Economic outlook: finding the way up

There are increasing signs that the world economy has turned the corner and has steered clear of a global recession. Amidst positive projections for this and particularly next year, it is easy to forget how close a call it was. As some observers have noticed, "it's the recession that wasn't". Although Japan experienced its most severe recession of the last decade, the US and the euro area still registered positive growth in 2001, whilst the financial system displayed its resilence in the aftermath of some global shocks. Today there seems to be a growing denial that the global economy was ever in any real danger. Although good prospects are preferable to bad memories, the current optimism bears two serious risks.

First, structural imbalances have largely remained. Containing the US current account and private sector debts, restructuring the Japanese financial and corporate system, and reforming Europe's product and labour markets will be crucial to put the world economy on a high and sustainable growth path. Besides, there are a number of potential threats to a strong economic recovery in the short run, notably the uncertainties related to the war against terrorism, the instability in the Middle-East, which has already pushed up oil prices, and possible risks of the economic situation in Latin America.

Secondly, it should be noted that while global growth was still positive in 2001, world trade growth slowed almost to zero from no less than 12 percent in the previous year. This was a considerably sharper fall than in 1991, which registered as a year of global recession. Although the current trade outlook is far more positive, it risks being undermined by indications that major economies are not committed to free international trade. The US curbs on steels imports not only disrupt world trade, but also send a wrong signal to the developing world. They might even overshadow the powerful impetus that was given to the start of the global trade liberalisation round last year. Together with our European partners, we therefore call on the US administration to also remain committed to free trade principles and practices, as well as to the rules of the WTO.

The international financial architecture: work in progress

In response to the various crises of the nineties, the IMF has played a crucial and constructive role in reforming the international financial architecture. But this architecture - consisting of measures to prevent and resolve financial crises - needs continuous maintenance and fortification, as illustrated by recent cases of Argentina and Turkey. There are three main players in the resolution of financial crises: the national authorities, the international community, notably the IMF and, last but not least, the private creditors. Financial crises should therefore also be managed by these three parties. As outlined below, strengthening the international financial architecture implies a stronger role for the Fund in surveillance, more private sector involvement in crisis resolution and greater country ownership of adjustment programs through a streamlined conditionality. Incentives need to be created to get all three parties on board.

IMF surveillance: the key pillar of crisis prevention

The effectiveness of surveillance as a crisis prevention tool depends on its ability to detect potential vulnerabilities in member countries. In this context, significant progress has been made in adapting the IMF surveillance to the changes in the global financial environment, particularly to the stronger integration of financial markets. Against this background, we support the work aimed at strengthening the financial sectors via the FSAPs and the Netherlands is keen to participate in such a program in 2003. We also welcome the Fund's efforts to intensify its assessments of offshore financial centres, since these centres play an increasingly large role in the intermediation of international capital. Cyprus was the first country to complete a full OFC-assessment, while also the Netherlands Antilles and Aruba are in the process of doing so. Moreover, we attach great significance to an effective Fund surveillance and invite the MD to develop proposals to making it more transparent, accountable and objective.

To this end, we would like to share five concrete and practical suggestions. First, we propose that every Article IV report contains debt sustainability analyses (including stress tests) as well as an assessment of the soundness of the financial sector. Second, in order to enhance transparency vis-à-vis private parties and the public at large, we encourage the Fund and its member states to move towards full publication of Article IV reports. If needed, the reports published might be filtered for market sensitive information. Third, to give Article IV consultations more bite, missions should be planned less on the basis of staff schedules and more on the basis of the agenda of the national policy debate. For example, missions could be held in the initial stages of the country's budget preparation or after rather than before national elections. Fourth, each program document could start with a brief account of past surveillance. This would directly promote the accountability of the IMF surveillance, indicate to what extent national authorities have adhered to IMF advice in the past as well as indicate to what extent earlier surveillance had rightly signalled risks. Finally, we call for enhanced co-ordination between the different surveillance activities of the Fund, such as Article IV consultations, FSAPs and ROSCs, which would foster its overall effectiveness.

Resolving financial crises: from bail-outs to work-outs

The application of the PSI-principles, agreed in Prague in 2000, in the management of the crises in Argentina and Turkey has been disappointing. In both cases, the Fund supplied exceptionally large financing packages, while the private sector was not involved in a systematic manner. However, in crisis management, it takes three to tango. Against this background, we strongly welcome the initiative taken by Fund management for a formal mechanism to facilitate an orderly restructuring of sovereign debt (SDRM). The rationale for such a mechanism is four-fold: it could help solve creditor coordination problems, prevent the building up of excessive debt positions, strengthen crisis management and enhance the credibility of the Fund's access policies. Although the IMF's diagnosis is widely shared, there is unfortunately less agreement on the proposed cure. In this regard, we are particularly puzzled by assertions that the proposed bankruptcy mechanism would not be market-oriented. Something that is a cornerstone of a market economy on a national level cannot suddenly become market-unfriendly when implemented on a global level¹. This is not to deny that there are considerable differences between corporate and sovereign bankruptcy procedures.

We encourage the elaboration of the SDRM-proposal, aiming at a statutory solution to the restructuring problem. In this context, we feel that the role of the Fund in the various stages of application of the mechanism could remain `light', as recently suggested by Ms. Krueger. Key decision-making powers would then be placed in the hands of the member country and the supermajority of the creditors. At the same time of course, the interests of debtor countries should not be overlooked. While supporting the SDRM, we acknowledge that, in light of the political and legal challenges it raises, it should be seen as a medium term goal. In the meantime, other complementary approaches to enhance the application of PSI should be pursued with urgency. In particular, it is important that a widespread use of collective action clauses is actively promoted. These clauses can play a key role in facilitating restructuring in the interim period before the new debt restructuring mechanism is in place and in restructuring in the `shadow of the law' once it has been established. Indeed, the two approaches should be viewed as mutually supportive, since collective action clauses will only bind in holders of the same bond issue, and thus will take us only part of the way. Other complementary measures are also needed: ensuring that predetermined access limits are adhered to; fleshing out the `lending into arrears policy in order to facilitate informal standstills; and deepening the analytical basis for the assessments of debt sustainability.

Boosting ownership through streamlining conditionality

In 2000, the majority of the IMF membership supported proposals of MD Köhler to focus and streamline conditionality and enhance country ownership of IMF-supported programs. One year and a half down the road, following profound discussions on both the coverage and the instruments of conditionality, the commitment to these objectives seems to be dwindling. This is the more worrying since actual progress has been limited so far, and the burden of conditionality on debtor countries remains considerable. We strongly encourage further efforts to deliver results in this field and are in favour of revising the conditionality guidelines, which is scheduled for this year's Annual Meeting.

Against this background, we would like to share four suggestions to promote national ownership. This would, in turn, enhance the effectiveness of IMF-lending and clean up IMF's reputation as "an institution that micro manages on a macro-scale". First, in designing adjustment programs, missions should discuss with the national authorities alternative policy scenarios to achieve the agreed program objectives and should spell out the trade-offs involved rather than prescribing a single set of detailed policy actions. Second, outcome-based conditionality should be promoted as much as possible. At the same time, we recognize that in the first phase of a program, monitoring may often still need to be based on the implementation of policy measures, which are considered time sensitive as well as essential. Thereafter, more emphasis may be placed on outcomes achieved. Outcome-based conditionality is therefore especially suitable for programs with their focus on structural policies, sustained economic growth and poverty reduction. In certain cases, this may be combined with so-called floating tranche disbursements, which would further increase the scope for ownership. Third, restraint should be exercised in using prior actions. The IMF should always justify why certain prior actions have been included in the program by spelling out why these are crucial for macro-economic and financial stability. Consideration could be given to setting a specific threshold with respect to the number of prior actions above which formal reporting to the Board would become mandatory. The use of prior actions could further be reduced by specifying these measures, if possible, as floating tranche conditions. Finally, important measures outside the Fund's mandate should primarily be dealt with by other institutions, notably the World Bank. We therefore support a further improvement in the mutual co-operation on this account. We hope these suggestions further stimulate a discussion on what we earlier labelled the four M's of conditionality: Mandate, Macro-management, Motivation and Multilateral cooperation.

Other areas of concern

• The role of the IMF in poor countries. The Financing for Development conference was a success. We commend the IMF and the World Bank on their key roles to mobilise support to increase development assistance in order to achieve the Millennium Development Goals (MDGs). The PRSP/PRGF review has revealed significant progress. But local capacity and genuine country ownership often remain the Achilles' heel of the PRSP-process and need to be addressed energetically. In order to sustain the success of the HIPC-initiative over the next years, its expected financing gap of at least US$ 0.7 bln needs to be dealt with soon.

• Money laundering and financing of terrorism. We strongly back the international fight against money-laundering and the financing of terrorism. Given their potential adverse impact of these subversive activities on national and international financial stability, the IMF, together with the World Bank and FATF, is encouraged to keep playing an active role in this field. In order to be effective the role of the IMF should remain within its mandate and expertise. A strict division of labor and responsibilities with other relevant organizations should guarantee a comprehensive assessment of all aspects of money laundering and terrorist financing in individual country assessments, based on the ROSC principles of being uniform, cooperative and voluntary. A possible extension of IMF conditionality critically rests on the assumption that measures with respect to money laundering and financing of terrorism are essential for macro-economic and financial stability.

• Independent Evaluation Office. We believe that the newly established Evaluation Office can play an important and constructive role in further shaping the role of the IMF in strengthening the international financial architecture. In this respect, we hope that it will pay due attention to all three parties involved, especially to ways the IMF has attempted to involve the private sector, when it analyses recent capital account crises.