Select Committee on Treasury Minutes of Evidence


Examination of Witnesses (Questions 100-119)

MR MERVYN KING, MS RACHEL LOMAX AND MR CHRIS SALMON

27 APRIL 2006

  Q100  Mr Newmark: It is still work in progress?

  Mr Salmon: The strategic review sets the direction but it does not provide details, so we have to see that detail.

  Q101  Mr Newmark: My next question is to do with sovereign debt reduction mechanisms. In April 2003, the IMF concluded that proposals for a Sovereign Debt Restructuring Mechanism were not feasible but that work should focus on improving orderly debt restructuring. What progress has been made in this area and what role should the IMF play?

  Mr King: Let me talk about the general part of this and then I will ask Chris to comment on the more recent progress. The Bank of England was heavily involved in this because the Bank of England and the Bank of Canada did some joint work, which proposed that it was necessary to take seriously the development of mechanisms in which the Fund would sanction debt restructurings. An orderly debt restructuring was something which we had to be willing to contemplate because it was better than a completely disorderly restructuring, which is of course exactly what occurred in the case of Argentina. It goes back to the question of debt sustainability. There will be moments when a country finds itself so deeply in trouble that it is simply implausible to imagine that it can pretend that it will be able to repay its debt without some serious restructuring. At that point it is better to recognise that fact. We found it immensely difficult to persuade some other G7 countries, particularly the Americans under the Clinton administration, of that. Their strategy was to grant much bigger and larger loans to those countries so the amount of debt just escalated. In the end, as in Argentina, it was inevitable that default occurred, and it did. We feel that it is necessary to recognise that at some point such a restructuring might occur. It is not the job of the international financial institutions to bail out the country. What that means, in effect, is not bailing out the citizens of that country—they are the ones often who lose, because they are the ones who have to repay the IMF. It is bailing out the large western financial institutions which lend to the emerging market countries. They were the ones who felt they could lend, because in the end they might well end up lending not to the country concerned but to the G7 or to the IMF. If you were lending to that group of countries, that was a very different prospect. The moral hazard implied in these potentially large programmes and the unwillingness to recognise that debt restructuring might occur was very important. Anne Krueger of the Fund proposed a Sovereign Debt Restructuring Mechanism.

  Q102  Mr Newmark: Based on Chapter 11 in the US bankruptcy code?

  Mr King: Based on, broadly speaking, the principles of Chapter 11. The difficulty with it is not the difficulty of thinking of a mechanism but that it would require legal changes and changes to the Articles of the Fund. Those would require ratification by all member countries. It was something which clearly was years away and might never have occurred, and indeed that was the pressure of many of the Wall Street financial institutions.

  Q103  Mr Newmark: Is not the concept of applying, effectively, private sector practice of Chapter 11 something which, in your view, does make sense, if one can get through the log-jam of the political process?

  Mr King: It does, and in fact I think we saw one example of that in Korea. It It was not so much a debt restructuring as a debt rescheduling. When When Korea got into financial difficulty, I think we were all convinced that this was genuinely a liquidity problem; it was not an issue about Korea's ability to repay but it needed some time. In the end what happened was essentially that Korea called a temporary halt, a standstill, on payments to creditors. It brought the creditors together and within a very few months was able to start the payments again, but it needed that temporary period to call a halt. That sort of standstill is a perfectly reasonable thing to do, in certain circumstances. Lenders. Lenders must recognise that there will be circumstances when that occurs. That is part of the implicit debt contract, and I think it is important that be recognised to be part of sovereign debt as well. One way you can try to prevent that happening in practice is to go right back to when the contracts were signed. That is the purpose of the Collective Action Clause in bond issues and it is something which bond issues in London have recognised for a long time. Issues in Wall Street now have come more into line with that.

  Q104  Mr Newmark: Because it deals with Qualified Majority Voting, it prevents individual countries holding out and you can get resolution quicker. It has been proposed by Daniel Cohen and Richard Portes that the IMF should act as a lender of first resort for developing countries, to prevent sort of a vicious spiral which a confidence crisis can unleash. Do you agree, and, if so, how would such a system operate?

  Mr King: As I say, my own personal view is that I have reservations about encouraging the Fund to develop yet more facilities. If we go on like this, soon we will have more facilities than borrowers. I think it is more important for the Fund to focus on surveillance than borrowing. There are some technical issues that we might raise questions on. It is an idea that is worth discussing, but I am not convinced that, at this stage, it is the major need for the Fund.

  Q105  Peter Viggers: The UK has commended the IMF's work in the field of money-laundering. To what extent should the IMF be involved in a fight against money-laundering or are there other institutions which will undertake the work more effectively?

  Mr King: It is a very good question and I have some sympathy with IMF management when they are subject to criticisms very often that their budget keeps expanding and yet suddenly find that each time there is a meeting they are asked to take on more responsibilities. I think the main work in this area has to come from finance ministers. John Snow, the US Treasury Secretary, made that clear in an article he wrote recently. Of course, the IMF is a useful forum for bringing together finance ministers. Again, I think perhaps its real role is—and it is one it has played quite effectively—to bring together groups of finance ministers from the relevant countries involved in a wide range of activities which encompass money-laundering, on the one hand, and actions to make it more difficult to finance terrorism, on the other. These are not operations which the Fund itself can easily carry out but it is a forum within which the finance ministers can discuss joint issues, questions of communication and share information. It makes it easier for those in national capitals responsible for those questions to work with their counterparts abroad.

  Q106  Peter Viggers: Turning to surveillance, do you think that the recommendation in the new Managing Director's Report, confirmed in the Communique«, go far enough; are you satisfied with the upshot of those discussions?

  Mr King: I think this was a very big step forward at the weekend. There was nothing in any previous discussions to compare with this quite clear four-point plan which the IMFC Communique« makes clear. I think the real task now is implementation, and I think that what we saw at the weekend was a very determined Managing Director who was quite clear that he wanted to move on the multilateral consultations sooner rather than later. I think the proof of the pudding is in the eating. I think, in terms of putting in place the commitment and support to the Fund by the member countries, through its senior group, the IMFC, is very important. All member countries, through the IMFC, signed up to this four-point plan. I think that is important, and the Managing Director now has the authority to take it forward.

  Q107  Peter Viggers: You have commended the Independent Evaluation Office for its work in overseeing activities. Do you think that the IEO is properly structured; does it need to be changed in any way? Just for a different point of view, would another international organisation, such as the OECD, be well placed to carry out an analysis of IMF's work?

  Mr King: I think the IEO is the right body. It has got a very clear remit to comment on the Fund and it has demonstrated, so far, a willingness to be very frank and blunt about the failures or shortcomings of Fund programmes. I think that is a big question to ask; would they be frank? It is not easy for an organisation to be as open about its shortcomings in something as controversial as the programme to Argentina. I think the Independent Evaluation Office did a really first-rate job, so I think they have proved their independence and they should be encouraged. The OECD should not be asked to comment on the IMF; they have got their own remit and role. I do not think they should be trying to copy what the IMF is doing, they should be focusing on structural questions: microeconomic policies, the questions which determine the long-run development of productivity in member countries. There is enormous benefit to be had from the peer review and exchange of ideas about those policies and experiences in each country, with different policies. That is what the OECD is for. It is not there to deal with the global macroeconomic policies and imbalances, which is the task of the IMF.

  Q108  Peter Viggers: What role is the IMF playing currently, in terms of monitoring the level of financial risk within the system, and does this impact on the UK authorities' activities in this area of monitoring financial risk?

  Mr King: The IMF has devoted more resources in recent years to looking at the risks in the international financial system. It is not a group of regulators or supervisors so it tends to look more generally at risks to the system as a whole. I suppose one can think of their role, in looking at risks, relative to that of the Financial Stability Forum or groups of supervisors, as analogous to the Bank of England's role in looking at financial stability generally, in contrast to the FSA's role of looking at individual institutions. I think they have done a very good job in trying to integrate the analysis of major economic shocks to the world economy and what that might do when transmitted through the financial system; does the financial system exacerbate or mitigate the risks caused by macroeconomic shocks? The Fund has, for example, contributed to the debates about about the much greater range of new financial instruments, particularly in the debt field. On the one hand, the new instruments offer opportunities for greater risk-sharing and mitigation of the risk. On the other hand, they also make it easier for people to take more risk if they wish to do so, so that might exacerbate an economic shock as it was transmitted through the financial system. I think the Fund have done quite a good job in this area. I think that its focus though has to be on the economic consequences, not the consequences for the financial sector. The IMF's role is to think about the position of economies and what is happening in the global economy; that is what it needs to focus on. From that perspective, what I suggested in the speech I gave in February was that the particular focus of the Fund should be on the balance-sheets of countries and financial sectors. It is the structure of a country's balance-sheet which really determines how these economic shocks are transmitted, not just into one country but from one country to another. That really is the focus of the Fund.

  Q109  Peter Viggers: This Committee has taken two different kinds of evidence on whether the IMF should be involved in the lecturing on free markets. Do you have a view on this?

  Mr King: I do not think the Fund is going to get very far just by lecturing people. It should be in the business of explaining things and letting people draw their own conclusions. That is where,I think, the Fund will have its biggest influence. I think you can see, from the demonstrations against the IMF, many of which bore no relationship at all to what the Fund has done, that the perception in many countries is that the Fund has gone in and lectured people and told them what they had to do. That of course is not true. What they have done is say, "If you would like to borrow this large amount of money then we think that, in order to be willing to lend you this money, these are the conditions that you should be prepared to meet." A lender is perfectly entitled to lay down conditions for a loan. I think the Fund needs to move away from that more. That is why I think, we should put less emphasis on lending, where conditionality is inevitable, and more emphasis on trying to explain to countries what the consequences are likely to be of the policies that are being pursued and to involve them in a discussion. When people see it laid down in a clear, analytical way they can draw their own conclusions. If you follow irresponsible monetary and fiscal policies you will get into trouble. There are occasions, I believe, when some politicians are willing to do that, because they have very short-term horizons, but most do not, most care about the future of their country and they can see what policies make sense. It does not need the Fund to lay down all this in such detail, but it can help finance ministers and central bank governors, when they come back home to national capitals, to help lay out the arguments and to persuade their own electorates. The lessons I think we saw with IMF programmes are that it is no good just to say "Here's a piece of paper; sign it," because if people at home are not convinced that these policies are the right policies to be pursued in the circumstances they will find ways round it. The conditionality will not be met. It is a question of winning hearts and minds, not a question of telling people what to do.

  Q110  Kerry McCarthy: Can I just pursue the question of conditionality. In the Managing Director's recent Report, there was a suggestion that there would be maybe a two-tier approach, that for some countries with strong track records there would be fewer conditions imposed. That seems to be contradicted slightly by what you have said, of a more general approach of winning hearts and minds and talking about the consequences rather than imposing conditions. Do you see that there should be a general approach which applies to all countries, or are you saying that there are some countries where it would be easier to implement that approach?

  Mr King: No. Perhaps I was not very clear, I am sorry. Where the IMF is lending to a country there will have to be conditionality. You will never get a loan without conditionality. There is a question of how detailed that conditionality should be and I think the Fund itself has recognised that in the nineties it was probably too detailed on conditionality in some cases. It has since moved away from some of the detailed conditionality. It needs really to stick to the broad macroeconomic parameters; that is what matters. Whether there are tariffs on particular items or not is not a matter for the IMF, it is a matter for WTO and the country itself. The big, macro picture is what the Fund is concerned about. In terms of lending, there will be some conditionality but, I think the Fund itself agrees, less detail. The interesting development in the Fund is to say "What can we do for countries to which we are not lending? There are lots of countries to which the Fund is not lending; what can we do?" I have talked about the multilateral surveillance and consultations in terms of the big players in the world economy. There are other economies, small players, where the Fund has said, "Well, perhaps we can do quite a lot to help that country, provide advice, without lending money." One way of doing that is to introduce something called a non-borrowing programme, in which the Fund and the country work together to discuss the economic policy of that country in a context which does not involve borrowing from the Fund. I think that is one way of making the advice more available without getting into any detailed conditionality, or indeed lending.

  Q111  Kerry McCarthy: As far as lending goes, do you see that there will be a flexible approach to conditionality in terms of the countries' track records?

  Mr King: I think I would put it in a less detailed way. There is always going to be conditionality in terms of the broad macroeconomic framework, and I do not think that will be flexible in the sense of saying "Because you had a good policy in the past, we won't bother to specify a macroeconomic framework." The Fund will still need to do that, but it will be less detailed and less microeconomic the more macroeconomic it is.

  Q112  Kerry McCarthy: Is the UK very much behind this move? There was the DFID paper recently on reducing conditionality. In terms of both the IMF and the World Bank, the UK's approach seems to be moving away from the stringent conditionality. To what extent are other countries on board, or is it something where the UK is trying to implement it on a bilateral basis; to what extent have we actually won the arguments, as far as the super-national organisations are concerned?

  Mr King: As I say, I think, as far as the IMF is concerned, we have won the argument. They themselves have acknowledged that, certainly in the 1990s, some of the conditionality was too detailed. In terms of the development aspects of Fund programmes, lending to low-income countries, where there are specific issues to do with development, that is very much for the Treasury and for DFID and not for the Bank; we would not set out a policy position on that.

  Mr Salmon: On this issue about conditionality, there was a review two or three years ago at the Fund where they looked at the need to streamline conditionality in response to the lessons of the 1990s. The conclusion reached was that it was important to focus conditionality on things which were macro-relevant, particularly on the structural side. There has already been a debate and an agreement that conditionality needs to be strengthened for mainstream Fund programmes. That was a conclusion which I think had broad support within the membership, so I think that debate has happened, to an extent, for the Fund at least.

  Q113  Kerry McCarthy: In terms of the relationship with the World Bank, and particularly the support for low-income countries, do you think the balance is right at the moment, or do you think there are some cases where the responsibility should be handed over to the World Bank now?

  Mr King: There is certainly a need to examine again the relative responsibilities. Indeed, the Fund and the Bank themselves have said that and they set up a working party with external representatives to examine precisely that question. I do not want to say what should be the outcome of that. I think it is very encouraging that both the Managing Director of the Fund and the President of the World Bank have come to the view that together they need to look carefully at the division of responsibilities betweenbewteen them and to make sure that there are not any unnecessary overlaps. I think that is a welcome development.

  Q114  Kerry McCarthy: You said earlier that you thought there were enough facilities and there was not a need for any more, but indeed one has been set up, the Exogenous Shocks Facility. I suppose I am aware it is a facility which has been established but has not yet been called upon?

  Mr King: No. This was addressed very much at the weekend. This is very specific. This is designed to help particularly poor countries who suffer from the consequences of big changes in oil prices. That is why some of the producers have contributed to it. That is very much, I see, part of the development nexus and I think those involved in the development side welcome this; it is a question of trying to help countries which have suffered from the big changes in relative prices in the world economy. That is for others to comment on. From our perspective, I thought one of the interesting aspects of discussing the big change in oil prices was that it took us right back to the points which in fact Keynes made when the Fund was set up as part of a system in which the countries with surpluses were treated symmetrically with the countries which had deficits. This issue of "symmetry", which has been a bone of contention ever since 1944 when the Fund was created, came up again at the weekend in the context of oil prices, where some of the oil producers said, "Why is it that everyone takes a great interest in our policies when the oil price is high but no-one seems to take any interest when the oil price is low?" What you see, when there are big changes in oil prices, whether up or down, is that there will be quite big changes in current account surpluses and deficits. We are seeing, with the increase in the oil price, that the oil-producing countries move into a large current account surplus, which is very big even though it is after China's. The rest of the world, by the laws of arithmetic, has to move into deficit. If the oil price were to go back to where it was not so many years ago, which was around 10 dollars—it seems hard to imagine now but it did, it fell from $20 to $10 in the early days of the MPC—then, in fact, the deficits would swing the other way. These are examples of imbalances, which are, if you like, good imbalances. Inevitably these are the result of movements in oil prices and you do not want to prevent those imbalances emerging initially and then gradually being unwound. It goes right back to the question of symmetry. Indeed, at the IMFC, one of the representatives of Africa raised the question, "Will this new, multilateral approach to surveillance enable us now, at long last, to have a discussion of these imbalances in a symmetric way?" The answer was yes. The whole point of this multilateral consultation process is to enable us to have a symmetric discussion of the surpluses and deficits and the imbalances rather than saying "Here's a country with a deficit, it's wicked, it must do something to solve its deficit." The US deficit is not the result of measures taken solely in the United States. It is a result of savings and investments decisions taken by people all round the globe. The same is true for China's surplus. You have to look more directly at the policy instruments and the policy frameworks, not just at the surpluses and deficits. Then you can point to someone and say, "You must do something."

  Q115  Mr Breed: Is it not what we have learned really from the last oil shocks back in the seventies, that, the surpluses and the deficits, it is the pace of change towards the symmetry that you are looking at? If you have very quick use of the surpluses, whatever they are going to do with it, either invest it in petrodollars or spend it on development, it is the pace at which they do that. Whereas what we are looking at, at the moment, is that there are going to be surpluses brought up, there are going to be deficits, but we address that in a timeframe much longer, therefore you do not get the shocks within the world economic system which we had back 20 or 30 years ago?

  Mr King: Very much so, because when the oil price moves by a great deal it is inevitable that the surplus of the oil producers will rise very quickly. It does not make sense then to tell them to undo it very quickly; you need a more gradual adjustment. Indeed, one of the interesting comments made at the weekend was that one of the oil-producing finance ministers said, "So why is it that people talk about petrodollars? They don't talk about tee-shirt dollars or bra dollars or natural gas dollars or dollars caused by movements in other commodities that are being traded. Can we have a more symmetric way of looking at this; let's do the analysis and think about it in purely economic terms. That is the way we should do it."

  Q116  Ms Keeble: I just wanted to ask some questions about the UK's perspective on the IMF's strategic review. You have referred quite a lot to the fact that you see the key role for the IMF, moving forward, as being providing intellectual leadership, you said earlier, but also you welcomed the fact the budget would be reducing because you thought it concentrated minds. You said it has not got much in the way of policy instruments and then you said it should have boring people as well. How do you see it actually providing the intellectual leadership?

  Mr King: I did not say you want boring people. You want outcomes to be boring. That is the objective in it. I think it is not just intellectual leadership, it is also the moral authority that comes from having, as happened last weekend, 184 countries around the world, through their elected members of the IMFC, agreeing to ask the Fund to carry out this function. That gives it a moral authority to call multilateral consultations, to report objectively and give its view. That is something which can be achieved only through a multilateral institution. That is why I think it is important. It is not an easy role to play because it does not have an instrument that it can move up and down at the behest of the Managing Director or the staff, or even by the Executive Board. The fact that it does not have an instrument does not mean, to my mind, that you say, "Oh, it's not much fun if we haven't got an instrument; let's go and play a different game altogether, where we can find an instrument." Instead of saying, "What would it be fun for the Fund to do?" the Fund should ask the question "What would be right for the world economy?". I think the Fund is the only body which can really keep its eye on the health of the world economy as a whole and how we are going to unwind gradually these global imbalances. That is its major task.

  Q117  Ms Keeble: How then does it ensure that is carried through, because having people in agreement issuing a communique« is one thing; looking through it, actually it poses some very tough political challenges? How do you make sure that the politics catch up the imbalance?

  Mr King: You cannot make sure. If countries persist in creating serious problems then those problems will be there. What I would point to is the fact that when the imbalances are big enough, the countries themselves want to talk to each other. The US has wanted to talk to China, they have had discussions and negotiations. In the 1980s, the G5 and G7, which did not exist then, were created to give a framework within which countries could talk to each other; not necessarily formally to co-ordinate their policies but to understand what each other might be likely to do. If we are setting our policy, we need to know what the major players in the world economy are likely to do. It is a limited role, in one sense, and it may be frustrating to some, but if it works it is immensely valuable and important. There is no getting away from the fact that there are big players in the world economy and they will set their national policies according to their own interests. This is a way of trying to demonstrate to them that when it comes to the major issues of imbalances and exchange rates it is in the interests of countries to work together, it is not in their own interest to diverge.

  Q118  Ms Keeble: If you are saying that what the IMF has to do is have leverage in the international discussions, what role does the UK play then, and in particular in ensuring that this changing role is carried through? I think your own speech was actually quite influential in that, because it did widen the public debate around the role of the IMF.

  Mr King: I think that is all we can do. We can contribute. Gordon Brown is the Chairman of the IMFC—very important role, and he played an important role at the weekend. I think we contribute in these ways. We should not try to say "Let's force our way into these consultations or meetings" "It's vital that we have a seat at a particular table"; that is not a very sensible approach. If people want us there because we have something useful to say, they will invite us, and our job is to make sure that people find our contributions helpful if they are not, we shall keep quiet.

  Q119  Ms Keeble: What do you think are the prospects for change, moving forward; in particular, what is the impact of China on that and the fact that China will have the biggest economy in about, it is 20 years, is it not?

  Mr King: It is a very big economy now. The weight that people attach to Chinese contributions and interventions in discussions is already very great; it plays a big role here. I think all we can hope to do is create a forum in which countries find it helpful to come together. I think we will benefit by having fewer television cameras around in Washington for the meetings, fewer press conferences for the press back home and more opportunity to sit and talk with people facing similar challenges in other countries, because many of the problems derive from the same issues. One of the experiments which took place this last weekend was that, before the IMFC meeting took place, there was a breakfast with only the 24 representatives from the IMFC around the table. It may tell you something about the bureaucratic nature of these meetings when I tell you that a breakfast was regarded as a major innovation, but it was. The remarkable thing was that actually it was very successful and people did talk much more openly and interactively about the problems in the world economy than ever they did in a large meeting, with lots of people at the table and hundreds in the background.


 
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