionin 2001, a sustained expansion in private domes-tic demand will be needed to meet even the mod-est growth ambitions expressed at the Lisbon sum-mit. Perhaps not surprisingly, and despite themoderate stimulus that has resulted from struc-tural reforms in the fiscal regimes in a number ofcountries, there has as yet been no policy com-mitment to the kind of domestic demand-ledgrowth enjoyed by the United States in recent

Unlike the Asian crisis, theUnited States downturn isnot expected to generatesignificant expansionaryimpulses elsewhere in theworld economy.


years. Indeed, even as overall macroeconomicconditions suggest that Europe should at last beready to test the limits of its potential growth rate– as the United States did in the second half of the1990s – the European Central Bank (ECB) sees nosigns that the euro zone’s non-inflationary growthpotential has risen above its current estimates of2.0–2.5 per cent,3 implying that it also sees noimmediate scope for relaxing monetary policy.

This reluctance to make a more concertedpolicy move to bolster recent performance is amatter of concern, since Europe will, in all likeli-

hood, be more affected by the slowdown in theUnited States than official views, based on thelimited trade ties to the United States, suggest.Euro-zone exports to the rest of the world stillaccount for more than 15 per cent of the area’soutput, which is considerably higher than for ei-ther the United States or Japan, and the relianceon exports over the past year of some of the largerEuropean countries suggests that they could stillbe hit quite hard by a global slowdown. Further-more, the integration of global production meansthat corporate profitability and investment planscan be quickly disrupted by changes in a country

Table 1.1

WORLD OUTPUT, 1990–2000

(Percentage change over previous year)

1990– 1995– 1990–Region/country 1995 a 2000 a 2000 a 1998 1999 2000b

World 2.0 3.1 2.6 1.9 2.7 4.0

Developed market-economy countries 1.8 2.9 2.3 2.1 2.6 3.5

of which:

United States 2.4 4.3 3.4 4.4 4.2 5.1Japan 1.4 1.1 1.3 -2.5 0.2 1.3European Union 1.5 2.5 2.0 2.7 2.4 3.3

of which:

Euro area 1.6 2.4 2.0 2.8 2.4 3.4

Germany 2.0 1.8 1.9 2.1 1.6 3.1France 1.0 2.4 1.7 3.2 2.9 3.1Italy 1.3 1.7 1.5 1.5 1.4 2.9

United Kingdom 1.6 2.8 2.2 2.6 2.2 3.1

Transition economies -6.9 1.9 -2.6 -0.6 2.3 5.6

Developing economies 5.0 4.3 4.6 1.5 3.3 5.5

of which:

Africa 1.5 3.6 2.5 3.2 2.9 3.5Latin America 3.6 2.9 3.3 1.9 0.1 3.7Asia 6.2 5.0 5.6 1.1 4.9 6.6

of which:

China 12.0 8.3 10.1 7.8 7.1 8.0Other economies 4.9 4.1 4.5 -0.8 4.2 6.2

Memo item:Developing economies, excluding China 4.1 3.7 3.9 0.5 2.7 5.1

Source: UNCTAD secretariat calculations, based on data in 1995 dollars.a Annual average.b Estimates.


which plays host to a large number of foreign af-filiates. This is particularly true for Europeanhigh-tech firms that have made very large acqui-sitions in the United States in recent years.Knock-on difficulties in European equity marketscreated by reduced corporate earnings in UnitedStates affiliates could be fur-ther aggravated by a lowerdollar, making it even moredifficult for these countriesto offset the decline in theirexports to the United Statesthrough higher domestic in-vestment expenditures.

Consequently, without adetermined change in eco-nomic policy, growth in theEU is unlikely to reach 3 percent in the current year, and it may be much lower.Moreover, given the current propensity to import,its growth rate would have to be higher than thatachieved in the United States in recent years if itis to generate an external deficit similar in size tothat of the United States and act as a global buyerof last resort for the recovering economies of Asiaand Latin America.

An orderly transition to a world where theleading economies all pull in the same directionis further complicated by the uncertainty sur-rounding exchange rate adjustments to current im-balances. The recent strength of the dollar has beendue to relatively high United States growth andprofit levels, the large inflows of capital seekingto join the information and communication tech-nology (ICT) revolution, positive interest rate dif-ferentials and the high liquidity premium attachedto dollar assets in the aftermath of the global li-quidity crisis that followed the Russian default in1998. If the United States economy were to slowdown sufficiently to induce the Federal Reserveto further relax monetary policy, this would elimi-nate two factors that underpin the dollar’s strength.Moreover, the large-scale acquisition of UnitedStates companies during the period of boom inhigh-tech stocks4 appears to be running out ofsteam, as European firms move to consolidateexisting operations rather than expand into whatis an increasingly uncertain market.5 However, thelikely impact on the dollar is not clearcut sincenot all merger and acquisition (M&A) activity is

financed by cash payments requiring the sale ofcurrency for dollars.6

In any event, with widespread expectationsof slower growth, falling interest rates and lowerprofitability of high-tech companies in the United

States, the liquidity premiumon United States assets re-mains the major support forthe dollar. Recent experienceteaches that this is not a reli-able foundation. The way glo-bal imbalances are correctedand, in particular, the behav-iour of the United States cur-rent-account deficit, may becrucial in determining whetherslower inflows into dollar as-sets leads to a major weaken-

ing of the currency and widespread disruption inglobal financial markets.

While a sharp depreciation of the dollar wouldincrease global financial fragility, a measured de-cline from its recent highs would be beneficial toglobal growth. The benefits to European growthof a stronger euro, which would allow interestrates to fall, are likely to outweigh the disadvan-tages of reduced competitiveness and earnings ofEuropean companies with affiliates operating inthe United States. In addition, a stronger eurowould further reduce the dependence of growthon external demand and encourage a more posi-tive role for Europe in sustaining global growth.

The United States slowdown is likely to havea damaging impact on the developing world, par-ticularly if it is not offset by strong growth in otherOECD economies, even assuming a measureddecline of the dollar. However, the impact on in-dividual countries and regions will depend on therelative importance of their trade and financiallinkages with the United States. In Asia, whererising net exports have financed a post-crisis ex-pansion, a weaker dollar, coupled with a sharpUnited States downturn, will quickly reduce cur-rent-account surpluses and could threaten bankand corporate restructuring.7 Linkages to UnitedStates firms are particularly strong in high-techsectors, such as semiconductors and personal com-puters, where declining sales and difficulties infinancing production translates directly into lower

While a sharp depreciationof the dollar would increaseglobal financial fragility, ameasured decline from itsrecent highs would bebeneficial to global growth.


component imports from Asia. While a substan-tial depreciation of the dollar would help exportsof countries such as China and Malaysia with pegsto that currency, it could create difficulties for thestability of regional exchange rates. It might alsotrigger currency depreciations across the region,which, together with the fall in semiconductorprices, could result in terms of trade losses anddeclining demand in countries affected. Japan’srecovery would not be helped either by a weakerdollar or by a depreciation of Asian currencies.On the other hand, if the Japanese economy weak-ens further, the yen/dollar exchange rate mightcome under pressure. This could lead to similarpressures for depreciation against the dollar acrossEast Asia rather than to a strengthening of regionalcurrencies against the yen.

By contrast, a weaker dollar, accompaniedby lower interest rates, could benefit many Latin

American countries that have linked their curren-cies either directly or indirectly to the dollar. Withthe exception of Mexico and some smaller Carib-bean economies, dependence on exports to theUnited States is lower than in Asia and financiallinks are more important. Brazil and, in particu-lar, Argentina could stand to gain from a weakerdollar and lower United States interest ratesthrough the effects on the public finances and theservices account of the balance of payments. Sincethe major Latin American economies still havelarge external financing gaps, they should benefitfrom lower international interest rates more thanthey lose from declining exports. However, evenin these countries, trade flows would probably de-cline. Furthermore, if the United States slowdownleads to an overall perception of increased risksand, hence, higher yield spreads for emerging-market borrowers, the final outcome might stillinvolve considerable costs for the region.

B. Developed economies

1. The slowdown in the United Stateseconomy

The recent expansion in the United States hasbeen driven by domestic demand and supportedby a Schumpeterian process of creative destructionthat increased investments in new technologiesand raised productivity performance. A series ofinternational events kept the lid on prices, evenas the economy grew at around 5 per cent andunemployment dropped below 4 per cent. Al-though the increase in petroleum prices in 2000pushed the rate of increase in the consumer priceindex close to 4 per cent for the first three quartersof 2000, underlying price pressures remain benign.

However, with growth over the past two yearsexceeding most estimates, the Federal Reserveraised the Federal Funds rate in several steps to6.5 per cent in mid-2000.8 While the strong economicactivity appeared resistant to tighter monetaryconditions until mid-2000, the slowdown in thethird and fourth quarters of 2000 was much morepronounced than expected and growth stalled inthe first quarter of 2001, suggesting that the riskof recession is by no means negligible. With hind-sight, it seems clear that the last increase in theFederal Funds rate of 50 basis points was unnec-essary, as was perhaps also the previous increasefrom 5.75 per cent to 6 per cent, given the lag-ging effect of changes in monetary policy. Inresponse to falling equity prices and sharply lower


indicators of consumer confidence, the FederalFunds rate was reduced by 50 basis points twiceduring January 2001.

Two mutually reinforcing developments ac-counted for the faster than expected slowdown:the decline in investment spending on informa-tion technologies; and the sharp drop in consumerconfidence, resulting in a slowdown in consumerspending.

One of the most striking characteristics of theUnited States expansion has been the sustainedboom in gross domestic fixed investment whichlasted much longer than in other major industrial

countries and in previous investment cycles in theUnited States itself (chart 1.1). By the first half of2000, gross fixed investments in the business sec-tor had risen to over 18 per cent of GDP (chart 1.2)and business investment in equipment and soft-ware to over 10 per cent. Spending on investmentsin ICT has contributed to about a quarter of realGDP growth over the past six years.9 Much of theinvestment was in the formation of new start-upcompanies which needed structures, equipment,and a full range of more traditional services suchas legal support and advertising. A good deal ofthis new investment has been financed by venturecapital funds in preparation for raising equity inthese companies through initial public offerings

Chart 1.1

INVESTMENT CYCLES IN MAJOR INDUSTRIAL COUNTRIES, 1981–2000

(Real gross fixed capital formation of the business sector, per cent change over previous year)

Source: OECD, Economic Outlook, various issues.

Per

cent

Per

cent

Per

cent

30

25

20

15

10

5

0

-5

-10

-15

30

25

20

15

10

5

0

-5

-10

-15

30

25

20

15

10

5

0

-5

-10

-15

1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999

1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999

United States

Germany

Japan

United Kingdom

30

25

20

15

10

5

0

-5

-10

-15

Per

cent


(IPOs). In 1999, new IPOs raised close to $60 bil-lion, a figure matched in 2000 (most of it beingraised in the first half of the year) (NVCA, 2001).Such IPOs originated from companies that hadbenefited from the high-tech bubble in the NASDAQindex, which produced triple-digit price-earningsratios and extremely easy financing conditions.

It is now clear that many of the new tech-nology companies could never have developedwithout the easy financial conditions made possi-ble by the boom in venture capital funding andthe stock market bubble. It is also clear that as aresult more capacity was created in the sector thanif the financing had been made available undernormal conditions by bank lending or retainedearnings. A sharp reversal of expectations con-cerning the future earnings capacity of thesecompanies led to a collapse in their share pricesin the first quarter of 2000. The NASDAQ index,which contains a high proportion of ICT-basedcompanies, finished the year down nearly 40 percent. The resulting loss in stocks initially issuedin 1999 and 2000 has been estimated at nearly$300 billion, and new issues were halted at theend of 2000 and the beginning of 2001. Thus, inthe second half of 2000, the new borrowing thatthese companies needed to cover their negativecash flows came to an end and many had to closedown or default. As a result, investment and re-lated expenditures came to a halt; in the fourthquarter, real non-residential fixed investment inequipment and software decreased by 4.7 per centon an annualized basis.

All this bears more than a passing resem-blance to the Asian experience10 of easy access tocheap credit and excessively optimistic expectationsof higher future earnings, leading to investmentsthat could not possibly be profitable. The Asianboom was followed by a stock market bust andrecession, and a similar result appears to be inprospect for the United States. The decline in equityprices has reduced household wealth and damp-ened consumer spending, which already appearsto have been affected by rising domestic pricesfor energy. In particular, the deregulation and lib-eralization of electricity and natural gas prices –which in some states have increased fivefold alongwith the return to more normal cold winter – haveresulted in sharply increased heating costs formany households. The decline in consumer con-

fidence and outlays is likely to be further rein-forced as the effects of layoffs due to corporaterestructuring and inventory adjustment spreadthroughout the economy.11 Growth in consumerexpenditure fell from an annual rate of 4.5 per centin the third quarter to 2.9 per cent in the fourthquarter.

Basically two scenarios are envisaged for theUnited States economy: a normal cyclical down-turn which will quickly bring about adjustmentsto productive capacity and inventories through ashort deceleration in growth during two or threequarters, to be followed by a rapid recovery; or,alternatively, a sustained period of disinvestment,producing recessions similar to those in Japan orEurope in the early 1990s.

At the beginning of 2001 certain develop-ments suggested there might be a quick recovery:petroleum prices were in the range of $20–25 abarrel, inventory accumulation appeared to havecome to a halt, equity prices seemed to be stabi-

Chart 1.2

UNITED STATES: PRIVATE INVESTMENTAND SAVINGS, 1990–2000

(Per cent of GDP)

Source: United States Department of Commerce, Bureau ofEconomic Analysis.

20

19

18

17

16

15

14

13

12

Per

centofG

DP

Gross private saving

Gross privatedomestic investment

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000


lizing and the trade balance had started to improve.Furthermore, the dollar had depreciated by over10 per cent against the euro from its earlier highs,and prospects for increased dollar earnings pro-vided support for equity prices of companies withlarge international operations. The Federal Re-serve moved aggressively to lower rates andannounced that it had changed its policy bias fromfighting inflation to fighting a rapid slowdown.

Despite these positive developments the riskof a sustained recession cannot be overlooked,since the late stages of the boom were underpinnedby historically large increases in private-sector in-debtedness, which is the counterpart of thehistorically large fiscal surplus (chart 1.3). Since1997, total private expenditure has exceeded dis-posable income, reversing the normal relation thathas held since 1952; by the third quarter of 2000the private-sector financing gap had reached 8 percent of GDP, the personal savings ratio had be-come negative, and household debt had reached110 per cent of annual disposable income. Thus,while the Government prepares to pay off its out-

standing debts, the private sector has been accu-mulating record amounts of debt relative to itsability to service that debt. Just as start-up com-panies in the ICT sector needed to borrow to stayin business, households need to borrow in orderto sustain their current rate of consumption. A de-cline in income growth associated with a recessionwould mean that households would have to in-crease borrowing just when their ability to meetthe payments on their outstanding debt is declining.

The fact that such a long period of expan-sion is unprecedented should make for a cautiousassessment of the current slowdown. However, if,as already noted, the investment boom does sharesome resemblance to that in Asia in the early1990s, the conflicting pressures on the economyfrom expansionary macroeconomic and stag-nationary structural impulses point to a moreuncertain future than either the V-shaped cyclicaldownturn and recovery or sustained recession sce-narios suggest (box 1.1). Moreover, although theUnited States economy is in a much stronger po-sition than in the past to make appropriate fiscaland monetary adjustments to avoid a prolongedrecession, it seems unlikely that the economy willreturn smoothly to its growth path of the past dec-ade, and certainly not to the nearly 5 per centgrowth it had reached after the Asian crisis.

2. European Union

In 2000, the European Union experiencedone of its best growth performances since the1990–1991 recession (table 1.1). Growth finallyexceeded 3 per cent and unemployment droppedto below 9 per cent. The growth disparities be-tween the larger and smaller economies thathad created difficulties in formulating a uniformmonetary policy also narrowed. France, Germanyand Italy grew at about 3 per cent in 2000, whilethe Spanish economy grew by more than 4 percent. Among the smaller economies, Ireland con-tinued to surge ahead of the pack, achieving aremarkable 11 per cent growth rate. With invest-ment and consumer spending leading the recovery,the euro area appeared to be emulating the kindof private-sector-led growth enjoyed by the United

Chart 1.3

UNITED STATES: PERSONAL SAVINGS ANDGOVERNMENT SAVINGS, 1990–2000

(Per cent of GDP)

Source: United States Department of Commerce, Bureau ofEconomic Analysis.

Per

centofG

DP

Personal saving

Government saving

8

6

4

2

0

-2

-41990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000


States. Indeed, the growth differential of about oneand three-quarter percentage points between theUnited States and the euro area over the last threeyears was reversed in the second half of 2000.

The failure of Europe to achieve a strong andsustained recovery after 1991 reflects, in part, theresponsiveness of European interest rates to thoseof the United States because of increased integra-tion of financial markets. Furthermore, attemptsby the ECB to establish credibility resulted in ris-ing rates in response to United States monetarytightening, regardless of whether that was consist-ent with European growth and employment trends.The tight fiscal policies to meet the convergencerequirements for the single currency and the Sta-bility and Growth Pact meant that the main sourceof demand expansion had to come from net ex-ports. The stimulus from this source after 1999reflected increased competitiveness created bythe depreciation of the euro,which went unchecked untilthe third quarter of 2000 whenjoint intervention by G-7 cen-tral banks seemed to halt anyfurther slide. Growth appearsto have peaked in mid-2000,around the same time as in theUnited States. France has con-tinued to grow vigorously onthe basis of domestic demandand managed to reduce its un-employment rate, but the Ger-man economy registered anunexpectedly sharp downturnin the last quarter of 2000, andmost leading indicators ofeconomic activity point to a slowdown in the eurozone in 2001.12 Net exports are expected to dragdown growth and the important question iswhether Europe can continue to build on lastyear’s growth performance in the face of theUnited States slowdown.

The United States slowdown will have animpact not only through trade. Sales of Germanand United Kingdom affiliates in the United Stateswere roughly five times their exports to the UnitedStates in 1998, a figure which is roughly doublethat for smaller European economies such as theNetherlands. Lower sales will hit profitability,which could make it more difficult to carry out

the restructuring necessary to introduce the high-tech production and organizational methods re-quired to compete with United States companies.Economic integration between these two indus-trial blocs appears to be more significant than acasual discussion of trade ratios might suggest.According to recent estimates, the elasticity ofeuro-area growth with respect to the United Statesis as high as 0.4.13 This suggests that the recentdecline in the United States growth rate of morethan 3 percentage points from its average over thelast five years, could cause a decline of around1.5 percentage points in European growth, bring-ing it below 2 per cent, irrespective of any furtherimpact from a loss of export competitiveness dueto the strengthening of the exchange rate.

Nevertheless, Europe seems better placedthan ever to decouple from the United States. SinceEuropean companies are not as highly leveraged

as their United States counter-parts, investment should beless influenced by liquidityshortages, increasing spreadsin high-yield and corporatecapital markets, or difficultiesin the ICT sector. The lowershare of equity in personalwealth also suggests that con-sumption expenditures shouldbe less constrained by declin-ing global equity prices. Inaddition, the macroeconomicpicture is broadly favourable.A necessary degree of conver-gence has been achieved acrossthe region and the launch of

the euro has been successful; its initial weaknessreflected cyclical rather than structural factors.Moreover, the fall in United States interest rateseases pressure on the ECB, and the fiscal situa-tion is healthy; changes in the fiscal regime of themajor economies (Italy, France and Germany) willprovide a stimulus of between 35 and 50 billioneuros in 2001, adding as much as 1 per cent ofGDP. The reversal in the upward trend of petro-leum prices should also have a greater positiveimpact on Europe, since it is a larger net importerof oil than the United States, and this will be rein-forced by a stronger euro, creating further in-creases in purchasing power for households andlower costs for European firms.

Europe seems well placedto build on last year’sgrowth performance andbolster global demand inthe face of a United Statesslowdown. To that end adeparture is necessaryfrom an undue reliance ofthe largest economies onexports for growth.


Box 1.1

DISSECTING THE UNITED STATES DOWNTURN

Many observers expect that the United States economy will experience a short Keynesian-typedownturn, associated with overinvestment and excessive inventories accumulation, followed by arelatively rapid recovery. Such an outcome places considerable faith in discretionary fiscal andmonetary adjustments. However, there are a number of factors suggesting that the current down-turn is quite different from that which is typical of the Keynesian cycle.

While the sustained high rate of expansion in business investment has played an important part inthe unprecedented period of expansion, even more striking has been the increase in investment innew computer and peripheral equipment, with average annual increases close to or above 50 percent during 1995–2000. Total investment in information-processing equipment and software rosemore slowly, at rates of around 25 per cent per annum. Although such spending represented lessthan 10 per cent of GDP in 2000, it accounted for almost one third of all output growth during1995–1999.

This exceptionally rapid increase in investment was driven primarily by new business venturesattempting to exploit in full the benefits of a Schumpeterian wave of technological innovation ininformation processing and telecommunications. The boom in venture capital funding and the bub-ble in the IPO market allowed the financing of new start-ups with no current earnings and highlyuncertain expectations of future earnings.1 The sharp rise in equity prices after initial public offer-ings lowered the cost of finance. Venture capital funds were thus able to recover their investmentsand explore new business plans. As long as the equity market remained bullish, even unsuccessfuland never profitable technology firms were able to continue to count on low-cost funding to meetongoing losses. However, such firms represent excess capacity that will not be absorbed even byan increase in aggregate demand on the cyclical upswing. In a downturn, they are likely to beeliminated by bankruptcy.

This process now seems to be under way. It started with the collapse of the NASDAQ index in thefirst quarter of 2000, when investors began to distinguish the new start-up companies that weremaking their way and held out good profit prospects from those that were being kept alive only bycontinuous cash infusions, with little hope of future earnings to justify their elevated share prices.It is possible to look at the cyclical downturn as the market finally exercising its role selectingfrom the wide range of information technology innovations those that will be viable in the long run.The kind of excess capacity that is present in the economy may thus be rather different from theexcess capacity in steel or automobile plants that had been associated with typical post-war cycles.

But even successful high-tech companies with positive earnings may not be immune from thecurrent process of market selection. Many of them have acquired smaller start-up companies. Oth-ers have created their own venture capital funds to invest in start-ups, or financed new start-ups viareduced prices and the provision of credit through vendor financing. Some have accepted stockoptions in lieu of payment. Thus, sharp declines in stock prices, liquidity difficulties or bankruptciesof the weaker companies will adversely affect the earnings prospects of the more successful ones.


Although the formal banking system has largely shunned the financing of new technology compa-nies, the share of business lending in bank portfolios rose during the second half of the 1990s.Much of this lending has been to the so-called “old economy” or “blue chip” companies with highcredit ratings, either in term lending, in back-up credit lines for commercial paper issues, or inunderwriting and supporting bond financing. However, the survival of these companies is threatenedby the process of Schumpeterian creative destruction that occurs as successful high-tech compa-nies adopt new, more profitable technological approaches. The performance of these “old economy”companies will suffer from the overall slowdown in activity, which may also entail problems forbanks that have substantial exposure to them. Recent weakness in high-yield bond markets, anddifficulties in the issuance of commercial paper experienced by many such companies suggest thatthis is indeed happening (Silverman and Hill, 2001).

A lack of precedent in the current United States economic situation calls for a cautionary assess-ment. However, there are good reasons to view the current cycle as an interruption in a wave ofSchumpeterian innovation rather than as a simple Keynesian problem of insufficient aggregatedemand.2 If that is so, the confidence that has been placed in monetary and fiscal policy in ensuringthat the downturn is short may be misplaced. Only a wave of bankruptcies, the extent of which isuncertain, can eliminate the excess capacity in much of the ICT sector and allow more promisinginvestment to resume. The length of the downturn will depend on how rapidly non-viable busi-nesses can be wound up, on the extent to which successful companies elsewhere in the economywill face financial difficulties as a result of this process, and on the impact of possible macroeco-nomic stimuli on the rest of the economy.

It does not follow from the above that monetary and fiscal stimuli would be inappropriate. How-ever, they would have a much smaller impact than in the past because they can do little to recreatethe investment momentum and liquidity conditions that allowed the recent rapid experimentationwith new technologies. The improvement that many observers expect from a rapid easing of mon-etary conditions may be slow to appear unless financial institutions, venture capitalists and house-holds are again willing to return to their exuberant support of new businesses that have no currentearnings and highly uncertain expected future earnings. But this is where the problem originated inthe first place.

1 Venture capital funds usually expect a success ratio of 1 to 10 on their investments.2 Some aspects of the current cycle resemble that described by von Hayek, who argued that an exces-

sively low cost of capital would create investments in techniques that were excessively capital-inten-sive; the subsequent return to a more normal level of capital costs would show that these investments areunprofitable, and the surplus capacity generated would have to be eliminated by a sharp downturn andwidespread bankruptcies. However, while many companies have invested without achieving their ex-pected sales, and the capital-output ratios may have increased, the problem is not one of excess capitalintensity, but rather the fact that overgenerous financing conditions allowed unprofitable investments tocome on stream.

Box 1.1 (concluded)


For all these reasons Europe seems wellplaced to build on last year’s growth performanceand bolster global demand in the face of a UnitedStates slowdown. A rapid expansion in Europe ofdomestic demand is also essential to deal with itslegacy of high unemployment. To that end a de-parture is necessary from an undue reliance of thelargest economies on exports for growth.14 Thecreation of an internal momentum for growth inEurope and its contribution to an expansion ofdemand are likely to depend in large part on thewillingness and ability of governments to use eco-nomic policy to anticipate, rather than react to,worsening conditions.

The structural changes that have been madein fiscal policy should boost real incomes andpartly offset the adverse impact of higher energyand heating costs. Nonetheless, consumer confi-dence in Europe does not appear to be improving,and growth in real compensation, which peakedin 1999 at around 3 per cent, had fallen to below2.5 per cent by the end of 2000. Current wageagreements in some of the larger economies werenegotiated under less advantageous conditions andwill not be renewed during 2001. For example,the very moderate wage settlements reached inGermany in 2000 still have a year to run. Wherewage agreements have been linked to an expectedinflation rate that in the event has been exceededon account of petroleum prices and the weaknessof the euro, there should be some recovery of realincomes.

The appreciation of the euro towards the endof 2000 has produced a de facto tightening ofmonetary policy, with real interest rates reachingcyclical highs – up from around 2 per cent in 1999to around 3.75 per cent15 in early 2001. With lowerpetroleum prices, the strengthening of the euro andmonetary growth moving towards ECB targets,there should be ample scope for discretionarymonetary easing to accompany any expansive fis-cal policy. However, recent pronouncements fromthe ECB indicate that it will continue to be solelyconcerned with internal price stability. This sitsill with the spirit of the preparatory discussion ofthe EMU, when there was a broad consensus thatmonetary policy could be used to counter sym-metric external shocks, such as an oil price hikeor a fall in global demand. Failure to counter theseinfluences could result in global imbalances pro-

ducing disruptive movements in exchange ratessimilar to those between the yen and the dollarthat helped precipitate the Asian crisis.

The United Kingdom economy, which re-mains outside EMU, has had a consistently bettergrowth performance than that of the euro areasince the 1990–1991 recession and was one of thefirst economies to lead the global recovery. How-ever, during 2000 growth was slightly below theEMU average and appeared to have peaked bymid-year. With industrial production fallingsharply in the last quarter of 2000, performancelooks set to mirror that in the United States, un-less electoral or other considerations result inprovision of a more direct stimulus.

3. Japan

Growth in Japan – led by exports – picked upin the first half of 2000 and fed through to in-creased corporate profits, investment, industrialproduction and output, suggesting that the foun-dation for recovery might be in place. The im-pression of an accelerating recovery was rein-forced when the Bank of Japan raised its interestrate to 0.25 per cent in August, since the Bankhad maintained that policy would not be tighteneduntil there were clear signs that the threat of a de-flationary spiral had subsided. However, growthslipped to an annual rate of -2.4 per cent in thethird quarter, and unemployment continued to rise,reaching 4.9 per cent by December despite the risein employment. Figures for output and private con-sumption in the second half were also disappoint-ing and, with the decline in exports, inventoriesbegan rising. As a result, subsequent Governmentestimates for growth in the fiscal year ending inMarch 2001 were lowered to below 0.5 per cent,measured in current prices.16 Final data for thefourth quarter may well show a new decline inoutput, returning Japan to recession.

Although weaker markets in the United Statesand in developing Asia have sharply dampenedthe export-led recovery, it is still unclear what theeffect has been on corporate earnings and invest-ment.17 Machinery orders from sectors other thanexport and ICT-related industries started to rise


in the second half of 1999 and this should havebeen reflected in production figures by the begin-ning of 2000.18 Whether this will be sufficient tooffset the decline in export and ICT-related sec-tors due to the slowdown in the United States willbe a factor determining whether or not the econo-my falls back into recession.

The Government has traditionally opted forthe fiscal tool to spur expansion. However, thefiscal stance became increasingly cautious as gov-ernment indebtedness rose. In response to the signsof a slowdown in the second half of 2000, a fur-ther budget was introduced in November whichproposed to increase govern-ment spending by 4.8 trillionyen. However, not all of thisamount constitutes a new stimu-lus, since the legislation lim-its the issuance of new govern-ment securities to 2.0 trillionyen and provides for the bal-ance to come from a rolloverof the 1999 fiscal year surplusof 1.5 trillion yen (i.e. carry-over of budgeted expendituresthat did not in fact take place) and an estimatedincrease of 1.2 trillion yen in tax revenues. Thestimulus resulting from the proposed budget forthe fiscal year starting in April 2001 is again mod-est, and another supplementary budget will, in alllikelihood, be required by mid-year.

Local governments are under heavy pressureto shore up their finances by cutting expenditure.Consequently, with little contribution expectedfrom exports, continued recovery will depend pri-marily on private domestic demand. Investmenthas shown signs of acceleration, but the implica-tion is that the consumer demand is expectedto take the lead. This will mean wage growthwill have to pick up to at least match productivitygrowth.

Considerable uncertainty remains over thefuture direction of monetary policy. There are in-creasing concerns that a return to a zero interestrate policy could delay corporate restructuringmeasures that are urgently needed to restore prof-itability. However, the return to negative growth

in the third quarter raises the possibility that therecovery may be cut off just as it gathers momen-tum.19 The fact that the unemployment rate is stillincreasing in conditions of rising employment in-dicates that previously discouraged workers arebeing drawn back into the labour force and thatthe economy could expand without inflationaryrisks substantially faster than at the potential rate(estimated at 1 per cent).

Assessment of the impact of the current mon-etary policy stance is difficult because prices havebeen falling for most of the 1990s, so that realinterest rates are positive even if they are close to

zero in nominal terms. Prob-lems with the balance sheetsof financial institutions alsomake it difficult to assess theamount of liquidity that hasbeen injected. Bank profitabil-ity and capital have improvedover the last several years,without this having led as yetto an increase in bank lendingor equity values. The loanbooks of domestic commercial

banks continue to contract at about 4 per cent perannum and the Tankan surveys during the year donot indicate any change in the negative percep-tion of banks’ willingness to lend.

The tightening of monetary policy since Au-gust 2000 has been reinforced by the appreciationof the yen. At the same time, equity prices peakedin April 2000, but following the trend in theNASDAQ in the United States, fell sharply inApril and May. However, rather than stabilizing,as in the United States, equity prices continued tofall, with a particularly sharp drop in mid-Decem-ber as it became clear that the economy wasslowing down. This set off renewed speculationabout difficulties in the banking sector and a pro-posal for a special government investment fundto shore up equity prices. If the recent increase ininvestment is cyclical – primarily due to the re-covery in Asia and the prolonged growth of theUnited States economy – rather than the result ofmicrostructural factors and the spread of invest-ment to non-export sectors, it may not survive theanticipated slowdown in global demand.

In Japan the return tonegative growth in the thirdquarter raises thepossibility that the recoverymay be cut off just as itgathers momentum.


1. Latin America

In all Latin American countries economicperformance improved in 2000 (table 1.2). Insome there was a very strong recovery, pushingthe regional rate of expansion to nearly 4 per cent,the highest since the outbreak of the Asian crisis.However, marked differences in performanceamong countries that prevailed in 1999 persistedin 2000. Mexico and the economies of CentralAmerica and the Caribbean,with close trading links to theUnited States, continued tooutperform those economiesthat are more dependent oncommodity exports and intra-regional trade.

Growth accelerated strong-ly in the two largest economies,Brazil and Mexico. Thanks tohigher oil prices, continued ex-pansion in the United Statesand robust domestic demand,growth in Mexico reached 7 percent, the best performance inmany years, while an aggres-sive policy of monetary eas-ing allowed Brazil not only to raise output growth(to 4 per cent) but also to reduce its fiscal deficit.The effect on prices of the currency depreciationof early 1999 remained muted despite the recov-ery, but the current-account balance improved lessthan had been expected. In Chile, too, there was asharp rebound in growth (to almost 6 per cent)from a recession in 1999.

In both Argentina and Uruguay the economycontracted (but more slowly) for the second con-secutive year. In Argentina deflationary adjustmentto the external shocks of 1998–1999 continued,resulting in some improvement in competitivenessand a trade surplus. However, since the servicesbalance deteriorated due to considerably higherfinancing costs, there was only a modest reductionin the large current-account deficit. Internationalfinancial markets, which are crucial for financingthe deficit, have been closely watching the Gov-ernment’s efforts to bring its debt under control

and to curb wage and price in-creases sufficiently to restorecompetitiveness and achievecurrent account sustainability(see chapter II, box 2.1).

The external environmentfor the Latin American econo-mies was generally favourableas the recovery of certain com-modity prices, which hadstarted during the second halfof 1999, continued into 2000.In particular, the hike in petro-leum prices benefited severalcountries, especially Venezuela,where GDP growth reboundedto over 3 per cent in 2000 af-

ter a sharp decline of more than 7 per cent in 1999.Several other countries, however, particularlyChile, Paraguay and Uruguay, suffered seriouslyfrom higher oil prices.

Prices of metals, including copper, alumin-ium, iron ore, nickel, tin and zinc, also recovered,as they did for some soft commodities, such as

C. Developing countries

Prospects for mostcountries in Latin Americadepend on the extent of thedownturn in the UnitedStates. For the region as awhole growth is expected toslacken, although furtherdepreciation of the dollarwould help increasecompetitiveness in the“dollarized” economies.


Table 1.2

GROWTH IN DEVELOPING COUNTRIES BY REGION, 1990–2000


1990– 1995– 1990–Region/country 1995a 2000a 2000a 1998 1999 2000b

Latin America 3.6 2.9 3.3 1.9 0.1 3.7

of which:Argentina 5.8 2.7 4.2 3.9 -3.2 -0.5Bolivia 4.1 3.2 3.7 4.7 0.6 2.0Brazil 3.1 2.2 2.7 -0.1 0.8 4.0Chile 8.7 4.5 6.6 3.4 -1.1 5.7Colombia 4.7 0.9 2.7 0.5 -4.5 3.0Ecuador 3.4 0.1 1.8 0.4 -7.3 2.6Mexico 1.5 5.5 3.5 4.8 3.7 7.0Peru 5.5 3.4 4.5 0.3 3.8 3.9Uruguay 3.7 2.1 2.9 4.6 -3.2 -1.0Venezuela 3.4 0.3 1.9 -0.1 -7.2 3.2

Africa 1.5 3.6 2.5 3.2 2.9 3.5

of which:Algeria 0.1 3.5 1.8 5.1 3.3 4.3Cameroon -1.9 4.8 1.4 5.1 4.4 4.2Côte d’Ivoire 1.9 4.6 3.2 4.5 2.8 2.2Egypt 3.4 5.2 4.3 5.6 6.0 3.9Ghana 4.3 4.4 4.3 4.7 4.4 4.0Kenya 1.6 2.3 1.9 2.1 1.5 1.6Mozambique 3.3 8.7 5.9 12.0 8.8 4.5Nigeria 2.4 3.2 2.8 1.9 1.1 3.5South Africa 0.8 2.2 1.5 0.6 1.2 2.7Uganda 7.0 6.2 6.6 5.5 7.8 5.0

Asia 6.1 5.0 5.6 1.1 4.9 6.6

Newly industrializing economies 6.9 5.0 6.0 -2.6 7.6 8.6

Hong Kong, China 5.3 3.5 4.4 -5.1 3.1 10.4Republic of Korea 7.4 4.8 6.1 -6.7 10.7 9.3Singapore 8.6 6.3 7.4 0.4 5.4 10.1Taiwan Province of China 6.4 5.8 6.1 4.7 5.7 6.0

ASEAN-4 7.0 1.6 4.3 -9.4 2.8 5.3

Indonesia 7.1 0.7 3.9 -13.0 0.3 5.2Malaysia 8.7 4.6 6.6 -7.4 5.4 8.7Philippines 2.2 3.4 2.8 -0.6 3.2 3.5Thailand 8.6 0.3 4.3 -10.2 4.2 4.2

ASEAN-4 plus Republic of Korea 7.2 3.2 5.2 -8.2 6.5 7.3

South Asia 4.5 5.5 5.0 5.6 5.7 5.5

Bangladesh 4.4 5.1 4.7 5.1 4.4 5.5India 4.5 6.1 5.3 6.3 6.4 5.7Nepal 5.2 4.1 4.6 2.3 2.3 5.5Pakistan 4.8 3.2 4.0 2.6 2.7 4.7Sri Lanka 5.4 4.8 5.1 4.7 4.2 5.0

West Asia 1.3 3.4 2.4 3.3 -0.5 4.3

China 12.0 8.3 10.1 7.8 7.1 8.0

Source: UNCTAD secretariat calculations, based on data in 1995 dollars.a Annual average.b Estimates.


cotton, fish meal, pulp, soybeans and wool. Onthe other hand, there was a continued decline inprices for food and beverages, particularly cocoa,coffee and sugar. Nevertheless, the terms of tradefor the region as a whole improved. Since, in ad-dition, relatively weak domestic demand keptincreases in imports well below those of exports,there was a (modest) improvement in the regionalcurrent-account deficit. FDI inflows declined in2000 and total net capital inflows remained farbelow the levels of 1996–1998.

For 2001, prospects for most of the LatinAmerican countries depend on the extent of thedownturn and the speed of the recovery in theUnited States economy. For the region as a whole,growth is expected to slacken as a result of aweaker export performance, although furtherdepreciation of the dollar would help increasecompetitiveness in the “dollarized” economies.The impact of reduced import demand in theUnited States will be the greatest in Mexico, andprobably small in Brazil, Chile and Peru. The twolatter countries, in particular, will continue to ben-efit from higher prices for base metals and fromrelatively robust growth in the Asian economies,which are important export markets. The outlookis particularly uncertain for Ecuador, where hy-perinflation continues to pose a major challengeto policy makers, as well as in Venezuela andColombia. Fiscal imbalances remain a serious prob-lem in some countries, including Argentina andBrazil, while others, having experienced financialcrises during the 1980s and 1990s, are still con-tending with weak and fragile banking systems.

Latin America continues to face large fi-nancing constraints. While the region remainsdependent on capital inflows, it continued in 2000to experience a negative net resource transfer.Lower United States interest rates mean reducedcosts of new borrowing and, eventually, of carry-ing of old debt, provided that sovereign riskspreads do not increase by more than the reduc-tion in the benchmark rates. On the other hand,the financing constraints may be aggravated if theslowdown in the United States leads to reducedglobal trade growth. With more countries choos-ing a regime of full dollarization, the region willbecome increasingly dependent on conditions andpolicy decisions in the United States.

2. Asia

Growth in the developing countries of Asiaas a whole (excluding China) accelerated furtherin 2000, reaching 6.2 per cent, after having al-ready recovered in 1999 from the contraction ofalmost 1 per cent in the previous year (table 1.1).There were, however, considerable differences inperformance among the subregions and their con-stituent countries (table 1.2).

A sharp turnaround was registered in WestAsia, from slightly negative growth in 1999 tomore than 4 per cent in 2000. Wary of the volatil-ity of oil prices, oil producers in the subregionwere initially cautious about spending their wind-fall of additional earnings, preferring to replenishtheir foreign exchange reserves and increase theirholdings in foreign assets. However, as oil pricesremained high because of strong world demandand low world stocks (see chapter II, section C),governments started to increase their spending oninfrastructure, education and health care. Higherrevenues reduced borrowing requirements anddomestic arrears. At the same time, stronger fis-cal and external balances, improved confidenceand strong domestic demand greatly boosted eco-nomic activity, contributing to overall economicgrowth in the oil-exporting economies of the region.Many oil-importing countries in the subregion,however, suffered from substantial terms-of-tradelosses.

The Turkish economy recovered well fromthe severe damage caused by the earthquake in1999 and the spillover effects of the Russian crisis.However, its exchange-rate-based stabilizationprogramme started running into difficulties inlate 2000, casting doubts on its ability to sustaingrowth (see chapter II, box 2.2).

The outlook for West Asia in 2001 is broadlyfavourable. Driven by increases in oil revenues,growth is expected to accelerate in Kuwait, Oman,Saudi Arabia, United Arab Emirates, Yemen and,to a lesser extent, in the Islamic Republic of Iran,where external debt repayments and higher foodimports because of drought are offsetting features.Qatar will additionally benefit from the rise in itsgas production and exports. Drought will also, tosome extent, offset the gains from higher oil prices


in several countries. From a longer-term perspec-tive, for most countries in the subregion growthwill continue to be constrained by low investmentrates. Moreover, without substantial diversifica-tion of production, they will remain exposed toterms-of-trade shocks. Many countries are press-ing ahead with reforms to improve the efficiencyof the public sector and have also introduced meas-ures to privatize and deregulate economic activitywith a view to encouraging the private sector andpromoting domestic and foreign investment.

In South Asia, overall economic activity con-tinued to be dominated by the performance of theIndian economy. Despite the lingering effects onexports of the Asian financial crisis and the morerecent sharp increase in oil prices, growth for theregion as a whole remained at the level of the twopreceding years. Growth in India, which has ex-panded strongly in recent years, slowed downslightly. The drought in northern India affectedagricultural production less than anticipated and,despite flooding in the state of Andhra Pradeshduring late August and early September, whichaffected the rice crop, the country has a large grainsurplus. Strong overall growth was underpinnedby a robust industrial performance and rapidlygrowing foreign demand for ICT-related services;in order to promote exports of services, legisla-tion was introduced to support the ICT sector anddevelop e-business infrastructure.

Continued strong growth in Sri Lanka in 2000was led by exports, especially garments. Highertea and rubber prices also contributed to the sharprise in export earnings. The more than 5 per centgrowth in Bangladesh was also export-led. In Pa-kistan growth accelerated, but still lagged behindthe other countries in the region; the external sec-tor remained fragile, reserves continued to declinefrom already low levels and the currency cameunder pressure following the depreciation of othercurrencies in the subregion.

The short-term prospects for the subregionare mixed. Growth in India will remain relativelystrong, despite some negative repercussions fromworld trade, underpinned by the country’s hugeagricultural sector, which stands to benefit frommoves to reform price-control policies and stimu-late domestic trade in agricultural products. Export-oriented manufacturing sectors are also expected

to benefit from a relaxation of the FDI regime inspecial economic zones, and robust expansion ofthe ICT sector will support service activities. InSri Lanka, growth will continue to be driven bystrong demand for its two major exports, garmentsand tea, whereas in Pakistan, financial difficul-ties are likely to be a restraining factor. All coun-tries in South Asia, but especially the smaller ones,are heavily dependent on energy imports and ag-ricultural exports. Adjustments to terms-of-tradelosses from the recent adverse movements in pri-mary commodity prices may dampen growth tosome extent, and further structural reforms in ag-riculture and industry may be needed to strengthencompetitiveness.

In East Asia, almost all major economies fur-ther consolidated their recovery. The five countriesthat had been most affected by the financial crisis– the ASEAN-4 (Indonesia, Malaysia, the Philip-pines and Thailand) and the Republic of Korea –registered an overall growth in 2000 of more than7 per cent, compared to 6.5 per cent in 1999. De-spite substantial currency devaluations and therapid pace of recovery, inflation rates have re-mained low. In Malaysia and Thailand there is apossibility of price deflation (which is already areality in China and Hong Kong (China)).

In addition to strong export performance,growth has been supported by low interest ratesand expansionary monetary policies. Althoughcapital outflows have continued as banks havereduced their foreign exposure, they have not out-grown current-account surpluses. This suggeststhat the generalized currency depreciation hasbeen the result of deliberate policy. There has beena significant recovery in intra-Asian trade, whichis now growing more rapidly than trade with ei-ther the United States or EU. For several EastAsian economies the internal driving forces be-hind recovery have started to shift from inventoryadjustment and government spending to the moreself-sustaining elements of business investmentand private consumption. On the other hand, thegains from export volume growth and higher ex-port prices were partly offset by higher oil pricesduring 2000.

Among the ASEAN-4, Malaysia continuedto be the best performer, with growth accelerat-ing to 8.7 per cent. However, by the end of the


year, domestic demand had slowed markedly andmanufacturing sales were growing considerablyfaster than output, which would indicate a declinein inventories. Producer prices have been declin-ing, and the rise in December 2000 of consumerprices was at an annual rate of just over 1 per cent.In Thailand exports rose by 20 per cent in 2000,contributing more to growth than in previousyears, when domestic consumption had been thedriving force. Despite higher energy prices, in-flation has virtually disappeared; capacity utili-zation is still below 60 per cent and there is stillexcess labour. As in Thailand, recovery in thePhilippines has been relatively slow. At the be-ginning of 2001, the country faced an extremelylarge fiscal imbalance and the peso came underpressure, despite a very strong current-accountposition. Indonesia experienced its first year ofstrong growth since the finan-cial crisis, but domestic demand,which has become increas-ingly important in sustaininggrowth in the other ASEANcountries, remains weak.

In the Republic of Korea,which has already regained itspre-crisis level of per capitaincome, growth slowed some-what in 2000, but still exceeded9 per cent. Economic activity continued to bedriven by exports, particularly of computers, andthere was a strong increase in manufacturing out-put, notably of semiconductors. A second year offast growth has led to a resurgence of capital in-flows, and although the currency depreciated byan average of around 10 per cent, there was a re-covery in the exchange rate at the end of the year.Inflation started to rise, reflecting, in part, theimpact of higher oil prices in a country that relieson imported oil for about half its energy needs.This prompted the Bank of Korea to raise its over-night call rate in October for the second time in2000. Consumer prices declined in October andNovember, resulting in an annual increase in theprice index of just over 2 per cent.

Output growth picked up sharply in HongKong (China) as tourism recovered, and Singa-pore experienced another sharp acceleration ofgrowth in 2000. However, in all the NIEs exportsbegan to fall in the course of the year. For exam-

ple, in Singapore, electronic exports in Decemberwere over 11 per cent lower than in December1999 and exports of semiconductors some 17 percent lower. Exports to all major markets exceptJapan and China declined. In Hong Kong (China)consumption has remained weak despite a fall inreal interest rates and in the unemployment rateand a stabilization of the property market, and inTaiwan Province of China the revival of domesticdemand in the first quarter of 2000 could not besustained.

In China, economic activity continued togather momentum in 2000, resulting in a one per-centage point increase in output growth over theprevious year and reversing the deflationary trendthat had been caused by weak domestic demandin recent years. Expansionary policies, strong ex-

ports and progress in structuralreforms resulted in rapid growthin construction and industry,which more than compensatedfor a sluggish performance inagriculture. Exports and im-ports also benefited from a realdepreciation of the renminbiand higher export tax rebates.There was also a sharp increasein new FDI commitments,which had been declining for

nearly four years. However, given its growing de-pendence on the United States market, the slow-down in that country is likely to reduce exportgrowth in 2001. Exports and imports may also beaffected by the prospect of China’s accession toWTO and the implications thereof for the ex-change rate. Although export growth is expectedto be slower in 2001, the economy should receivea stimulus from current stimulative fiscal and mon-etary policies. Infrastructure investment, in par-ticular, can be expected to increase, especially inthe western provinces.

Prospects for many developing countries inEast Asia in 2001 are closely linked to the high-tech cycle in the United States and the movementof their currencies against the dollar and the yen.Growth in the subregion depends to a large extenton external demand for electronics, and wouldtherefore be hit by any deceleration of global de-mand. The rate of increase in new orders receivedfrom the United States for electronic goods had

Prospects for manydeveloping countries inEast Asia in 2001 areclosely linked to the high-tech cycle in the UnitedStates.


already declined by half in October 2000. Theoutlook is for further declines as inventories inthe United States continue to increase, and therewere clear signs of declining semiconductor pricesin early 2001. Additionally, there is still a drag ongrowth from ongoing financial and corporate sec-tor restructuring. The NIEs are likely to grow at aslower pace in 2001, and Singapore and TaiwanProvince of China, in particular, will be affectedby weak demand for electronic products. Slowergrowth in the Republic of Korea will be a reflec-tion, in part, of the continuing problems of themajor chaebols and the associated risks of furtherproblems arising in the banking sector.

In Malaysia, lower electronics exports maycut the growth rate considerably in 2001. This mayrequire reconsideration of the policy of maintain-ing a fixed exchange rate, but a lower dollar mayalleviate the need to move the peg. Reversing theexpectations of deflation and lower growth willrequire aggressive monetary easing and fiscalstimulus. Growth prospects for Thailand are alsodampened by the likelihood of slower exportgrowth in 2001; and the slow pace of debt restruc-turing and the weakness of the banking sector arealso matters of concern in that country. However,with ample room for interest rate reductions andthe expectation of a vigorous fiscal stimulus, Thai-land is better placed to resist the downturn in theUnited States than other countries in the subregion.The impact of external shocks remains a threatfor Indonesia and the Philippines. Moreover, fis-cal positions are a cause for concern in thesecountries, and much remains still to be done inthe area of financial and corporate restructuring.In those two countries prospects are thus fraughtwith considerable downside risks.

3. Africa

Even more than in other regions, externalfactors continue to dominate growth and devel-opment prospects in Africa. Economic activity inthe oil-exporting countries was boosted by the risein oil prices, which led to significant improvementsin fiscal and external balances. The economies ofoil-importing countries, however, were severely

affected by high oil prices and external financingconstraints. In particular, sub-Saharan countriescontinued to be affected in varying degrees by thefallout from the 1997–1999 emerging-market cri-ses as prices of some of their major non-fuel exportcommodities remained depressed.

GDP growth in Africa picked up from 2.9 percent in 1999 to 3.5 per cent in 2000 (table 1.2). Incontrast to some recent years, it was the lowestamong developing regions and barely kept pacewith population growth. Even before the confir-mation of the slowdown in the United States,growth forecasts for Africa were being lowered,owing to weaker performance by some of thelarger economies, worsening weather conditionsand disruptions caused by civil and political un-rest.

Growth performance in 2000 varied muchamong the different subregions.20 Growth wasclose to the continental average in Central, Eastand West Africa, whereas it was higher in NorthAfrica but lower in Southern Africa. Output growthin Botswana, Mozambique, Uganda and the econo-mies of the CFA franc zone was above the Africanaverage, but in Angola, the Democratic Republicof the Congo, Ethiopia, Sierra Leone and Zimba-bwe it was well below this average.

Among the countries of North Africa, Alge-ria and the Libyan Arab Jamahiriya benefited fromhigher oil revenue, which provided a strong boostto growth. In Algeria, however, these benefitswere offset, to some extent, by adverse weatherconditions, especially poor rainfall, which alsoseriously affected Morocco and Tunisia. After adecline in 1999, output growth in Morocco is es-timated at 0.7 per cent in 2000, despite a declineof 17 per cent in agricultural production, whichaccounts for some 40 per cent of aggregate out-put. Agricultural output also fell in Tunisia (by15 per cent), leading to a reduction of the growthrate from 6.2 per cent in 1999 to 4.2 per cent in2000. With more favourable weather conditions,both countries may experience faster growth in2001. In Egypt, growth slowed to less than 4 percent in 2000, due to a tightening of monetarypolicy to keep inflation in check. The rapid ex-pansion of domestic credit in recent years and therise in the real effective exchange rate as a resultof a de facto peg to the dollar led to mounting


pressures on the external accounts and a substan-tial loss of foreign reserves.

Growth in Southern Africa in 2000 was re-strained by the continued weakness of the econo-my of South Africa. While inmost countries in the subre-gion growth continued to behealthy, recovery in the conti-nent’s largest economy contin-ued to remain fragile. GDPgrowth rose to 2.6 per cent in2000, supported by improvedcompetitiveness and the ex-pansion in global output andtrade, but a depreciation of therand, a surge in food pricesafter flooding in some areas,together with higher oil prices, led to a build-upof inflationary pressure. In Zimbabwe, the eco-nomic crisis continued to deepen and is estimatedto have resulted in an output contraction of some6 per cent in 2000. In Mozambique, where the im-plementation of the Government’s comprehensivereconstruction plan received generous and timelyinternational support, output is estimated to havegrown by more than 4 per cent (after 8.8 per centin 1999), although flooding caused substantialdamage early in the year.

The potential for higher growth in East Af-rica failed to be realized partly on account ofpolicy formulation and implementation and partlybecause of various adverse shocks. Economic ac-tivity in the Democratic Republic of the Congowas adversely affected by war, and in Eritrea andEthiopia by both drought and war. On the otherhand, the United Republic of Tanzania managedto withstand the adverse impact of weak pricesfor its main exports (coffee and cotton) eventhough it was hit by food shortages due to the fail-ure of seasonal rains. Kenya, which has beenamong the slowest-growing economies in Africain recent years, was also plagued by drought andweak export prices, but the resumption of IMFlending may boost confidence and the inflow ofaid. Uganda, a major coffee producer, continuedto achieve growth of about 5 per cent, despite afurther drop in international coffee prices.

Among the countries in West Africa, Nigeriabenefited greatly from rising oil prices, raising its

GDP growth by more than 2 percentage points, to3.5 per cent. The Government has initiated stepsto restore macroeconomic stability and improverelations with creditors. Ghana, maintained anoutput growth above 4 per cent, as it has done

consistently since 1995. Coun-tries in Central and West Africawhich are members of the CFAfranc zone (see also chapter V,box 5.2) have been among thebest performers on the conti-nent in recent years. Becausetheir currencies are linked tothe euro, some of them havebenefited from increased com-petitiveness due to the euro’sweakness vis-à-vis the dollar.However, growth in Côte

d’Ivoire is estimated to have continued its down-ward trend since 1998 as the economy had tocontend with weak cocoa prices and a significantslowdown in disbursements of external assistance.Overall, output growth in the CFA franc zone hasremained fairly robust and is expected to acceler-ate in 2001.

For Africa as a whole, the rate of outputgrowth in 2001 is expected to pick up moderately,supported by faster recovery in South Africa. Itshould remain strong particularly in Cameroon,Ghana, Mozambique, Uganda and the United Re-public of Tanzania, which have begun to reap someof the benefits of macroeconomic and structuralreforms. Underlying this improvement is the ex-pectation that the terms of trade of commodityexporters will stabilize or improve moderately dueto lower oil prices. Recent European and UnitedStates initiatives to open up their markets to thepoorest economies in Africa as well as bilateraldebt reduction accorded by some industrializedcountries should bring benefits. In addition,around 80 per cent of debt relief under the en-hanced Heavily Indebted Poor Countries (HIPC)Initiative concerns economies in sub-Saharan Af-rica. Presently, nine African countries (Benin,Burkina Faso, Cameroon, Mali, Mauritania, Mo-zambique, Senegal, Uganda and the UnitedRepublic of Tanzania) have already qualified, andseveral more are expected to reach the comple-tion point in the near future.21 However, the impactof these international measures will not be feltimmediately, and many countries in sub-Saharan

Most African economiesremain highly vulnerable tochanges in prices ofprimary commodities, andgrowth continues to beseverely constrained byinadequate infrastructure.


Africa continue to suffer from a debt overhang.Moreover, most African economies remain highlyvulnerable to changes in prices of primary com-modities, and growth continues to be severely

constrained by inadequate infrastructure in trans-port and communications. Levels of officialassistance remain insufficient to fill the resourcegap.

D. Transition economies

There was a strong recovery in the transitioneconomies in 2000 (table 1.1) and, on average, thegrowth rate was the highest since 1989. Whiledomestic demand continued to expand in mostcountries, the main stimulus was from exports.However, it is too early to judge whether thisgrowth will be sustainable in all cases and whetherthe process of catching up has really begun. Therecovery in 2000 was from a very low base andexport prospects are less promising in the light ofglobal conditions. The immediate policy chal-lenges vary for the different economies: some willhave to accelerate progress towards a marketeconomy, while others will need to correct macroeco-nomic imbalances or to cope with adverse shocks.

After the devastating financial crisis in 1998,the Russian Federation had one of the highest ratesof growth in 2000, at 7.6 per cent (table 1.3). Dueto their strong links with the Russian economy,most of the other CIS countries also posted highgrowth rates in 2000, with double-digit figures inKazakhstan and Turkmenistan. Depreciation of therouble and of the CIS currencies stimulated ex-ports and led to import substitution, all of whichboosted industrial output. It thus seems that thebusiness sector in these economies may be muchmore flexible and able to respond to market sig-nals than commonly believed, even though theprocess of corporate restructuring has yet to becompleted.

Among the central European countries, growthin the Czech Republic, Hungary and Slovenia inthe first nine months of 2000 exceeded expecta-tions. Hungary was the fastest growing economy(6 per cent). Industrial output accelerated sharplyin the Czech Republic and Slovakia. While ini-tially growing much faster than in 1999, the Polisheconomy showed some signs of slowing down inthe course of the year. Romania also reportedpositive growth but without clear signs of a break-through to sustained expansion, while in Bulgariaoutput continued to grow for the third successiveyear. The Baltic States recovered early from therecession of 1999, but growth flagged in the sec-ond half of 2000.

For the European transition economies as awhole, exports to the rest of the world increasedby one third. Whereas the CIS countries benefitedfrom the boom in commodities, those of Centraland Eastern Europe increased their exports ofmanufactured goods, as did also the Baltic States.Imports also increased everywhere, but in mostcases less than exports, resulting in a significantimprovement in current-account balances. Sub-stantial terms-of-trade gains in the relatively smallgroup of commodity-exporting CIS countries con-trasted with sizeable losses for the net commodityimporters, comprising all the Central and EasternEuropean and Baltic States, as well as a numberof CIS countries.


The strong performance of most of the tran-sition economies was accompanied by increasedinflationary pressures. Despite sharply rising pro-ductivity and a predominantly export-drivenrecovery, consumer prices generally rose fasterthan expected, mostly on account of soaring pricesfor fuel. In some cases, the resurgence of infla-tion spurred a tightening of monetary policy. The

rise in fuel prices threatened export competitive-ness, since there is still a relatively high energyintensity of output in the transition economies. Sofar this adverse effect has been more than offsetby productivity gains, but if productivity growthslows down and nominal wages are increased tooffset past inflation, exports could be adverselyaffected.

Table 1.3

TRANSITION ECONOMIES: SELECTED ECONOMIC INDICATORS, 1998–2000

GDP Consumer prices Current-account balance

Change over previous year a

(Percentage) (Percentage of GDP)

Region/country 1998 1999 2000b 1998 1999 2000c 1998 1999 2000d

Central and Eastern Europe

of which:

Bulgaria 3.5 2.4 4.5 0.9 6.2 11.0 -0.5 -5.5 -8.1Croatia 2.5 -0.4 2.8 5.6 4.6 7.3 -7.0 -7.5 -7.7Czech Republic -2.2 -0.8 2.7 6.7 2.5 4.2 -2.4 -1.9 -3.0Hungary 4.9 4.5 6.0 10.4 11.3 9.2 -4.9 -4.3 -3.6Poland 4.8 4.1 4.2e 8.5 9.9 10.6 -4.3 -7.4 -7.4Romania -5.4 -3.2 1.5 40.7 54.9 41.0 -7.2 -3.8 -2.9Slovakia 4.1 1.9 1.6 5.5 14.2 15.4 -9.7 -5.5 -1.6Slovenia 3.8 4.9 4.8 6.6 8.1 9.9 -0.8 -3.9 -2.7

Baltic States

of which:

Estonia 4.7 -1.1 5.5 6.8 3.9 3.0 -9.2 -5.7 -5.5Latvia 3.9 0.1 4.5 f 2.8 3.3 2.6 -10.7 -10.3 -5.6Lithuania 5.1 -4.2 2.1 2.4 0.3 1.3 -12.1 -11.2 -4.2

CIS

of which:

Belarus 8.4 3.4 2.5g 181.6 251.3 190.7 -7.6 -2.4 -3.3Russian Federation -4.9 3.2 7.6e 84.5 36.6 20.2 0.4 13.7 22.2Ukraine -1.9 -0.4 6.0e 20.0 19.2 30.3 -3.2 2.8 1.5

Source: ECE (2000, tables 1.2.1 and 1.2.2) and subsequent updates.a For consumer prices change from December to December unless otherwise indicated.b October official forecast unless otherwise indicated.c June 1999 to June 2000.d January–June.e Preliminary estimates.f 4–5 per cent.g 2–3 per cent.


The fiscal position has been better than ex-pected in most transition economies, not only dueto the strength of the recovery but also because ofwindfall gains related to price-sensitive revenueitems such as duties and excise taxes. In mostcountries, the recovery has notled to a significant increase inemployment, which suggeststhat there was slack to be takenup and also that there has beena further deepening of theprocess of economic restruc-turing. Indeed, unemploymentrates in several countries haveincreased or remained high.

The factors that were favourable to growthin the last two years are not in place in 2001. Worldtrade expansion is slowing, the stimulating effectof currency depreciations in the aftermath of the

Russian crisis is fading away and commodityprices have peaked. The stimulus to continuedgrowth will thus have to come from domestic de-mand. The task will be all the more difficult asinflation was on the rise in 2000. Several transi-

tion economies are determinedto achieve the conditions nec-essary for association with, oreven accession to, the Euro-pean Union, to which end theymay be obliged to take strongmeasures, in particular a re-strictive monetary policy tocombat the inflationary ten-dencies. However, such meas-ures would aggravate the em-

ployment situation, which is particularly seriousin south-east Europe, where unemployment al-ready exceeds 20 per cent of the labour force in anumber of countries.

Notes

The factors that werefavourable to growth in thetransition economies in thelast two years are not inplace in 2001.

1 At the end of September 2000, the InternationalMonetary Fund ( IMF) revised its growth estimatesupwards because: “The global economic expansionhas continued to gain strength, with global outputgrowth now projected at 4.7 per cent in 2000, 0.5 per-centage points higher than expected in the MayWorld Economic Outlook … Growth is projected toincrease in all major regions of the world, led bythe continued strength of the United States economy;the robust upswing in Europe; the consolidation ofthe recovery in Asia; and a rebound from last year’sslowdowns in emerging markets in Latin Americaand the Middle East and Europe” (IMF, 2000a: 1).

2 The proposed tax cuts reflect the policies of the newAdministration and their primary purpose is not theshort-term stabilization of domestic demand. Hencethey may not be reversed in response to a macro-economic need. If the optimists are proved right,

the impact will be felt just when the economy isagain growing at its potential, forcing a sharp tight-ening of monetary policy. This potential inconsist-ency between fiscal and monetary stances raisesfamiliar concerns for the rest of the world, particu-larly developing countries. Furthermore, to the ex-tent that the increase in disposable income result-ing from tax cuts is spent on consumer goods ratherthan saved, aggregate domestic savings would bereduced with the effect of aggravating external im-balances.

3 Speech by ECB Governing Council member andDeutsche Bundesbank President, Ernst Welteke, atthe University of Hohenheim, 23 January 2001, re-ported in Market News International. The reluctanceto revise its estimate of potential growth is basedon the view that: “on all the available evidence wecannot as yet conclude that a decisive shift in the


trend rate of productivity growth is discernible”(W. Duisenberg, ECB Press Conference, 14 Decem-ber 2000).

4 In 1999, non-resident companies spent $283 billionto acquire or establish businesses in the UnitedStates, up sharply from $215 billion in 1998 and$70 billion in 1997 (Zeile, 2000: 141). Of Europe’s$425.5 billion worth of FDI outflows in 1999,$235 billion were directed to the United States(UNCTAD, 2000a, annex tables B1 and B2; Zeile,2000, table 16).

5 Indeed, since non-repatriated profits of foreign-owned affiliates are counted as FDI inflows into theUnited States, a decline in sales there would reducerecorded FDI inflows and may lead to decisions torepatriate more profits, thereby increasing down-ward pressure on the dollar.

6 Since 1997 the share of cross-border M&As fi-nanced by stock swaps rather than cash has increaseddramatically. For developed countries as a whole,less than 10 per cent were financed by stock swapsin 1997, but the share rose to 31 per cent in 1998and reached 40 per cent in 1999. For the UnitedStates, it is estimated that roughly half of all inwardM&As have not involved direct acquisition of dol-lar assets with foreign currency, but have been fi-nanced by means of stock swaps, and that much ofthe remaining M&As have been financed by bor-rowing in the United States. Thus the EuropeanM&A boom in the United States after 1997 mayhave had a smaller direct impact on the foreign ex-change market than is commonly supposed. None-theless, there may be indirect portfolio effects, sincestock swaps increase the foreign currency denomi-nation of assets in United States investors’ portfo-lios. If United States investors were to sell their for-eign equity, repatriate the proceeds and invest indollar-denominated securities, the demand for dol-lars would increase in much the same way as a di-rect purchase.

7 The extent of the region’s dependence on UnitedStates growth is reflected in the share of its exportsto the United States. They account for more than 20per cent of GDP in Malaysia, Singapore and HongKong (China), more than 10 per cent in the Philip-pines and Taiwan Province of China, and 7 per centin the Republic of Korea.

8 As a result of the new productivity performance andthe absence of any wage or price reactions to tightlabour markets, the Federal Reserve now appearsto accept that the natural growth rate is above the2.0–2.5 per cent commonly cited in the first half of thedecade, although it has not explicitly endorsed a spe-cific target. The latest Economic Report of the Presi-dent estimates a potential growth rate of 3.8 per cent.

9 ICT investment includes business outlays for com-puters and peripherals, software, communications

gear, instruments, photocopying equipment and of-fice equipment. The first three categories accountfor 88 per cent of the total, while software aloneaccounts for 43 per cent. Expenditures on commu-nications equipment are only half as important asthose on software.

10 Since the United States investment boom was drivenprimarily by companies attempting to exploit newtechnological advances to create new markets, itdiffers from the late 1980s investment boom in Ja-pan and the early 1990s boom in the Republic ofKorea, both of which were driven primarily by ex-panding capacity in existing lines of business or bythe entry of new competitors into existing lines.

11 The Conference Board index at year-end was about11 per cent lower than its peak in May 2000, andthe University of Michigan index was about 12 percent below its peak of January 2000. The declinesin these two indices have been especially notice-able since both had previously been at historicallyhigh levels for extended periods. The University ofMichigan index dropped sharply from December2000 to January 2001.

12 Confidence indicators in the major EU economieshave been in decline since early in the third quarter.The German IFO index of future expectations hasdeclined since October 2000, and that of the overallbusiness climate in industry had already been indecline since May 2000; the French INSEE indica-tor, which had peaked in July at 40, fell to 17 inJanuary 2001. The Italian ISAE index fell from 40in January 2000 to 18 in November 2000 and evenfurther in December 2000.

13 See Credit Suisse/First Boston, Euro Area Weekly,12 January 2001.

14 Domestic demand seems to have played a more im-portant role in the strong growth performance ofsome smaller European economies in the second halfof the 1990s than in the larger economies.

15 Nominal interest rates adjusted for core inflation.16 However, since Japan is still suffering from defla-

tion, the estimated real growth is slightly higher.17 Over 40 per cent of Japanese exports are to Asia

and over 25 per cent to the United States. Exportsto EU are less than 20 per cent and are probablymore sensitive to exchange rate changes. Conse-quently, they should improve with a recovery of theeuro relative to the yen.

18 Although the December Tankan survey revised sec-ond half profits downwards and excess capacity fig-ures rose.

19 The Central Bank appears to take the view that, tothe extent that higher interest rates create pressurefor restructuring, they will through increased effi-ciency lead to lower prices and deflation. However,a Bank of Japan study (6 October 1999: 56, box E)finds that: “data do not show evidence that techno-


logical innovation increases the number of indus-tries that make profits while decreasing their priceseven more in Japan”.

20 The subregions distinguished in this subsection areas defined by the United Nations Economic Com-mission for Africa: (1) Central Africa (Cameroon,Central African Republic, Chad, Congo, EquatorialGuinea, Gabon; Sao Tome and Principe); (2) EastAfrica (Burundi, Comoros, Democratic Republic ofthe Congo, Djibouti, Eritrea, Ethiopia, Kenya,Madagascar, Seychelles, Somalia, Rwanda, Ugandaand United Republic of Tanzania); (3) North Africa(Algeria, Egypt, Libyan Arab Jamahiriya, Maurita-nia, Morocco, Sudan and Tunisia); (4) Southern

Africa (Angola, Botswana, Lesotho, Malawi, Mau-ritius, Mozambique, Namibia, South Africa,Swaziland, Zambia and Zimbabwe); and (5) WestAfrica (Benin, Burkina Faso, Cape Verde, Côted’Ivoire, Gambia, Ghana, Guinea, Guinea-Bissau,Liberia, Mali, Niger, Nigeria, Senegal, Sierra Leoneand Togo). North Africa and Southern Africa ac-count respectively for about 40 per cent and 35 percent of African output, while the shares of WestAfrica, East Africa and Central Africa were 14 percent, 7 per cent and 4 per cent, respectively.

21 Potential qualifiers include Chad, Ethiopia, Gam-bia, Guinea, Guinea-Bissau, Madagascar, Malawi,Niger, Rwanda, Sao Tome and Principe, and Zambia.

29International Trade and Finance

After the Asian financial crisis world tradewent through a period of slow growth in 1998 and1999 (table 2.1); this phase ended in 2000. Esti-mates available at the beginning of 2001 indicatethat world trade in 2000 grew at around twice therate for 1999 and considerably faster than worldoutput (table 2.2).1 The resilience of the UnitedStates economy, a pick-up in economic activityin the EU and Japan, stronger than expected recov-ery in Latin America and the transition economies,and sustained growth in Asia all helped to stimu-late trade. The prolonged period of boom in theUnited States has left its mark on the global trad-ing system. Already in 1999, the United Stateseconomy accounted for an unprecedented 18.5 percent of global imports in value terms and the pro-portion in 2000 was even higher (see WTO, 2000,tables III.1 and III.2). In 2001 world trade expan-sion is expected to moderate, due to the slowdownin world industrial production and more stable oilprices.

All major regions recorded an expansionin trade volumes in 2000, but it was particularlymarked in the developing and, according to someestimates, transition economies (table 2.2). For the

developing countries as a group, the volume ofimports is estimated to have increased by morethan 11 per cent in 2000, compared to less than6 per cent in 1999 and a decline in 1998. In LatinAmerica and in the transition economies, importshad declined in 1999 but are estimated to havegrown by more than 10 per cent in 2000. In Asia,imports continued to grow, in some cases evenmore rapidly than they had in 1999. Growth inthe volume of imports accelerated sharply in HongKong (China) and Taiwan Province of China, butwas slower in Singapore and the Republic ofKorea. Among the ASEAN-4, the volume of im-ports grew faster than in 1999 in Indonesia andthe Philippines but slower in Malaysia and Thai-land. China again registered strong growth inimport volumes in 2000, exceeding even the 26 percent of the previous year. In Africa, which hasbeen less affected by the recent volatility in glo-bal markets, imports grew, but at a slower ratethan in other developing regions.

Import growth accelerated also in the devel-oped countries in 2000, albeit at a slower rate thanin the developing countries for the first time since1997. Imports into the United States again grew

Chapter II

INTERNATIONAL TRADE AND FINANCE

A. Recent developments in international trade


Table 2.1

EXPORTS AND IMPORTS BY REGION AND ECONOMIC GROUPING, 1997–1999


Export value Export volume

Region/economic grouping 1997 1998 1999 1997 1998 1999

World 3.5 -1.6 3.5 10.7 5.0 4.8


of which:Japan 2.4 -7.8 8.1 11.8 -1.3 2.1United States 10.2 -0.9 1.9 11.9 2.3 4.3European Union -0.5 4.0 -1.0 9.4 6.3 3.7

Transition economies 4.2 -4.7 -0.6 10.4 5.1 -1.7

Developing countries 7.0 -6.9 8.7 12.5 5.6 7.1

of which:Africa 2.0 -15.9 8.7 6.7 -1.8 3.8Latin America 10.6 -1.3 6.4 11.7 7.6 7.5Middle East 4.7 -22.5 23.6 12.6 6.9 -3.0Asia 7.2 -4.5 7.5 13.6 5.3 10.1

of which:Newly industrializing economies a 3.5 -7.5 5.3 11.6 3.8 7.0ASEAN-4 b 5.1 -4.0 10.7 12.2 10.7 13.1China 21.1 0.4 6.3 20.6 3.5 15.5

Memo item:ASEAN-4 plus Republic of Korea 5.0 -3.5 10.2 18.0 13.7 12.6

Import value Import volume

Region/economic grouping 1997 1998 1999 1997 1998 1999

World 3.5 -0.9 4.0 9.9 4.3 6.0


of which:Japan -3.0 -17.2 11.0 1.7 -5.3 9.5United States 9.4 5.0 12.2 12.1 11.7 11.3European Union -0.3 5.9 0.8 8.9 8.3 4.2

Transition economies 6.5 -1.8 -11.6 13.7 4.7 -8.8

Developing countries 6.1 -10.2 4.2 10.5 -3.8 5.6

of which:Africa 5.7 1.2 0.0 10.0 5.2 -2.0Latin America 18.2 5.0 -3.0 21.4 8.6 -1.0Middle East 8.1 -3.2 2.6 10.8 -3.8 1.7Asia 2.2 -18.5 8.9 7.3 -10.6 12.1

of which:Newly industrializing economies a 3.4 -19.5 7.3 7.4 -10.0 8.2ASEAN-4 b -2.4 -27.9 7.3 4.9 -23.1 9.2China 2.4 -1.3 18.2 5.4 2.5 25.7

Memo item:ASEAN-4 plus Republic of Korea -3.0 -30.9 15.0 3.5 -22.2 16.4

Source: UNCTAD secretariat calculations, based on statistics of WTO.a Hong Kong (China), Republic of Korea, Singapore and Taiwan Province of China.b Indonesia, Malaysia, Philippines and Thailand.


Table 2.2

EXPORTS AND IMPORTS BY REGION AND ECONOMIC GROUPING, 2000:ESTIMATES BY VARIOUS INSTITUTIONS


Export value Export volume

Region/economic grouping IMF UN IMF OECD UN

World 9.9 . 10.4a 13.3a 10.6

Developed market-economy countries . . 10.2b 12.9 10.2

of which:Japan . . 9.7c 12.5 8.6United States . . 8.8c 12.6 10.6d

European Union . . 9.5c 12.6 10.8e

Transition economies . 28.4 f . . 8.3 (15.8 f)

Developing countries 20.4 . 10.3 . 11.9

of which:Africa 25.6 . 6.6 . 4.7Latin America 17.9 20.5g 10.8 . 6.4 (4.2g)Asia 14.0 . 10.9 . .

of which:East and South Asia . . . . 13.5China . . . . 21.6

Import value Import volume

Region/economic grouping IMF UN IMF OECD UN

World . . 10.4a 13.3a 10.8

Developed market-economy countries . . 10.4b 12.7 8.8

of which:Japan . . 6.8c 11.5 6.4United States . . 13.0c 14.5 13.1d

European Union . . 8.7c 11.0 6.8e

Transition economies . 13.2 f . . 11.8 (17.0 f)

Developing countries 15.1 . 11.2 . 15.7

of which:Africa 9.0 . 6.2 . 7.1Latin America 13.9 17.5g 14.4 9.2 (12.3g)Asia 17.3 . 13.2 . .

of which:East and South Asia . . . . 15.1China . . . . 45.3

Source: IMF (2000a); OECD (2000a); UN/DESA-UNCTAD (2001).a Average of annual percentage change for world exports and imports.b Including NIEs.c Including services.d North America.e Western Europe.f ECE (January to September).g ECLAC.


faster than those into other developed economies;on some estimates they expanded by more than14 per cent in 2000. The continued role of theUnited States as a buyer of last resort for the restof the world underpinned the strong performanceof world trade in 2000. But import demand alsopicked up quite significantly in some of the largerEU countries, despite the weakness of the euro;overall import growth for the euro zone is esti-mated to have exceeded 10 per cent in 2000. Japan,although failing to match growth in either theUnited States or Europe, also had an acceleratedgrowth in its import volume in 2000, in part dueto a rebound in investment spending, especiallyon equipment related to information and commu-nication technology.

The strong expansion in global import de-mand in 2000 was accompanied by a correspond-ingly robust overall global export performance.2

A particularly rapid turnaround was registered interms of export volume growth in the Middle Eastand in the transition economies. For the latter,this is partly attributable to the increasingly closerties with western Europe (particularly Germany),where output growth picked up in 2000. The strongrise in export volume in the Russian Federationwas also due to higher demand for its commodi-ties, notably oil and metals. Higher export growthto other regions continued to power recovery inAsia and in parts of Latin America, aided by cur-rency depreciations. For Asian economies, anadditional factor was the revival of intraregionaltrade, which also contributed to the fast growthof Chinese exports.3 Similarly, the expansion inexport volume in Mexico owes much to its stronglinks to the United States economy. The excep-tions to this trend are those countries, mainly in

Africa and Latin America, whose exports arehighly concentrated in a small number of non-oilprimary commodities. The problems faced bythese countries have been compounded by stag-nant or declining world prices.

An acceleration in export volume in 2000 isalso discernible in developed countries, particu-larly in the euro zone, which benefited from thecompetitive edge given by the weakness of theeuro. Double-digit export growth in some of thelarger European economies, such as France andGermany, is particularly notable. Strong exportgrowth also helped to revive the Japanese econo-my in 2000.

The trade imbalances among major economicregions that had been building up in recent years,due to significant growth differentials between theUnited States and other developed economies andto the strong dollar, increased further in 2000.While the United States trade deficit reached arecord high, close to 4 per cent of GDP,4 therewas little change in the overall trade surpluses ofJapan and the European Union despite con-siderably higher oil import bills. Oil-exportingdeveloping countries and several transition econo-mies, notably the Russian Federation, registeredincreasing trade surpluses.

For 2001, growth in overall import demandis expected to be lower than in 2000 owing to theeconomic slowdown in the United States and insome countries which have recently experienceda rapid recovery. The level of private capital in-flows is likely to limit increases in the importcapacity of a number of developing countries, par-ticularly in Latin America.


In 2000, world non-oil commodity prices re-covered slightly from sharp declines in 1998 and1999. Although the overall increase of almost2 per cent was the first positive growth in fiveyears (table 2.3), prices remained well below1996–1997 levels. Faster growth in all the majoreconomic regions resulted in increases in demandfor a large number of commodities, leading tolower stock levels and higher prices in some cases.These increases were sufficient to offset acutedeclines in the prices of certain key commodities,notably coffee, cocoa and rice. The combined ad-verse effects of the persistent weakening of somenon-oil commodity prices, on the one hand, andthe increase in oil prices, on the other, generatedsevere balance-of-payments problems and welfarelosses for oil-importing developing countriesheavily dependent on the production and exportof a few commodities.

Thus, underlying the overall improvement inprices are sharply divergent trends among vari-ous commodity groups. The lingering effects ofthe decline in demand during 1998–1999 have leftproducers and exporters of a number of commodi-ties – including coffee, cocoa, rice and tropicallogs – with a large stock overhang that needs tobe significantly reduced further before prices canbegin to recover. For some commodities, particu-larly nickel and zinc, the fall in stocks which beganin late 1999 continued throughout 2000, as a re-sult of strong demand. Changes in the stock levelsof agricultural commodities, on the other hand,have been mixed.

Prices of minerals, ores and metals as a groupincreased by 12 per cent in 2000 from the low ofthe previous year, on account of nickel, copper,aluminium and tungsten. Nevertheless, prices for

all metals, except nickel, remained below their1996–1997 average. The marked rebound in pricesof base metals and some other industrial raw ma-terials is the outcome of strong demand, cutbacksin production and a reduction in inventories. Alu-minium prices, which began to recover in 1999after marked declines in 1998 and early 1999, roseby 14 per cent in 2000 in spite of large stocks andrising production. Copper prices increased bymore than 15 per cent because of strong demand,which reduced the large overhang in inventoriesbuilt up during 1997–1999. Nickel prices rose by44 per cent, following an increase of 30 per centin 1999, largely because of strong demand cre-ated by a rapid growth in steel production. Withdemand growth outstripping supply, nickel stocksdeclined significantly, falling to their lowest lev-els in many years. Iron ore and zinc prices haveincreased moderately, while tin and phosphaterock prices remained relatively unchanged. Forthe fourth consecutive year, lead prices continuedto fall, owing to large inventories and weak de-mand.

Changes in the prices of agricultural com-modities in 2000 showed large variations, re-flecting significant changes in the balance ofsupply and demand as well as changes in stocklevels. Prices of key agricultural products re-mained weak owing to continued productionincreases and large inventories. Continued highoutput of commodities such as coffee, cocoa andrice resulted in a further build-up of stocks andexerted further downward pressure on prices.Coffee prices continued to fall sharply in 2000,after a cumulative decline of 45 per cent over thetwo preceding years also due, in part, to weak de-mand, particularly in Europe and the UnitedStates. But a significant increase in coffee pro-

B. Non-oil commodity markets


duction in Viet Nam, which became the world’ssecond largest coffee exporter after Brazil, alsocontributed to the downward trend in coffee prices.Despite an increase in demand, cocoa pricesreached a record low in 2000 because of a largeoversupply which led to a further build-up ofstocks. The 7 per cent increase in the price of tea

offset the decline experienced in 1999, and wasdue primarily to a reduction in supply volumes,particularly from Kenya and India.

The 6 per cent rise in food prices in 2000was the first increase since 1996, reflecting a sharprecovery in sugar prices, which rose more than

Table 2.3

WORLD PRIMARY COMMODITY PRICES, 1996–2000


Commodity group 1996 1997 1998 1999 2000

All commodities a -4.2 0.0 -13.0 -14.2 1.9

Food and tropical beverages 2.1 2.8 -14.3 -18.3 1.0

Tropical beverages -15.2 33.3 -17.3 -20.9 -13.2

Coffee -19.1 54.7 -28.5 -23.2 -16.2Cocoa 1.2 11.2 3.7 -32.1 -22.2Tea b … 35.1 4.3 -7.0 6.8

Food 6.8 -3.5 -13.8 -18.1 5.9

Sugar -9.9 -4.9 -21.2 -30.0 30.5Beef -6.4 4.0 -7.0 6.1 5.7Maize 25.0 -25.3 -13.4 -5.5 -1.0Wheat 16.2 -22.6 -19.9 -10.9 3.5Rice 5.0 -10.7 1.3 -18.6 -18.1Bananas 7.5 4.3 -3.1 -9.9 -2.3

Vegetable oilseeds and oils -4.2 -0.9 7.1 -23.3 -22.8

Agricultural raw materials -9.9 -10.3 -10.8 -10.3 -1.0

Hides and skins -23.7 -19.8 -22.7 -27.6 73.8Cotton -14.8 -8.9 -8.3 -22.9 3.5Tobacco 15.6 15.6 -5.5 -7.0 -3.4Rubber -11.9 -28.3 -29.8 -12.6 7.9Tropical logs -20.1 -5.5 -1.2 -7.2 -4.3

Minerals, ores and metals -12.1 0.0 -16.0 -1.8 12.0

Aluminium -16.6 6.2 -15.1 0.3 13.8Phosphate rock 8.6 7.9 2.4 4.6 0.2Iron ore 6.0 1.1 2.8 -9.2 2.6Tin -0.8 -8.4 -1.9 -2.5 0.6Copper -21.8 -0.8 -27.3 -4.9 15.3Nickel -8.8 -7.6 -33.2 29.8 43.7Tungsten ore -17.9 -9.3 -6.4 -9.3 12.1Lead 22.7 -19.4 -15.3 -5.0 -9.7Zinc -0.6 28.4 -22.2 5.1 4.8

Source: UNCTAD, Monthly Commodity Price Bulletin, various issues.a Excluding crude petroleum.b New series, with data starting in 1996.


expected because of a large drawdown in stocks.Wheat prices recovered slightly but remained wellbelow their 1996 levels, while rice prices fell byabout 18 per cent. Surplus production capacitiesin major exporting countries have led to depressedprice levels of rice over the past few years. Veg-etable oilseeds and oils also remained depressed,dropping by 23 per cent in 2000 following a fallof similar magnitude in 1999.

For 2001, changes in the prices of non-oilcommodities will continue to be mixed amongindividual commodities and commodity groups.On the whole, most commodity markets can beexpected to remain weak; short-term prospects areclouded by considerable uncertainties associatedwith the performance of the United States econo-my and the impact of a slowdown there on therest of the world.

C. Recent developments and emerging trends in oil markets

1. Prices, supply and demand

The annual average price of crude oil in-creased by 58 per cent to $27.6 a barrel in 2000,the highest level since 1985, and monthly aver-age oil prices reached a peak of $31.5 a barrel inSeptember 20005 (chart 2.1). Throughout 1998 andearly 1999 oil prices had fallen, hitting a low ofabout $10 a barrel, due largely to the Asian eco-nomic crisis, which had greatly reduced global oildemand.6 In an effort to reverse the price decline,members of the Organization of the PetroleumExporting Countries (OPEC) and some non-OPECoil exporters (Mexico, Norway, Oman and theRussian Federation) jointly cut oil production byover 2 million barrels per day (bpd) in April 1999.The implementation of these supply cutbackscoincided with a revival of demand associatedwith economic recovery in East Asia and contin-ued high rates of growth in the United States. Theoverall outcome was a large drawdown in worldoil stocks, while prices tripled from February 1999to February 2000.

As the price hikes began to be felt in manyoil-importing countries, OPEC increased its pro-duction quota by 1.7 million bpd in April 2000

and informally adopted a production schemeaimed at keeping the oil price per barrel withinthe $22–28 range (see TDR 2000, chap. III, sect. C).Thus, as prices rose above the $28 limit, OPEC

Chart 2.1

MONTHLY AVERAGE SPOT PRICES OFOPEC CRUDE OILS, 1998–2000

(Dollars per barrel)

Source: OPEC, Monthly Oil Market Report, various issues.

1998 1999 2000J F M A M J J A S O N D J F M A M J J A S O N D J F M A M J J A S O N D

35

30

25

20

15

10

5

0

Do

llars

pe

rb

arre

l


raised its production target in July and Octoberby a total of 3.2 million bpd. Prices reached a peakin September and again in November 2000, astraders continued to worry about the decline instocks of crude oil, particularly in the United States.However, prices dropped sharply in December2000, to their lowest level in eight months. Fearsof a collapse in prices replaced concerns over highprices. In an effort to prevent a price slide belowits target price band amid concerns of slowing oildemand growth, particularly in the United States,OPEC cut production quotas of members, on a prorata basis, by 1.5 million bpd as of February 2001.

2. Impact of the increase in oil prices

It is commonly believed that higher oil pricesdepress global economic activity. The negativereal income effect of an oil price hike is consid-ered similar to a tax or levy on the real income ofprivate households and companies in oil-import-ing countries, reducing global demand. However,this view takes into account only the negative ef-fects on consumers in the western world, ignoringthe positive effect on oil producers. Any rise inthe price of oil which is not fully compensated bya fall in the quantity traded brings about a re-distribution of real income from consumers toproducers. This redistribution is likely to changethe structure of demand for goods on the worldmarket but does not necessarily reduce aggregateglobal demand and activity.

In any event, even the direct impact of therecent oil price increase on the industrialized oil-importing countries has been much less severethan the increases in 1973 and 1979–1980 forvarious reasons. Economic activity in the indus-trialized countries is much less oil-intensive thanit was 20 or 30 years ago, and despite the recentsharp increase in nominal terms, oil prices are stillrelatively low in real terms, with the average realprice of a barrel of oil in 2000 being about onethird of that in 1980, and 20 per cent lower thanin 1974 (chart 2.2). The importance of oil in tradehas thus declined considerably in the past twodecades, and so has the potential impact of oilprices on inflation in the industrialized countries.Since February 1999, in spite of a nearly three-

fold increase in crude oil prices, end-use prices inmost industrialized countries increased by onlyabout 30 per cent, causing a rise in the overallconsumer price index in the order of 0.5 percent-age points in both 1999 and 2000 (OECD, 2000a,tables I.8 and I.9).

Nevertheless, the oil price increases in 2000sparked a wide-ranging debate in major oil-consuming countries on issues relating to oil prices,oil taxation and oil security. The United StatesGovernment decided to release some of its stra-tegic reserves, normally earmarked for majoremergencies. And some European Governmentsgranted compensation to certain groups, in re-sponse to a consumer rebellion against high pumpprices. Oil-exporting countries, particularly mem-bers of OPEC, have often been held responsiblefor allegedly high prices of petrol and heating oil.

Chart 2.2

REAL OIL PRICES, 1974–2000

(Dollars per barrela)

Source: UNCTAD secretariat calculations, based on data fromBP Amoco, Statistical Review of World Energy 2000,and United States Department of Labor (www.stls.frb.org/fred/data/cpi).

a Prices in current dollars have been deflated by theUnited States consumer price index with the baseyear 2000.

Do

llars

pe

rb

arre

l

80

70

60

50

40

30

20

10

0

19

74

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00


However, consumer prices have risen even dur-ing periods of declining prices for crude oil,mainly because of the impact of taxation of fuelconsumption in the industrialized countries, par-ticularly in Europe (table 2.4). Gasoline taxes inthe EU, for example, on average amount to some68 per cent of the final price, with the remaining32 per cent equally distributed between industrymargin (i.e. refiners and traders) and oil-exportingcountries. In 1999, fuel taxes yielded a revenueof nearly $358 billion in the G-7 countries, anamount almost double that earned by OPEC mem-bers from their exports of crude oil.

For the developed countries, rising oil pricesin 1999 and 2000 represented an additional im-port cost of less than 0.5 per cent of GDP, but theyalso encouraged higher exports to oil-producingcountries. Given their different export structure,oil-importing developing countries typically re-ceive much less benefits from any additionaldemand from oil exporters. As oil use per unit ofoutput is higher in developing than in developedcountries, the overall impact of the oil price risesince 1999 has been much more severe in theformer.

Indeed, for many developing countries theimpact was stronger than that of the oil-price risesin the 1970s and early 1980s as their efforts toindustrialize and build their manufacturing in-dustries have increased their dependence onmodern fuels; their use of motor vehicles has alsoincreased considerably. As a result, they have be-come more oil-intensive over time, using almosttwice as much oil as developed countries per unitof output. According to one recent estimate, theimplied terms-of-trade loss due to the recent pricerise in oil has amounted to 1.4–2.0 per cent of GDPfor countries in South-East Asia, around 1 per centfor India and South Africa, and 0.5 per cent forBrazil (OECD, 2000a: 15).

Oil import bills of the oil-importing devel-oping countries rose by about $21 billion in 1999and by another $43 billion in 2000 (table 2.5). Asoil generally accounts for a large share of theirtotal imports, their current-account balance dete-riorated considerably, by more than 1 per cent ofGDP in 2000 alone. Such an effect is likely to havesevere consequences for growth and living stand-ards in many instances. For the oil-importingcountries of Africa, many of which are LDCs, the

Table 2.4

G-7 COUNTRIES: AVERAGE PUMP PRICES OF GASOLINEa ANDREVENUES FROM TAXES ON OIL PRODUCTSb

Revenue from taxesPrice Tax Taxes on oil products, 1999

(PercentageCountry ($ per litre) of total price) ($ billion)

United Kingdom 1.15 0.85 73.7 59.6

Japan 1.02 0.55 53.6 79.0

Italy 0.96 0.61 63.4 47.9

France 0.94 0.64 68.0 53.2

Germany 0.90 0.61 67.4 58.2

Canada 0.49 0.42 40.8 14.8

United States 0.41 0.10 24.8 95.7

Source: UNCTAD secretariat calculations, based on International Energy Agency, Monthly Market Report, 11 December 2000.a Average prices in November 2000.b 1999.


combined increase in the oil import bill over thepast two years amounted to about $6 billion,or 2 per cent of their GDP. Given their externalfinancing constraints and inability to achieveoffsetting export growth, many of them wereforced to reduce their imports of other goods.

On the other hand, the hike in oil prices hasalleviated balance-of-payments and budget con-straints in many of the oil-exporting developingcountries that had suffered severe terms-of-tradelosses in 1998. The oil export revenues of OPECmembers doubled from 1998 to 2000, reachingtheir highest level since 1981.

3. Prospects

The outlook for oil prices depends to a largeextent on the production policies of OPEC. Withthe exception of Kuwait, Saudi Arabia, and theUnited Arab Emirates, whose combined spareproduction capacity is estimated to be about

3–4 million bpd, all other countries have beenproducing at full capacity. The major market un-certainty relates to oil exports from Iraq. On thedemand side, a key determinant will be GDPgrowth and energy policies in the major indus-trial countries. Over the next 12 months, worlddemand for oil is expected to ease, depending onthe extent of the slowdown in the United Statesand its impact on world economic activity. Oilstocks have increased but remain at relatively lowlevels, and this will continue to contribute to mar-ket fragility and price volatility. However, in theabsence of any serious disruptions in supply, av-erage oil prices in 2001 may fall to below $20 abarrel.

Over the medium to long term, oil prices willlargely be determined by the development of newproduction capacities and alternative energies.Apart from providing 40 per cent of global oilsupplies, OPEC members account for some 78 percent of the world’s proven crude oil reserves. Mostof these known reserves are characterized by lowdevelopment and operating costs and can be ex-ploited fairly rapidly.

Investment in exploration and production hasgenerally increased in response to the rise inprices, but the bulk of any new production capac-ity will not come on-stream until after 2001. Inparticular, international oil companies and otherindependent producers have been investing in newoil exploration and development ventures whichare likely to increase non-OPEC supply capacitysubstantially. Production increases are expectednot only from the Russian Federation and the Cen-tral Asian oil exporters, but also from countriesin Latin America, Africa and the Middle East.Moreover, technological advances have reducedthe cost of exploration and production by nearlyone half over the past decade, and have also madeit possible for oil companies to explore in newfrontier areas, particularly offshore, and to dis-cover oil more easily than ever before. On theother hand, the recent increase in oil prices has,once again, renewed interest in energy conserva-tion, alternative sources of energy and new fueltechnologies, such as hybrid engines and hydro-gen fuel-cells, so that oil, while remaining a majorsource of energy, may lose further in importancefor economic activity.

Table 2.5

OIL IMPORT BILLS OF OIL-IMPORTINGCOUNTRIES, 1998–2000

(Billions of dollars)

Country/region 1998 1999 2000

United States 47.3 67.2 106.3

Japan 23.5 34.0 53.6

Western Europe 45.2 63.3 99.5

Central Europe 5.0 7.2 11.4

Developing countries 52.1 72.8 116.1

Africa 5.0 7.0 11.0Asia 41.6 58.3 91.6

Latin America 5.5 8.5 13.5

Source: UNCTAD secretariat calculations.


In its discussion of developments in interna-tional financial markets during the early part of2000, TDR 2000 noted the especially high levelof uncertainty attaching to any prognosis. Thesecond half of the year was indeed marked by cri-ses and financial support packages for Argentina(box 2.1) and Turkey (box 2.2), as well as bymovements of financial indicators, such as in-creases in yield spreads on the international bondsof some developing countries, pointing to percep-tions of increased risk. But elsewhere in emergingmarkets, shifts in monetary conditions and pres-sures on exchange rates were generally moregradual or largely absent (except during briefperiods of political unrest in some countries).However, the year was also notable for sharp fallsin equity prices.

In Asia there have been few major changessince early 2000 in exchange-rate policy or re-gimes of exchange control, but in Latin Americathere has been a trend towards full dollarization.The range of currency regimes in developing andtransition economies thus continues to span thespectrum from rigid pegs (in Argentina and HongKong (China)) and outright dollarization (in Ec-uador and El Salvador) to various types of floating.Several countries have adopted freer floats since1997, while in some cases retaining the discre-tion to intervene in the market for their currenciesin certain circumstances, such as to maintain or-derly conditions or to avoid sudden depreciationsor appreciations.7 Venezuela has maintained itsmoving band under which the spot rate for thedollar is allowed to fluctuate within a range of7.5 per cent on either side of an adjustable centralrate. Malaysia has maintained a fixed exchange

rate of the ringgit with the dollar since September1998. In Indonesia in January 2001, in order toreduce volatility of the rupiah and given the dan-ger of further destabilization of a still vulnerablefinancial sector, the Government introduced apackage of restrictions on selected capital trans-actions with non-residents (foreign persons andfirms and Indonesian entities abroad), which tookthe form of ceilings on derivatives transactions,and of prohibition on borrowing, lending and in-vestment, likely to affect the exchange rate.

Ecuador adopted a scheme of dollarizationin March 2000, and El Salvador in January 2001.In Ecuador, the dollar became legal tender, butthe national currency (fully backed by dollars)remained in circulation to facilitate small trans-actions. A major objective of such a step is to bringinterest rates down towards United States levels.However, this process may be slowed by increasedcredit and political risk stemming from pricechanges associated with adjustments to the ex-change rate at which dollars are substituted forthe national currency and by associated disrup-tions of output and employment. So far, short-terminterest rates in Ecuador have fallen substantially,but those with longer maturities remain greatly inexcess of dollar rates.

Amongst major financial indicators there wasa dramatic change of direction during 2000 inindices of equity prices in emerging markets(chart 2.3). After rises of more than 50 per cent inindices for all major regions in 1999, there weresharp falls in 2000, the decline being largest inAsia. While these declines were partly fuelled byincreased economic uncertainty and a less favour-

D. Currency markets and selected financial indicatorsin emerging markets


Box 2.1

EXTERNAL SHOCKS, ADJUSTMENT AND CRISIS IN ARGENTINA

Despite substantial efforts by the new Government to implement an economic programme an-nounced in December 1999 and supported by an IMF stand-by credit, economic performance in2000 was disappointing, as the economy failed to recover from the recession caused by a falloutfrom the Russian default.

Since the adoption of the Convertibility Law in 1991, the peso has traded at parity with the UnitedStates dollar, supported by a currency board. This, of course, precluded the use of exchange rate ormonetary policy to offset dollar appreciation or higher United States interest rates, so that the onlypossible adjustment was through a deflationary process to improve competitiveness. This adjust-ment affected the attainment of economic policy goals in different ways. On the one hand, defla-tion produced a real depreciation of around 10 per cent in 2000 in the effective exchange rate(when measured in terms of relative unit labour costs). Together with higher prices of energy(which represents over 10 per cent of the country’s merchandise exports) and the slow growth ofimports due to recession, this has resulted in a marked swing in the trade balance, from a deficit in1999 to a surplus in 2000. On the other hand, however, tax yields were sharply reduced and thefiscal deficit failed to improve. Moreover, the rate of unemployment, which before the downturn in1998 had fallen to below 13 per cent, resumed its rise, exceeding 14 per cent. Although the netfinancing requirement of the Government fell in 2000, its net external borrowing increased some-what.

The improving trade performance and the IMF stand-by credit failed to contain yield spreads,which rose sharply in May and remained at 650–700 basis points until August as markets, becameconcerned about the deteriorating social climate produced by the renewed economic slowdownand its impact on public finances. There was also concern about the effects of a further tighteningof interest rates in the United States. The Government was, nonetheless, able to implement itsexternal financing plan: by early September it had raised over $14.5 billion, more than 80 per centof the gross financing required for 2000. However, the increase in interest rates charged to primeborrowers, from about 9 per cent to a peak of nearly 20 per cent in November, contributed to afurther slowing of economic activity.

In October and November, political instability created turbulence in capital markets, and by theend of the latter month yield spreads rose to nearly 900 basis points and total international reservesfell by about $3 billion.1 In order to prevent an additional drain on reserves, the Central Bankdecided to limit commercial banks’ use of short-term Treasury paper (Letes) as collateral for theirpases activos.2 It also drew on its stand-by arrangement with the Fund.

At the same time, the Government launched a revised economic plan and approached IMF to raiseits financing commitment. In the package announced in January 2001, the Fund increased Argen-tina’s existing stand-by credit to $13.7 billion, corresponding to 500 per cent of the country’squota (about $3 billion of which is to be provided under the Supplemental Reserve Facility).3 TheWorld Bank and the Inter-American Development Bank (IDB) promised new loans of about $4.8 bil-lion over two years, and the Spanish Government contributed $1 billion. Disbursements from thesemultilateral and bilateral sources are expected to cover about one third of the Government’s esti-mated gross financing requirements of some $30 billion in 2001. The remainder will be financedby agreements with local banks through rollover of maturing bonds and new issues and through


expected purchases of bonds by local pension funds. The Government is also planning other place-ments in international capital markets.

Basing itself on the experience of similar agreements with IMF made by Thailand, Indonesia andthe Republic of Korea, where targeted reductions in fiscal deficits had to be revised in conditionsof recession, the Argentine letter of intent provides for an increase in the deficit to 2.2 per cent ofGDP in order to avoid a fiscal contraction in the early stages of recovery. This figure includes thecost of measures to stimulate investment, some additional spending on temporary public employ-ment programmes, and other social spending aimed at mitigating economic hardship for the mostvulnerable groups. Federal primary spending is, nonetheless, expected to decline in 2001 by 0.5 percent of GDP from the previous year’s level, and the primary surplus to rise to 1.7 per cent GDP(from 1 per cent in 2000). The overall deficit is to be eliminated by 2005, and fiscal consolidationto be extended to provincial governments. The ratio of public debt to GDP is programmed todecline from 2003 onwards. This implies a freeze on non-interest nominal federal expenditure atthe 2000 level and likewise on expenditure by those provincial governments that are in deficit. Inaddition, IMF conditionality relates to reform of fiscal administration, social security, industrialand competition policy, trade policy, the financial sector, and corporate governance.

Following the implementation of the new package, which coincided with a fall in United Statesinterest rates and depreciation of the dollar, equity prices recovered, and Argentina has been ableto raise new funds in the international market.4 Current global conditions could enable Argentinato emerge from the vicious circle in which the need to increase the external surplus requires lowerwages and prices, thus reducing tax yields and undermining the target of a lower fiscal balance.Lower interest rates should enable the interest costs of the debt – and thus the fiscal deficit – to bereduced without cutting expenditures, while a cheaper dollar would help boost exports without theneed for lowering wages and prices.

Nevertheless, since there is an outstanding debt of $120 billion, equivalent to 350 per cent of thecountry’s annual export earnings, and since two thirds of foreign exchange receipts are absorbedby debt service, the downside risks should not be underestimated, particularly if there is a loss ofinvestor confidence in emerging markets.

1 The figure refers to reserve holdings of the Central Bank plus deposits held by the financial systemabroad.

2 These are repurchase agreements which the Central Bank uses to provide liquidity to the banking sys-tem because under the Convertibility Law, it cannot rediscount commercial bank assets.

3 Argentina received about $3 billion immediately, with three additional drawings of about $1.3 billioneach programmed for the remainder of 2001 following the continuous review process. About $4 billionwill be available in 2002 and $1 billion in 2003.

4 In February 2001 the Government launched a 500 million euro-bond issue with a maturity of six yearsand an interest rate of 10 per cent, representing a 550 basis-point spread over German and Frenchgovernment issues. It also completed a debt swap of $3 million short-term debt for a new five-yeartreasury note and a new 11-year global bond, with another one announced for before the end of the firstquarter.

Box 2.1 (concluded)


Box 2.2

STABILIZATION AND CRISIS IN TURKEY

The recent Turkish crisis has a number of features common to crises in emerging-market econo-mies that implement exchange-rate-based stabilization programmes. Such programmes typicallyuse the exchange rate as an anchor for inflationary expectations, often relying on capital inflowsattracted by arbitrage opportunities to finance growing external deficits, with a resulting apprecia-tion of the currency. The consequent build-up of external financial vulnerability eventually givesrise to a rapid exit of capital, leading to overshooting of the exchange rate in the opposite directionand/or hikes in interest rates. Through such a boom-bust financial cycle, some countries (e.g. Mexicoand Brazil) have succeeded in overcoming their chronic price instability and avoiding a return ofrapid inflation, despite the collapse of their currencies and the external adjustment necessitated bythe crisis. The Turkish programme initially followed a similar path, but ran into difficulties at amuch earlier stage of the disinflation process, causing it to abandon the peg and casting doubts onits chances of success. The difficulties arose largely because the programme was launched in aclimate of structural problems and fragilities on many different fronts, notably in the public fi-nances and the banking sector.

Following chronic inflation since the mid-1980s averaging an annual 70 per cent, the Governmentlaunched a stabilization programme in December 1999 supported by an IMF stand-by credit, withthe aim of bringing the rate of inflation down to 25 per cent by the end of 2000 and to the single-digit level by the end of 2002. The programme was adopted after a poor economic performance in1999, when GNP fell by 6 per cent, partly due to devastating earthquakes and the fallout from theRussian crisis. Furthermore, there were large public sector deficits (an operational deficit of 14 percent of GNP for the consolidated public accounts), mainly on account of mounting interest pay-ments on government debt and the losses of public enterprises. The banking sector was also highlyfragile and largely dependent for its earnings on high-yielding T-bills associated with rapid infla-tion. Financial markets were consequently highly vulnerable to disinflation, and there emerged aninconsistency in policy since much of the fiscal adjustment was predicated on declines in the verynominal and real interest rates on which many banks depended for their viability. By contrast, theexternal account was almost in balance. The Central Bank of Turkey (CBOT) was effectively fol-lowing a policy of an adjustable peg designed to prevent a significant real appreciation of the lira.

The stabilization programme was based on a preannounced crawling peg. The exchange rate tar-gets were set in terms of a basket made up of the dollar and the euro, with greater weight accordedto the former. The value of the basket in lira was set to increase by 20 per cent for the year 2000 asa whole (equal to the target rate for wholesale price inflation), at declining monthly rates. July2001 was set as the date for exit from the preannounced crawling peg to more flexible rates withina band. The programme also provided for a “quasi-currency board” (whereby money-printing againstdomestic assets was precluded), as well as for targets for primary budget surpluses. As the CBOTwas committed not to engage in sterilization, macroeconomic equilibrium was to be attained mainlythrough changes in interest rates: if capital inflows fell short of the current-account deficit, liquid-ity would be withdrawn from the economy and interest rates would rise, thus restoring externalequilibrium by attracting more capital inflows, on the one hand, and by restraining domestic de-mand and imports, on the other.

In the event, during the first 11 months the targets for the nominal exchange rate, net domesticassets, and primary budget deficits were attained, but prices proved to be stickier than expected;annual inflation had come down only to some 40 per cent at the end of 2000, from an average of65 per cent in 1999. The consequent real appreciation of the currency was aggravated by the rise ofthe dollar against the euro. Interest rates fell significantly faster than the rate of inflation, eventhough they were highly volatile: annualized rates on 3-month T-bills averaged less than 40 percent in January–November 2000, compared to over 100 per cent in 1999. Despite fiscal tightening,


the economy made a sharp recovery, growing over 6 per cent for the year 2000 as a whole. To-gether with the appreciation of the currency and a rising oil import bill, this led to a doubling of thetrade deficit, to an estimated $20 billion, and pushed the current-account deficit to an unprec-edented 5 per cent of GNP.

Even though real interest rates fell sharply during the year, there were considerable arbitrage op-portunities for foreign capital, since the nominal depreciation of the currency fell far short of thedifferentials with foreign interest rates. Consequently, until the crisis broke out in November, pri-vate capital inflows and large-scale foreign borrowing by the Treasury were more than sufficient tomeet the growing current-account deficit, resulting in increases in reserves and an expansion ofdomestic liquidity. The latter, together with the shift in government borrowing from domestic tointernational markets, helped to lower interest rates, thereby supporting aggregate demand.

As in most emerging-market crises, it is difficult to identify a single event behind the collapse ofconfidence and flight from domestic assets that occurred in November 2000. Probably the mostimportant factors included: disappointing inflation results for October; unexpectedly high monthlytrade deficits; political difficulties encountered in privatization; worsening relations with the EU;the economic situation in Argentina; and disclosure of irregularities in the banking system and acriminal investigation into several banks taken over by the Deposit Insurance Fund. There mayalso have been a rush to liquidity due to competitive manoeuvring among some private banks.However, quite apart from all this, the programme had clearly run into the familiar problems ofexchange-rate-based stabilization that relies on short-term arbitrage flows. As confidence eroded,foreign creditors refused to roll over their contracts with local banks. For their part, the banks soldliras in an effort to reduce their end-of-year open foreign exchange positions. The exit from the liracreated difficulties for banks relying on foreign funds and resulted in a liquidity crunch and a hikein interest rates by draining international reserves. Banks carrying large T-bill portfolios withfunds borrowed in overnight markets suffered significant losses and bid for funds in the interbankmarket, at the same time unloading large amounts of government paper. Within a few days stockprices plummeted and overnight rates reached three-digit levels. The CBOT faced the classicaldilemma posed by loss of confidence under currency-board regimes: either to defend the monetaryrule and, ultimately, the currency peg, at the expense of a deeper financial crisis, or to act as alender of last resort and rescue the financial system by injecting liquidity over and above its netdomestic asset targets. After some hesitation it started supplying liquidity to troubled banks. Butthis only served to accelerate the erosion of international reserves as the sale of liras on the foreignexchange market accelerated.

Within a few days the CBOT reversed its policy and – evidently after consultations with, andsecuring commitments from, the IMF – reinstated the currency-board rule, with a new ceiling ondomestic assets. As liquidity injection was discontinued and reserves were still sufficient to meetshort-term external liabilities, capital outflows stopped, but interest rates shot up, overnight ratesreaching four-digit levels. At the beginning of December a new agreement was reached with theIMF, including a financial package of some $10.5 billion. The Government undertook fresh com-mitments, including further spending cuts and tax increases, dismantling of agricultural supportpolicies, liberalization of key goods and services markets, financial sector restructuring and priva-tization. It also extended guarantees for foreign creditors, as well as for all depositors at localbanks, in order to help restore confidence in the banking system.

Although reserves and interest rates were stabilized, it became increasingly clear that the pro-gramme was not viable. Inflation remained above the monthly rates of depreciation of the currencyvis-à-vis the basket, leading to further appreciation of the currency. Interest rates stayed very high,at some 65 per cent on the newly issued T-bills, as lira assets continued to be viewed as highly risky,and the economy went into contraction. The last straw was a political skirmish in February 2001, at

Box 2.2 (continued)


able macroeconomic outlook, they also reflecteda recent strengthening of the links between equityprices in emerging markets and those in majordeveloped countries. This was evident, for example,in increased daily correlations between emerging-market indices and the NASDAQ index (see IIF,2001; Mathieson, Schinasi et al., 2000, box 3.3). Inpart, this is a response to the growing importancein emerging stock markets of firms belonging tothe technology, media and telecommunicationssector: from the end of 1995 to the end of 2000the share in equity indices of such firms increasedfrom 18 per cent to 32 per cent in Latin America,and from below 15 per cent to more than 23 percent in Asia.8 But the correlations are probablyalso due to a growing tendency amongst interna-tional investors to associate emerging-marketequities as a class more closely with high-risk seg-ments of developed-country markets.

In Asian emerging-market economies therehas generally been little change in monetary con-ditions (see chart 2.4 for selected countries). Themain exceptions were Indonesia, where conditionstightened slightly throughout 2000, and the Phil-ippines, where they tightened in the last quarter,partly in response to political uncertainty. Severalcountries in the region experienced currency depre-

ciations in 2000: these varied from minor move-ments (Singapore and Taiwan Province of China)to relatively large declines (15 per cent in Thailand,24 per cent in the Philippines, and 38 per cent inIndonesia). Movements of real effective exchangerates were smaller, and the indices for the greatmajority of Asian emerging-market countries re-main below their levels of early 1997.9

In Latin American emerging markets, mon-etary conditions were subject to greater variation.The sharp tightening in Argentina in response toits financial crisis is described in box 2.1. A numberof other countries (Brazil, Chile, Colombia andMexico) have adopted inflation targets as a ma-jor element in determining their monetary policy(JP Morgan, 2000b: 19–22.), though the defini-tion of the target varies and, thus, the relation be-tween the monetary stance and the current rate ofinflation. In Brazil and Chile monetary conditionstended to ease during 2000, while in Colombiagradual tightening was followed by stabilization,and in Mexico short-term rates of interest weresubject to substantial fluctuation (chart 2.4). InVenezuela interest rates drifted for much of theyear and subsequently decreased, and in Peru theoverall direction was also towards greater ease,though this movement was subject to interruptions,

the time of writing this report, which triggered a massive outflow of capital, forcing the Govern-ment to abandon the currency peg and move to floating, again with the support of the BrettonWoods institutions. Within a few days the currency lost about one third of its value against thedollar and overnight rates reached four-digit figures.

The Government declared its intention of continuing to implement the stabilization programme,targeting directly the inflation rate. This would effectively mean a return to traditional stabilizationpolicies, the success of which would depend in large part on macroeconomic tightening. The com-bination of fiscal tightening, interest rate hikes and the collapse of the currency could push theeconomy into a deep recession, in much the same way as in the Republic of Korea. However, theburden placed on the poor may become politically unacceptable, particularly since it would becoming on top of a highly unequal income distribution and falling living standards. If inflation isnot rapidly reduced and growth restored with the help of exports and official aid, it may prove verydifficult to persist with tight macroeconomic policies. Under such circumstances inflation maycome back with greater force.

Box 2.2 (concluded)


Chart 2.3

EQUITY PRICE INDICES OF SELECTED EMERGING-MARKET ECONOMIES,JANUARY 1999 TO JANUARY 2001

(January 1999 = 100; local currency terms)

Source: Primark Datastream.

Czech RepublicHungaryPolandSouth Africa

ChinaIndonesiaMalaysiaPhilippinesRep. of KoreaThailand

Ind

ice

s

Ind

ice

s

Jan-99 Jan-00 Jan-01Jul-99 Jul-00




800

700

600

500

400

300

200

100

0

Ind

ice

s

Argentina

Turkey

250

200

150

100

50

Brazil

Mexico

Venezuela

Ind

ice

s

250

200

150

100

50

250

200

150

100

50


Chart 2.4

EXCHANGE RATES AND MONEY-MARKET RATES IN SELECTEDEMERGING-MARKET ECONOMIES, JULY 1999 TO JANUARY 2001

/...

Peso

sp

er$

Re

al p

er$

Argentina

Mexico

Brazil

Venezuela

Exchange rate: left-hand scale Money-market rate: right-hand scale

5

4

3

2

1

0

5

4

3

2

1

0

10

8

6

4

2

0Jul 1999 Jan 2000 Jul 2000 Jan 2001 Jul 1999 Jan 2000 Jul 2000 Jan 2001

Jul 1999 Jan 2000 Jul 2000 Jan 2001 Jul 1999 Jan 2000 Jul 2000 Jan 2001



Perc

ent

Perc

ent

Perc

ent

20

15

10

5

0

16

12

8

4

0

16

12

8

4

0

12

10

8

6

4

2

0

Peso

sp

er$

30

25

20

15

10

5

0

25

20

15

10

5

0

Perc

ent

25

20

15

10

5

0

10

0b

oliv

are

sp

er$

40

30

20

10

0

Perc

ent

20

15

10

5

0

Indonesia

10

00

rup

iahs

pe

r$

Rin

gg

itp

er$

Malaysia

Perc

ent

4

3

2

1

0

Peso

sp

er$

Philippines150

100

50

0

Perc

ent

10

0w

on

pe

r$

Republic of Korea40

30

20

10

0

Perc

ent

10

5

0


Chart 2.4 (concluded)

EXCHANGE RATES AND MONEY-MARKET RATES IN SELECTEDEMERGING-MARKET ECONOMIES, JULY 1999 TO JANUARY 2001

Source: Primark Datastream; JP Morgan, Global Data Watch, various issues.Note: Argentina, Brazil, Mexico, Indonesia, Malaysia, Philippines, Republic of Korea, Singapore, Taiwan Province of China,

Thailand, Czech Republic, Hungary and Poland: three-month domestic money-market rates or nearest equivalent;Venezuela: average lending middle rate; South Africa: discount three-month middle rate; Turkey: three-month Treasurybill rate.

Exchange rate: left-hand scale Money-market rate: right-hand scale



Jul 1999 Jan 2000 Jul 2000 Jan 2001


Jul 1999 Jan 2000 Jul 2000 Jan 2001

5

4

3

2

1

0

Singapore

Sing

ap

ore

do

llars

pe

r$

Perc

ent

4

3

2

1

0

Taiwan Province of China

Taiw

an

do

llars

pe

r$

Perc

ent

80

60

40

20

0

6

5

4

3

2

1

0

Bahtp

er$

ThailandPe

rc

ent

125

100

750

50

25

0

5

4

3

2

1

0

Koru

ny

pe

r$

Czech Republic

Perc

ent

100

75

50

25

0

8

6

4

2

0

Forin

tp

er$

Hungary

Perc

ent

16

12

8

4

0

800

600

400

200

0

Poland

Zlo

tys

pe

r$

Perc

ent

10

8

6

4

2

0

20

15

10

5

0

South Africa

Ra

nd

pe

r$

Perc

ent

20

15

10

5

0

14

12

10

8

6

4

2

0

2500

2000

1500

1000

500

0

70

60

50

40

30

20

10

0

Turkey

Lira

sp

er$

Perc

ent


for example, owing to political unrest in the thirdquarter. The spot exchange rates of Latin Ameri-can emerging-market countries generally re-mained fairly stable, Brazil and Chile experienc-ing small depreciations and Colombia a larger one.Movements of real effective exchange rates weremore marked, generally in the direction of appre-ciation. Since 1997, relative competitiveness asmeasured by this indicator has improved some-what in Brazil and Peru, but declined in Argen-tina, Chile and Mexico.

Turkey was struck by a financial crisis in thefinal quarter of 2000, as creditors’ confidence brokedown in an exchange-rate-based stabilizationprogramme that relied heavily on capital inflows(box 2.2). In other emerging-market economies,

exchange rates and interest rates were mostly sub-ject to only small movements (chart 2.4). The prin-cipal exception was South Africa, where the ex-change rate came under attack in late 2000, a yearduring which the rand depreciated more than20 per cent. In Hungary, monetary conditionstightened late in 2000, and in Poland monetarypolicy loosened at the end of the year after earliertightening, while conditions changed little in theCzech Republic. The currencies of the three lat-ter countries depreciated slightly during part ofthe year but strengthened subsequently. Their realeffective exchange rates appreciated, with the risefor Poland being more than 10 per cent. Thelonger-term movements have also tended towardsappreciation since 1997, though for Hungary thechange has been minimal.

E. Private capital flows to emerging-market economies

The uncertainty surrounding the forecasts inearly 2000 of private capital flows to emergingmarkets proved to be justified: during the secondpart of the year there were substantial downwardrevisions of both provisional estimates of such fi-nancing and of new forecasts. Provisional figuresfor 2000 still point either to little change or to afall from 1999 levels. The outlook for 2001 isagain highly uncertain, owing partly to the diffi-culty in forecasting the impact on financial flowsof slowing economic growth in major industrialcountries, particularly the United States (see chap-ter I, section A), and partly to the awareness thatlinks and fault lines in the new global network offinancial markets are not fully understood and thushard to identify in advance.

1. Developments in 2000

Of the two sets of estimates in table 2.6, oneshows a small rise in net private external financ-ing for developing and transition economies andthe other a sharp decline.10 Since both series areprovisional, they may yet be substantially revised.Nonetheless, they are indicative of the continu-ing shortfall of such financing in comparison withthe levels achieved in 1996–1997. The totals re-flect considerable regional divergences. The IMFestimates show substantial declines for Asia, theMiddle East and Europe, a slight recovery forLatin America, and little change for Africa. If al-lowance is made for the effect of outflows due to


Table 2.6

NET CAPITAL FLOWS TO DEVELOPING AND TRANSITION ECONOMIES, 1997–2000:ESTIMATES OF THE INSTITUTE FOR INTERNATIONAL FINANCE AND THE IMF


Type of flow/region 1997 1998 1999 2000

Estimates of the Institute for International Finance

Net private capital inflows

Total 269 139 148 154

by category:

Private creditorsCommercial banks 44 -54 -43 -16Non-bank private creditors 84 59 28 20

Equity investmentDirect equity 116 119 146 128Portfolio equity 25 15 18 22

by region:

Africa/Middle East 15 6 10 7Asia/Pacific 73 -1 31 49Europe 74 56 36 30Latin America 107 99 71 68

Memo item:Resident lending/other, net a

Total -197 -147 -125 -127Africa/Middle East -4 1 -5 -6Asia/Pacific -105 -73 -60 -73Europe -56 -26 -25 -27Latin America -33 -49 -36 -20

Estimates of the International Monetary Fund

Net private capital inflows

Total 115 66 67 36

Net direct investment 141 152 155 142Net portfolio investment 39 0 5 17Other net flows b -66 -86 -92 -123

Africa 12 7 10 9


Asia 7 -41 2 -18

Net direct investment 55 60 54 48Net portfolio investment 8 -15 4 5Other net flows b -57 -85 -56 -71

Middle East and Europe 23 10 1 -18

Net direct investment 7 8 5 8Net portfolio investment -6 -17 -10 -7Other net flows b 21 19 6 -20

Western hemisphere 68 62 40 48


Transition economies 6 28 13 16

New direct investment 17 20 21 22Net portfolio investment 11 6 -7 8Other net flows b -22 2 0 -14

Source: IIF (2001); IMF (2000a).a For explanation of this term, see note 10.b Other net flows comprises other long-term net investment flows, including official and private borrowing.


net lending by residents and selected other adjust-ments to the estimated net private flows, theregional pattern for 2000 displayed by the IIF fig-ures is not dissimilar, with some recovery in LatinAmerica, little change in Africa, a decline in Eu-rope and continuing net outflows for Asia.

A major factor in the decline in net privatefinancial flows to developing and transition econo-mies since 1997 has been the contraction of banklending. Since 1998, repayments to banks havetended to exceed new loans, and the total expo-sure of BIS-reporting banks to these economieshas decreased by more than $150 billion since1997 (table 2.7). The contraction in lending ofBIS-reporting banks slowed in the first two quar-ters of 2000. It reflected primarily developmentsin East and South Asia, net repayments by which

were responsible for a larger part of the decline innet total lending to developing and transitioneconomies in 1999.

Elsewhere, experience in the first half of 2000was varied. The decrease in banks’ exposure toEastern Europe was strongly influenced by the fig-ure for the Russian Federation. In Latin America,much of the rise was due to lending to Mexico,much of which was associated with the financingof Spanish banks’ purchases of Mexican finan-cial firms (BIS, 2000a: 19). The growth in BIS-reporting banks’ claims on Africa was relativelylittle affected by the financial crises of the 1990s.Although exposure to certain countries such asEgypt, Morocco and Tunisia has increased signifi-cantly in recent years, the total borrowing of theregion nonetheless remains relatively small.

Table 2.7

EXTERNAL ASSETS OF BANKS IN THE BIS REPORTINGa AREA VIS-À-VISDEVELOPING AND TRANSITION ECONOMIES, 1997–2000

Stock1997 1998 1999 2000b (end-June 2000)

Percentage rates of increasec $ billion

Totald 8.6 -7.7 -8.5 0.4 884

of which in:

Latin America 11.3 -2.8 -5.6 2.7 288

Africa 19.6 0.3 0.8 -0.9 43

West Asia 16.5 18.0 1.4 -0.2 78

East and South Asia 1.1 -21.7 -17.1 -1.5 305

Central Asia 35.5 17.6 26.9 -2.1 3

Eastern Europe 19.4 -0.4 -1.5 -4.4 95

Other Europee 27.1 9.4 15.6 11.1 54

All borrowersf 15.4 3.0 2.5 5.8 10252

Source: BIS, International Banking and Financial Market Developments, various issues.a Including certain offshore branches of United States banks.b First two quarters.c Based on data for the end of the period after adjustment for movements of exchange rates.d Excluding offshore banking centres, i.e. in Latin America: Bahamas, Barbados, Bermuda, Cayman Islands, Netherlands

Antilles, and Panama; in Africa: Liberia; in West Asia: Bahrain and Lebanon; and in South-East Asia: Hong Kong(China), Singapore and Vanuatu, but including residual amounts which could not be attributed to countries.

e Malta, Bosnia and Herzegovina, Croatia, Slovenia, The former Yugoslav Republic of Macedonia, and Yugoslavia.f Including multilateral institutions.


Recent financial crises have been followedby a lengthening of the maturity profile of out-standing bank loans to the countries affected.Thus, in Indonesia, Malaysia, Philippines, theRepublic of Korea and Thailand, the proportionof bank claims with a residual maturity of one yearor less fell from over 65 per cent in late 1993 toabout 50 per cent by the end of 1998.11 Since then,movements have been less marked, though therehas been a continuing decline in the proportion ofloans with short maturities for the Philippines anda rise for the Republic of Korea (where much ofthe upturn was due to maturing longer-term debtrather than new short-term borrowing). In theRussian Federation, loans with a residual matu-rity of up to one year declined (partly as a resultof restructuring exercises), from 46 per cent inmid-1998 to 26 per cent in mid-2000, and in Bra-zil they fell from 63 per cent to 54 per cent duringthe same period. Elsewhere the degree of concen-tration of bank debt at short-term maturities hasvaried among countries and regions, the share of

such maturities for African and West Asian coun-tries, for example, being about 55 per cent and thatfor Eastern European countries only 40 per cent.

Latin American borrowers were once againthe most important issuers of international bondsand other debt securities, accounting for more than50 per cent of total net issues in the first threequarters of 2000 (table 2.8). During the year anumber of such borrowers also exchanged Bradybonds for Eurobonds at lower interest rates andlonger maturities.12 Preliminary figures indicate adecrease in issuance in the fourth quarter of 2000(which reflects, inter alia, the absence from themarket of Argentina and Turkey, substantial issu-ers earlier in the year), and a recovery early in2001 (as in 2000, driven mainly by Latin Americanborrowers). Outstanding issues of debt securitiesby developing countries remain heavily concen-trated among a restricted group of borrowers andamount to less than half of BIS-reporting banks’exposure to them (a figure similar in magnitude

Table 2.8

INTERNATIONAL ISSUANCE OF DEBT SECURITIESa BY DEVELOPINGAND TRANSITION ECONOMIES,b 1997–2000


Gross issuesc Net issues

1997 1998 1999 2000d 1997 1998 1999 2000d

Total 123.6 78.3 79.2 69.8 82.1 37.4 34.1 30.8

of which in:

Latin America 64.0 43.0 48.0 39.9 41.1 22.5 26.4 21.8

East and South Asia 39.8 10.8 16.7 15.2 25.4 -0.7 -1.1 1.9

Europe 11.4 20.4 10.3 11.1 11.1 15.1 6.5 4.7

Memo item:

World 1508.6 1657.2 2305.0 993.0 560.4 681.1 1215.4 797.7

Source: UNCTAD secretariat calculations, based on BIS, International Banking and Financial Market Developments, variousissues.

a International money market instruments and international bonds and notes, classified by residence of issuer.b Other than offshore financial centres.c Gross issues include gross issuance of money market instruments and announced issues of international bonds and

notes.d First three quarters.


to that of outstanding bank loans with a residualmaturity of up to one year).

The spreads on the international bonds ofemerging-market economies (chart 2.5) were sub-ject to considerable country-by-country variationuntil October, when there were widespread increaseswith the advent of more unsettled conditions infinancial markets, the rises being most marked forArgentina, Brazil, the Philippines and Turkey.Spreads then stabilized or fell slightly towards theend of the year, probably partly in response to thepackages of international financial support puttogether for Argentina and Turkey.

After a period of relative buoyancy in theaftermath of the financial crises of the late 1990s,net flows of foreign direct investment (FDI) todeveloping and transition economies decreased in2000. But much of the contraction was accountedfor by a limited number of recipients; for someAsian countries the rise in FDI which followedthe region’s financial crisis may have largely runits course, and the figures for the Republic ofKorea were reduced by an increase in outwardFDI; as regards Argentina, the figure fell backfrom a level boosted in the previous year by theproceeds of a single privatization project (the pe-troleum conglomerate, YPF; TDR 2000, chap. III,sect. E.1). Flows of FDI to Brazil continued toremain high, preliminary estimates being of a mag-nitude similar to the country’s deficit on currentaccount.

Capital flows to developing and transitioneconomies in the form of private equity can taketwo forms: international equity issues and foreigninvestment in local equity markets. Sums raisedin the first form amounted to more than $32 bil-lion in the first three quarters of 2000, a little morethan 50 per cent of the figure being due to issuersin East and South Asia (BIS, 2000a, table 18). Sepa-rate figures for foreign investment in local equitymarkets in 2000 are not yet available, but provi-sional estimates of the IIF for all forms of foreignportfolio equity investment fall well short of thatgiven above for international issues for the firstthree quarters only, pointing to the probability ofsubstantial net foreign disinvestment in local eq-uity markets. Much of the disinvestment is likelyto have taken place in the second half of the yearin response to the widespread price falls described

in the preceding section. Indeed, a two-way con-nection between such falls and foreign disinvest-ment was probably at work here, each giving ad-ditional impetus to the other.

2. Outlook

The outlook for private financial flows todeveloping and transition economies remainsuncertain. One view emphasizes that emerging-market economies as a group are now less sus-ceptible to financial shocks owing to such featuresas lower dependence on short-term bank debt andmore flexible exchange rate regimes. But as theexperience of Argentina and Turkey during thepast year has shown, reduced vulnerability for thegroup does not necessarily imply that individualcountries are innoculated against the outbreak ofserious balance-of-payments problems. Moreover,the access of emerging-market economies to pri-vate external financing remains linked, throughvarious channels, to global conditions. Some ofthese channels involve traditional connectionsbetween their access to financing and prospectsfor global economic growth, trade, as well as forthe terms of trade.13 Others involve a prominentrole for impulses between different financial mar-kets which are generally very difficult to forecast:these include contagion effects between emerg-ing markets themselves as well as destabilizinginfluences transmitted from markets in the Northto those in the South.

Relations between markets in developed andtransition economies, on the one hand, and inindustrial countries, on the other, are subject tochange as a result of various processes associatedwith greater financial integration. In the precedingsection reference was made to recent strengtheningof the links between equity markets in emerging-market economies and developed countries. Otherchanges have been in the direction of greaterdecoupling. For example, during the first halfof 2000 the trend in spreads on the debt of de-veloping countries was downwards at a timewhen spreads of high-yield debt of developed-country borrowers denominated in dollars andeuros were moving upwards (BIS, 2000b: 5–6; IIF,2001: 9). Moreover, the heightened volatility of


Chart 2.5

YIELD SPREADa OF SELECTED INTERNATIONALLY ISSUED EMERGING-MARKET BONDS,JULY 1999 TO JANUARY 2001

(Basis pointsb)

Source: Primark Datastream.a Differential between the yield on a representative bond issued by the borrowing country and those of the same maturity

issued by the Government of the country in whose currency the borrower’s bonds are denominated.b One basis point equals 0.01 per cent.

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the NASDAQ index during 2000 was accompa-nied by a weakening of its link with the yield onthe debt of emerging market economies.14 Never-theless, major turbulence in the financial marketsof developed countries may continue to have im-portant spillover effects in emerging markets. Andrecent experience indicates that owing to newmethods of risk management, such as techniquesof cross-border hedging, some of the fault linesassociated with these effects are difficult to iden-

tify in advance.15 Thus, financial flows to devel-oping and transition economies are now subjectnot only to traditional supply-driven influencesoriginating in industrial countries, such as thosedue to shifts in monetary policy and in the riskaversion of investors and lenders, but also to theimpact of portfolio management decisions of in-ternational financial firms which may have littleconnection to the fundamentals of the countrieswhose markets are affected.

F. External financing and debt of the least developed countries

The LDCs are the major “pocket of poverty”in the world economy. As domestic savings inthese countries are insufficient to attain a fasterpace of growth, they continue to depend on exter-nal finance, and especially on official capitalflows, for the financing of their development. Butaggregate net capital inflows fell in the 1990s, inreal as well as in nominal terms and in relation tothe recipient countries GDP (table 2.9).

Given their weak economic fundamentals andhigh-risk profiles, most LDCs have practically nodirect access to international capital markets.While for developing countries as a group, pri-vate flows other than FDI represented almost halfof the net aggregate capital inflow in the 1990s,and about 2.3 per cent of their GDP, such privateinflows into LDCs were negligible over much ofthe past decade and were even negative in 1998and 1999. Flows of FDI to LDCs are also rela-tively small, but in relation to GDP they have beenalmost as important for LDCs as a group as forother developing countries. However, FDI in LDCshas been mainly in mineral extraction rather thanin manufacturing, and has essentially been con-centrated on a few countries that are rich in oil,gas and other natural resources.

Official capital continues to be the predomi-nant source of external financing of the LDCs; formore than a decade, the share of official flows intheir long-term inflows has remained at around88 per cent, whereas in other developing coun-tries this share had steadily declined to around20 per cent by the end of the 1990s (TDR 1999,table 5.1, and UNCTAD, 2000b: 56).

During the 1990s, official capital flows to alldeveloping countries declined considerably inboth nominal and real terms,16 and despite therhetoric about poverty alleviation, ODA grants andbilateral credits to LDCs, where the incidence ofpoverty is the highest, have also fallen. Indeed,unlike other aid recipients, the LDCs did not ben-efit from the partial recovery in nominal officialflows during 1998–1999. As a share of donor GNP,aggregate official flows from the members of theOECD’s Development Assistance Committee(DAC) to the LDCs amounted to only 0.05 percent from 1997 through 1999 – far short of thetarget ratio of 0.15 per cent set at the SecondUnited Nations Conference on the Least Devel-oped Countries in 1990. It is also only half of whatit was at the beginning of the 1990s, in spite ofthe commitments by donors to increase aid to the


LDCs. Among the members of DAC, only fivecountries met the 0.15 per cent target in 1999:Denmark (0.32 per cent), Luxembourg (0.16 percent), the Netherlands (0.16 per cent), Norway(0.30 per cent) and Sweden (0.17 per cent)(OECD, 2000b, table 31).

Apart from insufficient inflows of capital,especially in the form of long-term credit andgrants, the majority of LDCs continue to be bur-dened with a serious debt overhang. In 1999,outstanding external debt of the LDCs as a shareof their aggregate GDP amounted to 89 per cent,and the average ratio of debt service paid (as op-posed to scheduled payments) to exports was15 per cent. A number of countries continued tobe unable to meet their obligations in full, accu-mulating further arrears on scheduled payments.

Given their debt overhang, there is an urgentneed to reduce the debt burden of LDCs. Amongthe 41 countries identified as heavily indebtedpoor countries (HIPCs), 31 are LDCs. By the endof 2000, a total of 22 countries, 17 of which areAfrican LDCs, had reached the “decision point”under the HIPC Initiative, and are due to startreceiving interim debt relief from multilateralcreditors as well as enhanced relief from ParisClub creditors. So far, Uganda is the only LDC tohave reached the “completion point” under theInitiative, whereby it is entitled to enjoy the fullbenefits provided by the Initiative. Meanwhile, anadditional 11 LDCs, most of which are affectedby conflicts, have a debt burden that is regardedas unsustainable according to HIPC criteria, evenafter the application of traditional relief mecha-nisms. However, under current procedures it maytake several years before these countries are ableto fulfil the conditions required to reach the de-cision point. Moreover, there are several debt-stressed LDCs which are not defined as HIPCs(UNCTAD, 1999, box 3).

Current expectations regarding the economicimpact of the HIPC Initiative on countries whichhave reached decision point are unrealistic. First,the additional fiscal space which is opened up bythe Initiative is not particularly large. While themagnitude of debt relief appears significant interms of a reduction in the present value of futuredebt service obligations, the annual savings ondebt service provided through HIPC assistance

per se up to 2005 are modest for most countriesthat have reached decision point. Secondly, themedium-term forecasts of a durable exit from thedebt problem assume high rates of economic andexport growth, sustained over a long period, of-ten over and above the rates achieved in the 1990s,as well as declining import intensity of growth.Thirdly, there is a risk that the financial resourcesfreed by the debt relief will not be fully additional.For 14 of the 17 African LDCs which have reacheddecision point, official flows fell considerablybetween 1996 and 1999. This suggests that, withthe provision of HIPC assistance, there may be ageneral reduction in such flows unless there is achange in official attitudes; throughout the 1990sofficial capital flows to LDCs were closely related

Table 2.9

CAPITAL INFLOW OF LDCs BY TYPE OFFLOW, AND NET TRANSFER, 1990–1999

(Percentage of GNP)

1990–Type of flow 1997 1998 1999

Total net inflow 10.5 7.7 7.5

Official inflows 9.2 6.4 6.0

ODA grants a 6.5 4.8 4.7

Official credit 2.7 1.6 1.4

Bilateral 0.3 -0.1 -0.4Multilateral 2.4 1.7 1.7

Private inflows 1.3 1.3 1.5

Foreign direct investment 1.1 1.5 1.6

Other 0.2 -0.2 -0.1

Interest payments 0.9 0.8 0.8

Profit remittances 0.6 0.5 0.6

Net transfer b 9.0 6.4 6.1

Source: UNCTAD secretariat calculations, based on WorldBank, Global Development Finance, 2001, preliminaryversion (CD-ROM).

a This item corresponds to “Grants” as defined by theWorld Bank in the source and excludes funds allo-cated through technical cooperation.

b Net capital inflow less interest payments on externaldebt and profit remittances.


to their indebtedness and levels of debt servicepayments (UNCTAD, 2000b: 123–6).

Furthermore, the HIPC process has becomeeven more complicated with the explicit linkingof debt relief to poverty alleviation, through Pov-erty Reduction Strategy Papers. As has recentlybeen suggested by the Dutch Minister for Devel-opment Cooperation, if the successful implemen-tation of these wide-ranging poverty reductionstrategies requires broader and faster debt relief,then development partners will have to be pre-pared to provide additional financing.17

An important and welcome developmentin 2000 was the commitment by an increasingnumber of creditor countries, in the context of theHIPC Initiative, to grant full cancellation of bilat-eral debt. However, the commitment does notinvolve a rapid or across-the-board cancellation forall LDCs, and implementation will depend on theirprogress in economic policy reforms and povertyreduction. Country coverage, timing of relief, andthe coverage of debts (including post-cut-off-datedebt) can also be expected to vary among creditors.

The underlying economic problems of LDCsare manifold, so that debt write-off alone will beinsufficient to set them on a path of sustainabledevelopment. A solution to their debt problem isnonetheless a necessary condition, and the spe-cial situation of LDCs requires an assessment oftheir needs for debt relief quite independently ofHIPC considerations. Given that debt forgivenesscannot be expected to be forthcoming swiftly,interim arrangements should be considered to al-low for immediate alleviation of their acute debtburden. To that end, and pending the full imple-mentation of the HIPC Initiative, an immediatesuspension of the debt-service payments of allLDCs, without any additional interest obligations,should be considered. In this way, rather thanhaving to divert scarce resources to service debt,governments would be able to use them to financebadly needed social expenditure programmes andproductive investments. For the same reason, itis also necessary to reverse the declining trend ofofficial financing. In the absence of adequate pri-vate capital inflows, a greater injection of officialexternal finance is indispensable for kick-startingthe capital accumulation process in LDCs.18

Notes

1 It is not easy to fully account for serious discrepan-cies, in magnitude and even in direction in somecases, in time series for trade published by WTO,IMF and UN/DESA.

2 For some of the reasons underlying the discrepancybetween world exports and imports, see TDR 2000(chap. III, note 1).

3 For a detailed discussion on the role of intra-Asiantrade in the recovery of the East Asian economies,see TDR 2000 (chap. III).

4 The United States deficit on trade in goods and serv-ices in 2000 is estimated by IMF to be in the orderof $360 billion, and the current-account balance in

the order of $420 billion (4.2 per cent of GDP).JP Morgan estimates it to be as high as $439 billion(4.4 per cent of GDP). See IMF (2000a, table I.2 andappendix tables 27 to 29) and JP Morgan (2000a).

5 Average spot price of the basket of seven crude oilsproduced by members of OPEC.

6 The marginal cost of production in the highest-costareas of non-OPEC countries ranges from $10 to$15 per barrel. Consequently, an oil price of notmuch higher than $15 per barrel should, in princi-ple, provide oil companies with sufficient incentivesto operate in these high-cost areas. However, un-like other commodities, oil is a strategic resource


and its price is also influenced by speculative fac-tors. For a more detailed discussion of the factorsshaping the world oil market in recent years, seeTDR 1999 (Part One, chap. III, sect. E).

7 For a discussion of recent debate on different re-gimes for the exchange rate, see Part Two, chap. V.

8 See IIF (2001: 11). The technology, media and tele-communications sector has accounted for an evenhigher share of recent international equity issuanceby emerging-market economies: 57 per cent in 1999and 77 per cent in the first half of 2000. SeeMathieson, Schinasi et al. (2000, box 3.5).

9 The real effective changes cited here are the estimatesof JP Morgan available at www.jpmorgan.com.

10 Differences among institutions in estimates of pri-vate financial flows to developing and transitioneconomies reflect mainly differences in coverageand in methods of estimation. The estimates of IMFcover the great majority of its member countries.They are on a balance-of-payments basis and, thus,net of outflows by residents. The IIF covers a sam-ple of 29 “emerging-market economies”, and its es-timates of net private flows are before adjustmentsfor net lending by residents, changes in monetarygold, and errors and omissions in the balance ofpayments, which typically represent a substantialproportion of its figures for net private flows. TheIIF estimates of January 2001 reflect a substantialdownward adjustment in comparison with those ofSeptember 2000, which projected a figure of $188billion for net private flows for the year as a whole,with an offsetting item of $127 billion for “residentlending/other”.

11 The data on the residual maturity of BIS-reportingbanks’ exposure to countries have been taken fromvarious BIS press releases on BIS-consolidated in-ternational banking statistics.

12 Exchanges of Brady for new bonds are partly thereason for the substantial divergence between grossand net issues of international bonds reported in ta-ble 2.8. The incentives for such exchanges typicallyinclude: gaining access to collateral in the form ofUnited States Treasury instruments backing theBrady bonds; reduction of the country’s debt stockin cases where the Brady bonds are exchanged at adiscount; and extension of the yield curve for thecountry’s internationally issued debt instruments tothe extent that the new bonds carry long maturities.

13 For a discussion of the various channels of trans-mission between developments in the global econo-my and capital flows, see JP Morgan (2000c: 7–8).

14 For a discussion of correlations between the yieldon emerging-market debt and the NASDAQ index,see Mathieson, Schinasi et al. (2000, chap. III, box 3.3).

15 For further discussion of evidence concerning theeffects of these methods, see Cornford (2000a: 3).

16 For a more detailed analysis of the long-term pat-terns of external financing in the developing coun-tries, see TDR 1999 (Part Two); and for a discus-sion of external financing in Africa, where mostLDCs are located, see UNCTAD (2000c).

17 E. Herfkens, “Bringing Solidarity to Brussels”,speech given at UNCTAD Trade and DevelopmentBoard, Geneva, 27 February 2001.

18 For a more detailed discussion, see TDR 1998 (PartTwo), and UNCTAD (2000c).

Part Two

REFORM OF THE INTERNATIONALFINANCIAL ARCHITECTURE

61Towards Reform of the International Financial Architecture: Which Way Forward?

The increased frequency and virulence ofinternational currency and financial crises, involv-ing even countries with a record of good govern-ance and macroeconomic discipline, suggests thatinstability is global and systemic. Although thereis room to improve national policies and institu-tions, that alone would not be sufficient to dealwith the problem, particularly in developing coun-tries, where the potential threat posed by inher-ently unstable capital flows is much greater. Astrengthening of institutions and arrangementsat the international level is essential if the threatof such crises is to be reduced and if they are tobe better managed whenever they do occur. Yet,despite growing agreement on the global and sys-temic nature of financial instability, the interna-tional community has so far been unable to achievesignificant progress in establishing effective glo-bal arrangements that address the main concernsof developing countries.

In the aftermath of the Asian crisis a numberof proposals have been made by governments,international organizations, academia and marketparticipants for the reform of the international fi-nancial architecture.1 They cover broadly four

areas: global rules and institutions governinginternational capital flows; the exchange rate sys-tem; orderly workouts for international debt; andthe reform of the IMF, with special reference tosurveillance, conditionality, the provision of inter-national liquidity, and its potential function aslender of last resort. Implementation of any ofthese proposals would entail the creation of newinternational institutions and mechanisms as wellas reform of the existing ones.

Some of these proposals have been discussedin the IMF itself, as well as in other internationalfinancial institutions, such as BIS and the newlyestablished Financial Stability Forum (FSF), andalso among the Governments of G-7 countries.While certain initiatives have been taken as aresult, the reform process, rather than focusing oninternational action to address systemic instabil-ity and risks, has placed emphasis on what shouldbe done by national institutions and mechanisms.Even in this regard it has failed to adopt an even-handed approach between debtors and creditors.Efforts have concentrated on disciplining debtors,setting guidelines and standards for major areasof national policy, principally in debtor countries,

Chapter III

TOWARDS REFORM OF THE INTERNATIONALFINANCIAL ARCHITECTURE:

WHICH WAY FORWARD?

A. Introduction


and providing incentives and sanctions for theirimplementation. Debtor countries have been urgedto better manage risk by adopting strict financialstandards and regulations, carrying adequateamounts of international reserves, establishingcontingent credit lines and making contractual ar-rangements with private creditors so as to involvethem in crisis resolution. The international finan-cial system has continued to be organized aroundthe principle of laissez-faire, and developing coun-tries are advised to adhere to the objective of anopen capital account and convertibility, and toresort to controls over capital flows only as anexceptional and temporary measure. All this hasextended the global reach of financial marketswithout a corresponding strengthening of globalinstitutions.

The failure to achieve greater progress is, toa considerable extent, political in nature. Theproposals referred to abovehave often run into conflictwith the interests of creditors.But governments in some debt-or countries also oppose re-form measures that wouldhave the effect of loweringthe volume of capital inflowsand/or raising their cost, evenwhen such measures could beexpected to reduce instabilityand the frequency of emerg-ing-market crises. Many ob-servers have been quick to dis-miss such proposals as notonly politically unrealistic butalso technically impossible.However, as long as systemicfailure continues to threatenglobal welfare, resistance to more fundamentalreform of the international financial architecturemust be overcome:

It is easy to fall into the trap of thinking thatbig institutional changes are unrealistic orinfeasible, especially in the United Stateswhere macroeconomic policy institutionshave generally evolved only slowly for thepast few decades. Not so long ago, the pros-pects for a single European currency seemed

no more likely than those for the breakupof the Soviet empire or the reunificationof Germany. Perhaps large institutionalchanges only seem impossible until theyhappen – at which point they seem foreor-dained. Even if none of the large-scale plansis feasible in the present world political en-vironment, after another crisis or two, theimpossible may start seeming realistic.(Rogoff, 1999: 28)

Part Two of this Report reviews the main ini-tiatives undertaken so far in the reform of the in-ternational financial architecture, and the advicegiven to developing countries in some key policyareas, such as structural reforms and exchange ratepolicy, for the prevention and management of in-stability and crises. The discussion follows froman earlier analysis, made in TDR 1998, and con-centrates on more recent developments. This chap-ter provides an overview of the issues, comparing

briefly what has so far beenachieved with the kind ofmeasures proposed in order toaddress systemic failures andglobal instability. The nextchapter reviews recent initia-tives regarding global stand-ards and regulation, whilechapter V discusses whetherdeveloping countries can bothkeep an open capital accountand avoid currency instabilityand misalignments by choos-ing appropriate exchange rateregimes, despite persistentmisalignments and gyrationsof the three major reserve cur-rencies and large swings in in-ternational capital flows. It

also assesses the scope for regional cooperationfor establishing collective defence mechanismsagainst financial instability, drawing on the EUexperience. The final chapter takes up the ques-tion of the management of financial crises andburden-sharing, and discusses the current state ofplay in two crucial areas, namely the provision ofinternational liquidity and the involvement of theprivate sector in crisis management and resolu-tion.

Rather than focusing oninternational action toaddress systemic instabilityand risks, the reformprocess has placedemphasis on what shouldbe done by nationalinstitutions and mecha-nisms. Even in this regard ithas failed to adopt an even-handed approach betweendebtors and creditors.


As the Second World War drew to an end, aset of organizations was envisaged which woulddeal with exchange rates and international pay-ments, the reconstruction and rehabilitation of wardamaged economies, and international trade andinvestment. The institutions established to handlethese issues were the IMF, the World Bank, andthe GATT. However, international capital move-ments did not fall within their purview. The origi-nal structure did not include a global regime forcapital movements in largepart because it was consideredthat capital mobility was notcompatible with currency sta-bility and expansion of tradeand employment. However, nosuch regime was establishedeven after the breakdown of theBretton Woods arrangements,despite the growing importanceof private capital flows (Akyüzand Cornford, 1999: 1–7).

The only global regimeapplying to cross-border mon-etary transactions was thatof the IMF, but the most im-portant obligations in its Arti-cles of Agreement relate to current and not capi-tal transactions. Concerning the latter, Article IVstates that one of the essential purposes of the in-ternational monetary system is to provide a frame-work facilitating the exchange of capital amongcountries, a statement which is included amonggeneral obligations regarding exchange arrange-ments. The more specific references to capitaltransfers, in Article VI, permit recourse to capitalcontrols so long as they do not restrict paymentsfor current transactions, and actually give the Fundthe authority to request a member country to im-

pose controls to prevent the use of funds from itsGeneral Resources Account to finance a large orsustained capital outflow. The only recent initia-tive regarding the global regime is the attempt toinclude capital convertibility among the objectivesof the IMF.

The BIS was originally set up as a forum fora small number of countries to deal with only cer-tain aspects of international capital flows.2 Since

the 1970s it has provided sec-retariat support for a numberof bodies established to reduceor manage the risks in cross-border banking transactions.These bodies are not respon-sible for setting rules for in-ternational capital movementsas such. Their work is aimed atreaching agreements on stand-ards to be applied by nationalauthorities for strengtheningthe defences of financial firms,both individually and in theaggregate against destabiliza-tion due to cross-border trans-actions and risk exposures.

The increased frequency of financial crises,together with the increasingly global character offinancial markets, has prompted both analysts andpractioners to formulate proposals for the crea-tion of a number of international institutionsexplicitly designed to regulate and stabilize inter-national capital flows. One such proposal is forthe creation of a global mega-agency for finan-cial regulation and supervision, or World FinancialAuthority, with responsibility for setting regula-tory standards for all financial enterprises, offshoreas well as onshore (Eatwell and Taylor, 1998; 2000).

B. The governance of international capital flows

The obligations contained inthe new codes andstandards initiatives seem toreflect the view that the mainflaws in the system forinternational capital move-ments are to be found inrecipient countries, whichshould thus bear the mainburden of the adjustmentsneeded to prevent or containfinancial crises.


Another proposal is to establish a Board of Overse-ers of Major International Institutions and Markets,with wide-ranging powers for setting standardsand for the oversight and regulation of commercialbanking, securities business and insurance.3 Yetanother proposal, which focuses on stabilizing in-ternational bank lending, is for the establishmentof an International Credit Insurance Corporationdesigned to reduce the likelihood of excessivecredit expansion (Soros, 1998).

These proposals are based on two arguments.The first is that, since financial businesses arebecoming increasingly interrelated and operateacross borders, their regula-tion and supervision should alsobe carried out on a unified andglobal basis. The second argu-ment focuses on the instabil-ity of capital movements un-der the present patchwork ofregimes, which only more glo-bally uniform regulation couldbe expected to address. What-ever their specific strengthsand weaknesses, these propos-als emphasize the need for in-ternational institutions andmechanisms that can preventexcessive risk-taking in cross-border lending and invest-ment, reduce systemic fail-ures, and eliminate several, of-ten glaring, lacunae in the na-tional regulatory regimes of creditor and debtorcountries. The official approach to these problemshas been quite different, focusing on loweringthe risk of financial distress and contagion bystrengthening the domestic financial systems indebtor countries. It has also emphasized theprovision of timely and adequate information re-garding the activities of the public sector and fi-nancial markets in debtor countries in order to al-low international lenders and creditors to makebetter decisions, thereby reducing market failure,as well as to improve bilateral surveillance.

As examined in some detail in chapter IV,various codes and standards have been establishedthrough institutions such as the IMF, BIS and theFSF not only for the financial sector itself, butalso in respect of macroeconomic policy and

policy regarding disclosure. While their applica-tion should be generally beneficial, particularlyover the long term, they will not necessarily con-tribute to financial stability, and in many casesthey will involve substantial initial costs. More-over, the programmes of reform required of recipi-ent countries are wide-ranging and do not alwaysaccommodate differences in levels of developmentand the availability of human resources.

Considered from the standpoint of systemicreform, the reform package contains many omis-sions and reflects an asymmetric view of differ-ent parties’ responsibilities for the changes re-

quired. In particular, it doesnot adequately address theconcerns of developing coun-tries over the frequently sup-ply-driven character of fluc-tuations in international capi-tal flows, which are stronglyinfluenced by monetary con-ditions in major industrialcountries, especially theUnited States, and over the li-quidity positions and herd be-haviour of lenders and inves-tors in those countries. The ob-ligations contained in the newcodes and standards initiativesseem to reflect the view thatthe main flaws in the systemfor international capital move-ments are to be found in re-

cipient countries, which should thus bear the mainburden of the adjustments needed to prevent orcontain financial crises. By contrast, new meas-ures to reduce volatile capital flows at source orto increase the transparency of currently largelyunregulated cross-border financial operations arenotable mostly for their inadequacy or their com-plete absence. The recommendations directed atsource countries call for only limited actions thatare beyond the bounds of existing policies or ini-tiatives or involve changes in market practicesbeyond those already being undertaken.

Despite the emphasis on ownership and vol-untary participation, implementation of the codesand standards is to be backed by an extensive sys-tem of externally applied incentives and sanctions,some of which risk becoming features of IMF

“… there are dangers inthrowing at developingcountries a Washington-consensus view of economicpolicy, even if this consensusis now refurbished with newinternational codes andstandards … the new set ofexternal disciplines comehand-in-hand with aparticular model ofeconomic development ofdoubtful worth …”


conditionality. Although the rules and guidelinesare mostly of a fairly general nature, there remainsa danger that their actual implementation willincorporate elements from particular developed-country models, owing to the role in assessmentexercises of multilateral financial institutions andsupervisors from G-7 countries. As one writer hasput it:

… there are dangers in throwing at develop-ing countries a Washington-consensus view ofeconomic policy, even if this consensus is nowrefurbished with new international codes andstandards and with “second-generationreforms”. The dangers arise from severalsources. First, the new set of external disci-plines come hand-in-hand with a particularmodel of economic development of doubtfulworth … Second, it is doubtful that the newpolicy agenda will make the international sys-tem itself much safer. … Indeed, by focusingattention on internal structural reforms in thedeveloping world, the current approach leadsto complacency on short-term capital flows,and could increase rather than reduce systemic

risks. Finally, the practical difficulties of im-plementing many of the institutional reformsunder discussion are severely underestimated.(Rodrik, 1999: 3)

What has been proposed so far under theheading of codes and standards falls well short ofamounting to an integral component of a newglobal policy framework for reducing financialinstability. It should be recalled that an essentialelement of the rationale of the codes and stand-ards initiatives consisted of their role as the nec-essary counterpart of further financial liberaliza-tion, particularly in developing economies. But theinitiatives currently under consideration hardlyjustify imposing further obligations on countriesas to capital-account convertibility, cross-borderinvestment, or the liberalization of financial serv-ices more generally. In the absence of effectiveglobal action, much of the burden of coping withinternational financial instability still falls on na-tional governments. It is thus vital that they re-main free in their choice of policy.

C. The exchange rate system

The second key area in the reform of the in-ternational financial architecture is the exchangerate system, notably the arrangements regardingthe three major reserve currencies (the dollar, theeuro and the yen). Indeed, it would be more ap-propriate to speak of the need to establish a glo-bal system of exchange rates rather than reformthe existing system; ever since the breakdown ofthe Bretton Woods system of fixed, but adjustable,exchange rates there have in effect been no glo-bal arrangements. While floating was adopted onthe understanding that success depended upon the

prevalence of orderly underlying conditions, theinternational arrangements to that end as speci-fied in the Articles of Agreement of the IMF, andin the April 1977 decision on exchange rate ar-rangements, failed to define the obligations andcommitments that such arrangements involved. Aspointed out by Robert Triffin, the obligations were“so general and obvious as to appear rather su-perfluous”, and the system “essentially proposedto legalize … the widespread and illegal repudia-tion of Bretton Woods commitments, withoutputting any other binding commitments in their


place” (Triffin, 1976: 47–48). While the April 1977decision required members to “intervene in theexchange market if necessary to counter dis-orderly conditions”, it failed to define these con-ditions and to provide explicit guidelines for in-tervention. Similarly, the principles of surveillanceover exchange rate policies “were sufficiently gen-eral for constraint on behaviour to depend almostentirely on the surveillance procedures” (Dam,1982: 259), and the consultation procedures haveso far failed to generate specific rules of conductthat could lend support to any contention that thepresent arrangements constitute a “system”.4

Given this institutional hia-tus and lack of policy coordi-nation among the major indus-trial countries, it should comeas no surprise that floating hasfailed to deliver what was origi-nally expected: reasonably sta-ble exchange rates; orderlybalance-of-payments adjust-ment; greater macroeconomicpolicy autonomy; and removalof asymmetries between de-ficit and surplus countries.Rather, the system is charac-terized not only by short-termvolatility, but also by persist-ent currency misalignmentsand gyrations. The major in-dustrial countries have contin-ued to favour floating and haverefrained from intervening in currency marketsexcept at times of acute stress and imbalances, suchas the events leading to agreements on coordinatedmonetary policy actions and exchange market in-terventions in the Plaza and Louvre Accords of1985 and 1987, respectively.

The damage inflicted by disorderly exchangerate behaviour tends to be limited for the reservecurrency (G-3) countries themselves, compared todeveloping countries, because they have largeeconomies that are much less dependent on inter-national trade. Moreover, the exposure of theireconomic agents to exchange rate risks is limitedbecause they can both lend and borrow in theirnational currencies. By contrast, exchange ratemisalignments and gyrations among the G-3currencies are a major source of disturbance for

developing countries that has played an impor-tant role in almost all major emerging-market cri-ses (Akyüz and Cornford, 1999: 31). Thus, the ques-tion arises whether it is meaningful to predicateattainment of exchange rate stability by emerging-market countries purely on their adoption of ap-propriate macroeconomic policies and exchangerate regimes when the currencies of the majorindustrial countries are still so unstable. Indeed,many observers have suggested that the globaleconomy will not achieve greater systemic stabil-ity without some reform of the G-3 exchange rateregime, and that emerging markets will continue

to be vulnerable to currencycrises as long as the major re-serve currencies remain highlyunstable.

Certainly, given the de-gree of global interdependence,a stable system of exchangerates and payments positionscalls for a minimum degree ofcoherence among the macr-oeconomic policies of majorindustrial countries. But theexisting modalities of multilat-eral surveillance do not in-clude ways of attaining suchcoherence or dealing with uni-directional impulses resultingfrom changes in the monetaryand exchange rate policies ofthe United States and other

major industrial countries. In this respect govern-ance in macroeconomic and financial policieslacks the kind of multilateral disciplines that ex-ist for international trade.

One proposal to attain stable and properlyaligned exchange rates is through the introduc-tion of target zones among the three majorcurrencies together with a commitment by thecountries to defend such zones through coordi-nated intervention and macroeconomic policyaction.5 It is felt that such a commitment wouldsecure the policy coherence needed for exchangerate stability without undermining growth andcould alter the behaviour of currency markets,which, in turn, would reduce the need for inter-vention. Such an arrangement could be institution-alized and placed under IMF surveillance.

Can emerging-marketcountries attain exchangerate stability purely byadopting appropriatemacroeconomic policiesand exchange rate regimeswhen the currencies of themajor industrial countriesare still so unstable? Theexchange rate system assuch has hardly figured onthe agenda for the reformof the international financialarchitecture.


A more radical proposal is to do away withexchange rates and adopt a single world currency,to be issued by a World Monetary Authority whichcould also act as a lender of last resort. There hasbeen growing interest in such an arrangement sincethe introduction of the euro and the recurrent cur-rency crises in emerging markets. However, it isgenerally felt that the present extent of economicconvergence and depth of glo-bal integration fall far short ofwhat would be required forsuch an arrangement to oper-ate effectively (Rogoff, 1999:33–34).

In any event, it is inter-esting to note that the ex-change rate system has hardlyfigured on the agenda for thereform of the international fi-nancial architecture. The report by the then Act-ing Managing Director of IMF to the InternationalMonetary and Financial Committee (IMF, 2000b)recognized the difficult choice faced by mostcountries between maintaining, on the one hand,truly flexible rates and, on the other, hard pegs.Referring to the three major currencies, the re-port pointed to “large misalignments and vola-tility” in their exchange rates as a cause for con-cern, particularly for small, open commodity-exporting countries. However, it did not discussany initiatives that might betaken by the international com-munity in this respect, im-plying that the matter couldonly be sorted out betweenthe United States, Japan andthe EU (see also Culpeper,2000: 15).

Indeed, as noted in chap-ter V, discussions on exchangerates have concentrated on thekind of regimes that develop-ing countries would need toadopt in order to attain greater stability. The main-stream advice is to choose between free floatingor locking into a reserve currency through cur-rency boards or dollarization (the “hard” pegs),thus opting for one of the two “corner” solutions,as opposed to intermediate regimes of adjustableor soft pegs. Increasingly questions are being

raised as to whether the existence of so many in-dependent currencies makes sense in a closely in-tegrated global financial system.

However, much of this is a false debate.Whichever option is chosen, it will not be able toensure appropriate alignment and stability ofexchange rates in developing countries as long

as major reserve currenciesthemselves are so unstable andmisaligned, and internationalcapital flows are volatile andbeyond the control of recipi-ent countries. Moreover, suchconditions create inconsist-encies within the developingworld in attaining orderly ex-change rates. Briefly put, thereis no satisfactory unilateral so-lution to exchange rate instabil-

ity and misalignments in emerging markets, par-ticularly under free capital movements.

Since global arrangements for a stable sys-tem are not on the immediate agenda, the ques-tion arises as to whether regional mechanismscould provide a way out. Indeed, there is now agrowing interest in East Asia and some countriesof South America in regionalization (as opposedto dollarization) as a means of providing a collec-tive defence mechanism against systemic failures

and instability. The EU expe-rience holds useful lessons inthis respect, including the in-stitutional arrangements forthe maintenance and adjust-ment of intraregional curren-cy bands, intervention mecha-nisms, regimes for capitalmovements, and various facili-ties designed to provide pay-ments support to individualcountries and regional lender-of-last-resort services. How-ever, applying this experience

to arrangements among developing countriesposes certain difficulties, particularly with respectto the exchange rate regime to be pursued vis-à-vis reserve currencies and access to internationalliquidity, issues of special importance under con-ditions of intraregional contagion. Regional mon-etary arrangements among emerging markets

Governance in macro-economic and financialpolicies lacks the kind ofmultilateral disciplinesthat exist for internationaltrade.

There is now a growinginterest in East Asia andsome countries of SouthAmerica in regionalizationas a means of providing acollective defence mecha-nism against systemicfailures and instability.


could thus be greatly facilitated if they involvedalso the major reserve-currency countries. In thisrespect, the recent initiatives taken by ASEAN+3

(see chapter V, box 5.1) constitute an importantstep along what may prove to be a long and diffi-cult path to closer regional monetary integration.

D. Orderly workout mechanisms for international debt

A third major area of reform concerns orderlyworkout mechanisms for international debt. Suchmechanisms have gained added importance inview of shortcomings in global arrangements forthe prevention of financial crises. The prospectthat crises will continue to occur, even with in-creasing frequency and severity, poses a dilemmafor the international community. Once a crisisoccurs, it is difficult to avoid widespread messydefaults on external liabilities in the absence ofbailouts, with attendant consequences for inter-national financial stability. But bailouts are be-coming increasingly problematic. Not only do theycreate moral hazard for lenders, but also they shiftthe burden onto debtor countries and their tax-payers, who ultimately pay off the official debt.Furthermore, the funds required have been get-ting larger and more difficult to raise. For thesereasons, one of the main issues in the reformagenda is how to “involve” or “bail in” the pri-vate sector in crisis management and resolutionso as to redress the balance of burden-sharing be-tween official and private creditors as well asbetween debtor and creditor countries.

One way out of this dilemma would be re-course to the principles of orderly debt workoutsalong the lines of chapter 11 of the United StatesBankruptcy Code, a proposal first put forward bythe UNCTAD secretariat (in TDR 1986) in thecontext of the debt crisis of the 1980s, and morerecently re-examined by it (in TDR 1998) in rela-tion to emerging-market crises. Application ofthese principles would be especially relevant tointernational currency and debt crises resultingfrom liquidity problems because they are designed

primarily to address financial restructuring ratherthan liquidation. They allow a temporary stand-still on debt servicing based on recognition that agrab race for assets by creditors is detrimental tothe debtor as well as to the creditors themselvesas a group. They provide the debtor with accessto the working capital needed to carry out its op-erations while granting seniority status to newdebt. Finally, they involve reorganization of theassets and liabilities of the debtor, includingextension of maturities and, where needed, debt-equity conversion and debt write-off.

One way to implement these principles is tocreate an international bankruptcy court in orderto apply an international version of chapter 11 (or,as appropriate, chapter 9) drawn up in the form ofan international treaty ratified by all members ofthe United Nations (Raffer, 1990). However, full-fledged international bankruptcy procedures arenot necessary to ensure an orderly workout forinternational debt. Another option would be toestablish a framework for the application to inter-national debtors of key insolvency principles,namely debt standstill and lending into arrears(i.e. lending to a debtor in arrears to its creditor).Since prompt action is necessary to ward off specu-lative attacks and financial panic, the decision forstandstill should rest with the debtor country andthen be sanctioned by an international body, so asto provide the debtor with insolvency protectionin the national courts of creditor countries. Re-structuring of private debt could then be left tonational bankruptcy procedures, while for sover-eign debt direct negotiations with creditors appearto be the only feasible solution.


As discussed in chapter VI, while it has beenincreasingly accepted that market discipline willonly work if creditors bear the consequences ofthe risks they take, the international communityhas not been able to reach an agreement on howto involve the private sector in crisis managementand resolution. Even though a framework such asthe one described above has found considerablesupport among many industrial countries, there isstrong opposition from some major powers, andfrom participants in privatemarkets, to mandatory mecha-nisms for “binding in” and“bailing in” the private sector.Considering that such mecha-nisms would alter the balanceof negotiating strength betweendebtors and creditors and cre-ate moral hazard for debtors,they advocate, instead, volun-tary and contractual arrange-ments between debtors andcreditors to facilitate debt work-outs, such as the insertion ofcollective action clauses in bondcontracts. Moreover, a numberof middle-income countries,particularly those with a rela-tively high degree of depend-ence on financial inflows, areopposed to both mandatorystandstills and the inclusion ofcollective action clauses inbond contracts for fear thattheir access to international financial marketswould be impaired.

The discussions in the IMF Executive Boardon this issue emphasized the catalytic role of theFund in involving the private sector and that, ifthe latter did not respond, the debtor countryshould seek agreement with its creditors on a vol-untary standstill. The Board recognized that, “inextreme circumstances, if it is not possible to reachagreement on a voluntary standstill, members mayfind it necessary, as a last resort, to impose oneunilaterally”. However, there is no agreement overempowering the IMF, through an amendment ofits Articles of Agreement, to impose a stay oncreditor litigation in order to provide statutory pro-tection to debtors imposing temporary standstills.While it is generally accepted that the Fund may

signal its acceptance of a unilateral standstill bylending into arrears, no explicit guidelines havebeen established on when and how such supportwould be provided, thus leaving considerable dis-cretion to the Fund and its major shareholdersregarding the modalities of its intervention in fi-nancial crises in emerging markets.

As in other areas, the reform process has thusbeen unable to establish an appropriate interna-

tional framework for involv-ing the private sector in themanagement and resolution offinancial crises, passing thebuck again to debtor countries.True enough, contractual ar-rangements, such as collectiveaction clauses in bond con-tracts and call options in inter-bank credit lines, can provideconsiderable relief for coun-tries facing debt servicing dif-ficulties, and the misgivingsthat such arrangements mayimpede access to capital mar-kets may be misplaced. Butthese are not matters for con-sideration in the reform of theinternational financial archi-tecture, unless global mecha-nisms are introduced to facili-tate such arrangements. Thereis also resistance to introduc-ing automatic rollover and col-

lective action clauses in international debt con-tracts based on an international mandate. Further-more, certain features of external debt of devel-oping countries, including wide dispersion ofcreditors and debtors and the existence of a largevariety of debt contracts, governed by differentlaws, render it extremely difficult to rely on vol-untary mechanisms for securing rapid debt stand-stills and rollovers. Without a statutory protectionof debtors, negotiations with creditors for restruc-turing loans cannot be expected to result in equi-table burden sharing. Indeed, in recent examplesof negotiated settlements the creditors have notborne the consequences of the risk they had taken;rather, they have forced the developing countrygovernments to assume responsibility for the pri-vate debt and accept a simple maturity extensionat penalty rates.

The IMF Board recognizedthat, “in extremecircumstances, if it is notpossible to reachagreement on a voluntarystandstill, members mayfind it necessary, as a lastresort, to impose oneunilaterally”. However, thereis no agreement overempowering the IMF toimpose a stay on creditorlitigation in order to providestatutory protection todebtors imposingtemporary standstills.


Naturally, reforms and recent initiatives inthe areas discussed above generally imply sig-nificant changes in the mandate and policies ofthe IMF, particularly with respect to bilateraland multilateral surveillance, conditionality andthe provision of international liquidity. As notedabove, the Fund is closely involved in settingcodes and standards for macroeconomic andfinancial policies and monitoring compliance, andeffective multilateral surveillance is a prerequi-site for a stable system of exchange rates. Privatesector involvement in crisis management and reso-lution also crucially depends on IMF lending poli-cies, as well as on its support and sanctioning ofstandstills and capital and exchange controls.Consequently, the reform of the international fi-nancial architecture presupposes a reform of theIMF.

1. Surveillance and conditionality

As discussed in TDR 1998, asymmetries inIMF surveillance, in the aftermath of the EastAsian crisis, along with excessive conditionalityattached to IMF lending, were widely consideredto be two of the principal areas deserving atten-tion in the reform of the international financialarchitecture. However, the recent approach to re-form has resulted in increased asymmetries insurveillance and in enhanced conditionality, sinceit has focused primarily on policy and institutionalshortcomings in debtor countries.

As already noted, surveillance has not beensuccessful in ensuring stable and appropriatelyaligned exchange rates among the three major re-serve currencies. Nor has it been able to protectweaker and smaller economies against adverse im-pulses originating from monetary and financialpolicies in the major industrial countries. It is truethat the need for stronger IMF surveillance in re-sponse to conditions produced by greater globalfinancial integration and recurrent crises was rec-ognized by the Interim Committee in April 1998,when it agreed that the Fund “should intensify itssurveillance of financial sector issues and capitalflows, giving particular attention to policy inter-dependence and risks of contagion, and ensure thatit is fully aware of market views and perspectives”(IMF Interim Committee Communiqué of 16 April1998). However, despite the reference to interde-pendence and contagion, these proposals have notso far been effectively extended to cover weak-nesses arising from the lack of balance in existingprocedures.

Rather, there has been an intensification ofIMF surveillance and conditionality as a result oftheir extension to financial sector issues in debtorcountries, in accordance with the diagnosis thatthis is where the main problem lies. As notedabove, new codes and standards are likely to re-sult in enhanced conditionality, particularly for theuse of new facilities, including contingency fi-nancing, for overcoming financial crises. Quiteapart from whether the result could be unneces-sary interference with the proper jurisdiction of asovereign government, as some commentatorsbelieved it was in the Republic of Korea (Feld-

E. Reform of the IMF


stein, 1998), there is also the potential problemthat the type of measures and institutions promotedmay not be the appropriate ones:

An unappreciated irony in this is that con-ditionality on developing countries is beingratcheted up at precisely the moment whenour comprehension of how the worldeconomy works and what small countriesneed to do to prosper within it has beenrevealed to be sorely lacking. (Rodrik,1999: 2)

The International Monetary and FinancialCommittee (IMFC, formerly the Interim Commit-tee), recognizing the need to streamline IMFconditionality, has urged “the Executive Board totake forward its review of all aspects of policyconditionality associated with Fund financing inorder to ensure that, while not weakening thatconditionality, it focuses on the most essential is-sues”.6 For his part, the Fund’s new ManagingDirector, Horst Köhler, has likewise concluded that:

To strengthen its efficiency and legitimacy,the Fund needs to refocus. The Fund’s focusmust clearly be to promote macroeconomicstability as an essential condition for sus-tained growth. To pursue this objective, theFund has to concentrate on fostering soundmonetary, fiscal and exchange rate policies,along with their institutional underpinningand closely related structural reforms. …I trust that ownership is promoted when theFund’s conditionality focuses in content andtiming predominantly on what is crucial forthe achievement of macroeconomic stabil-ity and growth. Less can be more if it helpsto break the ground for sustained process ofadjustment and growth.7

Perhaps it is too early to judge how far inpractice this refocusing has been pursued, but itis notable that the recent Fund programmes inTurkey and Argentina show no significant ten-dency to depart from past practice (see chapter II,boxes 2.1 and 2.2). They stipulate a wide rangeof policy actions not only in the purview of otherinternational organizations, such as WTO and thedevelopment banks, but also of national economicand social development strategies, including ac-tions relating to privatization and deregulation,agricultural support, social security and pensionsystems, industrial and competition policy, andtrade policy.

2. Liquidity provision andlender-of-last-resort financing

The other major area of reform concerns theprovision of adequate liquidity. A consensus hasemerged over the past decade that the Fund shouldprovide international liquidity not only to coun-tries facing payments difficulties on current ac-count but also to those facing crises on capitalaccount. Two main facilities have been establishedfor this purpose: a Supplemental Reserve Facility(SRF) for countries already facing paymentsdifficulties, and a Contingency Credit Line (CCL)to provide a precautionary line of defence againstinternational financial contagion (see chapter VI,box 6.3). While there are difficulties regarding theterms and conditions attached to such facilities,the real issue is whether and to what extentprovision of such financing conflicts with, or com-plements the objective of, involving private credi-tors and investors in the management and resolu-tion of emerging-market crises.

In several debtor countries, governmentsappear to favour unlimited liquidity support, re-gardless of the terms and conditions and theburden that may eventually be placed on the coun-try’s tax payers by international rescue operations.This attitude is consistent with their aversion toimposing temporary payments standstills and capi-tal and exchange controls at times of crisis. Onthe other hand, while there is no consensus in theIMF Board on mandatory arrangements for involv-ing the private sector, there is now a growingemphasis on making official assistance conditionalon private sector participation. However, no formallimits have been set for access to Fund resourcesbeyond which such participation would be re-quired. As discussed in chapter VI, absence ofexplicit access limits as well as of mandatorystandstill mechanisms may render it extremelydifficult to secure private sector involvement, forc-ing the Fund to engage in large-scale interventions.

Indeed, since the main objective of large-scale contingency or crisis financing would be toallow debtor countries to remain current on pay-ments to their creditors, it is difficult to see howthis could be reconciled with a meaningful pri-vate sector involvement in crisis resolution andburden sharing. Consequently, a credible and ef-


fective strategy for involving the private sectorshould combine temporary standstills with strictlimits on access to Fund resources. While there isgrowing agreement on theneed to limit crisis lending, itis also suggested that theremay be a need for exception-ally large contingency financ-ing when the crisis appearsto be “systemic”. In practice,such an approach could resultin differentiation among debt-or countries: those for whichthe crisis is considered “sys-temic” would be eligible forconsiderable liquidity supportwithout any prior condition forprivate sector participation, asin recent operations in Argen-tina and Turkey; those wherethe crisis is not so consideredwould face strict limits andwould be encouraged to involve the private sec-tor through default, as seems to have been the casefor Ecuador and Pakistan.

There are proposals to go further and allowthe IMF to act as, or to transform that institutioninto, an international lender of last resort foremerging markets. Proposals of this nature havebeen put forward by the Deputy Managing Direc-tor of the Fund (Fischer, 1999) and, in the broadercontext of reforming the international financialinstitutions, by the International Financial Insti-tutions Advisory Commission (Meltzer Commis-sion). Indeed, the idea has received much greatersympathy than any other proposal for institutionalchanges at the global level, from among peoplewith sharply different views about the reform ofthe IMF and situated at opposite ends of thepolitical spectrum, although certain aspects ofthe Meltzer Commission’s recommendations arehighly contentious.8 The key suggestion is thatcountries meeting certain ex ante conditions forsolvency should be eligible for lender-of-last-resort financing. In the proposal by the MeltzerCommission, access to liquidity would be auto-matic for countries meeting a priori requirements,and no additional conditionality or negotiationswould be required. Lending would be limited toa maximum of one year’s tax revenue of the bor-rowing country. This could result in far greater

packages than any crisis lending by the IMF sofar. The problem of moral hazard would be tackledby conditionality rather than by tighter limits on

lending. By contrast, the re-port does not make any recom-mendation for involving theprivate sector, except to sug-gest that, for the time being,the matter should be left tonegotiations between debtorsand creditors.

Arrangements of this na-ture would, however, compoundcertain problems encounteredin the current practice regard-ing IMF bailouts. Without dis-cretion to create its own li-quidity, the Fund would haveto rely on major industrial coun-tries to secure the funds neededfor such operations. In such

circumstances it is highly questionable whether itwould really be able to act as an impartial lenderof last resort, analogous to a national central bank,since its decisions and resources would dependon the consent of its major shareholders, who aretypically creditors of those countries experiencingexternal financial difficulties. This problem couldbe partly overcome by authorizing the Fund toissue permanent or reversible SDRs, but attribut-ing such a key role to the SDR would face strongopposition from the same source.

Furthermore, there are also political and tech-nical difficulties regarding the terms of access tosuch a facility. Financing by a genuine inter-national lender of last resort, which would beunlimited and unconditional except for penaltyrates, would require very tight global supervisionover borrowers to ensure their solvency, whichit would not be easy to reconcile with nationalsovereignty. Nor would prequalification be com-patible with the practice of “constructive ambi-guity” that all modern national lenders of resortare said to follow.9 It would also require the IMFto act as a de facto credit-rating agency. However,it is very difficult to establish generally agreedstandards for solvency, and assessments of a givenset of economic indicators can vary considerably,as evidenced by differences among private ratingagencies (Akyüz and Cornford, 1999: 48). Dis-

Since the main objective oflarge-scale contingency orcrisis financing would be toallow debtor countries toremain current onpayments to their creditors,it is difficult to see how thiscould be reconciled with ameaningful private sectorinvolvement in crisisresolution and burdensharing.


agreements in this respect between the develop-ing countries concerned and the Fund staff couldlead the countries to opt out and seek alternativearrangements, thereby reducing the effectivenessof the proposed mechanism. Moreover, since itwould be necessary constantly to monitor the ful-filment of the preconditions, adjusting them asnecessary in response to changes in financial mar-kets or other changes beyond the control of theGovernment of the recipient country, prequali-fication would not avoid difficulties in relationsbetween the Fund and the member concerned.

Transforming the Fund into an internationallender of last resort would involve a fundamentaldeparture from the underlying premises of theBretton Woods system, which provided for the useof capital controls to deal with instability. In dis-cussion of such a facility its introduction is fre-quently linked to concomitant arrangementsregarding rights and obliga-tions with respect to interna-tional capital transactions, to-gether with a basic commit-ment to capital-account liber-alization. This departure fromthe Bretton Woods arrange-ments is particularly notable inthe report of the Meltzer Com-mission, which virtually pro-poses, inter alia, the discon-tinuation of all other forms ofIMF lending, including thosefor current account financing.Such a drastic shift in the na-ture of IMF lending, from cur-rent account to capital accountfinancing, would lead to a fur-ther segmentation of the Fund’s membership,with consequences for its governance and uni-versality. Indeed, as noted by a former UnitedStates Treasury Secretary, only a small number

of relatively prosperous emerging economieswould be eligible for lender-of-last-resort financ-ing.10

Moreover, under these proposals, a large ma-jority of developing countries would be excludedfrom multilateral financing. The Meltzer Commis-sion argued, throughout its discussion of lendingpolicies by both IMF and the World Bank, that cur-rent account financing to developing countriesshould, in principle, be provided by private mar-kets. However, markets cannot always be reliedon to fulfil this task properly. One of the originalobjectives of the IMF was to provide short-termfinancing when reserves were inadequate to meetcurrent account needs resulting from temporarytrading shocks and disturbances, while the WorldBank was to meet longer-term financing needs ofreconstruction and development. For temporarypayments disequilibrium, it was agreed that short-

term financing was necessaryin order to avoid sharp cutsin domestic absorption or dis-ruptive exchange rate adjust-ments. Even when the effectsof such shocks were deemedto be more lasting, IMF financ-ing was believed to be neces-sary to allow orderly adjust-ment. Experience shows thatfinancial markets often fail tomeet such needs since theytend to be pro-cyclical, withthe result that credit lines arecut off just when they are mostneeded. Given the increasedinstability of the external trad-ing and financial environment

of developing countries, a reform of the BrettonWoods institutions should seek to improve, ratherthan eliminate, counter-cyclical and emergency fi-nancing of the current account.

Given the increasedinstability of the externaltrading and financialenvironment of developingcountries, a reform of theBretton Woods institutionsshould seek to improve,rather than eliminate,counter-cyclical andemergency financing of thecurrent account.


There are certainly conceptual and technicaldifficulties in designing effective global mecha-nisms for the prevention and management offinancial instability and crises. Such difficultiesare also encountered in designing national finan-cial safety nets, and explain why a fail-safe systemis unreachable. At the international level thereis the additional problem that any system of con-trol and intervention would need to be reconciledwith national sovereignty and accommodate thediversity among nations. Political constraints andconflicts of interest, including among the G-7members themselves, rather than conceptual andtechnical problems, appear to be the main reasonwhy the international community has not been ableto achieve significant progress in setting up ef-fective global arrangements.

So far the major industrial countries have notaddressed the establishment of a multilateral sys-tem for international finance based on a few coreprinciples and rules preferring instead a strength-ening of the financial systems of debtor countriesin crisis prevention, and favouring a differenti-ated, case-by-case approach to crisis intervention.This approach not only has created asymmetry be-tween debtors and creditors, but also has left fartoo much discretion with the major creditor coun-tries, on account of their leverage in internationalfinancial institutions. It has kept out of the reformagenda many issues of immediate concern to de-veloping countries, which are discussed in thefollowing chapters. However, even a rules-basedsystem raises concerns for developing countries:under the current distribution of power and gov-ernance of global institutions, such a system wouldbe likely to reflect the interests of larger and richer

countries rather than to redress the imbalancesbetween international debtors and creditors. Suchbiases against developing countries already existin the rules-based trading system, although rela-tions here are more symmetrical than in thefinancial domain.

If reforms to the existing financial structuresare to be credible, they must provide for greatercollective influence from developing countries andembody a genuine spirit of cooperation among allcountries, facing many different problems butsharing a common desire to see a more stable in-ternational financial and monetary system. No lessthan a fundamental reform of the governance ofmultilateral institutions is therefore necessary.11

The areas in which reform is needed are exploredin a study undertaken for the G-24, which arguesthat governance within the Bretton Woods insti-tutions needs to be improved regarding suchmatters as representation and ownership, account-ability and transparency, and adaptation andchange:

The allocation of quotas and the correlatemembership rights in both institutions nolonger reflect the application of a coherent,justifiable set of principles: quotas no longerreflect relative economic and political power,and the principle of equal representation,which was once implemented by the alloca-tion of “basic votes”, has been significantlyeroded. Furthermore, decision-making prac-tices have not adapted to the changed man-dates of both institutions, whose work nowtakes them further and further into influenc-ing domestic policy choices in developingcountries. (Woods, 1998: 95)

F. Governance of international finance


While, as recognized in that study, effortshave been made to respond to calls for more trans-parent, accountable and participatory governance,the basic modalities and pro-cedures for taking decisions re-main largely unchanged. Thus,whereas developed countriesaccount for only 17 per cent ofvoting strength in the UnitedNations, 24 per cent in WTO,and 34 per cent in the Interna-tional Fund for AgriculturalDevelopment (IFAD), they ac-count for over 61 per cent inthe Bretton Woods institu-tions. And a single countryholds virtual veto power overimportant decisions such ascapital increases or SDR allocations. It is nowagreed in many quarters that the procedures forselection of the Managing Director of IMF andthe President of the World Bank should givegreater weight to the views of developing and tran-sition economies, since the raison d’être of theseinstitutions is now to be found mainly in their man-dates and operations with respect to these econo-mies. More fundamentally, crucial decisions onglobal issues are often taken outside the appro-priate multilateral forums in various groupings ofmajor industrial countries such as the G-7 or G-10,where there is no developing country representa-tion or participation. Consequently, “nothing con-sequential happens in the formally constituted or-ganizations that do have operational capabilities– the IMF, the World Bank, the Bank for Interna-tional Settlements – without the prior consent, andusually the active endorsement, of the ‘Gs’ (hereused as a short form for all the deliberative groupsand committees dominated by the major industrialcountries)” (Culpeper 2000: 5).

The inclusion of developing countries in thediscussions of financial architecture reform thattake place outside the Bretton Woods institutions,notably in the newly created G-20, is thus gener-ally welcomed as an important step in ensuringbetter participation and governance in interna-tional finance. However, even though its firstchairman, the Canadian Finance Minister PaulMartin, declared that the G-20 “has a mandate toexplore virtually every area of international fi-nance and the potential to deal with some of the

most visible and troubling aspects of today’sintegrated world economy”,12 so far the focus ofits work has not substantially deviated from

the G-7 reform agenda, includ-ing a stock-taking of progressmade by all members in reduc-ing vulnerabilities to crises,an evaluation of countries’compliance with internationalcodes and standards, the com-pletion of the so-called trans-parency reports, and an exami-nation of different exchangerate regimes and their role indebtor countries in cushioningthe impact of international fi-nancial crises (Culpeper, 2000:19). Furthermore, despite the

G-20’s broader membership, there are still seri-ous limitations on participation and accountabil-ity:

The G-20 is severely flawed in that it con-tains no representation … from the poorestand smallest developing countries. … Pre-sumably, this is because the poorest andsmallest are unlikely ever to constitute anysystemic threat. But there are major “archi-tectural” issues surrounding the provisionof adequate development finance to thesecountries and their peoples. … Nor does theG-20 possess any mechanisms either for re-porting or for accountability to the broaderinternational community, such as the con-stituency system provides within the IMFand World Bank, or any provisions fornon-governmental inputs or transparency.(Helleiner, 2000: 13–14)

A number of proposals have been made onhow to reform the multilateral process as well asto improve the membership, accountability andreform agenda of the G-20. Certainly, progress inthese areas will depend on the willingness of themajor industrial countries to extend the reformagenda and process so that they also address theconcerns of developing countries. It will dependno less on positions taken by developing coun-tries themselves. As noted above, there is no con-sensus among the developing countries on sev-eral issues of the reform agenda. Many of the dif-ferences pertain to the modalities of official in-tervention in the management and resolution of

If reforms to the existingfinancial structures are tobe credible, they mustprovide for greatercollective influence fromdeveloping countries andembody a genuine spirit ofcooperation.


financial crises. Most countries appear to givepriority to access to large amounts of contingencyfinancing as a defence against contagion and in-stability, despite their con-cerns as to the appropriatenessof several of its features. Attimes of crisis many countriesseem unwilling to impose tem-porary standstills, preferringofficial bailouts, even thoughthey often complain that theirterms and conditions deepenthe crisis, put an unfair shareof the burden of adjustment onthe debtors, and allow thecreditors to get away scot-free.This unwillingness may partlyreflect an assessment that therisks of imposing a standstillare excessively high when suchaction is still considered an aberrant response to acrisis (so far resorted to by only a few countries).

There appears to be greater convergence ofviews and interests regarding measures for crisisprevention and governance of international fi-

nance. Objectives commonly shared by develop-ing countries include: more balanced and sym-metrical treatment of debtors and creditors regard-

ing codes, transparency andregulation; more stable ex-change rates among the majorreserve currencies; effectiveIMF surveillance of the poli-cies of the major industrialcountries, especially with re-spect to their effects on capi-tal flows, exchange rates andtrade flows of developing coun-tries; a less intrusive condi-tionality; and, above all, moredemocratic and participatorymultilateral institutions andprocesses. Effective reform ofthe international monetary andfinancial system will ultimate-

ly depend on the ability and willingness of devel-oping countries to combine their efforts aroundthese common objectives, and on acceptance bydeveloped countries that accommodating these ob-jectives is essential to building a more inclusivesystem of global economic governance.

Progress will depend on thewillingness of the majorindustrial countries toextend the reform agendaand process so that theyalso address the concernsof developing countries. Itwill depend no less onpositions taken bydeveloping countriesthemselves.

Notes

1 For a survey of these proposals, see TDR 1998, PartOne, chap. IV; Akyüz (2000a); and Rogoff (1999).

2 For a useful summary of the history, structure, func-tions and legal status of the BIS, see Edwards (1985:52–63). Until recently the principal shareholders ofthe BIS were 28 predominantly West European cen-tral banks, with those of Belgium, France, Germany,Italy and United Kingdom holding over 50 per centof the votes. The United States Federal Reserveparticipates in meetings and committees linked to

the BIS without being a shareholder. More recentlythe BIS invited additional central banks from emerg-ing markets to become shareholders.

3 Kaufman (1992: 57); and “Preventing the next glo-bal financial crisis”, Washington Post, 28 January2001, A.17. See also speaking notes by H. Kaufmanfor the Extraordinary Ministerial Meeting of theGroup of 24, Caracas, February 1998.

4 See also UNCTAD secretariat (1987), which reviewsthe experience with floating in the 1980s. In respect


of both the institutional hiatus and exchange ratebehaviour little has changed in the past 15 years.

5 This proposal was first made in Williamson (1983).6 Communiqué of the International Monetary and Fi-

nancial Committee of the Board of Governors ofthe International Monetary Fund, 24 September2000, Washington, DC: para. 11.

7 Horst Köhler, Address to the Board of Governors,Fifty-fifth Annual Meeting, Prague, 26 September2000.

8 See, for example, Wolf (2000); Eichengreen andPortes (2000); Summers (2000a); and also L.H. Sum-mers’ Testimony before the Banking Committee of

the House of Representatives, 23 March 2000; andGoldstein (2000). For similar proposals, see the ref-erences in Rogoff (1999).

9 The concept belongs to Gerald Corrigan, quoted inRogoff (1999: 27).

10 L.H. Summers, Testimony Before the Banking Com-mittee of the House of Representatives, 23 March2000: 14.

11 For an illuminating discussion of global governanceissues, see Helleiner (2000).

12 Paul Martin, Speech to the House of CommonsStanding Committee on Foreign Affairs and Inter-national Trade, Ottawa, 18 May 2000.

79Standards and Regulation

Many recent initiatives for international fi-nancial reform are directed at reaching agreementon, and implementation of, standards for majorareas of economic policy. Most of these standardsare ultimately intended to contribute to economicstability both at the national and internationallevel. Their main proximate targets are thestrengthening of domestic financial systems andthe promotion of international financial stability“… by facilitating better-informed lending and in-vestment decisions, improving market integrity,and reducing the risks of financial distress andcontagion” (FSF, 2000a, para. 23). In pursuit ofthese objectives, the standards cover not only thefinancial sector, but also aspects of macroeco-nomic policy and policy on disclosure. Manyfeatures of these standards reflect concerns aris-ing out of the experience of recent financial crises,though in a number of cases they also build oninitiatives involving mainly industrial countriesand originating from events of the more distantpast. While the standards themselves are designedto promote stability, their development can alsobe viewed as part of a process of arriving at a setof globally accepted rules for policy in the finan-cial and monetary spheres. Such rules couldfurnish one of the prerequisites for the provisionof international financial support for countries

experiencing currency crises. In this sense, theyare an international analogue of the national rulesfor the financial sector, compliance with which isa condition for lender-of-last-resort financing.

The Financial Stability Forum (FSF)1 hasidentified a number of standards which it consid-ers particularly relevant to strengthening financialsystems. These vary in the precise degree to whichthey have received international endorsement, butthey have been broadly accepted, in principle, asrepresenting basic requirements for good practice.As can be seen from table 4.1, the standards coverthe areas of macroeconomic policy and data trans-parency, institutional and market infrastructure,and financial regulation and supervision – areasthat are closely interrelated in many ways. Macro-economic policy, for example, can crucially affectthe more sectoral dimensions of financial stabil-ity through its impact on the values of financialfirms’ assets and liabilities (and thus on the con-text in which financial regulation and supervisionare conducted). It can also affect the functioningof the system for payments and settlement, whichis at the heart of the infrastructure of financialmarkets. Similarly, effective financial regulationand supervision are inextricably related to ac-counting, auditing and insolvency procedures.

Chapter IV

STANDARDS AND REGULATION

A. Introduction


Insurance products are frequently incorporatedin, or sold in close conjunction with, investmentproducts, thus increasing the channels throughwhich disturbances affecting the market for onefinancial service can be transmitted to marketsfor another. And even such an apparently self-

contained issue as money laundering has, on oc-casion, threatened the stability of financial firms.2

The list of organizations associated with thekey standards in table 4.1 is not exhaustive, andthe standards themselves give only a brief idea of

Table 4.1

KEY STANDARDS FOR FINANCIAL SYSTEMS

Subject area Key standard Issuing body

Macroeconomic policy and data transparency

Monetary and financial Code of Good Practices on Transparency IMFpolicy transparency in Monetary and Financial Policies

Fiscal policy transparency Code of Good Practices in Fiscal Transparency IMF

Data dissemination Special Data Dissemination Standard (SDDS) IMFGeneral Data Dissemination System (GDDS)a

Institutional and market infrastructure

Insolvency Principles and Guidelines on Effective Insolvency Systemsb World Bank

Corporate governance Principles of Corporate Governance OECD

Accounting International Accounting Standards (IAS)c IASCd

Auditing International Standards on Auditing (ISA) IFACd

Payment and settlement Core Principles for Systemically Important Payment Systems CPSS

Market integrity The Forty Recommendations of the Financial Action FATFTask Force on Money Laundering

Financial regulation and supervision

Banking supervision Core Principles for Effective Banking Supervision BCBS

Securities regulation Objectives and Principles of Securities Regulation IOSCO

Insurance supervision Insurance Supervisory Principles IAIS

Source: FSF (2000a: 19).a Economies that have, or might seek, access to international capital markets are encouraged to subscribe to the more

stringent SDDS and all other economies are encouraged to adopt the GDDS.b The World Bank is coordinating a broad-based effort to develop these principles and guidelines. The United Nations

Commission on International Trade Law (UNCITRAL), which adopted the Model Law on Cross-Border Insolvency in1997, will help facilitate implementation.

c The BCBS has reviewed relevant IAS, and a joint BCBS-IASC group is further considering bank-related issues inspecific IAS. IOSCO has reviewed and recommended use of 30 IAS in cross-border listings and offerings, supplemented,where necessary, to address issues at a national or regional level. The IAIS’s review of relevant IAS is under way.

d The International Accounting Standards Committee (IASC) and the International Federation of Accountants (IFAC) aredistinct from other standard-setting bodies in that they are private sector bodies.


the many initiatives taking place under each head-ing. When the FSF reviewed the standards agendain March 2000, the 12 subject areas were alreadyonly a subset of a larger group which eventuallynumbered 64 (FSF, 2000a, paras. 55–57 and An-nex 8). The discussion in section B focuses on themain thrust and contents of the standards in ta-ble 4.1. It also aims to illustrate some omissionsand some of the practical problems posed by im-plementation of the standards. Section C looks atthe process of participation in the formulation andapplication of the standards initiatives. This leadsnaturally to the issue of bias in the official think-ing which underlies the selection of the subjectscovered by these initiatives and the asymmetricalway in which they are approached. To illustratethe strengths and weaknesses of this thinking,

section C examines in some detail three majorreports of FSF working groups. Section D dealsmore systematically with implementation issuesand some of the problems already raised in thecontext of particular standards in section B. Vari-ous incentives and sanctions are discussed as wellas the findings of a preliminary survey to reviewprogress so far. As discussed in section E, the con-tribution of standards to the achievement of greaterfinancial stability depends to a great extent on theirincorporation into the rules and norms of busi-ness practice. This in turn is closely connected tothe regulatory and supervisory regime withinwhich these rules and norms are applied. How-ever, improvements on this front have inherentlimits, as illustrated by examples taken from thekey area of banking supervision.

B. Themes of the key standards

Each of the codes discussed here is intendedto accomplish improvements at both macroeco-nomic and microeconomic levels. A significantpart of the impetus behind the initiatives discussedin subsections B.1–B.3 was furnished by particu-lar financial crises and systemic incidents of stress– mostly recent ones. Their major objectives aremacroeconomic or systemic, though particularfeatures of the behaviour of specific economicagents are also targeted. In the case of the codesdiscussed in subsections B.4–B.9, the balancebetween macroeconomic and microeconomicobjectives is different, with much less explicit em-phasis given to the former. Moreover, many of thelatter codes are of long-standing origin and ante-date the crises of the 1990s. It is their incorpora-tion into a global programme of financial reformthat is recent.

1. Macroeconomic policy and datatransparency

The Code of Good Practices on Transparencyin Monetary and Financial Policies (IMF, 2000c)identifies desirable transparency practices in theconduct of monetary policy and of policies to-wards the financial sector. These practices require:clarity with respect to the roles, responsibilitiesand objectives of central banks and financial agen-cies other than central banks with responsibilityfor overseeing and supervising different parts ofthe financial sector; open processes for the for-mulation and reporting of decisions on monetaryand financial policy; public availability of infor-mation concerning policies in both spheres; andaccountability and assurances of integrity for the


central bank, other financial agencies and theirstaff.

The Code of Good Practices on Fiscal Trans-parency (IMF, 1998a) is based on four principles:first, the roles and respon-sibilities of and within thegovernment should be trans-parent, and for this purposethere should be a clear legaland administrative frameworkfor fiscal management; sec-ondly, governments shouldcommit themselves to publicdisclosure of comprehensive,reliable information on fiscalactivities; thirdly, the processof budget preparation, execu-tion and reporting should beopen; and, fourthly, fiscal information should besubject to public and independent scrutiny.

The Special Data Dissemination Standardwas developed by the IMF in response to recog-nition, after the Mexican crisis, of widespreaddeficiencies in major categories of economic dataavailable. It prescribes the data which countriesintending to use the world’s capital markets shouldbe expected to make public concerning the real,fiscal, financial and external sectors of theireconomy. Moreover, it laysdown minimum benchmarksto be met in terms of periodic-ity and timeliness in the pro-vision of that information.Since its inception, the SpecialData Dissemination Standard(SDDS) has been strengthenedby the inclusion of a re-quirement to disclose notonly reserve assets, but alsoreserve-related liabilities andother potential drains on re-serves, such as short derivativepositions and guarantees ex-tended by the government forborrowing by the privatesector in foreign currency. The SDDS is sup-plemented by the General Data DisseminationSystem (GDDS), which is designed to improvethe quality of data disclosed by all member coun-tries of the IMF.

The rationale for these codes and standardshas several facets. The effectiveness of monetary,financial and fiscal policies can be enhanced ifthe objectives and instruments of policy in theseareas are known to the public and if the govern-

ment’s commitment to theseobjectives is credible. Goodgovernance more generally re-quires that central banks, otherfinancial agencies and fiscalauthorities are accountable.But an important aspect of theCodes’ rationale goes beyondtheir benefits at the domesticlevel and concerns interna-tional lenders and investors.Here, the idea is that transpar-ency should help lenders andinvestors to evaluate and price

risk more accurately, thus contributing to policydiscipline in recipient countries. Moreover, the as-sessment of individual countries made possible bythese Codes is expected to prevent the so-calledcontagion effect, whereby a loss of confidence inone country spreads to others simply because theybelong to the same category or region.3

That transparency regarding major areas ofmacroeconomic policy can contribute to theircredibility, and to good governance more gen-

erally, seems incontrovertible.Transparency is also capableof facilitating multilateralsurveillance by organizationssuch as the IMF. Understand-ably, the Codes confine them-selves to process rather thansubstance, since codes of rulesfor policy would be enor-mously complex if they wereto cover the great variety ofdifferent situations and coun-tries. In addition, it would bemuch more difficult to reachconsensus on such rules thanon those limited to process.

Regarding the expectation that either theCodes concerning macroeconomic policy or theSDDS will lead to much improved decisions byinternational lenders and investors, and thus to im-proved resource allocation and enhanced policy

The new disclosure rulesof the Special DataDissemination Standardfailed to serve as aneffective early warningsystem in the case of theAsian crisis.

A common characteristic ofthe countries affected byrecent financial crises wastheir openness to capitalflows, while there weresubstantial differences inmany of their macro-economic indicators andother features of theireconomies.


discipline for the governments of the receivingcountries, there are grounds for scepticism. Thenew disclosure rules of the SDDS failed to serveas an effective early warning system in the caseof the Asian crisis. Indeed, information was widelyavailable concerning the balance of payments ofthe countries involved, the external financial flowsto them, their corporate governance, trends in theirdomestic lending and in their banks’ exposure toovervalued property sectors, and major featuresof external assets and liabilities (though there weregaps in what was publicly disclosed concerningthe last of these items, gaps which subsequentstrengthening of the SDDS was designed to fill).And if the availability of pertinent data failed todeter capital flows associated with the build-upof eventually unsustainable external financialpositions in certain Asian countries, the sameapplied, a fortiori, to the behaviour of interna-tional lenders and investors in the RussianFederation prior to the crisis of mid-1998.

A more fundamental limitation of the poten-tial contribution of transparency to the preventionof financial instability is due to the considerablevariation in accompanying macroeconomic con-ditions and other features of policy regimes –a variation evident during recent financial crises.A common characteristic of the countries affectedby these crises was their openness to capital flows,but there were substantial differences in manyof their macroeconomic indicators and otherfeatures of their economies. These differences in-volved external deficits, the extent of currencyovervaluations, the size of budget deficits, the rela-tive importance of consumption and investmentin the booms preceding the crises, the relative sizeof countries’ external debt owed by the public andprivate sectors, and the coverage and effectivenessof regimes of financial regulation and supervision.

Analysis of recent international financial cri-ses also points to other difficulties as to the extentto which improved disclosure of macroeconomicvariables can contribute to greater financial stabil-ity, in particular to the avoidance of the contagioneffect. National balance sheets do not always re-flect the pressures on external payments that canresult from the adjustment of derivative positionswhich are off-balance-sheet and not always ad-equately covered by accounting rules. Moreover,derivative positions, even if covered under these

rules, are capable of blurring distinctions betweendifferent categories of exposure, such as thosebetween short and longer term. There is now aconsensus that cross-border hedging and otherpractices make many of the international finan-cial system’s fault lines difficult to identify inadvance. As a recent report of the Financial Stabil-ity Forum states:

Certain commonly employed risk manage-ment techniques … can have the effect ofadding to the volatility of both prices andflows in the international capital market …That is, investors acquire or dispose ofclaims whose risk characteristics and pricehistory resemble those of the asset beingproxied but where the market is deeper, moreliquid, or subject to fewer restrictions andcontrols. Such behaviour was one of the fac-tors behind the large fluctuations in capitalflows to South Africa and several countriesin Eastern Europe around the time of theAsian crisis. (FSF, 2000b, para. 28)

In the context of more recent events, atten-tion has been drawn to the way in which Brazilianbonds have become an instrument widely used byinvestors in emerging markets to hedge positionsin the debt of other countries such as the RussianFederation, Morocco and the Republic of Korea.

2. Banking supervision

Weaknesses in the banking sector and inad-equate banking supervision4 have played a centralrole in recent financial crises in developed as wellas developing countries. Recognition of the in-creasing potential for destabilizing the cross-border effects of banking crises – owing to theinternationalization of the banking business – hasled to initiatives since the 1970s that aim to im-prove international cooperation in banking regu-lation and supervision. Initially, these initiativeswere directed primarily at banks in industrialcountries and offshore financial centres in re-sponse to a number of events that highlighted theinadequacies in their banking regulation andsupervision. These events provided much of theinspiration for subsequent efforts to improve regu-latory and supervisory cooperation. The standardswhich emerged from these initiatives eventually


also achieved widespread acceptance among de-veloping and transition economies. The BaselCommittee on Banking Supervision (BCBS) – themost important vehicle for most of these initia-tives – has increasingly assumed the role of glo-bal standard-setter in this area.5

A major outcome of the BCBS’s extensionof the focus of its activities beyond the concernsof its member countries is the Core Principles forEffective Banking Supervision issued in late 1997.In the development of these Principles, the BCBScollaborated with supervisors of economies out-side the Group of Ten (includ-ing several developing andtransition economies). Theycover seven major subject ar-eas: (i) the preconditions foreffective banking supervision;(ii) the licensing and structureof banks; (iii) prudential re-gulations and requirements;(iv) methods of ongoing su-pervision; (v) information re-quirements; (vi) the formalpowers of supervisors; and (vii) cross-borderbanking. In April 1998, the BCBS undertook asurvey of compliance with the Core Principles in140 economies, an effort paralleled by IMF andWorld Bank reviews of compliance in selectedcountries.6 Subsequently a Core Principles Liai-son Group (CPLG) of 22 members7 was set up toprovide feedback to the BCBS on the practical im-plementation of these Principles. The reviews ofcompliance and feedback from the CPLG led tothe development by the BCBS of the Core Princi-ples Methodology issued in October 1999 (BCBS,1999a).

This document on methodology is intendedto provide guidance in the form of “essential” and“additional” criteria for the assessment of com-pliance by the different parties to which this taskmay be entrusted, such as the IMF, the WorldBank, regional supervisory groups, regional de-velopment banks and consulting firms, but not theBCBS itself. In addition to the specific criteriarelating to banking supervision, the assessors arealso required to form a view as to the presence ofcertain more general preconditions regarding suchsubjects as: (i) sound, sustainable macroeconomicpolicies; (ii) a well developed public infrastruc-

ture, including an adequate body of law covering,for example, contracts, bankruptcy, collateral andloan recovery, as well as accounting standardsapproaching those of international best practices;(iii) market discipline based on financial transpar-ency, effective corporate governance and theabsence of government intervention in banks’commercial decisions except in accordance withdisclosed policies and guidelines; (iv) adequatesupervisory procedures for dealing with problemsin banks; and (v) adequate mechanisms for sys-temic protection such as a lender-of-last-resortfacility or deposit insurance (or both). The parts

of the assessment directedmore specifically at bankingsupervision comprise not onlythe procedures of supervisionbut also its subject matter(which, of course, includesthe standards for prudentialregulation and for banks’own internal controls and riskmanagement covered in theBCBS’s own documents overthe years). With respect to

subjects such as accounting and auditing stand-ards and insolvency law, the Core Principles forEffective Banking Supervision clearly overlap tosome degree other key standards mentioned intable 4.1.

Assessment of compliance with the CorePrinciples requires evaluation of several relatedrequirements, including prudential regulation andother aspects of the legal framework, supervisoryguidelines, on-site examinations and off-siteanalysis, supervisory reporting and other aspectsof public disclosure, and enforcement or itsabsence. Assessment is also required of the super-visory authority’s skills, resources and commit-ment, and of its actual implementation of the CorePrinciples. If evaluation of the preconditions foreffective supervision (mentioned earlier) and as-sessment of the criteria relating to supervision it-self are considered together, the exercise coverssubstantial parts of a country’s commercial law,its accounting and auditing standards, and to someextent the quality of its government’s macroeco-nomic management.

The assessment of relevant laws, regulationsand supervisory procedures would appear to be

Internationally promulgatedstandards can help upgradenational rules and norms,but the objective should notbe uniform rules for allcountries.


fairly straightforward, but that of supervisory ca-pacity and the effectiveness of implementationmore complex.8 Thus, perhaps understandably, theannex to the Core Principles Methodology, whichsets out the structure and methodology for assess-ment reports prepared by the IMF and the WorldBank, focuses principally on the former set of sub-jects and not the latter. Assessment of supervisorycapacity and the effectiveness of implementationis generally likely to be feasible only through ex-tended in-depth scrutiny. This would require alengthy presence of the assessor in the countryundergoing assessment, either in the form of apermanent presence, or through a process involv-ing several visits. If the latter option were selectedfor the purpose (and it seems rather more likelyto be acceptable and more in accord with normalprocedures for IMF surveillance), an authoritativeassessment of compliance with the Core Princi-ples may take years.

Assessment of the more general precondi-tions for effective supervision is not mentionedin the annex to the Core Principles Methodology,but here, too, a lengthy exercise is likely to benecessary. In particular, assessment of the manydimensions of a country’s legal regime and of itsaccounting and auditing standards requires evalu-ation not only of laws, regulations and principlespromulgated by professional bodies (such as thoseof accountants), but also of their implementation,and of the way in which they are incorporated intorules and norms in practice.9 Many features ofcountries’ legal regimes and business norms reflectdifferences in historical roots and in compromisesamong social groups. Internationally promulgatedstandards can help upgrade national rules andnorms, but many aspects of the process will begradual, and the objective should not be uniformrules for all countries.10

At the level of the countries being assessed,such exercises will often place an additional bur-den on a limited supply of supervisory capacity.In time, this capacity can be expanded, but thetraining of a bank supervisor typically requiresa considerable period. And once trained, a super-visor may be faced with attractive alternativeemployment opportunities in the private sector,or even in the IMF or the World Bank themselves(which have recently been increasing the numberof their staff with expertise in this area). There is,

of course, awareness of the problem of humanresources among bodies such as the BCBS, theIMF, the World Bank and the CPLG, and effortsare being made to coordinate initiatives and toensure that scarce expert resources are used in themost efficient way. However, there remains a realdanger that international assessment of countries’supervision will be at the expense of actual su-pervision on the ground.

3. Payments and settlement

Payment systems enable the transfer of fundsbetween financial institutions on their own behalfand on behalf of their customers, a role whichmakes such systems a potential source of systemicrisk. This role is evident from a consideration offour key dimensions of an economy’s flow-of-fundsprocess: (i) the activities of various economicagents; (ii) the markets for financial instruments,assets and liabilities; (iii) the supporting infra-structure, of which an integral component is thepayments system; and (iv) economic conditionsbinding the markets together and ensuring thatthey clear. Failures in any of the first three di-mensions are capable of disrupting links betweenthe markets and between economic agents whosemutual interdependence is based on several dif-ferent kinds of transaction and exposure. If large,such disruptions can easily take on a systemiccharacter.11 Moreover, payment systems also playan essential role in foreign exchange transactions,which are thus an interface between differentcountries’ payment systems.12 As a result of thelinks and similarities between systems of paymentand settlement for fund transfers and for transac-tions in other financial assets, the main vehiclefor international initiatives in this area, the BISCommittee on Payment and Settlement Systems(CPSS), has extended its purview beyond fundtransfers to settlement systems for securities andforeign exchange and to clearing arrangements forexchange-traded derivatives (White, 1998:196–198). Moreover, the specific stability issues posedby securities settlement are currently the subjectof a joint working group of the CPSS and theInternational Organization of Securities Commis-sions (IOSCO).13 But the discussion here will be


limited to the key standard in the area of paymentand settlement mentioned in table 4.1.

The initiative to develop an internationallyagreed framework of core principles for the design,operation and oversight of payment and settlementsystems reflects increased recognition of the risksassociated with rapidly rising volumes of pay-ments (CPSS, 2000a).14 The main risks in thesesystems are: credit risk, when a counterparty isunable to meet obligations within the system cur-rently or in future; liquidity risk (clearly closelyrelated, but not identical, to credit risk), when acounterparty has insufficient funds to meet obli-gations within the system, though it may be ableto do so at some future time; legal risk, when aninadequate legal framework or legal uncertaintiescause or exacerbate credit or liquidity risks; andoperational risk, when factors such as technicalmalfunctions or operational mistakes cause orexacerbate credit or liquidity risks. As discussedabove, any of these risks can have systemic con-sequences, as the inability of a counterparty orcounterparties to meet obligations within the sys-tem can have a domino effect on the ability ofother counterparties to meet their obligations,and thus, ultimately, threaten the stability of thefinancial sector as a whole.15 The task force es-tablished to develop the Core Principles was tolimit itself to “systemically important paymentsystems”, namely those capable of triggering ortransmitting shocks across domestic and interna-tional financial markets.

The first Core Principle is directed at legalrisk and specifies the need for a robust legal basisfor the payment system, a requirement that linksits rules and procedures to related areas of lawsuch as those concerning banking, contract andinsolvency. The second and third Principles con-cern rules and procedures for enabling participantsto have a clear understanding of the system’s im-pact on financial risks. They also recognize theneed for defining how credit and liquidity risksare to be managed and for identifying responsi-bilities for this purpose. A system’s risks can beexacerbated by the length of time required forfinal settlement or by the nature of the asset usedto settle claims. Thus the fourth and sixth Princi-ples specify the need for prompt settlement andfor a settlement asset that is either a claim on thecentral bank or one carrying little or no credit risk

(owing to the negligible risk of its issuer’s fail-ure). The fifth Principle requires a minimumstandard of robustness for multilateral nettingsystems.16 The seventh Principle is intended tominimize operational risk through ensuring a highdegree of security and operational reliability. Theeighth, ninth and tenth Principles address the moregeneral issues of the system’s efficiency and prac-ticality (including the need for explicit recognitionof any trade-off between safety and efficiency).They also address the need for objective and pub-licly disclosed criteria for participation in thesystem, permitting fair and open access, and ef-fective, accountable and transparent governancearrangements. The Core Principles attribute tocentral banks key responsibility for ensuring thatpayment systems comply with the Principles.

The second part of the Report on the CorePrinciples for Systemically Important PaymentSystems provides details on issues such as the iden-tification of systemically important paymentsystems, the modalities of their review and reform,structural, technical and institutional factors to beconsidered, and the kinds of cooperation neces-sary with participants in the system, user groupsand other parties to the reform process (CPSS,2000b).17 The second part also takes up certaincross-border aspects of payment systems. TheCore Principles are now included in the jointIMF-World Bank Financial Sector AssessmentProgramme (FSAP).18 However, experience in in-dustrial countries suggests that the upgrading ofpayment systems required by the Principles islikely to entail a lengthy process owing to themany different actions required and the many dif-ferent parties involved.

4. Accounting and auditing

Improvements in financial reporting andtransparency are essential to most of the initia-tives on codes and principles, but in the area ofaccounting and auditing in table 4.1 there is anexplicit aim to harmonize standards. Through theirimpact on disclosure, these standards have an ob-vious bearing on counterparties’ ability to assessthe financial risks of transactions. The need forinternational harmonization is also due to the


growth in cross-border business, especially inlending and investment. The principal body withresponsibility for promulgating international ac-counting standards is the International AccountingStandards Committee (IASC).19

Much of the recent work of theIASC has been directed atreaching a compromise on aset of standards acceptableboth to the United States andto other member countries,and which satisfies disclosurerequirements for the issuanceand trading of securities in theworld’s major financial mar-kets. A number of the difficult problems here con-cerns the reconciliation of the understandablypluralistic approach of the IASC with the morespecific and constraining rules of the GenerallyAccepted Accounting Principles (GAAP) of theUnited States.20

While debate on the International Account-ing Standards (IAS) is concerned mainly withhighly specific subjects,21 its impact on the inter-national financial system is likely to depend moreon its success in raising standards of accountingand financial reporting worldwide. And this willalso be related to accompanying initiatives to raiseauditing standards. The targets of such efforts in-clude internal auditing (i.e. as-sessment of the extent and ef-fectiveness of a firm’s man-agement and accounting con-trols and of the safeguardingand efficient use of its assets)as well as external auditing(i.e. auditing of financial state-ments and supporting evi-dence to determine the con-formity of the former with ap-plicable standards). Internalauditing is now a legal require-ment in several countries, and auditing commit-tees have frequently acquired greater importancein countries where shifts in corporate governancehave resulted in increased power for boards of di-rectors vis-à-vis senior operating executives. Butit is external auditing which is the principal sub-ject of international initiatives. Here the problemsof harmonization relate partly to differences in theaccounting standards underlying financial state-

ments but also to divergences in audit standard-setting processes themselves. These divergencesresult, for example, from the fact that in somecountries auditing standards are set by the ac-

counting profession whereasin others they are based on re-quirements mandated in lawsand regulations, or they resultfrom a process involving thejoint participation of both theaccounting profession and thegovernment. The institutionspecified in table 4.1 as hav-ing the lead responsibility forinternational harmonization of

auditing standards is the International Federationof Accountants (IFAC),22 which closely collabo-rates with other bodies also occupying key posi-tions in this area such as IOSCO and relevantEU institutions.

While improved standards of accounting andauditing have the potential for contributing to bet-ter decision-making by lenders and investorsthrough enhanced transparency, recent experiencecautions against exaggerated expectations in thisregard, especially in the short run. There is also aquestion as to how far the greater transparency –which is the main ultimate objective under thisheading – leads to greater financial stability. As the

celebrated investment manager,Warren Buffett, warns, “the ac-countants’ job is to record, notto evaluate”, and “… the busi-ness world is simply too com-plex for a single set of rules toeffectively describe reality forall enterprises” (Cunningham,2000: 196, 202). In the case offinancial firms, the difficultiesare multiplied by the speedwith which assets and liabili-ties can change, even in cases

where high standards of reporting are observed.Moreover, as already noted, although financial re-porting was poor in several of the countries in-volved in recent financial crises, there was noshortage of information available to lenders andinvestors about key macroeconomic variables andthe general economic and legal environment in thecountries concerned. And if the information ingood financial reporting has such a beneficial ef-

There is also a question asto how far the greatertransparency leads togreater financial stability.

If the information in goodfinancial reporting has sucha beneficial effect ondecision-making, why werelenders and investors notmore wary in its absence?


fect on decision-making, why were lenders andinvestors not more wary in its absence, especiallyin view of weaknesses which should have beenevident from the macroeconomic informationwhich was available?

5. Corporate governance

Corporate governance involves the relation-ships between the management of a business andits board of directors, its shareholders and lend-ers, and its other stakeholders such as employees,customers, suppliers and the community of whichit is a part. The subject thusconcerns the framework inwhich the business objectivesare set and how the means ofattaining them and otherwisemonitoring performance aredetermined. The OECD Prin-ciples of Corporate Govern-ance (OECD, 1999) cover fivebasic subjects: (i) Protectionof the rights of shareholders,a heading that includes allow-ing the market for corporatecontrol to function efficiently,transparently and fairly for allshareholders; (ii) Equitabletreatment of shareholders, in-cluding minority and foreign shareholders, withfull disclosure of material information and the pro-hibition of abusive self-dealing and insider trad-ing; (iii) Recognition and protection of the exer-cise of the rights of stakeholders as establishedby law, and encouragement of cooperation be-tween corporations and stakeholders in creatingwealth, jobs and financially sound enterprises;(iv) Timely and accurate disclosure and transpar-ency with respect to matters relevant to companyperformance, ownership and governance, whichshould include an annual audit conducted by anindependent auditor; and (v) A framework of cor-porate governance to ensure strategic guidance forthe company and effective monitoring of its man-agement by the board of directors, as well as theboard’s accountability to the company and share-holders (certain key functions of the board beingspecified under this heading).

Corporate governance sets rules on matterswhere variations of approach among countries areoften rooted in societal differences – for exam-ple, with respect to the relative importance offamily-owned firms as opposed to corporations,or to prevalent norms regarding the primacy ofsometimes conflicting business objectives, suchas long-term sustainability, on the one hand, andvalue for shareholders, on the other. These societaldifferences, in turn, generally reflect differencesin national histories and in the political and socialconsensus which has grown out of them.23 Thepreamble to the OECD Principles acknowledgesthat there is no single model of good corporategovernance and the Principles themselves arefairly general. They avoid rules for the more con-

tentious aspects of relationsbetween companies and theirlenders and investors, such asappropriate levels of leverage.They also avoid the more de-tailed rules for the market forcorporate control. Neverthe-less, there remains a dangerthat the technical assistanceand assessment exercises as-sociated with the promulgationof these Principles – whichwill also involve other organi-zations such as the World Bank– will contain features that re-flect biases in favour of conceptslinked to particular models of

corporate governance, most notably those of theUnited Kingdom or the United States.

Regarding the potential of better corporategovernance to contribute to financial stability, aconclusion similar to that for auditing and account-ing seems in order. Improvements in this area canbe expected to lead to better decision-making onseveral matters, but if they are based on princi-ples similar to those enunciated by the OECD, theyare likely to be gradual. Moreover, the better de-cision-making achieved in this way may have onlylimited effects on instability, which results fromforces which corporate governance can mitigatebut not eliminate. These forces include the pres-sures on loan officers to achieve target levels ofprofit in financial firms (a chronic problem, butone still not satisfactorily addressed in most firms’internal controls), weakness in even state-of-the-

Corporate governance setsrules on matters wherevariations of approachamong countries are oftenrooted in societal differencesthat generally reflectdifferences in nationalhistories and in the politicaland social consensus whichhas grown out of them.


art techniques for controlling credit, market andother financial risks, and psychological factorsconducive to imitative and herd behaviour in thefinancial sector.

6. Insolvency

Insolvency rules are such a substantial partof corporate governance as defined above that theyhave generated a separate literature on the subject.There is general recognition that existing regimesfor insolvency are characterized by widespreadweaknesses, or indeed by their total absence insome situations and countries.24 At the nationallevel (particularly in many developing and tran-sition economies), weakness isassociated with problems re-garding the enforcement ofcontracts, ineffective modal-ities for the netting, clearanceand settlement of outstandingobligations, poorly function-ing arrangements for the col-lateral and security of loans,and conflicts of law. All thesefeatures can pose serious prob-lems for certain aspects of thevaluation of firms and securi-ties, and they can be a source of increased financialrisk. Their presence in emerging markets can there-fore be a significant deterrent to foreign investment.

The lead role in developing globally accept-able rules for insolvency has been attributed tothe World Bank, whose objective is to develop an“integrated matrix” of components and criteria forsuch rules, highlighting existing best practices.25

These elements are intended to be a complementof a country’s legal and commercial system withguidance provided as to how they would interactwith and affect the system. Consensus on them isto be developed through a series of assessmentexercises and international insolvency symposia.The principal focus of the World Bank’s initiativeis national regimes in developing and transitioneconomies.

The feedback from this process has led to aConsultation Draft organized into the following

three parts: (i) legal, institutional, regulatory, andrestructuring and rehabilitation building blocks;(ii) different categories of insolvency conditionssuch as systemic insolvency and that of banks andenterprises; and (iii) an international dimensionconcerned with encouraging developing andtransition economies to take account of bothinternational best practices and issues with a cross-border dimension in order to facilitate their accessto international financial markets.

Improved insolvency rules have a more di-rect link to financial stability than many of theother subjects covered by the codes in table 4.1.Their main role under this heading is to help con-tain the problems due to the insolvencies of par-ticular firms and to prevent broader contagioneffects. The beneficial impact of this role obvi-

ously extends to cross-borderlending and investment. How-ever, as noted above, the fo-cus of the initiative being ledby the World Bank is on rulesfor developing and transitioneconomies, even though cross-border insolvencies (i.e. insol-vencies involving firms withbusiness entities in more thanone country) pose difficultproblems of coordination andconflicts of law in developed

countries as well. Here the danger is that the in-solvency of a large firm with an extensive inter-national network of entities could seriously disruptcross-border transactions. A special threat is thatposed by the possibility of the failure of a largemultinational bank having a home jurisdiction ina developed country.26 Most of the problems whichwould result from such a failure concern the cross-border dimensions of insolvency, and attempts todevelop international rules are currently concen-trated in other forums.27

7. Securities regulation

The Objectives and Principles of SecuritiesRegulation, published by IOSCO in September1998, sets out three major objectives: the protec-tion of investors; ensuring that markets are fair,

The insolvency of a largefirm with an extensiveinternational network ofentities could seriouslydisrupt cross-bordertransactions.


efficient and transparent; and the reduction of sys-temic risk. To achieve these objectives, it lists 30principles covering responsibilities of the regula-tor, self-regulation, enforcement of securitiesregulation, cooperation in regulation domesticallyand internationally, the responsibilities of issuers,rules and standards for collective investmentschemes, requirements for market intermediaries,and rules and standards for the secondary market.The principles explicitly related to systemic riskare covered mainly under the last two headings,and are concerned with capital and prudentialstandards for market intermediaries, proceduresfor dealing with the failure of a market interme-diary, and systems for clearing and settlingsecurities transactions which minimize such risk.In other words, the focus of the principles for re-ducing systemic risk is on measures directed atfirms and market infrastructure.

Unsurprisingly for a code produced by a glo-bal organization of specialist regulators, theseprinciples are concerned mainly with the fairnessand efficient functioning of markets themselves.Connections to broader issues of macroeconomicpolicy and to policy towards the financial sector,both of which have been associated with systemicinstability in developing and transition economies,are ignored. A more comprehensive and repre-sentative set of principles for securities markets –including issues highlighted by recent crises indeveloping and transition economies – should ar-guably address some aspects of policy towards thecapital account of the balance of payments (suchas appropriate conditions for the access of foreignportfolio investors) and the commercial presenceof foreign investment institutions.

8. Insurance

Traditionally, insurance is not regarded as asource of systemic risk. Consequently, the princi-pal objectives of its regulation and supervision areclient protection and the closely related subjectsof the safety and soundness of insurance compa-nies and their proper conduct of business. Thisinvolves such matters as disclosure, honesty, in-tegrity and competence of firms and employees,marketing practices, and the objectivity of advice

to customers. The principal grounds for down-playing the systemic risks of the insurance sectorare that companies’ liabilities are long term andnot prone to runs, while their assets are typicallyliquid. Moreover, mutual linkages among insur-ance companies and linkages between suchcompanies and other financial firms are limitedowing to the lack of a role for the former in clear-ing and payments and to the extent and depthof the markets where their assets are traded(Goodhart et al., 1998:14).

However, recently questions have been raisedas to the adequacy of this characterization. Thisis partly due to the expanding role of the insur-ance sector in savings and investment productsstemming from the close links between manykinds of life insurance policy and personal savingor investment instruments. The recent expansionin its turn is due partly to trends in the conglom-eration of financial firms that have witnessed morewidespread involvement of insurance companiesin the sale and management of investment funds,on the one hand, and of banks in the insurancebusiness, on the other. These trends have increasedthe possibility of contagion between insurance andother forms of financial business and, where largefirms are involved, the scale of the possible ad-verse consequences of such contagion. In the caseof developing and transition economies, an addi-tional danger should be taken into account,namely, that the failure of one or more financialfirms – including those with substantial insuranceinterests – may trigger a run on the currency. Theresulting depreciation can have adverse conse-quences extending well beyond the sector wherethe problems originate.

The focus of the Insurance Core Principles28

is the organization and practice of the sector’ssupervision, as well as the following sector-specific subjects: the corporate governance ofinsurance companies, their internal controls, pru-dential rules, conduct-of-business issues and thesupervision of cross-border business. The pruden-tial rules cover the management of an insurancecompany’s assets, the identification and classifi-cation of liabilities, rules for capital requirementsand for the use, disclosure and monitoring of de-rivatives and other off-balance-sheet items, andreinsurance as an instrument for risk containment.The principle covering the supervision of cross-


border business operations is designed to ensurethat no cross-border insurance entity escapes su-pervision, and that adequate arrangements are inplace for consultations and information exchangebetween such an entity’s home-country andhost-country supervisors. Thus the focus of theInsurance Core Principles is functional, while is-sues explicitly relating to the supervision offinancial conglomerates are left to other forums(IAIS, 2000a).29

9. Market integrity and money laundering

Money laundering is one of the most politi-cally sensitive subjects covered by the codes andprinciples listed in table 4.1. It is an area wherefinancial supervision interfaces directly with lawenforcement – including some of the latter’stougher manifestations – since the activities fi-nanced with laundered money include drugdealing and terrorism. Indeed, the attention givento money laundering reflects, to a significant ex-tent, the political difficulties in major developedcountries in dealing with the problem of drugconsumption. The policies adopted here have fo-cused mainly on repression ofproduction and consumptionas opposed to alternative ap-proaches, with the result thatprofits from illegal supply re-main high. Money launderingis also closely connected tocorrupt activities in developedand developing countries sinceit is used for concealing thesize, sources and recipients ofthe money involved in suchactivities. Generally acceptedestimates of the global scale ofmoney laundering do not yet ex-ist, but there is no doubt that it is very large. Moneylaundering has long been an important issue in rela-tions between OECD countries and offshorefinancial centres. However, some recent scandalsindicate that it also remains a problem for coun-tries with traditional financial centres.30

The principal international body entrustedwith the task of combating money laundering is

the Financial Action Task Force on Money Laun-dering (FATF),31 established after the Group ofSeven summit in 1989. Its current membershipconsists of 29 (mainly developed) countries andtwo international organizations – the EuropeanCommission and the Gulf Cooperation Council.In 1990, the FATF drew up a list of 40 recom-mendations which members are expected to adopt.These were revised in 1996 to take account of ex-perience gained in the meantime and of changesin money laundering practices (FATF, 1999). Im-plementation by member countries of theserecommendations is monitored on the basis of atwo-pronged approach – an annual self-assessmentexercise and periodic peer reviews of a membercountry by teams drawn from other members.More recently, the FATF has also conducted anexercise to identify jurisdictions deemed to benon-cooperative in the combat against moneylaundering (FATF, 2000). It clearly hopes thatidentification and the attendant publicity willprompt improvements in the 15 countries it hasidentified so far. In addition, its members haveagreed to issue advisories to regulated financialinstitutions within their jurisdictions, requiringthem to take extra care in business undertaken withcounterparties in the 15 countries – an action thatis likely to impose extra costs on such business.

The FATF’s 40 recom-mendations include the fol-lowing obligations: criminal-ization of the laundering of theproceeds of serious crimes; theidentification of all customersand the keeping of appropri-ate records; a requirement thatfinancial institutions reportsuspicious transactions to thecompetent national authorityand that they develop pro-grammes to counter moneylaundering, including compre-

hensive internal controls and employee training;adequate supervision of money laundering and thesharing of expertise by supervisors with other do-mestic judicial and law enforcement authorities;and the strengthening of international cooperationthrough information exchange, mutual legal as-sistance and bilateral and multilateral agreements.There are relations between the FATF’s initiativesand others directed at offshore financial centres.32

Money laundering has longbeen an important issue inrelations between OECDcountries and offshorefinancial centres. However,some recent scandalsindicate that it also remainsa problem for countries withtraditional financial centres.


For example, the harmful tax competition tech-niques for evading tax through recourse to off-shore financial centres that are the subject of theOECD initiative (OECD, 2000d) are often the sameas or similar to those used in money laundering.Likewise, “know your client” rules – a standardpart of an effective regime for financial regulation– generally cover much the same ground as theFATF’s requirements concerning customer iden-tification. However, as in the case of other codesand principles discussed in this section, the con-tributions of the FATF’s recommendations to in-ternational financial stability are mostly indirect.

Disclosures about involvement in moneylaundering have sometimes been associated with

C. Influence and participation in the formulationand implementation of standards

the failure of financial firms. However, moneylaundering – like the facilities offered by offshorecentres – has played, at most, a marginal role inrecent financial crises. Nevertheless, by makingcertain types of capital flight more difficult orcostly, better control of money laundering can helprestrain certain potentially destabilizing capitalflows and accumulation of external debt not linkedto legitimate economic activity. But the effective-ness of such restraint will depend on the degreeof active cooperation between countries which aresources and recipients of laundered money. Ruleson money laundering are therefore an essentialcomponent of regulatory regimes for financialfirms; without them such regimes could scarcelybe characterized as effective or comprehensive.

Since standards became an integral compo-nent of international financial reform, muchemphasis has been placed on the importance of“ownership” of their adoption and implementationby the countries affected. Extensive consultationhas taken place as part of the assessment of im-plementation now under way and the results caneventually be expected to affect the future devel-opment of the standards themselves. However, notall of the exercises under this heading have beenfree of asymmetries among the different partiesinvolved. This has led, on occasion, to questionsabout fairness. Lack of symmetry, particularly inthe degree to which developing countries’ con-cerns are taken into account, is also evident in theselection of subjects to which some of the stand-ards are to apply. This would appear, at least partly,to reflect divergences in viewpoints concerningthe functioning of the international financial sys-tem and the issues appropriate for policy action.

“Ownership” is related to countries’ percep-tions of their national interest in the adoption andimplementation of standards. Such perceptions canbe assisted by the exchange of experiences in fo-rums such as the multilateral financial institutionsand the standards-setting bodies, providing theopportunity to contribute to standards setting,alignment of programmes for standards implemen-tation with domestic agendas for financial reform,and encouraging and aiding self-assessment (FSF,2000a: 2). The promotion of country ownershipis an objective of outreach programmes on stand-ards implementation (IMF, 2000e), which operatethrough vehicles such as technical assistance,workshops and regional meetings. These act-ivities have also involved the IMF and the WorldBank, institutions with relevant expertise suchas supervisors from major industrial countries,and others participating in processes of peer re-view.


The asymmetries mentioned above are notomnipresent and are not always easily identified,since they are often woven into basic assumptionsor categories underlying the standards in table 4.1.The bias in some of the Codes towards subjectslikely to be of greater concern to developed coun-tries often reflects the historical origins of theinitiatives in question. Much of the cross-borderbusiness affecting the subjects covered was tradi-tionally between parties in industrial countries,with developing countries’ involvement beingonly fairly recent. Yet despite their increasingprominence in this context, certain concerns ofdeveloping countries appearto have been set aside duringstandards formulation andtheir interests ignored or down-played during the follow-up.Moreover, parts of policy docu-ments, the issuance of whichhas coincided with the stand-ards initiatives – and whichtreat important parts of theirrationale – in some cases sub-stantially reflect official view-points in major developedcountries, as evident from re-cent reports of the FSF.

For example, the report of the FSF’s WorkingGroup on Capital Flows (FSF, 2000b) focuses mainlyon improved risk-management practices and en-hanced transparency on the part of private andpublic sectors in countries receiving internationallending and investment as the principal means ofcountering the instability of these flows.33 The re-port also identifies various biases or incentives inthe policies of recipient countries that are likelyto lead to excessive dependence on short-term (andthus potentially volatile) inflows. But it downplaysthe impact of the behaviour of lenders and inves-tors in developed countries as well as the effectsof macroeconomic policies in these countries oncapital flows to developing and transition econo-mies. The report gives considerable attention toimprovements in the provision and use of officialstatistics and of information in financial report-ing by the private sector in recipient countries.However, it shies away from endorsing a require-ment for frequent disclosure of data on the largeshort-term positions in assets denominated in acountry’s currency held by foreign firms other than

banks (a category that includes hedge funds),which several developing (and some developed)countries perceive as threats to the stability of theirexchange rates and financial markets.

Similarly, the report of the FSF Working Groupon Highly Leveraged Institutions (HLIs)34 hastended to play down widely expressed concernsof certain countries in some of its policy recom-mendations (FSF, 2000c). This Working Groupdistinguished between two broad groups of issuesposed by HLIs: systemic risks (of the kind exem-plified by the collapse of Long Term Capital Man-

agement (LTCM)), on the onehand, and “market dynamicsissues” (i.e. the amplificationof instability and the threats tomarket integrity which mayresult from HLIs’ operationsin “small- and medium-sizedopen” economies), on the oth-er. The systemic risks whichmay be caused by HLIs arenaturally of concern to devel-oping and transition econo-mies. Like other participantsin international financial mar-kets, for example, they were

affected by the increases in risk premiums and thesharply reduced availability of financing in late1998, to which the collapse of LTCM contributed.Nevertheless, their special concerns are relatedmore to the “market dynamics issues”.

The Working Group conducted an exami-nation of “market dynamics issues” in the ex-periences of six economies during 1998.35 Itsconclusions amounted to a qualified endorsementof concerns which had been expressed regardingHLIs. Thus the capacity of HLIs to establish largeand concentrated positions in small- and medium-sized markets was acknowledged, and with this,their potential to exert a destabilizing influence.But there was less consensus as to the importanceof their influence in comparison with other fac-tors during particular instances of instability inthe different economies during 1998. Similar con-clusions were reached regarding the threat tomarket integrity posed by some aggressive prac-tices attributed to HLIs, such as heavy selling ofcurrencies in illiquid markets, dissemination ofrumours about future developments, selective dis-

Certain concerns ofdeveloping countriesappear to have been setaside during standardsformulation and theirinterests ignored ordownplayed during thefollow-up.


closure of information about firms’ positions andstrategies, and correlated position-taking in themarkets for different assets within a country andalso across currencies with the objective of achiev-ing profitable movements in relative prices.36 Here,too, the capacity of HLIs to engage in such prac-tices was recognized, but there was less agreementas to its significance at different times and in dif-ferent countries.

The major thrust of the Working Group’srecommendations is directed at reducing the sys-temic risk HLIs are capable of causing rather thanat “market dynamics issues”. The recommenda-tions, directed primarily at systemic risk, havemany connections to those of official bodies andindustry groups of major industrial countries sur-veyed at some length in an annex to the report.These include: stronger risk management by bothHLIs and their counterparties; enhanced regula-tory oversight of HLIs’ credit providers; furtherprogress in industry practices with regard to suchaspects as the measurement of exposures and ofliquidity risk, stress testing, collateral managementand external valuation, as well as in buildingmarket infrastructure in areas such as the harmo-nization of documentation, valuation and bank-ruptcy practices. In addition, the Working Grouprecommended fuller public disclosures by HLIsin the context of a movement towards improvedand more comparable risk-based public disclosureby financial institutions more generally.

Most of these recommendations are capableof having beneficial effects on “market dynamicsissues” and of reducing systemic risk. However,the Working Group limited itself to two recom-mendations of particular relevance to the formersubject. The first recommendation aims at strength-ening some kinds of surveillance of activity infinancial markets at the national level with a viewto identifying rising leverage and other concernsrelating to market dynamics that may requirepreventive measures. The second aims to promoteguidelines of good practice for currency tradingwith the support of leading market participantswho would review and, as necessary, revise existingcodes and guidelines in this area in the light of con-cerns recently expressed about trading behaviour.

Underlying the second of these two recom-mendations is a recognition of the absence in most

emerging financial markets of guidelines andcodes of conduct for trading practices, such as areissued in most major financial centres by tradeassociations, industry groups and committees ofmarket participants. The recommendation is thatmajor financial institutions should take the ini-tiative in preparing and promoting codes andguidelines for jurisdictions where they currentlydo not exist. If this recommendation is to be effec-tive, it must not only lead to industry initiativesof the kind envisaged, but also to changes in ac-tual behaviour, even though such guidelines andcodes lack legal weight.

Regarding surveillance and transparency con-cerning market positions, the report on HLIs ismore forthcoming than that on capital flows,though the somewhat veiled character of the ex-position renders the nature of the different optionsconsidered, and the Group’s view on their associ-ated pros and cons, hard to grasp precisely. Thecollection of aggregate high-frequency informa-tion on positions in key markets is not acceptedon the grounds of feasibility, cost and difficultiesin obtaining compliance.37 National initiatives in-volving proactive surveillance between monetaryauthorities, supervisors and market participants re-ceive greater support from the Working Group,but subject to reservations and doubts concerningsuch matters as the costs and benefits of, and in-ternational participation needed for, disclosure ofinformation on positions in major emerging-mar-ket currencies. Some surveillance of this kind (butpossibly mainly of an informal nature) presum-ably already exists in several countries, since itwould appear to have been the source of part ofthe information contained in the report’s surveyof the experience of HLIs’ operations in six juris-dictions. The strongest reservations of the Reportin this area concern enhanced oversight by nation-al authorities of the provision of local currency,which is necessary for the settlement of the greatmajority of speculative positions against a cur-rency. These reservations are due primarily to theWorking Group’s view that formal procedures forthis purpose constitute capital controls.

The unavoidable conclusion regarding theWorking Group’s recommendations on “marketdynamics issues” is that they fall well short ofsymmetry. Although they recognize the concernsrecently expressed about HLIs’ practices in this


area as legitimate, they devote much more atten-tion to the obligations for transparency soughtfrom economic actors in developing and transitioneconomies as part of international financial reform.

Asymmetries in the assessment proceduresassociated with the standards initiatives are alsoexemplified in another report of the FSF (2000d),that of its Working Group on Offshore Centres(OFCs).38 In the context of international financialreform, there is concern that, although OFCs donot seem to have been a major cause of systemicproblems so far, they mightbecome so in the future. Thisis because of the growth inthe assets, liabilities and off-balance-sheet activities of in-stitutions based in OFCs, aswell as growing interbank re-lations. In particular, the fearis that OFCs could prove animportant source of contagion.The terms of reference of theWorking Group included ageneral stock-taking of the usemade of OFCs, and, more par-ticularly, a review of their progress in enforcinginternational prudential and disclosure standards,and in complying with international agreementson the exchange of supervisory information andother information relevant to combating financialfraud and money laundering.

For this purpose, the Working Group organ-ized a survey of OFCs that aimed at assessingcompliance with the international standards ofsupervision established by the BCBS, the IAIS andIOSCO (i.e. with standards for the banking, in-surance and securities business). The survey wasconducted through two questionnaires – one foronshore supervisors in 30 major financial centresand the other for 37 OFCs. The first questionnairewas designed to elicit views on the quality of regu-lation and supervision in those OFCs with which

the onshore supervisors had some degree of fa-miliarity, and on the quality of cooperation theyhad experienced with OFC supervisors. The sec-ond questionnaire was intended to provide infor-mation on how these OFCs interacted with thehome supervisors of suppliers of financial serv-ices operating in or from their jurisdictions (i.e.branches, subsidiaries or affiliates of suppliersincorporated in an onshore jurisdiction). The sur-vey was the basis of a classification of OFCs intothree groups: (i) those generally viewed as co-operative, with a high quality of supervision,

which largely adhered to inter-national standards; (ii) thosegenerally seen as having pro-cedures for supervision andcooperation in place, but whereactual performance fell belowinternational standards andthere was substantial room forimprovement; (iii) those gen-erally seen as having a lowquality of supervision and be-ing non-cooperative with on-shore supervisors (or both),and as making little or no at-

tempt to adhere to international standards. How-ever, several supervisors in OFCs considered thatthe procedures followed in this exercise had pro-vided them with an inadequate opportunity forself-assessment of their regulatory regimes andof the quality of their supervision. Providing OFCswith such an opportunity would have been in bet-ter accord with the spirit of the report’s proposalsconcerning the future programme for assessmentof standards implementation on the part of OFCs.One of the stages specified is self-assessmentassisted by external supervisory expertise (FSF,2000d: 56–60). As a class, OFCs do not arousemuch sympathy within the international commu-nity. However, smooth progress in global initia-tives on standards requires a perception of even-handedness regarding different aspects of theirapplication among all the parties involved.39

Smooth progress in globalinitiatives on standardsrequires a perception ofeven-handedness regardingdifferent aspects of theirapplication among all theparties involved.


Implementation of standards is a process withseveral dimensions and stages. The first step speci-fied in the strategy of the FSF Task Force (FSF,2000a, sect. III) is to identify and achieve inter-national consensus on standards. This is followedby a prioritization exercise so that the process ofimplementation becomes manageable – an exer-cise which has led to the list of key standards intable 4.1. Action plans at the national level thenneed to be drawn up. The primary agents involvedhere are national governments, which consultmultilateral financial institutions and standard-setting bodies as necessary and can receive tech-nical assistance of various kinds. Once implemen-tation of plans is under way, it is subject to as-sessment, partly by the relevant national authori-ties themselves, but also bymultilateral financial institu-tions, standard-setting bodies,and possibly other parties;technical assistance is alsoprovided under this heading.Another integral part of theprocess of implementation isthe dissemination of informa-tion on progress, in particular,to market participants such aslenders and investors.

Implementation is also tobe promoted by official andmarket sanctions and incentives, which have manymutual links.40 One important example on the of-ficial side is the technical assistance alreadymentioned. Others might involve the inclusion ofstandards implementation in policy surveillance(closely linked to assessment exercises), condi-tions attached to official financing (especially that

of multilateral financial institutions), and takinginto account the observance of standards in deci-sions on eligibility for membership of internationalbodies and in regulatory and supervisory decisionsin host countries with respect to a country’s fi-nancial firms abroad. In some of these cases theFSF Task Force is endorsing actions already takenor is advocating further steps in the direction ofsuch actions. But in others the sanctions and in-centives put forward have not yet been the subjectof official decisions and the Task Force itself hasexpressed its awareness of possible drawbacks.

In terms of actions already taken, implemen-tation of financial standards is now included inthe IMF’s policy surveillance under Article IV

(which takes account of theconclusions of the FSAP men-tioned in subsection B.2). Oneof the conditions for a coun-try’s eligibility for financingthrough the IMF’s Contin-gency Credit Line (CCL)41 isa positive assessment duringthe most recent Article IV con-sultations of its progress in ad-hering to internationally ac-cepted standards. There arealso indications of pressure tolink standards implementationto the conditions associated

with other IMF facilities. In particular, steps toimplement and observe specific standards havebeen included in some IMF country programmes.Finally, the granting of market access to a foreignfinancial firm in several countries is already con-ditional on the standard of supervision in its homecountry, and the incentive put forward by the Task

One of the conditions for acountry’s eligibility forfinancing through the IMF’sContingency Credit Line isa positive assessment of itsprogress in adhering tointernationally acceptedstandards.

D. Implementation, sanctions and incentives


Force would presumably reinforce such condi-tions.

Possible official sanctions and incentiveswhich are not currently in place and would notrepresent extension or reinforcement of existingpolicies include various measures. Membership ofbodies such as IOSCO, the Basel-based bodiesconcerned with financial regulation and supervi-sion, or the OECD might be linked to progress instandards implementation. Butthis, as the FSF Task Forcenotes, could actually have theperverse effect of removing asource of peer pressure. Riskweights in setting prudentialcapital requirements for bor-rowing counterparties couldbe differentiated in accordancewith the observance of stand-ards in the jurisdictions wherethey operate. This presupposeseffective assessment of com-pliance, which is not yet inplace and may prove difficultto achieve in some cases. Nonetheless, steps inthis direction are part of some proposals currentlyunder consideration (see box 4.1).42 Supervisioncould be tightened and other regulatory actionstaken regarding the subsidiaries or branches offoreign financial firms whose home supervisorsare in countries where implementation of stand-ards is weak. Such actions might include restrict-ing inter-affiliate transactions and increasingscrutiny of customer identification, for example.As the FSF notes, this would require disclosureto supervisors in host countries of all pertinent in-formation concerning compliance with the stand-ards in question. Another challenge would be toachieve a level of coordination sufficient to avoidregulatory arbitrage among financial centres.

Assessment of the effectiveness and appro-priateness of official and market sanctions andincentives in standards implementation has nowcommenced. The FSAP43 and IMF Article IV sur-veillance will inevitably play a key role in theformer. Among the subjects of surveillance wouldbe progress in standards implementation under theheading of the strength of the financial sector moregenerally. The extensive – and thus resource-con-suming – process of assessment should itself be

subject to continuing evaluation by a body whichneeds to keep a certain distance from the asses-sors. This may prove to be one of the key rolesfor the FSF, though one possibly complicated bymembership in it of important institutions respon-sible for this assessment.

Market sanctions and incentives are to de-pend most importantly on market participants’ useof information on an economy’s observance of

standards in their risk assess-ment. Such information is thenreflected in differentiated cred-it ratings, spreads for borrow-ers, exposure limits and otherlending and investment deci-sions. If these sanctions andincentives are to work, the keyrequirements are: (i) that mar-ket participants be familiarwith international standards;(ii) that they judge them to berelevant to their risk assess-ments; (iii) that they have ac-cess to information on their

observance; and (iv) that this information be de-ployed as an input in their risk assessments (FSF,2000a). Official assistance to the operation of mar-ket sanctions and incentives can take the form ofpromoting disclosure of relevant information aswell as pressures on, and encouragement to, mar-ket participants to take account of standards ob-servance in their decisions.

The effectiveness of market sanctions andincentives depends on their incorporation intomarket practices. Although experience so far hasbeen of a short duration, the FSF has soughtfeedback from market participants to enable pre-liminary conclusions on the effectiveness of suchsanctions and incentives, most importantly in theform of an informal dialogue with participantsfrom 100 financial firms in 11 jurisdictions (FSF,2000e, sect. III).44 This outreach exercise revealedonly limited awareness of the 12 key standards intable 4.1, though the degree of awareness varied,being greatest for the Special Data DisseminationStandard (SDDS) and International AccountingStandards (IAS). Few market participants took ac-count of an economy’s observance of the stand-ards in their lending and investment decisions,although observance of the SDDS was found to

Market participantsconsidered observance ofthe standards lessimportant than theadequacy of a country’slegal and judicialframework, political risk,and economic and financialfundamentals.


Box 4.1

BASEL CAPITAL STANDARDS

The Basel Capital Accord of 1988 was the result of an initiative to develop more internationallyuniform prudential standards for the capital required for banks’ credit risks. The objectives of theAccord were to strengthen the international banking system and to promote convergence of na-tional capital standards, thus removing competitive inequalities among banks resulting from dif-ferences on this front. The key features of this Accord were a common measure of qualifyingcapital, a common framework for the valuation of bank assets in accordance with their associatedcredit risks (including those classified as off-balance-sheet), and a minimum level of capital deter-mined by a ratio of 8 per cent of qualifying capital to aggregate risk-weighted assets. In subsequentyears, a series of amendments and interpretations were issued concerning various parts of theAccord. These extended the definition and purview of qualifying capital, recognized the reduc-tions in risk exposure which could be achieved by bilateral netting meeting certain conditions,interpreted the Accord’s application to multilateral netting schemes, allowed for the effects on riskexposure of collateralization with securities issued by selected OECD public-sector entities, andreduced the risk weights for exposures to regulated securities firms. Simultaneously, the BaselCommittee continued its work on other banking risks, of which the main practical outcome so farhas been the amendment of the 1988 Accord to cover market risk, which was adopted in 1996. The1988 Basel Accord was designed to apply to the internationally active banks of member countriesof the Basel Committee on Banking Supervision, but its impact was rapidly felt more widely; by1999 it formed part of the regime of prudential regulation not only for international, but also forstrictly domestic banks, in more than 100 countries.

From its inception, the 1988 Basel Accord was the subject of criticism directed at such features asits failure to make adequate allowance for the degree of reduction in risk exposure achievablethrough diversification, the possibility that it would lead banks to restrict their lending, and itsarbitrary and undifferentiated calibration of certain credit risks. In the case of country risk, withvery limited exceptions this calibration distinguished only between OECD and non-OECD countries– a feature of the Accord which some developing countries considered unjustifiably discrimina-tory. In the aftermath of the financial crises of the 1990s, the Accord’s contribution to financialstability more generally became a focus of attention. There was special concern here with regard tothe incentives which the Accord’s risk weighting was capable of providing to short-term interbanklending – a significant element of the volatile capital movements during these crises.

The Basel Committee responded by initiating a comprehensive overhaul of the 1988 Accord. Itsfirst proposal for this purpose (A New Capital Adequacy Framework – henceforth New Frame-work), published in June 1999 (BCBS, 1999b), incorporates three main elements or “pillars”:(i) minimum capital rules based on weights that are intended to be more closely connected to creditrisk than those of the 1988 Accord; (ii) supervisory review of capital adequacy in accordance withspecified qualitative principles; and (iii) market discipline based on the provision of reliable andtimely information. In early 2001 (as this TDR was completed), a revised set of proposals wasissued that is designed to take account of comments by the banking industry and supervisors aroundthe world.

The New Framework contains two basic approaches to the numerical standards for capital ad-equacy: the standardized and the internal-ratings-based approaches. A major feature of the stand-ardized approach is the proposal for recourse to the ratings of credit rating agencies in settingweights for credit risk. The New Framework’s proposal regarding the internal-ratings-based ap-proach is still tentative and will require adequate safeguards concerning such matters as the cali-bration of risk and comparability. However, the approach is likely to be an option in the revisedproposals for banks with sufficiently sophisticated systems for handling credit risk.

The New Framework’s proposal for recourse to the ratings of credit rating agencies in settingweights for credit risk has proved highly contentious. Perhaps most importantly, there is a wide-spread view that the track record of the major agencies, especially with respect to identifying theprobability of serious threats to the debt-service capacity of, or defaults by, sovereign borrowers,


is not good enough to justify reliance on them for setting weights for credit risk. Much recentcriticism has focused on the agencies’ performance during the Asian debt crisis. A notable featureof this crisis was the large and swift downgrading of some of the countries affected. Thus a majorconcern here is that, if credit rating agencies’ announcements simply parallel changes in marketsentiment or, still worse, actually follow such changes, they are capable of exacerbating fluctua-tions in the conditions in credit markets and thus financial crises. Recourse to agencies’ ratings forcredit-risk weighting might result in the new capital standards, on occasion, actually exacerbatingthe instability of bank lending.

Statistical studies1 of the effects of rating agencies’ announcements concerning creditworthinesson countries’ borrowing costs show a strong correlation between such announcements and thespreads on dollar-denominated bonds above the yields of United States Treasury bonds of the samematurity. But mere correlation does not settle questions regarding the nature of the role of agenciesduring fluctuations in credit conditions. Only if the announcements of credit agencies concerningchanges in creditworthiness preceded changes in market conditions would it seem reasonable toattribute to them an effective ex-ante capacity to rate credit risk. However, the results of researchon the subject provide weak support for this proposition. Indeed, the findings of this research helpto explain widespread opposition in official circles to major agencies’ ratings for setting banks’minimum capital levels (and not only those in developing and transition economies), an oppositionwhich, it should be noted, is apparently matched by some reluctance among the agencies them-selves to assume such a responsibility.

There is also concern about the expansion in the use of agencies’ ratings for the purposes of eco-nomic policy. The ratings of major rating agencies already have a role in the regulatory frameworkof a number of countries. In the United States, for example, they are used to distinguish investmentgrade from speculative securities for various purposes such as rules governing the securities hold-ings of banks and insurance companies. Nonetheless, the proposals of the New Framework wouldsubstantially extend the influence of major rating agencies and could easily lead to increased offi-cial regulation and oversight.

Other questions have focused on the coverage of major agencies’ ratings in the context of their useof credit-risk weighting. Even in the European Union, according to provisional estimates of theEuropean Commission, coverage of the major credit rating agencies is limited to less than 1,000corporates. In India, to take a developing-country example, in early 1999, out of 9,640 borrowersenjoying fund-based working capital facilities from banks, only 300 had been rated by any of themajor agencies (Reserve Bank of India, 2000: 13–14). Of course, as noted above, the New Frame-work envisages internal-ratings-based approaches to the setting of banks’ credit-risk weights as analternative to recourse to the ratings of credit rating agencies for sufficiently sophisticated banks.But other banks might still need to make extensive use of the New Framework’s proposed riskweightings for unrated exposures. In view of the unsatisfactory character of this alternative, therehave been calls for greater emphasis in the Basel Committee’s revised proposals on recourse to theratings of domestic (as opposed to major international) rating agencies – a proposal not in factexcluded from the New Framework so long as the agencies in question meet certain minimumcriteria.

As for the promotion of greater stability in international bank lending through incentives to tightercontrol over short-term interbank exposures, the proposals of the New Framework are widely re-garded as still inadequate. This is because, under one of the options for credit-risk weighting,exposures with an original maturity of up to six months to banks within a broad range of creditratings would be attributed a weighting more favourable than those with longer maturities (subjectto a floor). In the light of recent experience, a more restrictive approach to short-term interbankclaims may indeed be required.

1 These studies are summarized in Cornford (2000b, sect. VI.A).

Box 4.1 (concluded)


influence economies’ credit ratings. Generally,market participants considered observance of thestandards less important than the adequacy of acountry’s legal and judicial framework, politicalrisk (often rated as more important than regula-tory or supervisory risk), and economic and fi-nancial fundamentals. Rating agencies, which tendto be better acquainted with both the standardsand the assessment exercises undertaken so far,nonetheless considered that their direct access tonational authorities provided them with a betterunderstanding of the quality of regulation andsupervision, of policy and data transparency, andof market infrastructure.45

It is too early to make more than a highlypreliminary evaluation of standards implementa-tion and of the effectiveness of incentives. Thelarge potential costs of the administrative burdenassociated with implementation and assessmentare widely acknowledged. But the effectivenessof measures proposed to alleviate this burden hasyet to be proved. In the case of the official sanc-tions and incentives mentioned above, many arestill only being considered and not all will neces-sarily be adopted. The inclusion of standards im-plementation in IMF conditionality is still at anearly stage, and its extension in this area remainshighly contentious. The impact of market sanc-

tions and incentives on standards is likely to taketime. This is indeed reflected in the feedback frommarket participants concerning factors that over-ride standards observance in their decisions. Forexample, market participants’ reference to theoverriding significance of the quality of the legaland judicial framework – one of the targets of thestandards – should be viewed in the light of thelength of time required for the standards to havean impact. Similar considerations apply in vary-ing degrees to political risk (where market par-ticipants cited the threat of nationalization andpolicy reversals) and economic and financialfundamentals. Regarding incorporation of stand-ards observance as a factor in the decision-making processes of market participants, there isa chicken-and-egg problem, at least in the mediumterm. By taking account of standards observancein their lending and investment decisions, marketparticipants are supposed to make an importantcontribution to such observance. However, dur-ing the early stage of standards observance, itsimpact on the determinants of creditworthinessand the investment climate is at most still super-ficial. This means that market participants willcontinue to rate this subject as being of limitedimportance, and it will, therefore, have a corre-spondingly low weight in their lending and invest-ment decisions.


As already mentioned, the improvementsdescribed in previous sections will entail extensivechanges for many countries, and their implemen-tation could be lengthy. This is particularly trueof the required reforms in the legal and regula-tory framework and of their incorporation into thenorms of business practice, which is a prerequi-site for receiving the full benefit of these reforms.The gradual and difficult nature of this processfor developing and transition economies shouldnot be taken as a reflection on their legislative andadministrative competence or their political will.For example, the process of deregulating finan-cial sectors in OECD countries or of putting inplace a single-market regime in the EuropeanUnion for the banking and securities business –both processes involving obstacles and constraintssimilar to those confronting the global regimes offinancial standards – took decades.46

The limits on the efficacy of enhanced stand-ards and associated legal and regulatory reformsreflect various factors. One of these is the rooted-ness of standards in past experience, which makesthem less than perfect for dealing with the conse-quences of innovation. Moreover, many of thestandards covered by recent initiatives are directedat the behaviour of economic agents and the func-tioning of firms and markets. Stronger foundationsat this level can reduce – but not eliminate – thelikelihood and magnitude of systemic instability.Malpractice and fraud may become easier to de-tect as standards are enhanced, but they will notdisappear. The collapse of Barings in early 1995is an example of the broader destabilizing poten-tial of events originating in malpractice within asingle firm. More importantly, systemic crises in

the financial sector are often closely linked tomacroeconomic dynamics and to developments atthe international level – or regional level within acountry – which transcend particular nationalfinancial sectors. A Utopian vision of standardsmight include standards for macroeconomic poli-cy designed to put an end to phenomena such asboom-bust cycles, which historically have fre-quently proved to be the financial sector’s nemesis.But, as already noted in subsection B.1, the codesof good practices regarding various aspects ofmacroeconomic policy in table 4.1 concern trans-parency and procedural issues, and not the con-tents of such policy itself.

The crucial field of banking supervision il-lustrates the limitations of standards. A naturalstarting-point here is the licensing of banks. Insome countries the relevant criteria were longdesigned primarily to ensure adequate levels ofcompetence and integrity among those owning andcontrolling a bank. But licensing is often also usedto serve less limited objectives, such as the avoid-ance of “overbanking”, limitation of financial con-glomeration, and (in the case of foreign entities)restricting foreign ownership of the banking sec-tor, or ensuring that the parent institution is ad-equately supervised in its home country. Theobjectives of licensing may have (usually proxi-mate) relations to banking stability, but they can-not prevent serious banking instability or bankingcrises. Another major subject of banking supervi-sion is implementation of prudential regulation,much of which is concerned with ensuring ad-equate management and internal controls, butwhich also includes prudential capital require-ments.47 A key purpose of capital here is to pro-

E. Standards, financial regimes and financial stability


vide a stable resource to absorb any losses incurredby an institution, and thus protect the interests ofits depositors. Capital requirements for credit andmarket risks are also clearly intended to contri-bute to financial risk management of assets andliabilities, as well as to appropriate pricing of thedifferent products and services which a bankoffers. Prudential capital, by strengthening finan-cial firms, reduces the likelihood of major finan-cial instability originating in the failure of a singlefirm. It also increases such firms’ defences againstinstability originating elsewhere. However, itscontribution to restraining financial instabilitystops here. Other prudential guidelines or rulesare directed at subjects such as exposure to foreign-exchange risks, risks due to large exposures tosingle counterparties or groups of related counter-parties, adequate liquidity, loan-loss provisions, consolidatedfinancial reporting and coun-try exposures. These guide-lines and rules serve the sameobjectives as prudential capi-tal, and their efficacy is sub-ject to the same limitations.

These limitations are ex-plicable, at least in part, interms of the considerationsraised above concerning standards more generally.Financial regulation is constantly struggling tokeep up with financial innovation, and in thisstruggle it is not always successful. There is thus acontinuing danger that new practices or transac-tions, not yet adequately covered by the regulatoryframework, may prove a source of financial in-stability. Closely related in many ways to financialinnovation, are difficulties – which have becomemore important in recent years – regarding thetransparency required for regulation and supervi-sion. The balance sheets of many financial firmshave an increasingly chameleon-like quality whichreduces the value of their financial returns toregulators. Consequently, the tensions betweenfinancial innovation and effective regulation inmodern financial markets are unlikely to disap-pear. In principle, one can envisage a tighteningof regulation sufficiently drastic as to come closeto eliminating the dangers due to innovation. How-ever, the tightening would be too stifling to bepolitically acceptable in any country that valuesdynamism in its financial sector.

Probably the most important determinant ofthe intrinsic limitations of regulation and super-vision is the unavoidable dependence of financialstability on macroeconomic stability more gener-ally.48 Most assets of banks are susceptible tochanges in their quality resulting from broaderchanges in economic conditions. So long as cy-cles of financial boom and bust are features of theeconomic system, so also will be unforeseeabledeteriorations in the status of many bank assets.49

Where banking crises are combined with currencycrises, and cross-border as well as domestic fi-nancing contributes to the boom (as in many re-cent instances involving developing economies),the process is fuelled by forces similar to thosethat characterize purely domestic credit cycles.These include herd behaviour of lenders and in-

vestors, driven partly by thevery conditions their lendingand investment have helped tocreate, but also by competitionwithin the financial sector.Other forces include the all tooready acceptance, for exam-ple, of benchmarks resultingfrom collective behaviour,poor credit evaluation (oftenexacerbated in the case ofcross-border financing by less

familiarity with the borrowers and their econo-mies), and the pressures on loan officers resultingfrom target returns on capital. An important dis-tinctive feature of boom-bust cycles with a cross-border dimension is another macroeconomic fac-tor – the exchange rate. Capital inflows generallycome in the first place in response to exchange-rate adjusted returns, and thus on assumptionsabout the stability of the exchange rate. The out-flows are in most cases associated with movementsin contradiction with these assumptions, in theform of a large depreciation of the currency. Thisoften has devastating effects on the net indebted-ness and income of many domestic economicactors.

In thinking about the interaction betweenbroader types of financial instability and difficultyin controlling financial risks, as experienced inthe internal controls of banks as well as in theirsupervision, the concept of “latent concentrationrisk” (used in some recent literature on credit riskto denote problems due to unpredictable correla-

Financial regulation isconstantly struggling tokeep up with financialinnovation, and in thisstruggle it is not alwayssuccessful.


tions between defaults) can be an illuminating one.This concept also serves to pinpoint relations be-tween uncertainty, on the one hand, and the limi-tations of banking supervision, on the other.50

Concentration risk is traditionally handled in thecontext of banking regulation and supervisionthrough limits on the size of exposures to particu-lar borrowers. For this purpose, “borrower” istypically defined to include groups of counter-parties characterized by links due to commonownership, common directors, cross-guarantees,or forms of short-term commercial interdepend-ency. But boom-bust cycles bring into focus risks

due to latent concentration, as they lead to dete-rioration in the economic positions of counter-parties apparently unconnected in other, morenormal, times. Indeed, a common feature of theboom-bust cycle would appear to be exacerbationof the risk of latent concentration as lenders moveinto an area or sector en masse prior to attemptsto exit similarly. To some extent, the risks oflatent concentration can be handled through pru-dential measures, such as banks’ general loan-lossreserves and capital requirements for credit risk,but there are limits to the efficiency of such meas-ures.

Notes

1 The Financial Stability Forum was established bythe finance ministers and central bank governors ofthe Group of Seven in February 1999 to promoteinternational financial stability through improvedexchange of information and cooperation with res-pect to financial supervision and surveillance. Itsmembership consists of the national authorities re-sponsible for financial stability in selected OECDcountries, Hong Kong (China) and Singapore, andmajor international financial institutions, interna-tional supervisory and regulatory bodies and cen-tral-bank expert groupings.

2 An example of such dangers was furnished by thelarge-scale withdrawal of funds from and subsequentbankruptcy of two Deak and Co. subsidiaries (DeakPerera Wall Street and Deak Perera InternationalBanking Corporation) in response to informationin a 1984 report of the United States PresidentialCommission on Organized Crime concerning DeakPerera’s involvement in money laundering.

3 This part of the rationale for standards is particu-larly emphasized in Drage, Mann and Michael(1998:77–78).

4 The distinction between banking regulation and su-pervision in the literature is not particularly clearcut.But regulation can be taken roughly to refer to rules,

both those set out in banking legislation and thosereferring to the instruments and procedures of thecompetent authorities. Supervision refers to imple-mentation including licensing, ongoing off-site andon-site supervision of institutions, enforcement andsanctioning, crisis management, the operation ofdeposit insurance, and procedures for handling bankinsolvencies. These distinctions follow closely thosein Lastra (1996: 108).

5 The BCBS comprises representatives of the centralbanks and supervisory authorities of Belgium,Canada, France, Germany, Italy, Japan, Luxem-bourg, Netherlands, Sweden, Switzerland, UnitedKingdom and United States. For an account of theacceptance of the BCBS’s standards beyond itsmembership, primarily in relation to prudentialstandards for bank capital, see Cornford (2000b,sect. III).

6 For a discussion of these assessments of compli-ance, see IMF (2000d).

7 The members of the CPLG are from Argentina, Aus-tralia, Brazil, Chile, China, Czech Republic, Com-mission Bancaire de l’Union Monétaire OuestAfricain, France, Germany, Hong Kong (China),India, Italy, Japan, Mexico, Netherlands, Republicof Korea, Russian Federation, Saudi Arabia, Singa-


pore, South Africa, United Kingdom and UnitedStates. In addition, the CPLG has representativesfrom the European Commission, the Financial Sta-bility Institute, the IMF and the World Bank.

8 This is recognized in the IMF paper cited above con-cerning the experience of the early assessment ex-ercises as follows: “Due to lack of manpower andtime, the assessments are not always as in-depth aswarranted to identify all the underlying weaknesses.It is also difficult to obtain a thorough understand-ing of the adequacy of supervisory staff numbersand skills, as well as the skills of commercial bank-ers. A genuine assessment of bank supervision re-quires in-depth on-site review – including interviewswith supervisors and bankers – resulting in well-researched judgements on institutional capacity andsupervisors’ concrete achievements” (IMF, 2000d,para. 57).

9 In 1996, for example, before the outbreak of theEast Asian financial crisis, the ratio of capital torisk-weighted assets in the Republic of Korea, ac-cording to official estimates, was above 9 per cent.However, if accounting rules closer to internationalnorms had been used, non-performing loans for thesector as a whole would have exceeded its combinedcapital funds (Delhaise, 1998: 115). By the mid-1990s, in a number of countries affected by the cri-sis, the capital standards of the 1988 Basel Accordwere part of the legal regime for banks (TDR 1998,Part One, chap. III, box 3). But in the absence ofproper rules for the valuation of banks’ assets, thisstandard had little meaning for many of the institu-tions to which it was supposed to apply.

10 For a survey of banks’ accounting practices andother financial reporting under regulatory regimesin 23 mainly industrial countries that highlights theprevalence and extent of shortfalls from interna-tional best practice in the first half of the 1990s, seeCornford (1999, sect. III).

11 This framework for analysing policies aimed at thestability of the financial sector is frequently de-ployed by William White of the BIS (White,1996: 23).

12 Traditionally, such transactions have depended onnational payment systems for the transfer of fundsbetween correspondent banks of the countries whosecurrencies are involved. For example, in the case ofa cross-border payments order transmitted betweenbanks through SWIFT (Society for WorldwideInterbank Financial Telecommunication – a privatecompany which transmits financial messages for thebenefit of its shareholding member banks and ofother approved categories of financial institutionsin 88 countries), the banks must arrange the clear-ing and settlement themselves, either relying onmutual bilateral correspondent relationships or for-warding the orders to domestic systems for interbank

fund transfers. Many major banks have introduced“straight-through processing”, in which there is anautomated linkage between their SWIFT connec-tion and their computers linked to the domestic pay-ments system (BIS, 1997: 482–485). More recentlythere has been growth in the direct settlement offoreign exchange transactions between parties indifferent jurisdictions through systems processingpayments in more than one currency.

13 IOSCO is a grouping of securities regulators (bothgovernmental and self-regulatory bodies) from morethan 90 countries. Created in 1984, it is a private,non-profit organization whose main objectives arecooperation for better market regulation, informa-tion exchange, standard setting, and mutual assist-ance in the interest of protecting market integrity.

14 For a commentary on the Core Principles and dis-cussion of the initiative’s background, see Sawyerand Trundle (2000). (John Trundle of the Bank ofEngland was chairman of the Task Force which drewup the Core Principles.)

15 More specifically, the initiative was a response tothe conclusion in the report of an ad hoc workingparty on financial stability in emerging marketeconomies, set up after the 1996 summit of theGroup of Seven, concerning the essential role ofsound payment systems in the smooth operation ofmarket economies, as well as to growing concernregarding the subject among emerging marketeconomies themselves. See mimeograph documentof the Working Party on Financial Stability inEmerging Market Economies, Financial stability inemerging market economies: A strategy for the for-mulation, adoption and implementation of soundprinciples and practices to strengthen financial sys-tems (April 1997, chap. II).

16 In a multilateral netting arrangement a participantnets obligations vis-à-vis other participants as agroup throughout a specified period (typically aday), and then settles the debit or credit balanceoutstanding at the end of this period through thearrangement’s common agent.

17 Part 2 was a response to widespread comments elic-ited by Part 1 that more detail on interpretation andimplementation was needed.

18 This Programme is aimed at assessing the vul-nerabilities of countries’ financial sectors and iden-tifying priorities for action, partly in the light of in-ternationally agreed standards for these sectors.

19 The IASC was created in 1973 by major professionalaccounting bodies and now includes more than130 such bodies from more than 100 countries. Theentities concerned with international accountingstandards include not only professional accountingbodies, international accounting firms, transnationalcorporations and other international lenders and in-vestors, but also other bodies such as international


trade unions concerned with cross-border businessactivities.

20 A 1997 study of the United States Financial Ac-counting Standards Board (FASB) identified 255variations between United States and internationalstandards, many of which were judged as signifi-cant. See Scott and Wellons (2000: 67). For a moreextended discussion of the IASC-US ComparisonProject, which was the source of this finding, seeGrossfeld (2000).

21 Specific topics identified as the most difficult forthe achievement of reconciliation and understand-ing among countries in a survey of institutional in-vestors, firms, underwriters and regulators in the firsthalf of the 1990s (quoted in Iqbal, Melcher andElmallah, 1997: 34) were the following: account-ing for goodwill, deferred taxes, inventory valua-tion, depreciation methods, discretionary reserves,fixed-asset valuation, pensions, foreign currencytransactions, leases, financial statement consolida-tion and financial disclosure requirements.

22 IFAC was established in 1977 to promulgate inter-national standards in auditing and closely relatedsubjects. IFAC and IASC have an agreement of “mu-tual commitments” for close cooperation and mu-tual consultations, and membership in one automati-cally entails membership in the other.

23 This point is forcefully made with the support of awealth of case studies from the business history ofthe United States in Kennedy (2000, part 1).

24 The arrangements proposed below, in chap. VI,sect. B, for orderly workouts in the case of cross-border debt depend, for their functioning, on ad-equate national insolvency regimes.

25 The account which follows relies heavily on theGroup of Thirty (2000, chap. 2, sect. 1).

26 This point was made recently in an OECD publica-tion: “The incidence of banking crises, and the coststhese have imposed on countries, is quite large andthe systemic consequences of the failure of a largeinstitution are of a different order of magnitude fromthose associated with the failure of smaller institu-tions. In particular, the costs of bailing out a verybig institution might be large relative to the resourcesof the country in which the institution resides. … itis not clear that an increase in size and perhaps geo-graphic scope of an institution makes the risk of itsfailure any greater than before. Accidents do hap-pen, however, and it is likely that the systemic con-sequences of bank failures grow as institutions be-come larger and larger. The situation is also morecomplex in the case of internationally operatingbanks” (OECD, 2000c: 138–139).

27 See Group of Thirty (2000, especially chaps. 4–6). Thepolicy issues are surveyed in Group of Thirty (1998).

28 For more detailed guidelines for the Principles’ ap-plication, see International Association of Insurance

Supervisors (IAIS, 2000b). The IAIS is an associa-tion of insurance supervisors established in 1994and now includes supervisors from more than100 countries.

29 The main forum dealing explicitly with these issuesis the Joint Forum on Financial Conglomerates,which was founded in 1996 and brings together de-veloped-country representatives from the BCBS,IOSCO and IAIS. The Joint Forum has reviewedvarious means of facilitating the exchange of infor-mation among supervisors within their own sectorsand among supervisors in different sectors, and hasinvestigated legal and other barriers that impede theexchange of information among supervisors withintheir own sectors and between supervisors in differentsectors. It has also examined other ways to enhancesupervisory coordination, and is working on devel-oping principles for the more effective supervisionof regulated firms within financial conglomerates.

30 See, for example, the coverage of recent events ofmoney laundering in London in the Financial Times,20 October 2000, and of a report of the subcommit-tee of the United States Senate concerning use ofcorrespondent services provided by the country’sbanks for the purpose of money laundering in theInternational Herald Tribune, 6 February 2001. ANew York Times editorial reproduced in the lattercommented as follows: “Banks are undoubtedlywary of legal restrictions that raise costs and dis-courage depositors, particularly in their lucrativeprivate banking divisions. But America cannot con-demn corruption abroad while allowing its ownbanks to make fortunes off it.”

31 Various other regional or international bodies, ei-ther exclusively or as part of their work, also par-ticipate in combating money laundering. These in-clude the Asia/Pacific Group on Money Launder-ing (APG), the Caribbean Financial Action TaskForce (CFATF), the PC-R-EV Committee of theCouncil of Europe, and the Offshore Group of Bank-ing Supervisors.

32 Attention is drawn to such connections between dif-ferent international initiatives concerning offshorefinancial centres by José Roldan, President of theFATF during the period July 2000–2001, in an in-terview (Roldan, 2000: 21–22).

33 For a more detailed commentary on this report, seeCornford (2000a).

34 This FSF report focuses mainly on large, substan-tially unregulated institutions characterized by lowtransparency, primarily hedge funds. But, as the re-port notes, a clear distinction cannot always bedrawn between the practices of these institutions andothers subjected to greater regulation.

35 The six economies were Australia, Hong Kong(China), Malaysia, New Zealand, Singapore andSouth Africa.


36 One instance of such activity, which attracted muchattention in 1998, was the “double play” in whichsome financial institutions are believed to have en-gaged in Hong Kong (China). This operation is de-scribed as follows in the Working Group’s report(FSF, 2000c: 117): “Some market participants sug-gested that there were attempts to carry out a ‘dou-ble play’ involving the equity and currency mar-kets, whereby short positions would be first estab-lished in the equity (or equity futures) market, andsales of Hong Kong dollars would then be used todrive up interest rates and thereby depress equityprices. Some other market participants questionedwhether such a strategy was pursued. Any doubleplay would have been facilitated at that time by in-stitutional factors in the linked exchange rate ar-rangement which made short-term interest rates verysensitive to changes in the monetary base, and alsoby reduced market liquidity as a result of the Asiancrisis. Among those taking short positions in the eq-uity market were four large hedge funds, whose fu-tures and options positions were equivalent to around40 percent of all outstanding equity futures contractsas of early August, prior to the HKMA [Hong KongMonetary Authority] intervention (there were no lim-its or reporting requirements on large equity futurespositions at this time). Position data suggest a correla-tion, albeit far from perfect, in the timing of the estab-lishment of the short positions.” See also Yam (1998).

37 A working group of the Committee on the GlobalFinancial System on Transparence Regarding Ag-gregate Positions (the Patat Group), whose mandatewas to look at what aggregate data on financialmarkets could be collected to enhance their efficientoperation, was abolished because of its finding that“it would not be possible to obtain adequately com-prehensive and timely information on a voluntarybasis, and legislative solutions were deemed imprac-tical” (see White, 2000: 22).

38 As the report notes (FSF, 2000d: 9), OFCs are noteasily defined, but can be characterized as jurisdic-tions that attract a high level of non-resident activ-ity. Traditionally, the term has implied some or allof the following: low or no taxes on business orinvestment income; no withholding taxes; light andflexible incorporation and licensing regimes; lightand flexible supervisory regimes; flexible use oftrusts and other special corporate vehicles; no re-quirement for financial institutions and/or corpo-rate structures to have a physical presence; an inap-propriately high level of client confidentiality basedon impenetrable secrecy laws; and unavailability ofsimilar incentives to residents. Since OFCs gener-ally target non-residents, their business substantiallyexceeds domestic business. The funds on the booksof most OFC are invested in the major internationalmoney-centre markets.

39 The point was eloquently expressed in a recent edi-torial in the periodical, The Financial Regulator, asfollows: “ The interconnection of the world finan-cial system has created … problematic externali-ties, with … small countries now able to do a lot ofdamage. With world government some way off,these externalities are likely to prove tricky to man-age. For the foreseeable future there is no bettersolution than international cooperation. When bigcountries push little countries around, even for thebest of reasons, they give this crucial cooperation abad name. The challenge for those interested in glo-bal financial stability is to find some way of negoti-ating better regulation while avoiding … the heavy-handedness characterizing the current drive againstoffshore centres.” See “Justice for offshore centres”,The Financial Regulator, September 2000.

40 The term “incentive” is used by the FSF in this con-text to cover measures which include sanctions aswell as incentives.

41 For a description of the CCL, see chap. VI, box 6.3.42 BCBS has proposed in its A New Capital Adequacy

Framework (see box 4.1) the following incentiveswith regard to observance of standards: (i) to be eli-gible for claims on it to receive a risk weightingbelow 100 per cent, a country would have to sub-scribe to the SDDS; (ii) claims on a bank will onlyreceive a risk weighting of less than 100 per cent ifthe banking supervisor in that country has imple-mented – or has endorsed and is in the process ofimplementing – the BCBS’ Core Principles for Ef-fective Banking Supervision; and (iii) claims on asecurities firm will only receive a risk weighting ofless than 100 per cent if that firm’s supervisor hasendorsed – and is in the process of implementing –IOSCO’s Objectives and Principles of SecuritiesRegulation (1998).

43 See note 18 (sect. B.3) above.44 The jurisdictions covered by the outreach exercise

were Argentina, Australia, Canada, France, Ger-many, Hong Kong (China), Italy, Japan, Sweden,United Kingdom and United States.

45 Nevertheless, as discussed in box 4.1 (on proposalsfor reform of the Basel Capital Accord), how effec-tively the agencies have used this understanding isstill open to question.

46 Deregulation of interest rates in major OECD coun-tries, for example, has taken from seven to morethan 20 years in all but a small minority of cases.The establishment of a single market for financialservices in the EU took more than 30 years (seeCornford and Brandon, 1999: 11–13).

47 Capital requirements are attributed a central role incountries’ regimes of prudential regulation and su-pervision. They have also been the subject of majorinternational initiatives, of which the most impor-tant is the Basel Capital Accord that is currently


undergoing a major revision . See box 4.1 on BaselCapital Standards.

48 This dependence, of course, provides the link be-tween sectoral policies aimed at financial stabilityand macroeconomic policies, including those di-rected at the balance of payments (amongst which,especially for developing and transition economies,should be counted controls on capital transactions).

49 The argument here follows closely that of Akyüzand Cornford (1999: 30–31). See also TDR 1998(Part One, chap. IV, sect. C.3).

50 See, for example, Caouette, Altman and Narayanan(1998: 91, 240). The limitations of credit risk mod-els in handling correlations among defaults are re-viewed in BCBS (1999c, Part II, sect. 6, and Part III,sect. 3).

109Exchange Rate Regimes and the Scope for Regional Cooperation

Exchange rate regimes in developing coun-tries and transition economies have attractedincreased attention in the recent debate on the re-form of the international financial architecture inview of their contribution to external vulnerabil-ity, and currency and financial crises. In countriesthat are closely integrated into international finan-cial markets, adjustable peg regimes (the so-calledsoft pegs) are increasingly seen as the major causeof boom-bust cycles in financial flows. Conse-quently, the mainstream advice is that they eitheradopt a regime of freely floating exchange ratesor that they make a credible commitment to de-fend a fixed exchange rate by locking into areserve currency through currency boards or byadopting a reserve currency as their national cur-rency (dollarization); in other words, they areadvised to go for one of the so-called “corner”solutions as opposed to the intermediate regimesof adjustable pegs.1 According to some estimates,almost two thirds of emerging-market economieswere using intermediate exchange rate regimesin 1991, but by 1999 this proportion had fallen to42 per cent, and the proportion using hard pegsor some variant of floating had risen to 58 percent (Fischer, 2001, fig. 2). However, while many

countries afflicted by financial crisis in the pastdecade have subsequently adopted floating rates,the increased volatility associated with such re-gimes has become a source of concern. As a result,there now appears to be a greater interest amongdeveloping countries and transition economies inhard pegs. And increasingly, in a closely integratedglobal financial system, the existence of manyindependent currencies is being called into ques-tion (Hausmann, 1999).

For emerging-market economies, adjustablepeg regimes are problematic under free capitalmobility as they lead to boom-bust cycles andovershooting of exchange rates. However, neitherfree floating nor hard pegs constitute viable alter-natives. Currency misalignments and gyrationsassociated with floating regimes can have seriousconsequences for developing countries with smalland open economies and a relatively large stockof external debt denominated in reserve curren-cies. On the other hand, for most developingcountries and transition economies, a policy oflocking into a reserve currency and surrenderingmonetary policy autonomy can entail considerablecosts in terms of growth, employment and inter-

Chapter V

EXCHANGE RATE REGIMES AND THE SCOPEFOR REGIONAL COOPERATION

A. Introduction


national competitiveness – costs that far exceedthe benefits such a regime may yield in terms ofprice and exchange rate stability. These conclu-sions are shared in a paper on exchange rateregimes for emerging-market economies jointlyprepared by staff of the French and Japanese Min-istries of Finance, on the occasion of the meetingof European and Asian finance ministers in Kobe,Japan, in January 2001:

There is no guarantee that currency boardarrangements escape from the same draw-backs as pegged regimes. … Free-floatingstrategies have their own costs of possibleexcessive volatility and free riding risks.(Ministry of Finance, Japan, 2001: 3–4)

A consequence of the mainstream advice isthat developing countries with similar foreigntrade structures and market orientation couldend up at opposite ends of thespectrum of exchange rates –some with floating and oth-ers with fixed exchange ratesagainst the dollar – even ifthere is a considerable amountof trade amongst them. Con-sequently, not only would theircurrencies be floating againsteach other, but also their bi-lateral exchange rates wouldbe greatly influenced by theoverall movement of the dol-lar against other currencies.Given the misalignments andfluctuations that character-ize the currency markets, thiswould imply erratic, unex-pected shifts in the competitive position of devel-oping countries vis-à-vis each other. When thereis considerable bilateral trade, as between Braziland Argentina, such shifts can have an importantimpact on their economies, leading to tensions intrade relations. Briefly stated, unilateral corner so-lutions may result in inconsistent outcomes for thedeveloping countries taken together.

The key question is whether there exists aviable and appropriate exchange rate regime fordeveloping and transition economies that areclosely integrated into global financial marketswhen major reserve currencies are subject to fre-quent gyrations and misalignments, and when the

size and speed of international capital movementscan very quickly overwhelm the authorities in suchcountries and narrow their policy options. Canthese countries be expected to solve their exchangerate problems unilaterally when the magnitude, di-rection and terms and conditions of capital flowsare greatly influenced by policies in major reservecurrency countries, and when international cur-rency and financial markets are dominated byspeculative and herd behaviour? Certainly, con-trols over capital flows can facilitate the prudentmanagement of their exchange rates. Indeed, a fewcountries, such as China, have so far been able topursue adjustable peg regimes without runninginto serious problems. However, several emerg-ing markets have already made a political choicein favour of close integration into the globalfinancial system and are unwilling to control capi-tal flows. Furthermore, it may be very difficult for

any single country to resist thestrong trend towards liberali-zation of capital movements,particularly if it has close linkswith international marketsthrough FDI and trade flows.

While all this implies thatthe solution should, in princi-ple, be sought at the globallevel, the prospects for this arenot very promising, given thestance of the major powers onthe question of exchange rates.Since global arrangements fora stable system of exchangerates are not foreseeable in thenear future, the question arises

as to whether viable solutions can be found at theregional level. In this respect, the post-BrettonWoods experience of Europe in establishingmechanisms to achieve a stable pattern of intra-regional exchange rates, and eventually move toa currency union, may hold useful lessons for de-veloping regions, particularly East Asia and SouthAmerica. However, while regional currency ar-rangements and monetary cooperation amongdeveloping countries could bring some benefits,they do not resolve the problem of what currencyregime to adopt and how to achieve exchange ratestability vis-à-vis G-3 currencies. Even if theycould achieve greater integration, developingcountries could not neglect their exchange rates

The key question is whetherthere exists a viable andappropriate exchange rateregime for developingeconomies when majorreserve currencies aresubject to frequent gyrationsand misalignments, andwhen international capitalmovements are extremelyunstable.


vis-à-vis such currencies. It thus appears that re-gional arrangements among developing countriesmay need to involve major reserve-currency coun-

tries or rely on a common regime of capital con-trols in order to achieve stability and avoid costlycrises.

B. Exchange rate regimes

1. Soft pegs

It has long been established that an economywhich is fully committed to free movement ofcapital (or which does not succeed in effectivelycontrolling capital movements) cannot both fix itsexchange rate (at a given value or within a nar-row band) and pursue an independent monetarypolicy. Any attempt to do so will eventually runinto inconsistencies that will force the country toabandon one of the objectives. One option wouldbe to adhere to fixed exchange rates throughcurrency boards or outright dollarization at theexpense of autonomy in monetary policy. Anotherwould be to move to floating exchange rates,thereby freeing monetary policy from defendinga particular exchange rate (or a narrow band).The breakdown of the Bretton Woods system ofadjustable pegs, the 1992–1993 crisis in the Ex-change Rate Mechanism (ERM) of the EuropeanMonetary System (EMS) and the recent episodesof crisis in emerging markets are all seen as theoutcome of the inconsistency between capitalaccount openness, exchange rate targeting andindependent monetary policy.

The Bretton Woods system of adjustablepegs operated with widespread controls overinternational capital movements. However, incon-sistencies between the pattern of exchange ratesand the domestic policy stances of major coun-tries created serious payments imbalances and

incentives for capital to move across borders, cir-cumventing the controls. This eventually led tothe breakdown of the system and the adoption offloating rates. Even though the adjustable pegs inthe EMS constituted a step towards monetary un-ion (hard pegs) and were supported by extensiveintraregional monetary cooperation, inconsisten-cies between macroeconomic fundamentals andexchange rates led to a crisis and breakdown ofthe ERM in 1992–1993.The adoption of soft pegsis also considered to be one of the root causes ofrecent financial crises in emerging-market econo-mies such as Mexico, Thailand, Indonesia, theRepublic of Korea, the Russian Federation andBrazil. The subsequent move by these countriesto floating rates is often interpreted as the recog-nition that soft pegs are not viable for countriesclosely integrated into the global financial mar-kets.

The role of soft pegs in contributing to ex-ternal fragility and the outbreak of financial crisesin emerging markets is well established.2 Mostemerging-market economies offer higher nominalinterest rates than the industrialized world, in largepart because of higher inflation rates. These createshort-term arbitrage opportunities for internationalinvestors and lenders, as well as incentives fordomestic firms to reduce their costs of finance byborrowing abroad. On the other hand, by provid-ing implicit guarantees to international debtors andcreditors, currency pegs can encourage imprudentlending and borrowing. The risk of depreciation


is discounted owing to the stability of the nomi-nal exchange rate and the confidence createdby rapid liberalization and opening up of theeconomy. The credibility of the peg as well asarbitrage opportunities are enhanced when thecountry pursues a tight monetary policy in orderto bring down inflation or prevent overheating ofthe economy.

However, a nominal peg with a higher infla-tion rate also causes an appreciation of the cur-rency in real terms and a widening of the current-account deficit. If external deficits and liabilitiesare allowed to mount, the currency risk will riserapidly. Since there is no firm commitment to de-fend the peg, the worsening fundamentals even-tually give rise to expectations of a devaluationand a rapid exit of capital. Not only does this causeliquidity shortages; it also forces the monetary au-thorities to tighten monetarypolicy and restrict liquidityeven further. Sooner or later,the exchange rate peg is aban-doned, leading to a free fallwhich, together with the hikein interest rates, causes enor-mous dislocation in the econo-my.

Despite the risk of costlycurrency swings and crises,many countries with relativelyhigh rates of inflation have often favoured stabi-lizing the internal value of their currencies bystabilizing their external value through anchoringto a reserve currency with a good record of sta-bility. This is true not only for the small and openEuropean economies such as Austria, the Nether-lands and Belgium, but even for a large economysuch as Italy, which faced several speculativeattacks against its currency and experienced dis-ruptions throughout the process of convergencetowards the inflation rates of its larger tradingpartners in the EU. Many emerging-market econo-mies, notably in Latin America, have also usedsoft pegs for disinflation. Although it proved dif-ficult to achieve an orderly exit from such pegs inorder to realign their currencies, it is notable thatthese countries managed to avoid the return ofrapid inflation in the aftermath of crises, despitesharp declines in their currencies. For instance,after the introduction of an exchange-based

stabilization plan (Plano Real) in 1994, Brazil suc-ceeded in bringing down its inflation rate from afour-digit level to a single-digit level by 1998. De-spite various adjustments in the value of the realand a relatively rapid decline in inflation, theBrazilian currency had appreciated by some 20 percent at the end of the disinflation process. How-ever, it was not possible to engineer an orderlyrealignment of the exchange rate, which cameunder severe pressure at the end of 1998, partlydue to spillovers from the Russian crisis. Butafter an initial hike, inflation stabilized at low lev-els despite a sharp drop in the value of the realagainst the dollar (see TDR 1999, Part One,chap. III, sect. B).

Appreciation is generally unavoidable in ex-change-based stabilization programmes because ofstickiness of domestic prices. More fundamental-

ly, it is part of the rationale ofsuccessful disinflation, sincegreater exposure to interna-tional trade – resulting in lowerimport prices and increasedcompetition in export markets– helps to discipline domesticproducers and acts as a breakon income claims. However,such programmes are oftenlaunched without adequate at-tention to the potential prob-lems of real currency appre-

ciation and without a clear exit strategy (i.e. whenand how to alter the peg and/or the regime andrealign the exchange rate). Although economicallyit may appear simple to restore international com-petitiveness by a one-off adjustment in the ex-change rate, this solution may be politically diffi-cult. Indeed, problems in finding a political solu-tion tend to be underestimated. Governments areoften unwilling to abandon the peg and devalueafter exerting considerable effort in attempting toconvince people that the fixed rate has broughtthem more good than harm. They are also afraidof losing markets’ confidence and facing a sharpreversal of capital flows and a collapse of theircurrency.

Given the herd behaviour of financial mar-kets, such fears of a hard landing are not alwaysunfounded, even though, as noted above, sharpcurrency declines rarely result in the return of

Exchange-rate-basedstabilization programmesare often launched withoutadequate attention to thepotential problems of realcurrency appreciation andwithout a clear exit strategy.


rapid inflation. Forewarning an exit strategy isrisky, since it is not always easy to judge how rap-idly inflation will decline. The Turkish exchange-based stabilization programme of December 1999had such a strategy. However, it failed to meet itsinflation target and, after a series of economic andpolitical crises, the Government was obliged toabandon the peg and move to the other corner,floating, before the preannounced exit date (seechapter II, box 2.1). In Europe, institutional arrange-ments in the context of theEMS that involved assistancefrom anchor countries havehelped, on several occasions,to engineer necessary adjust-ments in the currencies of thepegging countries withoutleading to instability and con-tagion (see below). However,such arrangements are not eas-ily replicable for emergingmarkets that peg unilaterally.Support from international financial institutionscould help achieve orderly exits, but the experi-ence so far has not been very encouraging.3

Soft pegs are not used only for disinflation.In East Asia, for example, exchange rate stabilitywas an important ingredient of the export-orienteddevelopment strategy of the individual economiesand was intended to support the regional divisionof labour in the context of the “flying-geese” pro-cess. Because of the concentration of Asian exportsin dollar-denominated markets, nominal exchangerates in the region, although not fixed, had beenkept generally stable within a band of around10 per cent in relation to the dollar since the late1980s. Given their low inflation rates, in most EastAsian economies the appreciation of the currencywas moderate or negligible. The combination ofstable nominal exchange rates, rapid economicgrowth and relatively high nominal interest ratesinspired confidence and attracted internationalinvestors and lenders. However, this led to a build-up of considerable currency risks and externalfinancial fragility, resulting eventually in a rapidexit of capital, with spillover effects throughoutthe region through herd behaviour. Even in Indo-nesia, orderly currency adjustment was notpossible despite sound macroeconomic fundamen-tals and the timely action taken by the Governmentto widen the currency band in order to stop conta-

gious speculation (TDR 1998, Part One, chap. III;Akyüz, 2000b).

One way out of these problems is to use con-trols over capital flows while maintaining a softpeg. Taxes and reserve requirements on inflowsdesigned to remove short-term arbitrage opportu-nities can help preserve monetary autonomy, anda policy of high interest rates can be pursued with-out encouraging speculative capital inflows and a

build-up of excessive currencyrisk. However, as long as do-mestic inflation is high, cur-rency appreciation cannot beavoided. This is particularlyserious when currency pegsare used for disinflation. Inany case, a large majority ofdeveloping countries havebeen unwilling to impose con-trols on capital inflows duringthe boom phase of the finan-

cial cycle, as a means of deterring short-termarbitrage flows, for the same reasons that theywere unwilling to exit from pegged exchange ratesafter successful disinflation. Again, as explainedin the next chapter, they are even less willing toimpose controls over capital outflows in order tostabilize exchange rates and free monetary policyfrom pressures in the currency markets at timesof speculative attacks and crisis.

2. Floating

Does free floating constitute a viable alter-native for developing countries and transitioneconomies? Can such countries really leave theexternal value of their currencies to the whims ofinternational capital flows and dedicate monetarypolicy entirely to domestic objectives such as pricestability or full employment? To what extentwould such objectives be undermined by exces-sive volatility and misalignments associated withfree floating?

Quite apart from how appropriate such a re-gime might be, for a number of reasons it is par-ticularly unsuitable for developing countries andtransition economies, as well as for smaller in-

A large majority ofdeveloping countries havebeen unwilling to imposecontrols on capital inflowsduring the boom phase ofthe financial cycle.


dustrial countries. Compared to the major indus-trial economies, developing and emerging-marketeconomies are much more dependent on foreigntrade, which is typically invoiced in foreign cur-rencies. On average, the share of internationaltrade in their domestic production is twice as largeas in the United States, the EU or Japan, so thatthe impact of exchange rate movements on theirdomestic economic conditions – including prices,production and employment – is much greater.Moreover, these economies have higher net ex-ternal indebtedness, a larger proportion of whichis denominated in foreign currencies. Conse-quently, sharp changes in theirexchange rate tend to gener-ate debt servicing difficulties,liquidity and solvency prob-lems. In sharp contrast, a coun-try such as the United Statescan borrow in its own curren-cy, therefore effectively pass-ing the exchange rate risk ontocreditors.4

It is also argued thatmost developing and transi-tion economies lack credibleinstitutions, and this in itselfis a cause of greater volatility in market sentimentand exchange rates, which is believed to have ledto a widespread “fear of floating” among emerg-ing markets. Consequently, a large number ofthose countries which claim to allow their ex-change rates to float actually pursue intermediateregimes, and use interest rates and currency-mar-ket intervention to influence exchange rates. Thisfinding also contradicts the claim that emergingmarkets have been moving away from adjustablepeg regimes (Calvo and Reinhart, 2000; Fischer,2001; Reinhart, 2000).

The experience of major industrial countrieswith floating rates during the interwar years aswell as since the breakdown of the Bretton Woodssystem suggests that volatility, gyrations and mis-alignments in exchange rates cannot simply be at-tributed to lack of credible institutions. Rather,they are systemic features of currency marketsdominated by short-term arbitrage flows. TheFrench experience in the 1920s, for example, waslucidly described in a report of the League of Na-tions in 1944:

The dangers of such cumulative and self-aggravating movements under a regime offreely fluctuating exchanges are clearlydemonstrated by the French experience of1922–26. Exchange rates in such circum-stances are bound to become highly un-stable, and the influence of psychologicalfactors may at times be overwhelming.French economists were so much impressedby this experience that they developed a spe-cial “psychological theory” of exchangefluctuations, stressing the indeterminatecharacter of exchange rates when left to findtheir own level in a market swayed by specu-lative anticipations … The experience of the

French franc from 1922 to1926 and of such interludesof uncontrolled fluctuationsas occurred in certain cur-rencies in the ’thirties dem-onstrates not only the diffi-culty of maintaining a freelyfluctuating exchange on aneven keel, … it also showshow difficult it may be fora country’s trade balance toadjust itself to wide and vio-lent variations. (League ofNations, 1944: 118, 119)

Writing in 1937 about the same experience, vonHayek explained gyrations not only in terms ofshort-term capital flows; he also argued that float-ing rates encouraged such capital flows:

It is because … the movements of short termfunds are frequently due, not to changes inthe demand for capital for investment, butto changes in the demand for cash as liquid-ity reserves, that short term internationalcapital movements have such a bad reputa-tion as causes of monetary disturbances.And this reputation is not altogether unde-served. … I am altogether unable to see whyunder a regime of variable exchanges thevolume of short term capital movementsshould be anything but greater. Every sus-picion that exchange rates were likely tochange in the near future would create anadditional powerful motive for shiftingfunds from the country whose currency waslikely to fall or to the country whose cur-rency was likely to rise … This means thatif the original cause is already a short-termcapital movement, the variability of ex-changes will tend to multiply its magnitude

The experience of majorindustrial countries withfloating rates suggests thatvolatility, gyrations andmisalignments in exchangerates cannot simply beattributed to lack of credibleinstitutions.


and may turn what originally might havebeen a minor inconvenience into a major dis-turbance. (von Hayek, 1937: 62–64)

As discussed in some detail in earlier UNCTADreports, since the breakdown of the Bretton Woodsarrangements, volatility, per-sistent misalignments and gy-rations have also been thedominant features of the ex-change rates of the major re-serve currencies.5 Despite asignificant convergence of in-flation rates and trends in unitlabour costs during the pastdecade, the G-3 exchange rateshave continued to show per-sistent misalignments and largegyrations. Such disorderly be-haviour has caused serious prob-lems for developing countriesin the management of their currencies and exter-nal debt, and has often been an important factorin major emerging-market crises. But these prob-lems have generally been ignored by the majorindustrial countries which, for the most part, havegeared their monetary policy to domestic objec-tives, notably combating inflation. Only on a fewoccasions have the United States and Japan, forexample, which are committed to free floating,resorted to intervention and ad hoc policy co-ordination when currency instability and mis-alignments posed serious threats to their economicprospects – in the second half of the 1980s, in or-der to realign and stabilize thedollar in the face of mountingprotectionist pressures associ-ated with large trade imbal-ances, and again in the mid-1990s, when the yen rose to un-precedented levels against thedollar.

Developing countries are encouraged toadopt floating on the grounds that the resultingexchange rate uncertainty would remove implicitguarantees and discourage imprudent lending andborrowing. However, experience shows that cri-ses are as likely to occur under floating ratesas under adjustable pegs (World Bank, 1998).Under financial liberalization and free capital mo-bility, nominal exchange rates fail to move in an

orderly way to adjust to differences in inflationrates (i.e. the purchasing power parity is not pre-served), while adjustment of interest rates to in-flation is quite rapid. As a result, currencies ofhigh-inflation countries tend to appreciate over theshort term. Under soft pegs, excessive capital

inflows (i.e. inflows in excessof current-account needs) at-tracted by arbitrage opportu-nities would increase interna-tional reserves, while underfloating, they would lead tonominal appreciations, whichreinforce – rather than temper– capital inflows and aggra-vate the loss of competitive-ness caused by high inflation.Although appreciations alsoheighten currency risks, mar-kets can ignore them whenthey are driven by herd behav-

iour. For instance, if the currencies in East Asiahad been allowed to float in the early 1990s, wheninflows were in excess of current-account needs,the result could have been further appreciationsand widening payments imbalances. Indeed, in theface of such large capital inflows during the early1990s, many governments in East Asia generallychose to intervene in order to prevent apprecia-tion (TDR 1998, box 2).

As already noted, the post-war experience ofemerging markets with floating is rather limited;it is largely concentrated in the aftermath of

recent episodes of financialcrisis. Nevertheless, it revealsa number of features thatbelie the promises of its ad-vocates. In Latin America, forinstance, domestic interestrates have been more sensitiveto changes in United Statesrates, and more variable in

countries with floating regimes than those withfixed or pegged rates, implying less – rather thanmore – monetary autonomy and greater risk to thefinancial system (Hausmann, 1999). Floating ap-pears to promote pro-cyclical monetary policiesas interest rates tend to rise during recession. Italso leads to the shrinking of domestic financialmarkets and to high interest rates by increasingthe risk of holding domestic assets.

Despite a significantconvergence of inflationrates and trends in unitlabour costs during the pastdecade, the G-3 exchangerates have continued toshow persistent misalign-ments and large gyrations.

Crises are as likely to occurunder floating rates asunder adjustable pegs.


3. Hard pegs

It thus appears that emerging-market econo-mies with open capital accounts cannot achievesustained economic and financial stability by ei-ther pegging or floating their currencies. Thereremain the options of hard pegs, currency boardsor outright dollarization. At the end of the 1990s,the currencies of 45 economies, members of theIMF, had hard pegs, of which 37 (including thethen 11 euro-currency coun-tries) had no independent le-gal tender, and the remainder(including Argentina, HongKong (China) and the transi-tion economies of Bulgaria,Estonia and Lithuania) hadcurrency boards(Fischer, 2001).With the exception of EMU,most economies without an in-dependent legal tender weresmall. More recently, Ecuadorand El Salvador have adoptedthe dollar as their national cur-rency and Guatemala is in theprocess of doing so.

Such regimes are considered particularly ap-propriate for countries with a long history of mon-etary disorder, rapid inflation and lack of fiscaldiscipline (i.e. where there is “exceptional distrustof discretionary monetary policy”) (Eichengreen,1999: 109). They effectively imply abolishing thecentral bank and discarding discretionary mon-etary policy and the function of lender of last re-sort. Not only do they remove the nominal ex-change rate as an instrument of external adjust-ment, but also they subordinate all other policyobjectives to that of maintaining a fixed nominalexchange rate or dollarization. However, thesesame features also provide the credibility neededfor the success of such regimes since they implythat governments are prepared to be disciplinedby external forces, particularly by a foreign cen-tral bank with a record of credible monetarypolicy. The expected economic benefits includelow inflation, low and stable interest rates, lowcost of external borrowing and, if there is outrightdollarization, the ability to borrow abroad in thecurrency circulating domestically. Furthermore,dollarization is expected to deepen the financial

sector, extend the maturities of domestic finan-cial assets and encourage long-term financing. Itis often favoured by private business in emergingmarkets because it increases predictability andreduces the cost of transactions.

Some of these benefits can be significant. Fora small economy which is closely integrated with,and dependent on, a large reserve-currency coun-try such benefits may also offset the potential costsof no longer being able to use interest and ex-

change rates in response to do-mestic and external shocks,and to manage business cy-cles as well as the loss of sei-gniorage from printing money.However, for most developingcountries, currency boards anddollarization are not viable al-ternatives over the long term,even though they may help toquickly restore credibility af-ter a long history of monetarydisorder, fiscal indisciplineand rapid inflation. In particu-lar, large and unpredictablemovements in the exchangerates of major reserve curren-

cies make the option of unilaterally locking intoand floating with them especially unattractive.6

Hard pegs do not insulate economies fromexternal financial and real shocks, any more thandid the gold standard. Unless the anchor countryexperiences very similar shocks and responds ina manner that is also appropriate to the anchoringcountry, the costs of giving up an independentmonetary policy and defending a hard peg can bevery high in terms of lost output and employment.But for obvious structural and institutional rea-sons, a combination of developing and industrialcountries does not constitute an optimal currencyarea, and they are often subject to asymmetricshocks, especially if the developing countries arehighly dependent on primary exports. Further-more, in the absence of close economic integra-tion, the business cycles of anchor and anchoringcountries are unlikely to be synchronized, so thata particular monetary policy stance pursued by theformer may be unsuitable for the latter. Thus, acountry with a hard peg may find its currency andinterest rates rising at a time when its economy is

Not only do hard pegsremove the nominalexchange rate as aninstrument of externaladjustment, but also theysubordinate all other policyobjectives to that ofmaintaining a fixed nominalexchange rate ordollarization.


already suffering from recession and loss of com-petitiveness in international markets, as Argentinahas over the past two years (see chapter II, box 2.2).

It is often suggested that asymmetric shocksand asynchronous cycles do not matter as longas wages and prices are fullyflexible. In this respect, thereis a certain degree of ambiva-lence in the orthodox thinkingon exchange rate policy, sinceone of the original argumentsin favour of floating rates wasthat sticky wages and pricesprevented rapid adjustment tointernal and external shockswithout sacrificing growth andemployment (Friedman, 1953).Even when wages and pricesare reasonably flexible, the ad-justment process can entaillarge costs because it is not instantaneous. Withan absolutely fixed exchange rate, the only instru-ment at hand to correct real appreciation is a cutin nominal wages, but that cannot be achievedwithout reducing aggregate domestic demand andincreasing unemployment. Furthermore, for thereasons explained by Keynes more than 60 yearsago, such cuts, will, in turn, reduce aggregate de-mand and add to deflationary pressures when theyresult in lower real wages. Thus it would be verydifficult to restore competitiveness without defla-tion. Fiscal austerity designed to reduce externaldeficits would only deepen the crisis, leading towhat Robert McKinnon described nearly 40 yearsago as a situation of the “tail wagging the dog”(McKinnon, 1963: 720). It is therefore surprisingthat the most important argument advanced infavour of flexible exchange rates, namely the slug-gishness of nominal wage and price adjustment,is overlooked by the advocates of currency boardsor dollarization.

Nor can currency boards ensure that domes-tic interest rates remain at the level of the countryto which the currency is pegged. When the econo-my suffers from loss of competitiveness and largepayments deficits, the resulting decline in reservesleads to a reduction in liquidity, pushing up inter-

est rates and threatening to destabilize the bank-ing system. It has indeed been shown that a cur-rency board regime makes payments crises lesslikely only by making bank crises more likely(Chang and Velasco, 1998). International inves-tors may not take the hard peg for granted and

may demand a large risk pre-mium, as demonstrated by thelarge spreads that most curren-cy board countries have had topay over the past few years.Speculative attacks againsta currency can occur in a cur-rency board system as in anyother exchange rate regime,and costs incurred in defend-ing a hard peg may exceedthose incurred by countries ex-periencing a collapse of softpegs. For instance, in terms ofloss of output and employ-

ment, Argentina and Hong Kong (China) sufferedas much as or even more than their neighbourswhich experienced sharp declines in their curren-cies during recent emerging-market crises. For fi-nancially open economies, differences among suchregimes are due less to their capacity to preventdamage to the real economy and more to the waydamage is inflicted.

Historically, exits from currency boards haveoccurred in the context of decolonization, whenthe pound sterling was often the anchor currency.Unlike their modern counterparts, the rationale forestablishing such regimes was not to gain cred-ibility; rather, they were imposed by the colonialpower with a view to reinforcing trade ties withits colonies. In principle, by retaining a nationalcurrency, currency board regimes – as distinctfrom dollarization – allow for devaluation andeven exit. However, there is no modern currencyboard regime with a known exit strategy; indeed,making such a strategy known would defeat itsvery purpose. For this reason, an orderly exit froma currency board regime is unlikely to be possible,especially when the economic costs of adhesionmilitate in favour of change. By contrast, whenthe regime works well, governments feel no needfor exit.

A currency board regimemakes payments crisesless likely only by makingbank crises more likely, andcosts incurred in defendinga hard peg may exceedthose incurred by countriesexperiencing a collapse ofsoft pegs.


Given the difficulties that developing coun-tries have been facing in finding unilateral solu-tions to the problem of managing their currenciesand preventing financial crises, and given theresistance of the major powers to genuine reformof the international financial architecture, atten-tion has increasingly focused on regional solutions(Chang, 2000; Mistry, 1999; Park and Wang, 2000).In this context, there is growing interest in the les-sons provided by the Europeanexperience with regional mon-etary cooperation and curren-cy arrangements in the post-Bretton Woods era, which cul-minated in a monetary unionat the end of the 1990s.

The first response of Eu-rope to the collapse of theBretton Woods system inthe early 1970s consisted of“snake” and “snake in the tun-nel” arrangements that weredesigned to stabilize the intra-European exchange rates with-in relatively narrow bands inan environment of extreme volatility. This wasfollowed by the creation of the EMS in 1979 withthe participation of the members of the EuropeanEconomic Community (EEC), and eventually bythe introduction of the euro and the establishmentof the European Monetary Union (EMU) in 1999.7

Thus it took some 30 years to pass from soft pegsto hard pegs.

After the collapse of the Bretton Woods sys-tem, European countries were able to avoid infla-tionary spillovers from the United States by ap-

preciation of their currencies vis-à-vis the dollar,and floating against the dollar was seen as con-sistent with their objective of stabilizing the in-ternal value of their currencies. However, giventhe relatively high degree of regional integration,a move towards free floating among the Europeancurrencies posed a potential threat of instabilityand disruptions to intraregional trade and resourceallocation, particularly for small and open econo-

mies. A policy of establishinga stable pattern of intraregion-al exchange rates and collec-tively floating against the dol-lar was seen as an appropriatesolution, since the trade of theregion as a whole with the restof the world was relatively small.In effect, regional integrationand monetary cooperation wasdesigned to establish Europeas a single large economy –like that of the United States– with limited dependence oninternational (extra-European)trade.

Although the decision to join such arrange-ments (or, in the Austrian view, to “tie their ownhands” in monetary affairs) was taken unilater-ally by each country, the system that emergedinvolved multilateral commitments at the regionallevel. Since the deutsche mark had been the moststable currency after the war and Germany wasthe largest market in the region, the Germancurrency provided a natural anchor for manyEuropean countries following the collapse of theBretton Woods arrangements. Given the politicalwill of the participating countries to move towards

C. Regional arrangements: the European experience

Although the smallerEuropean countriessacrificed part of theirmonetary autonomy, theywere considerablystrengthened vis-à-viscurrency markets andbecame less dependent oninternational financialinstitutions.


greater integration, Germany did not simplyprovide an anchor currency; it also assumed re-sponsibilities vis-à-vis the anchoring countries insecuring the stability of thearrangements through suchmeans as intervention in thecurrency markets and provi-sion of lender-of-last-resortfinancing, although the latterrole has never been explicitlystated. As for the smallercountries, although they sac-rificed part of their monetaryautonomy, they were consid-erably strengthened vis-à-viscurrency markets and becameless dependent on interna-tional financial institutions.

In the process leading to a common currency,the adjustable pegs adopted were crucially differ-ent from the unilateral soft pegs used by emergingmarkets in recent years in that both anchoring andanchor countries shared the common objective ofachieving monetary convergence and internal andexternal stability for their currencies. The systemwas also designed to reduce one-way bets, whichmight have been encouraged by inflation and in-terest rate differentials, by establishing bandsaround the so-called “parity grids”. It establishedobligations for symmetric interventions as well asunlimited short-term credit facilities among cen-tral banks designed to maintain bilateral exchangerates within the band. It also made available tomember countries various types of external pay-ments support to enable ERM participants both tokeep their currencies within prescribed fluctua-tion limits and to cope with circumstances thatmight threaten orderly conditions in the marketfor a member country’s currency.8 In addition, itstipulated concrete procedures for realignment ofthe bands. Furthermore, European integration al-lowed special arrangements in the ERM for theless advanced countries – Greece, Ireland, Portu-gal and Spain – including the provision ofconsiderable fiscal compensation, which did muchto enable them to achieve monetary and fiscalconvergence and meet the EMU stability criteria.

These arrangements were also supported bya European Community regime for capital move-ments, which, until a directive in 1988, provided

governments with some leeway for restricting dif-ferent categories of transaction, along with someliberalization obligations which were less strin-

gent for short-term and poten-tially speculative transactions.The 1988 directive abolishedrestrictions on capital move-ments between residents ofEuropean Community coun-tries, subject to provisos con-cerning the right to controlshort-term movements duringperiods of financial strain.9

The directive also stated thatEuropean Community coun-tries should endeavour to at-tain the same degree of liber-alization of capital movementsvis-à-vis third countries as

among themselves. However, governments re-tained the right to take protective measures withregard to certain capital transactions in responseto disruptive short-term capital movements. Uponadoption of the single currency, such measurescould be taken only in respect of capital move-ments to or from third countries.

Despite the establishment of institutions tosupport the exchange rate arrangements and inte-gration, the path to monetary union has not beensmooth; it has often been disrupted by shocks andpolicy mistakes. In some instances disruptionswere similar to currency crises experienced byemerging markets under soft pegs. As in emerg-ing markets, occasionally pressures developed asa result of differences in the underlying inflationrates: at the high end of the inflation spectrum wasItaly (and subsequently the United Kingdom), fol-lowed by France with moderate inflation, whileGermany and Austria were at the lower end. Forhigh-inflation countries, therefore, currency re-alignments were needed from time to time untiltheir inflation rates converged towards that of theanchor country. On many occasions inflation dif-ferentials were widened by external or internalshocks which, in effect, tested the resilience ofthe system and the commitments of the partici-pating countries to internal and external stability.The first shock came soon after the collapse ofthe Bretton Woods arrangements in the form of ahike in oil prices. In the United Kingdom and Italyunit labour costs rose much faster, and inflation

Currency arrangementswere also supported by aEuropean Communityregime for capitalmovements, which, until adirective in 1988, providedgovernments with someleeway for restrictingdifferent categories oftransaction.


persisted longer than in France, Austria and Ger-many (chart 5.1). In consequence, the paritiesbetween the currencies of these countries becameunsustainable, necessitating realignments.

However, such realignments have not alwaysbeen an orderly process. The events leading to the1992–1993 EMS crisis provide useful lessons onhow regional currency arrangements, even withsupporting institutions, can break down when ex-change rates are inconsistent with underlyinginflation and interest rates. The beginning of thiscrisis originated from the policy response to the1987 global stock market crash, when centralbanks in the United States and Europe loweredinterest rates to historical lows. This provided astrong monetary stimulus at a rather late stage ofrecovery, pushing up growth rates in Europe to4 per cent or higher, with the United Kingdomleading in the late 1980s and Germany in the early1990s (owing also to the impact of unification).Acceleration in growth, however, was associatedwith greater divergence of inflation rates; unit la-bour costs went up drastically in Italy and theUnited Kingdom, compared to Germany andFrance (chart 5.2). However, the nominal ex-change rate of the lira against the deutsche markwas kept virtually stable from 1987 until 1992,implying a real appreciation of 23 per cent. Forthe United Kingdom, which had entered the ERMin 1990 with an already overvalued currency, therate of appreciation was even higher. In both coun-tries, loss of competitiveness was reflected in asharp swing in the current account from a surplusto a deficit. Until the outbreak of the crisis, thesedeficits were sustained by large inflows of capi-tal, notably from Germany, on account of sizeableinterest rate differentials. Thus the EMS crisis thatforced Italy and the United Kingdom to leave ERMand devalue in September 1992 was similar inmany respects to emerging-market crises. Forthese two countries, such an adjustment in nomi-nal rates was certainly preferable to maintainingthe grids and trying to restore competitivenessthrough a deflationary adjustment. By contrast,as discussed in TDR 1993 (Part Two, chap. I,sect. B), the attack on the French franc could notbe depicted as a case of the market eventuallyimposing discipline, because the underlying fun-damentals of the French economy were as strongas those in Germany.

Chart 5.1

UNIT LABOUR COSTS IN SELECTEDEUROPEAN COUNTRIES AFTERA NEGATIVE SUPPLY SHOCK,

1972–1976

(Per cent change over previous year)

Source: AMECO database, European Commission, 2000.

Chart 5.2

UNIT LABOUR COSTS AFTER A POSITIVEDEMAND SHOCK, 1987–1991

(Per cent change over previous year)

Source: See chart 5.1.

1972 1973 1974 1975 1976

Pe

rce

nt

ch

an

ge

ove

rp

revio

us

ye

ar

35

30

25

20

15

10

5

0

United Kingdom

Italy

France

Austria

Germany

Per

centchange

ove

rpre

vio

us

year

10

9

8

7

6

5

4

3

2

1

0

United Kingdom

Italy

France

Austria

Germany

1987 1988 1989 1990 1991


This experience shows that, just as with uni-lateral pegging or fixing, regional currency ar-rangements, even with supporting institutions, canrun into trouble in the absence of appropriatepolicy actions to bring exchange rates into con-formity with underlying fundamentals. Again,while it is true that the hegemony of an anchor coun-try in regional arrangements is balanced by respon-sibilities that are not present in unilateral pegging orfixing, policies pursued by such a country may stillturn out to be too restrictive for other members. In-deed, tight German monetary policy appears tohave been a factor in the speculative attack on theFrench franc during the EMS crisis.

With the move to a single currency, smallermembers of the EMU are expected to exert a some-

what greater influence on the common monetarypolicy. Furthermore, strong trade linkages can bea force for stability and convergence, with expand-ing economies providing additional demand andexport markets for those members experiencing adownturn. Even though asymmetric shocks andstructural differences may still produce significantdivergence of economic performance among coun-tries at different levels of development, suchdifferences do not need to cause serious policydilemmas if countries are prepared to use the vari-ous instruments they still have at their disposal.However, under certain circumstances, the con-straints imposed on fiscal policy by the Stabilityand Growth Pact could impair the ability to smoothout intraregional differences in economic perform-ance.

D. Options for developing countries:dollarization or regionalization?

Despite the temporary setbacks in 1992–1993,and shortcomings in the design of policies andinstitutional arrangements which constrainedpolicy options, European monetary cooperationhas been successful in securing stability in intra-regional exchange rates, containing financialcontagion and dealing with fluctuations vis-à-visthe dollar and the yen. To what extent can such ar-rangements be replicated by developing countriesas a means of collective defence against systemicinstability? Is it feasible for developing countries toestablish regional arrangements among themselveswithout involving G-3 countries, and to follow apath similar to that pursued by Europe – from aregionally secured exchange rate band to a cur-rency union? Alternatively, could they go directlyto currency union by adopting a regional currency?

Interest in regional monetary arrangementsand cooperation in the developing world has in-creased rapidly since the outbreak of the Asiancrisis. For example, at the 1997 Annual Meetingsof the IMF and the World Bank, soon after theoutbreak of the crisis, a proposal was made to es-tablish an Asian Monetary Fund. Subsequently,an initiative was launched in May 2000 involvingswap and repurchase arrangements among mem-ber countries of the Association of South-EastAsian Nations (ASEAN), China, Japan and theRepublic of Korea (see box 5.1). More recently, thejoint French-Japanese paper cited in section Aabove (Ministry of Finance, Japan, 2001: 5–6) hasgiven support to the strengthening of regional co-operation in East Asia, drawing on the Europeanexperience:


Box 5.1

REGIONAL MONETARY AND FINANCIAL COOPERATION AMONG DEVELOPING COUNTRIES

At present there are few regional financial and monetary arrangements among developing coun-tries, apart from those in East Asia described in box 5.2. Such arrangements as do exist range fromagreements to pool foreign exchange reserves, such as the Andean Reserve Fund and the ArabMonetary Fund, to currency pegging (Rand Monetary Area) and a regional currency (Eastern Carib-bean Monetary Union). The Communauté financière africaine (CFA) also has a common currency,but is unique in that it involves an agreement between its members and a major European countryon cooperation in monetary and exchange-rate policy.

The Andean Reserve Fund was established in 1976 by the members of the Andean Community –Bolivia, Colombia, Ecuador, Peru and Venezuela – and has a subscribed capital of $2 billion. TheFund provides financial support to its members in the form of loans or guarantees for balance-of-payments support, short-term (liquidity) loans, emergency loans, loans to support public externaldebt restructuring, and export credit. Conditionality for drawing on these facilities is softer thanthat of IMF. The Fund also aims at contributing to the harmonization of the exchange-rate, mon-etary and financial policies of member countries. It is thus intended to promote economic andfinancial stability in the region and to further the integration process in Latin America.1

The Arab Monetary Fund was established in 1976 with a structure similar to that of IMF andcomprises all members of the League of Arab States (except the Comoros). It has a subscribedcapital of 326,500 Arab accounting dinars, equivalent to about $1.3 billion. The Fund aims atpromoting exchange-rate stability among Arab currencies and at rendering them mutually convert-ible, and it provides financial support for members that encounter balance-of-payments problems.It is also intended to serve as an instrument to enhance monetary policy cooperation among mem-bers and to coordinate their policies in dealing with international financial and economic prob-lems. Its final aim is to promote the establishment of a common currency.

In the Rand Monetary Area, Lesotho and Swaziland, both economically closely integrated withSouth Africa, peg their currencies to the South African rand without formally engaging in coordi-nation of monetary policy.

The Eastern Caribbean Monetary Union is an arrangement for a common currency among themembers of the Organization of Eastern Caribbean States, a group of small island developingcountries.2 The currency is pegged to the dollar, but in contrast to France with respect to the CFA(see below), the United States does not play an active role in the pegging arrangement.

The creation of the Communauté financière africaine goes back to 1948, but the agreements gov-erning the current operation of the CFA-zone were signed in 1973. There are two regional groups,each with its own central bank: the Economic and Monetary Union of West Africa, and the CentralAfrican Economic and Monetary Community.3 The 14 countries involved have a common cur-rency, the CFA franc, that is not traded on the foreign exchange markets but is convertible with theFrench franc at a fixed parity. There is free capital mobility within the CFA-zone, and betweenthese countries and France, and the foreign exchange reserves of its members are pooled. TheFrench Treasury guarantees the convertibility of the CFA franc into French francs at a fixed parity andassumes the role of lender of last resort. On the other hand, the arrangement includes a mechanismthat limits the independence of the two regional central banks, and the French Treasury can influ-ence monetary policy in the CFA zone as well as determination of the parity with the French franc.

Each of the two central banks has an operations account with the French Treasury into which theyhave to deposit 65 per cent of their foreign exchange reserves, but which also provides an overdraftfacility (at market-related interest) that is, in principle, unlimited. On the other hand, in their op-erations the central banks have to observe two rules that are designed to check the supply of CFAfrancs: (i) their sight liabilities are required to have a foreign exchange cover of at least 20 per


cent, and (ii) their lending to each member Government is limited to 20 per cent of that Government’srevenue of the previous year. Moreover, France has seats on the Boards of both central banks.4

It appears that membership in the CFA has helped to keep inflation in the CFA countries concernedconsiderably below the average of other African countries; between 1975 and 1985, per capitaincome also grew faster. However, the system came under increasing strain after 1985 due to exter-nal shocks and weakening macroeconomic fundamentals (Hadjimichael and Galy, 1997). The CFAcountries suffered from severe terms-of-trade losses as world market prices for some of their majorexport commodities (cocoa, coffee, cotton and oil) dropped sharply and the French franc appreci-ated markedly against the dollar following the Plaza Accord of 1985. Consequently, the nominaleffective exchange rate of the CFA franc rose by almost 7 per cent annually between 1986 and1993. CFA countries’ exports lost competitiveness in world markets as domestic costs could not bereined in; both the combined current-account and the fiscal deficit of the CFA zone increased by6.5 per cent of GDP, and the 20 per cent limit of monetization of government debt was substan-tially exceeded by several countries.

In 1994 it was decided to adjust the parity of the CFA franc with the French franc, from 50 CFAfrancs to 100 CFA francs to one French franc (see also TDR 1995, chap. 1, box 1; Clément, 1996).This was the first – and so far only – devaluation since 1948, but it demonstrated the vulnerabilityof the arrangement, especially in the absence of a mechanism that would allow for a gradual ad-justment of the nominal exchange rate in the light of macroeconomic and balance-of-paymentsdevelopments. The probability that these developments diverge between commodity-dependentdeveloping countries and the developed country whose currency serves as an anchor is relativelyhigh, given the difference in their exposure to external shocks.

The stability and proper alignment of exchange rates of the CFA countries vis-à-vis their tradepartners and competitors exert a major influence on their overall economic performance. First,trade in these countries accounts for a very high share of GDP. Second, intra-CFA trade is limited,accounting, on average, for only 8 per cent of its members’ total trade.5 Third, because of structuraldifferences, CFA and EU countries do not constitute an optimal currency area. Even though half ofthe total trade of CFA countries is with the EU, their export and import structures are very differentand the CFA countries face competition from third parties in commodity exports both to the EUand elsewhere. Thus, while bringing a certain amount of monetary discipline and protection againstspeculative attacks, a policy of locking into the French franc (and, hence, subsequently into theeuro) and floating with it against other currencies poses problems for trade and international com-petitiveness.

1 For more detailed information, see FLAR (2000).2 The member States are Antigua and Barbuda; Dominica; Grenada; Montserrat; St. Kitts and Nevis; Saint

Lucia; and St Vincent and the Grenadines. The British Virgin Islands and Anguilla are associate members.3 The Economic and Monetary Union of West Africa comprises Benin, Burkina Faso, Côte d’Ivoire, Guinea-

Bissau, Mali, Niger, Senegal and Togo; and the Central African Economic and Monetary Communitycomprises Cameroon, Central African Republic, Chad, Congo, Equatorial Guinea and Gabon. The twogroups maintain separate currencies, but since both have the same parity with the French franc, they aresubject to the same regulatory framework. And because there is free capital mobility between each ofthe two regions, the CFA franc zone can be considered as a single currency area. The Comoros has asimilar arrangement but maintains its own central bank.

4 For a detailed treatment of the institutional aspects of the CFA, see Banque de France (1997).5 Trade with countries within the CFA franc zone ranges from 1.5 per cent of total trade in Congo to

23.3 per cent in Mali. By contrast, trade links with Europe are very close. They are slightly closer forthe member States of the Central African Economic and Monetary Community (50 per cent of exportsand 66 per cent of imports) than for the members of the Economic and Monetary Union of West Africa(49.3 and 46.3 per cent, respectively).

Box 5.1 (concluded)


Strengthened regional co-operation is a wayof ensuring both stability and flexibility …The European Monetary Union process pro-vides a useful example of how furtherintegration can be achieved … In this re-gard, an important step was taken in ChiangMai on 6 May 2000 to establish a regionalfinancial arrangement to supplement exist-ing international facilities … Regionalco-operation frameworks should be fully in-tegrated into the overall monetary andfinancial system.

Interest has also been expressed in establishingregional currencies, as opposed to dollarization,in Latin America. A recent statement made by thePresident of the Inter-American DevelopmentBank stated:

The issue (of dollarization) is very contro-versial and has both its defenders anddetractors, but we do not think the condi-tions are appropriate in most countries fortaking that route … We believe, however,that the important conditions are in place forthinking about sub-regional currencies.(Reported in SUNS, 11 January 2000.)

If established and sustained, regional curren-cies among developing country groupings canbring considerable benefits, similar to those ex-pected from the introduction of the euro. They canreduce transaction costs of doing business withina region and eliminate exchange rate spreads andcommissions in currency trading associated withintraregional trade and investment. For example,such effects are estimated toraise the combined GDP of theeuro area by some 0.5 per cent.The adoption of the euro isalso expected to raise intrare-gional trade, primarily throughtrade diversion (TDR 1999,Part One, chap. III). Further-more, a supranational centralbank can reduce the influenceof populist national politics onmonetary policy, while never-theless being accountable tomember countries. Unlike dol-larization, such an arrangement would also bringbenefits in terms of seigniorage (Sachs and Larrain,1999: 89).

Establishing regional arrangements – includ-ing regional currencies – among developingcountries would also reduce the likelihood of syn-chronous cycles and asymmetric shocks to theextent that there are similarities in their economicstructures and institutions. In other words, a group-ing of developing countries alone is more likelyto meet the conditions of an optimal currency areathan one which also involves developed countries.

However, in drawing lessons from Europe fordeveloping countries, it is necessary to take intoaccount certain differences between the two. TheEuropean experience shows that small and highlyopen economies with close regional trade links canestablish and sustain a system of stable exchangerates around a major reserve currency so long asthere are clear guidelines regarding the mainte-nance and alteration of members’ currency bands,appropriate allocation of responsibilities and sup-porting institutions and policies. Such arrange-ments can be operated for quite a long timewithout major disruptions and can help to deepenintegration (see box 5.2). For larger groups andfor countries of equal size or economic power,however, there could be significant difficulties inestablishing and sustaining such systems. Therewould be an additional difficulty when the groupdoes not contain a major reserve-currency country.

Consequently, unless they are organizedaround a major reserve-currency country, devel-oping countries of comparable size may find itdifficult to form a group to establish and sustainERM-type currency grids and ensure that the

monetary and financial poli-cies pursued independentlyby each country are mutuallycompatible and consistent withthe stability of exchange rates.Moreover, without the involve-ment of a large reserve-currencycountry, it could be difficult toput in place effective defencemechanisms against specu-lative attacks on individualcurrencies. Under these condi-tions, while a rapid move tomonetary union through the

adoption of a regional currency might be consid-ered desirable, it would face similar problems ofimplementation as the introduction of an exchange

Is it feasible for developingcountries to establishregional currencyarrangements amongthemselves withoutinvolving G-3 countries,and to follow a path similarto that pursued by Europe?


Box 5.2

THE CHIANG MAI INITIATIVE

Even before the financial crisis of 1997, there had been a growing interest in East Asia inpursuing regional policy coordination and monetary cooperation. Various swap arrange-ments and repurchase agreements had been introduced, and these initiatives intensified dur-ing the Mexican crisis in the mid-1990s. However, none of these moves prepared the regionfor the currency runs of 1997 and 1998.

In a Joint Statement on East Asia Cooperation issued at the summit of “ASEAN plus 3” (the10 members of ASEAN plus China, Japan, and the Republic of Korea) in November 1999, itwas agreed to “strengthen policy dialogue, coordination and collaboration on the financial,monetary and fiscal issues of common interest” (Ministry of Finance, Japan, 2000a: 8).Against this background, the region’s Finance Ministers launched the so-called “ChiangMai Initiative” in May 2000, aimed at building networks for multilayered financial coop-eration to match the growing economic interdependence of Asian countries and the conse-quently greater risk that financial shocks could lead to regional contagion.1 The Initiativeenvisages the use of the ASEAN+3 framework to improve exchange of information on capi-tal flows and to launch moves towards the establishment of a regional economic and finan-cial monitoring system. The core of the Initiative is a financing arrangement among the13 countries that would strengthen the mechanism of intraregional support against currencyruns. This arrangement, building on the previous ASEAN Swap Arrangement (ASA), isintended to supplement existing international financial cooperation mechanisms. It is alsoexpected to contribute to the stability of exchange rates within the region.

The previous ASA, which dates back to 1977, comprised only five countries (Indonesia,Malaysia, the Philippines, Singapore, and Thailand). Total funds committed under the ar-rangement were $200 million – a negligible amount compared to the combined loss of for-eign exchange reserves of $17 billion that the five countries experienced between June andAugust 1997.

The new ASA envisaged under the Chiang Mai Initative includes Brunei Darussalam andallows for the gradual accession of the four remaining ASEAN countries (Cambodia, LaoPeople’s Democratic Republic, Myanmar and Viet Nam). But its most important element isthe inclusion of bilateral swap and repurchase arrangements between the ASEAN countriesand China, Japan, and the Republic of Korea. Funds available under the new ASA total$1 billion. However, the commitments of the three non-ASEAN countries to the bilateralswap arrangements are likely to be substantially greater than this; they will be determinedby the level of their foreign currency reserves and the amounts that were involved in earlieragreements between Japan and the Republic of Korea ($5 billion) and Japan and Malaysia($2.5 billion). The conditions for drawing on the facilities and a number of technicalitiesremain to be agreed in negotiations among the countries concerned, but it appears that as-sistance under the bilateral swap arrangements will, in principle, be linked to IMF support(Ministry of Finance, Japan, 2000b).

1 For further information on the Initiative, see Ministry of Foreign Affairs of the Kingdom ofThailand (2000); Ministry of Finance, Japan (2000a and 2000b); “Asia finance: Central banksswap notes”, The Economist, 16 May 2000.


rate mechanism. Recognition of such difficultiesand adoption of appropriate mechanisms to over-come them are essential if developing countries areto succeed in their attempts to form regional mon-etary groupings aimed at attaining greater ex-change rate and financial stability.

The absence of a major reserve-currencycountry in regional arrangements also poses prob-lems of credibility. It may be especially difficultfor countries with a long history of monetary dis-order and inflation to form a credible monetaryunion without involving a major reserve-currencycountry with a good record of monetary disciplineand stability. In this regard, Latin America isclearly less favourably placed than East Asia.

More fundamentally, for developing coun-tries to manage on their own regional exchangerates vis-à-vis the G-3 currencies is a dauntingtask, whether it is undertaken within the frame-work of a monetary union or under ERM-typearrangements. They cannot simply float their cur-rencies and adopt an attitude of benign neglecttowards the value of their cur-rencies vis-à-vis the rest of theworld, even under conditionsof deep regional integration.For instance, in East Asia,while intraregional tradeamong the countries of theregion (ASEAN, first-tier NIEsand China) is important andconstantly growing, it stillaccounts for less than half oftheir total trade (TDR 1996,Part Two, chap. I, sect. E),compared to two thirds in theEU. Furthermore, as a propor-tion of GDP, the trade of EastAsian developing countries with the rest of theworld is more than twice as large as that of theUnited States, the EU or Japan. Accordingly, theirexchange rates vis-à-vis G-3 currencies can exerta considerable influence on their economic per-formance. Furthermore, regional arrangementswould not protect them against financial shocks,since they carry large stocks of external debt inG-3 currencies.

These factors thus render floating against G-3currencies unattractive and raise the question of

what constitutes an appropriate exchange rate re-gime at the regional level. One option is toestablish a crawling band, with the central ratedefined in terms of a basket of G-3 currencies.10

The joint French-Japanese paper cited above sug-gested that such an intermediate regime could bea possible step towards monetary union:

A possible solution for many emerging mar-ket economies could be a managed floatingexchange-rate regime whereby the currencymoves within a given implicit or explicitband with its centre targeted to a basket ofcurrencies. … managed free-floating ex-change rate regimes may be accompaniedfor some time, in certain circumstances, bymarket-based regulatory measures to curbexcessive capital inflows. (Ministry of Fi-nance, Japan, 2001:3–4)

The paper went on to argue that a “group ofcountries with close trade and financial linksshould adopt a mechanism that automaticallymoves the region’s exchange rates in the samedirection by similar percentages”. This would im-

ply fixed bands for currenciesof members, as in the ERM.But as the European experi-ence shows, there would alsobe a need to alter such bandsin line with changes in infla-tion rates, for example. Sucha regime, pursued collectively,may need to be supported bya collective system of controlover capital movements. Forreasons already mentioned,control over capital flows –both inward and outward – canbe more easily agreed uponwhen countries act together

rather than separately. In such an arrangement,intraregional capital flows may be deregulated –as in the EMU – but capital flows to and from non-member countries would have to be controlled –as in the formative years of the EMS – in order torestrict short-term, potentially destabilizing move-ments.

Any regional monetary arrangement wouldneed to include mechanisms to support the re-gional currency, or currencies, in order to keepexchange rates in line with targets and stem specu-

For developing countries tomanage on their ownregional exchange ratesvis-à-vis the G-3 currenciesis a daunting task, whetherit is undertaken within theframework of a monetaryunion or under ERM-typearrangements.


lative attacks. Since the East Asian crisis, variousproposals have been put forward to establish re-gional support mechanisms for intervention incurrency markets and for theprovision of international li-quidity to countries facing arapid exit of capital. The 1997proposal to establish an Asianfacility of $100 billion was“derailed quickly by theUnited States Treasury andIMF for fear that it would de-tract from the role (and power)of the latter and make it evenmore difficult to get the UnitedStates’ contribution to theIMF’s latest quota increaseauthorized by the United States Congress” (Mistry,1999: 108).11 Another proposal made was to pooland deploy national reserves to defend currenciesfacing speculative attacks and to provide interna-tional liquidity to countries without the stringentconditions typically attached to such lending byinternational financial institutions. For instance onthe eve of the Thai crisis in 1997, the combinednet reserves of East Asia – including Japan – ex-ceeded $500 billion, and by 2000 had risen toabout $800 billion (Park andWang, 2000). Pooling of reservescan also be supplemented byregional agreements to borrowamong regional central banks,modelled on the IMF’s GeneralArrangements to Borrow (GAB),as recently proposed by Sin-gapore as a form of mutual as-sistance.

Arrangements such aspooling of national reserves orswap facilities among centralbanks can undoubtedly domuch to stabilize exchangerates, even when they involveonly developing countries of the region. However,they are likely to be more effective in smoothingout short-term volatility and responding to isolatedcurrency pressures than in stalling systemic crises.Given the herd behaviour of financial markets, thespeed of spillovers and extent of contagion, it maybe impossible to sustain an ERM-type currencyband at times of crisis simply by drawing on a

pool of national reserves, if there is no possibilityof recourse to a regional lender of last resort. Be-sides, maintaining a high level of reserves for this

purpose would be a very ex-pensive way of securing insur-ance against financial panics.As discussed in the next chap-ter, a more viable alternativewould be to resort to unilateralstandstills and exchange andcapital controls at times ofspeculative attacks.

In a world of systemicand global financial instabil-ity, any regional arrangementdesigned to achieve exchange

rate stability in order to prevent crises, and man-age them better if they nonetheless occur, shouldalso incorporate a number of other mechanisms,with the aim of ensuring enhanced regional sur-veillance, information-sharing and early warning.Domestic reforms would still be needed in manyof the areas discussed in the previous chapter inorder to provide a sound basis for regional coop-eration. Just as domestic policy actions withoutappropriate global arrangements would not be

sufficient to ensure greater fi-nancial stability, regional ar-rangements could fail in theabsence of sound domestic in-stitutions and policies.

As European experiencehas shown, progress towardsa currency union can be a longand drawn-out process, requir-ing political will and a “cul-ture” of regionalism. Regionalmonetary arrangements link-ing several national currenciesthrough exchange rate bandscan encounter serious prob-lems even when there are sup-

porting institutions. It would not be easy for de-veloping countries to replicate the Europeanexperience, with or without the help of G-3 coun-tries. However, the threat of virulent financialcrises, together with the lack of genuine progressin the reform of the international financial archi-tecture, has created a sense of urgency in emerg-ing markets, notably in East Asia, for building col-

Any regional monetaryarrangement would need toinclude mechanisms tosupport the regionalcurrencies in order to keepexchange rates in line withtargets and stemspeculative attacks.

As European experiencehas shown, progresstowards a currency unioncan be a long and drawn-out process, requiringpolitical will and a “culture”of regionalism. Recentinitiatives and proposals inEast Asia, however modestthey may be, constitute animportant step forward.


lective defence mechanisms at the regional level.In this context, recent initiatives and proposals,

however modest they may be, constitute an im-portant step forward.

Notes

1 For instance, the report of the International Finan-cial Institutions Advisory Commission set up by theUnited States Congress (commonly referred to asthe “Meltzer Report”), recommended “that countriesavoid pegged or adjustable rates. The IMF shoulduse its policy consultations to recommend eitherfirmly fixed rates (currency board or dollarization)or fluctuating rates” (IFIC, 2000: 8).Similar viewshave been expressed by the former Treasury Secre-tary of the United States concerning the choice ofan appropriate exchange rate regime, “... which, foreconomies with access to international capital mar-kets, increasingly means a move away from themiddle ground of pegged but adjustable fixed ex-change rates towards the two corner regimes of ei-ther flexible exchange rates or a fixed exchange ratesupported, if necessary, by a commitment to giveup altogether an independent monetary policy”(Summers, 2000b: 8).

2 For an earlier account of this process, before therecent surge in capital flows to emerging markets,see TDR 1991 (Part Two, chap. III, sect. F); TDR1998 (Part One, chap. III, sect. B); and TDR 1999(Part Two, chap. VI).

3 For instance, the 1998 Brazilian programme withthe IMF had stipulated an orderly exit from the pegthrough gradual devaluations throughout 1999, aswell as emergency financing, but this did not pre-vent the crisis.

4 This inability of a country to borrow in its own cur-rency has been coined the “original sin hypothesis”(Hausmann, 1999; Eichengreen and Hausmann,1999). A corollary of this hypothesis is that “... thecountry’s aggregate net foreign exposure must beunhedged, by definition. To assume the ability tohedge is equivalent to assume that countries canborrow abroad in their own currencies but choosenot to do so, in spite of the fact that the market does

not appear to exist” (Eichengreen and Hausmann,1999: 25).

5 For an assessment of the experience in the 1980s,see UNCTAD secretariat (1987); Akyüz and Dell(1987); and also TDR 1990 (Part Two, chap. I). Forthe more recent experience, see previous TDR 1993(Part Two, chap. I); TDR 1994 (Part Two, chap. II);TDR 1995 (Part Two, chap. I); TDR 1996 (Part Two,chap. I); and TDR 1999 (chap. III).

6 For a debate on the relative costs and benefits ofhard pegs and floating rates, see Hausmann (1999)and Sachs and Larrain (1999).

7 The first major political initiative for a Europeanmonetary union was taken in 1969 with the adop-tion of the Werner Report, which proposed: for thefirst stage, a reduction of the fluctuation marginsbetween the currencies of the member States of theCommunity; for the second stage, the achievementof complete freedom of capital movements, with in-tegration of financial markets; and for the final stage,an irrevocable fixing of exchange rates between thecurrencies. In its first effort at creating a zone ofcurrency stability, the EEC attempted in 1971 to fixEuropean parities closer to each other than to thedollar, but with some flexibility (“the snake”). The“snake” rapidly died with the collapse of the dol-lar-based Bretton Woods system, but was reborn in1972 as the “snake in the tunnel”, a system whichnarrowed the fluctuation margins between the Com-munity currencies (the snake) in relation to thoseoperating between these currencies and the dollar(the tunnel). During the currency turmoil that ac-companied the 1973 oil crisis, this arrangementcould not function well, leading to various exits andfloating, until the establishment of the EMS in 1979.The United Kingdom was a member of the EMSbut did not participate in the ERM until 1990. Forthe history of European monetary integration and


the functioning of the EMS, see Bofinger andFlassbeck (2000).

8 For a useful survey of mechanisms for external pay-ments support in the EEC, see Edwards (1985: 326–346). As part of the establishment of the Economicand Monetary Union, the European Monetary Co-operation Fund – the body which administered short-term facilities under the heading of mutual externalfinancial support – was dissolved and its functionstaken over by the European Monetary Institute (EMI).

9 In addition, there was an obligation to take the meas-ures necessary for the proper functioning of sys-tems of taxation, prudential supervision, etc. Formore details, see Akyüz and Cornford (1995).

10 Such a regime is coined BBC (basket, band andcrawl) (Williamson, 2000).

11 This source also provides a detailed discussion ofother proposals for regional arrangements.

131Crisis Management and Burden Sharing

There is a growing body of opinion that ef-fective management of financial crises in emergingmarkets requires a judicious combination of ac-tion on three fronts: a domestic macroeconomicpolicy response, particularly through monetaryand fiscal measures and exchange rate adjustment;timely and adequate provision of international li-quidity with appropriate conditionality; and theinvolvement of the private sector, especially in-ternational creditors. With benefit of hindsight, itis now agreed that the international policy re-sponse to the Asian crisis was far from optimal,at least during the initial phase. An undue burdenwas placed on domestic policies; rather than re-storing confidence and stabilizing markets, hikesin interest rates and fiscal austerity served todeepen the recession and aggravate the financialproblems of private debtors. The international res-cue packages were designed not so much to protectcurrencies against speculative attacks or financeimports as to meet the demands of creditors andmaintain an open capital account. Rather than in-volving private creditors in the management andresolution of the crises, international intervention,coordinated by the IMF, in effect served to bailthem out.1

This form of intervention is increasingly con-sidered objectionable on grounds of moral hazardand equity. It is seen as preventing market disci-pline and encouraging imprudent lending, sinceprivate creditors are paid off with official moneyand not made to bear the consequences of the risksthey take. Even when the external debt is owedby the private sector, the burden ultimately fallson taxpayers in the debtor country, because gov-ernments are often obliged to serve as guarantors.At the same time, the funds required for suchinterventions have been getting ever larger and arenow reaching the limits of political acceptability.Thus, a major objective of private sector involve-ment in crisis resolution is to redress the balanceof burden sharing between official and privatecreditors as well as between debtors and creditors.

For these reasons, the issues of private sectorinvolvement and provision of official assistancein crisis management and resolution have beenhigh on the agenda in the debate on reform of theinternational financial architecture since the out-break of the East Asian crisis. However, despiteprolonged deliberations and a proliferation ofmeetings and forums, the international commu-

Chapter VI

CRISIS MANAGEMENT AND BURDEN SHARING

A. Introduction


nity has not been able to reach agreement on howto involve the private sector and how best to designofficial lending in financial crises. As acknowl-edged by the IMF, “While some success has beenachieved in securing concerted private sector in-volvement, it has become increasingly clear thatthe international community does not have at

its disposal the full range of tools that wouldbe needed to assure a reasonably orderly – andtimely – involvement of the private sector” (IMF,2000f: 10). This chapter seeks to address this prob-lem by defining the state of play, examining theissues that remain to be resolved and assessingvarious options proposed.

B. Private sector involvement and orderly debt workouts

Private sector involvement in financial cri-sis resolution refers to the continued or increasedexposure of international creditors to a debtorcountry facing serious difficulties in meeting itsexternal financial obligations, as well as to ar-rangements that alter the terms and conditions ofsuch exposure, including maturity rollovers anddebt write-offs.2 In this con-text, it is useful to make a dis-tinction between mechanismsdesigned to prevent panics andself-fulfilling debt runs, on theone hand, and those designedto share the burden of a crisisbetween debtors and creditors,on the other. To the extent thatprivate sector involvementwould help restrain asset grab-bing, it would also reduce theburden to be shared. For in-stance, debt standstills and rollovers can preventa liquidity crisis from translating into widespreadinsolvencies and defaults by helping to stabilizethe currency and interest rates. In this sense,private sector involvement in financial crises isnot always a zero sum game. It can also help re-solve conflict of interest among creditors them-selves by ensuring more equitable treatment.

Market protagonists often argue that foreigninvestors almost always pay their fair share of the

burden of financial crises in emerging markets.According to this view, international banks incurlosses as a result of arrears and bankruptcies, whileholders of international bonds suffer because thefinancial difficulties of the debtors affect the mar-ket value of bonds, and most private investorsmark their positions to market (Buchheit, 1999: 6).

Losses incurred in domesticbond and equity markets arealso cited as examples of bur-den sharing by private inves-tors.3

In assessing creditorlosses, it is important to bearin mind that, so long as thevalue of claims on the debtorremains unchanged, mark-to-market losses may involveonly a redistribution among

investors. On the other hand, net losses by credi-tors are often compensated by risk spreads onlending to emerging markets. For instance, on theeve of the Asian crisis, the total bank debt ofemerging markets was close to $800 billion.Applying a modest 300 basis points as the aver-age spread on these loans would yield a sum ofmore than $20 billion per annum in risk premium,compared to the estimated total mark-to-marketlosses4 of foreign banks of some $60 billion in-curred in emerging-market crises since 1997.

A major objective of privatesector involvement in crisisresolution is to redress thebalance of burden sharingbetween official and privatecreditors as well as betweendebtors and creditors.


Foreign investors are directly involved inburden sharing when their claims are denominatedin the currency of the debtor country and they rushto exit. This hurts them twice, by triggering sharpdrops both in asset prices and in the value of thedomestic currency. For this reason, countries thatborrow in their own currencies(or adopt a reserve currency astheir own) are expected to beless prone to currency and debtcrises since potential losseswould deter rapid exit andspeculative attacks.

However, the denomina-tion of external debt in the cur-rency of the debtor countrydoes not eliminate the so-called collective action prob-lem which underlines self-ful-filling debt runs and providesthe principal rationale for debtstandstills; even though creditors as a group are bet-ter off if they maintain their exposure, individualinvestors have an incentive to exit quickly for fearof others doing so before them. The consequent de-clines in domestic asset prices and in the value ofthe currency not only hurt creditors, but also haveserious repercussions for the debtor economy. Insome cases, there could be a run for the strongforeign-owned domestic banks as well, placing aparticular burden on locally-owned and smallerbanks and other financial institutions. It is for thesereasons that governments of debtor countries areoften compelled to take action to prevent a rapidexit of foreign investors from domestic capitalmarkets. Such actions may go beyond monetarytightening. In Mexico, for instance, market pres-sures in 1994 forced the Government to shiftfrom peso-denominated cetes to dollar-indexedtesebonos in the hope that removing the currencyrisks would persuade foreign creditors to stay.However, this did not prevent the eventual rushto exit, the collapse of the peso and hikes in inter-est rates. Thus, even when external debt is denomi-nated in domestic currency, arrangements to in-volve private creditors through standstills androllovers can play an important role in efforts toachieve greater financial stability.

As discussed in detail in TDR 1998, the ra-tionale and key principles for an orderly debt

workout can be found in domestic bankruptcy pro-cedures. Although chapter 11 of the United StatesBankruptcy Code is the most cited reference, othermajor industrial countries apply similar principles.These principles combine three key elements:(i) provisions for an automatic standstill on debt

servicing that prevents a “grabrace” for assets among thecreditors; (ii) maintaining thedebtor’s access to the workingcapital required for the con-tinuation of its operations (i.e.lending into arrears); and(iii) an arrangement for thereorganization of the debtor’sassets and liabilities, includingdebt rollover, extension of ex-isting loans, and debt write-offor conversion. The way theseelements are combined de-pends on the particularities ofeach case, but the aim is to

share the adjustment burden between debtor andcreditors and to assure an equitable distributionof the costs among creditors.

Under these procedures, standstills give thedebtor the “breathing space” required to formu-late a debt reorganization plan. While, in principle,agreement is sought from creditors for restructur-ing debt, the procedures also make provisions todiscourage holdouts by allowing for majority –rather than unanimous – approval of the creditorsfor the reorganization plan. The bankruptcy courtacts as a neutral umpire and facilitator, and whennecessary has the authority to impose a bindingsettlement on the competing claims of the credi-tors and debtor under so-called “cramdown”provisions.

Naturally, the application of national bank-ruptcy procedures to cross-border debt involves anumber of complex issues. However, fully-fledgedinternational bankruptcy procedures would not beneeded to ensure an orderly workout of interna-tional debt. The key element is internationallysanctioned mandatory standstills. Under certaincircumstances, it might be possible to reach agree-ment on voluntary standstills with creditors but,as recognized by the IMF, “… in the face of abroad-based outflow of capital, it may be diffi-cult to reach agreement with the relevant resident

While debtor countrieshave the option to imposeunilateral paymentsuspension, without astatutory basis such actioncan create considerableuncertainties, therebyreducing the likelihood oforderly debt workouts.


and nonresident investors ...” (IMF, 2000f: 10).On the other hand, while debtor countries havethe option to impose unilateral payment suspen-sion, without a statutory basis such action can cre-ate considerable uncertainties, thereby reducingthe likelihood of orderly debt workouts. Further-more, debtors could be deterred from applyingtemporary payment standstills for fear of litiga-tion and asset seizure by creditors, as well as of last-ing adverse effects on their reputation.

Standstills on sovereign debt involve suspen-sion of payments by governments themselves,while on private external debt they require animposition of temporary exchange controls whichrestrict payments abroad on specified transactions,including interest payments. Further restrictionsmay also be needed on capital transactions of resi-dents and non-residents (suchas acquisition of assets abroador repatriation of foreign capi-tal). Clearly, the extent towhich standstills would need tobe combined with such meas-ures depends on the degree ofrestrictiveness of the capitalaccount regime already inplace.

Since standstills and ex-change controls need to be im-posed and implemented rap-idly, the decision should restwith the country concerned,subject to a subsequent review by an internationalbody. According to one proposal, the decisionwould need to be sanctioned by the IMF. Clearly,for the debtor to enjoy insolvency protection, itwould be necessary for such a ruling to be legallyenforceable in national courts. This would requirea broad interpretation of Article VIII(2)(b) of theArticles of Agreement of the IMF, which couldbe provided either by the IMF Executive Boardor through an amendment of these Articles so asto cover debt standstills. In this context, Canadahas proposed an Emergency Standstill Clause tobe mandated by IMF members (Department of Fi-nance, Canada, 1998).

However, as argued in TDR 1998, the IMFBoard is not a neutral body and cannot, therefore,

be expected to act as an independent arbiter, be-cause countries affected by its decisions are alsoamong its shareholders. Moreover, since the Funditself is a creditor, and acts as the authority forimposing conditionality on the borrowing coun-tries, there can be conflicts of interest vis-à-visboth debtors and other creditors. An appropriateprocedure would thus be to establish an independ-ent panel for sanctioning such decisions. Such aprocedure would, in important respects, be simi-lar to GATT/WTO safeguard provisions that allowdeveloping countries to take emergency actionswhen faced with balance-of-payments difficulties(see box 6.1).

For private borrowers the restructuring ofdebts should, in principle, be left to national bank-ruptcy procedures. However, these remain highly

inadequate in most developingcountries (see chapter IV, sub-section B.6). Promoting an or-derly workout of private debt,therefore, crucially dependson establishing and develop-ing appropriate procedures.Ordinary procedures for han-dling individual bankruptciesmay be inappropriate and dif-ficult to apply under a morewidespread crisis, and theremay be a need to provide gen-eral protection to debtors whenbankruptcies are of a systemicnature. One proposal that has

been put forward is “… to provide quasi automaticprotection to debtors from debt increases due to adevaluation beyond a margin …” (Miller andStiglitz, 1999: 4). Clearly, the need for such pro-tection will depend on the extent to which stand-stills and exchange controls succeed in prevent-ing sharp declines in currencies. For sovereigndebtors, it is difficult to envisage formal bank-ruptcy procedures at the international level, butthey too could be given a certain degree of pro-tection against debt increases brought about bycurrency collapses. Beyond that, negotiations be-tween debtors and creditors appear to be the onlyfeasible solution. As discussed below, these maybe facilitated by the inclusion of various provi-sions in debt contracts, as well as by appropriateintervention of multilateral financial institutions.

While the internationalcommunity has increasinglycome to recognize thatmarket discipline will onlywork if creditors bear theconsequences of the risksthey take, it has beenunable to reach agreementon how to bring this about.


Box 6.1

GATT AND GATS BALANCE-OF-PAYMENTS PROVISIONSAND EXCHANGE RESTRICTIONS

The balance-of-payments provisions of Articles XII and XVIIIB of GATT 1994 al-low a Member to suspend its obligations under the Agreement, and to impose importrestrictions in order to forestall a serious decline in, or otherwise protect the level of,its foreign exchange reserves, or to ensure a level of reserves adequate for implemen-tation of its programme of economic development.1 The provisions of Article XVIIIB(part of Article XVIII dealing with governmental assistance to economic develop-ment) are directed particularly at payments difficulties arising mainly from a coun-try’s efforts to expand its internal market or from instability in its terms of trade.Permissible actions include quantitative restrictions as well as price-based measures.In applying such restrictions, the Member may select particular products or productgroups. The decision is taken unilaterally, with notification to the WTO Secretariatand subsequent consultations with other Members in the Committee on Balance-of-Payments Restrictions. Restrictions are imposed on a temporary basis, and are ex-pected to be lifted as conditions improve. However, the Member cannot be requiredto remove restrictions by altering its development policy.

Similar provisions are to be found in Article XII of the General Agreement on Tradein Services (GATS), which stipulates that, in the event of serious difficulties in thebalance of payments and in external finance, or a threat thereof, a Member may adoptor maintain restrictions on trade in services on which it has undertaken specific com-mitments, including on payments or transfers for transactions related to such com-mitments. Again, such restrictions are allowed to ensure, inter alia, the maintenanceof a level of financial reserves adequate for implementation of the Member’s pro-gramme of economic development or economic transition. The conditions andmodalities related to the application of such restrictions are similar to those in theGATT 1994 balance-of-payments provisions.

Clearly, these provisions are designed to avoid conditions in which countries areforced to sacrifice economic growth and development as a result of temporary diffi-culties originating in the current account of the balance of payments, particularlytrade deficits. Even though they may not be invoked directly for the restriction offoreign exchange transactions and the imposition of temporary standstills on debtpayments at times of severe payments difficulties arising from the rapid exit of capi-tal – and a consequent capital-account crisis – resort to such action in those circum-stances would be entirely in harmony with the provisions’ underlying rationale.

1 For more detailed discussion, see Jackson (1997, chap. 7); and Das (1999, chap. III.3).


Despite its potential benefits to both debtorsand creditors, private sector involvement in crisisresolution has proved to be one of the most con-tentious issues in the debate on reform of the in-ternational financial architecture. While the inter-national community has increasingly come to rec-ognize that market discipline will only work ifcreditors bear the consequences of the risks theytake, it has been unable to reach agreement on howto bring this about. According to one view, avoluntary and case-by-caseapproach would constitute themost effective way of involv-ing the private sector in crisisresolution. Another view isthat, for greater financial sta-bility and equitable burdensharing, a rules-based manda-tory approach is preferable.This divergence of views is notsimply between debtor andcreditor countries, but alsoamong the major creditorcountries.

The main argument in favour of a rules-basedsystem is that a case-by-case approach could leadto asymmetric treatment – not only betweendebtors and creditors, but also among differentcreditors. It would also leave considerable discre-tion to some major industrial powers, which havesignificant leverage in international financialinstitutions, to decide on the kind of interventionto be made in emerging-market crises. Privatemarket actors, as well as some major industrialcountries, are generally opposed to involuntarymechanisms on the grounds that they create moral

hazard for debtors, that they alter the balance ofnegotiating strength in favour of the latter, thatthey delay the restoration of market access, andthat they can be used to postpone the adjustmentsneeded.5

The recent debate within the IMF on privatesector involvement in crisis resolution appears tohave focused on three mechanisms. First, it isagreed that the Fund should try, where appropriate,

to act as a catalyst for lendingby other creditors to a coun-try facing payments difficul-ties. If this is inappropriate, orif it fails to bring in the pri-vate sector, the debtor coun-try should seek to reach anagreement with its creditors ona voluntary standstill. Finally,it is recognized that, as a lastresort, the debtor country mayfind it necessary to impose aunilateral standstill when vol-untary agreement is not feasi-

ble. All these measures should also be accompa-nied by appropriate monetary and fiscal tighten-ing and exchange rate adjustment. A report of themeeting of the IMF Executive Board concerningthe involvement of the private sector in the reso-lution of financial crises stated:

Directors agreed that, under the suggestedframework for involving the private sector,the Fund’s approach would need to be aflexible one, and the complex issues involvedwould require the exercise of considerablejudgement. … In cases where the member’sfinancing needs are relatively small or where,

C. Recent debate within the IMF

Current practices leave toomuch discretion to the Fundand its major shareholdersin decisions regarding thetiming and extent of theofficial financing it shouldprovide, and under whatconditions.


despite large financing needs, the memberhas good prospects of gaining market accessin the near future, the combination of strongadjustment policies and Fund support shouldbe expected to catalyze private sector in-volvement. In other cases, however, whenan early restoration of market access onterms consistent with medium-term exter-nal sustainability is judged to be unrealistic,or where the debt burden is unsustainable,more concerted support from private credi-tors may be necessary, possibly includingdebt restructuring …

Directors noted that the term “standstill”covers a range of techniques for reducingnet payment of debt service or net outflowsof capital after a country has lost spontane-ous access to international capital markets.These range from voluntary arrangementswith creditors limiting net outflows of capi-tal, to various concerted means of achievingthis objective.

Directors underscored that the approach tocrisis resolution must not undermine theobligation of countries to meet their debt infull and on time. Nevertheless, they notedthat, in extreme circumstances, if it is notfeasible to reach agreement on a voluntarystandstill, members may find it necessary,as a last resort, to impose one unilaterally.Directors noted that … there could be a riskthat this action would trigger capital out-flows. They recognized that if a tighteningof financial policies and appropriate ex-change rate flexibility were not successfulin stanching such outflows, a member wouldneed to consider whether it might be neces-sary to resort to the introduction of morecomprehensive exchange or capital controls.(IMF, 2000h)6

Clearly, there still remains the possibility oflarge-scale bailout operations. Some countriesapparently attempted to exclude this possibility,but could not secure consensus:

A number of Directors favoured linking astrong presumption of a requirement forconcerted private sector involvement tothe level of the member’s access to Fundresources. These Directors noted that arules-based approach would give more

predictability to the suggested frameworkfor private sector involvement, while limit-ing the risk that large-scale financing couldbe used to allow the private sector to exit.Many other Directors, however, stressed thatthe introduction of a threshold level ofaccess to Fund resources, above which con-certed private sector involvement would beautomatically required, could in some caseshinder the resumption of market access fora member with good prospects for the suc-cessful use of the catalytic approach tosecuring private sector involvement.

Nor has there been agreement over empow-ering the IMF to impose stay on creditor litigationin order to provide statutory protection to debtorsthat impose temporary standstills:

Most Directors considered that the appro-priate mechanism for signalling the Fund’sacceptance of a standstill imposed by amember was through a decision for the Fundto lend into arrears to private creditors …Some Directors favored an amendment toArticle VIII, section 2(b), that would allowthe Fund to provide a member with someprotection against the risk of litigationthrough a temporary stay on creditor litiga-tion. Other Directors did not favor such anapproach, and noted that in recent casesmembers’ ability to reach cooperative agree-ments with private creditors had not beenhampered by litigation.

Considerable flexibility is undoubtedly neededin handling financial crises since their form andseverity can vary from country to country. How-ever, current practices leave too much discretionto the Fund and its major shareholders in decisionsregarding the timing and extent of the officialfinancing it should provide, and under what con-ditions; how much private sector involvement itshould require; and under what circumstances itshould give support to unilateral payment stand-stills and capital controls. The suggested frame-work generally fails to meet the main concerns ofdebtor countries regarding burden sharing in cri-sis resolution and the modalities of IMF supportand conditionality. Nor does it provide clear guide-lines to influence the expectations and behavioursof debtors and creditors with the aim of securinggreater stability.


The above discussion suggests that there isnow a greater emphasis on private sector in-volvement when designing official assistance tocountries facing financial difficulties. The ele-ments of this strategy include the use of officialmoney as a catalyst for private financing, lendinginto arrears to precipitate agreement between debt-ors and creditors, and making official assistanceconditional on prior private sector participation.Some of these policies were, in fact, used for theresolution of the debt crisis in the 1980s, althoughtheir objectives were not always fully met. Forinstance, under the so-called Baker Plan, officiallending to highly-indebted developing countriessought to play a catalytic role, but faced stiff op-position from commercial banks, which refusedto lend to these countries. The practice of IMFlending to debtors that are in arrears on paymentsowed to private creditors dates back to the BradyPlan of 1989, when commercial banks were nolonger willing to cooperate in restructuring thirdworld debt as they had made sufficient provisionsand reduced their exposure to developing countryborrowers. A decision by the IMF Board in Sep-tember 1998 formally acknowledged lending intoarrears as part of the Fund’s lending policy andextended this practice to bonds and non-bank cred-its in the expectation that it would help countrieswith Fund-approved adjustment programmes torestructure their private debt.7

The current emphasis on official assistancebeing made conditional on private sector partici-pation includes a commitment not to lend or grantofficial debt relief unless private markets similarlyroll over their maturing claims, lend new moneyor restructure their claims. This strategy, which

has come to be known as “comparability of treat-ment”, aims not only at preventing moral hazardas it pertains to private creditors, but also at en-suring an acceptable form of burden sharingbetween the private and official creditors. Its un-derlying principle is that public assistance shouldnot be made available unless debtors get somerelief from private creditors, and no class of pri-vate creditors should be exempt from burdensharing.8 In 1999, Paris Club creditors specificallyadvised Pakistan to seek comparable treatmentfrom its private bondholders by rescheduling itseurobond obligations. However, this policy doesnot seem to have been implemented in the caseof recent official assistance to Ecuador, when theIMF did not insist that the country reach an agree-ment on restructuring with the holders of its Bradybonds as a precondition for official assistance (seebox 6.2; and Eichengreen and Ruhl, 2000: 19).

Certainly, the emphasis on burden sharingand comparable treatment between private andofficial creditors constitutes a major advance overthe debt strategies adopted in the 1980s and in themore recent emerging-market crises. During theseepisodes, official intervention was designed pri-marily to keep sovereign debtors current on debtservicing to private creditors and the seniorityaccorded to multilateral debt went unchallenged.However, the emphasis on burden sharing amongcreditors does not necessarily lead to improvedoutcomes regarding the more important questionof burden sharing between debtors and creditors.

In this respect, a key issue is whether a strat-egy that makes official assistance conditional onprivate sector participation could succeed in pro-

D. Official assistance, moral hazard and burden sharing


Box 6.2

RECENT BOND RESTRUCTURING AGREEMENTS

A number of recent sovereign bond restructuring agreements have been widely hailed by the inter-national community for their success “... in puncturing unsustainable expectations of some inves-tors that international sovereign bonds were, in effect, immune from restructuring ...” (IMF,2000f: 10). However, they also show that, under current institutional arrangements, there are noestablished mechanisms for an orderly restructuring of sovereign bonds, and that the process canbe complex and tedious.1 Success in bringing bondholders to the negotiating table does not dependon the presence of CACs in bond documents alone. A credible threat of default could be just aseffective. However, even then, the debtors are not guaranteed to receive significant debt relief,particularly on a mark-to-market basis.

Pakistan restructured its international bonds at the end of 1999 without invoking the CACs presentin its bonds, preferring a voluntary offer to exchange its outstanding eurobonds for a new six-yearinstrument, which was accepted by a majority of the bondholders. Communication problems werenot serious because the bonds were held by only a few Pakistani investors. It is believed that thepresence of CACs and a trustee, as well as the request of the Paris Club to extend “comparability oftreatment” to eurobonds, along with a credible threat of default, played an important role in dis-couraging holdouts.2 However, the terms of restructuring were quite favourable to bondholderscompared to the prevailing market price, and the new bonds offered were more liquid. Accordingto the IMF, there was a “haircut” for the creditors compared to the relative listing price but not tothe relative market value, and although the initial impact of the restructuring on the debt profile ofthe country was somewhat positive, “by 2001 market estimates suggest that debt-service paymentswill be back to levels before restructuring and will be higher for the remaining life of the exchangebond” (IMF, 2000g: 137 and table 5.2).

By contrast, Ukraine made use of the CACs present in four of its outstanding bonds in a restruc-turing concluded in April 2000. Unlike Pakistan, the bonds were spread widely among retail hold-ers, particularly in Germany, but the country managed to obtain the agreement of more than 95 percent of the holders on the outstanding value of debt. As in Pakistan, however, this involved onlythe extension of principal maturities rather than relief, since reorganization was undertaken on amark-to-market basis. Indeed, there was a net gain for creditors relative to market value (IMF,2000g, table 5.2).

From mid-1999 Ecuador started having serious difficulties in making interest payments on itsBrady bonds, ending up in a default in the second half of the year. As rolling over maturities wouldnot have provided a solution, the country sought a large amount of debt reduction by offering anexchange for global bonds issued at market rates, but with a 20-year maturity period. This wasrejected by the bondholders, who furthermore, voted for acceleration. After a number of failedattempts, Ecuador invited eight of the larger institutional holders of its bonds to join a Consulta-tive Group, with the aim of providing a formal mechanism of communication with bondholdersrather than negotiating terms for an exchange offer. In mid-August, bondholders accepted Ecua-dor’s offer to exchange defaulted Brady bonds for 30-year global bonds at a 40 per cent reductionin principal, while the market discount was over 60 per cent. This resulted in a net gain for thecreditors relative to market value.3

1 On these restructuring exercises, see De la Cruz (2000); Eichengreen and Ruhl (2000); Buchheit (1999);and IMF (2000g, box 5.3).

2 For a different view on the impact of the Paris Club’s request, see Eichengreen and Ruhl (2000: 26–28).3 For an assessment of the Ecuadorian restructuring, see Acosta (2000).


moting orderly debt workouts with private credi-tors. The rationale for this strategy is that, if theFund were to stand aside and refuse to lend to acountry under financial stress unless the marketsrolled over their claims first, private creditorswould be confronted with the prospect of default,which would encourage themto negotiate and reach agree-ment with the debtor. Themain weakness of this strategyis that, if the default is not verycostly, creditors will have lit-tle incentive for restructuringtheir claims. On the otherhand, if it is costly, the IMFwill not be able to stand by andlet it happen, since the threatto international financial sta-bility, as well as to the countryconcerned, would be serious.The insistence on IMF non-intervention would beno more credible than an announcement by a gov-ernment that it will not intervene to save citizenswho have built houses in a flood plain.9 This di-lemma provides a strong case for explicit rulesprohibiting the building of houses in flood plainsor a “grab race” for assets.10

Thus it appears that a credible strategy forinvolving the private sector in crisis resolutionshould combine temporary standstills with strictlimits on access to Fund resources. Indeed, such astrategy has received increased support in recentyears.11 According to one view, access could belimited by charging penalty rates. However, sincesuch price-based measures are unlikely to succeedin checking distress borrowing under crisis con-ditions, quantitative limits will be needed. A recentreport by the United States Council on ForeignRelations (CFR) on reform of the international fi-nancial architecture argued that the IMF shouldadhere consistently to normal access limits of100 per cent of quota annually and 300 per centon a cumulative basis, and that countries shouldbe able to resort to unilateral standstills when suchfinancing proves inadequate to stabilize marketsand their balance of payments. The amounts com-mitted in recent interventions in emerging-marketcrises, beginning with the one in Mexico in 1995,far exceeded these limits, being in the range of500 per cent to 1,900 per cent of quota.

However, in setting such access limits, itshould be recognized that IMF quotas have laggedbehind growth of global output, trade and finan-cial flows, and their current levels may not pro-vide appropriate yardsticks to evaluate the size ofIMF packages. According to one estimate, adjust-

ing quotas for the growth inworld output and trade since1945 would require them to beraised by three and nine times,respectively (Fischer, 1999).In an earlier proposal – madein an IMF paper on the eve ofthe Mexican crisis – to createa short-term financing facilityfor intervention in financialcrises, 300 per cent of quota wasconsidered a possible upperlimit (see TDR 1998, chap. IV,sect. B.4). Such amounts ap-

pear to be more realistic than current normal ac-cess limits.

Fund resources are not the only source ofrescue packages, and in many cases bailouts relyeven more on the money provided by some majorcreditor countries. This practice has often in-creased the scope for these countries to pursuetheir own national interests in the design of res-cue packages, including the conditionalitiesattached to lending. It is highly probable that ma-jor creditor countries will continue to act in thismanner whenever and wherever they see their in-terests involved, and some debtor countries mayeven prefer to strike bilateral deals with themrather than going through multilateral channels.However, limits on access to Fund resourcesshould be observed independently of bilaterallending under crisis. Furthermore, it is desirableto keep such ad hoc bilateral arrangements sepa-rate from multilateral lending in order to reducethe scope for undue influence over Fund policiesby some of its major shareholders.

A key question is whether such access limitsshould be exceeded under certain circumstances.For instance, while arguing for strict limits, theCFR report suggested, “In the unusual case inwhich there appears to be a systemic crisis (thatis, a multicountry crisis where failure to intervenethreatens the performance of the world economyand where there is widespread failure in the abil-

A credible strategy forinvolving the private sectorin crisis resolution shouldcombine temporarystandstills with strict limitson access to Fundresources.


ity of private capital markets to distinguish cred-itworthy from less creditworthy borrowers), theIMF would return to its ‘systemic’ backup facili-ties …” (CFRTF, 1999: 63). It proposed the crea-tion of a facility to help prevent contagion, to befunded by a one-off allocation of special drawingrights (SDRs),12 which would replace the existingIMF facilities for crisis lending (see box 6.3).

While the concerns underlying different lend-ing policies for systemic and non-systemic crisesmay be justified, in practice exceptions to normallending limits could leave considerable room forlarge-scale bailout operations and excessive IMFdiscretion. One possible implication is that coun-tries not considered systemically important couldface strict limits in access to Fund resources, but

Box 6.3

RECENT INITIATIVES IN IMF CRISIS LENDING

The IMF has recently taken steps to strengthen its capacity to provide financing in crises, thoughthis capacity still falls short of that of a genuine international lender of last resort.1 The Supple-mental Reserve Facility (SRF), approved by the IMF’s Executive Board in response to the deepen-ing of the East Asian crisis in December 1997, was designed to provide financing without limits tocountries experiencing exceptional payments difficulties, but under a highly conditional stand-byor Extended Arrangement (IMF, 1998b: 7). However, the SRF depends on the existing resources ofthe Fund which, recent experience suggests, are likely to be inadequate on their own to meet thecosts of large interventions.

The Contingency Credit Line (CCL), created in Spring 1999, is intended to provide a precaution-ary line of defence in the form of short-term financing, which would be available to meet balance-of-payments problems arising from international financial contagion (IMF, 1999). Thus, unlike theSRF, which is available to countries in crisis, the CCL is a preventive measure. Countries can pre-qualify for the CCL if they comply with conditions related to macroeconomic and external finan-cial indicators and with international standards in areas such as transparency, banking supervisionand the quality of banks’ relations and financing arrangements with the private sector. The pres-sures on the capital account and international reserves of a qualifying country must result from asudden loss of confidence amongst investors triggered largely by external factors. Moreover, al-though no limits on the scale of available funds are specified, like the SRF, the CCL depends on theexisting resources of the Fund. Originally, it was expected that the precautionary nature of theCCL would restrict the level of actual drawings. However, in the event, no country has applied forthis facility. It is suggested that, under the initial terms, countries had no incentive to pre-qualifi-cation because fees and interest charges on the CCL were the same as under the SRF. In addition,access was not automatic, but subject to the Board’s assessment of policies and risks of contagioneffects. The IMF Board took steps in September 2000 to lower charges as well as to allow someautomatic access with a view to enhancing the potential use of the CCL (IMF, 2000j), but thereappear to be more serious design problems. In particular, countries seem to avoid recourse to it forfear that it will have the effect of a tocsin in international financial markets, thus stifling access tocredit.2

1 For a discussion of these facilities, see IMF (2000i). For a discussion of the issues involved in establish-ing an international lender of last resort, see TDR 1998 (chap. IV, sect. B.4), and Akyüz and Cornford(1999).

2 For an earlier assessment along these lines, see Akyüz and Cornford (1999: 36). For a more recentassessment, see Goldstein (2000: 12–13).


would have the option of imposing unilateralstandstills. However, for larger emerging marketsbailouts would still be preferred to standstills.Recent events involving defaults by Pakistan andEcuador (see box 6.2), but rescue operations forArgentina and Turkey (see chapter II) bear this

out. In the latter cases, difficulties experiencedwere largely due to the currency regimes pursuedrather than to financial contagion from abroad.However, there is wide concern that if these cri-ses had been allowed to deepen, they could havespread to other emerging markets.

E. Voluntary and contractual arrangements

As noted above, considerable emphasis isnow being placed on voluntary mechanisms forthe involvement of the private sector in crisis man-agement and resolution. However, certain featuresof the external debt of developing countries renderit extremely difficult to rely on such mechanisms,particularly for securing rapid debt standstills androllovers. These include a wider dispersion ofcreditors and debtors and the existence of a largervariety of debt contracts associated with the grow-ing spread and integration of international capitalmarkets, as well as innovations in sourcing for-eign capital. As a result, the scope of some of thevoluntary mechanisms used in the past has greatlydiminished.

Perhaps the most important development,often cited in this context, is the shift from syndi-cated bank loans to bonds in sovereign borrowing,since, for reasons examined below, bond restruc-turing is inherently more difficult. Sovereign bondissues were a common practice in the interwaryears when emerging markets had relatively easyaccess to bond markets. During the global finan-cial turmoil of the late 1920s and early 1930s,many of these bond issues ended up in defaults.There was little recourse to bond financing byemerging-market governments prior to the 1990s.The share of bonds in the public and publicly guar-anteed long-term debt of developing countries

stood at some 6.5 per cent in 1980, but rose rap-idly over the past two decades, reaching about21 per cent in 1990 and almost 50 per cent in 1999(World Bank, 2000). This ratio is lower for pri-vate, non-guaranteed debt, but the increase in theshare of bonds in private external debt is equallyimpressive – from about 1 per cent in 1990 to some24 per cent in 1999. According to the Institute ofInternational Finance (IIF), from 1992 to 1998,of a total of about $1,400 billion net capital flowsto 29 major emerging markets, 23 per cent camefrom commercial banks and 27 per cent from otherprivate creditors, mainly through bonds (IIF, 1999,table 1).

A second important development is that in-ternational lending to emerging markets has beenincreasingly to private sector borrowers. The shareof public and publicly guaranteed debt in thetotal long-term debt of developing countries ex-ceeded 75 per cent in the 1980s, but stood at lessthan 60 per cent in 1999. The increased impor-tance of private sector borrowing has meant a rapidincrease in the dispersion of debtors. While animportant part of private borrowing consists ofinterbank loans, direct lending to corporations isalso important in some emerging markets. In In-donesia, for example, such borrowing accountedfor more than three quarters of the total privatedebt. Furthermore, in developing countries, an


increasing proportion of the private sector’s ex-ternal bank debt is in the form of bilateral ratherthan syndicated lending, implying also a greaterdispersion of creditors. The creditor base is furtherbroadened as a result of repackaging arrangementsand credit derivatives, whereby economic inter-est in the original loan is passed on to third parties(Yianni, 1999: 81–84).

Various developments regarding emerging-market debt have also increased the scope for rapidexit and creditor runs, thereby reducing the roomfor cooperative solutions. Perhaps the most im-portant of these is the shift in bank lending towardsmore short-term loans. In the mid-1980s, bankloans with a maturity of less than one year ac-counted for around 43 per cent of total bank loans,but they increased to almost 60 per cent on theeve of the Asian crisis, and dropped to about50 per cent thereafter. Similarly, the widespreaduse of acceleration and cross-default clauses andput options in credit contracts has increased thescope for dissident holdouts, making it difficultfor debtors and creditors to reach rapid agreementon voluntary standstills and workouts.13

A number of proposals have been made fordesigning mechanisms to facilitate voluntary in-volvement of the private sector in crisis resolution.In discussing these mechanisms, it is useful tomake a distinction between bond covenants andother contractual and cooperative arrangementsdesigned to “bind in” and “bail in” the privatesector.

1. Bond restructuring and collectiveaction clauses

As already noted, the notion that sovereignbonds as well as bank loans may need to be re-structured has only recently been accepted by theinternational community (though not necessarilyby all segments of financial markets). The emerg-ing-market sovereign debtors that had issuedbonds in the 1970s and 1980s generally remainedcurrent on such obligations during the debt crisisof the 1980s while rescheduling and restructuringtheir commercial bank debt – a factor that appearsto have played an important role in the rapid ex-

pansion of bond financing in the 1990s relative tobank lending. As a result of this rapid increase,together with the increased frequency of virulentfinancial crises, bond restructuring has gainedin importance, particularly for sovereign borrow-ers.

However, there are serious difficulties inbond restructuring compared to rescheduling andrestructuring of syndicated credits. First of all,there are collective representation and collectiveaction problems, which are more acute with bondsthan with loan contracts. These arise from com-munication difficulties between the bond issuerand holders; in general bondholders are anony-mous and more diverse and include a variety ofinvestors, both individual and institutional. Thecommunication problem is further aggravated bytrading in secondary markets. Moreover, there arelegal impediments to the establishment of com-munication mechanisms between issuers andholders, as well as to dealing with non-participat-ing holders, that vary according to the legislationgoverning bonds. Again, as legislation for bondcontracts varies, it becomes difficult to applyuniform procedures in restructuring. Current ar-rangements also encourage holdouts and litigationby bondholders since, unlike the practice duringthe interwar years, sovereign issuers are often re-quired to include a waiver of sovereign immunity.Thus, sovereign debtors do not enjoy the protec-tion accorded to private debtors under domesticbankruptcy and insolvency procedures that oftenoverrule holdouts and eliminate free riders.

Quite independently of the contractual andlegal provisions governing a bond, a sovereignissuer facing serious financial difficulties alwayshas the option of making an offer to exchange itsexisting bonds with new instruments containingnew terms of payment. However, the problems ofcommunication and holdouts render such ex-change offers difficult to implement effectively.Thus, since the Mexican crisis, emerging-marketborrowers have been increasingly urged to includeso-called collective action clauses (CACs) in bondcontracts in order to improve communication withbondholders and facilitate bond restructuring.14

Such clauses appear to be particularly desirablefor sovereign borrowers, who do not benefit fromnational bankruptcy codes. There are basicallythree types of CACs:


• collective representation clauses, designed toestablish a representative forum (e.g. a trus-tee) for coordinating negotiations betweenthe issuer and bondholders;

• majority action clauses, designed to empowera qualified majority (often 75 per cent) ofbondholders to agree to a change in paymentterms in a manner which is binding on allbondholders, thereby preventing holdouts;and

• sharing clauses, designed to ensure that allpayments by the debtor are shared amongbondholders on a pro-rated basis, and to pre-vent maverick litigation.

It should be noted that the inclusion of CACsin bond contracts, where allowed by law, is op-tional – not mandatory – and often depends onmarket convention. Issuers generally adopt thedocumentation practices prevailing in the juris-diction of the governing law. In general, collectiverepresentation clauses are not contained in bondsgoverned either by English law or New York law.Majority action clauses are routinely included inbond contracts governed by English law, but notin those issued under New York law, even thoughthe latter does not precludethem from sovereign issues.Similarly, bonds governed byGerman and Japanese laws donot generally contain majorityaction clauses. In these cases,any change to the terms ofpayment requires a unanimousdecision by the bondholders.This is also true for Bradybonds, even when governed byEnglish law. It appears that theinclusion of a unanimity rulewas a major reason for theBrady process to be imple-mented through loan-for-bondexchanges rather than throughamendments to the existing loancontracts (Buchheit, 1999: 9).Sharing clauses are routinely included in syndi-cated bank loans, but are uncommon in publiclyissued bonds since they are often viewed by mar-kets as a threat to the legal right of creditors toenforce their claims.15 The absence of sharing

clauses, together with the waiver of sovereignimmunity, leaves considerable room for bondhold-ers to hold out against restructuring and to enterinto a “grab race” for assets through litigation.

According to available data, about one thirdof total bonds issued by emerging markets duringthe 1990s were governed by English law; the shareof bonds issued under New York law was lower,but still exceeded a quarter, followed by those is-sued under German law (just under one fifth) andJapanese law (around 13 per cent). It appears thatAsian, and particularly Latin American, emerg-ing markets have made greater use of New Yorklaw than English law in their issues. Japanese lawis seldom used in Latin American issues but gov-erns about a quarter of Asian issues, while theopposite is true concerning the use of German law.Between 1995 and 2000, there was an increase inthe proportion of bonds governed by New Yorklaw, but it is not clear if this is linked to the in-creased frequency of financial crises in emergingmarkets (Dixon and Wall, 2000: 145–146; Eichen-green and Mody, 2000a, table 1).

It is estimated that about half of all outstand-ing international bond issues – including thoseissued by industrial countries – do not include

CACs, and this proportion iseven greater for emerging-market bonds. A major con-cern of emerging markets isthat the inclusion of CACswould curtail their access tomarkets and raise the cost ofborrowing because it wouldsignal a greater likelihood ofdefault. They thus insist thatsuch clauses be introducedfirst in sovereign bonds of in-dustrial countries. Some in-dustrial countries, such asCanada and the United King-dom, have recently decided toinclude or extend CACs intheir international bond andnote issues in order to encour-

age a wider use of such clauses, particularly byemerging markets. International private sectorgroups find majority voting acceptable, subject toa threshold in the order of 90–95 per cent, but theyprefer voluntary exchange offers, and are opposed

A major concern ofemerging markets is thatthe inclusion of collectiveaction clauses would curtailtheir access to markets andraise the cost of borrowingbecause it would signal agreater likelihood of default,but the empirical evidenceon the impact of suchclauses on the cost ofinternational bond financingis inconclusive.


to making CACs mandatory in bond contracts(IMF, 2000g: table 5.2; Dixon and Wall, 2000: ta-ble 2).

The empirical evidence on the impact ofCACs on the cost of international bond financingis inconclusive (BIS, 1999; Eichengreen andMody, 2000b; Dixon and Wall, 2000). Indeed,CACs can have two opposite effects. On the onehand, their inclusion can raise the default prob-ability in the eyes of investors since they maycreate moral hazard for thedebtor, leading to a higher riskpremium. On the other hand,in the event of a default, suchclauses help recover the claimsof investors by facilitatingbond restructuring. The neteffect depends on how CACsaffect the perceived defaultprobability and the expectedrecovery rate. For countrieswith high credit ratings, the latter effect coulddominate, so that the inclusion of CACs may, infact, lower the cost of bond financing. For lower-rated bonds, however, such clauses may well leadto sharp increases in the perceived risk of default,thereby raising the spread on new issues.

It is not clear if the introduction of CACs inbond contracts could make a major impact on debtrestructuring, since experience in this respect ishighly limited.16 In any case, even if such clauseswere rapidly introduced by emerging-market bor-rowers in their new bond issues, the initial impactwould be limited because of the existence of alarge stock of outstanding bonds without CACs.On the other hand, CACs have been rarely usedby emerging markets for bond restructuring evenwhen they are present in bond contracts, partlybecause of the fear that bondholders’ meetingscould be used to mobilize opposition against at-tempts to restructure bonds and to take a decisionfor acceleration (which typically requires the con-sent of 25 per cent of bondholders). Clearly, suchrisks can be serious, since the ultimate decisionon restructuring lies with bondholders, and thesovereign debtor does not have the means of ob-taining court approval for its restructuring plan,as provided, for instance, under the “cramdown”provisions of the United States Bankruptcy Codefor corporate borrowers.

In assessing the potential role of CACs ininvolving the private sector in crisis resolution, itis important to distinguish between standstills andfinancial restructuring. The existing practice re-garding bond issues leaves little scope for securinga rapid standstill on a voluntary basis.17 Such astandstill requires representational bodies, such astrustees or bondholder committees, as well as pro-hibition of litigation by individual bondholdersand/or sharing clauses. As already noted, there isstrong resistance by private investors to the in-

clusion of such clauses acrossalmost all jurisdictions, andthey are not likely to be intro-duced on a voluntary basis.Majority action clauses alonecannot secure rapid voluntarystandstill and “cramdown”on dissident bondholders, be-cause invoking such clauses isa tedious process and leavesample time and opportunities

for rogue bondholders to impose a financial stran-glehold over the debtor.

Private investors often point out that themajor financial crises in emerging markets werenot precipitated by a rapid exit of holders of sov-ereign bonds through litigation and a “grab race”for assets, but by short-term hot money (Buchheit,1999: 7). This is certainly true for East Asia, wheresovereign bond debt was generally negligible.However, with the rapid growth of the bond mar-ket, granting bondholders unmitigated power oflitigation and asset attachment is potentially a se-rious source of instability. As already discussed,the current emphasis in official lending on pri-vate sector participation is unlikely to generateadequate incentives for voluntary standstill androllover of private debt at times of crisis.

The consequences of unilateral suspension ofpayments on bonds could be more serious thandefaults on bank debt because the effect would beimmediately transmitted to secondary markets. Asharp increase in the risk premium and a declinein bond prices would then create considerableopportunities for profit-making by litigious inves-tors (the so called “vultures”), who could acquiredistressed debt at substantial discounts and pur-sue a “grab race” for assets.18 On the other hand,as some recent bond restructuring exercises show,

The existing practiceregarding bond issuesleaves little scope forsecuring a rapid standstillon a voluntary basis.


even when unilateral defaults lead to an agree-ment on restructuring, the process tends to bedisorderly and does not always guarantee signifi-cant relief for the debtor (see box 6.2).

Thus a possible solution would be to combineinternationally sanctioned mandatory standstillswith majority action clauses in order to prevent a“grab race” for assets and facilitate voluntaryrestructuring. One proposal (Buiter and Silbert,1999) favours a contractually-based approach tostandstill, which would require all internationalloan agreements to include an automatic univer-sal debt rollover option with a penalty (UDROP).However, such a clause is unlikely to be intro-duced voluntarily and would need an internationalmandate. Another proposal is to empower theFund to impose or sanction standstills on bond-holders at the outbreak of a crisis (see, for exam-ple, Miller and Zhang, 1998). This could be com-bined with IMF lending into arrears, when needed,in order to alleviate the liquidity squeeze on thedebtor country and encourage a rapid restructur-ing. Debt restructuring should be left to a volun-tary agreement between the bondholders and theissuer, subject to provisions in the bond contracts.It is neither feasible nor desirable to empower theIMF or any other international authority to im-pose restructuring of sovereign debt, such as theone practised under the “cram-down” provisions of chapter 11of the United States Bank-ruptcy Code. Nevertheless, theFund could still exert consid-erable influence on the pro-cess through its policy of con-ditionality on lending.

It has been argued thatproposals such as CACs andstanding committees “… areappropriate if it is one’s judge-ment that most countries thatexperience crises have prob-lems with fundamentals that require debts to berestructured in the absence of a bailout. ...UDROPs and internationally sanctioned standstillsare appropriate if one instead believes that mostcrises are caused by creditor panic, and that allthat is required to restore order to financial mar-kets is a cooling-off period” (Eichengreen andRuhl, 2000: 4, footnote 4). However, the consid-

erations above suggest that both instruments areneeded in the arsenal of measures since resolu-tion of most crises requires both a cooling-offperiod and debt-restructuring. Even when the un-derlying fundamentals are responsible for a crisis,debtors need breathing space, as markets have atendency to overreact, and this leads to overshoot-ing of asset prices and exchange rates, therebyaggravating the financial difficulties of the debt-ors. Under such circumstances, standstills wouldallow time to design and implement cooperativesolutions to debt crises.

2. Restructuring bank loans

For the reasons already discussed, it is gen-erally believed that debt workouts are easier forinternational bank loans than for sovereign bonds,as they allow greater scope for voluntary and con-certed mechanisms. Furthermore, the experiencein the 1980s with restructuring of syndicatedcredits, and the more recent negotiations androllover of bank loans in the Republic of Koreaand Brazil, are often cited as successful examplesof debt workouts with banks.19 However, a closerlook at these experiences shows that there are con-

siderable weaknesses in theprocedures followed, and theoutcomes reached appear tobail out – rather than bail in –the private sector.

A main factor, whichfacilitated negotiations withcommercial banks in the1980s, was the existence ofadvisory or steering commit-tees consisting of representa-tives of banks selected mainlyon the basis of their exposureto the debtor country con-

cerned. Clearly, this helped solve the representa-tion problem by providing a forum for nego-tiations. Furthermore, the presence of sharingclauses in syndicated loan contracts, together withsovereign immunity, deterred litigation againstdebtor countries. However, agreement required theunanimous consent of committee members, whowere also expected to strike a deal that would be

A possible solutionwould be to combineinternationally sanctionedmandatory standstills withmajority action clauses inorder to prevent a “grabrace” for assets andfacilitate voluntaryrestructuring.


acceptable to non-participating banks. This, in ef-fect, allowed considerable room for holdouts byindividual banks, in much the same way as bondcontracts without majority action clauses. Suchholdouts resulted in protracted negotiations, lead-ing to frictions not only between debtors and credi-tors but also among creditors themselves. As notedby an observer of sovereign debt reschedulings inthe 1980s: “From the borrower’s perspective, theunanimous consent method translated into alwaysbeing negotiated down to the minimum commondenominator, one acceptable to all members of thecommittee based on consultation with their respec-tive constituencies. Namely, one bank had theability to prevent an entire package from beingadopted if it disagreed with any one of its fea-tures” (De la Cruz, 2000: 12).

The primary strategy of these negotiationswas to avoid default and to ensure that the debtorhad enough liquidity to stay current (i.e. to con-tinue servicing its debt). The money needed wasprovided by the creditor banks as part of the re-scheduling process as well as through officiallending. In this way banks could keep these as-sets in their balance sheets without violatingregulatory norms regarding credit performance.Maturities were rolled over as they became due,but concessional interest rates and debt cancella-tion were not among the guiding principles ofcommercial debt workouts.

Thus, as described in TDR 1988, the processinvolved “concerted lending”, whereby each bankrescheduled its loans and contributed new moneyin proportion to its existing exposure, the aggre-gate amount being the minimum considered nec-essary to avoid arrears. The IMF also made itsprovision of resources to debtor countries – to keepthem current on interest payments to commercialbanks – contingent upon the banks’ making thecontributions required of them. Thus, official in-tervention amounted to using public money to paycreditor banks even though it was designed to bindthe banks in. Developing countries saw their debtgrowing, not only to commercial banks, but alsoto the official creditors, as they borrowed to re-main current on their interest payments (TDR1988, Part One, chap. V).

The negotiated settlements also resulted inthe socialization of private debt in developing

countries when governments were forced to as-sume loan losses, thereby, in effect shifting theburden to the tax payers. For example, in the caseof Chile, it was noted that “private debts have beenincluded in debt rescheduling being negotiatedbetween the Chilean State and the foreign bankadvisory committee for Chile. Apparently theChilean Government caved in under pressure fromthe bank advisory committee … To make theirviewpoint absolutely clear, foreign banks appar-ently tightened up their granting of very short-termcommercial credits to Chile during the first quar-ter of 1983, a technique reportedly used with somesuccess 10 years earlier vis-à-vis the same coun-try. The International Monetary Fund, also activein the debt rescheduling exercise, has not publiclyobjected to this threat” (Diaz Alejandro, 1985: 12).For Latin America as a whole, before the outbreakof the crisis in 1982, around two thirds of the lend-ing by United States banks was to private sectorborrowers. In 1983, the first year of debt restruc-turing, the share of publicly guaranteed debt roseto two thirds, and eventually reached 85 per centin 1985 (UNCTC, 1991).

This process of protracted negotiations be-tween banks and debtors, with the intermediationof international financial institutions (a strategywidely described at the time as “muddling through”),continued for several years without making a dentin resolving the problem and removing the debtoverhang. Highly-indebted developing countriesincreasingly questioned the rationale of engagingin such Ponzi financing – whereby they had tokeep on borrowing in order to service their debt –which eventually pushed some of them into de-fault on interest payments and led to legal battleswith the banks. On the other hand, creditors toobecame highly sceptical of the merits of “puttinggood money after bad”, and started to dispose ofsuch debt in secondary markets as they accumu-lated adequate provisions. Through the BradyPlan, the resolution of the crisis eventually in-volved the private sector, but only after costingthe debtors a lost development decade.

In more recent episodes of financial crisis inemerging markets, creditor banks were again ableto organize themselves into groups to conductnegotiations with the debtors – with the Republicof Korea in January 1998, and with Brazil inMarch 1999. Again, in both cases negotiations and


agreements came only after the deepening of thecrisis. In the case of Brazil, banks were unwillingto roll over debt in late 1998 and agreement wasreached only after the collapse of the currency.The Government of the Republic of Korea hadalready suspended payments at the end of Decem-ber 1997 and, as recognized by the IMF, “… theagreement to stabilize interbank exposure toKorea was struck … when it was generally rec-ognized that reserves were almost exhausted andthat, absent an agreement, a default was inevita-ble” (IMF, 2000f: footnote 26). A number of bankshad already left, which contributed to the turmoilin the foreign exchange market.

While the rescheduling of debt providedsome breathing space in both cases, the impactwas far less than what could have been achievedwith timely standstills. As theGovernment of the Republicof Korea noted in its subse-quent report to the G-20, “Manyof those who have analysedKorea’s 1997–1998 crisis con-tend that Korea could havesolved its liquidity problemssooner had a standstill mecha-nism been in place at the timeit requested IMF assistance”(Ministry of Finance andEconomy, Republic of Korea,1999: 13), that is, at the endof November 1997.20 In Indonesia, restructuringcame even later than in the Republic of Korea(eight months after the first IMF programme) andmade very little impact on stabilizing the econo-my.21

More significantly, such debt restructuringexercises can hardly be portrayed as examples ofthe private sector bearing the consequences ofthe risks it had taken. In the restructuring in theRepublic of Korea, private debts were effectivelynationalized via a government guarantee. Thiswas also the case for subsequent reschedulingsby Thailand and Indonesia. Moreover, creditorsended up better after the rescheduling; there wasno debt write-off but simply a maturity extension,with new loans carrying higher spreads than theoriginal loans. Although the maturity extensionspreads were considered to be relatively low, par-ticularly compared to the IMF’s Supplemental

Reserve Facility (SRF), such a comparison over-looks the fact that the original bank loans alreadycarried a risk premium.22

Problematic as they are, it is found that suchrestructuring exercises cannot be replicated inmany other countries. According to the IMF, “thesuccess of the Korean operation reflected two spe-cific features, which are unlikely to apply to othercases. First, Korea maintained a restrictive capi-tal account regime that forced a high proportionof imported foreign saving to be channelledthrough domestic banks … Second, at the onsetof the crisis, the sovereign external debt burdenwas very low. As a result, the extension of a sov-ereign guarantee … did not place excessive bur-den on the sovereign” (IMF, 1999: 41–42). It isthus recognized that debt restructuring with for-

eign banks can run into seri-ous difficulties when debtorsare widely dispersed and thecapital account is wide open.The latter feature could indeeddiscourage creditor banksfrom entering into restructur-ing since it would allow otherinvestors to exit at their ex-pense. It is also recognized thata concerted rescheduling of in-ternational private bank debtin emerging markets wouldrequire sovereign guarantees –

a practice inherited, as noted above, from the1980s – though this is not consistent with the es-tablished principles of orderly workouts of pri-vate debt.

A further difficulty with such concerted re-scheduling operations is that they require theexertion of moral suasion by the supervisory au-thorities of creditor banks. This gives considerablediscretionary power to major industrial countries,that may not apply it in a predictable and equita-ble manner to different episodes of crisis. Asrecognized by the IMF, “supervisory authoritiesare likely to be reluctant to exert moral suasionover the commercial decisions of the banks undertheir supervision except in the most extreme cir-cumstances, especially in the context of debtorsthat do not pose a systemic threat to the nationalor international banking system” (IMF, 1999:41–42). Again, this means that “non-systemic

“Many of those who haveanalysed Korea’s 1997–1998 crisis contend thatKorea could have solved itsliquidity problems soonerhad a standstill mechanismbeen in place at the time itrequested IMF assistance.”


countries” would have no option but to imposeunilateral standstills.

Thus it appears that, for international bankloans, too, there are serious difficulties in reach-ing orderly and timely workouts on a voluntaryand concerted basis in order to stem self-fulfill-ing debt runs and ensure that the creditors bearthe consequences of the risks they take. As in thecase of bonds, certain ex ante contractual arrange-ments can help facilitate orderly workouts. One

possibility would be to introduce call options ininterbank credits lines that would provide an au-tomatic rollover under certain conditions, such asa request for IMF assistance by the debtor coun-try. However, unless all debt contracts incorporatesuch automatic standstill clauses, including themin interbank lines alone can be counterproductiveas it can trigger capital flight as soon as a debtorcountry runs into financial difficulties and entersinto negotiations with the IMF. But such clausesare unlikely to be introduced voluntarily.

F. Conclusions

It thus appears that an effective and viablestrategy for private sector involvement in finan-cial crises in emerging markets would be tocombine voluntary mechanisms designed to fa-cilitate debt restructuring with internationallysanctioned temporary standstills to be used whenneeded. These arrangements need to be accompa-nied by the provision of international liquidityaimed primarily at helping debtor countries tomaintain imports and economic activity, ratherthan to maintain open capital accounts and allowprivate creditors and investors to escape the cri-sis without losses. In general, normal access toIMF facilities, appropriately adjusted to allow forthe expansion of world output and trade, shouldmeet such needs. While in some cases additionalfinancing may be required, it should also be rec-ognized that, once exceptions are allowed ongrounds of preventing global spillovers and sys-temic instability, they could easily become therule, thereby aggravating the moral hazard prob-lem. In this respect, the minimum strategy shouldbe to require private participation, once officialfinancing is raised above the normal lending lim-its – or a threshold level – as suggested by someof the Directors at the IMF Board.

Much has been written on the pros and consof officially sanctioned payment standstills in theresolution of financial crises in emerging markets.There is strong resistance by some major creditorcountries as well as private investors to a manda-tory temporary stay on creditor litigation on thegrounds that it would give rise to debtor moralhazard and weaken market discipline. That thisneed not be the case has been argued forcefullyby the Deputy Governor of the Bank of England:

Some have argued that articulating a clearerrole for standstill may perversely alterdebtor incentives, by weakening the pre-sumption that debtors should pay their debtsin full and on time. But an orderly standstillprocess should support, not supplant, mar-ket forces and market disciplines. Corporatebankruptcy law grew up as it became clearthat market forces delivered losers as wellas winners and that some orderly means wasneeded of dealing with the losers. In thisway, bankruptcy law supports the marketmechanism.

The situation is no different in a sovereigncontext. A well-articulated framework fordealing with sovereign liquidity problems


should reduce the inefficiencies and ineq-uities of the current unstructured approachto standstills. It would support the interna-tional capital market mechanism. It wouldbe no more likely to induce debtors todefault than bankruptcy law is to induce cor-porate debtors to default. (Clementi, 2000)

Another concern is that the threat of a stand-still could accelerate capital outflows, therebyaggravating the crisis. Indeed,that is why standstills and ex-change controls need to be im-posed rapidly, and why thedecision to do so should restwith the country concerned.Furthermore, as noted above,the threat of suspension ofpayments could provide an in-centive for creditors to engagein voluntary solutions, particu-larly for sovereign debt, there-by avoiding the need to im-pose standstills.

It is also argued that standstills could makeit difficult for the debtor country to regain rapidaccess to international financial markets, forcingit to make painful trade adjustments or to continueto rely on official financing. But that is preciselywhy such decisions can be expected to be takenwith prudence. After all, countries that may needto impose temporary stand-stills are likely to be those thatare closely integrated with in-ternational financial marketsand would stand to lose if thedecision was not exercisedwith care and prudence. In thisrespect, the recent Malaysianexperience holds some usefullessons. The measures adoptedby Malaysia included tempo-rary and selective paymentsstandstills, which sought toprevent the deepening of thecurrency crisis and widespreadinsolvencies. There was nosignificant outflow of capitalwhen the controls were lifted in September 1999,and the country enjoyed an upgrading of its for-eign currency credit in December of the same year

as well as the normalization of relations with in-ternational capital markets.23

There is concern among policy makers insome emerging-market countries that the inclu-sion of internationally sanctioned standstillsamong the arsenal of measures for managingand resolving financial crises and the tying of theprovision of large-scale emergency financingto greater involvement of the private sector

would limit their access tointernational capital marketsand would also reduce privatecapital flows to their econo-mies. Such concerns are par-ticularly widespread in mid-dle-income countries with lowsaving and investment ratesand uneven growth perform-ance, and with only limitedsuccess in attracting greenfieldFDI in tradeable sectors andachieving a stronger exportbase. Such countries are heav-

ily dependent on financial inflows to meet cur-rent-account deficits that tend to increase rapidlyas soon as domestic demand picks up.

The measures advocated here will almost cer-tainly somewhat reduce aggregate financial flowsto emerging markets by deterring short-term,speculative capital. However, this outcome would

have a beneficial side, sincesuch capital flows add littleto the financing of develop-ment, while provoking signifi-cant instability and leading toa stop-go pattern of growth(see TDR 1999, chap. V, andTDR 2000, chap. IV). In thissense, arguments in favour ofsuch measures have a ration-ale similar to those in favourof regulation and control ofshort-term, speculative capitalinflows. There is often a temp-tation for countries to rely onsurges in financial inflows,while paying insufficient at-

tention to their longer-term consequences. However,it is difficult to attain rapid and sustained growthwithout undertaking the reforms needed to address

The threat of suspension ofpayments could provide anincentive for creditors toengage in voluntarysolutions, particularly forsovereign debt, therebyavoiding the need toimpose standstills.

The measures advocatedhere will almost certainlysomewhat reduceaggregate financial flows toemerging markets bydeterring short-term,speculative capital.However, this outcomewould have a beneficialside.


structural and institutional impediments to capitalaccumulation and productivity growth – reformswhich will reduce dependence on financial inflows.

As noted above, the risk of spillovers andcontagion to other emerging markets seems to bethe main reason for the reluctance of internationalfinancial institutions to encourage standstills incountries that are consideredimportant for the stability ofthe system as a whole. Variouschannels of contagion havebeen mentioned in this context,including cutting exposure toother countries, liquidating as-sets held in other markets inorder to meet margin pay-ments, or a general withdrawalof funds from emerging mar-kets (IMF, 2000f: 22). How-ever, the introduction and useof standstills as part of stand-ard tools in crisis interventionwould influence investor andcreditor behaviour and portfo-lio decisions, which could re-sult in reducing such potentially destabilizinginterdependences. More importantly, as notedabove, such orderly debt workout mechanisms arequite different from messy unilateral defaults intheir impact on the functioning of internationalfinancial markets.

Perhaps one of the most important potentialbenefits of binding in and bailing in the privatesector is the possible impact on policy-making inthe major creditor countries. Interest rate and ex-change rate policies in these countries exert a sig-nificant influence on the competitiveness, balanceof payments and capital flows of debtor develop-ing countries, which cannot always be counteredwith domestic policy adjustment. Indeed, mostmajor financial crises in emerging markets have

been associated with sharp swings in exchangerates, interest rates and market liquidity in themajor industrial countries. The latter have notalways paid attention to the global repercussionsof their policies, mainly because adverse spilloversto their financial markets from emerging-marketcrises have been contained, thanks largely tobailout operations. Nor has the IMF been able to

deal with unidirectional im-pulses resulting from changesin the monetary and exchangerate policies of the UnitedStates and other major OECDcountries, in large part becauseof shortcomings in the exist-ing modalities of multilateralsurveillance (Akyüz and Corn-ford, 1999: 31–33). Burdensharing by creditors in emerg-ing-market crises can thus beexpected to compel policymakers in the major industrialcountries to pay greater atten-tion to the possible impact oftheir policies on emergingmarkets. Indeed, it appears

that the potential for adverse spillovers from thecrisis in the Russian Federation played a crucialrole in the decision of the United States FederalReserve to lower interest rates in late 1998, eventhough, on the eve of the Russian default, the Fedwas widely expected to move in the opposite di-rection. As is well known, the default caused con-siderable losses to Western investors and credi-tors, and threatened to set a precedent regardingcompliance of emerging markets with their exter-nal obligations. Thus, it can be expected that ef-fective mechanisms designed to involve the pri-vate sector in the resolution of emerging-marketcrises could bring a greater global discipline topolicy-making in the major industrial countries –something that multilateral surveillance has so farfailed to achieve.

Effective mechanismsdesigned to involve theprivate sector in theresolution of emerging-market crises could bring agreater global discipline topolicy-making in the majorindustrial countries –something that multilateralsurveillance has so farfailed to achieve.


1 For an analysis of the policy response to the Asiancrisis, see TDR 1998 (chap. III), and TDR 2000(chap. IV).

2 A wider use of the concept includes greater trans-parency in standards of policy-making and improveddata dissemination, as these measures are seen tobe essential for markets to appropriately assess andprice risks (IMF, 2000g, chap. V).

3 According to the Institute of International Finance,losses incurred by private investors since 1997 inemerging- market crises have amounted to $240billion for equity investors, $60 billion for interna-tional banks and $50 billion for other privatecreditors on a mark-to-market basis (Haldane,1999: 190). Losses incurred by foreign banks in theAsian crisis are estimated at some $20 billion (Zonisand Wilkin, 2000: 96).

4 Losses resulting from daily adjustments to reflectcurrent market value, as opposed to historic account-ing (or book) value.

5 On the private sector position, see IIF (1999), andIMF (2000g).

6 Unless stated otherwise, all quotations that followin this section are from the same source (i.e. IMF,2000h). For a more detailed discussion, see IMF(2000f). Temporary suspension was proposed in anearlier Working Party report to the Group of Ten:“… in certain exceptional cases, the suspension ofdebt payments may be a necessary part of the crisisresolution process” (Group of Ten, 1996: 3). Sub-sequently, it was supported by the Council on For-eign Relations Task Force (CFRTF); see CFRTF(1999).

7 This was also first proposed by the G-10 WorkingParty: “Such lending can both signal confidence inthe debtor country’s policies and longer-term pros-pects and indicate to unpaid creditors that their in-terest would best be served by quickly reaching anagreement with the debtor” (Group of Ten, 1996: 3).

8 On the “comparability of treatment” principle andits recent application, see Buchheit (1999); De laCruz (2000); and IMF (2000g).

9 For this so-called problem of “the inconsistency ofoptimal plans”, see Kydland and Prescott (1977).

10 See Miller and Zhang (1998). The same argumentsabout the ineffectiveness of official assistance policyin securing private sector involvement in crisis reso-lution were used in favour of the introduction ofcollective action clauses in bond contracts in orderto facilitate restructuring (see Eichengreen and Ruhl,2000).

11 A notable exception to calls for smaller IMF pack-ages is the so-called “Meltzer Report” (see Interna-tional Financial Institutions Advisory Commission,2000). For a discussion of the debate on IMF crisis-lending, see Goldstein (2000).

12 In creating this facility all Fund members wouldagree to donate their share of the allocation to thefacility and there would also be agreement that onlydeveloping countries would be entitled to draw onthe facility. This clearly differs from another pro-posal, which is to allow the Fund to issue reversibleSDRs to itself for use in lender-of-last-resort op-erations - that is to say, the allocated SDRs wouldbe repurchased when the crisis was over. See Ezekiel(1998); United Nations (1999); and Ahluwalia(1999).

13 Acceleration clauses allow creditors to demand im-mediate repayment of unpaid principal following adefault. Under cross-default (or cross-acceleration)clauses, creditors are entitled to bring forward theirclaims if the debtor has defaulted on other debts.Put options allow creditors to demand repaymentahead of the scheduled contract date, under certainconditions.

14 See, for example, Group of Ten (1996). This recom-mendation has been reiterated following the Asiancrisis (see Group of Twenty-Two, 1998). For a dis-cussion of problems in bond restructuring andCACs, see Eichengreen and Portes (1995); Dixonand Wall (2000); and Buchheit (1999).

15 In the case of English-law bonds issued under a trustdeed, the trustee represents the interest of all bond-holders and shares any proceeds recovered on a pro

Notes


rata basis. However, trustees rarely exist for sover-eign issues (Yianni, 1999: 79–81; Dixon and Wall,2000, box 1).

16 For some recent experiences of bond restructuringby emerging markets, see box 6.2.

17 This is also recognized by the IMF (2000f: 16).18 The Bulgarian case of 1996–1997 is cited as an ex-

ample of such market breaks leading to litigations(Miller and Zhang, 1998: 16).

19 See, for example, IMF (1999: 41–42; and 2000b,chap. V); and Eichengreen and Ruhl (2000: 5, foot-note 7).

20 For support of this position based on a study of theMalaysian capital controls, see Kaplan and Rodrik(2000, particularly pp. 27–28).

21 For a description of the East Asian restructuring seeRadelet (1999: 66–67).

22 The deal included a total debt of $21,740 millionowed to 13 banks, and the maturities were extended

from one to three years, involving spreads between225 and 275 basis points. The spread on SRF was300 basis points – lower than the maximum spreadon maturity extension mentioned in the previousnote (Ministry of Finance and Economy, Republicof Korea, 1999: 14).

23 See TDR 2000, box 4.1. This situation was also rec-ognized by the IMF: “They [Malaysia’s controls]do not appear to have had any significant long-termeffect on investor behavior” (IMF, 2000f, foot-note 28). While it is suggested that “capital controlsmay have contributed to a decline in FDI” comparedto the Republic of Korea and Thailand (ibid.: 24),it is quite likely that an important aspect of thestronger recovery of FDI in those two countries in1999 was the spate of fire-sale investments andtakeovers associated with the collapse of asset pricesand exchange rates.

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IMF (2000c). Standards and Codes – Code of Good Prac-tices on Transparency in Monetary and FinancialPolicies. Washington, DC, International MonetaryFund, 3 August (www.imf.org/external/standards/index.htm).

IMF (2000d). Experience with Basel Core Principle Assess-ments. Washington, DC, Monetary and ExchangeAffairs Department, International Monetary Fund,12 April.

IMF (2000e). Outreach efforts on standards and codesstress consultation and inclusiveness. IMF Survey.Washington, DC, International Monetary Fund,14 August.

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IMF (2000i). Review of Fund Facilities – PreliminaryConsiderations. Washington, DC, InternationalMonetary Fund, 2 March.

IMF (2000j). Review of IMF Loan Facilities. A Factsheet.Washington, DC, International Monetary Fund,30 November.

International Financial Institutions Advisory Commission(IFIC) (2000). Report (“Meltzer Report”). Washing-ton, DC, March.

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Iqbal MZ, Melcher TU and Elmallah AA (1997). Interna-tional Accounting: A Global Perspective. Cincinnati,OH, South-Western College Publishing.

Jackson JH (1997). The World Trading System: Law andPolicy of International Economic Relations (sec-ond edition). Cambridge, MA, and London, TheMIT Press.

JP Morgan (2000a). World Financial Markets. New York,5 October.

JP Morgan (2000b). Global Data Watch. New York,27 October.

JP Morgan (2000c). Latin American Economic Outlook.New York.

Kaplan E and Rodrik D (2000). Did the Malaysian capi-tal controls work? Paper prepared for an NBER

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161Selected UNCTAD Publications

UNITED NATIONS CONFERENCEON TRADE AND DEVELOPMENT

Palais des NationsCH-1211 GENEVA 10

Switzerland(www.unctad.org)

Selected UNCTAD Publications

Trade and Development Report, 1999 United Nations publication, sales no. E.99.II.D.1ISBN 92-1-112438-7

Part One The World Economy: Fragile Recovery with Downside Risks

I The World Economy: Performance and Prospects

II International Trade and the Trading System

III International Financial Markets: Instability, Trends and Prospects

Part Two Trade, External Financing and Economic Growth in Developing Countries

Introduction

IV Payments Deficits, Liberalization and Growth in Developing Countries

Annex: Trade deficits, liberalization and growth in developing countries:

Some econometric estimates

V Capital Flows to Developing Countries

VI Rethinking Policies for Development

Trade and Development Report, 2000 United Nations publication, sales no. E.00.II.D.19ISBN 92-1-112489-1

I The Current Global Recovery and Imbalances in a Longer-term Perspective

II The World Economy: Performance and Prospects

III International Markets

IV Crisis and Recovery in East Asia


Volume X (1999) United Nations publication, sales no. E.99.II.D.14ISBN 92-1-112453-0

Andrew Cornford and Jim BrandonThe WTO Agreement on Financial Services: Problems of Financial Globalization in Practice

A.V. GanesanStrategic Options Available to Developing Countries with Regard to aMultilateral Agreement on Investment

Carlos M. CorreaKey Issues for Developing Countries in a Possible Multilateral Agreement on Investment

Manuel R. AgosinCapital-Account Convertibility and Multilateral Investment Agreements:What is in the Interest of Developing Countries?

Christian LarraínBanking supervision in developing economies

Percy S. MistryCoping with Financial Crises: Are Regional Arrangements the Missing Link?

Devesh KapurThe World Bank’s Net Income and Reserves: Sources and Allocation

Lance TaylorLax Public Sector, Destabilizing Private Sector: Origins of Capital Market Crises

Paul MosleyGlobalization, Economic Policy and Growth Performance

These publications may be obtained from bookstores and distributors throughout the world. Consult your bookstoreor write to United Nations Publications/Sales Section, Palais des Nations, CH-1211 Geneva 10, Switzerland(Fax: +41-22-917.0027; E-mail: [email protected]; Internet: www.un.org/publications); or from United NationsPublications, Two UN Plaza, Room DC2-853, Dept. PERS, New York, NY 10017, USA (Tel. +1-212-963.8302 or+1-800-253.9646; Fax +1-212-963.3489; E-mail: [email protected]).

Volume XI* (1999) United Nations publication, sales no. E.99.II.D.25ISBN 92-1-112465-4

Montek S. AhluwaliaThe IMF and the World Bank in the New Financial Architecture

Stephany Griffith-Jones with Jenny KimmisThe BIS and its Role in International Financial Governance

Aziz Ali MohammedAdequacy of International Liquidity in the Current Financial Environment

Steven RadeletOrderly Workouts for Cross-border Private Debt

Andrew CornfordStandards for Transparency and Banking Regulation and Supervision: Contrasts and Potential

William MilbergForeign Direct Investment and Development: Balancing Costs and Benefits

Kwesi BotchweyCountry Ownership and Development Cooperation: Issues and the Way Forward

Giovanni Andrea CorniaSocial Funds in Stabilization and Adjustment Programmes

Bhagirath Lal DasStrengthening Developing Countries in the WTO

* This volume concludes the series International Monetary and Financial Issues for the 1990s, published in the context of theUNCTAD Project of Technical Support to the Intergovernmental Group of Twenty-Four on International Monetary Affairs.As of the year 2000, the studies prepared under this project are published individually, jointly by UNCTAD and HarvardUniversity, in a new series entitled G-24 Discussion Paper Series.

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International Monetary and Financial Issues for the 1990s

163Selected UNCTAD Publications

G-24 Discussion Paper Series

Research papers for the IntergovernmentalGroup of Twenty-Four on International Monetary Affairs

G-24 Discussion Paper Series are available on the website at: www.unctad.org/en/pub/pubframe.htm. Copies may beobtained from the Editorial Assistant, Macroeconomic and Development Policies, Division on Globalization andDevelopment Strategies, United Nations Conference on Trade and Development (UNCTAD), Palais des Nations,CH-1211 Geneva 10, Switzerland (Tel. +41-22-907.5733; Fax +41-22-907.0274; E-mail: [email protected]).

African Development in a Comparative Perspective United Nations sales no. GV.E.99.0.21

Published for and on behalf of the United Nations ISBN 92-1-101004-7 (United Nations)

Introduction

I Growth and Development in Africa: Trends and Prospects

II The Role, Structure and Performance of Agriculture

III Agricultural Policies, Prices and ProductionIV Trade, Accumulation and Industry

V Policy Challenges and Institutional Reform

This publication may be obtained from United Nations Publications/Sales Section, Palais des Nations, CH-1211Geneva 10, Switzerland (Fax: +41-22-917.0027; E-mail: [email protected]; Internet: www.un.org/publications); orfrom James Currey Ltd, 73 Botley Road, Oxford OX2 0BS, UK; or from Africa World Press, P.O. Box 1892 TrentonNJ 08607, USA.

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No. 1 March 2000 Arvind PANAGARIYA The Millennium Round and Developing Countries: Ne-gotiating Strategies and Areas of Benefits

No. 2 May 2000 T. Ademola OYEJIDE Interests and Options of Developing and Least-devel-oped Countries in a New Round of Multilateral TradeNegotiations

No. 3 May 2000 Andrew CORNFORD The Basle Committee’s Proposals for Revised CapitalStandards: Rationale, Design and Possible Incidence

No. 4 June 2000 Katharina PISTOR The Standardization of Law and Its Effect on Develop-ing Economies

No. 5 June 2000 Andrés VELASCO Exchange-rate Policies for Developing Countries: WhatHave We Learned? What Do We Still Not Know?

No. 6 August 2000 Devesh KAPUR and Governance-related Conditionalities of the InternationalRichard WEBB Financial Institutions

No. 7 December 2000 Andrew CORNFORD Commentary on the Financial Stability Forum’s Reportof the Working Group on Capital Flows

No. 8 January 2001 Ilan GOLDFAJN and Can Flexible Exchange Rates Still “Work” in FinanciallyGino OLIVARES Open Economies?

No. 9 February 2001 Gordon H. HANSON Should Countries Promote Foreign Direct Investment?

No. 10 March 2001 JOMO K.S. Growth After the Asian Crisis: What Remains of theEast Asian Model?


No. 140, February 1999 M. BRANCHI, Traditional agricultural exports, external dependencyG. GABRIELE & and domestic prices policies: African coffee exportsV. SPIEZIA in a comparative perspective

No. 141, May 1999 Lorenza JACHIA & Free trade between South Africa and the EuropeanEthél TELJEUR Union – A quantitative analysis

No. 142, October 1999 J. François OUTREVILLE Financial development, human capital and politicalstability

No. 143, November 1999 Yilmaz AKYÜZ & Capital flows to developing countries and the reformAndrew CORNFORD of the international financial system

No. 144, December 1999 Wei GE The dynamics of export-processing zones

No. 145, January 2000 B. ANDERSEN, Copyrights, competition and development: The caseZ. KOZUL-WRIGHT & of the music industryR. KOZUL-WRIGHT

No. 146, February 2000 Manuel R. AGOSIN & Foreign investment in developing countries: Does itRicardo MAYER crowd in domestic investment?

No. 147, April 2000 Martin KHOR Globalization and the South: Some critical issues

No. 148, April 2000 Yilmaz AKYÜZ The debate on the international financial architecture:Reforming the reformers

No. 149, July 2000 Mehdi SHAFAEDDIN What did Frederick List actually say? Someclarifications on the infant industry argument

No. 150, August 2000 Jörg MAYER Globalization, technology transfer and skill accumula-tion in low-income countries

No. 151, October 2000 Bernard SHULL Financial modernization legislation in the UnitedStates – Background and implications

No. 152, December 2000 Dilip K. DAS Asian crisis: Distilling critical lessons

No. 153, December 2000 Mehdi SHAFAEDDIN Free trade or fair trade? Fallacies surrounding thetheories of trade liberalization and protection andcontradictions in international trade rules

UNCTAD Discussion Papers

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Copies of UNCTAD Discussion Papers and Reprint Series may be obtained from the Editorial Assistant, Macroeco-nomic and Development Policies, GDS, UNCTAD, Palais des Nations, CH-1211 Geneva 10, Switzerland (Tel. 41-22-907.57.33; Fax 41-22-907.02.74; E-mail: [email protected]). The full texts of UNCTAD Discussion Papersfrom No. 140 onwards, as well as abstracts of earlier ones, are available on the UNCTAD website at: www.unctad.org/en/pub/pubframe.htm.

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