Question

What kinds of specific actions has the IMF (www.imf.org) taken in order to address economic or financial crises in Uruguay?

Answer 1

Until the l970s, most crises were "balance of payments" crises. These usually came about under fixed exchange rate systems in which either macroeconomic policies had been inconsistent with a fixed exchange rate peg (as, for example, when a country was experiencing a significantly higher rate of inflation than the rest of the world); or when a significant deterioration in the terms of trade occurred against the backdrop of a highly restrictive trade regime with few foreign exchange reserves.

Balance of payments crises, or current account crises as they then were, were normally preceded by at least a short period of several months during which import demand was increasing sharply (in anticipation of devaluation) and exports were shrinking (as exporters withheld stocks to benefit from the anticipated devaluation). Since crises had typically been preceded by overly- expansionary domestic policies, the IMF responded with financial support for a program that normally entailed an exchange-rate change and the tightening of fiscal and monetary policy, along with other reforms that were deemed integral to that tightening. Sometimes a removal, or at least a relaxation, of quantitative restrictions on imports was also a part of the package.

Indeed, after the collapse of the Bretton Woods system in the early 1970s, floating exchange rates became the norm for industrial countries; and deregulation, of the capital account and in many areas of the domestic economy increasingly came to be the stated policy goal, if not always implemented in full.

Long after the end of fixed exchange rates among the major trading countries, most developing countries continued to peg their currencies to one of the major currencies, often the dollar. But at the same time, the increasing role of private capital flows, and the increasing stock of outstanding debt led to crises (especially after the second oil price increase in the early l980s) where the instigating factor was an inability to service debt, rather than an inability to finance current account transactions. Even then, however, about half of all outstanding debt was to official creditors, and IMF programs were not significantly dissimilar from those earlier undertaken—except that there was coordination with the rollover of debt (and even new money) from private sector banks, the major lenders.

By the l990s, however, private capital flows to emerging markets were growing very rapidly, and sovereign debt to the private sector greatly exceeded that to the official sector. Many of the headline crises of the l990s were thus "capital account" crises, rather than the older current account crises.

Much of the IMF's work in the past decade has been learning more about capital account crises. What are the warning signals that a crisis is imminent? And how best to respond both to the warning signals, and, when necessary, the crises themselves?.

Capital account crises differ in several ways from current account crises.

1. In the first place, they can occur much more rapidly and require a much more immediate response than current account crises. This is because it is not only the current flows of goods and services that can require financing (and be subject to speculation) but also the stock of outstanding financial instruments.

2. Capital account crises take place when holders of the country's debt lose confidence in the country's ability in the future to service its debt. Thus, a crisis can come about — at least in principle — even if the country's underlying macroeconomic policies are reasonably sound. At the same time, the shift from bank loans to bonds as the principal source of debt finance increases a country's vulnerability to a turnaround in confidence.

3. Equally, the greater reliance on bond finance means that when there are genuine doubts about the sustainability of macroeconomic policy, those doubts can translate into a crisis very rapidly indeed. Policy inconsistencies are treated with great suspicion by the financial markets. It is very difficult for governments to buy time in such circumstances.

4. Fixed exchange rates tend to compound the problems. One of the key lessons of the l990s is that, with open capital accounts, countries can be extremely vulnerable to capital account crises if there is any doubt about either the sustainability of the exchange rate peg or the sustainability of debt servicing. Thus, with a fixed exchange rate, there are two major sources of vulnerability: anticipation of exchange rate sustainability, or lack of it; and expectations regarding the future course of debt-servicing.

5. The appropriate policy response must therefore aim to restore investors' belief that their holdings of the country's obligations will be serviced.

First and foremost, we have placed much greater emphasis than ever before on the sustainability of macroeconomic policy. By this, I mean that we have gone far beyond what might be regarded as the traditional prescription of developing policy that delivers macroeconomic stability over the medium term.

Given that, as I noted earlier, crises can occur even when governments are pursuing what would be regarded as conventionally sound policies, they—and we—have to pay much close greater attention to factors such as debt sustainability and debt management. Governments need to be able to demonstrate to the financial markets that their overall debt burden is manageable: and is likely to remain so under most circumstances.

Whereas analyses of countries in earlier years focused on likely trends in the balance of payments, attention now turns as well to the future course of total debt, recognizing the country's planned fiscal trajectory and financing needs. Anticipating the primary surplus for future periods and the likely real interest rate the country is likely to be paying on its outstanding indebtedness enables a calculation of the evolution of the stock of debt. Contrasting that evolution with likely growth rates of real output enables a judgment (and sensitivity testing) of the country's ability to sustain its current policies. In Fund surveillance, debt sustainability is now routinely examined. In countries with Fund programs, debt sustainability going forward is a necessary condition for Fund support.

The balance between domestic and foreign debt is not the central issue here. Creditors will take an overall view of debt sustainability. The denomination of the debt, however, can be important, depending on the exchange rate regime is in place.

Partly for that reason, we have grown much more sceptical about the benefits of fixed exchange rates, and today far fewer countries, especially among emerging markets, are attempting to maintain fixed exchange rate regimes.

As a result of the experience with the capital account crises of the past decade or so, we now place much greater reliance on structural reforms. I know that when we in the IMF talk about structural reform people tend to assume we are talking about things like labour and product market reform. Of course such changes remain essential when developing sustainable policies.

However, we are increasingly aware of the need to place greater emphasis on reform in other areas of the economy. Countries need properly functioning and well-regulated financial sectors. As capital has rapidly grown more mobile, so have weak financial sectors become more vulnerable. Banks and other financial institutions need to be well-structured and properly supervised. The laws governing financial relationships—and here I include bankruptcy laws—need to be clear and effective. The Fund has worked hard to encourage governments to press ahead with such reforms.

We also recognize that many countries, some of them with very limited resources, can be overwhelmed by the speed of change. The IMF has in recent years worked hard to provide technical assistance to enable governments to develop and implement the sort of changes I've been describing. Such assistance might take the form of expert help in developing statistical reporting systems, or legal advice in drawing up new bankruptcy laws, or systems for trading public sector expenditures. The more the Fund can do to help countries develop effective policy frameworks as well as effective policies, the more successful will be our efforts to prevent crises before they start.

At the same time, because of the role of confidence in determining investors' behavior, the importance of transparency of policy has increased greatly. Encouraging—and helping—governments to develop sustainable policies has gone hand in hand with efforts to make such policies more transparent. The IMF itself now publishes many more of the documents it produces (including, with the agreement of the governments concerned, Article IV — surveillance — papers, as well as program papers). We have developed standards and codes meant to lead to greater transparency that we encourage governments to adopt. The easier it is to understand what is happening, whether it be at the policymaking level or, for example, in measuring financial sector stability, the easier it will be to reassure creditors and investors. If they are continuously informed of changes in economic policies and circumstances in individual countries, the likelihood of a sudden swing in sentiment is greatly reduced relative to those times when release of information "surprised" the market.