Global Economic Outlook

1. Even before the September 11 terrorist attacks, the global economic outlook had already deteriorated when compared to the beginning of the year. The economic slowdown in the United States was proving more persistent than initially expected. The prospects for growth in other advanced economies had also weakened, being negatively affected by larger than expected linkages to the United States. As a result, the world was already experiencing a dangerous synchronization of the business cycle. Developing economies were either going through an involuntary economic slowdown due to a reduction in exports, or were required to adopt a more restrictive stance of macroeconomic policies to secure external viability given the reduction of international capital flows, thus intensifying the deceleration of world economic growth.

2. As inflationary pressures remained subdued, macroeconomic policy in advanced economies had been appropriately geared towards supporting domestic demand, aiming to revert the downturn in growth or, in the case of Japan, to mitigate output contraction. In the United States, the authorities have appropriately eased significantly monetary policy and, given the strong initial fiscal position, adopted a tax cut package that helped in supporting aggregate demand.

3. In Europe, where growth performance continued to be disappointing and unemployment significantly higher than in the United States, interest rate cuts in the first half of the year and in the third quarter prior to September 11 were modest but welcome, if belated cuts were implemented afterwards, as the balance of risks leaned more towards weaker activity rather than higher inflation. Additionally, a priority policy action in Europe is a reinvigoration of structural reforms that could raise the rate of growth of potential output. There remains a substantial unfinished agenda of structural reform, particularly in the areas of labor market flexibility, pension and health care systems, capital market integration, and competition in product markets.

4. In Japan, the priority policy response continues to be a speeding up of structural reforms aiming to deal with financial sector weaknesses and the excess levels of debt of the corporate sector that were generated during the 1990s bubble. The package of banking and corporate reforms, announced in the first half of the year, needs to be implemented vigorously and speedily. In addition, the authorities should continue to use flexibly the new monetary framework and to avoid an early withdrawal of fiscal stimulus before a firming of economic recovery.

5. In the aftermath of the September 11 terrorist attacks, the downside risks to the global economic outlook have increased and become more apparent. The prompt and adequate response of advanced economies, implemented through a well-coordinated action of their monetary authorities, created a minimum level of assurances for international capital markets to resume business. Unfortunately, the increased uncertainty thereafter, the heightened risk aversion and flight to quality among market players both within and across countries, the loss of business confidence throughout the world, together with the increased transaction costs generated by security concerns, have prevented most emerging market economies from reaping the benefits of global monetary easing. Following September 11, an increasing concentration of liquidity in mature markets has occurred, aggravating external financing conditions for developing countries.

6. It is clear now that the world economy is experiencing a serious synchronized slowdown, with a recession in the United States, zero growth in the Euro area, and recession and deflation in Japan, and that the bottoming out of the world economy seems to have been postponed to sometime during the second half of 2002. The consequences of such a more protracted global slowdown are difficult to assess given the strong and complex linkages across economies and the fact that, differently from the 1991 recession, we now witness a synchronized slowdown in the major industrial economies.

7. Given the depth, possible duration, and synchronized nature of the present slowdown and its associated downside risks, the developing world is facing an enormous challenge. Developing economies have been directly affected by weaker external demand through trade channels, with a negative impact on prices and volumes of their exports. World trade is projected to grow a mere 1.7 percent this year compared to 13.3 percent in 2000, while export growth in developing countries plummeted from 19 percent last year to an expected 3 percent in 2001. In addition, the developments in global financial markets, which started with the correction of asset prices in the United States and were aggravated with the terrorist attacks, resulted in tighter international liquidity along with a substantial increase in risk aversion.

8. Latin America, in particular, has been affected by the global environment and by other country-specific difficulties, and it has seen a substantial downward revision of its growth prospects. Most Latin American countries have reacted with a tightening of macroeconomic policies.

Policy Responses

9. The current global economic and financial situation calls for increased international cooperation and international policy coordination to prevent the already difficult international situation from deteriorating. Now more than ever, it is time for countries to cooperate more and coordinate closely with each other, and the IMF is the main forum for such cooperation and coordination. The Fund must take a leading role in improving the policy dialogue among member countries, developing and developed, especially those that have systemic global importance. I am pleased, therefore, with the leadership shown by the Managing Director in his October 5 statement, with which I am in full agreement, on the situation of the world economy and the required policy responses.

10. Industrial countries, which are the key engines of the world economy, have a special international responsibility to help sustain world demand. Their macroeconomic policies should continue to maintain monetary easing, to allow the full operation of automatic stabilizers in fiscal policy and, where appropriate, to promote discretionary fiscal easing in a manner and degree that are consistent with each country's medium-term fiscal position and sustainability. An acceleration of structural reforms aimed at raising the growth potential can be an important element to rebuild investors' confidence.

11. The key example of structural reform that would be both growth- and welfare- enhancing worldwide is trade liberalization. A reduction of tariffs, non-tariff barriers, and trade-distorting domestic subsidies that hinder developing countries' exports, would benefit consumers and taxpayers in industrial and developing countries, particularly those that rely on trade as an engine of growth or that need to secure external financing without resorting to policy-induced output contractions.

12. The launching of a new trade round to further liberalize and strengthen a rules-based multilateral trading system is also long overdue. The lack of progress on market access for developing countries' exports represents a clear impediment for global growth and development. Against a backdrop of weak confidence indicators, the risks of slow progress in multilateral trade initiatives and of individual countries resorting to a defensive trade policy stance or to protectionist measures are considerable and must be resisted.

13. The Fund must be ready to help financially countries that maintain sound policies either by augmenting existing arrangements,where needed, and by approving new arrangements, especially those of a precautionary nature such as the CCL. It should also be proactive in terms of policy dialogue and in helping policy coordination amongst the various countries' policy responses. Multilateral development banks should also help to provide counter-cyclical development financing by increasing project and budget/balance of payments support lending.

14. At this juncture, a number of positive developments can be highlighted: a substantial monetary easing already in the pipeline for industrial countries, subdued inflation, and the circumstance that long-term productivity in advanced economies does not appear to have been considerably affected, other than by the anticipated cyclical contraction. We are confident that it is possible to prevent a further deterioration of economic prospects and that a recovery of the global economy may occur during the second half of next year.

15. However, looking ahead, the adequate policy responses and the mix between adjustment and financing would depend on the situation of the entire world economy. It may be the case that more finance and less adjustment would be needed if the global economic situation were to deteriorate further. In such case, the Fund must be ready to adjust its policies, and to meet a global liquidity need, if it arises, by supplementing existing reserve assets to avoid economic stagnation and deflation. The Fund's Executive Board and Management are entrusted with adequate room for maneuver to respond flexibly and timely, looking at the global situation and examining what is the appropriate response on a country-by-country basis.

Brazil

16. After performing remarkably well in 2000, the Brazilian economy has slowed down considerably in the first half of 2001 as a result of a combination of factors -among which, the worsening of the global economic environment, the difficult financing conditions for countries in the region, and the domestic energy shortage that became evident in the second quarter of the year. The Brazilian government swiftly adjusted the macroeconomic policy stance and adopted other policy measures. These events, together with the required policy response, led to a temporary deceleration in the rate of growth of GDP from 4 ½ percent in 2000 to approximately 3.1 percent in the first half of 2001, while unemployment remained relatively unchanged at 6.7 percent.

17. However, the fundamentals of the Brazilian economy are strong and the country is in a more solid footing to withstand external shocks than it was a few years ago. Prior to September 11, in a preventive and proactive response to the worsening of the external environment, the government had strengthened its fiscal policy framework. Given that the underlying causes of the recent inflation surge were essentially related to supply and external shocks, the central bank allowed for the initial drift in the price level, but responded swiftly to limit the second-round effects of such shocks. Since mid-March 2001, the central bank increased interest rates by as much as 375 basis points.

18. In August, the Brazilian government adopted additional policy measures -an increase in the primary surplus to 3.35 percent of GDP in 2001 and to 3.5 percent of GDP in 2002 to 2004, compared with the levels of 2.7 percent and 2.5 percent respectively that were envisaged at the beginning of the year. It also requested financial support from the Fund in the form of a one-year Stand-By Arrangement, which is sufficient to cover existing financing needs under current circumstances.

19. Since September 11, Brazil implemented a series of additional policy measures to further tighten the monetary policy stance and to contain potential risks arising from worsening international financing conditions. The reserve requirements on time deposits were raised from 0 percent to 10 percent, while operational changes were introduced in the computation of reserve requirements on demand deposits. These two measures together represent a significant tightening in liquidity conditions. Banks' capital requirements to cover net foreign exchange positions were raised. The securities exchange commission (CVM) allowed listed companies to recognize over a longer period, instead of in one calendar year, the losses that they might have had in foreign exchange operations. This tightening of monetary and credit conditions, along with increased capital requirements on net foreign exchange positions, has limited the expansion of demand for hedging against exchange rate risk. More importantly so, there has been a refocusing of market participants on the macroeconomic fundamentals of the Brazilian economy. Improvements in the trade balance and the current account have underscored the progress made on Brazil's external position.

Colombia

20. The pace of Colombia's economic recovery has slowed in 2001 as both external and domestic factors combined to reduce GDP growth in the first nine months of the year. To a considerable extent, the slowdown reflected a weakening of external and domestic demand. In particular, external markets weakened affecting coffee and more recently the export of manufactured goods. The domestic security situation contributed to the slowdown on the domestic front. Notwithstanding, policy implementation has strengthened, fiscal performance remained on track, and the foreign exchange market has remained orderly. Colombia has enjoyed significant success in accessing the international private capital markets.

Combating Money Laundering and the Financing of Terrorism

21. Our chair strongly supports a strengthening of international cooperation in combating money laundering and the financing of terrorism, and an intensification of the Fund's activities in this area in a way that is consistent with the Fund's mandate and principles. Money laundering has significant adverse consequences both at the national and the international levels. It can create reputation risks for financial institutions, compromise the integrity of the financial system, and distort the efficient global allocation of resources. This can create significant negative externalities that can be transmitted across national borders.

22. Terrorism and its financing can also compromise the integrity of both national and international financial systems and have far-reaching economic consequences for the national and global economies as demonstrated by the September 11 events. Indeed, these tragic events have strengthened the growing international consensus not to tolerate that the financial system is abused either as a hideout place for ill-gotten money through money laundering activities, or as a conduit for financing criminal activities such as terrorism.

23. The Financial Action Task Force (FATF) 40 Recommendations are recognized as the key international standard to deter money laundering by a large number of countries, including those in our constituency. The UN Security Council Resolution 1373 requiring all member states to prevent and suppress the financing of terrorism, and the adoption by the FATF at its recent extraordinary meeting in Washington of eight new recommendations on terrorist financing constitute important multilateral developments that need to be incorporated in the Fund's work against financial abuse.

24. Efforts to combat money laundering and financial abuse are needed in all countries, be they offshore financial centers or major international financial centers. No country can solve the issue of financial abuse alone. A crucial aspect of international cooperation against financial crime is a fluid cross-border information sharing and exchange arrangements. Global consolidated supervision can also be a powerful instrument to combat money laundering and financial crime.

25. A discussion of member countries' actions against money laundering, financing of terrorism and other forms of financial abuse needs to be incorporated in the Article IV surveillance process and in all Financial Sector Stability Assessments and Offshore Financial Center Assessments. Priority should be given to countries where the financial system is perceived as subject to significant money laundering and financial abuse, and to countries with large financial centers that have systemic importance worldwide.

26. The Fund also needs to strengthen its coordination in this area with the FATF and regional anti-money laundering organizations with a view to develop and implement a ROSC process to assess standards against financial abuse in a uniform, cooperative, and voluntary manner. Coordination with other agencies would also be necessary to increase the provision of technical assistance in drafting laws, regulations, and supervisory guidelines that conform to accepted standards, as well as in the establishment and operation of Financial Intelligence Units.

27. Brazil's efforts to combat money laundering date back to 1991 when it ratified the Vienna Convention. In March 1998, Congress approved a new law that allowed for a major overhaul of the legal and operational framework to combat money laundering. The new law expanded the list of antecedent crimes associated with money laundering, created a Financial Intelligence Unit (COAF), and extended the obligation of reporting suspicious transactions beyond the banking system to encompass stock exchange brokers, commodity dealers, real estate agents, credit card companies, leasing and factoring companies, lotteries, jewelry and precious metals dealers, and fine arts dealers.

28. Brazil is a member of the FATF, was assessed by the FAFT in February 2000, and is one of the ten members of the FATF that is compliant with all its 40 recommendations. In 2000, the reporting of suspicious transactions increased substantially, reaching 7,451, and led to 114 criminal inquiries in which 98 persons were indicted.

29. Joining in the international efforts to combat the financing of terrorism, Brazil has enacted UN Security Council Resolution 1333, through Presidential Decree N. 3755, of February 19, 2001 and UN Security Council Resolution 1373, through Presidential Decree N. 3.976 of October 18, 2001. Since September 11, Brazil has carried on a comprehensive investigation to track down financial transaction of and/or asset holdings by suspected individuals in connection with the terrorist attack to the United States.

30. Colombia has adopted legislation regarding the control and prevention of money laundering that permits it to comply with the 40 recommendations suggested by the FATF. Colombia is also reviewing its instruments to control the facilitation and transfer of terrorist funds. The information and Financial Analysis Unit (UIAF) was established in 1999 as part of the country's integrated system to fight money laundering. Its main function is to detect funds originating from drug related criminal activities. Law N.526 allows the UIAF to track overseas funds in coordination with corresponding entities in other countries.