Timothy F Geithner: The Bretton Woods institutions in the 21st century
Remarks by Mr Timothy F Geithner, President and Chief Executive Officer of the Federal Reserve
Bank of New York, before the Bretton Woods Committee, New York, 10 June 2004.
* * *
It is a pleasure to join you for this meeting of the Bretton Woods Committee. This is a great and
accomplished organization. Although the international financial institutions are one of the most
important legacies of the great statesmen of the last century, the task of supporting them is not always
easy. The Committee has been effective in this role, not just by helping to explain the
accomplishments of the International Monetary Fund and the World Bank to an occasionally skeptical
public, but also by helping to shape the debate on how these institutions need to change.
The Fund, from its inception, was burdened by a mismatch between the aspirations of its architects
and the authority and instruments they gave the institution to pursue those ambitions. Its authority over
the policies of its members was limited. Its resources were small, and the facilities established to
deploy those resources were modest relative to the problems they were designed to address.
At its creation, the architects of the Fund hoped to build a system that would deliver exchange rate
stability globally, in a world much less integrated than it is today, without giving the Fund the capacity
to induce, much less compel, its members to pursue the economic policies that might have made that
objective more realistic. They gave the IMF a financial mission that had some of the characteristics of
a lender of last resort to sovereigns, but without mechanisms to constrain risk-taking behavior. By
necessity, they left the Fund in the position where it was ultimately dependent on the strength of the
governments of its members, and on their willingness to act to address their economic challenges.
To their credit, the founders gave the institution a basic charter that permitted evolution. And as the
needs of the world have changed, the institution has been able to change as well. It has been much
more responsive to change, and much more agile in responding to a rapidly changing mix of
challenges than other multilateral organizations. But the constraints that were established at the outset
still exist today.
I am going to focus, in my remarks today, on the Fund's role in promoting financial resilience and
mitigating crises in emerging market countries. But first, let me mention briefly several of the other
areas where the Fund has a very important role to play in the international economy and financial
system. The Fund can provide a useful voice and a forum for advising the major economies to pursue
policies that can contribute better to global economic expansion and financial stability. The Fund can
play an important role in considering, from a global or systemic perspective, the exchange rate policies
of its members. And the Fund plays a vital role in providing the macroeconomic policy framework that
is the critical to sustaining better growth outcomes and the effectiveness of the global development
assistance effort for the poorest, low-income countries.
I think the Fund is reasonably close to the frontier, the sensible or achievable frontier, in these areas.
Some may wish it were more effective in persuading the G-3 to avoid policies that create the risk of
abrupt changes in financial market conditions or exchange rates, but it will never be decisive in this
arena. And it might do more to further improve the design of macroeconomic policies and institutions
in the poorest developing countries. But outside those areas, the challenges to sustained growth in per
capita income lie largely in areas beyond the core competence of the IMF.
In the emerging market context, in contrast, there is greater distance between the Fund of today and
the achievable frontier. This is a timely and critical issue, because of the magnitude of the challenges
that still confront many emerging market economies.
Let me start with a broad review of the progress made over the past decade across emerging markets
in reducing their vulnerability to financial crisis.
•
International reserves have increased substantially, providing a larger cushion against
adversity. Among the largest borrowers, half now hold reserves greater than 150 percent of
maturing short- and long-term debt; less than one-sixth had such coverage heading into
1997.
•
There have been improvements in fiscal performance, with some notable cases of
governments achieving and sustaining large primary surpluses.
•
External balances have improved, with current accounts in most of the emerging world in
surplus or modest deficit. Only 2 of the 20 largest borrowers now are running deficits in
excess of 3 percent.
•
Exchange rate regimes are more resilient and less fragile, as a substantial majority of the
largest borrowing countries have moved to flexible regimes, and away from the
fixed-butadjustable pegs that proved so dangerous in the crises of the last decade.
•
Important progress has been made in building credibility for new monetary policy regimes,
and inflation is generally moderate.
•
Governments have made major investments in recapitalizing and restructuring their troubled
financial systems. For example, in Asia, where some of the most severe problems were
encountered, governments have spent over $500 billion carving out problem loans and
bolstering capital.
• Growth rates have improved with the restoration of domestic stability and recovery in
external demand. Indeed, aggregate growth currently is running at its highest rate since the
onset of the crisis in 1997.
•
With these improvements, and generally accommodative external financial conditions,
borrowing costs have fallen, capital market access was restored for many countries, and
credit growth resumed. Net credit growth to sovereigns has remained moderate, however, as
much of the borrowing has gone to refinancing the existing stock of debt on more favorable
terms.
•
The market for emerging market debt also has matured. There has been more differentiation
in the response of spreads, both on the way down as credit fundamentals seemed to
improve, and during the recent correction.
This progress is indicative of a general increase in the sophistication and skill of economic policy
makers in the emerging world, and in the quality of understanding of the benefits of macroeconomic
stability and how to achieve it. Many countries benefited from the advice and financial support from the
IMF and the multilateral development banks. But the most successful were those with policy makers
who were ahead of the Fund and the Bank in diagnosing and addressing their problems, rather than
being dragged reluctantly toward a more credible policy stance.
These improvements have left the emerging markets as a group less vulnerable to financial crisis than
they were in the mid-1990s. The combination of deeper reserve cushions, stronger external positions,
improved balance sheets, more flexible exchange rate regimes, and better inflation performance
provide a very different setting from what existed the last time we faced a transition after a sustained
period of benign financial conditions and low interest rates.
These aggregate improvements mask substantial differences across countries and a number of areas
of lingering vulnerability. Let me highlight some, and then suggest some implications for how the Fund
might better position itself to deal with the challenges they present.
•
Some of the most daunting challenges are in the fiscal and public debt area, where a
number of emerging market economies across different regions face very high, and in some
cases still growing public sector debt levels. Average public debt burdens in the emerging
world have risen to about 70 percent of GDP, and among countries rated single B and
below, the mean rises above 80 percent.
•
The challenge of managing debt burdens of this size is magnified by the fact that the debt
structures in a number of countries are still quite vulnerable to foreign currency, liquidity, and
interest rate risk. The substantial share of public debt denominated in foreign currency - 70
percent on average for the lowest rated group of borrowers - and the relatively short maturity
of the debt stock mean that a relatively modest shock can produce a substantial increase in
debt burdens, raising the amount of fiscal effort needed to keep the debt stock on a stable or
declining path, and increasing the economy's vulnerability to a crisis.
• In some countries, the fiscal trajectory is too weak to place the debt-to-GDP ratio on a
sustainable path. In others, the fiscal position is strong enough to stabilize the debt
dynamics, but provides little buffer against adverse shocks, and very little room for fiscal
policy to help cushion the effects of such a shock.
•
Important challenges remain in the financial area as well. In many countries, large public
sector debt burdens have left banking systems highly exposed to the sovereign, constraining
authorities' room for maneuver. There are also problems in banks' corporate and consumer
loan books, and a number of banking systems also have a large share of foreign currency
denominated liabilities, in some cases held by non-residents.
•
The durability of recent improvements in external positions, which reflect weak domestic
demand in many countries, is also open to question. As domestic demand strengthens,
external balances could move into deficit again, which in some cases will reintroduce a
greater external risk.
•
And in many cases, the financial exposure of the IMF and the multilateral development
banks is already high.
These balance sheet challenges took a long time to develop, and they will take a long time to reverse.
They are the legacy of years of past fiscal decisions, magnified by the impact of crises on growth, the
exchange rate, and the financial sector. They leave an exacting set of policy challenges. They raise
the risk that future shocks to domestic confidence or adverse changes in the external environment
could lead to new pressures on exchange rates, on interest rates, and on the capacity of countries to
fund themselves on sustainable terms. Apart from the risk of crisis, these debt levels are large enough
to depress domestic investment and long-term growth prospects.
In part because of these balance sheet and debt burdens, many emerging market economies face a
protracted transition before they can expect to be comfortably considered stable investment grade
credits, with sufficient levels of self-insurance against external and domestic challenges to financial
stability.
One of the most pressing challenges for the Fund is to help assist in this process of reducing
vulnerability, by promoting an unwinding of these large balance sheet risks and, at the same time,
providing a credible form of contingent insurance for those hopefully rare circumstances when its
members face extraordinary financing needs.
The Fund would be better able to contribute to this process if it were to strengthen its policies in a
number of specific areas. My suggestions cover four types of reforms: changes to the substantive
focus of Fund policy advice; to the relationship between the Fund and its members in the surveillance
framework; to the Fund's approach to countries undertaking a debt restructuring; and to how the Fund
uses its financial resources. They involve adopting: a risk based approach for focusing the Fund's
crisis prevention work; a more intensive framework for the surveillance process to provide a stronger
anchor for the member's economic program; a reinforced framework for providing support to countries
undertaking a debt restructuring; and a more credible form of financial insurance that creates better
incentives for stronger policies in advance of crisis.
These proposals do not require amending the Articles of Agreement of the Fund, and can be achieved
without major changes in the structure of the institution. They are evolutionary rather than
revolutionary.
More policy ambition
Studies by IMF staff, the IMF's Independent Evaluation Office, and others catalogue a number of
criticisms of the substantive content of the Fund's policy advice. Many of these studies conclude that
the Fund has had insufficient ambition in its prescriptions for reform and in a number of cases was too
deferential to domestic political constraints on adjustment and reform. Some conclude it was too
supportive of choices by its members to run exchange rate regimes that were incompatible with the
rest of the policy framework, that led to substantial appreciation of the real effective exchange rate
over time, that encouraged borrowing in foreign currency, and that proved too brittle under stress.
Some suggest the Fund was in some cases insufficiently attentive to or ineffective in addressing the
increases in debt, particularly foreign exchange denominated and linked debt, that created the balance
sheet problems, which made crises so damaging and difficult to resolve. It accommodated, if not
supported, decisions by its members to calibrate policies designed for a more benign external
environment than was realistic and therefore encouraged less self-insurance than was necessary to
manage safely. And it was drawn too far into a range of efficiency-improving long-term institutional
reforms that necessarily diffused attention from critical vulnerabilities.
To some extent, these criticisms suffer the classic failure of claiming that what seems obvious in
hindsight was as clear at the time. Many are unfair in the degree of influence they expect the Fund to
be able to exert over a reluctant member - recall the constraints I described at the beginning on the
Fund's powers over its members. And many of the criticisms fail to recognize the difficulty of making
definitive judgements about the path of policies consistent with sustainability.
Yet elements of this general diagnosis of the Fund's policy advice to emerging market economies
have substantial merit. If the Fund is going to contribute to a process of well-targeted reform,
particularly in the more vulnerable countries, it probably needs to raise the bar, to increase the level of
ambition of its policy recommendations. Greater policy focus is required on the principal sources of
near-term vulnerability, ideally without fully eclipsing longer-term institution building and structural
reforms important to raising growth potential.
A risk-based framework for determining the hierarchy of policy priorities is important. Such a
framework would almost certainly entail more focus on unwinding large balance sheet problems (both
with respect to the sovereign and the financial system), reducing sovereign debt to more sustainable
levels, making debt dynamics less vulnerable to shocks, increasing liquidity buffers, and preserving
appropriate exchange rate arrangements. Addressing these issues would help reduce the risk of future
capital account crises. It would create better conditions for private sector growth. In virtually every
context where public sector debt burdens are high and fiscal deficits large, more ambition in the
adjustment path should be positive for growth through the effect on confidence, interest rates, and the
exchange rate.
Of course the Fund can't want reform more than its members. The principal burden for running a set of
policies more commensurate with the risks emerging markets face in this world rests with their
governments. The role of the Fund should be to help guide and encourage them to the point where
they build in a more substantial degree of self-insurance. The Fund should not acquiesce in and
validate policy frameworks that fall substantially short of the threshold necessary to safely navigate
this world of high variability in the external environment and occasional domestic political pressures to
weaken policies.
Changing the surveillance framework
Part of the challenge entails reorienting surveillance, the process through which the Fund's policy
advice is delivered, to make it more effective. The surveillance framework of today has a number of
features that make it poorly suited to a small open emerging market economy that has fragile
credibility, a limited buffer against shocks, and considerable exposure to a rapidly changing economic
and financial environment. The assessments occur quite infrequently, only every 12 to 24 months. The
assessments can only be published with the approval of the member state, which tends to take the
edge off the diagnoses and prescriptions. Assessments do not come with a clear evaluation relative to
thresholds that help define degrees of vulnerability, or relative to other countries in similar
circumstances. The assessments are judgments of the Fund's Executive Board, not formally of the
staff, which can also work to take the edge off candid economic and financial judgments. Risks are not
clearly and candidly identified and explored. And the process does not come with consequences,
since critical evaluation can be withheld from the public, and neither favorable nor critical evaluations
necessarily have consequences for access to financial assistance from the Fund.
The model we use for bank supervision in the United States offers an interesting contrast. We
undertake a continuous process of onsite examination. We use a risk-based framework for focussing
attention on critical factors. We produce a confidential rating of select dimensions of the financial
profile of the institutions and their risk management and control infrastructure. We assess the models
banks use to measure risk and the scenarios used to stress test exposures, but the banks have the
responsibility for designing and running the risk management infrastructure. By looking across a broad
range of world class financial institutions, we have a good sense of the evolving frontier of best
practice in risk management which we can then use to help benchmark other institutions and pull
common practice closer to that frontier. For a number of reasons, this can't be the model for the
Fund's relationships with its members. But it provides an interesting prism in thinking about
surveillance.
The Fund has explored a number of ideas to strengthen the surveillance framework. One of the most
promising is to establish a process with more frequent, published staff assessments of performance
against a medium-term framework designed by the member country. That assessment could convey a
clear judgement about the degree of progress being made in reducing vulnerabilities, improving
resilience, and strengthening the structural underpinnings of growth. Analysis of public and external
debt trends, benchmarked against sustainability and vulnerability thresholds, and stress tests for
relevant shocks could play a key role in this process.
There are compelling arguments for combining such a framework with contingent access to Fund
resources. Surveillance today does not provide a meaningful check on ex ante policies, and resources
are only made available when the financial need is acute. Access to supplemental resources from the
Fund on a precautionary or contingent basis could make a critical difference in preventing short-term
liquidity crises from becoming full-scale solvency problems leading to default. Of course, access to
such contingent financing should be limited to countries whose policies were judged reasonably
sustainable, and consistent with a reduction in balance sheet risks over time. With an enhanced
surveillance framework designed to help keep policy on a stronger path that does reduce risk over
time, and with contingent finance that could be mobilized quickly, the Fund would be better positioned
to contain the risk of deeper financial crisis. And more of the policy reform that is a necessary
accompaniment to Fund finance resources could be supported ex ante, rather than ex post. Catalyzing
better policies sooner is the best defense, though it will never be a perfect defense, against crises.
Facilitating restructurings
We have seen some progress in the last few years in efforts to improve the framework for sovereign
restructurings. In particular, collective action clauses have now become the market standard where
emerging market governments issue debt under foreign law. It will take some time for the full stock of
sovereign emerging market debt to include these provisions for restructuring by majority action, but
this progress is nonetheless important.
But there are also some experiences that overshadow these more encouraging developments, and
expose a breakdown in the broad consensus that had formed the basis for the successful past
strategies of collaboration among the official sector, borrowers, and private creditors.
Without commenting on the specifics of any particular case, let me offer a view of what I see as
fundamental tenets of a credible approach by the international community to situations where a
sovereign finds it necessary to restructure its obligations to private creditors:
The IMF should be willing to lend to a sovereign that is in default to its private creditors only when two
conditions have been established:
First, the country must commit to a credible medium-term adjustment program, one that offers the
prospect of a successful restructuring and a reasonably early return to the capital markets. This has to
be established up front for any restructuring effort to work. Commitment to a credible adjustment path
that offers the reasonable prospect of a return to financial viability and growth is the necessary
foundation for engagement by the creditors in a restructuring process. Without that, there is little basis
for meaningful engagement. The science of economics does not provide a definitive answer to what
that adjustment path must be, but it does offer the means to determine a reasonable band of
outcomes between the inadequate and the excessive. This judgment must be made by the
government. It can be informed by consultations with the creditors. Ultimately, though, it has to be
endorsed by the Fund, if the Fund is to lend.
Second, before the Fund can commit its support, the country must develop, in consultation with its
advisors, and outline to the Fund and its creditors, a credible and monitorable framework for
cooperatively achieving a viable debt restructuring, one that leaves the country with a sustainable debt
burden. The issues of appropriate adjustment and appropriate broad terms of proposed restructuring
are closely intertwined and need to be assessed in tandem. For the Fund, it should be an essential
prerequisite that the country demonstrate at the outset that its approach has credible prospects for
enlisting broad creditor concurrence, and for being consistent with the country's macroeconomic
framework and payment prospects.
Reaffirming these conditions as the foundation for Fund support in restructuring or arrears cases
would be a useful contribution to the system, and would leave the Fund better positioned to contribute
to the favorable resolution of future crises that involve restructurings.
Strengthening the Fund's financial instruments
The Fund has taken a number of important steps to make its financial instruments more effective for
dealing with the challenges inherent in a world with ever more integrated national financial systems.
The reforms of late 90's - the increase in the size of the Fund and its supplemental borrowing
arrangements, the launch of new facilities that offered the means for large-scale lending at penalty
rates in carefully circumscribed cases, the introduction of greater flexibility in the phasing of resources,
and in how those resources could be used to reestablish confidence - were extremely important. More
recently the Fund adopted a set of criteria designed to limit the risk that the Fund would make
largescale resources available too frequently and in conditions where they would be unlikely to contribute to
a resolution of the crisis. These various reforms gave the Fund a substantially more effective
insurance mechanism for emerging market economies than it had before.
Building on this progress, I see the key elements of a credible insurance mechanism as including the
following:
•
Finance must be conditioned on a policy framework strong enough and timely enough to
restore confidence. Fund resources can't compensate for a lack of policy credibility, and
lending official resources to fund an inadequate policy effort may make the situation worse.
• The scale of finance provided has to be calibrated to the need, and the needs can be
substantial in today's world. The Fund can only fill part of the gap, but it has to be able to fill
a credible share of the gap if it is to play a successful part in catalyzing other resources to
flow.
•
Flexibility to structure programs appropriate to the circumstances and the borrower's policy
efforts is essential. The Fund needs to be able to substantially front-load financial packages,
when this is warranted. Making available small tranches of resources over the life of a
program does little to address the realities of open emerging market economies facing
liquidity problems. Rather than the classic staircase pattern of disbursements, the Fund
should consider, in some cases, providing a larger up front tranche that floats and is
available if stress materializes and policy is responding appropriately.
• The Fund should stand ready to support countries in pursuing reasonable restructuring
proposals when warranted by the circumstances. Official financial resources in that context
can be helpful in meeting some targeted needs.
• And finally, the Fund needs a more credible capacity to withstand arrears, so that it does not
face the reality or the perception that is can be induced to accept weak programs only to
allow it to refinance its exposure.
Conclusion
These are modest proposals. They only cover a small piece of the world of the Fund, much less the
broader Bretton Woods institutions. They would not fundamentally change the balance established by
the Fund's articles between the rights and obligations of its members. But they would help position the
Fund to deal with future financial pressure in emerging markets. And given the scale of the economic
costs imposed by recent crises, that is an important goal.
Thank you.