Opening Address to the Manila Framework Group Meeting

Ladies and Gentlemen,

Welcome to Melbourne and the fourth Manila Framework Group Meeting.

This regular meeting of Finance & Central Bank deputies originated in response to the Asian crisis.

The objective was to develop regional strategies to address the crisis based on improved surveillance and a strengthening of the IMF’s capacity to respond to crises.

It is some 18 months since the first meeting of the Manila Framework Group, and we continue to work in the shadow of the Asian crisis.

But progress has been achieved, and this Group has made an important input into managing the crisis. In November 1997, it set the framework for second-tier, bilateral financing to the crisis economies, and laid the groundwork for continuing regional economic surveillance and cooperation. It recommended measures to strengthen the IMF’s capacity to mobilise assistance quickly in a crisis and these measures were put in place in the form of the Fund’s Supplemental Reserve Facility.

But our work is far from over and I believe we are entering a critical period in terms of ensuring that the momentum for international financial reform is maintained.

This is the challenge facing the international community and this Group can play an instrumental role in maintaining the reform momentum. We have represented here today fourteen economies; three of the G-7 economies; China; all the major regional economies seriously affected by crisis; the regional financial centres of Hong Kong SAR, Singapore and Australia; and senior representatives of the IMF. We have a representative group ideally scaled for intensive discussion and genuine dialogue. It is important that we maximise the opportunity we have over the next two days.

The need to maintain the momentum for reform is a major issue I will be pursuing when I attend the Interim Committee Meeting of the IMF in Washington in April and the meeting of the APEC Finance Ministers in May. I will carry forward to those meetings the outcomes from this meeting.

In working towards an improved international financial system, there are some key elements I would identify.

• The importance of an effective regional voice – and here the Manila Framework Group meeting can make a major contribution.
• The need to learn from the crisis, particularly in terms of the operation of the IMF programs, and to devise better processes of crisis management.
• The need to "bail in" the private sector to forestall or manage a crisis.
• The need for better supervision of highly leveraged international investors, such as hedge funds, and
• The need for improved transparency and regional economic surveillance.

These issues will be discussed over the next few days. They are issues I will be raising at the IMF Interim Committee and the meeting of the APEC Finance Ministers. I will make a few comments on all of them this morning. But one element I wish to single out in particular is the issue of improved transparency.

By improved transparency I refer to a situation in which the objectives of policy, and the legal, institutional and economic frameworks for that policy, are clearly explained and where policy decisions and the rationale for them are explained to the public in a timely way.

My emphasis on transparency and surveillance is because, in economic crises as much as in illness, an ounce of prevention is worth a pound of cure. Better transparency offers an important contribution to crisis prevention, by timely identification of emerging policy or institutional fragilities, and by assisting smooth and timely correction of them.

Moreover, if we use better policy transparency and the benchmarks of international ‘best practices’ in the process of surveillance, we have a better chance of maintaining the momentum of reform and developing domestic political ‘ownership’ of necessary reforms.

Much has been said in international fora about the need for improved transparency, but follow-up action has often been missing. To move beyond the rhetoric and provide a concrete step towards advancing improved transparency, I am today releasing a ‘self-assessment’ Transparency Report on Australia's economic policies and institutions. Such a Report is an important, tangible contribution by Australia towards maintaining the momentum for reform.

Maintaining the momentum for reform

The next year or two is the key period when we should fully apply the lessons of the Asian crisis, and thereby return to robust, stable regional growth and reduce the risks of future crises.

But that is an opportunity that we will have to take, it is far from a certainty.

Indeed, the corresponding periods in the wakes of earlier crises should remind us of the very real risk of a loss of momentum at this critical stage of the reform process.

In the depths of any economic crisis, emergent domestic reformers often have the upper hand. Old institutions and ways of government and business have been shown to have failed.

Foreigners who lent and invested too freely into environments whose risks they did not fully understand have been ‘burnt’, and the withdrawal or consolidation of their capital reinforces the domestic push for reform. And imperfect aspects of the international financial architecture which contributed to the crisis are identified and the slow process of reform to the international system is started.

But as economic recovery commences, the momentum for continuing reform can begin to flag:

• Domestic vested interests re-assert themselves to halt or slow down overdue national reforms. And in the face of the difficult, slow work of institution building, ‘reform fatigue’ can set in;
• International lenders and investors quickly forget the lessons of past excessive lending, and begin again to underwrite poor domestic policy practices; and
• Vested interests in the international financial sector, who benefit from the international community’s sharing of their risks (but not of their profits), resist necessary evolution in the international financial architecture.

So as I have already mentioned, a key challenge for this Group is: how do we maintain the momentum for change over this critical period?

Transparency, international policy ‘best practice’, and improved surveillance

With the need to maintain the momentum for reform firmly in mind, I come back to the importance of enhanced transparency and surveillance, and its contribution to maintaining the momentum of reform, for speeding economic recovery, and improving the stability of growth and its resilience to future economic shocks.

Better transparency can contribute to these results because it:

• increases the accountability of governments and public and private sector agents for their economic decisions;
• facilitates greater consistency between different arms of economic policy;
• improves public and private sector governance; and
• gives markets continuous notification of the accumulating consequences of existing policies.

Such information flows facilitate continuous, smoother market adjustment, even when there may be tensions in policy settings. Faster, smoother adjustments would be far superior to the discontinuous, herd-like and panic-stricken adjustments which are more common where information is unavailable, or hoarded and released only occasionally.

The objective of better transparency has been greatly enhanced by the preparation of a series of internationally agreed ‘standards’, ‘principles’ or ‘best practices’ for economic policy and institutions.

Codes of good practice or their equivalent now exist, or are in advanced stages of preparation for: releases of economic data; fiscal transparency; monetary and financial policies; banking supervision; securities market regulation; insurance regulation; accounting standards; auditing standards; corporate governance; and cross-border insolvency.

With the exception of international accounting standards, which have been prepared in segments since at least 1974, most of these other standards have come to fruition only since 1997, though based on work initiated earlier.

The implications for the international economic policy landscape of this recent work are not yet widely understood in the mainstream policy debate in any of our economies.

I think it is particularly significant that recent work has extended the array of international guiding principles beyond the ‘traditional’ concerns of macroeconomic reporting and fiscal and monetary policy setting, towards the structural issues of corporate governance, accounting and auditing, and financial sector supervision, which have been shown to have been very important underlying factors in the Asian crisis. These areas have been rightly characterised by one authority as comprising the key ‘institutions of innovation and prosperity’.

Economies that can demonstrate they are at or near the prevailing standards of best international policy and institutional practice gain advantages as destinations for international flows of lending and investment, in the growth of their living standards, and in the stability with which they weather international shocks.

Australia's own experience up to and through the recent Asian crisis is, I believe, a powerful example of these benefits.

We improved our policies and institutions: - inflation fell, total factor productivity growth accelerated, our general government fiscal balances and debt levels were brought to very healthy levels, and our GDP growth rose towards the top of OECD and Asian ranks.

Some international commentators have marvelled that an unexpected Asian crisis in which ‘contagion’ played a large part, nevertheless touched the Australian economy relatively lightly.

Australian exporters found alternative markets, and global financial and equities markets differentiated between our prospects and those of many of our close trade partners.

They were able to discriminate in this way because of transparent differences (in Australia's favour) between our policies and market institutions, and our neighbours’. But they could only do this because of the very transparent system we have been operating. Let me give one example, Australia’s Charter of Budget Honesty has been recognised as best practice in terms of fiscal policy transparency.

The benefits of greater transparency should be the strongest incentive for greater transparency. Again, Australia provides a good example. To give just one indicator, the margin of Australian over US bonds, which had been as high as 500 basis points in the 1980s and early 1990s, trended down to less than 100 basis points by mid 1997. The bond market traded fairly smoothly during the crisis, and apart from one blip in August last year, the margin has stayed quite low and is now about 30 basis points.

Australia's self-assessment Transparency Report

Last year I chaired an Australian Taskforce on International Financial Reform. It brought together senior representatives from the Australian private and public sectors. The Taskforce, which reported late last year, noted that there was a clear consensus in the international community that greater transparency is required. To advance improved transparency, the Taskforce recommended that the IMF prepare a Transparency Report for each member, but in addition countries could prepare and publish a report on the extent to which they meet recognised disclosure standards. The Taskforce proposed Australia should take a lead in preparing its own Transparency Report.

The self-assessment Transparency Report which I am releasing today, offers an example of how economies can explain their institutional arrangements and reforms, and make sure they are understood in global markets. The Report benchmarks Australia's practices against a wide array of ‘best practice’ international standards.

Australia’s self-assessment Transparency Report is a tangible contribution towards promoting improved transparency. As well as the Australian example, IMF members will soon be able to study staff-prepared transparency reports on some other economies, and members will be able to consider the relative merits of different approaches.

Transparency as a path to improving policies

Countries may agree in principle with the case for greater transparency, and yet be wary of transparency reporting if they are some distance from international best practice in some areas. What good could possibly come from acknowledging shortcomings?

In my experience market participants can be more unsettled by what they don’t know, but suspect, than by what they do know.

Even where there are short-term inadequacies in some policies or institutions, market participants can be reassured by a frank acknowledgment of the need for reform, and a clear statement of the timing, process and endpoint of reform.

In contrast, it can be risky to hope that policy or institutional problems will not be noticed before they can be quietly fixed up by an indefinite and private process.

That is a particularly dangerous course once markets have become attuned to areas of concern such as financial sector fragility or weak corporate governance. Better, by far, to acknowledge the problem and show a determination to correct it.

In Australia’s experience, an important part of the benefit of transparency reporting is the discipline that comes from the preparation of the report. The objective is not to fill in a ‘pass or fail’ checklist for ‘one size fits all’ policies. It is to think about the principles embodied in ‘best practices’, and to apply them in one’s own cultural and institutional situation through policies which thereby gain domestic ownership and support.

When all is said and done, perhaps some economies will still be reluctant to participate in transparency reporting and enhanced surveillance. But whether governments want to embrace transparency reporting or not, markets will increasingly use the transparency of a country’s policy positions and economic institutions, and the country’s policy conformity with international ‘best practices’, in forming assessments of the sustainability of its policies and performance.

The more economies use some form of transparency reporting, the more market participants will wonder what is going on in the economies that don’t. Such unrequited curiosity is likely to come at an increasing cost to countries with less transparent policies, in terms of higher borrowing premia and less foreign investment.

The IMF-assisted programs in Asia

Time permits me only a few selective comments on the lessons from the IMF-assisted programs in Asia.

However it seems clear enough that key elements of difficulty with the programs included:

• forecasting inaccuracies as to the breadth and depth of the Asian slowdown, with associated problems in initial fiscal targets;
• problems of limited ‘ownership’ by the national authorities of the policy commitments in the programs;
• problems in carrying vital community support for difficult but necessary policy reforms; and
• related to all the foregoing, hiccups in implementation of letters of intent and questions about the credibility of the programs.

I would like to relate these four difficulties to my earlier comments on the scope for improved transparency and surveillance to reduce the risk and extent of crises.

It is possible to identify several sources of difficulty in forecasting the breadth, depth and timing of the Asian crisis.

At one level, we need to examine whether there is a possible IMF bias towards optimistic forecasts of the results of IMF-supported programs.

But there were also important failures by all participants (including the IMF) in understanding the extent and importance of some of the structural weaknesses affecting the Asian economies.

That failure was common both to underestimating the persistency of weakness in Japanese growth, and to underestimating the risk of market contagion by which the crisis spread to economies suddenly (and belatedly) perceived to share common institutional and policy weaknesses.

If this diagnosis is true, what can we do about it? I believe the answer lies partly in greater transparency, greater use of international ‘best practices’ in evaluating the state of national policies and institutions, and better use of such information in surveillance.

Similarly, I suspect better transparency and greater reference to international ‘best practices’ could (paradoxically) help improve national ‘ownership’ of reform programs, and increase community support for those programs.

If continuous, transparent benchmarking of national policy practice against international ‘best practice’ had been more widespread, it seems unlikely that countries would have been as complacent as some were with inappropriate policy approaches which have proven, under the stress-testing of crisis, to be unsuitable to the requirements of stable growth in a globalised economy.

International financial system reform

The Australian Government wants to see steady progress and a strong regional voice in the improvements of the international financial architecture. We have been very active in all the international forums working for reform

Two key ‘architectural’ issues that I have already mentioned are the need to help ‘bail in’ private sector creditors to forestall or manage crises, and the need to improve the supervisory oversight of the activities of highly-leveraged international investors such as hedge funds.

The issue of ‘bailing in’ the private sector creditors is very important for borrowing economies, not just creditors, because clarity about the procedures to be followed will influence creditors’ assessments of risk, and thus borrowing countries' access to funds. Borrowing economies therefore need to be active participants in the development of reforms.

I should also note that borrowing countries have two domestic avenues to improve their access to funds and their immunity to capital flight in the event of future crises:

• First, they can enhance their credit worthiness by the domestic transparency measures and associated reforms I have mentioned earlier.
• Secondly, they could place particular weight on reform of their insolvency laws and associated legal institutions.

One of the lessons from the Asian crisis is that without smooth-functioning domestic insolvency arrangements, international creditors face a strong incentive wholly to withdraw lines of credit or refuse to roll over existing loans as a crisis deepens: if creditors are not ‘out the door’ early, they may never get any of their loans back from bankrupt borrowers where insolvency regimes excessively favour equity holders (or are simply inoperative).

Turning to the second architectural issue of oversight of heavily-leveraged international investors, a great deal of useful work is underway in sub-committees of the Basle Committee on Banking Supervision to achieve a better statistical grasp on the problem, and to protect the systemic integrity of the banking system in the major financial centres. Australia is an active contributor to that work, through the participation of the Reserve Bank of Australia.

But the ‘hedge fund issue’ is broader than this, including the plausible concerns of regional economies about possible manipulation by heavily leveraged institutions of the value of their currencies.

We need to be able to satisfy ourselves whether better disclosure of the exposure of creditors and counterparties to hedge funds is sufficient to address these concerns.

While there have been some useful developments on these ‘architectural’ issues, I encourage regional debtor economies to register their perspectives strongly, through meetings such as this one, the G-7 outreach seminars, the Spring meetings of the Fund, and through APEC. As I noted previously, these are key issues Australia will be seeking to see progressed at these meetings.

Conclusion

I wish you well in your important work over the next few days.

As we enter the new century, I believe we have the opportunity to make better transparency the distinctive breakthrough in the international financial architecture in the wake of the Asian crisis.

We also have the opportunity to contribute, through this meeting’s discussion of the application of transparency measures and international policy best practices, to the speediest possible recovery from economic crisis. Most importantly for our children, we can contribute to the construction of the institutions and policies that will again deliver strong growth in standards of living, and will be more robust against the threat of future, presently unforeseeable crises.

Australia's self-assessment Transparency Report provides one example of a path forward in these important policy reforms and institution-building.

You also have the opportunity, through the discussion of international financial architecture issues and the IMF programs in Asia, to contribute a strong regional voice to the global debate on these matters.

May I again affirm that the Australian Government places the highest emphasis on building sound regional input to global debate through the Manila Framework Group, and the larger APEC forum.

But I would also repeat that while we have the opportunity to make a significant regional contribution to the process of reform, it is by no means certain. It is up to all of us to seize the opportunity we have before us.

My best wishes and encouragement for this meeting, which I now declare open.