1.  World Economic Outlook and Policy Responses

The World Economy

Although the global economy has been sluggish since the middle of 2000, there have been increasing signs of a bottoming out over recent months, and it is now expected that the economic upturn will occur by the middle of this year, supported by the completion of inventory adjustments and supportive macroeconomic policies in each country. The movement in financial markets, especially, has already priced in an early recovery of the world economy. The signs of recovery are most clearly observed in the United States. Contrary to some projections, the negative impact of the September 11 terrorist attacks remains insignificant. In the euro area, it is expected that the recovery will follow the same path as in the US, supported by the completion of inventory adjustments and an improvement in external environments. The introduction of euro notes and coins early this year will contribute to the further promotion of market integration in the euro area. In Asia, the level of growth remains relatively high, and continuous robust growth is expected in China and India. The signs of recovery are also becoming ever more apparent in Korea.

Nevertheless, downside risks still remain. First, should the pace of the recovery in the global economy turn out to be slower than expected, it could cause asset prices to plunge, thereby worsening the balance-sheet problem in the household and corporate sectors. Second, especially in Europe, the rigidity of the labor markets could result in disproportionately high wage and price hikes relative to the pace of economic recovery, which would hinder robust recovery. Third, the situation in Argentina is worrying. Although the spillover effect from Argentina on other emerging economies has been quite limited so far, it remains necessary for the Argentine authorities to endeavor to conclude a new package with the Fund promptly in order to avoid possible negative effects on the world economy.

It is important for each country to maintain sound macroeconomic and structural policies that will contribute to sustained economic growth and sound financial markets.

The Japanese Economy

The Japanese economy remains in a difficult situation. In late February, the government launched an "anti-deflation package", and the Bank of Japan also took further monetary easing measures, including an increase in the outright purchase amount of long-term Japanese government bonds, and made it clear that it will continue its utmost efforts to secure market stability and to realize the full permeation of the effects of monetary easing by providing ample liquidity.

These concerted efforts by the government and the Bank of Japan, along with progress in the disposal of nonperforming loans and the materialization of corporate restructuring plans, both of which were partly promoted by the special inspections carried out by the Financial Services Agency, have been welcomed by the market, and the stock indices have soared. The alleged "March financial crisis" has turned out to be just an illusion, and the financial system remains stable. In addition, industrial production and exports are now bottoming out, and a new basis for growth, including improvement of the external environment and progress in inventory adjustments, is being steadily built. The Japanese economy is expected to begin to recover in the latter half of this year.

One of the most significant problems in our economy is the nonperforming loan issue. In order to accelerate the disposal of nonperforming loans, the Japanese government recently decided to:

i) Accelerate the current timeframe for the removal of nonperforming loans from banks' balance sheets, which calls for removing loans newly classified as "in danger of bankruptcy" or below within three years, by adding a new target that requires, in principle, disposal of 50 percent of the nonperforming loans within one year and 80 percent within two years.

ii) Enhance the effectiveness and efficiency of inspections by introducing a de facto resident inspection system for each major banking group.

iii) Explore measures to promote the consolidation of financial institutions, particularly regional institutions.

There have been concrete developments in the disposal of nonperforming loans since last year. In particular, special inspections were carried out in major banks, mainly focusing on their major debtors that have experienced significant changes in the value of their stocks and in their credit ratings. A broad range of assets was examined to determine whether debtor classifications and level of write-off and provisioning are adequate. The results were released last week. The losses from the NPL disposal, which was announced by the major banks in tandem with the release of the special inspections results, amounted to 7.8 trillion yen, an 80% increase over the last year's losses from NPL disposal. This increase confirms that the pace of NPL disposal is indeed accelerating.

Progress is also being achieved on the corporate restructuring front. The Resolution and Collection Corporation (RCC) has already been utilized in some cases. In addition, a corporate reconstruction fund (deleveraging fund) was established led by private financial institutions, and several asset management corporations have been set up in order to establish such funds in the coming months. These actions are expected to further promote corporate revival.

Furthermore, measures to enable the RCC to purchase nonperforming loans from financial institutions at fair value and to participate in auctions of nonperforming loans held by financial institutions were enforced this January. The government has decided to urge major banks to aggressively utilize the functions of the RCC, including its function as a trustee, so that NPL disposal will be further accelerated.

On structural reform, I recognize that reform cannot proceed without pain. I am confident, however, that beneath the pain a new basis for growth is steadily materializing: NPL disposal and corporate restructuring and revival are under way, and corporate management is becoming more innovative and dynamic, led by younger people with new visions and ways of doing business.

In order to support this trend and invigorate private economic activity, it is important to focus the government's policy measures, such as fiscal and tax measures and deregulation, on areas identified as having high growth potential, while at the same time ensuring fiscal discipline.

To this end, the government intends to conduct an intensive discussion to determine the basic direction of policy management, mainly in terms of economic and fiscal structural reform, and will announce in June its new thinking on economic and fiscal policy management.

The Twelfth Quota Review

Although there is a general trend toward broad recovery, various risks still remain in the world economy. In addition to stepping up its efforts toward preventing crises, the IMF must fulfill its responsibility to secure sufficient resources to enable it to provide timely and adequate financial support to member countries that are making appropriate efforts to restore balance of payments stability. The Fund's liquidity ratio, which is an indicator of the adequacy of the Fund's resources, fell from 150 percent in August to 105 percent in September and has hovered around that figure ever since. Thus, from the medium-term perspective we cannot be confident that an adequate amount of lending resources is still available.

The IMF has begun the process of the Twelfth Quota Review for which a Committee of the Whole has been established. Japan urges the IMF to engage in more active discussion in order to arrive at a general quota increase expeditiously.

The total size and allocation of the current quotas do not appropriately reflect the reality of the world economy, as the past quota increases were not designed well enough to take proper account of global economic growth, increases in capital flows, and changes in the relative economic positions of member countries since the establishment of the IMF. As a result, at present, neither the amount nor the shares of members' allocated quotas are appropriate. Given the importance of its quota to a member--since it is the amount of quota that defines the member's financial contribution to the Fund, its access to IMF resources, and its voting power--in addition to increasing overall quota size, we need to consider adjusting individual members' quota shares.

2.  Effective Prevention and Orderly Resolution of Crises

To strengthen the IMF's crisis prevention function, further improvement in IMF surveillance is called for. To this end, the IMF needs to cover areas, such as the financial sector, that have an important impact on the macroeconomic situation, while strengthening its focus on issues within its own expertise. I hope that the ongoing review of the IMF's surveillance activities will follow this principle.

As the Managing Director notes in his report, however, it is impossible to eliminate all risks of future crises. An important challenge is how to achieve an orderly resolution of financial crises once they occur. The international community has for the past several years been working on a framework for more orderly resolution of financial crises. Following Ms. Krueger's proposal for a sovereign debt restructuring mechanism (SDRM), the work on a crisis resolution framework has attracted increased attention and interest from many quarters, including from market participants. Although the proposed mechanism is unlikely to be introduced within the next few years, I think it is appropriate to continue to examine it, particularly since it would complement the informal mechanisms described below.

In addition to further examination of the SDRM, it is important for us to build on our efforts to date and press ahead with the work toward the realization of orderly resolution of actual crises. In this connection, I urge the IMF to:

• Reconfirm that the IMF's and other official resources are limited and that any access to IMF resources beyond normal access limits has to be strictly exceptional. To this end, whenever the IMF management and staff recommend the granting of exceptional financing, they should explain fully to the Board why such financing is necessary and justified. It is of course important to make access limits more realistic in order to ensure that adequate resources are available in case of so-called capital account crises, which have occurred frequently in recent years, and so reduce the need for exceptional financing. There is also the underlying issue that increases in IMF quotas have not kept pace with changes in the world economy. This too underlines the urgency of a quota increase and a change in quotas shares.

• Further encourage the inclusion of collective action clauses (CACs) in bond contracts. CACs are very useful tools for enabling an orderly resolution of crises, based on private contracts between debtors and creditors. There has been little progress in this area, however, despite long-standing discussions in favor of such clauses. Their use must be promoted by providing proper incentives, such as making their inclusion in sovereign bond contracts a condition for the use of Fund resources.

• Clarify its role and the modalities of its involvement in a member country's decision on standstills as well as its lending into arrears. This would help prevent the reluctance of debtor countries to restructure their debt making the situation worse. In cases where the IMF lends into arrears, there is a need to monitor whether the policy measures taken by the borrowing country are appropriate and whether IMF resources are being properly used. These two objectives can be accomplished by intensified monitoring by the Board. Ex-post evaluations by the Independent Evaluation Office would also be very useful.

3.  Recent Challenges

The Role of the IMF in Low-Income Countries

With regard to the Poverty Reduction and Growth Facility (PRGF), I am pleased to note that the loan resources for the interim PRGF have already been secured through contributions from member countries, including an additional contribution from Japan amounting to $ 1 billion.

The importance of capacity building in low-income countries cannot be overemphasized. Japan, being well aware of this, has contributed more than one third of the Fund's technical assistance resources.

Streamlining IMF Conditionality

Since the last IMFC meeting, steady progress has been made in streamlining IMF conditionality and strengthening program country ownership. The IMF's Executive Board discussed these issues in March, based on quantitative analysis of changes in the areas covered by conditionality and in the number of conditions, as well as qualitative analysis of how conditionality has been streamlined in selected actual programs. It is encouraging to know that a firm commitment to streamlining conditionality was made by IMF management and the staff in the March Board discussion. Japan fully supports the Managing Director's intention to reach agreement on new conditionality guidelines before the next IMFC meeting. Looking forward, what is most important is whether the performance of IMF programs will improve as a result of the streamlined conditionality. I believe the Independent Evaluation Office should conduct an ex-post review of this after the new guidelines are introduced.

Combating the Financing of Terrorism

Japan has made significant progress in combating the financing of terrorism. We have taken a number of asset-freezing actions on the basis of the UNSC Resolutions, and a total of 281 individuals and entities related to the Taliban, as well as 12 non-Taliban individuals and entities, have already been named. Furthermore, we have just taken an asset-freezing action against 10 individuals and entities, in coordination with G-7 countries. In addition, a set of new laws to combat the financing of terrorism was submitted to the Diet in March for its approval. These laws are expected to be approved shortly. Japan strongly encourages all member countries to take the actions described in last fall's IMFC communiqué, as well as to conduct self-assessment according to the FATF's Special Recommendations to combat terrorist financing.

I highly appreciate the efforts made by international bodies such as the IMF and the FATF to combat the financing of terrorism. I would like to see further progress in effective coordination among relevant organizations, for example in developing a uniform methodology to appraise measures for anti-money laundering and combating the financing of terrorism. I welcome the assessments made by the IMF of countries' efforts at anti-money laundering and combating the financing of terrorism through FSAPs, offshore center assessments, and the Article IV consultations. Finally, it is important to establish a mechanism by which appropriate technical assistance can be provided in a cooperative manner by related international institutions such as the IMF and the FATF. Japan would be willing to actively support and contribute to such an initiative.

Modalities of International Meetings

Although last fall's Annual Meetings, including the IMFC meeting, were shortened and these Spring Meetings are also under strict time constraints, the meetings have been scheduled efficiently and provide adequate time for effective discussions. I commend the IMF, the World Bank, and our host country for their efforts. Looking forward, we need to continue to review the arrangements for and agendas of various international meetings to make them as effective and efficient as possible. While it is of course necessary to maintain meetings where truly substantive discussion takes place, we should make further efforts to significantly streamline international meetings.