Public Information Notice No. 03/50

Public Information Notice: Enhancing the Effectiveness of Surveillance: Operational Responses, the Agenda Ahead, and Next Steps

April 10, 2003

On March 28, 2003, the Executive Board of the International Monetary Fund (IMF) reviewed the IMF's strategy for enhancing the effectiveness of its surveillance, and examined ways to carry the agenda forward.

Background

A great number of initiatives to strengthen IMF surveillance has been introduced in the wake of the capital account crises of the 1990s. During the 2002 biennial review of IMF surveillance, the Executive Board of the IMF discussed how the framework for surveillance has been shaped by these initiatives and concluded that substantial ground had been covered in enhancing the effectiveness of surveillance. Executive Directors agreed, however, that more needed to be done to ensure that the IMF's policy advice is sound and has impact, and saw merit in exploring further ways to achieve this objective.

Executive Board Assessment

Executive Directors welcomed the opportunity to discuss possible avenues of further enhancing the effectiveness of Fund surveillance, given the central role of surveillance in the Fund's efforts to help prevent crises and achieve financial stability and high and sustainable growth throughout the membership. They revisited relevant conclusions of earlier reviews of surveillance, took stock of the range of initiatives already undertaken to strengthen surveillance, and discussed a number of areas where further work—going forward—would be helpful. While the views expressed by Directors on specific issues addressed in the staff paper were of a preliminary nature, they will certainly help shape the staff's future in-depth work on these issues.

Directors noted that past reviews point to five key ingredients of effective surveillance: timely, comprehensive and accurate information; focused, high quality analysis; openness to different perspectives to minimize the risk of "tunnel vision"; effective communication of assessments to the authorities and the public; and desired impact on members' policy decisions. They agreed that, building on the lessons learned from the Mexican and Asian crises of the 1990s, a range of steps has been taken in recent years to shape Fund surveillance to better meet these criteria.

Directors noted that efforts to strengthen surveillance and crisis prevention have covered a wide range of areas, although there is scope for further progress in virtually all of them. These include: improved data provision to the Fund and data dissemination to the public; more systematic financial sector surveillance—in particular, through the Financial Sector Assessment Program (FSAP); and strengthened assessments of policy frameworks and institutions against internationally recognized standards and codes. In addition, vulnerability assessments have been significantly strengthened, with better analyses of debt sustainability and capital account developments and more systematic consideration of market participants' perspectives. Surveillance in program countries is being strengthened by ensuring that economic conditions and policies are re-assessed from a fresh perspective. Going forward, greater attention will also be paid to ex post assessments of performance under Fund programs. Directors also underscored the important role of greater transparency, which enhances surveillance by increasing accountability, facilitating better risk assessment, and helping to mobilize support for policy actions.

Directors were generally of the view that the strengthened architecture of surveillance that has been put in place in recent years continues to provide a sound framework for the conduct of the Fund's surveillance activities. The first priority now is to take full advantage of the potential of the present framework by ensuring that progress with implementation is sustained—with support of technical assistance where needed—and that the various surveillance outputs are adequately linked. Regular reviews of the experience with the various initiatives will set the stage for further improvements as needed. Directors acknowledged that continued further enhancement of the effectiveness of surveillance will remain an ongoing challenge, and they identified a number of areas in which further work and reflection would be useful.

Calibration of policies to reduce vulnerabilities. Directors saw a continuing need to build on progress with vulnerability assessments by better calibrating the Fund's policy advice to measures that will help members reduce their vulnerability to external shocks. They supported the analytical work that is underway in this area, in particular on the shock absorbers needed to cope with temporary disruptions in access to international capital markets or with sudden capital outflows. The staff will also further explore the development of a well-defined set of criteria for sound policies to provide a more transparent and objective basis for the Fund's policy advice. Many Directors, however, saw considerable difficulty in developing such criteria without falling into a one-size-fits-all approach, and cautioned against allowing such criteria to transform Article IV consultations into a rating exercise. They also observed that this approach should apply to the whole membership as relevant.

Analysis of political factors. Further to their recent discussion on the prolonged use of Fund resources, Directors also had an exchange of views on the contribution that more systematic analysis of political factors influencing the ability to establish and maintain shock absorbers could enhance the effectiveness of the Fund's policy advice. It was noted that fuller discussion in staff reports of available policy trade-offs and a description of why certain policy suggestions were not followed, could be one way of taking political economy issues into account. The merits of carefully building up experience in the area of political economy were recognized. Many Directors cautioned, however, that the staff has limited expertise in political analysis and that political economy considerations should not undermine the technical quality of its policy advice. Directors stressed that, in this area, the scope of the Fund's work, and the potential role of resident representatives, will need to be clearly spelled out.

Incentives for sound policies. Directors took note of various proposals that have been advanced to strengthen incentives to implement sound policies. This could be done in theory either by including more explicit, publicized ratings in the Fund's assessments of members' policies, or by further tightening the link between the quality of a country's present policies and access to Fund resources. Overall, there appears to be little interest in pursuing these specific proposals, and Directors underscored the complex issues that they would involve. Enhancing the incentives for the implementation of sound policies, nevertheless, remains a challenge for effective surveillance. A number of Directors considered that efforts in this area should be guided by the experience that sound policies, based on strong country ownership, pay off in terms of high quality growth.

Systemically or regionally important countries. Directors underscored the importance of effective surveillance of the policies of systemically or regionally important countries, given their potentially strong and widely felt externalities. While the Fund already pays increasingly close attention to the economic and financial spillovers from these countries, Directors did see scope for further efforts to raise the profile of these externalities in the Fund's bilateral, regional, and multilateral surveillance, including with respect to the global impact of the trade policies of the larger economies. Some Directors suggested the inclusion of a specific discussion on externalities in Article IV reports on relevant countries.

Cross-country experiences. Directors observed that the Fund's cross-country experience is one of its most valuable assets in its policy dialogue with member countries. They agreed that this asset should be used more fully to ensure that insights from cross-country studies and reviews of past experiences of Fund members are incorporated systematically into surveillance, in particular at the early stages of the preparation process for Article IV consultations.

Candor and transparency. Today's discussion confirmed the high priority that Directors accord to candor and transparency as essential ingredients of an effective surveillance process. Given the potential tension between candor and transparency, Directors agreed that a key challenge, going forward, is to ensure that the candor of the presentation of the diagnosis and policy recommendations in surveillance reports is fully preserved, while at the same time making further sustained efforts to enhance the transparency of Fund surveillance. Directors noted that they would have a further opportunity to discuss these issues on the occasion of the forthcoming review of the Fund's transparency policy.

Surveillance in program countries. Directors supported the ongoing efforts to ensure that Article IV consultations in program countries involve an independent reassessment of economic conditions and policies, and present this fresh perspective at a time when it is most beneficial. Most Directors also welcomed a number of procedural steps that will further enhance the role of Article IV consultations in program countries, while maintaining the complementarities between surveillance and program activities, and looked forward to assessing the experience with these new arrangements on the occasion of the next review of Fund surveillance. Some Directors, however, suggested that early consideration be given to other steps that would further enhance the independence of surveillance, and asked for a detailed assessment of the pros and cons of greater operational separation between program and surveillance activities. It was suggested that a better understanding by the Board of the internal review process for surveillance reports could be useful in informing future discussions of this topic. Directors saw merit in a further examination of the role and conduct of surveillance in low-income program countries, in particular taking into account the important role that Poverty Reduction Strategy Papers play in framing these countries' policy agenda.

Most Directors generally considered that the present institutional framework of surveillance continues to serve its purpose well. Some Directors expressed interest in undertaking a review of the role of the Board in the surveillance process, particularly of its peer review function, and suggested that such a review be supported by an external assessment of the Board's role.

Directors stressed the importance of adequate assessments of the effectiveness of surveillance. Assessing the impact of surveillance raises, however, difficult methodological issues related to the establishment of either counterfactuals or a direct causal link between the Fund's policy recommendations and members' policy actions. In light of this, Directors considered that the various tools used in past reviews of surveillance, including assessments of the implementation of new policy initiatives, selected country case studies, and surveys of interested parties, remain broadly appropriate. In this context, it was suggested that it would be useful to review the experience with IMF surveillance in situations where other institutions also play a role in monitoring a country's economic policies. Directors looked forward to gaining experience with the recent decision to include in Article IV reports more systematic coverage of the authorities' response to key policy challenges identified in past consultations, and to evaluating this measure at the time of the next biennial surveillance review. A few Directors suggested that further steps be explored to enhance the assessment of the effectiveness of surveillance.

Directors noted that several steps are already planned to move the policy agenda forward. These include the review of the framework for debt sustainability assessments; work on the feasibility and desirability of adapting the Contingent Credit Lines eligibility framework for possible use in surveillance; the review of progress on financial soundness indicators as well as a seminar discussion on the balance sheet approach to financial crises; the review of the Fund's transparency policy; and implementation of the conclusions of the review on prolonged use of Fund resources.