The Global Economic Outlook and Developments in Financial Markets

The current geopolitical situation entails significant risks which are being reflected in the wait-and-see attitude of consumers, investors and financial markets. However, if the war in Iraq comes to an end soon and the geopolitical situation in the Middle East stabilizes, global economic prospects will be substantially improved. To the extent that geopolitical uncertainties recede, more fundamental economic issues will come back to the top of the agenda. In this situation, strong international cooperation, based on appropriate and sustainable economic policies, can contribute to reducing market uncertainties.

We share the IMF's assessment that a possible further weakening of economic prospects and further strains on financial markets would require appropriate and flexible responses. However, more important than short-term measures is a renewed orientation of policies towards medium-term sustainability and the strengthening of economic fundamentals.

For industrial countries it is necessary to continue with or to return to credible budget consolidation. At the same time, the challenges posed by demographic changes need to be addressed vigorously. Therefore, budget consolidation has to be accompanied by reforms of the social security systems. This is especially important for Germany. The German government will proceed with implementing far-reaching reforms in the labor market and in the health sector in the course of this year. Reforms of the pension system have already been implemented and will be continued.

The industrial countries must also continue their efforts to ensure sound financial sectors. Financial sectors have proven their resilience so far, but present strains have to be overcome. To counter these strains, it is important to strengthen cooperation between supervisory authorities, to improve corporate governance and to make accounting more transparent. While we have achieved substantial progress, much remains to be done.

For emerging markets, sustainable macro-economic policies and a continuation of structural reforms are necessary to further reduce economic vulnerabilities. Against the backdrop of the financial crises since the mid 1990s, emerging markets should increase their efforts to establish sound and well performing financial sectors. This includes sustainable public debt, stronger reliance on domestic sources of capital formation as well as implementation and adherence to international standards and codes.

We continue to believe that free trade is one of the cornerstones of a prospering global economy. Free trade provides the opportunity for all countries, including the poorest, to reap the benefits of globalization. It is, therefore, important to further open markets to facilitate trade. In particular, it is necessary to achieve substantial progress within the Doha Round, also in order to improve market access for developing countries.

From our point of view, it is important to return to potential growth as soon as possible. In order to achieve this, structural impediments to sustainable growth have to be removed more vigorously and public finances have to be put on a more sustainable foundation.

Strengthening Crisis Prevention

Prevention is clearly the first line of defense against financial crises, and surveillance is the Fund's most important mandate in this regard. We welcome the continuing progress in strengthening the Fund's surveillance and support further improvements within the existing framework.

For surveillance to be effective, quality, objectivity and independence from political program constraints are key. A number of avenues could be pursued to foster these goals: The focus on risks and vulnerabilities facing member countries should be further sharpened, including in the areas of exchange rate policy and debt management. Second opinions from outside the Fund could be sought on specific policy issues, to complement the valuable work undertaken by the Independent Evaluation Office (IEO). Transparency could be enhanced by further boosting publication rates of Article IV documents as well as Reports on the Observance of Standards and Codes (ROSCs) and Financial Sector Stability Assessments (FSSAs).

At the same time, the frankness currently prevailing in consultations between Fund staff and the authorities is an asset that must be preserved. While the Fund should avoid assuming the role of a "rating agency" in its assessments of members' policies, appropriate measures to strengthen surveillance always deserve our support. We, therefore, welcome the ongoing efforts to provide a fresh perspective on Article IV consultations in countries which have an adjustment program supported by Fund resources. However, proposals to fundamentally change the existing institutional framework of surveillance raise issues of Fund governance, staff resources, costs, and synergy losses. While we support the efforts to strengthen the objectivity and independence of IMF surveillance work, we would like to emphasize that it is primarily IMF lending policy whose objectivity and political independence require to be strengthened and defended.

We welcome the increased interest of members to produce ROSCs and conduct Financial Sector Assessment Programs (FSAPs). We are also encouraged by the existing evidence suggesting that ROSCs and FSAPs are increasingly being recognized by markets as valuable inputs into their risk assessments. This is likely to facilitate access of borrowing countries to international capital markets. In addition, ROSCs and FSAPs are generating a valuable body of knowledge and experience both on the part of the participating countries and the Bretton Woods Institutions. We support the recently agreed measures to increase the cost-effectiveness of these initiatives and to better tailor them to country-specific circumstances, without undermining the quality and comparability of results across countries. The focus should remain on the systemically important countries.

Improving the Capacity to Resolve Financial Crises

We welcome the comprehensive approach the IMF has adopted in its efforts to improve the international framework for resolving financial crises. These endeavors are guided by several principles. Firstly, economic and social dislocation resulting from crises that can be attributed to the lack of a clear framework for crisis resolution, must be reduced. Secondly, the behavior of the official sector in the event of crises must be made as clear and predictable as possible. Thirdly, obstacles to effective crisis resolution must be removed, while limiting interference with the market process to a minimum. Pragmatism and flexibility are important, but more is needed to reach these objectives. The crisis resolution framework needs to be sufficiently comprehensive, encompassing a number of areas, including first and foremost the Fund's access policy, the involvement of the private sector, and the orderly restructuring of unsustainable sovereign debt.

We are encouraged by the progress that has recently been made in several areas. Consistent with the need for greater discipline in the provision of official financing in crisis situations, the Fund's access policy has been further sharpened. Predictable and credible access limits are essential for stabilizing international private capital flows and to induce early debtor and private creditor contributions to the resolution of financial crises when they occur. If applied consistently, the newly agreed procedures and the four substantive criteria for granting exceptional access in capital account crises are designed to ensure and to signal that such access indeed remains truly exceptional. In this context, it will be important for the credibility of the Fund's access policy to consistently restrict exceptional access in capital account crises under the terms required by the Supplemental Reserve Facility (SRF) which had been designed for precisely such cases. Blending of the SRF with other facilities above the regular access limits should be ruled out given the lengthening of the maturity of the SRF. At the same time, the analytical tools to make informed decisions on exceptional access need to be developed further, in particular the tool of prudent debt sustainability tests.

We also welcome the progress that has been made in facilitating timely and orderly restructuring of unsustainable sovereign debt positions. We support the current deliberations on the development of a code of good conduct. Such a code could help guide creditors and debtors and it could promote a constructive dialogue between the two. Closer debtor-creditor relations in ,,good times" will be most helpful in times of financial distress. To be successful, a code of good conduct needs to be based on a broad consensus. All relevant stakeholders should therefore be involved in the process of drafting such a code.

The inclusion of collective action clauses (CACs) in recent Mexican bond emissions is a welcome step. We are encouraged by the favorable initial experience which suggests that the inclusion of CACs has had no (or only a negligible) impact on interest spreads. This experience should help to overcome the ,,first mover problem" and we encourage other issuers to follow suit. As far as Germany is concerned, the government remains of the view that the use of CACs fully conforms with German law. Nevertheless, legal clarification is now underway to promote the adoption of CACs in bonds issued under German law. While the specific choice of CACs is ultimately a matter of negotiation between debtors and creditors, the IMF has an important role to play in persuading issuing countries and markets of the benefits of CACs. In this regard, the recent recommendations put forward by a G10 working group provide a good point of reference.

A code of good conduct and CACs are valuable and promising tools. However, we believe that in times of particularly acute distress, the need for more far-reaching instruments cannot be ruled out. The sovereign debt restructuring mechanism (SDRM) proposed by Fund Management is one such comprehensive instrument. Such an ambitious project clearly needs time to be realized. The necessary broad-based international support for the SDRM has yet to materialize.

However, the question remains how to deal with collective action problems and disruptive litigation on the part of creditors once a cessation of payments has become an inevitable fact. The Fund should not shy away from these issues, but continue to consider how to best address them. At the same time, there is merit in focusing on instruments, such as CACs and the code of good conduct, that are less ambitious and hence feasible over a shorter time-span. A code of good conduct needs to be complemented by CACs in order to be truly effective. But in the longer run, neither instrument will be a substitute for a more comprehensive framework. We expect that the discussion on the SDRM will continue.

Implementing Initiatives to Support Low-Income Countries

We are pleased to learn that the quality of country-led Poverty Reduction Strategy Papers (PRSPs) has increased markedly and that the alignment between PRSPs and Poverty Reduction and Growth Facility (PRGF) based programs has improved. We support the IMF's approach to closely analyze the different scenarios on which PRSPs are based and to critically

examine the coherence between national budgets and PRSPs in recipient countries. In addition, an effective collaboration among all donors and low-income countries is necessary. These are essential ingredients to achieve the Millennium Development Goals. Furthermore, only budget proposals which are neither overly optimistic nor unduly pessimistic can serve as a reliable basis for a fruitful cooperation between donors and recipient countries.

We continue to believe that good governance in debtor countries is key to achieving and sustaining economic development. If this causality is taken into account, then debt forgiveness should be aimed at good governance. We, therefore, propose that any additional financial support should primarily benefit countries with a convincing track record of good governance.

Strengthening the voice of developing countries is an important element to bring equal partnership between industrial and developing countries, which was agreed upon in the "Monterrey Consensus", to life. This can only be achieved by a number of closely coordinated instruments and measures which benefit all involved. Within such a broader framework, we support the strengthening of the offices of the Sub-Saharan African Executive Directors in the Fund. A further building block to strengthen the voice of developing countries in the Fund could consist of the allocation of additional basic votes for all members. This would give a clear signal that all voices of the universal membership are heard in an appropriate manner in the Fund. IMF management and staff could utilize the next quota review to point the way on how progress can be achieved in this regard. While a discussion on how to strengthen the voice of developing countries can be helpful to identify areas of weakness, overall the current system of country representation on the Board of the IMF has proven to be efficient. It should not be substantially changed unless an alternative that is clearly superior in most if not all aspects has been identified.

The pressing problems of developing countries, especially of the poorest, have to be tackled urgently. The "Monterrey Consensus" and the implementation of the Millennium Development Goals highlight not only the responsibilities of donors in this context but also - and possibly to an even larger extent - the responsibility of the poorest countries themselves. We, therefore, do not support a new discussion on development goals or official development aid (ODA). The current discussion should be continued in a results oriented manner by the appropriate experts in the United Nations and its organs.

The proposed International Finance Facility (IFF) is subject to a number of pertinent questions, both on technical and, even more important, on political issues. These comprise the involvement of national parliaments and their willingness and ability to make definite commitments spanning several decades, but also the credibility of development aid in general. We have serious doubts whether the proposed IFF would be helpful with regard to development cooperation. We, therefore, are not in favor of such a facility, which, in our view, would not be in the best interest of donors and recipients.

Combating Money Laundering and the Financing of Terrorism

We commend the IMF, the World Bank and the Financial Action Task Force (FATF) for agreeing and endorsing a common methodology for assessing the adequacy of member countries' institutional frameworks and actions regarding anti money laundering (AML) and combating the financing of terrorism (CFT). We welcome the integration of the FATF 40+8 recommendations into the list of areas where standards and codes are useful to the operational work of the Fund as well as the cooperative international approach this step represents as an important achievement. This will considerably improve global adherence to these important recommendations, thereby contributing to safeguarding the integrity of the international financial system. The common methodology is currently being used during a one year AML/CFT-pilot program. While a comprehensive review of the actual cooperation among the institutions involved is envisaged at the end of the pilot program, it is crucial that the agreed common methodology remains the basis for the evaluations within the framework of the FSAP. This will ensure the high quality and usefulness of these assessments which are a key tool to overcoming the still remaining weaknesses of AML/CFT systems in many jurisdictions identified by the joint interim report. With regard to sharing the assessment burden, we are confident that a fair solution can be found by the institutions involved in the FATF's working group on International Financial Institutions' Issues. Regarding further discussions on informal transfer systems, especially on how to identify and supervise Hawala activities and how to restrict the basis of illegal Hawala transactions, we believe that a close coordination of the Fund's activities with those of the FATF and its respective working groups is important.

IMF Quotas and Governance

We welcome the recent conclusion of the Twelfth General Review of Quotas. Taking current developments in the world economy and IMF lending policies into due account, we remain confident that the Fund has ample resources to adequately respond to members' future financing needs. As for the Fund's quota distribution, it should reasonably reflect the relative economic strength of member countries in the world economy. This should remain the guiding principle for any revision of the quota formulas. A new quota formula should be as simple and transparent as possible.

The IMF's transparency policy

We welcome the ongoing efforts to enhance the transparency and openness on the part of the IMF and its member countries. We encourage the Fund to establish a two-way communication with civil society organizations and other interlocutors in order to enhance public understanding of the Fund's work and to take into account the views of its critics as well as its supporters. These efforts should be pursued while fully respecting the role of the Executive Board and the member authorities which bear the sole responsibility for the conduct of the IMF's policies. In the same vein, enhanced publication of staff reports for Article IV consultations and use of Fund resources, as well as ROSCs and FSSAs will facilitate a better assessment of risks by borrowers and creditors. There is further scope for improvement in this area, given the uneven publication rate across countries and regions.

Activities of the Independent Evaluation Office

We strongly appreciate the work of the Independent Evaluation Office (IEO), especially the candid and frank assessment of difficult and sometimes delicate topics. We encourage the office to continue with its excellent work, as manifested in the first evaluation report. The IEO is an additional element to strengthen transparency and internal governance of the IMF.