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G7 Finance Ministers' Meeting, Rome, July 7, 2001
Performance Assessment

Abstract: The G7 leaders wisely refrained from proposing to fine-tune the world economy through concerted action against what so far is only a mild growth recession in all but one of their countries. They urged a continued focus on structural reforms in Europe and Japan instead. Abstention from concrete initiatives beyond exhortation, perhaps less well-advised, characterized the finance ministers' statement also. The ministers revisited many of the issues that had been covered extensively already at the Cologne summit. In doing so they failed to break appreciable new ground in either the analysis of the causes of financial instability, such as most recently experienced in Turkey and Argentina, or in the preventive measures suggested. In particular, nothing new appears to have been learned about the appropriate exchange-rate system and the reduced number of currencies that can safely survive in liberalized financial and investment markets.

The G7 finance ministers met in Rome on July 7, 2001, to prepare for the July 20-22 Genoa G8 summit. The longest serving member is Paul Martin of Canada, while Paul O'Neill of the United States, Masajuro Shiokawa of Japan, and Gulio Tremonti of Italy are new to the group. Hans Eichel of Germany, Gordon Brown of the United Kingdom, and Laurent Fabius of France are the remaining members.

The ministers issued an 11-page statement whose main provisions appear below. The statement is available from the web site of the G8 Research Group at http://www.g7.utoronto.ca/g7/finance/fm010707.htm. Its main recommendations are reflected in the section on "Strengthening the International Financial System" of the much shorter G7 statement by the Heads of State and Government of the G7 countries issued at Genoa on July 20, 2001. We here include also a summary of the statement on the world economy that was contained only in the G7 Statement because it provides needed background to the finance ministers' concerns.

After summarizing, the present report briefly comments on the achievements and omissions of the finance ministers' statement in addressing international economic and financial issues. These issues are reduced growth in the world economy, taking continuing steps to strengthen the international financial infrastructure, and the multilateral development banks.

Lower Growth in the World Economy

1. The G7 statement noted a slowing of economic growth ranging from sharp (United States) to moderate (United Kingdom) even though growth remained positive in all G7 countries except Japan. In spite of this growth recession, the G7 felt that the continuation of structural reforms and watchful waiting were all that was called for at the present time. There was confidence that "sound economic policies and fundamentals provide a solid foundation for stronger growth."

2. High and volatile oil prices were a matter of continuing concern clouding the world economic outlook. Furthermore, the recent crisis in Turkey and the latent crisis in Argentina were casting a shadow.

Steps to Strengthen the International Financial Infrastructure

1. Private Sector Involvement in Crisis Prevention and Resolution. Such involvement is to be further encouraged through measures ranging from increased information sharing between countries and their private creditors to the adoption of collective-action clauses in loan covenants so as to permit creditor committees to accept, by qualified majority, reschedulings, writedowns, or other work-out plans that are applicable to all creditors. The purpose is to reduce moral hazard by lenders without encouraging default by borrowers.

2. Surveillance and Implementation of Standards and Codes. The preparation of country-specific inventories of measures is important to prepare for compliance with internationally accepted codes and standards guiding the transparent operation, constitution, and supervision of the different lines of the financial business in developing countries. Since 1999 this activity has become part of the comprehensive Financial Sector Assessment Program (FSAP) conducted by the IMF and the World Bank with a growing list of countries. The G7 finance ministers reaffirmed their commitment to promote the implementation and surveillance of internationally agreed codes and standards, in particular the 12 key standards identified, for instance, for banking, insurance, and securities markets, by the Financial Stability Forum coordinated by the Bank for International Settlements. Given that large parts of banking and insurance are effectively bankrupt in many developing countries, the gradual implementation of the standards and codes, including their capital requirments, might eventually reduce financial fragility.

3. Opening Access to the Capital Market. This section of the finance ministers' statement harks back explicitly to the Report on Strengthening the International Financial Architecture submitted to the Cologne Summit in 1999. It recognizes foreign direct investment and productive use of equity flows and borrowed resources as hallmarks of countries that have successfully integrated into the world economy. It also recognizes that opening up access to the capital market is a complex process that can benefit from policy advice and from technical and financial assistance. Nevertheless it concludes that excessive capital flow volatility can not feasibly or effectively be addressed by a Tobin tax on financial transactions. The goal of launching a new trade round at the Fourth WTO Ministerial in Qatar in November 2001 would also promote open access to markets, including the capiutal market and its services.

The Multilateral Development Banks (MDBs)

1. Multilateral Development Banks, like the World Bank and its Affiliates and the Regional Development Banks, are to place increased stress on helping countries organize themselves for poverty reduction in the context of a Comprehensive Development Framework and of country-owned development stratgies such as those developed in their Poverty Reduction Strategy Papers. Investment in human resources through the increased provision of health and education services are central to that strategy.

2. The MDBs are to work jointly with each other with the help of memorandums of understanding between the World Bank and the Regional Development Banks because such coordination is crucial to improving efficiency at the institutional level. Good governance is to be promoted by strengthening public-sector management, accountability and anti-corruption measures in all countries.

Overall Evaluation

The finance ministers revisited many of the issues that had been covered extensively already at the 1999 Cologne summit without breaking appreciable new ground in either the analysis of the causes of financial instability, such as most recently experienced in Turkey and Argentina, or in the preventive measures suggested. In particular, nothing new appears to have been learned about the appropriate exchange rate system and the reduced number of currencies that can safely survive in liberalized financial and investment markets. My comment here will elaborate on this point.

The finance ministers, like the IMF whose approach they endorse, did not focus on the root cause of international financial instability in emerging countries, which lies in their increasing exposure to currency competition and the resulting instability of their exchange rate and financial sector. If the currency of a financially small country is to serve anyone in a legitimate welfare sense, it would have to be the citizens of its own country. This, however, it fails to do in emerging-market countries where currency crises, asset-price deflations, and financial and economic meltdown tend to coincide. One of the greatest current failings of the international financial institutions and of the G8 is their failure publicly to recognize the needless pain and suffering caused by small countries hanging on to a separate currency that is being eroded by market forces and to recommend multilateral alternatives.

Let me make this point in some detail. Reacting to three major financial crises in emerging markets since mid-1997, the IMF and the World Bank in May 1999 launched the Financial Sector Assessment Program (FSAP). The program received a strong endorsement in the Rpeort of the G-7 Finance Ministers and Central Bank Governors on "Strengthening the International Financial System and the Multilateral Development Banks" that was issued in Rome on July 7, 2001. One of three components of the FSAP is an assessment of the financial system, including macroeconomic factors, that could affect the performance of the system and conditions in the system that could affect the macroeconomy. This component relates most directly to the Financial System Stability Assessment (FSSA) of individual countries. The FSSA is used as part of the annual Article IV consultations which the IMF holds with its member countries to review their macroeconomic and exchange-rate policies. The FSSA is designed to identify macroeconomic vulnerabilities in which macroeconomic indicators associated with financial system soundness (such as volatility in exchange rates and interest rates) play a part. This parenthetical mention of exchange rate volatility appears to refer to a stressful atmospheric condition that requires adjustment rather than to a form of trouble that can be avoided by replacing the local currency fully, and not just in part, with a strong international currency as market forces increasingly demand. The G-7 statement issued in Rome similarly promises stepped up efforts "to reduce volatility and improve the fiunctioning of the international monetary system" (point 7) without ever hinting that, for many emerging countries, getting rid of their troublesome own currency would contribute importantly to both goals. As dollarization of the Western Hemisphere South of the United States progresses and as euroland is acquiring a halo of euroizing countries, how to prepare for mutually beneficial multilateral forms of monetary union may have to become a subject at future finance minsters' meetings and G8 summits though it is unlikely to receive an official welcome in Canada.

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