Crisis Prevention: The International Agenda

1. Crisis Prevention: The International Agenda Jonathan T. Fried Executive Director Canada, Ireland and the Caribbean International Monetary Fund

2. Outline The Diagnosis: Underlying Causes of Crisis 2. The International Response Surveillance Asset and liability management Bond market development IMF facilities Debt Relief 3. Conclusion

3. The Diagnosis: Underlying Causes of Crisis Policy imbalances leading to financial vulnerabilities Weak, poorly-regulated financial systems that concentrate risk Institutional weakness in legal and accounting frameworks Information asymmetries that contribute to uncertainty and invite panic responses to bad news

4. The International Response (I): Surveillance Key service provided by the IMF Aids in crisis prevention by: Assessing fundamental risks, both external and domestic, with a focus on macro-critical issues Identifying weakness in prudential and regulatory frameworks Promoting best practice through the use of Standards and Codes

5. Surveillance, continued Experience shows surveillance could be improved by: Working to increase its candor and effectiveness Increasing the focus on financial sector More focus on macro-financial linkages Greater focus on FSAPs and integrating financial sector analyses Taking a more holistic look at exchange rates Developing new models Looking at them in from a multilateral perspective Increasing disclosure of findings

6. The International Response (II): Asset - Liability Management Identifying and reducing asset-liability mismatches Debt Management Debt Sustainability Analyses (DSAs): Designed to identify vulnerabilities in public sector balance sheets resulting from fiscal and macroeconomic developments and shocks Technical assistance

7. Asset - Liability Management, continued • Asset Management • Technical assistance in the design and management of wealth funds and reserve pooling arrangements • Advice on management of central bank reserves

8. The International Response (III): Developing Local Financial Markets Bond Markets • Original sin prevents sovereigns from borrowing long-term in their own currency and exposes them to risks • Deeper, more resilient domestic bond markets can reduce these risks • …and can foster the development of deeper, more liquid domestic capital markets

9. Developing Local Financial Markets, continued Area of major focus at present, requiring efforts along many dimensions: • Rule of law • Stable macroeconomic environment • Technical expertise: • Sound regulatory framework • Clearing and settlement systems • Sectoral regulations • Broadening investor base (e.g. facilitating investments by pension funds) • Transparency and international investor relations

10. The International Response (IV): The IMF’s Facilities IMF as a lender of last resort: • Its facilities – SBA and SRF – can help in liquidity crises, thereby having a deterrent effect on speculative attacks • In practice, it is difficult to distinguish liquidity from solvency crises • Precautionary SBAs and PSIs are currently the only pure crisis prevention facilities • Both are ill-suited for crisis prevention

11. The IMF’s Facilities, continued • IMF currently working on a purely preventative facility to plug the gap • Considering a “Reserve Augmentation Line” that would provide large sums unconditionally to qualifying countries • Several important issues • Lender and borrower moral hazard • Entry/exit problem • Rate of charge

12. The International Response (V): Debt Relief • HIPC and MDRI can be viewed as forms of crisis prevention • Reducing the debt service burden creates space for growth enhancing expenditures • Better economic outcomes reduce the likelihood of crisis • There is a debate: free-riders and non-concessional lending

13. Conclusion (I): Effective Surveillance is Fundamental Importance of surveillance hard to overstate • Ensures that countries are aware of flaws and vulnerabilities in their policy frameworks, and the likely source of shocks • Also ensures that markets have reliable information and analysis on the countries they invest in

14. Conclusion (II): Debt Management is Key Published DSAs provide countries and markets with good frameworks for analyzing a country’s risk profile: • Can lead countries to take corrective measures long before problems occur • Can also reduce speculative attacks in cases where vulnerabilities are low