Subcommittee on International Trade and Finance


Oversight Hearing on International Monetary Fund Reform


Prepared Testimony of the Honorable Timothy F. Geithner
Under Secretary of the Treasury for International Affairs
U.S. Department of the Treasury


9:30 a.m., Thursday, April 27, 2000


Mr. Chairman, Ranking Member, and members of the Committee, I welcome the opportunity to testify before this sub-committee today on reform of the International Financial Institutions (IFIs).

I would like to address four sets of issues today:

I. The Role of the International Financial Institutions

Let me begin by stating why we believe that America's interest in a strong IMF and a strong World Bank is in many ways more compelling today than it was at the founding of the Bretton Woods system 50 years ago.

The U.S. economy is more open today to the world economy, and therefore more vulnerable to the fortunes of our trading partners, than it was 50 years ago. Helping others succeed in an integrated, market-based world promotes U.S. economic and commercial interests, as well as our national security.

The scale of deprivation in the world is no less compelling today, and may be more so in the context of such an extraordinary rise in prosperity in the industrial countries and parts of the emerging market economies. Helping others share in the prosperity advances our core democratic values.

The world has changed dramatically with the development of the international capital markets. Yet, there are very few developing countries today that have durable access to the private capital markets on a scale that would allow them to forego any reliance on official finance going forward. While the IFIs must change to adapt to the revolution in the capital markets, the impression that private markets alone can finance the development challenges of emerging market economies is an illusion.

If the case for these institutions today is as strong or stronger than it was 50 years ago, what should their roles be in this very different world?

Our view is that the core missions of the institutions are:

To help prevent financial crises;

To help cushion the effects of financial crises and promote an early return to growth and financial stability;

To promote the market-oriented policies that provides the best basis for durable and equitable growth and poverty reduction in all countries;

To address common global challenges that are beyond the reach of individual nations and institutions; and

To anchor and facilitate the process of adjustment to global integration that holds such enormous potential for raising living standards in the United States and worldwide.

In carrying out these missions, the institutions have different responsibilities. The IMF's main responsibility is crisis prevention and response in the emerging market economies. The main focus of the World Bank and the regional development banks is the longer-term challenge of economic development and poverty reduction in the poorest countries. And yet, no matter how successful we are in clarifying the respective roles of the institutions, they will necessarily overlap to some degree, as the institutions are likely to be involved in the same countries at the same time, in some cases for protracted periods of time. In this context, it is crucial that they complement, not compete with one another.

The international financial institutions have made a major contribution to economic progress in their time. They have played a critical role in the major economic success stories of the last 50 years, including promoting the green revolution in high-yielding varieties of rice, the successful campaigns against river blindness, polio and other diseases, the dramatic increases in life expectancy across developing countries, the successful transition toward market economies in Poland and China, and most recently, the dramatic recovery from financial crisis achieved by Asia and much of Latin America.

For all their successes, when about half of the world's population lives on less than $2 a day, it is apparent that we still have a long way to go. One can debate whether the right approach was taken in every case. But it is in the nature of the IFIs' mission that they will often, inevitably be involved in countries at times of acute distress. To hold the IFIs accountable for that distress is to misunderstand the nature of their challenge.

These institutions cannot compensate for the failures of governments, nor can they fully insulate economies from the effects of war, pandemics of disease, natural disasters, and financial contagion. They are, however, the most effective, and the most cost-efficient means we have to promote the cause of economic growth and financial stability around the world, and in this sense, they are absolutely critical to our ability to promote American interests in today's complicated and rapidly changing world.

II. Recent Progress in Reform

Because these institutions are so important to the United States, we have spent a huge amount of effort and capital over the past several years to promote changes designed to help them adapt to the new challenges of the global economy. We have separately reported to Congress and testified on a broad range of recent IFI reforms, including improving the overall effectiveness of the institutions, trade, labor and environmental issues. Before outlining what we consider to be the most important areas for reform going forward, I want to highlight a few examples in areas that have been a particular focus of congressional attention over the last several years.

Transparency and Accountability:

We have helped bring about major improvements in the transparency of the institutions. Basic program documents of the IMF and the World Bank are now released systematically, which makes is possible for members of the public to evaluate the conditions that accompany financial support and to monitor implementation more easily.

We have also promoted the establishment of independent evaluation mechanisms across the institutions, most recently in the IMF, which has agreed to establish an independent evaluation unit.

Detailed information about the IMF's financial resources and liquidity position is now available on the IMF website, as is the Annual Report. In addition, the IMF Executive Board recently reached an agreement on quarterly publication of the operational budget, to be renamed the Financial Transactions Plan (FTP)87, with a one quarter lag. The first such FTP, covering the period March-May 2000, will be published in August.

Progress in these three areas has brought about a dramatic increase in the accountability of the institutions.

Changing the Design of Economic Conditionality:

We have worked successfully to bring about significant changes in the scope and nature of the economic reforms that the IFIs advocate and support, with greater emphasis on the development of institutions that enable markets to work effectively, stronger and more resilient financial systems, more open trade policies, greater disclosure at the national level, mechanisms to protect the poor from the impact of economic adjustment and crisis, measures to increase national ownership and participation in reforms, and to incorporate environment, social and labor issues into program design, as appropriate.

Financial Safeguards and Corruption:

In large part as a result of U.S. leadership, the IMF and the World Bank have brought corruption to the front of the development agenda. Both institutions have suspended or terminated loan programs in certain instances where the danger of corruption was acute, and both have expanded the use of external audits. The MDBs have created new delivery systems in areas such as social safety net programs, to guard better against the risk of diversion and leakage.

In the IMF, strengthening financial safeguards has been a key U.S. priority. With our strong urging and support, the Executive Board agreed this spring to implement a framework of strengthened measures to safeguard IMF resources and deter misreporting of information to the Fund. This includes a new requirement for current and future program countries to publish external audits of central bank financial statements, and to provide the IMF with information on their auditing and control mechanisms. The International Monetary and Financial Committee in April stressed the importance of forceful application of the new framework to enhance the integrity of the IMF's operations. Going forward, we will be focusing on vigorous and uniform application of the framework.

Changing the Terms of IMF Assistance:

We now have the capacity to ensure that when the IMF mobilizes large-scale financing in response to a crisis, such financing is extended at a substantial premium above the IMF's normal lending charges, and on shorter maturities. These changes help encourage countries to return to private sources of finance as soon as possible, and also help reduce moral hazard risk.

III. The Administration's Agenda for Further Change at the IMF and the MDBs

These changes are important, but we believe it is necessary to go beyond these reforms and provide a more far-reaching framework for how the institutions should adapt to the challenges of the 21st century. Over the past several months, Secretary Summers has outlined a broad agenda for reform of both the IMF and the MDBs. I would like to summarize the key elements of this agenda here.

1. The International Monetary Fund:

The Administration's plan for reforming the IMF starts from the central reality of the global financial system today, that the private sector is the overwhelming source of capital for growth. We believe that the IMF must increasingly reflect this reality, with a greater focus on promoting financial stability within countries, a stable flow of capital among them, and rapid recoveries following financial disruptions.

We have identified the following core areas for reform:

A greater focus on promoting the flow of information from governments to markets and investors.

In a more integrated global capital market, IMF surveillance needs to shift from a focus on collecting and sharing information within the club of nations, to promoting the collection and dissemination of information for investors, markets and the public as a whole. And the IMF needs to pay more attention not just to the quantity of information disclosed to markets, but also to its quality. Technical assistance has been and will continue to be critical in this area.

More generally, we believe that substantial deficiencies in the accuracy and quantity of data that a country discloses should be noted and highlighted by the IMF in the same way that macro-economic deficiencies are noted and highlighted.

Greater attention to financial vulnerability and macro-economic fundamentals.

In the wake of recent events, we believe that the IMF needs to focus much more attention on financial vulnerabilities, such as those that played a key role in causing the recent crisis in Asia.

This will mean, in particular, a greater focus on the strength of national balance sheets. In this context we believe the IMF should promote a more fully integrated assessment of a country's liquidity and balance sheet. To this end, it should work to incorporate more systematically, in its surveillance, indicators that provide a more meaningful guide to the adequacy of a country's reserves beyond simply their size relative to imports. Work is already under way at the IMF to explore how this can best be achieved.

By the same token, we believe that the IMF should highlight more clearly the risks of unsustainable exchange rate regimes. The presumption needs to be that countries participating in the world capital markets should increasingly avoid the "middle ground" of pegged exchange rates with discretionary monetary policies, in favor of either more firmly institutionalized fixed rates or floating regimes.

A more strategic financing role that is focused on emergency situations.

The IMF should adopt a more strategic financing role in emerging markets that is focused primarily on forestalling contagion and providing appropriate financing for emergency situations. This will require the Fund to streamline its financing instruments and adjust the incentives associated with financing.

A review of financing instruments has begun in the IMF. Already, a number of facilities that are no longer necessary have been eliminated. And we have made progress in gaining general agreement on the overall need for streamlining, and the International Monetary and Financial Committee in its April meeting called on the Executive Board to secure rapid progress in its review, paying particular attention to potential changes in the maturity, pricing structure and other features of existing facilities with the aim of instituting proper incentives. The Committee emphasized the need to enhance the effectiveness of the CCL and to prevent unduly prolonged use of resources provided under existing non-concessional lending facilities.

We have an ambitious agenda going forward in the IMF to achieve further concrete steps, so that the IMF comes to rely on a few core instruments for the bulk of its lending and so that those instruments incorporate incentives that support a more strategic financing role for the Fund. In this process, we will be advancing changes in pricing, so that access to Fund resources is made available on terms that provide an incentive for countries to rely increasingly on private financing when they can access private markets. Potential measures include introducing an escalation in charges with scale and/or maturity and instituting an overall increase in the basic rate of charge. We will also be promoting a lower price and clarified eligibility criteria for the Contingent Credit Line (CCL) to enhance its use as a preventive tool, pursuing more limited and effective use of the Extended Financing Facility (EFF), and seeking to strengthen post program monitoring.

Greater emphasis on catalyzing market-based solutions to crises.

The IMF needs to continue to develop ways of catalyzing market-based approaches to resolving crises, particularly where the private sector is involved. Such approaches must be designed carefully to find the right balance between maximizing the prospects for an early recovery from crises and the need to limit moral hazard risk. We have made some progress in identifying innovative approaches in cases such as Korea and Brazil, where creditors recognized their collective interest in maintaining positions, and in other cases, such as Pakistan and Ukraine, where countries launched successful debt exchanges that effectively changed the terms of their private obligations.

A sharper focus on poverty and growth in the poorest countries.

In the poorest countries, we foresee a continuing role for the IMF, but one that is more sharply focused on supporting macroeconomic stability and growth as part of a new World Bank/IMF development framework emphasizing poverty reduction. This new approach places poverty reduction at the center of IMF and World Bank programs in poor countries, and emphasizes better integration of poverty reduction and macroeconomic policies. The new framework sets out a clearer division of labor between the Bank and the IMF, with the Bank taking the lead in advising countries on the design of growth-enhancing national poverty reduction strategies and structural reforms, and the Fund focusing on promoting sound macroeconomic policy and related structural reforms in areas such as tax policy and fiscal management.

2. The World Bank and Regional Development Banks:

Our approach to the multilateral development banks (MDBs) starts from a number of crucial lessons from the global development experience of the past 50-plus years: that official support should reward and strengthen domestic efforts to reform rather than try to force those efforts into existence; that MDBs must support, not supplant, the development of open markets and the growth that open markets can bring; that MDB support should be conditioned on an effective framework for promoting market-led growth; and that conditions should focus on the essential, including critical public investments.

We believe that the MDBs need to bring this lesson to bear in improving their capacity to fulfil three core missions:

Above all, supporting effective growth and poverty reduction in the poorest countries at a time when there are 1.2 billion people living on less than $1 a day;

Targeting lending to countries with access to private markets on areas of clear market failure, catalyzing additional private flows and supporting government efforts to respond to financial disruptions.

Promoting the provision of global public goods for international health and environmental protection efforts.

These are the key changes that we are promoting in each of these areas:

More effective policies in the poorest countries.

What the MDBs do to promote development in the poorest countries is without a doubt their most morally urgent and important work. These are countries that cannot expect to mobilize private flows on a sustained basis, and can expect to rely on official flows for some time to come.

We believe that an effective approach in these economies, informed by the lessons of development experience, will require a shift in the emphasis of the MDBs in these countries in the following respects:

A greater focus on economic growth and poverty reduction. Official estimates of the need for external support must move increasingly from a focus on macro-economic issues to more clearly emphasizing human needs. As a condition for receiving debt relief and new loans, HIPC countries are now required not only to have established a solid track record of reform, but also to produce forward-looking Poverty Reduction Strategies. These strategies will and must form an important part of the basis for a satisfactory country financing framework. Over time we expect this to become the primary responsibility of the World Bank given its expertise and mandate in global poverty reduction. But the IMF needs to have a continuing role in macro-economic evaluation, because no plan is viable if there is not a sustainable financing framework.

Increased selectivity. As the World Bank has recognized in implementing IDA 12, we need increasingly to shift the balance in favor of supporting countries where donors can have confidence that assistance will be well used - and denying support more often where it is likely to be misused, particularly through corruption. By some estimates, this would more than triple the effectiveness of development assistance in reducing global poverty. And the MDBs need to focus assistance on programs and policies that have the highest development returns, particularly investments in access to health care, clean water, and basic education.

More focused conditionality: We believe that the MDBs should rely on a smaller number of clear and measurable performance targets, set more realistically, and then more vigorously adhered to. An important part of this shift will be developing more effective mechanisms within the MDBs for evaluating when targets and intermediate benchmarks have been met, including a stronger commitment to disbursing in stages, and more frequent formal reviews.

Transparency: There needs to be a much higher degree of transparency, with a stronger presumption for publication of key loan documents, and transparency in the relevant operations at the national level, so that the domestic population, outside investors and donors can track results.

Affecting resource allocation: The MDBs need to be able to demonstrate that the resources they provide, whether new assistance or debt relief, translate into additional spending for appropriate development priorities, rather than simply enabling countries to redirect scarce resources to unproductive uses, such as excessive military spending or subsidies that benefit narrow elites.

More focused MDB lending in emerging market economies.

Emerging market economies that have access to private sources of finance face challenges different from those confronting the poorest countries. MDB lending in these countries should be confined to areas where it can increase the country's overall capacity to access external resources, and add value that the private markets cannot.

This suggests an emphasis on three types of circumstances:

Where the MDBs can effectively employ their unique capacity to apply conditions and to promote key public investments - including basic health and education and other social spending and the development of an effective institutional infrastructure for markets - that add to the total stock of public resources available for these purposes.

Where the involvement of the MDBs can attract genuinely additional private flows: for example, where MDB co-financing arrangements and guarantees can enhance the credibility of developing country borrowers in the eyes of investors. In this context we believe that the MDBs should continue to explore more innovative ways of catalyzing private capital flows to such countries, where these can be pursued within strict and clear guidelines that safeguard the financial position of the institutions.

Where the MDBs can help counteract temporary disruptions or limitations in a country's access to private capital due to contagion or other external shocks. To this end, they should be taking advantage of the recent substantial improvement in global financial conditions to develop a large, more flexible, contingent financial capacity to respond to the deterioration in investor confidence in times of social and human distress. As we have seen, there are times when more structural changes can be achieved in 18 months than would otherwise been achieved in years. On the basis of recent experience, we strongly believe that the World Bank should find ways to upgrade substantially its capacity to respond rapidly and effectively to such emergencies in the future. As part of this approach, the World Bank and others need to work harder to ensure that their financing is genuinely productive, and that it supports, rather than supplants, private sector finance.

Accordingly:

We believe there should now be a strong presumption that the MDBs have no business lending in countries and for sectors in which private financing is available on appropriate terms, and where there is a risk that such lending will simply supplant private financing. These include credit programs that service mainly large-scale industry, support for large-scale infrastructure with no significant environmental benefit, and lending in sectors such as telecommunications, where the private sector is already active.

We further believe that in a world in which the MDBs are promoting policies that succeed in increasing the emerging markets' capacity to access private finance, the share of MDB lending that is devoted to these economies should be expected to decline in volume over time and become more closely linked to the end-goal of graduation. The MDBs cannot expect to live in a world where they can count on successive capital increases for their non-concessional loan windows. Going forward, they should incorporate this reality in their identification and management of financing in middle income countries.

For all MDB lending in emerging market economies, we also believe that a review of pricing policies is appropriate. Pricing needs to avoid excessive encouragement of public rather than private sector reliance. And it needs to assure that, given the enormous needs for concessional finance, the MDBs are in as strong a position as possible to contribute resources to concessional programs and to the creation of global public goods. A review based on these principles will, we suspect, lead to higher prices in many cases.

An enhanced focus on the provision of global public goods.

Increasingly, as integration proceeds, the world is confronting a broad class of problems that cross borders and defy solution by individual governments and markets. Whether it is money laundering and financial crime, global warming, new killer diseases, or reductions in global bio-diversity, the solutions to these problems will be global public goods, requiring concerted global cooperation. We believe that the World Bank and other development institutions potentially have an enormous contribution to make in helping to push the frontier of international efforts to promote these kinds of goods, many of which will especially benefit developing countries.

Infectious diseases, such as HIV/AIDS, tuberculosis, malaria and respiratory and diarrheal diseases, are responsible for almost half of all deaths of people under 45 worldwide. Life expectancy is now actually declining in a host of African countries struck by HIV/AIDS, with adult mortality rates in the worst affected countries now twice what they were even a few years ago. Yet the WHO estimates that only perhaps 10 percent of the $50-60 billion spent worldwide each year on health research is directed toward diseases that afflict 90 percent of the world's population.

President Clinton has proposed a number of important bilateral efforts that he hopes will catalyze further efforts by other bilateral and private donors. But we agree with President Wolfensohn that the World Bank has an important contribution to make, by helping to create a market for new treatments and vaccines in many of the countries worst affected. That is why the President is proposing that the MDBs dedicate a further $400 million to $900 million each year of their concessional lending for basic health care to immunize, prevent and treat infectious diseases in the poorest countries.

Mr. Chairman, the United States cannot act alone in reshaping the institutions. We need to build consensus in order to be effective.

We have made progress in building support for this agenda of reforms. At the meetings earlier this month, the G-7 Finance Ministers and Central Bank Governors endorsed a detailed set of specific objectives for the IMF, and a broad framework of reforms for the MDBs. The broader membership of the IMF has approved an initial consolidation of IMF facilities, important improvements in safeguards on IMF financial support, and an expansion of the scope of IMF surveillance to encompass key sources of financial vulnerability. At the World Bank, there is an emerging consensus around the need for enhanced financing of global public goods, particularly the fight against infectious diseases, greater selectivity, and more effective poverty reduction strategies.

We would be happy to provide the details of these changes to the Committee. We expect further progress in the months ahead, and will provide updates as that happens.

IV. Initial Reflections on Proposals in the Report of the International Financial Institution Advisory Commission

Mr. Chairman, as you know, we are working on a comprehensive response to the report and conclusions of the International Financial Institution Advisory Commission, which we expect to submit quite soon. In addressing the topic today, I would begin by underscoring that the Administration shares a number of important goals and aspirations with the report of the IFI Commission and the accompanying dissents. Notably:

The strong affirmation of the importance of the IMF and the multilateral developments banks;

The need for a clearer delineation of the respective roles of the World Bank and the IMF - and clearer priorities;

The focus on greater transparency, both by countries and by the institutions;

The importance of designing stronger incentives for countries to reduce their vulnerability to crisis;

The importance of strong, open financial systems, and flexible exchange rate regimes;

The need for more effective programs of support for development;

The call for substantial debt relief and for a larger pool of concessional financial assistance targeted to the poorest developing countries; and

The fundamental recognition that no amounts of official finance in the world can make up for a lack of domestic commitment. Countries implement and sustain reforms to which they are themselves committed.

Despite these positive elements of the report, we find the core recommendations of the majority report fundamentally incompatible with our compelling national economic and strategic interests in strengthening the capacity of the IFIs to address the major challenges facing the world economy today. To put it bluntly: we believe that the main recommendations, if implemented as described in the majority report, would fundamentally weaken these institutions to the point where they would no longer be effective in advancing our core values and interests around the world. Let me highlight briefly our most important reasons for reaching this conclusion.

First, we do not believe that it would be appropriate to prevent the IMF from being able to respond to financial emergencies in all but a very small number of countries that are able to meet a limited number of eligibility criteria. The criteria identified by the majority would constrain the capacity of the IMF from supporting recovery in a very broad range of cases, possibly including all of the emerging market countries affected by the financial crisis of 1997 and 1998. Even where these criteria were satisfied, their presence alone would not address many of the most common policy failures that leave economies vulnerable to crisis. Implementing a regime where countries automatically pre-qualify for financial assistance on a substantial scale would greatly increase moral hazard risks in the system. The majority report briefly refers to the possibility of lending to countries that do not pre-qualify, where there is some systemic risk to the global financial system. This potentially significant exception to the pre-qualification regime is not discussed in the report, and its significance is therefore hard to evaluate.

The world is a complicated place and the sources of crises change all the time. We believe it is necessary to maintain a capacity for policy response in a wide range of diverse circumstances, and to deploy the IFIs effectively and flexibly in the face of crises that threaten our interests. Implementing the majority recommendation, in our view, would fundamentally put this capacity at risk.

Second, we do not believe that it is in the interest of the United States or in the interest of the system as a whole to provide IMF financing to countries without conditions. Indeed, we think it would be irresponsible to do so. I don't think any Secretary of the Treasury would be prepared to see the IMF provide financial resources to a country without conditions designed to promote recovery and growth, to enhance the prospects of repayment, to reduce the risk of future crises, and to avoid diversion of resources to offshore bank accounts for private gain. The limited pre-qualification conditions the majority identifies are not sufficient to provide those protections.

Third, we do not believe it would be appropriate to force the World Bank and the regional banks out of the business of lending to emerging market economies. Given the basic reality that the bulk of the world's population and the greatest share of world output outside the major industrial countries are in the emerging market economies, we don't see why it makes sense to eliminate our capacity to promote growth and reform in these economies. It is fundamentally in our interest to help emerging markets grow to the point where they are less vulnerable to crisis and where they can graduate from needing assistance from the international financial institutions.

Fourth, we do not believe it makes sense to devolve World Bank lending activities to the regional banks where we often have less influence, and whose capacities often lag behind the World Bank's. To do so would simply have the effect of reducing our ability to design and implement the most effective development solutions.

Fifth, we do not believe that it is realistic, or desirable, to shift the multilateral development banks' entire concessional assistance capacity from loans to grants. And we think it is unrealistic to offer the prospect of 100 percent debt relief by the IFIs without recognizing and providing for the extraordinary costs involved.

An exclusively grant-based system would substantially reduce our future capacity to provide development assistance. For example, in the current IDA-12 replenishment, reflows on past credits are projected to finance over 38 percent of the commitments in the three-year lending program. In the absence of such reflows, demands on donors for additional appropriations would increase substantially. In this vein, we think it is inconceivable that the Congress would be able to fund any reasonable U.S. share of the roughly $29 billion in incremental costs of the 100 percent debt relief by the IFIs, as called for by the Commission.

Sixth, we do not believe it is realistic or desirable to shift to a delivery mechanism for development assistance that would channel disbursements largely to private suppliers, with resources provided only upon full completion of the project. Development experience suggests that you will achieve relatively little durable development without a policy environment that promotes growth and the development of a market economy, and a government that is able to deliver basic education, access to clean water, and health care. These are things that governments have to do. They cannot be done solely by private contractors. And it is hard to imagine that private investors would be willing to finance such activities as a bridge to MDB disbursements that may or may not happen.

Finally, we do not believe it makes sense to take the IMF out of the poorest developing countries. To do so would deprive us of the capacity to apply meaningful conditions on the macroeconomic policy framework and on other core areas of economic policy, such as the fight against corruption. These conditions are critical to whether the substantial financial resources the world provides these countries in grants and concessional loans will be well-used, or will end up dissipated and ill-spent.

We look forward to providing a complete response to the Congress on the full scope of the Commission's recommendations.

Concluding Remarks

The challenge of IFI reform is complicated. It requires a careful assessment of the risks in today's global economy, as well as the strengths and weaknesses of our existing institutions.

We are committed to pursuing an ambitious, but responsible program of reform in these institutions. We have delivered meaningful, concrete results in a relatively short period of time, on a scale that has not been achieved in recent experience. And we will continue to work closely with the Congress as we shape the agenda going forward.



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