FROM THE OFFICE OF PUBLIC AFFAIRS

Mr. Chairman, Ranking Member Biden, and Members of this Committee, I am pleased to have this opportunity to discuss recent developments in the global economy and the ongoing reform of the global financial architecture, especially the International Monetary Fund - which I know to have been of considerable interest to this committee and other members of Congress.

Let me focus my remarks on four issues:

• First, the current outlook for the global economy, including the crisis economies in which the IMF has recently been actively involved.
• Second, core lessons for national policy makers and the international community from the experiences of the past few years.
• Third, recent reforms of the IMF and the broader international financial architecture with particular reference to the areas that were emphasized in last year's IMF legislation.
• Fourth, further architectural reform issues that the United States will be pursuing going forward.

The Global Economic Outlook and Prospects for the Emerging Market Economies

Looking around, I think that most would agree that the global economic outlook has improved significantly since I spoke to the Subcommittee on International Economic Policy and Export and Trade Promotion last winter, and certainly since last year when Congress was grappling with the issues of IMF funding and reform.

Forceful domestic policy steps in Korea, Thailand and Brazil - combined with the substantial financial support that was mobilized by the official community - have brought important progress in setting these countries on the path to recovery. Market confidence in these and other emerging market economies is on the mend.

• In Korea, net foreign reserves have risen to more than $65 billion - compared to less than $5 billion at the end of 1997, when the country was looking squarely at the possibility of default. Overnight interest rates, which rose to 35 percent during the crisis, have been in the low single digits since early 1999. And private forecasters expect the economy to grow this year by more than 8 percent.
• In Thailand, net reserves are now hovering close to $30 billion, compared to around $1 billion in the thick of the crisis. Overnight interest rates are below 1 percent. And private forecasters predict growth of 3 or 4 percent in 1999.
• In Brazil, interest rates are today less than half their level in February, output is roughly where it was before the crisis and inflation this year is expected to remain in single digits.

This progress has contributed to a general improvement in global economic conditions. The United States economy continues to show strong, non-inflationary growth. There are signs of modest improvement in Europe and indications that the economic decline in Japan has been arrested.

But the global economy is not out of the woods yet. While the balance of risks for the global economy may have tilted somewhat in the right direction, it would be a mistake to see this trend as inexorable. Economic conditions in a number of countries and regions are still fragile. Near-term action on a number of fronts will be necessary to achieve a sustained and more balanced global recovery.

Notably:

In Japan: while important policy steps have been taken, it is far from clear that a sustained recovery is on the horizon. Until recovery is firmly established, Japan needs to continue with steps to promote domestic demand-led growth, including supportive monetary policies and continued fiscal stimulus until there is a self-sustaining recovery in domestic private demand. In addition, work needs to continue on the banking sector, notably the permanent disposal of bad assets.

In Europe: while the weakness of late 1998 and early 1999 appears to have come to an end, domestic demand still lags behind. If Europe is to play its part in supporting global growth, the policy emphasis should be on structural reforms to boost domestic investment and demand - in addition to supportive macro-economic policies.

In Latin America: while growth is expected to resume across much of Latin America next year, at a time of unsettled international financial markets countries will need to keep their focus on disciplined macro-economic policies and deepening economic reforms, including the strengthening of financial sectors.

In Emerging Asia: while important progress has been made in many of the crisis economies, the risk of reform fatigue and complacency are serious ones. Along with maintaining appropriate macro-economic policies, the Asian emerging market economies must push ahead with structural reforms, especially in the corporate and financial sectors, if they are to lay a durable foundation for market-led growth.

In Russia: the government has continued to face enormous economic and political challenges in the wake of the economic and financial collapse of August 1998. The capacity of the international community to help bring about positive change going forward will depend ultimately on the will and capacity of Russian authorities and the Russian people to carry forward critical structural and other reforms, including measures to strengthen their financial system and finally creating a genuine rule of law. In this context it is especially important that Russia intensify efforts to combat corruption and money laundering and safeguard against the inappropriate use of official resources. I will say a little more about this issue in few minutes.

Core Lessons of the Emerging Market Crises

The programs that the international community supported in Asia and elsewhere were defined by pragmatism about the nature of the challenge each country faced and were centered on strong macro-economic and structural measures to restore confidence. Where this approach has been implemented decisively by national authorities, stability and confidence have by and large returned-and governments have been able to relax monetary and fiscal conditions relatively quickly to support faster growth.

At the same time, battlefield medicine is always imperfect. Certainly there is room to debate whether, in every given instance, the precise policies that the IMF and the international community supported in response to these crises were always the right ones.

With the benefit of hindsight I think we can draw five broad lessons from the experience of the past few years:

First, countries shape their own destinies. By far the greatest responsibility for causing, and responding effectively, to crises lies with countries themselves. The fact that most countries with IMF programs in place have severe economic problems does not imply that the IMF is responsible for those problems - any more than the fact that most people in a hospital are severely ill would be evidence of medical malpractice.

Second, there is no substitute for strong national policies. Where the domestic commitment to strong policies is present, we have learned that conditioned international support can play an important role in countering the bank run psychology that has taken hold in the recent crises. But any amount of external support will just flow straight back out of the country if that domestic commitment is lacking.

Third, adopting a fixed exchange rate system without renouncing domestic monetary policy discretion is a recipe for trouble. These crises have brought home once and for all that a fixed, but not firmly institutionalized exchange rate regime holds enormous risks for emerging market economies in a world where fast-flowing capital and insufficiently developed domestic financial systems coincide.

Fourth, weak financial systems and opaque relationships between government and the private sector greatly enhance the risks of crises in a more globalized world. Lack of transparency, too much lending on the basis of too many implicit public guarantees - the risks of these and other micro-economic distortions that are associated with the phrase "crony capitalism" were all brought home in a much more dramatic way in the financial crises in Thailand, Indonesia and elsewhere. While these things had not prevented unprecedented growth gains in some of these countries in previous decades - they surely did contribute to the severity of the collapse when trouble came. That is why priorities such as increased transparency, effective bankruptcy and insolvency regimes and combating corruption have continued continue to be such a high priority for the United States in its approach to architectural reform.

Fifth, private sector coordination can play a valuable role in the restoration of confidence. When investors start to withdraw large quantities of capital from a country whose underlying prospects are strong, the system as a whole has a stake in supporting policies that successfully turn those investors around. We have seen, notably in Korea in December of 1997, and Brazil in February of 1999, that voluntary private sector involvement in recognition of its mutual interest in avoiding withdrawals can form part of a successful solution.

Financial crises of the scale and severity we have seen in recent years pose a major threat to the construction of a strong, truly global financial system - a threat to which the international community has rightly and vigorously responded in what has come to be called the reform of the global financial architecture.

This has produced some important achievements, of which perhaps the most significant over the long term will be the rejection of the idea that it could be the work of the major industrial nations alone. We have seen this reflected in the creation of the G20. This grouping, which will meet for the first time next month, will be a permanent informal mechanism for dialogue on key economic and financial issues among industrial and emerging market economies who among them will account for more than 80 percent of global GDP.

A fundamental change in the basic quality of economic and financial policies in the emerging market economies has been - and must continue to be - at the core of our efforts to build on these achievements and reduce the risk of these kinds of crises in the future. Going forward, we must continue to raise the bar on what is expected of countries in these areas, and to strengthen the incentives for countries to meet them.

And yet, while major improvements in national policies are clearly necessary for a stronger global financial system - they are not sufficient. A major element of architectural reform must also be more effective policies and incentives at the international level.

In recent years the Administration has pushed forward with this effort in three major respects, each of them supported by last year's IMF legislation:

• We have changed the terms of the exceptional financial support that the international community provides, to make it more market-based and reduce moral hazard, with the creation of the IMF's Supplementary Reserve Facility and most recently its Contingent Credit Line.
• We have catalyzed a major global effort to reduce national vulnerabilities to crises, with concrete steps to help countries develop stronger national financial systems and improved international surveillance, including increased incentives to pursue sound policies before trouble crisis strikes - including the additional incentives embodied in the terms of the CCL.
• And we have found new ways to involve the private sector in the resolution of crises - most notably in the case of Korea and of Brazil.

A more effective IMF will be central to all of these tasks and has rightly been a major focus of energy and interest in this Committee and elsewhere in Congress. Since the start of this Administration - and particularly in the wake of recent crises - the United States has worked to bring about a dramatic change in the orientation of the IMF.

Let me highlight five areas in particular that were emphasized in last's year legislation:

We have helped to bring about a sea of change in transparency and accountability - a sea of change that is perhaps most visible in the IMF's new policies on the public release of official documents.

• In large part as a result of Administration and Congressional urging, Public Information Notices, which summarize the key Board discussions about a country's policies, have been released in respect of 81 percent of the IMF's Article IV consultations with member countries to date in 1999. And 45 countries have now agreed to participate in the pilot project to publish the annual staff reports prepared for those consultations.
• Since June, 28 of 33 countries have agreed to publish the full set of their program documents considered by the IMF Board - including Letters of Intent - which detail the policy commitments that they have undertaken as a condition for IMF support.
• Many key policy documents are also now posted on the IMF web site; this includes publication in a timely manner of the key papers being debated by the Board on debt relief and the reform of the Enhanced Structural Adjustment Facility. The web site also now carries detailed information about the IMF's financial resources and liquidity position and the Annual Report.

We have urged the IMF, in cooperation with the World Bank, to press more actively to channel scarce public funds away from unproductive purposes such as showcase projects and excessive military spending - and toward policies that support growth and poverty reduction. But ensuring adequate funding for high-yield investments in human resources needs to be a higher priority. To make progress in this area, there will need to be greater transparency in and accountability for government spending, including military spending.

In large part as a result of pressure by the United States, the IMF has also recognized the importance of establishing or strengthening social safety nets in order to reduce the social costs of rapid structural adjustments. For example, the United States Executive Director has pressed for the IMF to pay greater attention to these issues in specific cases such as South Korea and Thailand, where we have called for improved unemployment insurance schemes and programs to retrain displaced workers.

Trade liberalization is often a key component of IMF arrangements. In the course of its recent negotiations the IMF has sought continued compliance with existing trade obligations and further commitments to market opening measures as part of a strategy for spurring growth. For example:

• As part of its IMF program, Indonesia has abolished import monopolies for soybeans and wheat; agreed to phase out all non-tariff barriers affecting imports; dissolved all cartels for plywood, cement and paper; removed restrictions on foreign investment in the wholesale and resale trades; and allowed foreign banks to buy domestic ones.
• Zambia's 1999 program with the IMF commits the government to reducing the weighted average tariff on foreign goods to 10 percent, and to cutting the maximum tariff from 25 percent to 20 percent by 2001. In July, the import ban on wheat flour was eliminated.

The United States is the most vigorous proponent of core labor standards in the IMF. Despite reluctance by many member countries to address this issue, some progress has been made. During this past year, as a result of U.S. efforts, labor issues were addressed in a number of important IMF programs. For example:

• In Brazil, we have stressed to the IMF and the Brazilian government that budget austerity measures not impact on those agencies responsible for enforcing labor laws, and that social programs for the poor and disadvantaged be spared from cuts as much as possible. Recently, the Brazilian government has submitted to Congress a labor reform package that provides for increased flexibility while reducing restrictions on the creation of new unions and promoting direct bargaining between unions and employers at the firm level.
• Under strong urging from the United States and the IMF, Indonesia introduced and approved legislation last year ratifying the ILO's Convention 87 on freedom of association - considered one of the most important ILO core conventions.

The United States is engaging other international organizations on this issue. We have vigorously promoted improved cooperation between the IMF and the ILO. As a result, in April, the ILO participated, for the first time ever, as an observer at a meeting of the IMF's Interim Committee - now the International Financial and Monetary Committee. It now has permanent observer status in that committee.

We have has consistently voiced in the IMF our belief that economic development is inextricably linked to environmental conditions - and that macro-economic stability is a minimum and necessary condition for preserving the environment. Operationally, the IMF relies on the expertise of the World Bank for analysis of environmental issues in individual countries. However, due in part to our urging, IMF staff has been increasingly diligent in ensuring that macroeconomic frameworks are supportive of sound environmental policies, with the goal of promoting sustainable development.

For example, in Brazil the IMF emphasized the importance of protecting to the greatest extent possible environmental and other priority expenditures from needed fiscal cuts. When evidence emerged that key pilot programs for environmental protection could suffer deep cuts, the United States government and the IFIs, led by the World Bank, raised concerns with the Brazilian government, and the funds were restored.

Mr. Chairman, these and other reforms that the United States has supported at the IMF are listed in greater detail in the Report on the implementation of last year's legislation that was submitted to Congress on October 1. As this Report makes clear, we have made progress in the effort to develop a 21^st century IMF. But we have no doubt that further change is needed.

We said many times last year that a well-funded IMF was indispensable to a stable global financial system. But as we also said at that time - that does not mean we can be satisfied with the IMF as it is.

Key Reform Priorities Going Forward

The reform of the global financial architecture is an organic and many-sided process that will never entirely be completed. But recent events have highlighted important areas for reform - and major issues that the United States and the international community will need to address going forward.

Let me highlight five crucial priorities for future architectural reforms:

In line with continued pressure from the United States, governance issues have played an increasingly important role in the decisions of the IMF and multilateral development banks. This has been brought out most clearly in the approach that the international community has recently taken toward Russia in the wake of the economic and financial collapse in the summer of 1998.

The IMF program in July 1999 was very different from all of Russia's prior IMF programs. The first disbursement under the new IMF program - as well as any subsequent disbursements - was predicated on the imposition of new safeguards to protect the use of that money. The funds were provided in the form of Special Drawing Rights, paid into an account at the IMF and can be used only to repay Russian obligations to the Fund. In addition, approval of the program required Russia to complete a satisfactory independent investigation of the Russian central bank's investment in Fimaco and of the July 1998 IMF disbursement.

Our continued support for IMF or World Bank engagement with Russia is predicated on Russia's compliance with crucial conditions to ensure financial integrity and to safeguard any assistance provided. Specifically, the most recent review of Russia's program is requiring the investigation of other offshore central bank subsidiaries, in addition to other steps to improve internal controls and initiate quarterly audits of the central bank's reserve management practices.

In light of our experience in Russia, the United States and others in the G7 have now called for authoritative and systematic reviews by the IMF and the World Bank to find ways to strengthen safeguards on the use of their funds in all of their lending activities. We believe that this review should include: more systematic use of external audits of the central banks that are the recipients of official funds; new IMF program requirements to enhance countries' internal safeguards against misappropriation; and steps to strengthen the IMF's capacity to deter and penalize misuse of its funds, including in "post-program" cases where all disbursements have been made.

The United States has actively promoted, as part of the strengthening of the international financial architecture, an appropriate role for the private sector in forestalling and resolving financial crises. To be sure, there are no easy answers to the question of what is the best mix of domestic policies, external official support and appropriate private sector involvement, if any, needed to restore confidence in the future crises that may arise.

Every crisis is unique, and we need to maintain the flexibility to respond accordingly. But the G7 Communiqué of last June established, for the first time, a useful broad framework for our efforts in future cases.

The G-7 framework promotes appropriate involvement of private sector lenders in crisis resolution and aims at a system in which countries are encouraged to address debt problems in a market-based, orderly way. It recognizes the need to balance competing considerations on a case-by-case basis, in a way that preserves the fundamental principle that creditors should bear the consequences of the risks they assume, while not undermining the equally essential principle that debtors should honor their obligations in full and on time. At the same time, we all understand that this is an enormously complex and important issue that will need to be the focus of continuing attention.

As I have said, many of the economies worst affected by crises have made enormous progress in the past year. But as global confidence begins to return and memories of the crises begin to ebb, it becomes even more important for us press forward the frontier to ensure that countries are less vulnerable to the kind of bank run dynamic we saw take hold in Asia and elsewhere.

Among other things, increased safety will require:

• Safer exchange rate regimes. The IMF and the official sector as a whole needs to help countries avoid the trap of an exchange rate regime that may appear to offer stability but that - if not solidly backed by credible institutional arrangements and consistent domestic policies - may encourage large risks to build up unnoticed. Over time, it should increasingly be the norm that countries involved with the world capital market avoid the "middle ground" of pegged exchange rates with discretionary monetary policies. And where countries choose the middle ground, and their own policies are not sufficient to stem an attack on a particular exchange rate level, the international community should have a compelling rationale before it provides exceptional support for the country to defend it.
• More prudent management of national balance sheets. A number of groups have looked at guidelines for improved risk management at a national level and simple balance sheet rules for countries to follow to reduce their vulnerability to sudden withdrawals of capital in the future. The next steps must be to develop more sophisticated systems for evaluating an economy's vulnerability to different types of shock, and to establish stronger incentives for countries to put these in place. In response to our call, the IMF and the World Bank will shortly develop best practice guidelines in this area as part of a more global effort.

With the partial recovery in global confidence we also have an opportunity to intensify the International Financial Institutions' search for more effective ways to support enduring growth in the very poorest countries. In the end the only ones who can build a better future for these countries are their own governments and citizens. But when many are laboring under the debts that they owe to the international community, we owe them a fresh start in the way we seek to help.

This global imperative is at the root of the new approach to the provision of concessional finance to the poorest countries that is reflected in the new Poverty Reduction and Growth Facility (PRGF), which the United States has promoted in the context of the Heavily Indebted Poor Country initiative (HIPC). The PRGF will be part of a collaborative approach with the World Bank based on poverty reduction strategies initiated by the countries themselves. By putting poverty reduction and high quality growth front and center, this new approach aims to support more effectively countries' efforts to put their economies on sound and sustainable footing and achieve their development goals.

Together with the enhanced debt relief under HIPC that was agreed by the G7 leaders in Cologne, this new joint IMF-Bank process for providing conditioned assistance to the poorest economies marks a major step forward - one with enormous potential for kick-starting reform and growth in sub-Saharan Africa and other markets of tomorrow.

Finally, as we consider the international financial architecture we have and the one we would like to have, we must always consider not merely the individual parts of that system such as the IMF, but the sum of those parts. Concretely, in light of recent experiences we must continue to focus on how the IMF, the World Bank and other IFIs all work together, so that each is playing to its strengths - and complementing the activities of the others rather than complicating them.

To be sure, the question of the appropriate role for each of these institutions has been endlessly debated and does not yield many easy answers. But the new PRGF - and the more inclusive approach to the provision of assistance that it represents - marks one important landmark in the search for a better solution. Further progress in enhancing collaboration between the IMF and the World Bank on the financial sector issues that have been so central to recent crises would mark another.

Already, at the urging of the United States, the staffs of these institutions have taken steps to work more closely with one another on these questions. And they are now moving forward with a new Joint Financial Sector Assessment Program (FSAP) that will involve in-depth assessments to identify financial system strengths and vulnerabilities in individual countries.

At the same time, in this area - as is true more generally - both the IMF and the World Bank will need to devote greater effort going forward to giving true meaning to the word "joint", and to better deploying their respective resources in the way they prevent and respond to crises and in their design and delivery of programs and technical assistance.

Mr. Chairman, as I said earlier, the reform of the IMF and the global financial architecture more generally is a process, not a journey with a final destination. However, taken together, it is fair to say that the events of the past few years - and the changes they have helped to set in train - mark an important new stage in the system's evolution.

What will be crucial going forward will be pushing forward in the areas I have highlighted, and pressing for the safer policies and institutions at a national level upon which this new system will ultimately depend. In a world of sovereign nations our goal cannot to be to prevent governments from ever making mistakes. What our goal must be, as we move forward from the events of the past few years, is to provide the best possible system for encouraging sound policies - and for minimizing the broader costs to the international system as a whole when crises strike.

With the major reforms that have taken place in the past year, including many that were specified in the legislation last fall, we have made some important progress. But we know that we have a great deal more to do. I look forward to working with you, Mr. Chairman, with others in this Committee and with others in Congress as we work to progress further in the months to come. Thank you. I would now welcome any questions.