The Annual Report for 1995 of the International Monetary Fund was released in Washington DC yesterday. As always, this authoritative document again contains a wealth of information on world economic conditions and on the major changes that are now taking place in individual countries, as well as in the global system of trade and payments.
Much can be learned from the experiences of the one-hundred and eighty members of the Fund, and particularly from the successes and the failures of macro-economic policies applied by these countries. This year's Annual Report has been drafted against the background of the celebration of the fiftieth anniversary of the two Bretton Woods institutions, that is the International Monetary Fund and the World Bank. In the words of the Fund, the anniversary came "in a year of intense activity for the Fund (and) stimulated an assessment of changes in the international monetary system, a review of the implications of these developments for the Fund's future resource base, and reflections on the ways in which the Fund should respond to them".
The Fund singles out as the dominant event of the past year the financial crisis in Mexico. The Mexican problem required swift and massive support from the IMF, and may prove to have represented a major change in the course of the Fund's policies. As originally designed, IMF assistance was intended to provide support to countries with temporary current account balance of payments deficits, and the conditionalities of the Fund were constructed around the need to correct the underlying fundamentals that will restore equilibrium in the current account. In the case of Mexico, the Fund had to contend with the new generation problem, and that is a massive outflow of capital that not only disrupted economic stability within Mexico itself, but also threatened the stability of the globally integrated financial markets.
The Fund describes the major economic structural change of recent years as the "increased globalization and integration of markets for goods, services and capital". This globalisation and integration are major factors behind the changing role of the Fund, at least as far as the industrial countries of the world are concerned. The Fund is no longer seen as a primary source of temporary international liquidity, but rather as an important facilitator for better co-operation and harmonisation of the macro-economic policies applied by the major countries. The Fund's responsibility "to oversee the effective functioning of the international monetary system and to exercise firm surveillance over members' exchange rate policies" has become even more important than before.
The financing function of the Fund is now being confined almost exclusively to the developing economies, the emerging economies and the economies of central and eastern Europe now in transition. This change in the priorities of the Fund forces the Institution to reconsider its rules for lending and, particularly in the opinion of most African countries, also the nature and the objectives of its conditionalities.
2. The Fund's view on the world economic situation
The Fund is fairly optimistic about the overall world economic situation. Reviewing the developments of the past year, the Report says:
"The world economy rebounded strongly in 1994. Total output rose by 3-3/4 per cent ... marking a significant improvement over the lackluster performance of 1990/93."
Looking ahead, the Report goes on to say:
"Directors were positive about longer-run trends in the world economy, citing improve- ments in economic policy and performance in a growing number of developing countries, improvements in economic management under way in transition economies, considerable progress toward price stability in many countries, and growing recognition in industrial countries of the need to improve the functioning of labor markets and to strengthen the financial position of the public sector".
The performances of the various sub-groups of countries as identified by the Fund were not in all cases as encouraging as indicated by the global picture. The Fund in particular refers to the continuing weak results of economic development in Africa:
"Economic conditions remained difficult in Africa despite the cyclical recovery of commodity prices. Output increased by less than 3 per cent, allowing for marginal increases in per capita incomes in only relatively few countries".
There is, nevertheless, a ray of hope, even for Africa:
"However, with further moves toward reform, most notably exchange market liberalization, conditions for stronger growth continued to improve in many African countries".
The Fund also has some positive advice for Africa:
"Critical to reversing the pattern of declining living standards were increased domestic saving, reduced inflation in some countries, and an enlarged scope for market mechanisms. As in other regions, it was also important to improve governance".
The Fund is similarly optimistic about the outlook for inflation. Indeed, the situation in many of the industrial countries at this stage is described by the Fund as one of "reasonable price stability". Good progress has also been made in the developing countries and, although there are still very high levels of inflation in a relatively small number of countries, the median inflation in the developing countries was only 10 per cent in 1994.
The Fund expresses some concern about unstable conditions in the financial markets, and particularly points to the relatively high real rates of interest in the world at this stage. This concern is expressed as follows:
"Increased demand for funds in more strongly expanding industrial economies, combined with the ongoing need for investment capital in transition economies and in developing coun- tries, pointed to a high level of private sector demand for capital in coming years. With private saving rates low or declining in many large countries, and with the considerable absorption of saving by the public sector, there was a risk of continued and perhaps increasing pressure on world real interest rates, which could constrain future growth."
The Report carries a light warning on the dangers of excessive volatility in exchange rates:
"Most Directors were concerned about the effects of exchange rate developments in the major industrial countries. They noted that such pressures posed a threat to the prospects for sustained noninflationary growth, with adverse implications for all countries".
These generally optimistic views on the prospects for the world economy are supported in a recent report on the economic outlook for 1995 and 1996 in the OECD countries. It is estimated by the OECD, for example, that the increase of almost 10 per cent in the volume of world trade in 1994, will be repeated in 1995, and may decline only slightly in 1996.
Against this background, the prospects for South Africa's exports remain good. With hopefully a return to a more normal agricultural production next year, the country should be in a good position to increase its total exports to reduce the present relatively large deficit on the current account of the balance of payments.
Prospects for the international capital markets are less clear. There were indications of some decline in net capital inflows during 1994 to developing countries in the Western Hemisphere and in the Middle East and Europe region. After the Mexican crisis at the end of 1994, capital flows to the developing world subsided further. It should also be noted that the capital flows have recently become more volatile, and the cost has risen considerably with the rising trend in interest rates.
3. Structural changes in the world economy
Mexico epitomised the problems of the structural changes in recent years in the world financial system. The new emerging international financial structure is now based on
a regime of fluctuating exchange rates applied by almost 70 of the members of the IMF;
relatively free international trade, payment and capital transfer systems; and
a growing integration of money, capital and foreign exchange markets on a global basis.
In this environment, the Board of Executive Directors of the Fund distinguishes three pressing issues in financial market regulation. Firstly, there is a need to give more attention to the growth of non-bank financial institutions, and particularly to the role and the functions of derivatives of conventional financial instruments. A number of serious cases over the past year, for example the Barings incident, obviously spring to mind.
Secondly, it has become necessary to provide for capital adequacy directives for all securities dealers, both within banking institutions and in non-banks.
Thirdly, the role of central banks in the supervision and regulation of financial markets and institutions will have to be reconsidered. The Fund quite rightly points out that there is a good case why a central bank should preferably remain free of regulatory responsibility because such a concentration of responsibility could undermine its ability to conduct monetary policy independently.
4. Policy directives from the IMF
This year's IMF Annual Report contains a myriad of policy directives which in many cases, can be regarded as being appropriate also for the current South African situation. Just a few quotations from the Report will serve to illustrate this point:
"... fiscal deficits also undermine both national and worldwide saving. The simplest and most direct way for governments to boost such saving is through reducing these imbalances".
"... countries should take advantage of the economic expansion to substantially reduce the public sector's absorption of private saving".
"In many (developing) countries, a substantial improvement in public sector saving was needed to put growth on a firmer basis ... over the medium term, a strengthening of the fiscal position allowed room for growth of the private sector".
"... capital flows to developing countries required careful monitoring, given the tenuous nature of certain types of capital flows and the potential for adverse domestic side- effects".
"Directors urged policymakers to ensure that capital inflows did not translate into higher consumption expenditures ...".
"... the advantages conferred by participating in global capital markets made it worthwhile for countries to subject themselves to the rules and discipline of the marketplace".
"... most developing countries have kept, until recently, tight control of outward capital movements. This slower progress toward capital account convertibility than in industrial countries may be due in part to the more acute shortage of domestic saving in developing countries and the greater perceived risk of capital flight, particularly in those countries with below-market interest rates and unsound macroeconomic policies".
"They (Board members) emphasized the importance of positive real interest rates for mobilizing the saving and investment critical for develop-ment".
"They (Board members) emphasized the importance of renewed and sustained effort to reduce inflation to low levels, noting that this was the only way to achieve a durable decline in interest rates, maintain competitiveness internationally, and lay the basis for higher rates of economic growth".
5. Lessons for South Africa
In reading through the Fund's Annual Report one cannot but realise how important international economic relations have become for all countries that want to share in the advantages of being part of the global village. South Africa is not only re-establishing the position in the world economy that it was expelled from in the eighties. We are now returning to a new world order that holds many new challenges for old and new participants, for developing, emerging and industrialised economies and for countries on all the continents of the globe.
If South Africa wants to compete with the other players in this game, we shall have to play according to the rules of the market place, and we shall have to be competitive. There is a lot of good advice available in the Annual Report of the Fund that can give us guidance on what will be expected from us. In a one-page summary on South Africa, the directive for exchange rate policy is the following:
"... any depreciation of the rand must be considered in the context of real wage correction and labor market reform and to be supported by macroeconomic policies; otherwise, it might spark a wage-price spiral".
The Fund's view on the South African monetary policy is also interesting:
"It was observed that monetary policy had been conducted in an unusually difficult environment in 1994. Nevertheless, the upturn in inflation and the sharp deterioration in the external current account suggested that the monetary stance had been insufficiently restrictive. Directors hoped that policy changes and the continued vigilance of the Reserve Bank would correct the problem in 1995".
We in the Reserve Bank take this good advice seriously. We recommend other policy makers in South Africa also to read the Fund's 1995 Annual Report with great care. There may also be some good advice, explicitly or implicitly, in the Report for them.