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Report to the Chairman, Committee on Financial Services, and to the
Vice Chairman, Joint Economic Committee, House of Representatives:
June 2003:
International Financial Crises:
Challenges Remain in IMF's Ability to Anticipate, Prevent, and Resolve
Financial Crises:
GAO-03-734:
GAO Highlights:
Highlights of GAO-03-734, a report to Chairman, House Committee on
Financial Services and Vice Chairman, House Joint Economic Committee
Why GAO Did This Study:
Building on reform initiatives instituted after the Mexican financial
crisis, the IMF implemented new initiatives in the mid-1990s to better
anticipate, prevent, and resolve sovereign financial crises. GAO was
asked to assess (1) the IMF’s framework for anticipating financial
crises, (2) the status of key IMF reform initiatives to prevent
financial crises, and (3) new IMF proposals to resolve future
financial crises.
What GAO Found:
While the Fund’s new vulnerability framework is more comprehensive
than its previous efforts, it is too early to assess whether it will
improve Fund efforts to anticipate crises. The new framework uses the
Fund’s major forecasting tools, the World Economic Outlook (WEO) and
the Early Warning System (EWS), which have not performed well in
anticipating prior crises. The forecasting of crises has been
historically difficult for all forecasters.
The Fund, with the World Bank, has made progress in implementing
initiatives to prevent crises, but several challenges remain. To
obtain better information about country financial sector weaknesses,
the Fund and Bank introduced the Financial Sector Assessment Program
(FSAP) to report on member countries’ financial sectors and the
Reports on the Observance of Standards and Codes (ROSC) to assess
member countries’ adherence to 12 standards. Assessments have not been
completed in some major emerging market countries primarily because
participation is voluntary, and use of this information has been
mixed. For example, some private sector market participants have found
the reports untimely, outdated, and dense.
Participation Gaps by 33 Major Emerging Market Countries in Key
Assessments, 1999-2003
[See PDF for image]
[End of figure]
The Fund is considering two approaches to restructuring unsustainable
sovereign debt; however, there are significant challenges to
implementing them. One approach involves creating an international
legal framework that would allow a specified majority of a country’s
external creditors to restructure most private sector loans. Under the
second approach, the Fund is encouraging members to include
renegotiation clauses in individual bonds. Many private sector
representatives wish to maintain the existing process in which the
Fund assists resolution by providing loans to some eligible members.
In response to concerns that its resources may have unintended
negative impacts during a crisis, the Fund has clarified and
strengthened its criteria for lending to members experiencing crises.
What GAO Recommends:
GAO recommends that the Secretary of the Treasury instruct the U.S.
Executive Director of the Fund to work with other Executive Board
members to encourage the Fund to
* improve the timeliness of FSAP and ROSC reports;
* expand the coverage, frequency, and publication of updates of
participants’ implementation of FSAP and ROSC recommendations;
* improve the FSAP and ROSC reports’ readability; and
* increase participation in the FSAP and all standards of the ROSC and
consider making participation mandatory.
Treasury, IMF, and the World Bank generally agreed with the report’s
recommendations. The IMF stated that we gave WEO and EWS forecasts
greater importance than is warranted in anticipating crises. However,
we focused on the only mature and quantifiable elements of the
vulnerability framework.
www.gao.gov/cgi-bin/getrpt?GAO-03-734.
To view the full report, including the scope and methodology, click on
the link above. For more information, contact Joseph A. Christoff at
(202) 512-8979 or christoffj@gao.gov.
[End of section]
Letter:
Background:
Results in Brief:
Too Early to Determine If Fund's New Process for Anticipating Financial
Crises Improves on Past Efforts:
Some Progress in Implementing Crisis Prevention Initiatives, but
Challenges Remain:
The Fund's Efforts to Better Resolve Future Financial Crises Face
Significant Challenges:
Conclusion:
Recommendations for Executive Action:
Agency Comments and Our Evaluation:
Appendix I: Objectives, Scope, and Methodology:
Appendix II: Private Sector Structured Interview Participants:
Appendix III: Assessment of IMF Forecasting:
GAO Analysis Used Standard Econometric Techniques for Forecast
Evaluation:
Appendix IV: Eighty-seven Emerging Market Countries:
Appendix V: Standards, Codes, and Principles Assessed under IMF and
World Bank Reports on the Observance of Standards and Codes:
Appendix VI: Update on the International Monetary Fund’s Safeguards
Assessments:
The Fund Introduces Safeguards Assessments for Member Countries That
Currently Borrow:
Implementation of the Fund’s Assessment Recommendations:
Appendix VII: Fund/World Bank FSAP and ROSC Process:
Appendix VIII: Country Participation in and Publication of FSAPs and
ROSCs:
Appendix IX: Fund Resources Provided under the Supplemental Reserve
Facility:
Appendix X: Comments from the Department of the Treasury:
Appendix XI: Comments from the International Monetary Fund:
GAO Comments:
Appendix XII: Comments from The World Bank:
GAO Comments:
Appendix XIII: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Staff Acknowledgments:
Table 1: Anticipated and Actual GDP Growth Rate of 14 Financial
Crises, 1990–2001:
Table 2: Forecast Quality for 87 Emerging Market Countries, 1990–2001:
Table 3: Forecast Quality for G-7 Countries, 1990–2001:
Table 4: Comparison of Year-Ahead WEO Forecasts for Program and
Nonprogram Countries, 1990–2001:46
Table 5: Comparison of Program and WEO Year-Ahead Forecasts, for 52
Countries in the Initial Years on Program, 1990–2001:
Table 6: IMF Supplemental Reserve Facility Loans, 1997–2002:
Figures:
Figure 1: IMF Initiatives to Anticipate, Prevent, and Resolve
Financial Crises:
Figure 2: IMF Vulnerability Assessment Framework:
Figure 3: Participation of 33 Major Emerging Markets in Key ROSC
Assessments, 1999–2003:
Figure 4: FSAP and ROSC Participation and Publication by Major
Emerging Market Countries:
Figure 5: FSAP and ROSC Participation and Publication by Other
Countries:
Abbreviations:
BCP: Basel Core Principles:
BMA: Bond Market Association:
CAC: Collective Action Clauses:
CCFF: Compensatory Contingency Finance Facility:
CPI: consumer price index:
CPSS: Committee on Payments and Settlements Systems:
DCSD: Developing Country Studies Division:
EFF: Extended Fund Facility:
EMCA: Emerging Market Creditors Association:
EMTA: Emerging Market Traders Association:
EWS: Early Warning System:
FATF: Financial Action Task Force:
FSA: Financial Sector Assessment:
FSAP: Financial Sector Assessment Program:
FSSA: Financial System Stability Assessment:
GDDS: General Data Dissemination Standard:
GDP: gross domestic product:
IAIS: International Association of Insurance Supervisors:
IASB: International Accounting Standards Board:
IFAC: International Federation of Accountants:
IMF: International Monetary Fund:
IOSCO: International Organization of Securities Commissions:
IPMA: International Primary Market Association:
ISMA: International Securities Market Association:
KLR: Kaminsky, Lizondo, and Reinhart:
MSE: mean square error:
OECD: Organization for Economic Cooperation and Development:
RMSE: root mean square error:
ROSC: Reports on the Observance of Standards and Codes:
RSS: Residual Sum of Squares:
SBA: Stand-By Arrangements:
SDDS: Special Data Dissemination Standard:
SDRM: Sovereign Debt Restructuring Mechanism:
SEC: U.S. Securities and Exchange Commission:
SIA: Securities Industry Association:
SRF: Supplemental Reserve Facility:
STF: Systemic Transformation Facility:
UNCITRAL: United Nations Commission on International Trade Law:
WEO: World Economic Outlook:
Letter June 16, 2003:
The Honorable Michael G. Oxley Chairman Committee on Financial Services
House of Representatives:
The Honorable Jim Saxton Vice Chairman Joint Economic Committee House
of Representatives:
In May 2000, in the aftermath of the Asian financial crisis, the newly
appointed Managing Director of the International Monetary Fund (IMF or
the Fund) announced his plans to strengthen the Fund's reform
initiatives to enable the Fund to more effectively safeguard the
stability of the international financial system. Building on reform
initiatives instituted in the mid-1990s, after the Mexican financial
crisis of 1994-95, these new initiatives were designed to better
anticipate, prevent, and resolve sovereign financial crises. A
sovereign financial crisis can occur when a country is unable or
unwilling to honor its debt obligations and investors lose confidence
in that country's financial markets. Recent crises have occurred
primarily in "emerging market" countries, larger and more economically
advanced developing countries such as Argentina, Brazil, and Turkey.
According to World Bank (the Bank) estimates, the financial costs to
countries that experienced crises in the 1980s and 1990s exceeded $1
trillion--greater than the total amount of all donors' assistance to
developing countries in the 1980s and 1990s.
This letter responds to your request that we examine the Fund's efforts
to better safeguard the stability of the international financial
system. In this report, we assess (1) IMF's framework for anticipating
financial crises, (2) the status of key IMF initiatives to prevent
financial crises, and (3) new IMF proposals to resolve future financial
crises. In addition, we analyzed the quality of IMF's forecasts
produced by the World Economic Outlook (WEO), the Fund's primary
forecasting tool (see appendix III).
As part of our assessment, we reviewed documents from the U.S.
government, international organizations, and private firms, including
testimonies, reports, and relevant laws. We used statistical models
that we developed to assess the Fund's WEO forecasts and program
projections for selected emerging market countries. We interviewed key
officials at the Fund, World Bank, Department of the Treasury
(Treasury), and emerging market bond and equity funds. We also
interviewed some representatives of private sector firms that
specialize in international finance, economics, and law. Appendix I
provides a more detailed description of our objectives, scope, and
methodology. Appendix II provides a list of the private sector firms we
interviewed.
Background:
In 1994-95, Mexico faced a severe financial crisis when a shift in
market sentiment led to sudden large capital outflows. Investors also
temporarily removed their funds from other emerging market countries,
an effect known as contagion. In response to the crisis, Mexico quickly
adopted a strong and ultimately successful program of adjustment and
reform. To support the program, the Fund approved a loan of $17.8
billion to Mexico--one of the largest loan commitments it had ever made
to a country. One of the major reasons cited for the crisis was the
lack of timely, reliable, and publicly available economic, financial,
and sociodemographic data for Mexico. Beginning in 1996, to correct
this weakness, the Fund created data standards to guide countries in
disseminating better data to the public. However, as we reported in
1997, the Fund needed to address a number of other financial, economic,
and political challenges, in addition to data limitations, to better
anticipate, prevent, and resolve financial crises.[Footnote 1]
Before the Fund could fully address these challenges, the Asian
financial crisis of 1997-98 occurred. After the Asian financial crisis,
the Fund assessed the effects of its responses to the crisis and
reassessed its role in safeguarding the stability of the international
financial system, including rethinking its core mission, operations,
and lending activities. The Fund also recognized that it needed to
improve its ability to anticipate financial crises; monitor countries'
activities; and increase public awareness, particularly that of the
investment community. Recognizing its inability to anticipate past
crises, the Fund instituted a quarterly vulnerability assessment
framework in 2001 to identify countries that may be susceptible to
crisis.
To improve its ability to prevent future crises, the Fund and the World
Bank in 1999 began performing joint assessments of member countries'
financial sectors to help identify and monitor existing and potential
weaknesses. In addition, the Fund and the World Bank began to work with
countries to promote adherence to voluntary standards to reassure the
international community that the countries' policies and practices
conform to standards and codes of good practice. These include
standards to improve transparency in government economic data; fiscal,
monetary, and financial policies; and guidelines on strengthening the
financial and corporate sectors.
The Fund acknowledges that it would be almost impossible to anticipate
or prevent all crises. According to the Fund, past efforts to resolve
financial crises during the 1990s were lengthy and very costly to
debtor countries. The Fund is encouraging the adoption of agreements
that would allow a quicker, more orderly, and predictable restructuring
of countries' debts. The Fund's ultimate goal is to maintain investor
confidence and stability in the international financial system. Figure
1 shows the Fund's key initiatives for better anticipating, preventing,
and resolving financial crises. Treasury through the U.S. Executive
Director to the Fund has the lead responsibility for monitoring the
IMF's progress in addressing these issues.
Figure 1: IMF Initiatives to Anticipate, Prevent, and Resolve Financial
Crises:
[See PDF for image]
[End of figure]
Results in Brief:
While it is too early to assess the effectiveness of the Fund's new
vulnerability framework for anticipating crises, this framework builds
on key elements that have been unable to anticipate past financial
crises. The new framework is more comprehensive than the Fund's
previous efforts, bringing together country-specific knowledge and
financial expertise within the Fund to better identify weaknesses in
emerging market economies that could lead to a crisis. However, the new
framework uses the Fund's major forecasting tools, the WEO and the
Early Warning System (EWS), which have not performed well in
anticipating prior crises. The WEO has not successfully anticipated
past financial crises, and the Fund's EWS models have had a high false
alarm rate, having predicted many crises that did not occur. The
forecasting of crises has been historically difficult for all
forecasters due to complex underlying factors, including concerns about
the reliability of important macroeconomic data on emerging market
countries.
The Fund, in collaboration with the World Bank, has made progress in
implementing initiatives to prevent financial crises, but several
challenges remain. In the late 1990s, the Fund and the World Bank
adopted two key initiatives designed to assist four parties: Fund
staff, World Bank staff, member country governments, and private sector
participants. First, financial sector assessments were introduced to
provide reports on aspects of member countries' financial sectors such
as banking systems and crisis management capacity. Second, the
standards initiative was adopted to assess member countries' adherence
to 12 standards in areas such as banking supervision and economic data
dissemination. Use of the information provided by these two initiatives
by various parties has been mixed, and several significant challenges
remain. Fund staff frequently incorporate information from the
assessments into their policy advice to member countries. However,
assessments have not been completed in some important emerging market
countries, such as China and Thailand, primarily because participation
is voluntary. World Bank staff's use of the assessments to inform
country development assistance programs is also affected by the lack of
participation by member countries and by borrower countries' competing
development needs. Member country governments sometimes use the
assessments in prioritizing their reform agendas but often find that
the reforms are too difficult to implement. Some private sector
participants find the published reports outdated, untimely, and too
dense to be useful in making investment decisions. The Fund and the
World Bank acknowledge that the assessments cannot prevent all crises
because reforms require many years to be fully implemented, and crises
can be caused by factors outside the scope of the reforms.
The Fund is considering two approaches to achieve a more orderly and
predictable restructuring of unsustainable debt between a country and
its creditors; however, there are significant challenges to
implementing both approaches. Fund officials assert that the current
process for renegotiating the terms of member countries' loans with
external private sector creditors is lengthy and costly. The Sovereign
Debt Restructuring Mechanism (SDRM), is a proposed international legal
framework that would allow a majority of a country's external creditors
to quickly restructure most private sector loans. The Fund is also
encouraging members to include Collective Action Clauses (CACs) in
individual bonds, which would allow a majority of bondholders to
renegotiate the bond's terms. Although some elements of both approaches
are acceptable to the private sector and to governments, a number of
political, legal, and technical challenges stand in the way of
implementing the SDRM; it seems unlikely that these issues will be
resolved in the immediate future. While private sector officials expect
that many restructurings need only involve the private sector and the
debtor country, under some circumstances, voluntary debt restructurings
will not adequately resolve all financial crises. In those cases, they
said the Fund should provide loans to eligible countries to help fill
their external financing gaps. However, some financial experts and
government representatives have raised concerns that such loans have
the potential to increase the probability of future crises. In
response, the Fund has clarified and strengthened its policy of lending
in crisis situations.
The Fund's crisis prevention initiatives are hindered by several
factors that limit their effectiveness. To strengthen the effectiveness
of these initiatives, we are recommending that the Secretary of the
Treasury instruct the U.S. Executive Director of the Fund to work with
other Executive Board members to encourage the Fund to improve the
readability, timeliness, coverage, and frequency of updates of
assessment reports. Additionally, the Fund should pursue strategies for
increasing participation in the assessment process including the
possibility of making participation mandatory for all members of the
IMF.
In responding to our draft report, Treasury, IMF, and the World Bank
generally agreed with the report's recommendations. However, the IMF
stated that we mischaracterized the role of WEO forecasts and EWS
models in IMF crisis anticipation efforts by saying that they have a
greater importance than is warranted. We disagree with this depiction.
Our assessment examined all six components of the IMF's vulnerability
assessment framework, including the WEO and EWS. As the only mature and
quantifiable elements of the framework, our analysis focused more
heavily on the track records of the WEO and EWS. The World Bank
expressed concern with the report's suggestion that consideration be
given in making participation in the FSAP and ROSC assessments
mandatory. While we are not suggesting that the assessments should be
made mandatory, the voluntary nature of these assessments has posed an
obstacle to full participation by important emerging market countries.
Too Early to Determine If Fund's New Process for Anticipating Financial
Crises Improves on Past Efforts:
In May 2001, the IMF implemented a new vulnerability assessment
framework for emerging market countries to strengthen the Fund's
ability to anticipate financial crises. This framework brings together
country-specific knowledge and financial expertise within the Fund to
better identify weaknesses in emerging market economies that could lead
to a crisis. Although the new vulnerability assessment framework is
more comprehensive than the Fund's previous efforts, it is new and
still evolving. It is too early to tell whether this new framework will
successfully anticipate future crises. The new framework uses the
Fund's major forecasting tools, the WEO and the EWS, which have not
performed well in anticipating prior crises. The WEO has not
successfully anticipated past financial crises, and the Fund's EWS
models have had a high false alarm rate, having predicted many crises
that did not occur. The forecasting of crises has been historically
difficult for all forecasters due to complex underlying factors,
including concerns about the reliability of important macroeconomic
data on emerging market countries.
The IMF Has Recently Implemented a New Vulnerability Assessment
Framework:
The Fund has attempted for many years to identify countries vulnerable
to financial crisis; however, their existing tools were insufficient to
anticipate the financial crises of the 1990s and led the Fund in 2001
to develop the new vulnerability assessment framework. This
comprehensive framework brings together detailed, country-specific
knowledge and financial expertise of various IMF departments, including
those with regional, macroeconomic, or forecasting expertise. The new
framework monitors the vulnerability of key emerging market countries
that borrow significantly from international capital markets. This
information is provided in a quarterly report on crisis vulnerability.
Fund staff report monthly on countries identified as vulnerable and
provide more frequent ad hoc analyses during volatile periods.
To conduct the vulnerability assessment, the Fund integrates six
independent inputs that represent the analyses and perspectives of
different departments of the Fund (see figure 2).
Figure 2: IMF Vulnerability Assessment Framework:
[See PDF for image]
[End of figure]
* World Economic Outlook: The WEO is a twice yearly publication that
provides analyses of global economic developments. Through the WEO, the
IMF provides current and following year forecasts for countries and
regions of key economic variables such as economic growth, inflation,
and current account.[Footnote 2] According to Fund staff, WEO forecasts
use the best available information and represent the most realistic
estimate of key economic variables, including those that could help
anticipate a financial crisis. The IMF uses these forecasts as an input
in the vulnerability assessment to gauge the impact of unanticipated
adverse changes in the global environment. For example, the WEO
forecasts for selected countries may be recalculated to examine the
impact of sudden increases in oil prices or an unanticipated recession
in the advanced economies.
* Early Warning System models: The Fund uses internal and private
sector EWS models that compute the probability of a country having a
crisis over the following 12 to 24 months. The model examines a series
of vulnerability indicators, including whether a country's real
exchange rate is overvalued, or whether the country has significantly
depleted its foreign exchange reserves.[Footnote 3] The output of the
EWS models helps the Fund focus on specific areas of vulnerability. For
example, if one variable, such as the exchange rate, signals a crisis,
the Fund would more closely examine related components of the
vulnerability assessment, such as a country's external financing
requirements.
* Country external financing requirements: On a quarterly basis, the
Fund produces an internal assessment of a country's ability to meet its
total external debt obligations and estimates whether that country has
sufficient foreign exchange to avoid a crisis. This assessment includes
estimating a country's ratio of foreign exchange reserves to short-term
external debt, estimating the magnitude of its current account deficit,
and considering whether and how it manages its exchange rate.
* Market information: On an ongoing basis, the Fund analyzes most
countries' cost of borrowing on the international market and whether
the country is paying a higher interest rate than similar countries.
The Fund uses this information to provide an internal analysis of the
private sector's expectations of a country's likelihood of default on
its foreign debt and to identify possible evidence that financial
problems are spreading across countries.
* Financial sector vulnerability: The Fund assesses the strengths and
weaknesses of a country's financial sector, including the banking
system. IMF staff evaluate the financial sector's vulnerability to
changes in market conditions, such as fluctuations in interest and
exchange rates. Although the detailed results of these assessments are
used internally by the Fund, summaries of key findings are frequently
published.
* Country expert perspectives: IMF country experts examine the data
produced by the above analyses, supplementing those results with
country-specific details such as the political risks of implementing
certain government policies or the relevance of certain market
information.
Until 1999, the Fund used the WEO as the primary forecasting tool to
help identify country risks and vulnerability to crises. The new
vulnerability framework, which has been in operation for about 2 years,
is a more comprehensive process. According to the Fund, the quarterly
integration of detailed information from country experts who
continuously monitor developments in their countries is a great
strength of the new vulnerability framework. Effective analysis by Fund
staff of the framework's six elements could better allow the Fund to
give timely advice to authorities in vulnerable countries. It is too
early to tell whether this framework will be successful in anticipating
future crises. We assess the performance of the WEO and EWS models, the
Fund's primary tools for anticipating crises prior to the
implementation of the new framework in May 2001.[Footnote 4]
Forecasting Elements of the Vulnerability Framework Have Performed
Poorly in the Past:
The new vulnerability assessment framework uses the Fund's two major
forecasting tools--the WEO and the EWS models--which have not performed
well in anticipating prior crises. The WEO has not successfully
anticipated the severe financial crises of the past decade. The Fund's
EWS models have had a high false alarm rate, having predicted many
crises that did not occur.
The WEO Is Not a Reliable Tool for Anticipating Crises:
Severe financial crises are characterized by a number of negative
economic outcomes, including large declines in gross domestic product
(GDP), also known as recessions. We found that the WEO had a poor
record of forecasting such declines in GDP, tending instead to follow
existing positive economic growth trends. In addition, the IMF
indicates that the current account is a key variable in explaining
financial crises. We found that for the current account, the accuracy
of 75 percent of WEO country forecasts was worse than simply assuming
that next year's value is the same as this year. The WEO's difficulty
forecasting both GDP and current account demonstrate poor performance
in anticipating the severe financial crises of the past decade.
WEO Has Performed Poorly at Forecasting Recessions:
In most cases, countries experiencing a financial crisis also
experience a severe recession in which their GDP declines
significantly. Although most recessions do not involve a major
financial crisis, successful anticipation of recessions, especially the
most severe ones, would greatly increase the likelihood of anticipating
impending financial crisis. However, we found that the WEO has a poor
track record of forecasting recessions, including those directly
associated with a financial crisis.
The WEO did not forecast most of the recessions that occurred in
emerging market countries in the last 10 years. During the 1991-2001
forecast period, 134 recessions occurred in all 87 emerging market
countries. We found that the WEO correctly forecast only 15, or 11
percent, of those recessions, while predicting an increase in GDP in
the other 119 actual recessions.[Footnote 5] The WEO is considerably
more likely to forecast a recession when a recession has occurred in
the prior year. However, a prior year recession did not occur in two-
thirds of the recessions that the WEO failed to forecast. Thus, WEO
forecasts generally follow the existing growth trend within a country,
making it unlikely that the WEO would correctly forecast an
unanticipated recession. Furthermore, this tendency to follow the
current growth trend makes it especially difficult for the WEO to
anticipate a financial crisis because nearly all of the crisis-related
recessions of the last decade occurred in years following positive
economic growth.
Further illustrating our point, the WEO was unable to anticipate large
declines in GDP, also known as recessions, that corresponded to 14
major financial crises of the past decade, including the Mexican and
Asian financial crises (see table 1).[Footnote 6]
Table 1: Anticipated and Actual GDP Growth Rate of 14 Financial Crises,
1990-2001:
Country: Argentina; Crisis years: 1995; WEO forecast GDP growth rate:
(percent): 4.0; Actual GDP growth rate[A]: (percent): -4.4.
Country: Argentina; Crisis years: 2001; WEO forecast GDP growth rate:
(percent): 3.7; Actual GDP growth rate[A]: (percent): -4.4.
Country: Brazil; Crisis years: 1998; WEO forecast GDP growth rate:
(percent): 4.0; Actual GDP growth rate[A]: (percent): 0.1.
Country: Ecuador; Crisis years: 1999; WEO forecast GDP growth rate:
(percent): 2.5; Actual GDP growth rate[A]: (percent): -7.3.
Country: Indonesia[B]; Crisis years: 1998; WEO forecast GDP growth
rate: (percent): 6.2; Actual GDP growth rate[A]: (percent): -13.7.
Country: Malaysia[B]; Crisis years: 1998; WEO forecast GDP growth rate:
(percent): 6.5; Actual GDP growth rate[A]: (percent): -6.7.
Country: Mexico; Crisis years: 1995; WEO forecast GDP growth rate:
(percent): 4.0; Actual GDP growth rate[A]: (percent): -6.9.
Country: Philippines[B]; Crisis years: 1998; WEO forecast GDP growth
rate: (percent): 5.0; Actual GDP growth rate[A]: (percent): -0.5.
Country: Russia; Crisis years: 1998; WEO forecast GDP growth rate:
(percent): 5.1; Actual GDP growth rate[A]: (percent): -4.6.
Country: South Korea[B]; Crisis years: 1998; WEO forecast GDP growth
rate: (percent): 6.0; Actual GDP growth rate[A]: (percent): -5.8.
Country: Thailand[B]; Crisis years: 1998; WEO forecast GDP growth rate:
(percent): 3.5; Actual GDP growth rate[A]: (percent): -9.4.
Country: Turkey; Crisis years: 1994; WEO forecast GDP growth rate:
(percent): 3.0; Actual GDP growth rate[A]: (percent): -5.5.
Country: Turkey; Crisis years: 2001; WEO forecast GDP growth rate:
(percent): 5.5; Actual GDP growth rate[A]: (percent): -7.4.
Country: Venezuela; Crisis years: 1994; WEO forecast GDP growth rate:
(percent): 2.5; Actual GDP growth rate[A]: (percent): -3.3.
Country: Average growth rates; Crisis years: [Empty]; WEO forecast GDP
growth rate: (percent): 4.4; Actual GDP growth rate[A]: (percent): -
5.7.
Sources: Various crisis studies and IMF.
[A] Actual GDP growth rate is from the WEO published 1 year later.
[B] The Asian crisis began in Thailand in the summer of 1997 and spread
to the other Asian countries in the latter part of 1997. The full
effects of the crisis on the GDP of other Asian countries and Russia
occurred in 1998. Thus we are using 1998 actual GDP growth rate data
for the Asian countries--Indonesia, Malaysia, Philippines, South Korea,
and Thailand. The crisis in Brazil extended into1999.
[End of table]
The WEO's failure to identify these recessions demonstrates that it did
not anticipate the corresponding financial crises. In 14 cases, we
found that the WEO forecast strong economic growth, averaging a 4.4
percent increase in GDP, despite large declines in actual GDP in 13 of
14 cases.[Footnote 7] In fact, actual GDP declined by an average of 5.7
percent during the first full year of these 14 financial crises.
Indonesia presents the most startling disparity, in which the WEO
forecast a growth of 6.2 percent in its GDP, when in fact Indonesia's
GDP declined by almost 14 percent in the first full year of its
financial crisis.
WEO Does a Poor Job in Forecasting the Current Account:
According to the Fund, a country's current account (primarily exports
minus imports of goods and services) is a key variable in anticipating
crises. Crises are associated with problems of external financing that
result from a country having difficulty obtaining foreign exchange.
Since exports are an important source of foreign exchange for
developing countries, projections of a country's current account
balance provide information about the country's ability to earn foreign
exchange and to service its external debt.[Footnote 8] According to the
Fund, an unsustainably large current account deficit can contribute to
or precipitate a crisis.[Footnote 9]
We found that WEO forecasts for current account were inaccurate most of
the time. Our analysis for the 87 emerging market countries shows that,
for more than 75 percent of the countries, the WEO current account
forecasts were less accurate than if the Fund had simply assumed that
the next year's current account would be the same as this year's. The
results are even more dramatic for G-7 countries; a forecast of no
change was a better predictor than the WEO forecast for six of the
seven countries. This demonstrates that, even in stable economies with
excellent data, the WEO has done a poor job of forecasting this key
crisis anticipation variable. (See appendix III for more detailed
explanation on our methodology and findings).
The Fund's Early Warning System Models Indicate Many Crises That Do Not
Occur:
Since 1999, the Fund has analyzed the results from internal and private
sector EWS models in its crisis anticipation efforts. The Fund's
internal efforts focused on two EWS models to systematically identify
countries vulnerable to crises: the Kaminsky, Lizondo, and Reinhart
(KLR) model, which monitors a set of 15 monthly variables that signal a
crisis whenever any cross a certain threshold; and the Developing
Country Studies Division (DCSD) model, which uses five variables to
compute the probability of a crisis occurring in the next 24
months.[Footnote 10] The Fund's models use a variable-by-variable
approach that allows economists to determine which variables are
signaling the crisis. Internal assessments of the Fund's EWS models
show that they are weak predictors of actual crises. While the models
worked reasonably well in anticipating Turkey's recent financial
crisis, they did not successfully anticipate Argentina's financial
crisis in 2002. According to the Fund, the models' most significant
limitation is that they have high false alarm rates; that is, they
predict many crises that did not occur. In about 80 percent of the
cases where a crisis was predicted over the next 24 months, no crisis
occurred. Furthermore, in about 9 percent of the cases where no crisis
was predicted, there was a crisis.[Footnote 11]
Forecasting Crises Has Been Historically Difficult for All Parties:
Financial crises have been historically difficult to anticipate because
of a number of complex underlying factors. Economic outcomes are often
influenced by unanticipated events such as conflicts and natural
disasters. Many factors, in addition to weaknesses in a country's
financial structure, can lead to a crisis. These include economic
disturbances, such as an unanticipated drop in export prices, political
events, and changes in investor sentiment leading to sudden withdrawals
of foreign capital. Furthermore, data may be inadequate, particularly
in developing countries where data are often not timely and are of poor
quality.
:
Forecasters consistently fail to foresee crises and recessions.
Forecasts produced by private sector economic forecasters, governments,
and multinational agencies including the IMF and the Organization for
Economic Cooperation and Development, routinely fail to foresee the
coming of crises and recessions, and often fail to outperform the naive
model, which simply assumes that next year's outcome will be the same
as this year's. This is true even for evaluations of recent U.S.
forecasts of GDP and inflation. Our review of a number of forecast
evaluation studies confirms that the inability to predict recessions is
a common feature of growth forecasts for both industrialized and
developing countries. The studies also showed that forecast accuracy
improves as the time horizon gets shorter, and that there is little
difference in forecast accuracy between private sector and WEO
forecasts.
Some Progress in Implementing Crisis Prevention Initiatives, but
Challenges Remain:
In the late 1990s, the Fund and the World Bank began implementing two
crisis prevention initiatives designed to assist four parties: IMF
staff, World Bank staff, member country governments, and private sector
participants. The first initiative, the financial sector assessments,
provides reports on aspects of member countries' financial sectors such
as banking systems and crisis management capacity. The second, the
standards initiative, assesses member countries' adherence to 12
standards in areas such as banking supervision and economic data
dissemination. Parties' use of the information provided by these two
initiatives has been mixed, and several significant challenges remain.
Fund staff frequently incorporate information from the assessments into
their policy advice when assessments are available; however,
assessments have not been completed in some important emerging market
countries primarily because participation is voluntary. Bank staff's
use of the assessments to inform country development assistance
programs is also affected by gaps in the completion of some assessments
and by borrower countries' competing development demands. Member
country governments sometimes use the assessments in prioritizing their
reform agendas but often find the reforms too difficult to implement.
Some private sector participants find the published reports untimely,
outdated, and too dense to be useful in making investment decisions.
The IMF and the Bank acknowledge that the initiatives cannot prevent
all crises because recommended reforms require many years to be fully
implemented, and crises can be caused by factors outside the scope of
the reforms.
:
Two Key Crisis Prevention Initiatives Target Four Parties:
In the wake of the Mexican and Asian financial crises of the 1990s, the
Fund and the World Bank became increasingly aware of the importance of
transparent financial data and policies, stronger financial systems,
and better-functioning markets as a complement to member country
governments' sound macroeconomic policies. Fund evaluations
acknowledge that the institution failed to collect information that
could have enabled it to detect financial and corporate sector
vulnerabilities and to provide appropriate policy advice to the
affected countries before the crises occurred.
In response to this, in the late 1990s, the Fund and the Bank jointly
launched two initiatives to prevent the long-term likelihood of
financial crises. The first initiative, the Financial Sector Assessment
Program (FSAP), consists of in-depth assessments of key elements of
member countries' financial sectors. These elements include the
structure of financial markets, financial systems' response to changes
in key variables such as exchange rates, legal arrangements for crisis
management, and the quality of financial sector supervision. The second
initiative, the Reports on the Observance of Standards and Codes
(ROSC), consists of assessments of member countries' adherence to 12
standards[Footnote 12] related to transparency in government policy
making and operations,[Footnote 13] financial sector regulation, and
corporate sector practices (see appendix V).[Footnote 14] Building on
earlier efforts to assess transparency, in 1999, the IMF and the Bank
began conducting joint assessments of observance of standards related
to financial sector regulation, covering areas such as banking
supervision and securities regulation. The Bank began performing
assessments of standards related to corporate sector practices,
including private sector accounting rules and corporate governance
principles, in 2000. Some transparency, financial sector, and corporate
sector standards may be assessed under the FSAP. Country participation
in both initiatives is voluntary. The Fund and the Bank initially
considered making participation in the ROSC assessments mandatory for
member countries after determining that the Fund's Articles of
Agreement could allow such a requirement.
IMF or World Bank staff lead FSAP and ROSC assessment teams, with
participation by experts from national central banks and supervisory
agencies and standard-setting bodies such as the Basel Committee and
the International Organization of Securities Commissions (IOSCO).
Before undertaking an FSAP or ROSC, the Fund and the Bank work with
country governments to choose areas on which to focus. During the
assessment process, FSAP and ROSC teams conduct at least one in-country
visit, allowing team members to work with government officials from the
finance ministry, the central bank, and regulatory bodies to collect
information for the assessment.[Footnote 15] For example, an FSAP team
in Russia analyzed financial information for the largest banks and
single largest corporation to determine how changes in economic
variables such as oil prices might affect the banking system. The South
Korean ROSC team interviewed government officials at financial sector
regulatory entities and private sector representatives to determine how
closely regulatory practices conform to standards and to identify
weaknesses that could put the financial sector at risk.
The two initiatives provide information to assist four parties that
play a role in crisis prevention: the Fund, the World Bank, member
country governments, and private sector investors. In-depth information
on member countries' financial sectors and adherence to standards of
good practice is intended to help the IMF and the Bank fulfill their
missions. Fund staff identify countries' vulnerabilities and develop
appropriate advice to redress them; Bank staff identify long-term
financial sector development needs and formulate relevant lending and
nonlending responses. Member countries can use these assessments to
help prioritize reform agendas and win domestic support for difficult
policy decisions that may make their financial sectors and institutions
more resistant to crisis. The Fund and the Bank often provide technical
assistance to help governments build capacity to implement reforms. The
financial crises of the 1990s also raised awareness of the private
sector's role in crisis prevention. Thus, the Fund and the Bank expect
the assessments to help private sector participants make sounder
investment decisions, thereby reducing volatility in capital markets.
Parties' Use of Assessments Is Mixed, and Significant Challenges
Remain:
The use of FSAP and ROSC assessments in crisis prevention efforts is
mixed, and significant limitations remain. Fund staff use the
assessments, when available, as inputs for the policy advice they
provide to member country governments. However, the Fund lacks crucial
information about vulnerabilities to financial crisis because some
major emerging market countries have not participated in the
assessments. World Bank staff's use of the assessments to inform
development assistance priorities is also affected by these gaps in
participation and by borrower countries' competing development needs.
Many member country governments face limitations in using assessments
to make policy decisions because the reforms recommended in the
assessments are often difficult to implement. Finally, some private
sector participants find assessments of limited use because they are
untimely, outdated, and dense.
The Fund Uses Assessments, When Available, to Inform Policy Advice:
The IMF uses FSAP and ROSC assessments, when available, as inputs for
the policy advice it provides member country governments. According to
Fund officials, these assessments highlight issues such as weak banking
supervision or high levels of debt held in foreign currency that could
make countries vulnerable to crisis. The assessments also provide
recommendations to address these issues. The findings and
recommendations inform the discussions of policy issues that Fund
officials have with member country authorities during Article IV
consultations.[Footnote 16] For example, when an FSAP was performed in
Mexico, Mexican authorities had begun replacing a system where the
government fully insured all bank deposits with one that covers
deposits up to a certain limit. The FSAP team was concerned because
this reform was undertaken before Mexico had developed a well-defined
framework for closing unprofitable banks. Without a clear framework for
bank closures, the introduction of limited deposit insurance could
damage depositor confidence in the banking system and precipitate a
banking crisis. According to Fund officials, the FSAP team and Mexican
authorities discussed the need to create such a framework, and a
subsequent Article IV mission reviewed the government's progress in
this area. In Poland, an FSAP team discovered that Polish households
and small businesses had high levels of debt held in foreign currency.
The team was concerned that a depreciation of Polish currency could
raise the cost of these loans and cause widespread repayment
difficulties, which could in turn lead to a banking crisis. FSAP team
members raised this issue with Polish central bank authorities and
followed up again during the next Article IV consultation. In both
countries, government officials followed the Fund's advice and
implemented reforms. The Mexican government began developing a
framework for closing banks, and Poland's central bank established a
team to monitor household and small business debt.
Since 1999, FSAP assessments have been conducted in more than 40 member
countries and ROSC assessments in about 90 member countries. However,
we found that assessments have not been completed for some major
emerging market countries, limiting the Fund's awareness of crisis
vulnerabilities in certain countries. Appendix VIII contains a record
of country participation in and publication of FSAP and ROSC
assessments. Fund and Bank staff encourage participation in FSAP and
ROSC assessments by countries whose economies have worldwide or
regional implications or have known vulnerabilities to a financial
crisis, but officials acknowledge that some governments have
persistently resisted their efforts. According to our analysis, between
1999 and 2003,[Footnote 17] 45 percent of 33 major emerging market
countries participated in an FSAP.[Footnote 18] However, the Fund has
not performed FSAPs in important countries such as China and Thailand
because their authorities have not agreed to participate. These gaps in
participation limit the Fund's ability to develop policy advice based
on in-depth knowledge of their financial sectors.
According to the Fund, the Mexican and Asian financial crises were
caused, in part, by vulnerabilities in areas covered by the ROSCs. Our
analysis found gaps in participation in assessments of several key
standards that the Fund identifies as contributing factors to past
crises (see figure 3). For example, only one-third of major emerging
market countries have participated in assessments of their adherence to
standards for dissemination of economic and financial data. About half
have participated in the fiscal, monetary and financial policy
formulation assessments and the banking supervision assessment. In
addition, Fund documents point to limited progress in assessing
adherence to the four World Bank-led corporate sector
standards[Footnote 19] (accounting, auditing, corporate governance,
and insolvency regimes), which play a key role in the effective
operation of domestic and international financial systems. Less than
one-third of the 33 major emerging market countries have participated
in one or more assessments related to accounting and auditing.
Figure 3: Participation of 33 Major Emerging Markets in Key ROSC
Assessments, 1999-2003:
[See PDF for image]
[End of figure]
:
The Fund asserts that its delayed response in preventing or mitigating
the Mexican and Asian crises was partially caused by insufficient
information on these vulnerabilities. For example, according to the
IMF, the Mexican government's publicly available data was outdated and
incomplete in 1993-94, which contributed to significant delays in
responding to the country's excessive indebtedness. The Fund also was
unaware of some Asian countries' unsound corporate accounting
practices, which contributed to the Asian financial crisis. Continued
participation gaps in these assessments suggest that the Fund still
lacks crucial information about some countries' potential vulnerability
to crisis.
The World Bank's Use of Assessments in Formulating Country Development
Assistance Programs Is Mixed:
The World Bank acknowledges the importance of FSAP and ROSC assessments
in formulating its financial sector development programs, but limited
participation in corporate sector assessments (described earlier)
affects the Bank's ability to respond to weaknesses in borrower
countries' financial sectors. According to the Bank, country
participation in corporate sector assessments has been lower than in
areas related to transparency and financial sector regulation because
the Bank has experienced delays in finalizing standards and
methodologies for evaluating the corporate sector. For example, the
methodologies for performing assessments of the accounting and auditing
standards were not finalized until October 2000.
Bank officials acknowledge that even when assessments are available,
Bank staff do not always incorporate the issues raised as a key
priority in formulating its country development assistance programs. In
justifying their limited prioritization of FSAPs and ROSCs, Bank
officials cited competing development demands and timing issues. First,
Bank officials stated that they must balance borrower countries'
financial sector reform needs with other demands for development
assistance. Most borrower country governments have multiple concerns,
and Bank staff may determine that its resources will have more impact
in areas other than financial sector development. Second, Bank
officials cited the scheduling of the FSAP and ROSC assessments as a
reason for their limited use since the timing of many assessments does
not coincide with the Bank's preparation of Country Assistance
Strategies.[Footnote 20]
Member Country Governments' Use of Assessments Is Limited:
Although member country authorities sometimes use FSAP and ROSC
assessments to inform policy decisions, reforms recommended in the
assessments are often difficult to implement. Some member country
governments have faced obstacles to implementing reforms, including
political opposition, legal constraints, and lack of technical
capacity. For example, IMF officials stated that political opposition
has limited the South Korean government's progress in eliminating
extrabudgetary funds, a key recommendation of the fiscal transparency
ROSC. Extrabudgetary funds diminish transparency because they are
exempt from rules that require scrutiny and prioritization of
expenditures for most of South Korea's budget. Fund officials cited
Peru as a case where legal constraints delayed reform efforts. The FSAP
and banking supervision ROSC found that protecting bank supervisors
from the political pressures of the powerful bankers' lobby would
strengthen Peru's banking supervision. According to Fund officials,
existing legislation precluded awarding supervisors greater
independence, and passage of new legislation was delayed. In Russia,
limited technical capacity interfered with the government's ability to
implement reform recommendations. For example, the FSAP team reviewed
the government's proposal to stimulate competition in the banking
sector by introducing a deposit insurance system for household
deposits. However, Fund staff noted that Russia's bank supervisory
agency lacks the capacity to implement a deposit insurance system for a
large number of banks.
Private Sector Participants Find Assessments Difficult to Use:
The Fund claims that private sector participants increasingly use the
results of FSAPs and ROSCs to inform investment decisions and risk
management. However, representatives of major international investment
firms and ratings agencies we interviewed stated that the reports were
untimely, outdated, and too dense to be useful. For example, several
respondents indicated that delays in publishing ROSC assessments
reduced their usefulness. Some private sector participants stated that
ROSC reports and FSAP summaries, known as Financial System Stability
Assessments (FSSAs), should be published within 6 months of performing
the assessments. However, our analysis of the 58 ROSC reports published
for major emerging market countries found that in one-third of the
cases, 9 months or more elapsed between assessment and publication.
Several private sector participants we interviewed stated that outdated
ROSC reports are unreliable for decision making. The Fund acknowledges
that assessments must be current for private sector participants to use
them. According to Fund data, 13 countries have published an update of
at least one ROSC module. However, IMF officials estimate that, of the
more than 40 FSAPs performed to date, only 4 have been fully updated.
Some private sector participants also stated that FSSA and ROSC reports
are not clearly written. Representatives of one multinational
investment bank stated that the assessments are written in a way that
is difficult to understand, which limits the reports' usefulness for
investment decisions. While these interviews were limited in number and
may not be representative of all private sector participants, they do
provide an indication of the problems these individuals may currently
have in using FSAPs and ROSCs.
Fund and Bank outreach sessions and a 2002 Fund survey corroborated our
findings on private sector participants' difficulties in using ROSC
assessments. The Fund reports that private sector participants place
high priority on timely publication and frequent updates of ROSC
assessments. For example, several participants observed that ROSC
reports for Argentina had not been updated since their publication in
1999. Moreover, respondents to the Fund's survey commented that ROSC
assessments should state more clearly the deficiencies in a country's
adherence to a standard. In a March 2003 review of the standards
initiative, the Fund and the Bank concluded that ROSC reports would be
more useful if they stated the main findings and their significance
clearly and prioritized recommendations more explicitly.
Crisis Prevention Initiatives Cannot Prevent all Crises:
The Fund and the World Bank acknowledge that FSAP and ROSC assessments
cannot prevent all crises because recommended reforms may require many
years to be fully implemented and because crises can be caused by
factors outside the reforms' scope. For example, Argentina participated
in four ROSC assessments in 1999 to improve economic data
dissemination; banking supervision; and transparency in the formulation
of fiscal, monetary, and financial policies. According to senior IMF
officials, the Argentine government followed many of the
recommendations generated by these assessments, but their actions did
not address vulnerabilities related to weak fiscal policy and a fixed
exchange rate regime that contributed to Argentina's 2001 crisis. Fund
officials cite Turkey as another example of a country that made
considerable progress in improving transparency and data provision
based on reforms recommended by the fiscal transparency and economic
data dissemination ROSC assessments of 2000-2001. However, according to
the Fund, these reforms could not have prevented Turkey's 2001 crisis,
which originated with declines in its exchange rate.
:
The Fund's Efforts to Better Resolve Future Financial Crises Face
Significant Challenges:
Fund officials assert that the current process for renegotiating the
terms of member countries' loans with external private sector creditors
is lengthy and costly. In 2001, the Fund began considering the SDRM, an
international legal framework that would allow a majority of a
country's external creditors to approve a restructuring of most private
sector loans. The Fund is also encouraging members to include CACs in
bonds, which would allow a majority of bondholders to renegotiate the
terms of that bond. Although some elements of both approaches are
acceptable to the private sector and governments, a number of
political, legal, and technical challenges stand in the way of
implementing the SDRM; it seems unlikely that these issues will be
resolved in the immediate future. While private sector officials expect
that many restructurings need only involve the private sector and the
debtor country, under some circumstances, voluntary debt restructurings
will not adequately resolve all financial crises. These officials
stated that, in those cases, the Fund should provide short-term loans
to eligible countries to help fill their external financing gaps.
However, concerns have been raised by some financial experts and
government representatives that such Fund loans have the potential to
increase the probability of future crises. In response to these
concerns, the Fund has clarified and strengthened its policy of lending
into crisis situations.
Efforts to Resolve Future Sovereign Debt Crises Face Significant
Challenges:
According to the Fund, countries facing severe liquidity problems often
go to extraordinary lengths to avoid renegotiating or restructuring the
terms of their loans. They do so because, in the past, restructuring
damaged the economy and the banking system of participating countries.
In some cases, even when a voluntary restructuring process is
initiated, individual creditors may hold out for the best possible
terms or sue in an attempt for better terms. Additionally, countries
believe that creditors also may be unwilling to make future loans if
they default on their existing debt.
The SDRM approach is an attempt to create a more orderly, predictable,
and comprehensive restructuring process and to lower the costs of
restructuring for both the debtor and creditors. The approach sought to
reduce the duration of the restructuring process from years to months
and to provide incentives to restructure debt before default to better
protect debtor and creditor interests. In the case of debtors, the Fund
maintains that an orderly restructuring process could reduce the
likelihood of a reduction in future capital flows. For creditors, it
could provide more favorable repayment terms from the restructured
debt.
The SDRM is a proposed international legal framework that would allow a
member country to declare its debt unsustainable and invoke a process
to restructure most of its external private sector loans.[Footnote 21]
A specified majority of the country's external creditors would vote to
approve the terms for restructuring, which would bind all eligible
private sector creditors. The framework is designed to increase the
incentives for the Fund's member countries and their creditors to reach
a rapid and collaborative agreement on restructuring unsustainable
debt.
A number of political, legal, and technical challenges stand in the way
of implementing the SDRM, and it seems unlikely that these issues will
be resolved in the immediate future. According to the Fund, successful
implementation of SDRM will require overcoming certain political
constraints. The SDRM could be put into practice either by countries
adopting a new international treaty or by amending the Fund's Articles
of Agreement. Both options would be difficult to implement since a
number of countries have indicated opposition to the SDRM. The draft
framework recommended that the SDRM be created through an amendment to
the Fund's Articles of Agreement because the SDRM is closely related to
the role already assigned to the Fund under the Articles in the
resolution of its members' external financial obligations. However, the
Fund acknowledged that, given the opposition of some countries,
changing the Articles could be difficult to achieve since it requires
acceptance by three-fifths of the members, having 85 percent of the
total voting representation. The United States, for example, could
unilaterally veto any proposed amendment to the Fund's Articles given
its 17 percent voting representation.
A key legal challenge to the implementation of SDRM is the need for
most countries to change their domestic laws to conform to the
requirements of any new Fund articles. Before a member country can vote
to accept an amendment, it must take all the necessary steps needed
under its own domestic law to ensure that the amendment will be given
full force and effect under its domestic law. However, some Fund
members have raised concerns over whether the domestic legal systems of
some member countries could accommodate a new legal framework that
applied to preexisting claims. The proposed SDRM approach also faces
technical challenges. For example, the proposed framework does not
specify how the claims of official bilateral creditors and some
guaranteed domestic debts would be treated. The Fund is consulting with
the Paris Club on how the Club's practices may be modified to better
facilitate coordination between official bilateral and the private
creditors in a debt restructuring process.[Footnote 22]
The Fund Has Encouraged the Adoption of Collective Action Clauses:
CACs are terms in individual bonds that permit a specified majority of
sovereign bondholders to agree on a debt restructuring that would bind
all holders of that bond. In June 2002, the Fund's Executive Board
endorsed the use of certain CAC provisions in new bonds and agreed to
encourage member countries to incorporate CACs into their sovereign
bonds in future restructurings. Inclusion of these clauses into new
bonds would be voluntary.
The Fund views CACs and SDRM as complementary instruments in resolving
future financial crises. According to the Fund, the existence of CACs
in certain bond agreements inspired the development of the SDRM
framework. Although the Fund has not created its own CAC framework, it
has endorsed the use of two key features from a G-10 Working Group
Report[Footnote 23] and an Industry Associations draft
proposal.[Footnote 24] These features include the following:
* Majority restructuring provision[Footnote 25] enables a qualified
majority of bondholders to bind all holders of a particular bond to the
financial terms of a restructuring, both before and after a default.
Although majority restructuring provisions have generally been included
in bonds governed by the laws of the United Kingdom or Japan, they have
not been included in bonds governed by the laws of the United States or
Germany.
* Majority enforcement provisions prevent a minority of creditors from
pursuing disruptive legal action after a default and before reaching a
restructuring agreement. Many international sovereign bonds governed by
both U.S. and English law contain these provisions. Specifically, the
Fund supports the requirement that (1) an affirmative vote of a minimum
percentage of bondholders is necessary to approve claims following a
default and (2) a specified majority of bondholders can reverse an
approval of a claim that has already occurred.
In early 2003, Mexico became the first emerging market country to issue
a public, SEC-registered global bond with CACs under New York law.
Previous issues under New York law by Lebanon, Qatar, and Egypt had
been placed privately to institutional investors and included only a
limited range of CACs. For example, the bonds issued by Egypt and
Qatar included a very limited form of majority enforcement provisions,
while Lebanese bonds did not contain them at all. Since Mexico's
successful issue, Brazil, South Africa, and Korea have issued bonds
with CACs. Uruguay included CACs in the bonds resulting from its debt
exchange. The details of the Brazil, South Africa, Korea, and Uruguay
bond provisions were not available at the time we conducted our review.
Some countries criticize CACs because they would only apply to new bond
offerings and not existing bonds. Accordingly, during a restructuring
of a country's bond obligations, not all creditors would be bound by
the CAC provisions. Borrowing countries also contend that inclusion of
CACs in bond offerings could suggest to creditors that countries
anticipate having difficulty repaying their loans. In response,
creditors may charge a higher interest rate. However, a May 2000
academic study[Footnote 26] compared interest rates on bonds issued in
the United States (where CACs are not used) with the United Kingdom
(where CACs are used) and found that CACs do not contribute to higher
rates in United Kingdom bonds.
While Private Sector Officials Prefer Voluntary Debt Restructuring,
They Expect Continued Fund Loans in Exceptional Circumstances:
To date, officials from the private sector, including lenders, have
expressed preference for continuing the current voluntary process,
which only involves the private sector and borrowing countries, in the
efforts to restructure sovereign debts. Many private sector officials
we interviewed oppose the proposed SDRM approach and the Fund's
attempts to integrate CACs into new bond issues, partly because they
would interfere with the normal bargaining process. They maintain that
a voluntary approach to the restructurings that took place from 1998 to
2001 in Ecuador, Pakistan, Russia, and Ukraine were
successful.[Footnote 27] Private sector officials assert that these and
other experiences have worked well enough, and that a substantive
change in current market practice is unnecessary. In contrast to the
Fund's assertion that new approaches are needed to make restructurings
shorter and less expensive, private sector officials note that most
recent voluntary restructurings successfully concluded in 1 year or
less and that creditor holdouts or litigation did not significantly
delay the restructurings.[Footnote 28]
While private sector officials expect that many restructurings need
only involve the private sector and the debtor country, under some
circumstances, voluntary debt restructurings will not adequately
resolve all financial crises. In those cases, they said the Fund should
provide loans to eligible countries to help fill their external
financing gaps. Such loans would assist the restructuring process and
facilitate efforts at implementing necessary reforms. However, large
Fund loans, such as those given during the Asian financial crises, have
received substantial criticism from financial experts and government
representatives, including U.S. government officials. One concern is
that the possibility of receiving substantial financial assistance
provides an incentive for debtor countries to adopt unsustainable
economic policies to forestall needed reform. Another concern is that
these large loans may encourage private sector creditors to continue
providing large capital flows to countries with unsustainable economic
policies because these otherwise risky investments have the potential
of being "bailed out" by future Fund loans. This condition is referred
to as "moral hazard." According to these critics, efforts to help
resolve existing financial crises through large Fund loans may increase
the probability of future crises due to these two concerns. The Fund
has advocated the SDRM framework and CACs to replace the current
voluntary approach, partially in response to concerns over the
potential adverse affects of its lending.
The Fund Has Clarified and Strengthened its Lending Practices to
Address Concerns Over Exceptional Lending:
To reduce the risk that Fund loans would increase the probability of
future financial crises, the Fund clarified and strengthened its policy
of lending in crisis situations. The Fund has clarified elements of its
Lending into Arrears Policy and strengthened its criteria for
requesting large short-term loans under the Supplemental Reserve
Facility (SRF). Since 1997, nine countries have received loans under
the two mechanisms.
The Fund's Lending into Arrears Policy permits the IMF to provide
resources to countries that are unable to repay their external
creditors and are thus considered in default. Conceived in the late
1980s and amended in the late 1990s, the policy is designed to protect
the value of creditor assets while providing creditors with incentives
to enter rapidly into restructuring negotiations with countries. The
Lending into Arrears Policy increases the likelihood that a country's
private sector lenders would agree to reduce the value of their loans
because Fund resources reduce short-term fiscal pressures experienced
by the country while in default. A country is eligible for Fund
resources while in default if the Fund determines that the debt burden
is unsustainable, and the country is making satisfactory progress in
implementing reforms. Additionally, the country must have demonstrated
a good faith effort to reach a restructuring agreement with creditors
to restore its ability to repay its debt. In 2002, the Fund clarified
the criteria to be used to determine whether the debtor country is
making a good faith effort. For example, the Fund would consider how
quickly the debtor engaged in negotiations with its creditors after it
defaulted. To date, the Fund has lent into arrears on international
bonds on four occasions--Ukraine, Ecuador, Moldova, and Argentina.
Introduced in 1997, the SRF provides large short-term loans to members
experiencing exceptional balance of payments difficulties prior to a
default. The interest rates on these loans are much higher than
standard Fund loans. The increased cost of these loans is expected to
reduce the probability that countries consider Fund resources a viable
means for underwriting unsustainable economic policies. Higher loan
terms also increase incentives for early repayment and compensate for
additional repayment risks to the Fund. Countries are expected to repay
SRF loans within 2 to 2½ years, but they may request extensions of up
to 6 months. All SRF loans carry a substantial surcharge of 3-5
percentage points. In 2003, the Fund strengthened its criteria for
providing large short-term loans under the SRF. For example, countries
requesting SRF loans must provide a more extensive justification for
their repayment difficulties. Additionally, the member has to
demonstrate good prospects of regaining access to private capital
markets within the time period that Fund resources are outstanding to
minimize long-term reliance on Fund resources. To date, the Fund has
provided SRF loans on nine occasions to six countries, including Korea,
Russia, Brazil, Turkey, Argentina, and Uruguay (see appendix IX).
Conclusion:
In accordance with its goal of strengthening the international
financial system, the Fund has undertaken a number of reforms to better
anticipate, prevent, and resolve sovereign financial crises. The Fund's
new vulnerability assessment process is more comprehensive than its
previous crisis anticipation efforts, but it is too soon to judge its
effectiveness. The Fund's proposed approaches to better resolve
financial crises have met considerable resistance, and it is unclear
whether they will ultimately be adopted. The Fund and the Bank have
made progress in their crisis prevention efforts by performing
assessments of member countries' financial sectors and adherence to
standards. However, the effectiveness of these crisis prevention
efforts is hindered by (1) private sector participants' limited use of
published assessments, which they find untimely, outdated, and too
dense to be useful and (2) gaps in crucial information about crisis
vulnerabilities in some important emerging market countries due to
voluntary participation in the assessments. These limitations prevent
multilateral institutions, national policy makers, and private sector
participants from making sound decisions, thus reducing the likelihood
that these reforms will help prevent crises.
Recommendations for Executive Action:
To help strengthen the Fund's crisis prevention initiatives we
recommend that the Secretary of the Treasury instruct the U.S.
Executive Director of the Fund to work with other Executive Board
members to encourage the Fund to:
* improve the timeliness of publication of Financial System Stability
Assessments and Reports on the Observance of Standards and Codes;
* expand the coverage, frequency, and publication of reports on member
countries' progress on implementing assessment recommendations;
* improve the assessment reports' readability, for example, by creating
a standardized format in which to present executive summaries and key
findings; and:
* pursue strategies for increasing participation in the Financial
Sector Assessment Program and all modules of the Reports on the
Observance of Standards and Codes, including the possibility of making
participation mandatory for all members of the IMF.
Agency Comments and Our Evaluation:
We received written comments on this report from the Department of the
Treasury, the International Monetary Fund, and the World Bank. These
comments and GAO's evaluation of them are reprinted in appendixes X,
XI, and XII. The organizations also separately provided technical
comments that GAO discussed with relevant officials and included in the
text of the report where appropriate.
Treasury agreed with the report's recommendations. Treasury recognized
that some important countries have not volunteered to participate in
the FSAP and ROSC and that there should be a shorter turnaround between
the completion of an assessment and its public release. Treasury also
pointed out that the acceptance of collective action clauses in some
recent bond offerings serves as an important signal to investors that
official financing is limited and that they cannot expect to be
protected from risks.
The IMF broadly agreed with the report's recommendations. However, the
IMF stated that we mischaracterized the role of the WEO forecasts and
EWS models in IMF crisis anticipation efforts by saying that they have
a greater importance than is warranted. We disagree with this
depiction. Our assessment examined all six components of the IMF's
vulnerability assessment framework, including the WEO and the EWS. As
the only mature and quantifiable elements of the framework, our
analysis focused more heavily on the track records of the WEO and EWS.
The IMF also stated that its responsibility to maintain financial
stability could make its predictions less accurate so as not to
contribute to a crisis. The IMF's comment not only validates our
finding on the WEO's weakness but also raises questions regarding the
purpose and credibility of the WEO forecasts.
The World Bank generally agreed with the report's recommendations.
However, the Bank expressed concern with the report's suggestion that
consideration be given to making participation in the FSAP and ROSC
assessments mandatory. While we are not suggesting that the assessments
should be made mandatory, the voluntary nature of the FSAP and ROSC has
posed an obstacle to full participation by important emerging market
countries.
:
We are sending copies of this report to the Secretary of the Treasury,
the International Monetary Fund, the World Bank, and interested
congressional committees. We also will make copies available to other
interested parties upon request. In addition, the report will be
available at no charge on the GAO Web site at http://www.gao.gov.
If you or your staff have any questions regarding this report, please
call me at (202) 512-8979. Other GAO contacts and staff are
acknowledged in appendix XIII.
[See PDF for image]
[End of figure]
Joseph A. Christoff,
Director
International Affairs and Trade:
Signed by Joseph A. Christoff:
[End of section]
Appendixes:
Appendix I: Objectives, Scope, and Methodology:
The Chairman of the House Financial Services and the Vice Chairman of
the Joint Economic Committee requested that we assess (1) the
International Monetary Fund's (IMF's or the Fund's) framework for
anticipating financial crises, (2) the status of key IMF initiatives to
prevent financial crises, and (3) new IMF proposals to resolve future
financial crises. They requested that our review cover the period after
the Mexican financial crisis of 1994-95.
To assess IMF's framework for anticipating financial crises, we
examined prior and new IMF mechanisms for anticipating crises. Our
analysis focused on the World Economic Outlook (WEO) forecasts and the
IMF's Early Warning System (EWS) models that were the IMF's primary
forecasting tools prior to the implementation of the new vulnerability
assessment framework in May 2001. Data on the performance of the other
four components of the framework were not made available to us because
these elements are considered part of the staff level deliberative
process, and are not provided to the Executive Board. We obtained near-
term data from the WEO forecasts, including real gross domestic product
(GDP) growth rate and current account balance for 87 emerging market
countries for the period 1990-2001 (see appendix III). We focused on
the 81 middle-income countries and an additional 6 low-income countries
listed by J.P. Morgan as emerging markets. To evaluate the WEO and
program forecasts, we used standard econometric techniques based on
methods commonly found in the forecasting literature. The formal
methodology of our forecast evaluations was based on several expert
publications, the replication of our summary statistics with another
author's results, and discussions with a forecasting expert. To
describe the performance of the IMF's EWS models in anticipating
crises, we reviewed and summarized the results of IMF evaluations. We
interviewed IMF staff, including country desk economists and staff from
several departments, to discuss the IMF's new framework for
vulnerability assessment, the EWS models, and the WEO methodology. We
also interviewed 23 major private sector emerging market participants
to discuss whether and how they use IMF forecasts in their investment
decisions.
To assess the status of key IMF initiatives to prevent financial
crises, we reviewed Fund and World Bank documents published between
1999 and 2003 on the creation of the Financial Sector Assessment
Program (FSAP) and Reports on the Observance of Standards and Codes
(ROSC) and evaluations of progress in implementing these reforms. We
interviewed senior Fund officials, including staff from the Monetary
Affairs and Exchange Department, the Policy Development and Review
Department, and the Fiscal Affairs Department. We also met with senior
advisers at the World Bank (the Bank) who oversee the Bank's
participation in the FSAP and ROSC initiatives. To gain a better
understanding of how the Fund uses FSAP and ROSC assessments to inform
the policy advice it provides to member country governments and
challenges it faces in using these assessments, we interviewed Fund
officials in nine area departments (Argentina, Brazil, Korea, Mexico,
Peru, Poland, Russia, Turkey, and Uruguay). We also spoke with Fund
officials in these area departments about member country governments'
use of the assessments in shaping their reform agendas and the
obstacles that member country authorities encounter in implementing the
reforms recommended in the assessments. To assess the extent to which
emerging market countries have participated in and authorized
publication of FSAP and ROSC assessments, we examined Fund and World
Bank data on country participation in the FSAP and 12 ROSC modules and
publication of the resulting reports between May 1999 and March 2003.
To obtain views on the private sector's use of Fund and World Bank
assessments, we conducted structured interviews with 13 representatives
of private sector firms, including ratings agencies, investment banks,
and pension funds. We focused on 33 countries (a subset of the 87 we
analyzed in the previous section) identified as the major emerging
market countries by J.P. Morgan.[Footnote 29]
To describe new proposals to resolve future financial crises and their
potential challenges, we obtained the most current Fund documentation
for the two key proposals, the Sovereign Debt Restructuring Mechanism
(SDRM) and Collective Action Clauses (CACs). We examined the purpose,
goals, requirements, and status of implementation. To obtain views on
the private sector's understanding of the components of the new
proposals and potential implementation challenges, we conducted
structured interviews with 22 representatives of private sector firms,
including ratings agencies, investment banks, and pension funds. We
also met with government, private sector emerging market participants,
and nongovernmental officials at several conferences. We also
interviewed Department of the Treasury officials and experts in
international finance and law. The IMF did not meet with us on these
proposals because they were still under negotiation at the time of our
review.
We conducted fieldwork in Washington, D.C., and in New York. We
performed our work from May 2002 to May 2003 in accordance with
generally accepted government auditing standards.
[End of section]
Appendix II: Private Sector Structured Interview Participants:
Company:
Citicorp; Perspectives obtained on IMF efforts in crisis: Anticipation:
Yes; Perspectives obtained on IMF efforts in crisis: Prevention: Yes;
Perspectives obtained on IMF efforts in crisis: Resolution: Yes.
Cleary Gottlieb & Hamilton; Perspectives obtained on IMF efforts in
crisis: Anticipation: Yes; Perspectives obtained on IMF efforts in
crisis: Prevention: No; Perspectives obtained on IMF efforts in
crisis: Resolution: Yes.
Credit Suisse; Perspectives obtained on IMF efforts in crisis:
Anticipation: Yes; Perspectives obtained on IMF efforts in crisis:
Prevention: Yes; Perspectives obtained on IMF efforts in crisis:
Resolution: Yes.
Darby's Overseas Investments; Perspectives obtained on IMF efforts in
crisis: Anticipation: Yes; Perspectives obtained on IMF efforts in
crisis: Prevention: Yes; Perspectives obtained on IMF efforts in
crisis: Resolution: Yes.
Elliot Associates; Perspectives obtained on IMF efforts in crisis:
Anticipation: Yes; Perspectives obtained on IMF efforts in crisis:
Prevention: No; Perspectives obtained on IMF efforts in crisis:
Resolution: Yes.
Emerging Market Traders Association; Perspectives obtained on IMF
efforts in crisis: Anticipation: Yes; Perspectives obtained on IMF
efforts in crisis: Prevention: No; Perspectives obtained on IMF
efforts in crisis: Resolution: Yes.
eStandards Forum; Perspectives obtained on IMF efforts in crisis:
Anticipation: Yes; Perspectives obtained on IMF efforts in crisis:
Prevention: Yes; Perspectives obtained on IMF efforts in crisis:
Resolution: Yes.
Eurasia Group; Perspectives obtained on IMF efforts in crisis:
Anticipation: Yes; Perspectives obtained on IMF efforts in crisis:
Prevention: Yes; Perspectives obtained on IMF efforts in crisis:
Resolution: Yes.
Fitch Ratings; Perspectives obtained on IMF efforts in crisis:
Anticipation: Yes; Perspectives obtained on IMF efforts in crisis:
Prevention: Yes; Perspectives obtained on IMF efforts in crisis:
Resolution: Yes.
HBK; Perspectives obtained on IMF efforts in crisis: Anticipation:
Yes; Perspectives obtained on IMF efforts in crisis: Prevention: No;
Perspectives obtained on IMF efforts in crisis: Resolution: Yes.
HSBC; Perspectives obtained on IMF efforts in crisis: Anticipation:
Yes; Perspectives obtained on IMF efforts in crisis: Prevention: Yes;
Perspectives obtained on IMF efforts in crisis: Resolution: Yes.
International Primary Markets Association; Perspectives obtained on
IMF efforts in crisis: Anticipation: Yes; Perspectives obtained on IMF
efforts in crisis: Prevention: No; Perspectives obtained on IMF
efforts in crisis: Resolution: Yes.
Institute for International Finance; Perspectives obtained on IMF
efforts in crisis: Anticipation: Yes; Perspectives obtained on IMF
efforts in crisis: Prevention: No; Perspectives obtained on IMF
efforts in crisis: Resolution: Yes.
Japan Center for International Finance; Perspectives obtained on IMF
efforts in crisis: Anticipation: Yes; Perspectives obtained on IMF
efforts in crisis: Prevention: No; Perspectives obtained on IMF
efforts in crisis: Resolution: Yes.
J.P. Morgan; Perspectives obtained on IMF efforts in crisis:
Anticipation: Yes; Perspectives obtained on IMF efforts in crisis:
Prevention: No; Perspectives obtained on IMF efforts in crisis:
Resolution: Yes.
Lehman Brothers; Perspectives obtained on IMF efforts in crisis:
Anticipation: Yes; Perspectives obtained on IMF efforts in crisis:
Prevention: Yes; Perspectives obtained on IMF efforts in crisis:
Resolution: Yes.
Mass Mutual; Perspectives obtained on IMF efforts in crisis:
Anticipation: Yes; Perspectives obtained on IMF efforts in crisis:
Prevention: No; Perspectives obtained on IMF efforts in crisis:
Resolution: Yes.
Moody's Investor Service; Perspectives obtained on IMF efforts in
crisis: Anticipation: Yes; Perspectives obtained on IMF efforts in
crisis: Prevention: Yes; Perspectives obtained on IMF efforts in
crisis: Resolution: Yes.
Securities Industry Association; Perspectives obtained on IMF efforts
in crisis: Anticipation: Yes; Perspectives obtained on IMF efforts in
crisis: Prevention: Yes; Perspectives obtained on IMF efforts in
crisis: Resolution: Yes.
Societe Generale; Perspectives obtained on IMF efforts in crisis:
Anticipation: Yes; Perspectives obtained on IMF efforts in crisis:
Prevention: Yes; Perspectives obtained on IMF efforts in crisis:
Resolution: Yes.
Standard & Poor's; Perspectives obtained on IMF efforts in crisis:
Anticipation: Yes; Perspectives obtained on IMF efforts in crisis:
Prevention: Yes; Perspectives obtained on IMF efforts in crisis:
Resolution: Yes.
Straus & Boies; Perspectives obtained on IMF efforts in crisis:
Anticipation: Yes; Perspectives obtained on IMF efforts in crisis:
Prevention: No; Perspectives obtained on IMF efforts in crisis:
Resolution: Yes.
Wilshire Associates; Perspectives obtained on IMF efforts in crisis:
Anticipation: Yes; Perspectives obtained on IMF efforts in crisis:
Prevention: Yes; Perspectives obtained on IMF efforts in crisis:
Resolution: No.
Source: GAO.
[End of table]
[End of section]
Appendix III: Assessment of IMF Forecasting:
[See PDF for image]
[End of figure]
[End of section]
Appendix IV: Eighty-seven Emerging Market Countries:
1; Country: Albania; Region[A]: Countries in transition; Income
group[B]: Lower middle income.
2; Country: Algeria; Region[A]: Africa; Income group[B]: Lower middle
income.
3; Country: Antigua and Barbuda; Region[A]: Western Hemisphere; Income
group[B]: Upper middle income.
4; Country: Argentina; Region[A]: Western Hemisphere; Income group[B]:
Upper middle income.
5; Country: Bahrain; Region[A]: Middle East and Turkey; Income
group[B]: Upper middle income.
6; Country: Belarus; Region[A]: Countries in transition; Income
group[B]: Lower middle income.
7; Country: Belize; Region[A]: Western Hemisphere; Income group[B]:
Lower middle income.
8; Country: Bolivia; Region[A]: Western Hemisphere; Income group[B]:
Lower middle income.
9; Country: Botswana; Region[A]: Africa; Income group[B]: Upper middle
income.
10; Country: Brazil; Region[A]: Western Hemisphere; Income group[B]:
Upper middle income.
11; Country: Bulgaria; Region[A]: Countries in transition; Income
group[B]: Lower middle income.
12; Country: Cape Verde; Region[A]: Africa; Income group[B]: Lower
middle income.
13; Country: Chile; Region[A]: Western Hemisphere; Income group[B]:
Lower middle income.
14; Country: China; Region[A]: Developing Asia; Income group[B]: Lower
middle income.
15; Country: Colombia; Region[A]: Western Hemisphere; Income group[B]:
Lower middle income.
16; Country: Costa Rica; Region[A]: Western Hemisphere; Income
group[B]: Upper middle income.
17; Country: Cote d'Ivoire; Region[A]: Africa; Income group[B]: Low
income.
18; Country: Croatia; Region[A]: Countries in transition; Income
group[B]: Upper middle income.
19; Country: Czech Republic; Region[A]: Countries in transition; Income
group[B]: Upper middle income.
20; Country: Djibouti; Region[A]: Africa; Income group[B]: Lower middle
income.
21; Country: Dominica; Region[A]: Western Hemisphere; Income group[B]:
Upper middle income.
22; Country: Dominican Republic; Region[A]: Western Hemisphere; Income
group[B]: Lower middle income.
23; Country: Ecuador; Region[A]: Western Hemisphere; Income group[B]:
Lower middle income.
24; Country: Egypt; Region[A]: Middle East and Turkey; Income group[B]:
Lower middle income.
25; Country: El Salvador; Region[A]: Western Hemisphere; Income
group[B]: Lower middle income.
26; Country: Equatorial Guinea; Region[A]: Africa; Income group[B]:
Lower middle income.
27; Country: Estonia; Region[A]: Countries in transition; Income
group[B]: Upper middle income.
28; Country: Fiji; Region[A]: Developing Asia; Income group[B]: Lower
middle income.
29; Country: Gabon; Region[A]: Africa; Income group[B]: Upper middle
income.
30; Country: Grenada; Region[A]: Western Hemisphere; Income group[B]:
Upper middle income.
31; Country: Guatemala; Region[A]: Western Hemisphere; Income group[B]:
Lower middle income.
32; Country: Guyana; Region[A]: Western Hemisphere; Income group[B]:
Lower middle income.
33; Country: Honduras; Region[A]: Western Hemisphere; Income group[B]:
Lower middle income.
34; Country: Hungary; Region[A]: Countries in transition; Income
group[B]: Upper middle income.
35; Country: India; Region[A]: Developing Asia; Income group[B]: Low
income.
36; Country: Indonesia; Region[A]: Developing Asia; Income group[B]:
Low income.
37; Country: Iran, Islamic Rep. of; Region[A]: Middle East and Turkey;
Income group[B]: Lower middle income.
38; Country: Iraq; Region[A]: Middle East and Turkey; Income group[B]:
Lower middle income.
39; Country: Jamaica; Region[A]: Western Hemisphere; Income group[B]:
Lower middle income.
40; Country: Jordan; Region[A]: Middle East and Turkey; Income
group[B]: Lower middle income.
41; Country: Kazakhstan; Region[A]: Countries in transition; Income
group[B]: Lower middle income.
42; Country: Kiribati; Region[A]: Developing Asia; Income group[B]:
Lower middle income.
43; Country: Korea; Region[A]: Developing Asia; Income group[B]: Upper
middle income.
44; Country: Latvia; Region[A]: Countries in transition; Income
group[B]: Lower middle income.
45; Country: Lebanon; Region[A]: Middle East and Turkey; Income
group[B]: Upper middle income.
46; Country: Libya; Region[A]: Middle East and Turkey; Income group[B]:
Upper middle income.
47; Country: Lithuania; Region[A]: Countries in transition; Income
group[B]: Lower middle income.
48; Country: Macedonia, former Yugoslav Rep. of; Region[A]: Countries
in transition; Income group[B]: Lower middle income.
49; Country: Malaysia; Region[A]: Developing Asia; Income group[B]:
Upper middle income.
50; Country: Maldives; Region[A]: Developing Asia; Income group[B]:
Lower middle income.
51; Country: Mauritius; Region[A]: Africa; Income group[B]: Upper
middle income.
52; Country: Mexico; Region[A]: Western Hemisphere; Income group[B]:
Upper middle income.
53; Country: Morocco; Region[A]: Africa; Income group[B]: Lower middle
income.
54; Country: Namibia; Region[A]: Africa; Income group[B]: Lower middle
income.
55; Country: Nigeria; Region[A]: Africa; Income group[B]: Low income.
56; Country: Oman; Region[A]: Middle East and Turkey; Income group[B]:
Upper middle income.
57; Country: Pakistan; Region[A]: Developing Asia; Income group[B]: Low
income.
58; Country: Panama; Region[A]: Western Hemisphere; Income group[B]:
Upper middle income.
59; Country: Papua New Guinea; Region[A]: Developing Asia; Income
group[B]: Lower middle income.
60; Country: Paraguay; Region[A]: Western Hemisphere; Income group[B]:
Lower middle income.
61; Country: Peru; Region[A]: Western Hemisphere; Income group[B]:
Lower middle income.
62; Country: Philippines; Region[A]: Developing Asia; Income group[B]:
Lower middle income.
63; Country: Poland; Region[A]: Countries in transition; Income
group[B]: Upper middle income.
64; Country: Romania; Region[A]: Countries in transition; Income
group[B]: Lower middle income.
65; Country: Russia; Region[A]: Countries in transition; Income
group[B]: Lower middle income.
66; Country: Samoa; Region[A]: Developing Asia; Income group[B]: Lower
middle income.
67; Country: Saudi Arabia; Region[A]: Middle East and Turkey; Income
group[B]: Upper middle income.
68; Country: Seychelles; Region[A]: Africa; Income group[B]: Upper
middle income.
69; Country: Slovak Republic; Region[A]: Countries in transition;
Income group[B]: Upper middle income.
70; Country: South Africa; Region[A]: Africa; Income group[B]: Upper
middle income.
71; Country: Sri Lanka; Region[A]: Developing Asia; Income group[B]:
Lower middle income.
72; Country: St. Kitts and Nevis; Region[A]: Western Hemisphere; Income
group[B]: Upper middle income.
73; Country: St. Lucia; Region[A]: Western Hemisphere; Income group[B]:
Upper middle income.
74; Country: St. Vincent and the Grenadines; Region[A]: Western
Hemisphere; Income group[B]: Lower middle income.
75; Country: Suriname; Region[A]: Western Hemisphere; Income group[B]:
Lower middle income.
76; Country: Swaziland; Region[A]: Africa; Income group[B]: Lower
middle income.
77; Country: Syrian Arab Rep.; Region[A]: Middle East and Turkey;
Income group[B]: Lower middle income.
78; Country: Thailand; Region[A]: Developing Asia; Income group[B]:
Lower middle income.
79; Country: Tonga; Region[A]: Developing Asia; Income group[B]: Lower
middle income.
80; Country: Trinidad and Tobago; Region[A]: Western Hemisphere; Income
group[B]: Upper middle income.
81; Country: Tunisia; Region[A]: Africa; Income group[B]: Lower middle
income.
82; Country: Turkey; Region[A]: Middle East and Turkey; Income
group[B]: Upper middle income.
83; Country: Turkmenistan; Region[A]: Countries in transition; Income
group[B]: Lower middle income.
84; Country: Ukraine; Region[A]: Countries in transition; Income
group[B]: Low income.
85; Country: Uruguay; Region[A]: Western Hemisphere; Income group[B]:
Upper middle income.
86; Country: Vanuatu; Region[A]: Developing Asia; Income group[B]:
Lower middle income.
87; Country: Venezuela; Region[A]: Western Hemisphere; Income group[B]:
Upper middle income.
Sources: IMF, World Bank, and J.P. Morgan.
[A] Based on WEO regional groupings, IMF 2002.
[B] World Bank analytical classification by income, July 2001.
[End of table]
[End of section]
Appendix V: Standards, Codes, and Principles Assessed under IMF and
World Bank Reports on the Observance of Standards and Codes:
[See PDF for image]
Sources: IMF and World Bank.
[End of table]
[End of section]
Appendix VI: Update on the International Monetary Fund's Safeguards
Assessments:
In response to allegations of misreporting and misuse of International
Monetary Fund (IMF or the Fund) disbursements in the late 1990s, the
Fund increased its efforts to protect its resources by introducing
safeguards assessments, a process for evaluating the controls employed
by the central banks of borrowing member countries and for recommending
measures to address inadequacies. Safeguards assessments have detected
numerous inadequacies that could lead to misuse of Fund resources and
have recommended measures to remedy them.
The Fund Introduces Safeguards Assessments for Member Countries That
Currently Borrow:
In 2000, the Fund introduced safeguards assessments, a process for
identifying inadequacies in central banks' ability to ensure the
integrity of their operations, especially the use of Fund resources.
Safeguards assessments evaluate central banks' internal and external
audit mechanisms, legal structure and independence, financial reporting
procedures, and systems of internal controls.
In April 2002, the Fund's Executive Board made safeguards assessments a
permanent policy. Safeguards assessments apply to all member countries
with current or anticipated borrowing arrangements with the Fund.
Countries with borrowing arrangements approved after June 30, 2000, are
subject to a full safeguards assessment covering the five areas listed
above. Countries with arrangements in effect before June 30, 2000, that
have not yet repaid all Fund resources, were subject to a partial
assessment covering only the external audit mechanism. Countries that
do not have borrowing arrangements or have already repaid all Fund
resources are not subject to safeguards assessments. According to Fund
officials, since 2000 the IMF has not provided financial resources to
countries that did not meet its safeguards requirements.
As of December 2002, the Fund had performed 37 full safeguards
assessments and 27 partial assessments, with 23 assessments under
way.[Footnote 46] The completed assessments detected a number of
serious vulnerabilities that could lead to misuse of central bank
resources, including those borrowed from the Fund. Of the full
safeguards assessments, the Fund found the following:
* Inadequate accounting standards in 82 percent of the central banks,
which interfere with the accurate recording of central bank operations.
For example, some central banks did not adhere to a financial reporting
framework such as the International Accounting Standards (IAS), which
would help prevent misreporting of transactions.
* Deficient internal audit in 79 percent of central banks, which
reduces their ability to address risks of misuse and misreporting of
Fund resources. For example, some internal audit departments did not
audit high-risk areas such as foreign reserves management.
* Poor controls over foreign reserves and data reporting to the Fund in
49 percent of the central banks, increasing the possibility of
misreporting and misuse of Fund resources. For example, safeguards
assessments identified improper techniques for valuing foreign reserves
and failure to reconcile data reported to the Fund for program
monitoring purposes with underlying accounting records.
According to Fund officials, when IMF staff detect significant
weaknesses in the controls of assessed central banks, they recommend
that the government take corrective actions. For actions that IMF staff
consider essential, they may incorporate the recommendations into the
list of preconditions that the Fund requires borrower countries meet
before receiving IMF resources, or they may suggest that the government
include the recommended actions in its official economic program. The
Fund reports that of the 275 recommendations that were expected to be
implemented on or before December 31, 2002, 23 percent were
incorporated as conditions for IMF resources or included in official
economic program statements.
Implementation of the Fund's Assessment Recommendations:
Fund staff monitor central banks' implementation of recommendations by
performing in-depth reviews of their audited annual financial
statements and other documents every 12 to 18 months until the borrower
country government has repaid all Fund resources. The Fund monitors on
a continuous basis, central banks' implementation of all other
safeguards measures and of developments within the central banks that
may lead to new vulnerabilities.
:
Recently, the Fund reported that central banks have implemented 90
percent of recommendations that IMF staff included as a precondition
for receiving IMF resources. According to Fund officials, the IMF
stopped disbursing resources in the few cases where governments failed
to implement these essential recommendations. Similarly, the Fund
reported that central banks have implemented 84 percent of measures
included in governments' official economic program statements.
On the other hand, the Fund reported that some recommendations made by
the safeguards assessments have not been implemented as intended,
although Fund officials state that these delays typically occurred in
nonpriority areas. When central bank authorities fail to implement the
recommendations, Fund staff increase pressure to comply, often
proposing the measures' inclusion as a precondition for the next
disbursement. However, the Fund reports that staff can only adopt this
approach in countries where the Fund is actively disbursing funds. For
countries that are not currently receiving Fund disbursements,
implementation of recommendations from the safeguards assessments tends
to be more problematic because the Fund cannot exert pressure through a
borrowing arrangement.
:
:
[End of section]
Appendix VII: Fund/World Bank FSAP and ROSC Process:
[See PDF for image]
[End of figure]
[End of section]
Appendix VIII Country Participation in and Publication of FSAPs and
ROSCs:
Figure 4 lists all countries that have participated in Financial Sector
Assessment Program (FSAP) or Reports on the Observance of Standards and
Codes (ROSC) assessments and whether or not these assessments were
published. The figure describes participation and publication by the 33
major emerging market countries. Countries highlighted in bold have not
participated in any assessments. Figure 5 describes participation and
publication by other countries (industrial, developing, and smaller
emerging markets).
Figure 4: FSAP and ROSC Participation and Publication by Major Emerging
Market Countries:
[See PDF for image]
[A] These countries participated in the FSAP under a pilot program. The
reports were not intended for publication.
[End of figure]
Figure 5: FSAP and ROSC Participation and Publication by Other
Countries:
[See PDF for image]
[A] These countries participated in the FSAP under a pilot program. The
reports were not intended for publication.
[End of figure]
[End of section]
Appendix IX: Fund Resources Provided under the Supplemental Reserve
Facility:
In recent financial crises, the International Monetary Fund (IMF or the
Fund) provided large short-term loans under the Supplemental Reserve
Facility (SRF) with high interest rates to member countries
experiencing exceptional balance of payments problems. These problems
resulted from a sharp decline of investor confidence and significant
outflows of capital. These loans generally were provided when the
countries had exceeded their financing limit under other loan
mechanisms, including the Stand-By Arrangement (SBA). In some
circumstances, such as Argentina and Uruguay, the Fund provided a mix
of SRF and SBA loans. Table 6 lists Fund members receiving SRF loans
from 1997 to 2002.
Table 6: IMF Supplemental Reserve Facility Loans, 1997-2002:
Country: Korea; Loan approval date: 12/18/97; Loan mix: SRF;:
SRF repaid as of May 2003: Yes.
Country: Russia; Loan approval date: 7/20/98;Loan mix: SRF;:
SRF repaid as of May 2003: Yes.
Country: Brazil; Loan approval date: 12/2/98; Loan mix: SRF;:
SRF repaid as of May 2003: Yes.
Country: Turkey; Loan approval date: 12/21/00; Loan mix: SRF;:
SRF repaid as of May 2003: Yes.
Country: Argentina; Loan approval date: 1/12/01; Loan mix: Country:
SRF (40%); SBA (60%); SRF repaid as of May 2003: Country: No.
Country: Argentina; Loan approval date: 9/7/01; Loan mix:
SRF (63%); SBA (37%); SRF repaid as of May 2003: No.
Country: Brazil; Loan approval date: 9/14/01; Loan mix: SRF;
SRF repaid as of May 2003: No.
Country: Uruguay; Loan approval date: 6/25/02; Loan mix:
SRF (33%); SBA (67%); SRF repaid as of May 2003: No.
Country: Brazil; Loan approval date: 9/6/02; Loan mix: SRF
(33%); SBA (67%); SRF repaid as of May 2003: No.
Source: IMF.
[End of table]
[End of section]
Appendix X: Comments from the Department of the Treasury:
DEPARTMENT OF THE TREASURY WASHINGTON. D.C.
UNDER SECRETARY:
June 3, 2003:
Mr. Joseph Christoff:
Director, International Affairs and Trade United States General
Accounting Office Washington, D.C. 20548:
Dear Mr. Christoff:
I am responding on behalf of Secretary Snow to your request of May 21
for Treasury Department comment on GAO-03-734 "International Financial
Crises: Challenges Remain in IMF's Ability to Anticipate, Prevent, and
Resolve Financial Crises.":
The Department of the Treasury agrees with the GAO's specific
recommendations on the FSAP and ROSC program. The FSAP and ROSC are
extremely valuable tools, and we strongly support an increase in the
FSAP/ROSC coverage and frequency. We appreciate the IMF's effort in
designing these products. Country demand for assessments and updates
has been strong. We recognize, however, that not all important
countries have volunteered to participate in the program.
Treasury consistently has urged the IMF and World Bank to move to a
presumption of publication for FSAP/ROSCs. Treasury staff have worked
with their IMF and World Bank counterparts to make the FSAP/ROSC more
"user-friendly" for the private and official sector audience for these
reports. The objective of shorter turn-around between assessment and
public release is one we share.
1 concur with the GAO report's finding that improving the IMF's
surveillance is an unfinished agenda, and Treasury will continue to
advocate for improvement in the quality and utility of IMF
surveillance. The GAO report notes correctly the WEO's mixed predictive
power. The foundation of IMF surveillance is the bilateral review
process. Article IV reports should be crisper and more focused-and
publicly available. Bilateral surveillance should use new tools such as
debt sustainability analysis, the increased use of vulnerability and
financial soundness indicators, and better statistical data. The last
few years have witnessed an improvement in the transparency of IMF
operations and the quantity and quality of country data made available
to the public.
As for crisis prevention and resolution, I would like to emphasize the
substantial momentum toward the introduction of collective action
clauses by emerging market countries that has built up over the last
year. The United States strongly encouraged the development and
implementation of collective action clauses as an important
contribution to the prevention and resolution of emerging market
financial crises through voluntary and market-based mechanisms.
Previous to this effort, no emerging market country had:
issued bonds publicly in New York with CACs. Mexico's CAC issuance this
year marked a turning point in accepted market practice, with Brazil,
South Africa, and Korea cementing the acceptance of CACs as standard
practice. The introduction of such clauses serves as an important
signal to investors that official financing is limited and that they
cannot expect to be protected from risks.
I appreciate the opportunity to comment on the GAO report.
Sincerely,
John B. Taylor:
Signed by John B. Taylor:
[End of section]
Appendix XI: Comments from the International Monetary Fund:
INTERNATIONAL MONETARY FUND WASHINGTON, D.C. 20431:
FIRST DEPUTY MANAGING DIRECTOR:
CABLE ADDRESS
INTERFUND:
June 2, 2003:
Mr. Christoff Director International Affairs and Trade:
United States General Accounting Office Washington, DC 20548:
Dear Mr. Christoff:
We welcome the opportunity to comment on your report entitled,
"Challenges Remain in the IMF's Ability to Anticipate, Prevent, and
Resolve Financial Crises." We broadly agree with its main
recommendation to improve the timeliness and coverage of the FSAP and
ROSC reports, increase the frequency of the reports and updates, and
encourage increased participation in these initiatives.
However, the report reflects some serious misconceptions about the
nature of the IMF's work-notably in its characterization of our
initiatives to anticipate crises. The central focus of the report is on
the limited value of the World Economic Outlook (WEO) and of early
warning system (EWS) models in predicting financial crises-neither of
which in fact plays this role in the Fund's efforts prevent crises. It
is true that macroeconomic projections for individual countries that
are published in the WEO rarely, if ever, depict a crisis occurring,
and the forecasts in the WEO have the familiar and well-documented
difficulties of forecasting in general.[NOTE 1]:
One reason that the WEO does not predict crises is that, if it did,
these predictions could be self-fulfilling-which would improve our
apparent accuracy, but would clearly be irresponsible. Given our
responsibilities for global financial stability, we are instead looking
for better ways to use our analysis to motivate vulnerable countries to
make policy changes that can help head off crises-even if this makes
our predictions appear less accurate.
That is not to say that our methods of assessing countries'
vulnerability to crises have been perfected. On the contrary, we are
constantly learning and seeking to improve these methods.
Moreover, in most cases the timing of a crisis cannot be confidently
predicted six months to a year in advance; usually a crisis can only be
characterized as more or less likely. Building on the experience of the
capital account crises of recent years, IMF staff have put in place a
range of initiatives to examine on a high-frequency basis the factors
that may make countries vulnerable to crisis-including the strengths
and weaknesses of their banking systems, their external financing
needs, the adequacy of their external reserves, and the composition of
their external debt. They have also developed an improved framework for
assessing the sustainability of external and public debt. This work has
improved the IMF's ability to predict crises by providing better
informed judgment of the risks and vulnerabilities facing individual
countries, regions, and the global economy. These risks are usually
discussed at some length in the text of the WEO.
The report also focuses on the high rate of "false alarms" in
econometric "early warning system" (EWS) models of crises. This is
true-both of the models used by the IMF and of other EWS models
developed in private financial institutions-for some logical reasons.
First of all, EWS models do not actually predict crises, but estimate a
probability of their occurrence. The user can set a threshold
probability at which to "call" a crisis: this involves a clear
tradeoff, since if this threshold is set conservatively low, there will
inevitably be false alarms, while if it is set higher we would fail to
predict real crises. Given that the purpose for which we use these
models is not to make final predictions of crises but to supplement
other approaches to identifying vulnerable countries that require
further scrutiny, setting a conservatively low threshold is
appropriate. We are of course well aware of the shortcomings of EWS
models, and that is why we do not rely on these models as our main tool
in assessing vulnerability.
We also felt the report was unduly negative on the experience with the
Financial Sector Assessment Program (FSAPs) and Reports on the
Observance of Standards and Codes (ROSCs). In our view, these have been
a valuable tool in assessing vulnerabilities related, respectively, to
financial systems and other aspects of the institutional frameworks,
although we are working to make them better focused and more effective.
We recognize that many recommendations made in these assessments are
difficult to implement, for a combination of technical and political
reasons. To address the technical constraints, these assessments are
frequently followed up by technical assistance from the IMF, the World
Bank and other agencies. Political and legal barriers to change are
often more difficult to overcome, but identifying the problems is an
important first step. Of course, we recognize that the ROSCs and FSAPs
are work in progress, and welcome the GAO's recommendation for
enhancing their effectiveness. In our view, these are worthwhile
projects which we should continue to improve, and the recent reviews in
the IMF and World Bank have led to a number of changes to strengthen
the implementation of both these initiatives.
Finally, the brief examination of the Fund's experience with safeguards
in Appendix VI provides a misleading assessment of the objectives and
outcomes of the safeguards policy. For this reason-and given that it
is, at best, only tenuously related to work on crisis prevention and
resolution and was not in the original terms of reference-it would be
appropriate to delete it from the final report. The discussion in the
report is a follow-up to a:
statement by the Joint Economic Committee that "Fund lending safeguards
are still lagging" (Press Release, April 2, 2003); a rebuttal of that
earlier statement has already been sent to the Joint Economic
Committee.
Very truly yours,
Anne Krueger:
First Deputy Managing Director:
Signed by Anne Krueger:
cc: Ms. Jacklin, Executive Director for the United States:
NOTE:
For example, recent WEO boxes have discussed The Accuracy of WEO
Growth Forecasts: 1991-2000 (December 2001; The Accuracy of Forecasts
of Recovery (April 2002); and How Well Do Forecasters Predict Turning
Points (May 2001). As well, the general over-optimism in the WEO's
forecasts for Africa has been noted several times in the WEO.
The following are GAO's comments on the letter from the International
Monetary Fund, dated June 2, 2003.
GAO Comments:
1. Our assessment of IMF's efforts to anticipate financial crises did
not focus exclusively on the World Economic Outlook (WEO) and the Early
Warning System (EWS) models. We examined all six components of the
IMF's vulnerability assessment framework. However, as the only mature
and quantifiable elements of the framework, our analysis focused more
heavily on the track records of the WEO and EWS. As we reported, these
elements have not performed well at anticipating prior crises. While we
acknowledge that the new framework is more comprehensive than past
efforts at anticipating crises, it is too early to assess whether this
framework will be successful in anticipating future crises.
2. The IMF's comment supports our finding. The IMF states that its
responsibility to maintain financial stability could make its
predictions appear less accurate since an accurate prediction of crises
within WEO forecasts would be irresponsible and could lead to a crisis.
In effect, the IMF acknowledges that their forecasts are overly
optimistic and validates our finding on the weakness of the WEO
component of the vulnerability assessment framework. This raises
questions regarding the purpose and credibility of the WEO forecasts.
3. We state in the report that the IMF's new vulnerability assessment
framework, which includes the examination of external reserve adequacy
and the strengths and weaknesses of banking systems, is more
comprehensive than its previous efforts to identify countries at risk
of crisis. However, it is too early to assess whether this framework
will be successful in anticipating future crises.
4. We recognize that the EWS models are just one of six components of
the IMF's vulnerability assessment framework. However, the IMF's own
internal review of the EWS models concluded that the false alarm rate
was too high.
5. The report recognizes that the FSAP and ROSC assessments constitute
a valuable source of information about vulnerabilities in member
countries and states that IMF staff use these assessments to formulate
policy recommendations. The report also recognizes that the IMF often
provides technical assistance to help member countries build their
capacity to implement FSAP and ROSC recommendations. However, the
report points out several factors that limit the usefulness of FSAP and
ROSC assessments. Our recommendation, with which the IMF agrees, is
designed to improve the timeliness and coverage of these assessments.
6. We based our description of IMF safeguards assessments on the IMF's
reviews of this program. We consider this topic to be within the scope
of this evaluation because the framework for conducting safeguards
assessments is derived from the IMF's Code of Good Practices on
Transparency in Monetary and Financial Policies. Safeguards assessments
are thus related to the standards initiative, which constitutes a
central element of this report.
[End of section]
Appendix XII: Comments from The World Bank:
The World Bank Washington, D.C. 20433 U.S.A.
OFFICE OF THE PRESIDENT:
June 2, 2003:
Mr. Joseph Christoff Director:
International Affairs and Trade U.S. General Accounting Office
Washington DC 20548:
Dear Mr. Christoff,
Thank you for the opportunity to comment on the sections of the General
Accounting Office's draft report --"International Financial Crises:
Challenges Remain in IMF's Ability to Anticipate, Prevent, and Resolve
Financial Crises" (GAO-03-734, May 2003) --that have been shared with
the World Bank.
The Bank's role and responsibilities in the topic matter covered in the
sections of the draft report are appropriately delineated, and we
appreciate the GAO's acknowledgement of the progress made in recent
years in implementing the Financial Sector Assessment Program (FSAP)
and the Reports on the Observance of Standards and Codes (ROSCs). We
believe the use of these assessments will help to reduce the risk of
financial crises and the associated economic and social costs. However,
these assessments cannot forestall all financial crises for a number of
reasons. Reforms proposed as a result of these assessments are sometimes
difficult to implement for technical or political reasons. In addition,
financial crises often are, as we have seen in recent years, caused by
factors beyond the scope of the two initiatives. In that regard, one of
the conclusions of the GAO review, suggesting that a principal obstacle
to crisis prevention is the limited use made of the assessments by
private sector participants and insufficient information about
vulnerabilities, seems unwarranted.
We generally agree with your recommendations to improve the timeliness
and coverage of the FSAP and ROSCs, further refine the presentation to
highlight main findings and recommendations, and encourage the
publication of the reports by our client countries. Indeed these were
the conclusions we reached in our recent reviews that were discussed by
the Bank and IMF Boards of Directors earlier this year. Both Boards
also highlighted the need for greater prioritization given the resource
constraints and capacities of the two institutions. Accordingly they
agreed that greater priority should continue to be given to
systemically important economies, while keeping appropriate balance in
coverage. We are concerned about the draft report's suggestion that
mandatory
participation should be considered (by the IMF's Board). The principle
of voluntary participation is an essential aspect of the FSAP and ROSC
initiatives and, in our view, critical for the quality of the
assessments and the ownership and likelihood of reforms that are the
key objective of the two exercises.
Again, let me thank you for the opportunity to comment on those
sections of the draft report that were shared with the Bank.
Jeffrey Goldstein
Acting President:
Signed by Jeffrey Goldstein:
The following are GAO's comments on the letter from the World Bank,
dated June 2, 2003.
GAO Comments:
1. The report states unambiguously that crises can stem from a number
of factors, some of which are outside the scope of the FSAP and ROSC
assessments. However, there is broad agreement that the roots of the
Mexican and Asian financial crises lay in weaknesses in financial
systems and other institutions. The IMF and the World Bank based their
decision to launch the FSAP and ROSC initiatives on the premise that
timely identification of financial sector and institutional
vulnerabilities can contribute to crisis prevention. The IMF and the
World Bank have also acknowledged that FSAP and ROSC assessments can
contribute to crisis prevention efforts by helping private sector
participants make better informed investment decisions.
2. Our recommendation to pursue strategies to increase participation in
the FSAP and ROSC assessments, including the possibility of making
these assessments mandatory, stems from the IMF's and the World Bank's
recognition of the need to prioritize participation by important
emerging market countries. Although many of these countries have
volunteered to participate in these assessments, others have not. While
we are not suggesting that the assessments should be made mandatory, it
is evident that the voluntary nature of the FSAP and ROSC has posed an
obstacle to full participation by important emerging market countries.
[End of section]
Appendix XIII: GAO Contacts and Staff Acknowledgments:
GAO Contacts:
Tom Melito (202) 512-9601 Zina Merritt (202) 512-5257:
Staff Acknowledgments:
In addition to those individuals named above, Eric Clemons, Suzanne
Dove, Bruce Kutnick, Jonathan Rose, R.G. Steinman, Ian Ferguson, Mary
Moutsos, Lynn Cothern, Carl Barden, David Dornisch, and Martin De
Alteriis made key contributions to this report.
(320114):
FOOTNOTES
[1] U.S. General Accounting Office, International Financial Crises:
Efforts to Anticipate, Avoid, and Resolve Sovereign Crises, GAO/GGD/
NSIAD-97-168 (Washington, D.C; July 7, 1997).
[2] The current account represents a country's trade balance (exports
less imports of goods and services) plus the net interest income (or
payments) on outstanding international investments (or debts) plus net
transfers (grants, workers' remittances).
[3] Foreign exchange reserves are those external assets that are
readily available to and controlled by monetary authorities. Reserves
can be used for direct financing of payment imbalances, for indirectly
regulating the exchange rate, and/or for other purposes.
[4] Data on the performance of the other four components of the
framework were not made available to us because these elements are
considered part of the staff level deliberative process and are not
provided to the Executive Board.
[5] In one case, the WEO forecast zero growth.
[6] Several studies examining international financial crises from 1990-
2001 identified 14 major financial crises in 12 prominent emerging
market countries that were considered to be fundamentally sound before
the crisis. Balance of payments problems, large GDP contractions, and
financial panic commonly characterize these crises.
[7] Brazil was the sole exception, having experienced a small 0.1
percent GDP annual growth rate during the 1998 financial crisis.
[8] A deficit in the current account can also be financed by capital
inflows, such as foreign private investment, a drawing down of a
country's international reserves, by bilateral or multilateral loans,
or by provision of exceptional finance, such as debt service relief.
[9] Fund studies indicate that the current account deficit, as a
percentage of GDP, is significantly larger before a crisis than during
relatively stable periods, which suggests that unsustainable current
account deficits tended to be part of the general overheating of the
economy before a crisis.
[10] More specifically, the DCSD model is a multivariate probit
regression. The five variables used are real exchange rate
overvaluation, current account, foreign exchange reserve losses, export
growth, and the ratio of short-term debt to foreign exchange reserves.
Also, the model defines a currency crisis as the weighted average of 1-
month changes in exchange rate and reserves more than 3 (country-
specific) standard deviations above country average.
[11] The DCSD model had a cutoff probability of 23 percent and the KLR
model had a cutoff probability of 15 percent. A forecast probability
above these cutoff points is deemed to signal a crisis.
[12] According to the Fund, 11 of these 12 standards are
internationally accepted. The World Bank's corporate insolvency and
creditor rights standard is still in draft form.
[13] In addition to the ROSC, the Fund launched an experimental program
in 2000 to help prevent possible misuse of Fund resources. This program
assesses weaknesses in central banks' ability to safeguard Fund
resources through internal controls, accounting, reporting, auditing
systems, and legal structure. In 2002, the Executive Board made
assessments of central banks' safeguards a permanent policy. See
appendix VI for an update on progress in this area.
[14] In February and March 2003, the IMF and Bank published reviews of
the FSAP and ROSC initiatives. See International Monetary Fund and
World Bank, Financial Sector Assessment Program--Review, Lessons, and
Issues Going Forward (Washington, D.C.: 2003); International Monetary
Fund and World Bank, International Standards: Strengthening
Surveillance, Domestic Institutions, and International Markets
(Washington, D.C.: 2003); International Monetary Fund, International
Standards: Background Paper on Strengthening Surveillance, Domestic
Institutions, and International Markets (Washington, D.C.: 2003); World
Bank, Reports on the Observance of Standards and Codes Background Paper
on Standards Review: Assessing Progress and Lessons Learned from Bank-
Led ROSC Modules (Washington, D.C.: 2003).
[15] Appendix VII contains a diagram of the FSAP and ROSC assessment
process.
[16] In accordance with Article IV of the IMF's Articles of Agreement,
the IMF holds regular consultations, normally every year, with each of
its members. These consultations focus on the member's exchange rate,
fiscal, and monetary policies; its balance of payments and external
debt developments; the influence of its policies on the country's
external accounts; the international and regional implications of those
policies; and on the identification of potential vulnerabilities. ("IMF
Surveillance: A Factsheet," http://www.imf.org, downloaded 4/23/03).
[17] Our analysis is based on Fund and Bank data through March 2003.
[18] These 33 countries, a subset of the 87 we analyzed in the previous
section, represent the most significant emerging market participants in
the international capital markets, as identified by J.P. Morgan.
[19] The Bank performs accounting and auditing assessments
simultaneously and publishes them as a single report. An agreed-upon
standard for insolvency regimes has not yet been finalized. The Bank's
draft standard for insolvency regimes is under review by the Bank and
the Fund.
[20] The Country Assistance Strategy describes the Bank's assessment of
development priorities in each borrower country and identifies the
level and composition of assistance to be provided based on this
assessment. These strategies are currently prepared every 3 years.
[21] The SDRM proposal has undergone several revisions. Our report
discusses the proposal presented to the International Monetary and
Financial Committee in April 2003. See http://www.imf.org/external/np/
omd/2003/040803.htm.
[22] The Paris Club is an informal group of official creditors whose
role is to find solutions to the payment difficulties experienced by
debtor countries. Paris Club creditors agree to provide a country with
debt relief through a postponement and, in the case of concessional
rescheduling, a reduction in debt service obligations.
[23] The G-10 Working Group on Contractual Clauses (the Working Group)
was formed in June 2002 at the behest of ministers and governors. The
mandate of the Working Group was to consider how sovereign debt
contracts could be modified to resolve debt crises in a more orderly
fashion.
[24] The proposal was put forward to Fund members for consideration by
the Institute of International Finance and six other financial industry
trade associations. The six financial industry associations are the
Emerging Market Traders Association (EMTA), the International Primary
Market Association (IPMA), the Bond Market Association (BMA), the
Securities Industry Association (SIA), the International Securities
Market Association (ISMA), and the Emerging Markets Creditors
Association (EMCA).
[25] These provisions are referred to in the G-10 Working Group Report
as "majority amendment provisions."
[26] See Eichengreen, Barry and Ashoka Mody. "Would Collective Action
Clauses Raise Borrowing Costs?" Working paper, Center for International
and Development Economics Research, Berkeley, CA, 2000.
[27] The restructurings in Russia involved domestic debt and Soviet-era
foreign debt owed to commercial banks. In 1998, Pakistan froze
withdrawals in foreign currency from all nonresident foreign currency
deposits and subsequently reached restructuring agreements with these
nonresident investors.
[28] For some countries, the negotiating process entailed several years
and more than one restructuring agreement.
[29] These 33 countries represent the most significant emerging market
participants in the international capital markets, as identified by
J.P. Morgan.
[30] Our analysis focused on 81 middle-income countries and an
additional 6 low-income countries listed by J.P. Morgan as emerging
markets.
[31] Herman Stekler, "Macroeconomic Forecast Evaluation Techniques,"
International Journal of Forecasting 7 (1991): 375-384; Michael J.
Artis, "How Accurate are the IMF's Short-Term Forecasts? Another
Examination of the World Economic Outlook," WP/96/89 (Washington, D.C.:
International Monetary Fund [IMF], August 1996); Prakash Loungani, "How
Accurate are Private Sector Forecasts? Cross-Country Evidence from
Consensus Forecasts of Output Growth," International Journal of
Forecasting 17 (2001): 419-432.
[32] We include the following General Resources Account-funded IMF
programs: Stand-By Arrangements (SBA), Extended Fund Facility (EFF),
Systemic Transformation Facility (STF), Compensatory Contingency
Finance Facility (CCFF). Under the CCFF, countries can borrow resources
on a stand-alone basis, i.e., outside of an IMF program. Macedonia and
South Africa borrowed funds under the CCFF.
[33] The G-7 include Canada, France, Germany, Italy, Japan, United
Kingdom, and United States.
[34] Of the 87 emerging market countries analyzed, 57 were on an IMF
program for some part of the 1990-2001 period.
[35] A persistent issue in the forecasting literature concerns which
"actual" value to use to evaluate the accuracy of the forecasts: the
first available estimate (available in May of the following year), the
first settled estimate (available in October of the following year), or
a later revision. We have taken the middle ground, as suggested by
Loungani (2001), on the basis that forecasters are not attempting to
predict later revisions, which incorporate information such as
revisions of weights and changes in methods of construction that
forecasters would not have been aware of at the time of the forecast.
[36] That is, the naive model assumes there is no change in the growth
rate between t-1 and t.
[37] A zero intercept implies that the errors are randomly distributed;
they vary unsystematically (unbiased). However, a forecast can be
unbiased and not efficient. A slope of 1 implies a straight line
through the zero intercept, denoting efficiency. A slope of 1 indicates
that the forecast and actual value essentially coincide.
[38] RSS is the residual sum of squares.
[39] Our finding of an optimistic (upward) bias for GDP forecasts is
consistent with, and helps explain, our finding in the main report of
the WEO's difficulty in forecasting recessions.
[40] An optimistic bias in the current account means that the forecast
was for a smaller current deficit or a larger surplus than occurred.
[41] We include countries that were on the following General Resources
Account-funded IMF programs and facilities: SBA, EFF, STF, CCFF. Some
countries were on more than one program during the forecast period.
[42] For most of the years studied, these forecasts were not made
public. In recent years, when countries agree, these forecasts are made
public.
[43] We used the original program numbers, that is, the projections
established at the outset when the IMF's Executive Board first approves
an arrangement.
[44] Harjit K. Arora & David J. Smyth, "Forecasting the Developing
World: An Accuracy Analysis of the IMF's Forecasts," International
Journal of Forecasting 6 (1990): 393-400; Michael J. Artis, "How
Accurate are the IMF's Short-Term Forecasts? Another Examination of the
World Economic Outlook," WP/96/89 (Washington, D.C.: International
Monetary Fund [IMF], August 1996); José M. Barrionuevo, "How Accurate
Are the World Economic Outlook Projections?" in World Economic Outlook,
ch. 2, Staff Studies for World Economic Outlook (Washington, D.C.: IMF,
1993); Roy Batchelor, "The IMF and OECD versus Consensus Forecasts"
(London, England: City University Business School, August 2000);
William W. Beach, Aaron B. Schavey, & Isabel M. Isidro, "How Reliable
Are IMF Economic Forecasts?" CDA 99-05 (Washington, D.C.: The Heritage
Foundation, The Heritage Center for Data Analysis, August 27, 1999);
David Fintzen & H.O. Stekler, "Why Did Forecasters Fail to Predict the
1990 Recession?" International Journal of Forecasting 15 (1999): 309-
323; IMF, "The Accuracy of World Economic Outlook Growth Forecasts:
1991-2000," in World Economic Outlook, Box 3.1 (Washington, D.C.: IMF,
December 2001): 37-39, and IMF, "How Well Do Forecasters Predict
Turning Points?" in World Economic Outlook, Box 1.1 (Washington, D.C.:
IMF, May 2002): 6-8; Grace Juhn & Prakash Loungani, "Further Cross-
Country Evidence on the Accuracy of the Private Sector's Output
Forecasts," IMF Staff Papers 49, no. 1 (2002); Prakash Loungani, "How
Accurate are Private Sector Forecasts? Cross-Country Evidence from
Consensus Forecasts of Output Growth," International Journal of
Forecasting 17 (2001): 419-432; Albert Musso & Steven Phillips,
"Comparing Projections and Outcomes of IMF-Supported Programs," IMF
Staff Papers 49, no. 1 (2002); Scott Shuh, "An Evaluation of Recent
Macroeconomic Forecast Errors," New England Economic Review (January/
February 2001); Marten Blix et al., "How Good is the Forecasting
Performance of Major Institutions?" Economic Review (Stockholm, Sweden:
Sveriges Riksbank Monetary Policy Department, March 2001): 38-68; and
Victor Zarnowitz, "The Record and Improvability of Economic
Forecasting," NBER Working Paper No. 2099 (December 1986).
[45] Forecasters evaluated the accuracy of many variables, including
output (GDP), inflation, current account, exports, and imports, among
others.
[46] International Monetary Fund, Safeguards Assessments - Semi-Annual
Update, SM/03/88 (Washington, D.C.: Mar. 6, 2003).
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