In late October, IMF Managing Director Rodrigode Rato wound up a four-day visit to the Middle

East after consulting with policymakers in Saudi Arabia,Lebanon, and Egypt. During the visit, he also inaugu-rated the Middle East Technical Assistance Center(METAC) in Beirut (see box below). The center hasbeen set up by the IMF to facili-tate technical assistance to theregion, especially to help meetthe massive institution-buildingneeds of countries like Iraq,Afghanistan, Sudan, and theWest Bank and Gaza that havebeen suffering from conflict.Throughout the visit, he urgedMiddle East leaders to seize theopportunity provided by theglobal economic recovery andhigher oil prices “to buildstronger macroeconomic foun-dations and enlarge savings forthe future generations, while atthe same time creating an environment that promotessustained economic growth and job creation by theprivate sector to meet the rapidly rising employment

needs.” He pledged the IMF’s readiness to work closelywith all countries in the region to achieve these goals.

During the first leg of his trip, de Rato consultedwith ministers of the six-nation Gulf CooperationCouncil (GCC) in Jeddah, Saudi Arabia, where he wel-

comed the GCC’s firm commit-ment to help maintain stabilityin the oil market by increasingproduction in response to grow-ing demand—a move, he said,that will help sustain the currentglobal economic expansion.

In recent decades, the GCCcountries have witnessedunprecedented economic andsocial transformation. Theirimproved financial positions,relatively low external debt levels,and modernized infrastructure,he said,“reflect positively onmanagement of oil wealth and

show the fruits of opening borders to trade, capital, andlabor.” The Middle East region—particularly the GCCcountries—has also benefited

InternationalMonetary FundVOLUME 33NUMBER 20NOVEMBER 8, 2004

In this issue

313De Rato visitsMiddle East

315Trade ResearchConference

317Why globalizationworks

319Labor unionshold dialogue withIMF, World Bank

320Tanzania legislators,civil society meetwith IMF

321Europe’s productivity

324Asia and capitalflows

327Market fordistressed debt

and…

322Recent publications

326New on the web

327Selected IMF rates

313

De Rato advises Middle Eastern economies to diversifywww.imf.org/imfsurvey

(Please turn to next page)

IMF Managing Director Rodrigo de Rato(left) with Lebanon’s outgoing Minister ofFinance Fouad Siniora in Beirut.

METAC to bolster region’s financial sector stability, modernize institutions

On October 25, IMF Managing Director Rodrigo de Rato

and outgoing Minister of Finance of Lebanon Fouad

Siniora inaugurated the Middle East Technical Assistance

Center (METAC) in Beirut, Lebanon. The office—the

IMF’s fifth regional technical assistance center—will

serve Afghanistan, Egypt, Iraq, Jordan, Lebanon, Libya,

Sudan, Syria, West Bank and Gaza, and Yemen. The cen-

ter is being established to help countries in the Middle

East strengthen their capacity for effective macroeco-

nomic management and to support the region’s integra-

tion in the world economy. Targeted capacity building

will be provided in areas such as public expenditure

management, revenue administration, bank restructur-

ing, banking supervision, and multisector statistics.

The center will also help postconflict countries restore

macroeconomic stability and develop basic institutions

for policymaking.

At the METAC opening, Siniora said that he saw the cen-

ter as an opportunity for member countries to share success-

ful experiences on macroeconomic and financial reforms and

to work together to benefit from these experiences. De Rato

noted that “the key role of IMF technical assistance is to

transfer knowledge and experience that helps countries in the

region strengthen their own ability to design and implement

economic policies, promote financial sector stability, and

modernize institutions.” The ultimate objective is to raise

economic growth to “levels sufficient to meet the needs of a

rapidly expanding labor force and to achieve real and sus-

tained improvements in the standards of living,” he added.

At its first meeting on October 26, METAC’s Steering

Committee reviewed the center’s preliminary work program.

That program will be finalized in the coming months as

assessments are made of country needs.

November 8, 2004

314

from the recent global rebound, which has contributedto higher demand for oil and other exports.

“New challenges, however, are emerging,” de Ratocautioned. To deal with intensifying unemploymentpressures, the GCC countries will need to achievehigher sustained growth in their non-oil sectors andreduce their financial dependence on volatile oil exportreceipts. He welcomed the authorities’ efforts to addressthese challenges by accelerating reforms. Increasedregional integration, culminating in an efficient mone-tary union, would also strengthen the region’s eco-nomic prospects. Significant progress toward regionalintegration has already been achieved, he said, but “theroad to monetary union will require intensified effortsto ensure political consensus on critical economic issuesand development of relevant convergence criteria, com-mon data standards, and development of relevant insti-tutions.” GCC nations set up a unified customs unionearly last year, and plan a common market by 2007 anda single currency three years later.

Saudi Arabia: critical for regionMeeting with Saudi Arabia’s Crown Prince Abdullah inRiyadh on October 24, de Rato noted the important rolethat Saudi Arabia plays in ensuring oil market stabilityand in furthering economic progress in the region. Hecommended Saudi Arabia’s decision to increase oil pro-duction, take steps to boost capacity, and enhance coor-dination between producers and consumers.

De Rato also lauded Saudi Arabia’s role in providingeconomic and financial support to Iraq and othercountries in the region.“The Kingdom’s support hasbeen critical,” he said,“in achieving substantial progresstoward regional integration, including the eliminationof most barriers to the free movement of goods, ser-vices, capital, and national labor, and in fostering eco-nomic liberalization policies in other non-GCC coun-tries, thus contributing to the sustained growth and sta-bility in the entire area.” He encouraged Saudi Arabia tocontinue to play a leadership role in easing regional ten-sions, promoting policies that foster liberalization andintegration, and helping Iraq strengthen its financialposition and restore its place in the regional economy.“The Saudi government’s decision to consider debtrelief for Iraq,” de Rato said,“would go a long way inimproving that country’s economic viability.”

On the domestic front, Saudi Arabia has witnessedunprecedented economic and social transformationin recent decades. To help tackle rising unemploy-ment, the authorities have taken steps to diversify theeconomy and improve private sector participation.But that strategy needs to be reinforced, de Rato said.“There is a need now to focus on the development ofthe private sector, particularly the growth of the

small and medium-sized enterprise sector to providejob opportunities for the growing Saudi workforce.”

Lebanon: reducing vulnerabilitiesOn October 25, de Rato traveled to Lebanon to inau-gurate METAC, where he said that Lebanon hadcome a long way to reestablish itself as a thrivingeconomy and as an important regional hub. In meet-ings with President Emile Lahoud, Speaker ofParliament Nabih Berri, Prime Minister-designateOmar Karameh, and outgoing Finance MinisterFouad Siniora, he underscored the IMF’s support forthe significant fiscal adjustment achieved in recentyears. But de Rato also underlined the need for fur-ther reforms to reduce the country’s public debt—which currently exceeds $35 billion—mainly throughfurther fiscal consolidation. “Efforts have to continueon the path of reforms,” he said, primarily withrespect to long-awaited privatization projects.

Egypt: improving the business climateDe Rato visited Egypt on October 26 for the final leg ofhis trip, where he met with President Hosni Mubarak,Prime Minister Ahmed Nazif, Minister of FinanceYoussef Boutros-Ghali, Central Bank Governor FaroukEl Okdah, parliamentarians, and other senior officials.De Rato said he was greatly encouraged by theirrenewed commitment to liberalizing Egypt’s economyand to removing impediments to private sector growth(such as recent decisions to lower tariffs, cut taxes, andprivatize public enterprises) and by their plan torestructure the country’s financial sector.

At the same time, de Rato encouraged Egypt to pressforward with measures to spur growth and reduceunemployment. Sustained higher growth, he said, willrequire close integration into the global trading andinvestment community through continued opening upunder Egypt’s multilateral and bilateral trade agree-ments.“Additional efforts,” he suggested, will be neededto “strengthen the climate for business and eliminateremaining impediments and restrictions.” Encouraginga further expansion of the private sector will, in turn,help meet the needs of Egypt’s rapidly growing laborforce, where faster job creation will be necessary toreduce unemployment, particularly among youth.Among Egypt’s main challenges will be to contain thefiscal deficit and arrest the growth of public debt; to thisend, de Rato urged the authorities to maintain a pru-dent fiscal policy in the short and medium term.

The full text of the Managing Director’s statements made during this trip to the Middle East are available on the IMF’swebsite (www.imf.org).

The Saudigovernment’sdecision toconsider debtrelief for Iraqwould go along way inimprovingthat country’seconomicviability.—Rodrigo de Rato

November 8, 2004

315

The landscape of the world trading system isbeing altered by a proliferation of regional

trade agreements (currently, over 200 are in place)and unilateral preference schemes granted to somedeveloping country exports for select products. Arethese changes, which are taking place against a gen-eral backdrop of on-off global trade liberalizationand unilateral liberalization in some countries, goodfor developing countries? Does the IMF have a roleto play in this process? A half-day conference onOctober 19 sponsored by the IMF’s ResearchDepartment took a closer look at these issues.

An overarching theme of the conference was thatpreferential trade policies—whether in the form oftrade agreements or tariff reductions for exports fromdeveloping countries—are not equivalent to trade liber-alization. It is useful to remember, the IMF’s JohnRomalis (Resident Scholar, Research Department) sug-gested, that these arrangements do not extend to everycountry’s trading partner. It would be more accurate tocall these “preferential” rather than free trade agree-ments, as they reduce trade barriers on trade flowsamong the member countries only.

While preferential access for developing countryexports might seem like a good idea at first glance, theWorld Bank’s Çaglar Özden (Economist, InternationalTrade Division) emphasized that such schemes are rid-dled with problems. Somewhat surprisingly, low-income countries do not fully utilize these preferenceschemes—on average, the preference utilization rate is35 percent. Furthermore, sectors of export interest to therecipient country are often “sensitive” sectors for thedonor country and, thus, frequently exempted frompreference schemes. In addition, these schemes oftencarry a fair amount of “strings,” requiring other steps tomeet concerns about rules of origin, labor and environ-mental standards, and intellectual property rights. And,frequently, once the preferences are utilized, they areremoved. A key test of the effectiveness of such schemesis whether they help create viable industries in the recip-ient countries; there is no clear evidence that they do.In effect, Özden saw preference schemes as having mini-mal impact and providing little incentive for recipientcountries to liberalize their own trade policies.

From preferential to multilateral?On the thorny issue of preferential agreements, theIMF’s Hans-Peter Lankes (Division Chief, Policy

Development and Review Department) observed thatsuch agreements are here to stay. He urged the WorldTrade Organization (WTO) to strengthen its over-sight of these agreements and asked the IMF todevote greater attention to them, in the context ofboth surveillance and program negotiations, in aneffort to ameliorate their undesirable effects.

But are these agreements beneficial? Romalisacknowledged that the evidence is ambiguous, but hedid see some benefit where trade between the membercountries is already large, which would lessen the possi-bility of trade diversion; when external tariffs are quitehigh; and when these agreements are made betweendeveloped and developing countries. On the largerquestion of whether agreements will hinder multilateralliberalization, he found the evidence mixed.

Other speakers were fairly unanimous in findingthese agreements undesirable, given their potentialfor diverting trade. IMF First Deputy ManagingDirector Anne Krueger saw the proliferation ofregional or preferential trade agreements as an obsta-cle to trade liberalization because once a countrysigned such an agreement, it cannot alter its tradepolicy without the consent of its partners. This, shesaid, provides a way for countries to “hide behindeach other” and avoid liberalization.

T.N. Srinivasan of Yale University went as far as tosay that such agreements “do not belong in a globallyliberalized, multilaterally liberalized world, and thesooner we get away from them, the better off we allwould be.” Srinivasan would support the formationof a regional trade agreement if it extended tariffreductions to nonmembers. But the World Bank’sAlan Winters (Director, Development ResearchGroup) did not think this feasible. Instead, he recom-mended that greater attention be paid to the fact thatwith so many regional agreements, every country isoutside some of them, and outsiders typically lose.

David Richardson of Syracuse University took asomewhat more nuanced view, suggesting that theseagreements could, in fact, be stepping stones to widermultilateral liberalization. Regional trade arrange-ments could become more palatable, he suggested, ifthey included a provision that bound participatingmembers to harmonizing and reducing external tar-iffs over perhaps 10 to 20 years. Harmonizationwould solve the rules-of-origin problem, and a reduc-tion in the external tariff would reduce the likelihoodof trade diversion. Progress in implementing this

IMF Trade Research Conference

Do trade agreements and trade openness help developing countries?

John Romalis

Çaglar Özden

November 8, 2004

316

reform, he added, could become a regular part of thetrade policy reviews conducted by the WTO.

Winners and losersCan developing countries afford trade reform, giventhat trade liberalization sometimes leads to a loss oftax revenue and, thus, a weaker fiscal position? Theconcern is a substantial one for some countries, espe-cially in Africa, which derives one-quarter to one-third of its tax revenue from taxes on internationaltrade. The IMF’s Michael Keen (Division Chief, FiscalAffairs Department) noted that in theory substitutingindirect taxes for trade taxes should generate a welfaregain, as well as raise revenue.

In preliminary research, however, he found that,with some exceptions, low- and middle-incomecountries were able to recover only 30–50 percent oflost trade-tax revenue. There is also some evidence,he added, that replacement of revenue has decreasedover time and is greater in Latin America and Africathan in the Middle East and Asia.

Keen’s findings raised a number of questions aboutwhether the observed revenue reductions were due topolicy changes or shocks, and whether the resultsestablish a causal relationship between changes in tar-iffs and revenue. Clearly, more work needs to be doneon this important topic.

There has been a great deal of discussion, too, aboutthe potential impact of agricultural trade liberalizationon developing countries. The popular belief is thatdeveloping countries would reap large gains from theremoval of agricultural support in the rich countries.But this may not be true, according to the IMF’sStephen Tokarick (Senior Economist, ResearchDepartment). He reported that estimates from a globalmodel of world trade show that the gains from liberal-ization accrue mainly to rich, not developing, countries.And while estimates show that developing countriesgain in the aggregate, some could lose, notably develop-ing countries that import agricultural products.

However, the matter is complicated by the possibil-ity that net-importing countries could become netexporters—and thus “winners”—if internationalprices for agricultural products rose following liberal-ization, which would increase production and reduceconsumption in these countries. Furthermore, devel-oping countries tend to tax, not subsidize, their agri-cultural sectors. An increase in international priceswould cause output to expand and offset the tax onagricultural production. Nonetheless, even if develop-ing countries face higher import costs, the size of theincreases is likely to be relatively small: about 2 per-cent of affected imports (although about nine coun-tries would experience an increase in costs up to

3 percent of imports). For these countries, some sortof financing mechanism, such as the IMF’s TradeIntegration Mechanism, might be needed.

The IMF’s roleDoes the IMF have a role in fostering trade liberaliza-tion? According to Raghuram Rajan (the IMF’sEconomic Counselor and Director of the ResearchDepartment), it will be important for the IMF to con-tinue to emphasize the benefits of freer, more opentrade—not just in goods but also in factors of produc-tion such as labor and capital. Indeed, the IMF’s Articlesof Agreement specifically call on the IMF to “facilitatethe expansion and balanced growth of internationaltrade,” observed the IMF’s Shang-Jin Wei (Head of theTrade Unit in the Research Department), and IMFresearch has already helped dispel some misconceptionsabout trade-related issues, such as outsourcing.

Srinivasan saw the organization primarily as anadvocate of trade liberalization, while others sug-gested a somewhat deeper, more engaged role.Krueger indicated that the IMF stands ready to workwith countries in addressing the potential adverseeffects of trade liberalization, particularly the loss oftax revenue, since this argument is sometimes used toforestall liberalization. Winters thought the IMFcould also provide objective research and advice onthe likely impact of trade liberalization, particularlythe fiscal implications, and help persuade countriesthat “trade policy needs to be made consistent andcoherent with countries’ objectives on development.”

Richardson offered the intriguing suggestion thatthe experience of the World Bank and the IMF withweighted voting could help the WTO deal with gov-ernance problems that have plagued that institution.

Final thoughtsA main conclusion emanating from the conference isthat preferential trade policies are not unambiguouslybeneficial; they may hurt the countries that enter intothem. Recent research has brought us closer to under-standing the nuances of the changing landscape inthe world trade system. As that global landscape con-tinues to change, however, the need for solid researchgoes on.

Stephen TokarickIMF Research Department

Michael Keen

Stephen Tokarick

Photo credits: Nabil Ismael, pages 313–14;

Henrik Gschwindt De Gyor, Eugene Salazar, and

Michael Spilotro for the IMF, pages 315–19, and 328;

and Michaela Schrader, page 320.

The debate on the merits of globalization contin-ues, with one side arguing that it raises living

standards and the other that it worsens poverty andinequality. At a September 22 IMF Book Forum,Martin Wolf, Associate Editor and Chief EconomicsCommentator at the Financial Times, offered a robustdefense of globalization and an upbeat assessment ofits prospects. In discussing his new book, WhyGlobalization Works, he rebutted claims that global-ization undermines sovereignty, weakens democracy,intensifies inequality, favors “exploitative” multina-tional corporations, and devastates the environment.

Given economic instability, fears of terrorism, pro-tectionist reactions to economic change, and the riseof new competitors—above all, China, and nowIndia—opponents of economic integration could yetdo grave damage, Wolf conceded. But the forcesagainst globalization are not strong enough to causeits disintegration, he said, and it seemed implausiblethat global integration would collapse, as it had in theinterwar years of the early 20th century as a conse-quence of international rivalries, economic instability,protectionist interests, and anti-liberal ideas.

Today, the situation is different in four fundamen-tal respects, Wolf explained. First, there is, for themoment, a single undisputed hegemon—the UnitedStates—and a war among great powers in the nearfuture seems unlikely. Second, all the great powersseem to have abandoned the notion that prosperityderives from territorial gains and plunder rather thanfrom internal economic development and peacefulexchange. Third, all the great powers now share acommitment to market-led economic developmentand international economic and political integrationof some kind. And, fourth, global institutions andclose international cooperation reinforce the basicstability of the political order.

Threats to globalization?But against this, noted Wolf, there is one obvious par-allel to the 1930s. The breakdown of the early 20thcentury order occurred in large part because of thepressures to accommodate rising powers in the globaleconomic and political order. “If the United Statesremains wedded to notions of global primacy ratherthan of a shared global order, conflict with a risingChina would seem almost inevitable,” he cautioned.In addition to these political pressures, China’s ascentwill force uncomfortable economic adjustment on the

rest of the world—a phenomenon that is already fuel-ing protectionist pressures in a number of countries.But a greater threat to the world’s commitment toopen borders is megaterrorism, saidWolf. He called for global coopera-tion and improved security mea-sures, rather than closing borders, asa means of controlling terrorists.

A second danger is economicinstability. The decisive event, with-out doubt, in the collapse of theintegrated economy of the late 19thand early 20th century was theGreat Depression, and its relatedfinancial and exchange rate crises.In developing countries, over thepast two decades, “financial andexchange rate crises have come withdepressing frequency,” said Wolf. Substantial financialand exchange rate crises also erupted in advancedeconomies in the 1980s and early 1990s; Japan is stillstruggling with the aftermath of its bubble economy;and the United States experienced a huge stock mar-ket bubble that peaked in 2000. All these are signs offinancial instability. “Yet it is almost impossible,” saidWolf, “to believe that the outcome will be anythinglike another 1930s.” The move to floating exchangerates has significantly reduced the risk of crises. And,he said, “it is striking that, despite recent crises, nosignificant country has reversed its commitment toliberal trade.”

Protectionist interests are also not as strong as theywere historically, Wolf noted, and “the rise of theinternationally integrated transnational company hasreduced the ability and willingness of producers towrap themselves in national flags.” In his view, “theconcept of a purely national business sector hasbecome, thankfully, increasingly irrelevant, diffusingprotectionist lobbying.” Also, while many people inhigh-income countries express concern about thedecline in relative wages and opportunities for skilledlabor, the political clout of these critics has, for betteror worse, diminished with the general decline of theindustrial working class. A web of strong interna-tional commitments also makes it far more difficultfor protectionist interests to capture legislatures asthey once did.

The final element of the 20th century collapse beganwith the rise of anti-liberal ideas. There are parallelstoday, particularly in the groups united to protest

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317

IMF Book Forum

Why globalization works

Wolf: “If we wish tomake our world abetter place, we mustlook not at the failuresof the market economybut at the hypocrisy,greed, and stupidity—and worse—that sooften mar our politicsin both developingand developedcountries.”

November 8, 2004

318

global capitalism. But these groups, which includeenvironmentalists, development lobbies, populists,socialists, communists, and anarchists, are “vastly lessintellectually coherent than the opponents of liberal-ism of a century ago,” Wolf said. They “are united onlyin what they oppose and offer no alternative way ofrunning an economy.” A movement that offers onlyprotest is unlikely to triumph, he concluded.

Making this world work betterIn Wolf’s view, the biggest obstacle to a more evenspread of global prosperity is neither global economicintegration nor transnational companies, as criticsallege. It is the multiplicity of independent sovereignstates, vastly divergent in their capacities and qualities.The most important source of inequality and persis-

tent poverty is the fact that humanity is lockedinto almost 200 distinct countries, some of whichare prosperous, well governed, and civilized, whilemany others are, alas, poor, mal-governed, and, atpresent, apparently incapable of providing thebasis for a tolerable existence. The principal chal-lenge in development, thus, is getting aroundpolitical fragmentation and its consequences.

How can the reality of a world divided intounequal sovereignities be reconciled with theopportunities afforded by integration? Some ofthe critics’ concerns need to be taken intoaccount, Wolf said. There is, for example, a rea-sonable case for permitting some form of infantindustry promotion—though not protection—in developing countries. There is also an over-whelmingly powerful argument for higher-

income countries to open their markets in favor ofthe exports from developing countries.

“But the most hysterical complaints of the criticsof integration are nonsense,” Wolf emphasized.Transnational companies do not rule the world.Neither the World Trade Organization nor the IMFcan force countries to do what they would very muchprefer not to do. Crises do not afflict sound financialsystems. Global economic integration does not renderstates helpless, nor has it created unprecedentedpoverty and inequality.

Ten commandments of globalization“What precisely should we be trying to do?” askedWolf. He offered what he called the “Ten Command-ments of Globalization.”

• The market economy is indeed the only arrange-ment capable of generating sustained increases inprosperity; providing the underpinnings of stable, lib-eral democracies; and giving individual human beingsthe opportunity to seek what they desire in life.

• Individual states remain the locus of politicaldebate and legitimacy. Supranational institutions mustalways remember that they derive their legitimacy andauthority from the states that belong to them.

• It is in the interest of both states and their citizensto participate in international treaty-based regimesand institutions that deliver global public goods.

• Such regimes do, however, need to be specific,focused, enforceable, and limited.

• Of those regimes, the World Trade Organization,though enormously successful, has strayed too farfrom its primary function of promoting trade liberal-ization—by, for example, becoming involved in trade-related aspects of international property rights—andshould be brought back firmly to its specific aim.

• There is a case for regimes covering investmentand global competition, but it would be best to createsuch regimes among select countries and forgo uni-versality, thus ensuring that these regimes have rea-sonably high standards.

• It is in the long-run interest of countries to inte-grate into global financial markets, but they must doso carefully, with a full and proper understanding ofthe risks.

• In the absence of a global lender of last resort, itis necessary, as the IMF has been arguing, to have aspecific and explicit system to coordinate and orga-nize standstills and renegotiate sovereign debt.

• Though official development assistance is very farfrom a guarantee of successful development, the sumsnow provided are so small and the resources of somecountries so inadequate that the case for increased aidis very strong. Without expanded assistance, a largepart of the world will fall ever further behind.

• Finally, and this is perhaps the most difficult,countries should always—or almost always—beallowed to learn from their own mistakes. But theinternational community also needs the capacity, thewill, and the wisdom to intervene where it is evidentthat states have permanently failed.

All these commandments matter, he argued, but thefirst two—about markets and states—are the mostimportant.“If we wish to make our world a betterplace, we must look not at the failures of the marketeconomy,” Wolf concluded,“but at the hypocrisy, greed,and stupidity—and worse—that so often mar our poli-tics in both developing and developed countries.”

Christine Ebrahim-zadehIMF External Relations Department

Why Globalization Works, by Martin Wolf, is published by Yale University Press. Copies are available for $30.00 each.

November 8, 2004

319

About 80 leaders of labor unions and internationalconfederations of unions, with nearly 200 million

workers worldwide, joined IMF and World Bank man-agement, staff, and Executive Directors in Washingtonon October 6–8 to discuss how to reduce poverty, cre-ate more jobs, enhance social inclusion, and reduceinequalities. While the unions’ leaders acknowledgedefforts by the Bretton Woods institutions to consultmore widely with unions and civil society, they said theIMF continues to pay too little attention to employ-ment, wages, and social protection in its economicadvice to countries. The meeting, the second in abiennial series instituted in 2002, built upon a tradi-tion of dialogue with the global labor movementbegun more than a decade ago.

In opening remarks, IMF Managing DirectorRodrigo de Rato welcomed the continued dialoguewith labor unions, noting that in many countriesorganized labor is an important, and sometimesindispensable, instrument for social change. In aworld characterized by ongoing and fast-movingtransformation, countries must adapt, he said, andthis often requires dealing with such challenges asaging populations, the need to modernize labor mar-kets, and the liberalization of trading systems.Participation of civil society—including labor unionsand employers’ organizations—in these economicand social debates can strengthen the consensus onwhat often constitutes difficult policy choices. Andstrong global expansions such as the current one,de Rato observed, provide a timely opportunity toundertake reforms, since changes in behavior are eas-ier to bring about during economic recovery.

The trade union delegation—led by Guy Ryder,General Secretary of the International Confederationof Free Trade Unions (ICFTU), and Willy Thys,General Secretary of the World Confederation ofLabor, with representatives from the Global UnionFederations and the OECD’s Trade Union AdvisoryCommittee—pointed out that, despite the IMF’supbeat assessment of the global economy, mostdeveloping countries will miss the United NationsMillennium Development Goals by a wide margin.If progress toward these goals is to be accelerated, theinternational community must take more ambitiousaction on debt relief and consider the various initia-tives being proposed—including some form of globaltaxation—to raise extra funding. They took note,however, of de Rato’s observation that the problem

with obtaining new resources ispolitical, not technical.

The labor union leaders alsostressed that poverty reductiondepends on implementing the rightpolicies. In their view, the BrettonWoods institutions’ emphasis on

pro-growth, market-oriented eco-nomic liberalization is inadequate “because growth isnot enough.” They argued that too little attention ispaid to employment, wages, and social protection;growth must be accompanied by “decent” job creationand an increase in social security and justice.

The union representatives welcomed the more sys-tematic consultations with local unions during theIMF’s annual country (Article IV) consultations andother missions. But they called for greater involvementof local unions in the elaboration of poverty reductionstrategies in low-income countries. IMF representativespointed out that the decision on whom to consult ismade chiefly by the governments themselves.

The IMF’s recommendations to countries on labormarket reform remained a point of contention formany of the union representatives. They expressedconcern that the IMF calls for greater labor marketflexibility regardless of a country’s circumstances, andthis, they said, tended to result in simple deregulationand increased social insecurity. They urged greaterconsultation with unions on policies to promote aless disruptive restructuring of the labor market.

Sofia Soromenho-RamosIMF External Relations Department

Reducing poverty tops agenda in talks between IMF and labor unions

Clockwise from top:Andrew Kailembo(General Secretary of ICFTU-AFRO,Nairobi), LawrenceEgulu (Public ServiceInternational), WillyThys (GeneralSecretary of the WorldConfederation ofLabor), Rodrigo deRato (IMF ManagingDirector), Guy Ryder(General Secretary ofthe ICFTU), WillyKiekens (IMF ExecutiveDirector).

A summary of the proceedings, jointly agreed by the participants, will be published at a later date on the IMF’swebsite (www.imf.org).

On October 14–15, the IMF and the TanzanianParliament’s Committee on Finance and

Economic Affairs sponsored a macroeconomic policyseminar—the first of its kind—forthe country’s legislators. A work-shop was held for representativesfrom civil society and the media thefollowing day. Both events—whichtook place in Bagamoyo and drewsome 30 parliamentarians and20 representatives from local thinktanks, nongovernmental organiza-tions, and the press—focused onTanzania’s widely heralded reformsunder President Benjamin Mkapato step up the pace of developmentand poverty reduction.

There was broad agreement among participantsthat Tanzania’s reforms, supported by the IMF andthe World Bank, have helped the country make a suc-cessful transition from a state-controlled to a market-oriented economy. In recent years, Tanzania hasenjoyed high economic growth (around 6 percent ayear), low inflation (around 4 percent a year), robustreserves, increasing foreign capital inflows, improvedgovernment revenue collection, and sound expendi-ture management. This performance is in stark con-trast to the previous 30 years when annual growthaveraged about 2 percent (less than the rate of popu-lation increase) and annual inflation averaged morethan 30 percent.

The country’s strong reform efforts have attractedsubstantial support from the international commu-nity, including $3 billion in debt relief under theIMF–World Bank Heavily Indebted Poor Countries(HIPC) Initiative, and aid is expected to increase sig-nificantly in FY 2005 to $1.4 billion (equivalent to13.3 percent of GDP). “Tanzania can serve as anexample of what can be achieved with determinationand effort,” said Robert Sharer, the IMF’s missionchief for Tanzania.

However, much remains to be done if Tanzania isto meet the United Nations Millennium Develop-ment Goals. Participants pointed to the fact thatpoverty and disease are still widespread, the countrycontinues to be dependent on donor assistance,development efforts remain constrained by a narrowexport base and regional instability, and the benefitshave not been evenly spread—with 90 percent of the

poor living in rural areas. Parliamentarians asked that the benefits from debt relief under the HIPCInitiative be used to improve social services andincrease expenditure for the poor. Representatives forthe local nongovernmental organizations and mediawondered whether the poor would even benefit frommacroeconomic stabilization.

Peter Ngumbullu, IMF Executive Director for theconstituency including Tanzania, said that these chal-lenges must be addressed through ambitious and con-sistent reforms, keyed in particular to improving thebusiness environment and bolstering the agriculturalsector. Deputy Minister of Finance Festus Limbu reiter-ated his government’s commitment to reforms, notingthat only nationally owned reforms can fully succeed.

Stepped-up dialogueAnother major concern was access to information andthe need for an open dialogue. Parliamentarians saidthat they—as elected representatives of the people—had not been sufficiently involved in the formulationand decision-making process regarding the develop-ment of Tanzania’s poverty reduction strategy, the bud-get, and other important economic reform issues. Theyemphasized their role in ensuring that the voices of thepeople are heard in the major policy debates, includingconveying to the IMF the social implications of its pol-icy advice. For that reason, they greatly welcomed thetwo-day workshop. Njelu Kasaka, Chair of theCommittee on Finance and Economic Affairs of theTanzanian Parliament, noted that recognition of legisla-tors as “an important interlocutor of the IMF is a com-mendable turnaround.” Marie Shaba, with the TanzaniaMedia Women’s Association, said that “this is really amilestone for us,” adding that “anti-IMF ideas may bethere because previously there had been no interac-tion.” Musa Bilegeya, Tanzania Association of Non-governmental Organizations, stressed,“let the peopledebate economic decisions.”

In recent years, the IMF has expanded its outreachto parliamentarians, organizing and participating incountry seminars, workshops, and regional confer-ences. IMF spokesperson Thomas Dawson empha-sized that these seminars offered an opportunity for atruly open two-way dialogue. “It allows us to listen toyour concerns and to improve our understanding ofthe political, cultural, and social context in whicheconomic decisions are taken,” he said.

Michaela SchraderIMF External Relations Department

Tanzania’s legislators, civil society seek greater rolein reforms and poverty reduction policymaking

Members of theTanzanian Parliament’sCommittee on Financeand Economic Affairsand participants in amacroeconomic policyseminar gather afterthe meeting.

November 8, 2004

320

In 2000, the European Union (EU) announced withmuch fanfare a 10-year strategy to overtake the

United States as the world’s most competitive econ-omy. Today—almost five years later—gloom is theprevailing mood on the likelihood of achieving thisgoal. A new report concludes that the Lisbonagenda—as the EU’s plan for improving competitive-ness is known—risks becoming “a synonym formissed opportunities and failed promises.” ButMarcello Estevão of the IMF’s European Departmentsuggests that things may not be as bad as they seem.Camilla Andersen of the IMF Survey spoke with him.

Europe has lagged the United States in terms ofeconomic growth since the mid-1990s, when GDP percapita growth in large European economies began tofall behind that of the United States. As a result ofthese trends, per capita income in the euro area (con-verted using purchasing power parities) was aboutone-third lower than in the United States in 2002,compared with about one-quarter lower in the early1990s. A number of theories have been advanced toexplain this widening of the gap. Some point to theinformation technology boom in the United States,which provided a major boost to productivity in thelate 1990s (see top chart). Others blame Europe’s lowrates of labor utilization, which are caused in part bylabor market rigidities that discourage people fromseeking work.

In a new IMF Working Paper, Estevão takes an in-depth look at the euro area’s productivity perfor-mance. He does not dismiss the productivity leapmade by the United States in the late 1990s. But heargues that the euro area’s low labor productivitygrowth is due less to slowing total factor productivitygrowth—something that would point to problems inadopting new technology and improving managerialefficiency—and more to a slowdown in capital invest-ment. This phenomenon, he says, can be explained bylabor market reform in many euro area economiesthat—combined with wage moderation—has made itadvantageous for companies to hire new workersrather than invest in new technology to improve theproductivity of existing workers.

Excessive pessimism is misplacedMany European countries are seeking to increase labormarket flexibility as a means to boost labor participa-tion, which is much lower in the euro area than in theUnited States (see bottom chart). While labor market

reform is something Europe needs—to deal with adwindling labor force caused by aging and falling birthrates—this reform also has the effect of temporarilyslowing labor productivity growth. “Slowing laborproductivity growth in Europe can be explained by the positive shock coming from the labor market.With more people being hired, there is a decline inlabor productivity growthbecause the capital-to-laborratio does not grow as fast,”Estevão says.

The EU’s Lisbon agendatries to address both labormarket participation andproductivity growth. Butaccording to Estevão, thesetwo goals are contradictoryto some extent. “When youincrease labor market par-ticipation, you are going tohave a negative effect onlabor productivity growth,”he says.

So should the EuropeanCommission and nationalgovernments stop fussingabout productivity? Yes andno. “It is not that productiv-ity is not important—it isvery important—but giventhe problems in Europecaused by low labor utiliza-tion, it makes sense to focuson increasing participationfirst,” Estevão says. But, hecontinues, policymakersneed to realize that this willhave a perverse effect on labor productivity over theshort to medium term. In sum, “excessive pessimismabout what is going on with labor productivitygrowth in Europe may be misplaced.” In terms of eco-nomic policy, Europe should focus on what mattersmost. According to Estevão, “this would entail focus-ing a bit less on productivity growth and a bit moreon increasing labor market utilization.”

Europe’s productivity growth—not as bad as it seems

U.S. labor productivity growth is higher (labor productivity growth in percent)

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

United States

euro area

2002199919961993199019871984198119781975

More people in the United States work

Note: The euro area comprises Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxemburg, the Netherlands, Portugal, and Spain.

Data: EC–AMECO database; OECD productivity database; and IMF staff calculations

(employment rates in percent of total production)

35

37

39

41

43

45

47

49

51

53

55

United States

euro area

200019951990198519801975197019651960

Copies of IMF Working Paper No. 04/200, “Why Is Productivityin the Euro Area So Sluggish?” are available for $15.00 eachfrom IMF Publication Services. See page 323 for ordering infor-mation. The full text of the paper is also available on the IMF’swebsite (www.imf.org).

November 8, 2004

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November 8, 2004

322

IMF Country Reports ($15.00)04/211: Pakistan: Eighth Review Under the Three-Year

Arrangement Under the PRGF and Request for

Waivers and Modification of Performance Criteria

04/212: Botswana: Selected Issues and Statistical

Appendix

04/213: Germany: ROSC—FATF Recommendations

for Anti–Money Laundering and Combating the

Financing of Terrorism

04/214: Zambia: 2003 Article IV Consultation and

Ex Post Assessment of Performance Under IMF-

Supported Programs

04/215: Pakistan: Financial System Stability Assessment,

including ROSCs on Monetary and Financial Policy

Transparency, Banking Supervision, and Securities

Regulation

04/216: Haiti: Staff-Monitored Program

04/217: Republic of Poland: 2004 Article IV Consultation

04/218: Republic of Poland: Selected Issues

04/219: Republic of Poland: ROSC on Fiscal

Transparency Module—Update

04/220: Romania: Selected Issues and Statistical

Appendix

04/221: Romania: 2004 Article IV Consultation and

Request for Stand-By Arrangement

04/222: Zambia: Request for Three-Year Arrangement

Under the PRGF

04/223: Democratic Republic of the Congo: Interim

PRSP Preparation Status Report

04/224: Democratic Republic of the Congo: Joint Staff

Assessment of the Interim PRSP Preparation Status

Report

04/225: Botswana: 2003 Article IV Consultation

04/226: Peru: Request for Stand-By Arrangement

04/227: Turkey: Seventh Review Under the Stand-By

Arrangement, and Requests for Waiver of Applicability

and Nonobservance of Performance Criteria,

Rephasing of Purchases, and Extension of

Arrangement

04/228: United States: Selected Issues

04/229: Botswana: ROSC on Data Module—Response by

the Authorities—Update

04/230: United States: 2004 Article IV Consultation

04/231: Republic of Congo: Selected Issues and Statistical

Appendix

04/232: Republic of Congo: 2004 Article IV Consultation

and New Staff-Monitored Program

04/233: Union of the Comoros: Selected Issues and

Statistical Appendix

04/234: Euro Area Policies: Staff Report

04/235: Euro Area Policies: Selected Issues

04/236: Austria: 2004 Article IV Consultation

04/237: Austria: Selected Issues

04/238: Austria: Financial System Stability Assessment,

including ROSCs on Banking Supervision, Securities

Regulation, Insurance Regulation, and Anti–Money

Laundering and Combating the Financing of

Terrorism

04/239: Nigeria: 2004 Article IV Consultation

04/240: Denmark: 2004 Article IV Consultation

04/241: Denmark: Selected Issues

04/242: Nigeria: Selected Issues and Statistical Appendix

04/243: Democratic Republic of the Congo: Fourth

Review Under the Three-Year Arrangement Under the

PRGF, Requests for Waiver of Performance Criteria

and Additional Interim Assistance Under the

Enhanced Initiative for HIPC

04/244: Sweden: 2004 Article IV Consultation

04/245: Sweden: Selected Issues

04/246: Bhutan: PRSP

04/247: Japan: Selected Issues

04/248: Republic of Tajikistan: Third Review of the

Three-Year Arrangement Under the PRGF, and

Request for Waiver of Performance Criterion

04/249: Japan: 2004 Article IV Consultation

04/250: Mexico: Selected Issues

04/251: Republic of Croatia: Selected Issues and

Statistical Appendix

04/252: Republic of Croatia: ROSC on Banking

Supervision, Payment Systems, and Securities

Regulation—Update

04/253: Republic of Croatia: 2004 Article IV

Consultation and Request for Stand-By Arrangement

04/254: Mexico: 2003 Article IV Consultation

04/255: Solomon Islands: Selected Issues and Statistical

Appendix

04/256: San Marino: Selected Issues and Statistical

Appendix

04/257: San Marino: 2004 Article IV Consultation

04/258: Solomon Islands: 2004 Article IV Consultation

04/259: Union of the Comoros: 2004 Article IV

Consultation

04/260: Republic of Latvia: 2004 Article IV Consultation

04/261: Republic of Latvia: Selected Issues

04/262: Japan: ROSC on Fiscal Transparency Module—

Update

04/263: Jamaica: 2004 Article IV Consultation

04/264: Czech Republic: ROSC on Fiscal Transparency

Module—Update

04/265: Czech Republic: Selected Issues

04/266: Czech Republic: 2004 Article IV Consultation

04/267: Bulgaria: Request for Stand-By Arrangement

04/268: Republic of Kazakhstan: Financial System

Stability Assessment—Update Including ROSCs on

Banking Supervision and Anti–Money Laundering

and Combating the Financing of Terrorism

04/269: Chile: Financial System Stability Assessment,

including ROSCs on Monetary and Financial Policy

Transparency, Banking Supervision, and Securities

Regulation

Recent publications

November 8, 2004

323

04/270: Rwanda: Second and Third Reviews Under the

Three-Year Arrangement Under the PRGF, Request for

Waiver of Performance Criteria, and Request for

Additional Interim Assistance Under the Enhanced

HIPC Initiative

04/271: Kingdom of the Netherlands—Netherlands

Antilles: Assessment of the Supervision and Regulation

of the Financial Sector Volume I—Review of Financial

Sector Regulation and Supervision

04/272: Kingdom of the Netherlands—Netherlands

Antilles: Assessment of the Supervision and Regulation

of the Financial Sector Volume II— Detailed Assessment

of Observance of Standards and Codes

04/273: Rwanda: PRSP Progress Report

04/274: Rwanda: Joint Staff Assessment of the PRSP

Progress Report

04/275: Niger: 2004 Article IV Consultation, Sixth Review

Under the Three-Year Arrangement Under the PRGF,

and Request for Waiver of Performance Criterion, and

Ex Post Assessment of Performance Under IMF-

Supported Programs

IMF Working Papers ($15.00)04/147: “Structural Factors Affecting Exchange Rate

Volatility: A Cross-Section Study,” Jorge I. Canales

Kriljenko and Karl F. Habermeier

04/148: “Country Insurance,” Tito Cordella and Eduardo

Levy Yeyati

04/149: “Bank Consolidation and Performance:

The Argentine Experience,” Ritu Basu, Pablo Druck,

David Marston, and Raul Susmel

04/150: “Identifying Threshold Effects in Credit Risk Stress

Testing,” Giancarlo Gasha and Armando Morales

04/151: “Analysis of Recent Growth in Low-Income CIS

Countries,” Elena Loukoianova and Anna Unigovskaya

04/152: “What Are the Potential Economic Benefits of

Enlarging the Gulf Cooperation Council?” Saade Chami,

Selim Elekdag, and Ivan Tchakarov

04/153: “Quantitative Assessment of the Financial Sector:

An Integrated Approach,” DeLisle Worrell

04/154: “Measuring the Trade Effects of EMU,” Hamid

Faruqee

04/155: “The IMF and Russia in the 1990s,” John Odling-Smee

04/156: “Fiscal Policy and Debt Sustainability: Cardoso’s

Brazil, 1995–2002,” Fabio Giambiagi and Marcio Ronci

04/157: “Front-Loaded or Back-Loaded Fiscal Adjustments:

What Works in Emerging Market Economies?”

Emanuele Baldacci, Benedict J. Clements, Sanjeev Gupta,

and Carlos Mulas-Granados

04/158: “Dimensions of Land Inequality and Economic

Development,” Lennart Erickson and Dietrich Vollrath

04/159: “Russia and the WTO: The ‘Gravity’ of Outsider

Status,” Bogdan Lissovolik and Yaroslav Lissovolik

04/160: “External Debt Sustainability in HIPC Completion

Point Countries,” Yan Sun

04/161: “Grants Versus Loans,” Tito Cordella and Hulya Ulku

04/162: “Credible Commitment to Optimal Escape from

a Liquidity Trap: The Role of the Balance Sheet of an

Independent Central Bank,” Olivier D. Jeanne and Lars

E.O. Svensson

04/163: “Can Public Discussion Enhance Program

Ownership?” Peter Isard and Allan Drazen

04/164: “Monetary Policy Rules and the U.S. Business Cycle:

Evidence and Implications,” Pau Rabanal

04/165: “Will You Buy My Peg? The Credibility of a Fixed

Exchange Rate Regime as a Determinant of Bilateral

Trade,” Bernhard Fritz-Krockow and Emilia M. Jurzyk

04/166: “Monetary and Exchange Rate Policies in

Colombia: Progress and Challenges,” Sergio Clavijo

04/167: “Foreign Currency Deposits and International

Liquidity Shortages in Pakistan,” Abbas Mirakhor and

Iqbal Zaidi

04/168: “The Challenge of Fiscal Adjustment in a

Democracy: The Case of India,” Catriona M. Purfield

and Ricardo Hausmann

04/169: “The Impact of Preference Erosion on Middle-

Income Developing Countries,” Katerina Alexandraki

and Hans P. Lankes

04/170: “Financing Uganda’s Poverty Reduction Strategy:

Is Aid Causing More Pain Than Gain?” Mwanza Nkusu

04/171: “Understanding India’s Services Revolution,” James

P. Gordon and Poonam Gupta

04/172: “The Role of KAMCO in Resolving Nonperforming

Loans in the Republic of Korea,” Dong He

Policy Discussion Papers04/4: “Pension Reform, Investment Restrictions, and

Capital Markets,” Jorge E. Roldos

04/5: “Banking Reform in the Lower Mekong Countries,”

Olaf Unteroberdoerster

Other IMF Research Bulletin, Volume 5, Nos. 2 and 3

IMF Staff Papers, Volume 51, No. 2

MacroLinks: A Program About the Interrelations Among

Macroeconomic Accounts Produced by the IMF Institute

(English, French, Spanish)

Publications are available from IMF Publication Services, Box X2004, IMF, Washington, DC 20431 U.S.A. Telephone: (202) 623-7430;fax: (202) 623-7201; e-mail: publications@imf.org.

For information on the IMF on the Internet—including the full texts of the English edition of the IMF Survey, the IMF Survey’s annualIMF in Focus, Finance & Development, an updated IMF Publications Catalog, and daily SDR exchange rates of 45 currencies—please visit theIMF’s website (www.imf.org). The full texts of all Working Papers and Policy Discussion Papers are also available on the IMF’s website.

FATF = Financial Action Task ForceHIPC = Heavily Indebted Poor CountriesPRGF = Poverty Reduction and Growth FacilityPRSP = Poverty Reduction Strategy PaperROSC = Report on the Observance of Standards and Codes

November 8, 2004

324

Between early 2003 and mid-2004, many emerg-ing markets in Asia experienced a strong revival

in private capital inflows. Although these inflowsslowed significantly in the second quarter of 2004,their resurgence reminded observers and policymak-ers of two “facts of life” for emerging market econ-omies: sharp increases in capital inflows are to beexpected, and they may entail difficult trade-offsbetween internal and external policy objectives. Arecent conference paper by Charles Adams, AndreaRichter Hume, Romuald Semblat, and AlessandroZanello reviews recent experience and draws severallessons for policymakers.

In 2003, about two-thirds of all private capital flowsto emerging markets went to Asia—about $100 billionin net terms. China attracted the bulk of flows to theregion, mostly in the form of foreign direct investment(FDI). India was another major recipient, though inits case portfolio investment flows predominated.Indonesia, Korea, Malaysia, and Thailand also experi-enced a sharp increase in portfolio investment.

Why is Asia so attractive? Improving macroeco-nomic fundamentals in much of the region created apowerful magnet for foreign savings. Expectations ofcurrency appreciation were another important pullfactor, especially in China and India. Furthermore,low interest rates in the major industrial countries,easing geopolitical tensions, and a gradual strength-ening of the global recovery spurred a quest forhigher returns among investors, who ventured intoriskier assets in emerging markets. The exceptionswere Indonesia and the Philippines, where somewhatweaker macroeconomic conditions and heighteneduncertainties muted private capital inflows.

Déjà vu all over again?Yet some observers took the seemingly good newswith a grain of salt, highlighting similarities betweenthe recent capital inflow episode and the run-up tothe Asian crisis, and voicing concerns that regionalvulnerabilities might re-emerge. Why such nervous-ness? The underlying concern is that while capitalinflows can benefit recipient economies by supple-menting domestic savings, they can also lead to a realexchange rate appreciation, weakened external posi-tions, and—ultimately—a capital flow reversal and anexchange rate crisis.

A closer inspection of the earlier capital inflowepisode, however, puts these concerns in perspective.

In the early 1990s, private capital flows to all emerg-ing markets expanded rapidly following the resolu-tion of the international debt crisis. As in the recentepisode, Asia was a major beneficiary of the pickup in capital flows, attracting some 40 percent of the $1 trillion global surge through 1996. Capital inflowswere driven by low interest rates in advanced econ-omies, relatively fixed exchange rates in the hostcountries, and structural changes in internationalfinancial markets—notably, liberalization of capitalaccount transactions as well as financial innovationsthat underpinned greater capital mobility. Theinflows eventually proved destabilizing, primarilybecause they exacerbated balance sheet weaknesses in the corporate and financial sectors through mis-matches in the currency and maturity structure ofdebt. They also fueled inflationary pressures that hadbeen gathering strength on the heels of a prolongedexpansion.

Faced with a surge of capital inflows, policymakershave a variety of tools at their disposal, notablycountercyclical macroeconomic measures (such asnominal exchange rate appreciation and fiscal tight-ening), administrative steps limiting capital inflowsand/or encouraging outflows, and ad hoc prudentialpolicies. Although most Asian countries adoptedthese measures to some degree, they were not ade-quate to deal with the tensions between internal andexternal balance that surging inflows had broughtabout by the mid-1990s. When capital flows reversedsharply in 1997 (in a rush-for-the-door as Thailand’sbanking crisis ballooned into a regionwide collapse ofconfidence), the consequences were devastating forthe regional economy.

A tale of two capital inflow episodesAt first glance, the recent surge of capital flows sharessimilarities with the run-up to the Asian crisis. Inboth cases, the inflows were very large, found theirroots in similar global conditions, and elicitedbroadly similar policy responses. On closer examina-tion, however, there are significant differences.

First, most economies in the region (with the pos-sible exception of China) were not on the verge ofoverheating when capital inflows revived, as was thecase in the mid-1990s. Economic growth in theregion, while healthy, has been primarily export-led,and domestic demand pressures have been moderate.Also, local asset price bubbles (in equity or housingmarkets) have generally been absent.

What has Asia learned about surging capital flows?

One-sidedinterventionhas produceda dramaticincrease inthe officialreserves ofAsianemergingeconomies.

November 8, 2004

325

Second, the scale of capital inflows this timearound has been significantly smaller in relation toGDP. On average, capital inflows represented about 4 percent of GDP in 2003, whereas in 1996, the sharewas nearer to 10 percent (see top chart). The compo-sition was also more favorable, with a lot less short-term external borrowing and significantly more FDIand portfolio equity investment in 2003.

Finally, resilience to a reversal in capital flows hasbeen strengthened. External vulnerability (as measuredby external debt-to-GDP ratios and reserve cover interms of short-term liabilities) is now much lowerthroughout the region. Current accounts are in surplusin most countries, implying that despite the sizableinflows, the region is still a net capital exporter. Andexchange rate systems in the majority of emergingAsia’s economies are—de jure and de facto—some-what more flexible, thus providing a natural buffer foradjusting to any external pressures that might emerge.With regard to domestic vulnerabilities arising fromhigh leverage ratios in the corporate sector and weakbalance sheets in banks, most economies in emergingAsia are also in much stronger positions than before.

A familiar trade-offDespite these differences, however, the recent capitalinflows episode presented policymakers with the samechallenges that they faced during the previous episode.And policy responses were not unlike those in the run-up to the Asian crisis. Burgeoning capital inflowsexerted pressure on regional currencies to appreciate.And central banks, seeking to avoid a loss of competi-tiveness that could undermine economic performance,chose to intervene in foreign exchange markets bypurchasing foreign currencies. This one-sided inter-vention has produced a dramatic increase in the offi-cial reserves of Asian emerging economies. Indeed,reserves rose (see bottom chart) by some $450 billionbetween the beginning of 2003 and mid-2004.

And intervention, in turn, created its own prob-lems. To limit the inflationary impact of an expand-ing domestic money supply, monetary authoritieshave drained liquidity through the issuance of centralbank paper or the sale of government securities.Allowing pressure for an eventual exchange rateappreciation to build, however, this policy may havevalidated investor perceptions of a one-way currencybet, further encouraging capital inflows. Adminis-trative measures to facilitate outflows may similarlyhave added to the attractiveness of investing in theregion. This vicious circle shows the difficultiesinvolved in trying to use monetary policy to simulta-neously address both domestic (inflation) and exter-nal (exchange rate) policy objectives.

What next?As it happened, the recent capital inflow episode fiz-zled out before the tension between achieving domes-tic and external policy objectives became unsustain-able. A reversal (and in some cases, a slowdown) inportfolio and other investment flows was sparked byseveral factors, including an upward adjustment inU.S. interest rate expectations and rising concernsabout a “hard landing” in China.

However, as expectations of a rapid rise in U.S.interest rates have moderated, global investmentfunds are once again casting an eye on Asia’s emerg-ing markets, and some countries are already experi-encing a revival in capital inflows.

Should capital inflows to emerging Asia pick up inearnest again, policymakers in the region are likely toface a greater challenge than before in meeting inter-nal and external objectives simultaneously. Headlineinflation has been rising across the region and is now

Capital inflows in 2003 were smaller

Data: IMF and national authorities

(percent of GDP)

–5

0

5

10

15

20

25

30

2003

1996

Thail

and

Taiwan

POC

Singa

pore

Philip

pines

Malaysi

aKore

a

Indon

esia

India

China

Intervention led to soaring reserves

1China, Hong Kong SAR, India, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan Province of China, and Thailand.

2Excludes the effects of the end–2003 recapitalization of two large commercial banks in China with foreign reserves of the People's Bank of China ($45 billion).

Data: IMF, CEIC, and national authorities

(billion U.S. dollars)

0

200

400

600

800

1000

1200

1400

1600

China2

Total1

Jun-

04

Mar

-04

Dec

-03

Sep-

03

Jun-

03

Mar

-03

Dec

-02

Sep-

02

Jun-

02

Mar

-02

Dec

-01

Sep-

01

Jun-

01

Mar

-01

Dec

-00

As expectationsof a rapid risein U.S. interestrates havemoderated,globalinvestmentfunds are onceagain castingan eye onAsia’s emergingmarkets.

November 8, 2004

326

averaging about 4 percent a year, some 2 percentagepoints higher than a year ago. Although supply-sideshocks related to high oil and commodity pricesmean that core inflation remains low in most coun-tries, in some of them inflation expectations areratcheting up, raising the fear of more entrenchedcost pressures. Against this backdrop, any foreignexchange market intervention by the central bankwould need to be heavily sterilized, lest the nascentprice spiral gain momentum. The scope for furthersterilized intervention may be reaching its limits,however, because of a shrinking availability of officialsecurities or because of the prospect of rising domes-tic interest rates (where official securities are imper-fect substitutes for the domestic assets that foreigninvestors want).

This suggests that a move toward more flexibleexchange rate systems will be needed across the region

to mitigate the inflationary impact of renewed capitalinflows. More flexible exchange rate systems would bebeneficial from both a domestic and a global perspec-tive. It would allow monetary policy to be better gearedtoward domestic stabilization, reduce susceptibility toexternal shocks, and contribute to resolving the globalcurrent account imbalances that continue to threatenthe world’s economic recovery.

Andrea Richter Hume and Alessandro ZanelloIMF Asia and Pacific Department

This article is based on a paper prepared by Charles Adams,Andrea Richter Hume, Romuald Semblat, and AlessandroZanello for a high-level seminar on capital flows co-sponsoredby the Bank of Thailand and the IMF. Copies of the paper areavailable on request from the authors.

Press Releases04/218: IMF Executive Board Completes First Review Under

Nepal’s Three-Year PRGF Arrangement and Approves

$10.6 Million Disbursement, October 20

04/219: IMF and World Bank Support $836 Million in Debt

Service Relief for Madagascar, October 21

04/220: Joint Statement by the General Secretary of the

World Council of Churches, President of the World Bank,

and Deputy Managing Director of the IMF, October 22

04/221: Andrew Crockett Named Chair of Per Jacobsson

Foundation, October 22

04/222: IMF Managing Director Rodrigo de Rato

Underscores Strengthening Economic Cooperation

Among the Gulf Cooperation Council Countries,

October 23

04/223: IMF Managing Director Rodrigo de Rato’s

Statement at the Conclusion of His Visit to Saudi Arabia,

October 23–24, 2004, October 24

04/224: Inauguration of the Middle East Technical

Assistance Center (METAC), October 25

04/225: IMF Staff Concludes Second Round of Discussions

on a New Stand-By Arrangement for Turkey, October 26

04/226: IMF Revises Guide to the General Data

Dissemination System, October 26

04/227: Statement by IMF Managing Director Rodrigo de

Rato at the Conclusion of a Visit to the Arab Republic of

Egypt, October 26

04/228: IMF Mission Statement on Discussions in Serbia

and Montenegro, October 27

04/229: Statement of the IMF Mission to the Dominican

Republic, October 29

04/230: Press Statement of the IMF Mission in Paraguay,

October 29

04/231: Director of the IMF’s African Department Visits

Cameroon, November 1

04/232: Press Statement by IMF Staff Mission to Algeria,

November 2

04/233: Statement by IMF Deputy Managing Director,

Mr. Takatoshi Kato, Upon the Conclusion of His Visit

to Angola, November 2

04/234: IMF Managing Director de Rato Names Sean

Hagan as General Counsel and Director of the Legal

Department, November 3

Public Information Notice04/120: IMF Concludes 2004 Article IV Consultation with

Germany, November 2

Speeches“Emerging Asia: Outlook, Challenges, and India’s Growing

Role,” David Burton, Director, IMF Asia and Pacific

Department, Reserve Bank of India, New Delhi,

October 21

Rodrigo de Rato, IMF Managing Director, World Trade

Organization’s General Council Meeting on Coherence,

Geneva, October 22

Agustín Carstens, IMF Deputy Managing Director, World

Council of Churches–World Bank–IMF High-Level

Encounter, Geneva, October 22

Rodrigo de Rato, IMF Managing Director, Meeting of the

Ministers of Finance and Governors of the Cooperation

Council of the Arab States of the Gulf, Jeddah, Saudi

Arabia, October 23

Rodrigo de Rato, IMF Managing Director, Middle East

Technical Assistance Center, Beirut, October 25

Transcripts“Rules-Based Fiscal Policy in Emerging Markets,” IMF Book

Forum, October 6

Available on the web (www.imf.org)

PRGF = Poverty Reduction and Growth Facility

A movetoward flexibleexchange ratesystems will beneeded acrossthe region tomitigate theinflationaryimpact ofrenewedcapital inflows.

November 8, 2004

327

C apitalism without default would be like religionwithout sin. Countries and corporations have

erred a lot in recent years, judging by the huge supply ofdefaulted or distressed assets. Surprisingly, there is alsoa healthy demand for these assets. Is this demand anattempt to feed off the distress of countries and corpora-tions or does it offer them a chance of redemption?Manmohan Singh, an economist in the IMF’sInternational Capital Markets Department, talks toPrakash Loungani of the IMF Survey about how themarket for distressed assets works.

IMF SURVEY: What is a distressed asset?SINGH: It means that the asset holder or lender is notgetting the income stream he was supposed to get.Either the corporation or the country has defaultedoutright or some payment is being made, but belowthe agreed rate—that’s called a subperforming asset.

IMF SURVEY: It seems odd that there’s a healthymarket in distressed assets.SINGH: Not really. Think of what happens when, let’ssay, people don’t pay a hospital bill. After a fewreminders, the hospital may turn it over to a collec-tion agency. The hospital doesn’t have the time orresources or the professional expertise to figure outwhy you haven’t paid. But the collection agency spe-cializes in this task. Or think of the market for junkcars. Some people buy junk cars and specialize inrepairing them and selling them for a higher pricethan the often ridiculously low price for which theybought them. So where you and I may see a wreck,these specialists might see some recovery value.

IMF SURVEY: OK, so let’s think of it as a market.Who are the sellers in the market for distressedassets?SINGH: Often the sellers are pension funds and insur-ance companies. They are required by law to classifyan asset as nonperforming when the original termsare not being honored by the borrower. Moreover,these companies then have to allocate some extracapital to shield themselves against the possible lossesfrom such nonperforming assets. That makes itexpensive to hold on to distressed assets. So they tendto sell them off. And that’s the time when sometimesthese assets are sold below their intrinsic valuebecause it’s being done under regulatory pressure.Sometimes the holders of these assets do not have the

expertise to assess their quality. So the fact that pay-ments have been missed is enough to make themwant to sell, particularly if they see that others in themarket are also selling.

IMF SURVEY: Who are the buyers of these assets?SINGH: There are many different types of buyers, butone important class is “high net worth individuals”—also known as “very rich people.” It is tempting to por-tray them as vultures feeding off other people’s dis-tress, and indeed there are times when some of themdo behave that way. But remember that these buyersalso provide a floor for the price of the distressed asset;their demand keeps the price from sinking to zero.Distressed-debt traders have played this role in recentyears in Ukraine, Moldova, Brazil, and Uruguay, as wellas in some of the Asian crisis countries.

IMF SURVEY: Aren’t these individuals subject to thesame regulations as the pension funds or insurancecompanies?SINGH: No, because they are risking their own money,not other people’s. In fact, that’s how the marketstarted. In the aftermath of the debt crisis of the1980s, there was a lot of distressed sovereign debtfloating around but U.S. banks were constrained byregulations on how much of it they could hold. Sosome high net worth individuals purchased this debton the cheap.

The behavior of pension funds and mutual fundsis also constrained because they often have to gener-ate returns that track some broad market index. But

Selected IMF rates

Week SDR interest Rate of Rate ofbeginning rate remuneration charge

October 25 2.06 2.06 3.17November 1 2.09 2.09 3.22

The SDR interest rate and the rate of remuneration are equal to aweighted average of interest rates on specified short-term domesticobligations in the money markets of the five countries whose cur-rencies constitute the SDR valuation basket. The rate of remunera-tion is the rate of return on members’ remunerated reserve tranchepositions. The rate of charge, a proportion of the SDR interest rate,is the cost of using the IMF’s financial resources. All three rates arecomputed each Friday for the following week. The basic rates ofremuneration and charge are further adjusted to reflect burden-sharing arrangements. For the latest rates, call (202) 623-7171 orcheck the IMF website (www.imf.org/cgi-shl/bur.pl?2004).

General information on IMF finances, including rates, may be accessedat www.imf.org/external/fin.htm.

Data: IMF Finance Department

Interview with Manmohan Singh

Dealing in distress?Understanding the market for distressed debt

The returnsto investorsin emergingmarketdistressed debtcases havebeen over50 percenta year andsometimesas high as300 percenta year.

—ManmohanSingh

investors in distressed assets are not bound by theserules. They have patience. They have deep pockets.And you need both because often these cases can betied up in litigation for years.

IMF SURVEY: So do investors in distressed assets endup making any money?SINGH: In the market for distressed sovereign debt theyoften do, particularly if they resort to litigation. Whilethe number of cases is admittedly small, I’ve foundthat the returns to investors in emerging market dis-tressed debt cases have been over 50 percent a yearand sometimes as high as 300 percent a year.Remember that investors buy some of this debt atonly 5 or 10 percent of the face value of the asset.Then they use the courts to press for full recoveryof the asset value. So the returnscan be very high.

IMF SURVEY: Does this explainwhy we sometimes see theprices of sovereign bonds riseon the announcement of adefault?SINGH: A default does immedi-ately attract these kinds ofinvestors, and their demand cansometimes drive up the price.Often these investors increasetheir leverage with the countryby picking up what are called“orphan bonds,” illiquid bondsthat have few other investors.Cheapest-to-deliver bonds thatare associated with creditdefault swaps also rise in valuefollowing a credit event, as wasseen in the case of Argentinaand Uruguay.

IMF SURVEY: You’ve also studied the market for dis-tressed corporate assets. How is that different fromthe market for distressed sovereign assets?SINGH: With the sovereign you have less leverage. Oneof your options is to go through the courts and assertyour creditor rights or simply negotiate for betterterms. But it is a protracted process with many lawsuitstaking as many as 10 years to settle. So even though itcan be very rewarding if successful, not everybody willhave the patience and the deep pockets to follow thatroute. Another option is to press the country to workwith the IMF and hope better economic policies at thenational level will bring about recovery in asset valuesand the country’s ability to pay.

With corporations there are many more strategiesthat can be followed, particularly many more optionsfor successful restructuring that can yield value foreveryone—the distressed corporation, the investor,and the country too.

IMF SURVEY: What’s a good example of such a turn-around?SINGH: Perhaps the most cited is the acquisition inMarch 2000 of Long-Term Credit Bank of Japan by aNew York-based private-equity firm called RipplewoodHoldings. They really cleaned up the bank’s balancesheets, upgraded its information and technology sys-tems, and devised a new retail strategy. Today the bank,which is now called Shinsei Bank, is considered one ofthe best in Japan and has seen its share price rise from

the depths of four years ago. AndRipplewood has exited the scenewith handsome profits.

IMF SURVEY: What are theimplications of such cases forJapan and the rest of Asia?SINGH: I think such cases canfight the perception that all dis-tressed-debt investors are justvultures. More investors, foreignand local, will start to take aninterest in this market if theyfeel there will be less prejudiceagainst them. But there is amore important demonstrationeffect of these cases. Oftencountries tend to just move thenonperforming loans of theircorporations to an asset man-agement company—which issort of a hospital for sickloans—and just let them sitthere instead of trying to

restructure them. What Japan’s recent experience, andthat of Korea after the Asian crisis, shows is that gen-uine restructuring creates value. Policymakers inChina and other countries in Asia facing a nonper-forming loan problem understand that they woulddo well to heed that message.

November 8, 2004

328

Laura WallaceEditor-in-Chief

Sheila MeehanManaging Editor

Christine Ebrahim-zadehProduction Manager

Camilla AndersenJacqueline Irving

Assistant Editors

Niccole Braynen-KimaniMaureen Burke

Lijun LiEditorial Assistants

Julio PregoGraphic Artist

_______

Graham HaccheSenior Advisor

Prakash LounganiAssociate Editor

The IMF Survey (ISSN 0047-083X) is published in English,French, and Spanish by theIMF 22 times a year, plus IMFin Focus. Opinions and materi-als in the IMF Survey do notnecessarily reflect official viewsof the IMF. Any maps used arefor the convenience of readers,based on National Geo-graphic’s Atlas of the World,Sixth Edition; the denomina-tions used and the boundariesshown do not imply any judg-ment by the IMF on the legalstatus of any territory or anyendorsement or acceptance of such boundaries. Text fromthe IMF Survey may bereprinted, with due credit given,but photographs and illustra-tions cannot be reproduced inany form. Address editorialcorrespondence to CurrentPublications Division, RoomIS7-1100, IMF, Washington, DC20431 U.S.A. Tel.: (202) 623-8585; or e-mail any commentsto imfsurvey@imf.org. The IMFSurvey is mailed first class inCanada, Mexico, and the UnitedStates, and by airspeed else-where. Private firms and indi-viduals are charged $79.00annually. Apply for subscrip-tions to Publication Services,Box X2004, IMF, Washington,DC 20431 U.S.A. Tel.: (202)623-7430; fax: (202) 623-7201;e-mail: publications@imf.org.

Singh: “What Japan’s recent experience,and that of Korea after the Asian crisis,shows is that genuine restructuring createsvalue.”

Copies of IMF Working Paper No. 04/86, “Japan’s Distressed-Debt Market,” by Kazunari Ohashi and Manmohan Singh,IMF Working Paper No. 03/161, “Recovery Rates fromDistressed Debt,” and No. 03/242, “Are Credit Default SwapSpreads High in Emerging Markets,” by Manmohan Singh areavailable for $15.00 each from IMF Publication Services. Seepage 323 for ordering information. The full text of the threepapers is also available on the IMF’s website (www.imf.org).