. .

Politics & Policy

Pakistan and new global financial architecture


Politics & Piolicy 

Oct 02 - 08, 2000

Text of the speech delivered by William B. Milam, US Ambassador to Pakistan, at a seminar arranged by Management Association of Pakistan

The title of my presentation is a question: How does Pakistan fit into the new global financial architecture? This question immediately elicits two more questions: 1) what is the new global financial architecture; and 2) in fact, what is financial architecture?

First, financial architecture is simply the framework of understanding in which the international financial system operates—its parameters, if you will. Secondly, the new global financial architecture arose from a retrospective undertaken by the G-7 in its June 1999 summit in Cologne on what went wrong and caused the new financial collapse in Asia in the mid 1990's and why it wasn't seen coming earlier. The G-7 concluded that, primarily, loose and non-transparent financial policies, out-of-date international financial institutions, and weak regulation caused the problem. These conclusions led the G-7 to endorse a number of reforms to the understandings that govern how the international financial system should work. These reforms are designed to reduce the risks of future financial crises and better manage those that occur.

This is not an abstraction; the subject is vitally important to Pakistan as it labours under a heavy debt burden and is in the process of beginning to reform and restructure its economic and financial system in ways that move the economy to higher sustainable growth rates. For Pakistan, this process begins with a new agreement with the International Monetary Fund (IMF) and follow up agreements with the World Bank and the Asian Development Bank.

The G-7 recognized that responsibility for maintaining global stability is shared among the industrial countries, the developing countries, especially those called emerging markets, and the international financial institutions. The G-7 proposed reforms are broken down into six broad categories:

• Strengthening and reforming the international financial institutions,

• Enhancing Transparency,

• Strengthening financial regulation in industrialized countries,

• Strengthening macroeconomic policies and financial systems in emerging markets,

• Improving crisis prevention/involving the private sector,

• Promoting social policies to protect the poor and most vulnerable elements of society.

Strengthening and reforming the international financial institutions: The IMF and the World Bank have the central role in the international economic and financial system. Rather than replace these institutions or create new ones, the G-7 decided to work toward making both institutions more efficient.

It called for enhanced international cooperation in financial market supervision and surveillance and created a group to work on the implications of highly leveraged institutions, offshore centers and short-term capital flows.

It also endorsed improving IMF surveillance of exchange rate and economic policies of member countries and improving IMF transparency. This new surveillance and scrutiny is apparent in the IMF's recent emphasis on a free market float of the Pakistani rupee.

Enhancing transparency: The G-7 concluded that the availability of timely and accurate information was essential for well functioning financial markets and market economies, both to guide market participants and as an incentive for policy makers. Here too, Pakistan has experienced a much more rigorous analysis of its financial data, reserve position and monetary and fiscal policies.

Strengthening financial regulation in industrialized Countries: The G-7 called on industrialized countries to improve their own financial regulations to ensure that creditors improve their risk management and risk assessment for lending to emerging markets. It discouraged investors from using excessive leverage. The G-7 proposed that private firms strengthen their own risk management and looked forward to ensure that banking institutions implement adequate risk management practices.

Strengthening macroeconomic policies and financial systems in emerging markets: Recent financial crises demonstrated the need to strengthen economic fundamentals and financial systems in emerging economies, to promote their own development and international and financial stability. Emerging economies should also adhere to sound principles of debt management and strengthen their financial sectors and supervisory regimes.

The G-7 called for appropriate exchange rate regimes for emerging market economies: stability depends on the exchange rate regime being backed by consistent macroeconomic policies and supported by a robust financial system.

Improving crisis prevention/involving the private sector: One of the major lessons from the late 1990's financial crisis was that the international community needed to strengthen its approach to crisis prevention and resolution. The G-7 endorsed the IMF's contingent credit line, which provides member countries with strong economic policies — a strong precautionary defense against future balance of payments problems that might arise from international financial contagion. The G-7 proposed a framework of principles and tools for involving the private sector in the resolution of crises. The aim was to help promote cooperative solutions between debtor countries and their creditors and to shape expectations in a way which reduces the risk that investors believe they will be protected from adverse outcomes.

Promoting social policies to protect the poor and most vulnerable elements of society: The G-7 noted that social policies are the "cornerstone of a viable international financial architecture. They supported the identification of principles and best practices in social policy to protect the poor and most vulnerable. While recognizing the financial constraints on the abilities of governments to fund social programmes, the G-7 noted that effective social policy can ease the task of adjustment during times of crisis and help build support for necessary reforms. The IMF was also called upon to take into consideration the degree to which its recommended adjustment programmes provide for adequate spending in the social sector.

What can Pakistan do to fit in?

Open markets: Keeping markets open for goods and capital will make the economy more resilient to shocks. The benefits and economic opportunities derived from open markets will lead to significant improvement in living standards in industrialized and emerging markets alike. We believe the process of globalization offers great additional potential to create wealth and employment.

Maintain sound macroeconomic policies: The challenge for Pakistan is to promote financial stability through national action as well as through enhanced international cooperation. All countries must assume their responsibility for pursuing sound macroeconomic and sustainable exchange rate policies and establishing strong and resilient financial systems. It requires the adoption and implementation of internationally agreed standards and rules to meet the demands of today's global financial system.

Enhanced transparency: The need is for Pakistan to establish public authorities to provide for enhanced transparency and disclosure, improved regulation and supervision of financial institutions and markets, and policies to protect the most vulnerable. It also requires that private creditors and investors bear responsibility for the risks that they take.

Sustainable exchange rate policy: Pakistan needs to pursue a sound and sustainable exchange rate regime. A fixed exchange rate requires Pakistan to subordinate other policy goals to that of fixing the exchange rate. However, it has been agreed that the international community should not provide large-scale official financing for a country intervening heavily to support a particular exchange rate level. Pakistan should also avoid controls on capital flows, although they may be justified for a transitional period, because such controls carry costs.

Debt management: Pakistan should work with the IFIs to promote best practices in debt management. There should be a greater reliance on long-maturity, and if possible domestic currency denominated, debt to maintain a debt profile that provides substantial protection against temporary market disruption, avoid transforming long-term debt into short-term debt.

We hope that Pakistan is able to build upon the standby agreement it has recently negotiated by next year, agreeing with the IMF to a Poverty Reduction Growth Facility (PRGF), which is a long-term concessional facility that focuses on long-term structural reforms.

Pakistan remains dependent on foreign donors and creditors to meet its financial needs. Even with IFI assistance, Pakistan has run a currant account deficit in recent years. Both annual debt servicing requirements and the current account deficit have hovered around 3 per cent of GDP in recent years, while gross external public debt is over 50 per cent of GDP. In addition, defense spending and debt repayments absorb close to 80 per cent of current expenditures.

Promoting social policies to protect the poor: Recent events in the world economy have underlined the important link between economic and social issues; and that good economies depend both on stable relationships between governments and their citizens, and strong social cohesion. An efficient social safety net, by equipping people for change, builds trust and encourages people to take the risks, which are a necessary part of a competitive modern market. This in turn helps to mitigate the risks and spreads the benefits of globalization.

Openness is the overriding theme in this new global financial architecture — openness which can't be abused because of enhanced standards of regulation, transparency, surveillance, and policy oversight. How can Pakistan fit into the new global financial architecture? In essence how can it fit into and prosper from an increasingly open international financial system? Simple! By embracing openness, welcoming the competition, maintaining policies and practices which draw in the world's capital instead of repelling it.

Pakistan's economic performance has been harmed because barriers to the global economy have resulted in ineffective governance and weak policy implementation.

Pakistan's clear potential for higher growth rates can only be realized by effective measures to achieve macroeconomic stabilization and increase economic efficiency.

Can Pakistan fit into the global economy? Time will tell. Meeting IMF pre-conditions and conditions have positioned Pakistan for renewed lending by the IMF, other IFIs and set the stage for a possible Paris Club rescheduling. This is a start, and it could be the beginning of a sustained effort at economic reform and restructuring that will attract both increased domestic investment and private capital inflows/foreign investment. The challenge at present is to begin the journey and stay on the road.