Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 80-99)

MR MERVYN KING, MS RACHEL LOMAX AND MR CHRIS SALMON

27 APRIL 2006

  Q80 Chairman: Governor, can I start officially and welcome you to the Committee. Could you introduce your present and absent colleagues for us, please?

Mr King: I hope that Rachel Lomax, Deputy Governor for Monetary Policy, will be joining us shortly. On my left is Chris Salmon, who is head of the division in the Bank which deals with IMF matters, and both Rachel and Chris were with me in Washington last weekend for the IMF meetings.

  Q81  Chairman: Thank you. We have looked at your speech, which you gave in India, in fact; that generated our interest in inviting you along this morning and I am very grateful that you have found time to come along to give us your views. In that speech you suggested that "we consider the fundamental question of what the Fund is for". The Fund itself acknowledges its scope has increased in recent times. To what extent do you believe it has gone beyond its remit and what do you think are the core remits of the Fund?

  Mr King: I do not think the Fund has gone beyond its remit. I think that many of the member countries have tried to broaden out the remit of the Fund and give it a wide range of responsibilities, many of which were rather ill-defined. The Fund has faced a difficult challenge. My own personal view is that it is never good for any institution, and certainly not one in the public sector, to lose track of the clear focus on its core mission. I think it does make sense to go back to first principles and ask the question "What is the Fund for?" It was interesting that in Washington this past weekend more people than before were prepared to ask that question. I think that there are two different views. One view—the one that I would espouse—is that the main mission of the Fund is to focus on its role as guardian of the international monetary system. Its job is to ensure the smooth workings of the international economy and, to that effect, it does not have any simple instrument that it could use. Its main role has to be in terms of intellectual leadership, guidance, authority and bringing people together to discuss issues which are accepted to be of common interest. I think the other view is that if there is not a very clear instrument in the area of surveillance, in the broadest sense, then the Fund should focus on its lending activities. My own view is that we have seen over the past 30 years a very big change in the environment in which the Fund operates. It is 30 years ago this year since the UK was the last major industrial country to borrow from the IMF. It is now inconceivable that any major developed economy would ever have to or wish to borrow from the IMF. The second view—that the Fund could see its main purpose as a lending institution—is not likely to be necessary, or indeed for there to be a demand for it, from the industrialised countries. As we saw in the 1990s, the Fund became a major lender to emerging market economies. I think actually one of the good news stories of the past five years is that the Fund is no longer a major lender. Far from being a problem this is actually very good news—these countries do not wish to borrow, do not need to borrow, and we ought to encourage that. I feel somewhat uncomfortable with the idea of an international institution whose income, whose status, and whose excitement seems to depend on other countries less well off getting into serious financial difficulty. We ought to be doing everything we can to create an environment in which crises are seen as bad things, rather than good for the IMF because they raise its income and good for the staff because they give them something exciting to do. I think that my own view is that, from now on, the main role and functions of the Fund will be primarily in surveillance. I think there is one further, very important reason why, which is that we have had paper currencies for a long time, a century or more, but only in the last 20 years, even in the developed world, have we learned how to manage fiat paper currencies effectively in terms of monetary policy. One of the consequences of that is that in the new world, new for the late 20th century and 21st century, of open capital markets, capital mobility, only credible monetary policies and credible fiscal policies enable you to borrow from abroad. If you were going to borrow from abroad, it would make absolutely no sense to borrow from abroad on a big scale in foreign currency terms. You are creating an immense risk by doing that. That is exactly what led to the crises in the late 1990s. I think the major lesson that has been learned by emerging markets is that borrowing in foreign currency, leading to potentially large currency mismatches between the balance sheet of your domestic economy and that of foreign claims on it, is very serious, it creates a big risk. What we have seen is a response of two kinds. One is that in the short run many of these emerging market countries have built up massive foreign exchange reserves to enable them, if there were to be a run on the banking system, to act as a sort of "do it yourself" lender of last resort to their own financial systems. Secondly, we have seen some emerging market economies now start to realise that they do not want to borrow in foreign currency terms. Either they are not borrowing or, where they are—as in the case of Mexico—they have gone to great lengths to ensure that they can now create a domestic debt market so they can borrow from foreigners in their own domestic currency. That is the only safe way to borrow in foreign currency terms. The only other way to borrow which is relatively safe is to encourage foreign direct investment and equity investment into your own economy. To borrow from abroad, in fixed-debt finance terms, in foreign currency, is a terrible risk.

  Q82  Chairman: Welcome, Rachel. The inquiry we are having is on globalisation but the IMF is a subset of it, so we are coming on, later on, to talk about the issue of globalisation in its widest sense. As far as IMF is concerned, do you have any initial comments you would like to make on the IMF's role and its future role?

  Ms Lomax: I do not think I have got anything really to add to what the Governor has said and I am happy to move on to questions.

  Q83  Chairman: The Chancellor, in his Foreword to the Treasury Report, in its dealings with IMF, calls for the IMF to become independent of governments. What benefits do you think that will bring to the IMF?

  Mr King: I think the main area that we focused on here—and it was something that we both discussed in Washington at the weekend—was making IMF surveillance somewhat more independent. The reason for that is that to make surveillance effective we genuinely want to know what the IMF really thinks. We do not want that somehow to be confused and concealed by lots of "behind doors" drafting of reports that they produce. What goes hand in hand with that is, if there is going to be independence of IMF surveillance and a very clear, stated view, that they must be held accountable for it. Hence the sort of twin-track approach of, on one the one hand, giving IMF surveillance more independence and, , and on the other hand, making the IMF more accountable for the quality of its surveillance and giving the Independent Evaluation Office there a bigger role, in reporting on surveillance. I think that the Independent Evaluation Office has been a big success; it produced some quite punchy reports on the lending programmes which the Fund made, particularly in the case of Argentina. The Independent Evaluation Office report certainly did not pull its punches and their reports are well worth reading. If we can encourage the same outspokenness in the IEO now, under its new leadership, as it demonstrated under its previous leadership then that would be a very, very good thing. In the lead-up to this debate, the Chancellor had been stressing also that it was very important to separate surveillance from those making decisions on the lending programmes. I think that is also very important, because there was a great temptation, if you were the part of the Fund that had been responsible for lending to a country, partly to be captured by that programme. You had an enormous amount invested in the success of that programme and you were very tempted to claim that it was being more successful than it was. The Fund was reluctant to pull the plug, and hence very often the comments that were made were not as bold and as blunt as they might have been.

  Q84  Chairman: There is a view that if you make it more independent then it is less accountable to its stakeholders, and the political, the global pool of polar dissatisfaction there has been with these institutions can continue. How do you counter that?

  Mr King: I think that goes to the governance of the Fund, and I think that having a very clear, straightforward, unbureaucratic method of governance of the Fund is crucial. That is why I commented on the role of the Executive Board. Any body which is the main vehicle of accountability which receives 300 pages of text to go through every single working day, every single week, is going to be snowed under with things. That is why I suggested that it was worth contemplating a non-resident Board, in order to make the accountability more effective. I do think that having senior people fly in from capitals to have regular Board meetings will be much more likely to hold the senior management accountable than the extraordinarily cumbersome method of governance that we have imposed on the Fund, and indeed many other international institutions. This general problem of a very expensive, very time-consuming, full-time Executive Board, staffed by people at middle level, not by senior officials from capitals, has made it—in my view—more difficult to hold the senior management accountable in many organisations more difficult to hold the senior management accountable as well as embroiling the senior management in a massively expensive bureaucratic exercise.

  Ms Lomax: Can I comment on that as well. Looking at the context in which the Chancellor made this remark, and of course the parallel with the Bank is quite interesting and suggestive, because, in a sense, the Bank is not completely independent of Government, it is operationally independent, but it operates within a very clear framework. The great innovation in 1997 was to be extremely clear about what the respective roles were of the Bank and the political end of Government, when it came to monetary policy, and to give the Bank a very clear remit and a clear framework for accountability. I think that is the sense of independence which is important for the Fund. There needs to be a lot more clarity about exactly what it is trying to do and what the framework of accountability is, and I think that was the point the Governor was making very strongly in his speech.

  Q85  Angela Eagle: Governor, looking at your speech, you quote from the founding intellect really, John Maynard Keynes, about the desirability of the Fund's approach to every problem being absolutely objective. Do you think that happened? Trying to focus here on the imbalances which have been built up by countries in Asia really to defend themselves against intervention from the Fund, do you think that kind of approach really is based on other countries' experience of IMF bail-out?

  Mr King: I think the decision by countries in Asia to build up large foreign exchange reserves is undoubtedly, in part, a result of the experience of the Asian crisis in the late 1990s. They got into difficulty then partly because they did not have large dollar reserves of their own. They had to turn to the Fund, it took sometimes both time and difficulty to organise that. The degree of conditionality that was imposed by the Fund on those countries—and I think the Fund recognised this with the benefit of hindsight—was excessive. Certainly it was much greater in detail than was imposed on Latin American countries which borrowed from the Fund. I do think that the Asian countries have a genuine cause for complaint about the way that was carried out. More fundamentally than that, in a way, I think the lesson learned was, as I said before, it is very risky to borrow from abroad in foreign currency: you might find yourselves subject to a run on your own currency and then find the burden of foreign currency debt increasing in terms of domestic resources. The lesson which was learned was: "Let's not get into the position where we find these potentially large currency mismatches on our national balance-sheet." That is the fundamental reason. I think that once you take that view the short-run answer is to make sure that, where the private sector or the banking sector does have large, foreign currency denominated loans, the country as a whole needs then to have large foreign currency reserves in order to balance that. In that way, they can ensure that they can provide those resources to the financial sector when needed without resort to borrowing from the Fund—a process which, inevitably, may exacerbate the run on the currency given the time it takes to put these things in place. I think that the experience of the 1990s was undoubtedly instrumental in persuading the countries in Asia to build up very large foreign exchange reserves. I think since then the Fund has been very clear about the consequences of doing that, namely the fact that policy is bound to exacerbate the imbalances in the world economy which existed already from trade flows and that at some point this will have to come to an end. It does not seem remotely sensible that even those countries will want to accumulate indefinitely larger foreign exchange reserves. I think that in the course of the past 12 months we have got to the point now where it is pretty clear that Asia does not want, in aggregate, to make significant further additions to its foreign exchange reserves. China has made clear that its strategy over the next 10 years is to see more growth coming from domestic demand than from net exports. That is the other side of the imbalance; over the next 10 years more of the growth in the United States will have to come from net external demand and less from very rapid, domestic demand growth.

  Q86  Angela Eagle: The irony really is that, because the IMF behaved in this way and got itself caricatured, or characterised, depending on your view, as the sort of enforcer of the Washington consensus, controlled by the United States, in its interests, leaping into Asian economies and telling them how they ought to behave, in a way which was probably less generous, as you said yourself, than what happened in Latin America, now somehow the IMF has got to prove to world opinion that it is not that way. Do you think that objectivity in surveillance is the way to do that, or do you think actually they need to do something even more dramatic?

  Mr King: There is a new management team at the Fund now and I think that the Managing Director gave very clear leadership; he was particularly forceful over the past weekend about being objective about the IMF analysis. Also, launching the new multilateral consultations which he has proposed will provide a way forward that will demonstrate to the major players that the IMF is completely even-handed and is objective in its analysis. The reason we need an IMF is precisely because it is possible then for all the parties to these discussions to regard the IMF as neutral. The staff analysis is very high quality; they have got some extremely good people there. I think the Fund just needs to keep playing thethe sensible game now of being objective in its multilateral consultations. That is the new exercise which it was given the authority to do at the weekend, and I think the Managing Director will run with that.

  Q87  Angela Eagle: In terms of again the history of Bretton Woods and all of that, Keynes was very certain when the Fund was created that he wanted one of its duties to be dealing with offshoring, which was then a much smaller phenomenon than it is now. We have a system now where there are literally billions of pounds stored offshore, avoiding tax, causing all sorts of problems, assisting global criminal organisations and laundering their money, and terrorist organisations. Do you think there is a role now to go back to the original intent which Keynes had, which was that the IMF should have some role in attempting to police mass tax evasion of the sort that we see with offshore?

  Mr King: I understand why there is a wish to do that, but I think that if you want to have policemen it makes sense to hire professional policemen. They are not in the IMF, they are in national capitals; it is a question of political will. I think one of the big mistakes is to try to ask the Fund to do too many things; in recent years the Fund has been asked to be a fireman and a policeman.

  Q88  Angela Eagle: It is all emergency services?

  Mr King: I think it should not be emergency services. I think this is not the kind of support one wants to inculcate. Perhaps I am influenced too much by my experiences at home, but one of the successes, I think, of the Bank of England is that we have moved away from an institution whose main contribution is dealing with crises towards an institution which sees its main business as being boring and actually ensuring stability. I have never forgotten that in one or two of the banking crises that were seen, when people had to come in and work at the weekend and it was all terribly dramatic, the only people who ever complained were those who were not called in to work—unpaid of course—at the weekend. A crisis, far from being a real problem for a public servant in those situations, is what makes the job exciting! You do not want people to have that kind of incentive. It is very important to have an institution like the IMF which does not benefit from financial crises, either financially or in terms of the culture and excitement of the work. You want people who see their job as being to try to maintain sensible, useful, background discussions among the different economies about how, slowly and steadily, we are going to unwind these imbalances. The last thing you want is a crisis in which the Fund sees that it will be at the centre of world events, at long last, again, as it was with Argentina and Brazil. "Wasn't it fun to go to Indonesia and stand over the President and make him sign something?" You do not want an institution where people feel that way; you want people who do not want to be at the centre of events. It is on your side of the table that you want people at the centre of events, not in the official organisation.

  Q89  Angela Eagle: It is the inevitability of gradualism towards complete boredom?

  Mr King: Exactly; that is exactly right.

  Q90  Mr Fallon: You have praised the Managing Director, but Professor Richard Portes told us that, in his view, the strategic review really had not taken us much further. Do you share that?

  Mr King: I am not sure when you saw him, but I think the events last weekend were a very significant departure from earlier versions of the strategic review as was the energy which the Fund was demonstrating. I had some sympathy with the fact that the initial versions of the strategic review were not bold enough, but I think that the energy and boldness shown last weekend were quite markedly different from that which we had seen before. I do feel now that the leadership of the IMF has picked up the baton and is seriously aware of its main mission. It. It knows there is a challenge in the future, because of the reduced lending by the Fund, its income stream has fallen—everyone in the Fund is aware of that. That is a very important pressure on an institution to think about its main role and focus. I think that the new approach to multilateral surveillance which was launched last weekend is one which the Managing Director will run with and he is very conscious of that being one of his main tasks in the year ahead.

  Q91  Mr Fallon: Some weekend work was effective?

  Mr King: This was one of the best weekends, maybe the only one, but it was certainly a more effective weekend.

  Q92  Mr Fallon: Professor Portes did make that comment on 31 January, so clearly it has moved on. In your own speech, one of the things you asked the IMF to focus on was beefing up its surveillance, but you used for that a wonderfully evocative metaphor of asking the IMF to turn into more of a cricket umpire, encouraging players not to sledge each other, and indeed encouraging players to walk. Is that realistic, is that really what you mean by making surveillance more effective; it is not the thing that umpires do any more, is it?

  Mr King: I think they do and they also have quite a good relationship with the players. The IMF has no instrument to enforce its views. It can produce analysis, it can say what the consequences are likely to be of a given configuration of policies, stressing the uncertainties, but it does not have any instrument. Nevertheless, I do not think that fact should lead it to go off and find some other activity where it might have an instrument; its main purpose is to think about the global economy and the financial system. What it can do is bring people together when they want to be brought together; you cannot impose that on them. I think we have seen over the last 20 years that there are periods when there are serious imbalances in the world economy, when the various players—big players in the world economy—want to come together. We saw that in the 1980s when the G5 and G7 were set up. We saw two years ago at Boca Raton—I was there—the G7 sat round the table and said, "We're the wrong people; we need other people in this room." It is very difficult to do that when it becomes a bilateral argument between the US and China. I think that the IMF can do two things. One is that it can be the neutral chairman of a group brought together to discuss these questions. There. There is no doubt there is a demand for that. We need to know what policies other countries are likely to follow. I was very surprised at the weekend to discover that when we had a special session organised by the Fund on the imbalances, although there was nothing new to say about the imbalances in terms of analysis, we had all read it many times before, the people round the table wanted to talk to each other and they wanted to hear what other people thought about it—did they share the analysis of the Fund? So bringing people together and providing that objective analysis which people will respect as being independent of any of the parties to these imbalances I think is a very valuable role. From time to time the demand for it will be larger than at other times. When the world economy is fairly quiescent and there are not any significant risks out there, I suspect this will not be perceived as being a very important or major role. That is not bad, in my view, let us let things just carry on. When the imbalances look as if they may start to unwind, I am completely confident that the major players will want to talk to each other. We see that the US and China have a lot to say to each other. It is better if they can say it to each other in a technical form, when the policy-makers are there, without too many cameras. With cameras. Withthe benefit of the Fund's analysis, they can try out ideas on each other and actually discover what the other's views are. That, I think, is a valuable role, even though the Fund does not have a particular instrument to use.

  Q93  Mr Fallon: The Managing Director, in his Medium-Term Strategy Report, wanted more emphasis on the original goal of surveillance, which was assessing the consistency of exchange rate and macroeconomic politics with national and international stability. Should that still be the object of the surveillance?

  Mr King: I think it has to be broader than that. If you look at the IMFC communique« from the weekend, you will see that one of the four points in the four-point action plan adopted by the IMFC adopted was to make sure that countries realise that they did have responsibilities to each other and that there needed to be a restatement of their policy frameworks, not just in the area of exchange rates, but also in the area of monetary policy and fiscal policy. You cannot think about exchange rates in isolation from monetary and fiscal policy and I think one way to make more of a success of the debate between the US and China is, in fact, to see it in a broader context. I think everybody now is recognising that fact. The The issues of multilateral surveillance and consultations and the questions that the Fund will focus on are not just a question of exchange rates but go broader than that to the entire spectrum of the three main parts of macroeconomic policy.

  Q94  Mr Fallon: Because they go broader than that, presumably it is more and more difficult for the Fund actually to start defining what a suitable exchange rate should be for a particular country?

  Mr King: I do not think the Fund should say "The appropriate exchange rate is X." What the Fund should be saying is, for example, if a country wishes to have a fixed exchange rate it is entitled to that choice, but it cannot then turn round and claim that also, at the same time, it wants to control its domestic inflation rate; it will not be able to do that. Indeed, if it tries to intervene in the foreign exchange market to prevent the domestic price level adjusting, what it will be doing is trying to distort real exchange rates. It is very difficult to think of the world economy operating properly, in any market sense, where countries try to influence or distort real exchange rates. The Fund can just draw up the consequences of sets of policies and it can give countries choices. I do not think it makes sense for the Fund to say to a country "You should do this, that and that," in terms of very specific details. What it can point to is the consequence of its current fiscal framework or lack of commitment to a fiscal framework, its current approach to monetary policy and its exchange rate framework. Countries can then draw their own conclusions and make their own decisions. It is not sensible to repeat what happened with emerging markets in the 1990s with developed economies now. The Fund will not succeed in doing that. What it can do is really help countries, encourage them to speak to each other by debating the Fund analysis. That will bolster their determination at home, when they get back to capitals, to do something which makes sense in the medium term and they will make their decisions. Unless they are committed themselves to those decisions, just doing something because the Fund says it is a good idea will never really work.

  Q95  Mr Fallon: This is talking to the team captains in the hotel after the first day's play?

  Mr King: Or indeed before the play begins. And those talks can be valuable.

  Q96  Mr Newmark: I would like to turn to contingent financing for crisis prevention and debt restructuring. I have a particular interest in that since I did corporate restructurings before I came in here last year. The Managing Director's Report on implementing the Fund's Medium-Term Strategy discusses a high-access, contingent financing arrangement. Do you think this is intended to replace the Contingent Credit Lines?

  Mr King: Yes; but I think there are differing views in the international community about whether this is a good idea or not. On the one hand, you can see the attractions of trying to encourage countries to adopt sensible policies before they need to rush into a borrowing programme; to say to them, "If you follow the right policies now, we'll say that you will have access to a certain amount of finance and you will have to wait until a crisis to be eligible for borrowing." On the other side of this is the view that this is still harking back to an era in which we were implicitly encouraging countries to borrow foreign currency, thus running the risk of a future need of an IMF programme. I think the real uncertainty in all this, which has not been resolved, is whether it is possible to create such a contingent facility in a way which genuinely convinces people that the Fund will not then be rather lax in allowing that to slip over to an Exceptional Access programme if countries perform badly and do not meet the conditions but get into a crisis. I think there is a real worry about that. One of the big successes of recent years has been the attempt to enforce the Exceptional Access Framework. It is not ideal, there have been cases where the Fund did not comply with it completely, but in my view it is very, very important to demonstrate that the Exceptional Access Framework is taken seriously. By which I mean that if countries decide to demand a much bigger loan than three times their quota, a big loan, and cannot satisfy the Fund that their policies have a sustainable path for their debt then the Fund should not be lending. In the past, particularly in the case of Argentina, but not just Argentina, I think our view was, and we said so at the time to the Fund and to other G7 countries, that it does not make sense to lend money in this situation because the policy framework against which we are lending is not sustainable and that, at some point, the country will not be able to repay its debts.

  Q97  Mr Newmark: My understanding of this whole framework though is that you are not dealing with those, frankly, at the bottom end, you are dealing with those in the middle which have some sort of history of stable macro policies, sustainable debt, transparent reporting, and so on, that they have fallen, temporarily, sort of off a cliff and you are there to help them out?

  Mr King: Certainly that is true and I do not want to dismiss that as a reasonable case for such a facility.

  Q98  Mr Newmark: Effectively, you are not saying it is a junk, debt-rated country?

  Mr King: No; absolutely. Taken at face value, there is a perfectly good case for that facility. The argument against it is not an argument on grounds of substance in those circumstances, it is a political economy concern that, in the past, the Fund has not shown itself to be as disciplined and rigorous as it might be in implementing what it said ex ante were the rules of the game. Mr Salmon is one of the experts on this.

  Q99  Mr Newmark: The Contingent Credit Lines were never drawn on and why do you think this was, and what can be done to make the new proposals by the Managing Director more successful? If you could tie the two together that would be helpful.

  Mr King: I will ask Mr Salmon to answer that.

  Mr Salmon: Your last question anticipated what I was about to say. The issue is a design issue and the failure of CCL to attract any customers shows the problem. You have to balance, on the one hand, safeguards for the Fund, how you make the entry criteria sufficiently tight so that only countries which have adequate policy qualify, versus benefits to the countries in the first place. They could not get the balance between those two things right with the CCL. The latent demand from some of the EMEs for this type of facility has continued, and so what the MD has said is "we will have another go to see whether we can get round these design issues". I think it is an empirical issue: can you can get, on the one hand, sufficient benefits versus sufficient safeguards for the Fund on the other hand, so that actually the set of countries which will want to use the facility is bigger than the nil set The Fund will work through the summer on these issues. I think our attitude will be, very much, looking at the detail of the proposal, to assess if the Fund got the trade-off right? We will reserve judgment until we have more details.


 
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