FROM THE OFFICE OF PUBLIC AFFAIRS

Mr. Chairman, thank you for giving me the opportunity today to discuss the International Monetary Fund, its role in the world economy and financial system, and why we believe it is important to act now to strengthen its financial resources.

New Risks in the Global Financial System

This hearing today takes place in the context of two developments of great importance to the United States and to this debate over funding for the International Monetary Fund (IMF).

The first is the emergence of a global financial market that has brought significant benefits to the world economy, but also new risks. National financial systems are now more closely integrated than ever before. Capital now flows across markets on an extraordinarily large scale. And technological innovations in telecommunications and finance make it possible for finance to flow much more quickly in response to events.

These developments have made it possible for private capital to finance an extraordinary improvement in living standards across many countries. But they also have increased the scale, force, and speed with which financial crises can occur.

These risks are illustrated clearly in the financial crisis in Asia, and this is the second development which makes these hearings on the IMF so important. The crisis that began this summer in Thailand and then spread throughout Southeast Asia and to Korea presents serious potential risks to American interests.

Our economic interests are at stake because large and sustained depreciations in the currencies of our trading partners and deep recessions in their economies will reduce the competitiveness of American companies, reduce demand for American exports, reduce the earnings of American firms, and reduce the value of pension funds across the country, all of which, of course, will affect American families and American workers.

Even if the crisis is contained to its current dimensions, the impact on the U.S. economy could be significant. While it is too early to offer a precise assessment of the overall impact of the Asian crisis, preliminary assessments by the OECD and a number of private forecasts have estimated that the impact on the U.S. economy may be around half a percentage point (0.5%) of U.S. GDP. If the crisis is not contained, the impact could be significantly greater.

Our security interests are at stake because economic instability, when it is acute and sustained, can threaten political stability. This risk is real, not just in those places where we now have American troops on the ground. It can be significant in any country where the basic institutions of the state are untested in crisis or where there does not exist an established pattern for stable governmental successions.

U.S. Policy

In response to these developments and in an effort to limit the risks they present, we have led a major international response to help reestablish financial stability in Asia and to help strengthen the architecture of the international financial system. The International Monetary Fund is at the center of these efforts, and it will remain critical to any effective U.S. response to protect our interests in this crisis, as well as future international financial crises.

Our strategy to protect U.S. interests in the immediate crisis has the following major elements:

• First, we have worked to encourage the countries in crisis to put in place strong programs of reform, and supported these programs with temporary financial assistance from the international financial institutions.
• Second, we have encouraged countries in the region and outside the region to take preemptive policy actions to reduce their vulnerability to contagion from the crisis.
• Third, we have worked to encourage Japan and the other major industrial countries to pursue policies to strengthen growth and open their markets, and thereby contribute to recovery in Asia.
• And, finally, we have taken steps, led by the U.S. Eximbank, to protect U.S. exports to the region, by mobilizing trade finance for the countries in crisis.

Restoring Financial Stability in Asia

The centerpiece of our approach has been to support strong programs of reform, backed by temporary, highly conditioned financial assistance, led by the IMF, as a bridge to recovery.

Policy and Reform

These programs of economic reform are designed to address the specific causes of the crisis in each country and to create the conditions necessary for stronger and more stable exchange rates and for a quick return to rising living standards.

To accomplish this, the programs focus on the types of reforms necessary to restore confidence, so that the people of these countries are willing to keep their savings in the currency of the country concerned and so that new flows of private capital will be available to finance recovery.

Although the specifics have necessarily varied across countries, the principal elements of each program include:

• Measures to strengthen the financial systems by closing weaker institutions, reinforcing stronger ones, and improving the supervisory system.
• Structural reforms to make the economy more market-oriented, better able to allocate capital efficiently, and less vulnerable to corruption.
• The liberalization of restrictions on trade and investment.
• Improved transparency and disclosure in the financial accounts of the government and central bank, and in the balance sheets of private banks and corporations.
• Measures to reduce the impact on the poorest segments of society by protecting health and other social expenditures from budget cuts.
• A supportive framework of monetary policies to help stabilize the exchange rate and contain the inflationary effects of depreciation, and fiscal policies to promote the necessary reduction in external deficits and to finance the costs of financial sector restructuring.

These programs are essentially programs of growth-oriented structural reforms. They are not austerity programs. Despite popular perception, the degree of fiscal and monetary tightening in these programs in Asia has been modest by comparison with the stabilization programs the IMF has employed in different circumstances.

It may be unavoidable that the reform programs and their architects get associated with and blamed for the economic distress that comes with financial crisis. But it is the crisis -- not the programs -- that induces the distress. And it is the programs that help cushion the decline in growth and living standards and help create the conditions necessary for recovery. Countries that have tried a different path of delayed adjustment and less comprehensive reform have normally found that by doing so they simply lengthened the crisis and delayed recovery.

The other common element in these programs is that they can be adjusted in response to changing circumstances. When growth slows more sharply than expected, for example, the IMF can move, as it has in each of the cases in Asia, to modify the fiscal targets in the programs so as not to impose excessive contraction on weakened economies. And when problems in the banking system become more acute than originally estimated, the IMF can act, as it has in Thailand and Indonesia, to strengthen the programs in response.

Temporary Financial Assistance

In support of these programs of reform, we have mobilized temporary financial support, led by the IMF and other international financial institutions, to rebuild reserves and help provide confidence.

The U.S. has also joined with other countries in being prepared to provide contingent supplemental resources that could be made available to augment these programs. We have a moderate share of these supplemental lines, and have not yet disbursed any funds.

This financial assistance by the international community is an essential part of the solution to these crises and a necessary complement to the programs of reform. It is necessary to provide confidence, to induce stronger reform programs, to provide some breathing space for the reforms to take hold, to supplement the countries' official reserves, and to help ensure that these governments can meet their international obligations and can stand behind their financial systems.

There is no amount of official money available in the world that could substitute for or compensate for a lack of commitment to reform in these countries. But even the most virtuous, most credible, most committed government could not successfully confront problems of this scale without temporary financial assistance. It's useful to recall that the United States drew a substantial amount of our reserve deposits from the IMF in 1978 -- largely financed through the General Arrangements to Borrow (GAB) -- when we faced a major decline in the value of the dollar.

The IMF reform programs are structured carefully to help ensure it works, to help limit the moral hazard risks that are inherent in any provision of official finance, and to maximize burden sharing. Several of these features are worth highlighting:

• Disbursements are tied to strict compliance with very detailed, concrete, time-specified policy commitments. They are tranched or phased to help induce both early up-front actions and sustained follow-through. The money does not flow unless and until the policy commitments are carried out.
• The assistance is in the form of temporary loans, not grants, at market-related interest rates. In fact, after the establishment of a new IMF facility at our initiative in December, much of the assistance for Korea is being made available for short maturities at a substantial premium to minimize use and to maximize the incentive to repay early.
• The assistance comes with strict limitations on the use of the money, with restrictions on support to private corporations, and with limits and conditions on liquidity support to banks.
• The assistance is led by the international financial institutions -- the IMF, the World Bank, and the Asian Development Bank -- which ensure that conditionality is maintained and that we leverage substantial contributions from the international community for any U.S. participation (direct or indirect).

Not providing this assistance, however appealing that might seem as an option, would risk more acute instability, with a greater and more protracted loss of economic output, deeper, more sustained depreciations in the currencies of our trading partners, and greater contagion, with all the attendant risks to the United States.

The Critical Role of the International Monetary Fund

The IMF is absolutely central to this effort. If it did not exist, we would have to invent it. We have a huge stake in making sure it has sufficient resources to respond to any intensification or spread of the current crisis and for any future crises.

• Without the IMF, there would be no multilateral mechanism for providing apolitical advice to shape strong reform programs.
• Without the IMF, at times of crisis, there would be greater depreciations in the currencies of our trading partners and sharper adverse impacts on the US and world economies.
• Without the IMF, at times of crisis, there would be greater pressure on the United States to act unilaterally with taxpayer resources to protect our interests without the global leverage the IMF provides.

Today, as much as when it was established with U.S. leadership more than 50 years ago, the IMF acts as a forward defense of American interests. It has played a critical role in supporting reform and growth in the transition economies, bringing Russia back from the brink of hyperinflation, and Poland from near collapse to one of the fastest growing economies of Europe. In Uganda it has helped underwrite ten years of remarkably successful economic reforms which have generated average annual growth rates, in real terms, of over six percent a year. And in Argentina, the IMF has supported -- including during the 1995 "tequila crisis" -- Argentina's deep economic transformation from a country characterized by anemic growth and hyperflation to one that enjoys strong growth (8% in 1997), near zero inflation, declining fiscal deficits, and a more private-sector oriented economy.

The IMF has been successful in so many cases because it promotes the core American economic values of sound money, respect for market forces, and free trade.

I thought that it may be helpful for me to say a few words about the financing structure of the IMF. In some ways, the IMF operates like a credit union. We extend a credit line -- for most of our quota subscription and for our GAB or NAB commitment -- which the IMF can draw on. Any drawing by the IMF gives us a sort of deposit in the IMF, which is of equal value, pays interest, is supported by over $30 billion in gold, and which we can withdraw essentially on demand if necessary. For these reasons, U.S. participation in the IMF is treated as an exchange of financial assets. U.S. transfers to the IMF are not scored as budget outlays, and do not come at the expense of domestic programs.

Chairman Greenspan and Secretary Rubin have testified several times over the past few months about the risks in the current crisis and the importance of action by the Congress to strengthen the IMF's resources. As you know, the President's request has two components:

• The first component is to authorize our participation in a facility to provide expanded emergency resources to the IMF called the New Arrangements to Borrow. Proposed after the Mexican financial crisis and modeled on the General Arrangements to Borrow (GAB) established by the G-10 more than three decades ago, these arrangements would make available an additional $23 billion from some 25 countries to supplement the IMF's normal lending resources in the event of a serious threat to the stability of the international financial system. The GAB was last increased in 1983 in response to a request from President Reagan, and also in conjunction with a normal quota increase. In the ensuing 15 years, the growth in the world economy, trade, and, most importantly, global capital flows have left these arrangements too small to deal effectively with the challenges of today's capital markets -- for instance, IMF resources as a percentage of private capital flows to developing countries are now one-twentieth as large as they were 15 years ago.
• The second component is to authorize our participation in a normal periodic increase in IMF quotas, which are the normal lending resources of the institution. These resources have been increased on average every seven years in an attempt to keep up with the growth of the world economy and the global financial system. This latest proposal, which would increase the overall quotas of the IMF by about 45 percent and provide roughly $65 billion in additional loanable resources, was negotiated last year, in consultation with the relevant committees in the Congress.

The IMF's recent stabilization programs for Asian countries have depleted its resources to levels approaching historical lows. Although the IMF has $45 billion in uncommitted resources, only $10-15 billion are now available for lending, because the IMF needs to reserve the remainder in cash balances to accommodate possible unconditional withdrawals by members. This is neither a sufficient cushion of resources to enable the IMF to perform its basic mission nor is it sufficient to ensure the IMF could respond effectively if the Asian crisis deepens or spreads to other markets. We believe it is extremely important that the Congress move quickly to approve both the NAB and quota requests, so that the IMF has sufficient resources to help protect U.S. interests in the event of unforeseeable but potentially very damaging financial emergencies over the near term.

Strengthening the Architecture of the International Financial System

At the same time that we have worked to confront the immediate crisis in Asia, we have worked to build consensus on reforms to help strengthen the architecture of the international financial system. We have a strong interest in trying to identify changes to the system that could help reduce the risk of, and make the system more resilient in the event of, future financial crises of this magnitude.

President Clinton began this effort four years ago at the G-7 Summit in Naples. At the Summit that followed in Halifax in 1995, we launched a major international effort to help make the international financial architecture, in Secretary Rubin's words, "as modern as the markets."

This initiative produced an international program to strengthen transparency and disclosure, the development of core principles for banking supervision in emerging markets, the establishment of an "Emergency Financing Mechanism" to accelerate the IMF's capacity to respond in crisis, and an expanded emergency facility for the IMF, the New Arrangements to Borrow.

Building on these steps, we have supported a number of additional reforms over the past few months. The most significant of these are the following:

• We launched a new effort to strengthen transparency and disclosure standards to help reinforce market discipline, by improving the quality of information available to the markets on the liabilities of central banks, the balance sheets of the banking system, and the external debt of the government and private institutions.
• We have won support for a number of steps to improve transparency in the operations of the IMF, including the release of Letters of Intent with respect to each of the three large Asian programs and summaries of the IMF annual reviews of countries, and new efforts to use independent, external evaluators to gauge the effectiveness of IMF programs in a number of areas.
• We have changed the policies and operations of the IMF and the World Bank to make it possible for them, when necessary, to mobilize the types of large-scale, front-loaded, and more innovative programs of temporary financial assistance more appropriate to the challenges of today's capital markets. Most important among these changes is the establishment of a new facility in the IMF, the Supplemental Reserve Facility, which will result in much of the resources provided in exceptional circumstances being extended at shorter maturities and at a substantial premium over the IMF's normal lending rates.
• We established a new forum for mutual surveillance and cooperation in Asia, to help deal with risks that might precipitate future crises.
• And we have encouraged greater participation by private financial institutions in the resolution of these crises, with a global effort by the major banks to refinance their short-term claims on Korean financial institutions.

We are now in the process of a more comprehensive review of changes to the international financial system that will help ensure we have effective institutions to manage the risks that accompany all the benefits of the global capital markets, and help deal with a world in which we are all more directly affected by the failures and successes of other economies and other governments. But we do not yet have solid and convincing means to induce sovereign states to take actions that would prevent a crisis, or to induce investors to make judgements about risk and return that overcome the more powerful forces of fear and self interest that drive markets.

These challenges will be the subject of a meeting of finance ministers and central bank governors from key countries around the world that we will convene later this year as a first step to try to build a global consensus on reforms to the architecture of the international financial system. We held a preparatory meeting of senior officials from the finance ministries and central banks of 22 countries in Washington last week. And the G-7 Finance Ministers and Central Bank Governors last weekend endorsed a framework of new initiatives in several areas.

This will be a complicated and difficult process, with lots of interesting, compelling solutions to be explored. The temptation will be to try to stop the clock somehow and suspend the reality of the global financial market while we try to figure out the best way forward, but that is not a tenable approach given the risks we now face.

Conclusion

The United States is central to this effort to contain and resolve the Asian crisis and to strengthen the architecture of the international financial system.

Our role is critical because the IMF cannot strengthen its financial position without us. If we do not act, the NAB will not come into force, and the quota increase will not go into effect. Our role is important because no other nation has the capacity to lead the global effort necessary to deal with a crisis of this magnitude. And our role is fundamental because our perceived willingness and capacity to support an effective international response is critical to confidence at what is a rather delicate moment for the global financial system.

We cannot guarantee that, by acting, we can turn things around and successfully limit any fallout for the U.S. economy and our strategic interests. Most of the solutions to these problems have to come from the countries themselves. But we have a responsibility to do what we can to protect our interests in this crisis. And strengthening the IMF is essential if we are to have the tools necessary to protect those interests.