Annual lists 2002 2001 2000 1999 1998 1997 1996 1995

Ottawa, October 8, 1995
1995-080

Notes for an address by the Minister of Finance of Canada, Paul Martin, to the IMF Interim Committee

Washington, D.C.
October 8, 1995

Delivered text is official version

Policy Priorities in the Recovery

A great deal has happened to the world economy since we met in Madrid one year ago. At that time, growth in some countries was proceeding at an unsustainable pace, leading to concerns that the recovery might be cut short by the emergence of inflationary pressure. The economic recovery in other countries, including many in continental Europe, remained sluggish, and Japan was still in recession.

Faced with this challenging environment, the Interim Committee adopted the Madrid Declaration, which called upon governments to take measures aimed at strengthening and sustaining the recovery, while making most effective use of the opportunities it provided to enhance our long-term prosperity. This meeting provides us with a good opportunity to review the progress we have made in implementing these measures and achieving the goals set out by the Interim Committee a year ago in Madrid.

Certainly, the last year has not been an entirely easy one for the global economy. Exchange market turmoil has forced many countries to raise interest rates above the levels desirable based on domestic economic considerations, leading to slower growth. The uncertainty generated by the Mexican exchange rate crisis spilled over to developing countries around the world, while uncertainty over the pace of monetary integration and over the likelihood of significant reduction in budget deficits caused considerable turmoil within the European Union.

At the same time, we must not lose sight of the many positive aspects of the current situation. Inflationary pressures remain contained in most industrial countries. Progress has been made in reducing fiscal deficits, although much remains to be done. There are encouraging signs that economic growth in the United States is moderating to a non-inflationary pace; in short, that the U.S. is on the way to achieving a "soft landing". These encouraging developments have in turn been reflected in international financial markets: long-term interest rates have declined over the last six months and the fall of the U.S. dollar since the beginning of the year has been partially reversed.

How can we best respond to adverse developments like those that have occurred over the last year, while building on our positive achievements? In considering this, it is important to bear in mind that instability like that we have experienced over the last year usually has its roots in market concerns about the stance of domestic macroeconomic and structural policies. This suggests that the best way of responding to turmoil is to redouble our efforts at pursuing sound policies and establishing credibility -- in short, re-dedicating ourselves to the policies we adopted last year in Madrid.

We must, however, also acknowledge that while a collective commitment to pursuing sound policies will certainly minimize instability, it will not guarantee the absence of problems. Developments over the last year have also clearly illustrated the importance of a smoothly-functioning international economic and financial architecture to help countries that encounter severe difficulties. I will return to this subject in detail later in my remarks.

What are the policies that will help strengthen the prospects for a vigorous and sustained period of growth? The Madrid Declaration identified an anti-inflationary monetary policy as the best way of prolonging the recovery, while fiscal consolidation and structural reform were recognized as offering the best way of enhancing our economies' long-term growth potential. For some time, fiscal deficits in industrial countries have been driving up global interest rates, "crowding out" private investment and weakening productivity growth. As we all know, action to cut fiscal deficits can sometimes be painful in the short-term. However, fiscal consolidation also brings enormous benefits in the form of lower interest rates and stronger long-term growth. Moreover, the experience of countries that have implemented strong and credible deficit reduction measures indicates that these benefits can sometimes accrue quite quickly, and help to ease any short-term dislocations.

It has also become increasingly clear over the last several years that economic growth, however robust and prolonged, may not by itself lead to a rapid and substantial decline in unemployment. Structural reforms are also needed. We can and should make maximum use of this recovery to improve the efficiency of labour markets by, among other things, removing regulations that discourage hiring. We must also address the serious work and employment disincentives embedded in many of our tax and social benefit systems.

Canada's Policy Approach

Canada's implementation of the measures called for last year in the Madrid declaration -- fiscal consolidation, anti-inflationary monetary policies, and structural reforms -- has helped us cope with the difficult events of the last year.

Our top economic priority is to succeed in putting Canada's public finances on a sustainable footing. Our strategy in doing this is to set rolling two-year deficit targets, on the way to a balanced budget, and then ensure that we achieve them. We have adopted this approach of setting short-term targets in order to keep the government's efforts concentrated on our fiscal goals and not allow us the costly luxury of postponing difficult choices.

Our present target is to reduce the deficit to 3 per cent of GDP by the 1996-97 fiscal year. In the run-up to last February's budget, some people were concerned that we would miss our fiscal targets, because of higher-than-expected interest rates.

With our actions we have proved these people wrong. In our last budget, we closed the gaps that some thought might emerge between future performance and our targets. We did this with far greater reliance on expenditure reductions than on tax increases, and by making prudent economic assumptions backed up by sizable contingency reserves.

Developments since the last budget have shown the importance of these prudent assumptions and contingency reserves. Growth has slowed, but the effect of this on our ability to meet our targets has been offset by interest rates that have remained well below the very prudent levels assumed in our budget planning.

This means that notwithstanding these difficulties, our targets will be met. Indeed, next February's Budget will contain a deficit target for 1997-98 -- that is, one year beyond the 3 per cent target already announced for 1996-97. We will achieve the targets for 1997-98 and beyond just as we have achieved our past targets. Our ultimate goal is to eliminate the deficit.

One of the imperatives of getting our fiscal house in order is to be able to have continuing, stable, federal funding for health care. There can be no questioning the commitment of the government of Canada, and of Canadians themselves, to our publicly-funded national Medicare program. We view this as a joint responsibility of the federal and provincial governments.

We are taking the approach outlined in the Madrid Declaration in other areas of economic policy. The Government and the Bank of Canada have jointly established targets of 1 to 3 per cent for inflation over the 1995 to 1998 period, and have geared monetary policy to ensuring that inflation does not leave this range. This approach has been very successful, contributing to the lowest inflation rates Canada has enjoyed in three decades. We are determined to sustain this excellent performance.

We in Canada are also making progress in the area of structural reform. We have dramatically reduced subsidies to business, and are taking action on labour market reform. Other areas in which we are implementing structural reform include changes in the nature of fiscal transfers between Canada's federal government and provinces, to improve accountability and ensure that the sacrifices necessary to put Canada's public finances on a sustainable footing are shared equally and fairly.

Canada's Economic Performance

Our decisive actions, and the difficult choices we have made, are paying off and will continue to do so.

Although growth has slowed this year, some of this decline is related to the hoped-for "soft landing" in the U.S. Ultimately this is a very positive development for the Canadian economy, since the moderation of growth in the U.S. will extend the recovery there, and reduce the danger that an inflationary "boom" in the U.S. would be followed by a recessionary "bust" there and in Canada. There are good reasons to believe that the current period of slower growth in the U.S. will create conditions for renewed growth throughout North America.

Interest rates in Canada have come down substantially since the spring, after rising in late 1994 and into 1995. Part of the increase late last year and early this year reflected the general turmoil in international financial markets associated with the Mexican peso crisis and uncertainty about the outlook for inflation in the U.S. and elsewhere. However, as I mentioned earlier, it also resulted from domestic factors, such as investor concern about the referendum in Québec and the depth of our commitment to address our fiscal situation.

Last February's budget, which reconfirmed our determination to achieve our fiscal targets, helped address one of the sources of domestic uncertainty, and was followed by declines in interest rates. However, it cannot be denied that Canadians are still facing interest rates that are much higher than they should be given our strong fundamentals, including our excellent inflation performance. Much of the reason for this relates to political factors, particularly the understandable uncertainty generated by the upcoming referendum in Québec.

The Canadian economy may experience further referendum-related turbulence before the benefits from our strong fundamentals re-assert themselves. However, I am confident Canada will benefit from a renewed financial market focus on these fundamentals once Québecers have chosen to remain in Canada, as I am certain they will.

Developments in Other Countries of the Constituency

Let me now turn briefly to the developments in Ireland and the Caribbean island economies that are part of the Constituency I represent in the Interim Committee.

The growth of the Irish economy has been robust in recent years. GNP will expand by more than 5 per cent this year, and medium-term prospects for growth are above the forecasts for Europe as a whole. This year's expansion includes a 9 per cent increase in investment. Despite the pace of activity, and the fairly even split of this growth between domestic and external sources, data just published point to inflation on target at about 2 1/2 per cent in the current year. The external account will show a strong surplus again as it has for some years.

The strong showing of the Irish economy is based on a fiscal stance which has seen public debt cut from 130 per cent of GDP to 90 per cent since the mid-1980s. The continuing challenge for fiscal policy is to keep current public spending under control to the extent required to sustain ongoing adherence to the European Union's Maastricht criteria. Ireland's record on this front has been one of the best in the Union to date.

Rapid economic development has brought about a substantial increase in employment, but a quickly expanding labour force has prevented this from being translated into a corresponding reduction in unemployment which remains the key problem for the Irish authorities. They are addressing it through micro aspects of fiscal policy which are designed to free up the labour market, and through other measures, including training and retraining, designed to maximize the potential for additional employment and its attractiveness in preference to unemployment.

Reference has often been made in the past to the fragility and special vulnerabilities of the economies of the Caribbean countries I represent, and to the need for strategies to cushion them against shocks from changing market behavior and from natural disasters. Even as we convene for this session of the Interim Committee, some of the Caribbean countries, along with other territories in the area, are reeling from the impact of recent hurricanes which wreaked damage of considerable severity on Antigua and Barbuda, Dominica, and St. Kitts and Nevis. Inevitably, the devastation suffered has been comprehensive in scope on account of the small physical and economic size of these countries, and provides, once more, a telling demonstration of the practical meaning of vulnerability. The evaporation for many months to come of any meaningful earnings from the economic mainstays of tourism and banana exports will cloud significantly the short to medium term prospects of these economies, and compound the difficulties of adjustment for them. We trust that the international community will be generous in assisting their recovery. But beyond that, the experience confirms the need to ensure that international development and financial policy is responsive to the peculiar fragility that is a permanent feature of countries such as these.

Elsewhere among Caribbean countries, the authorities are broadly sustaining their efforts towards fiscal and monetary soundness, and the lessons from the recent turmoil in international financial markets have not been lost on them. The control of fiscal and monetary conditions in many of these countries continue to contain inflation at moderate to low levels, and in notable cases policies have been strengthened to respond to developments that might otherwise pose a threat to the process of stabilization and to the conditions for sustainable growth. The Caribbean countries I represent look forward to cooperating with the Fund in its effort to strengthen surveillance.

Prospects for Economies in Transition

I turn now to economic and policy developments in countries in transition.

One of the most encouraging developments in the world economy in recent years has been the broadening and deepening of reforms in the formerly centrally-planned economies. Reforms have been broadened in the sense that a greater number of countries are now active in making the transition from central planning to market-based economies. Reforms have been deepened in the sense that the initial phase of reforms -- the freeing of prices, production, and external trade -- is now complete in many countries. These countries are now turning to other important areas, such as improving the stability and efficiency of the financial sector, and continuing with privatization.

Notwithstanding these encouraging developments in the countries in transition, much remains to be done. By taking resolute action early on to reduce budget deficits and inflation, and by developing a social safety net to protect the most vulnerable groups in society, these countries can make further strides in their transition to market economies.

Prospects for Developing Countries

Moving to the developing countries, many have experienced strong growth over the last few years following their adoption of policies consistent with macroeconomic stability and improved resource allocation. It is encouraging to see that the IMF World Economic Outlook expects another year of robust growth.

However, the strong performance of the developing countries as a group masks significant differences in growth rates. As mentioned earlier, the last year has not been an easy one for the world economy. And nowhere is this more true than for the developing countries of Latin America. Mexico, in particular, is still in the process of recovering from its recent financial crisis. That the crisis was not much more severe, and did not spread more widely, is due in large measure to the actions of the IMF.

However, even the timely and effective actions of the IMF and others could not eliminate the significant spillovers from the Mexican crisis that affected other major Latin American countries, including Brazil and Argentina, and, indeed, that were felt by "emerging markets" around the world. In general, the countries most strongly affected by these spillovers were those with weak financial sectors, where national savings are low, and where insufficient progress has been made on structural reforms. By taking action in these areas, developing countries can do much to reduce the chances of another crisis like that which affected Mexico.

Africa is another region in which growth prospects can be strengthened by improvements in economic policy. However, unlike the difficulties in Latin America, which are largely of a short-term nature related to reversals of capital flows, the problems of Africa are persistent. Addressing them demands further fundamental structural reforms and sustained improvements in macroeconomic policy.

Reform of the International Institutions

Last April, at our meeting in Washington, I spoke at some length about institutional reform and Canada's ambitions for the G-7 Economic Summit in Halifax. In subsequent months, I had the opportunity to speak with many of you and benefit from your views and advice.

The Halifax Summit has widely been seen as a constructive exercise. It provided a useful forum to re-examine the current structures of international cooperation and allowed Canada and its G-7 partners to put forward a number of important reform initiatives.

Shortly after the Summit, I wrote to the governors of the Bretton Woods institutions and the heads of the international financial institutions to share the conclusions of the Halifax Summit.

Generally speaking, there was broad agreement that the IMF and multilateral development banks continue to play an important role in ensuring global economic stability and international well-being. Nevertheless, there are clearly areas where improvements are both possible and desirable.

In the context of the Fund, Canada and its Summit partners are looking for reforms in the following key areas:

• strengthening the IMF's surveillance of national policies and financial market developments and promoting fuller disclosure of this information to market participants. Such measures will better help to identify problems before they reach crisis proportions.

• ensuring that procedures are in place to shorten the time that is needed to respond to financial crises when they do occur.

• doubling the resources currently available under the IMF's General Arrangements to Borrow to ensure that the Fund has adequate liquidity to meet these crises.

• ensuring that the Fund has sufficient resources to continue to finance the Enhanced Structural Adjustment Facility for the benefit of the IMF's poorest countries.

While this is an ambitious list, the response to date has been extremely encouraging. These reform initiatives have struck a responsive chord with other shareholder governments. In fact, much of the Halifax agenda is at the core of our discussions today.

Let me also highlight work that is continuing on a number of other issues. At the Halifax Summit, Leaders underlined the need for closer cooperation in the regulation and supervision of financial institutions and markets. Recent episodes, including the collapse of Barings Bank, have reinforced this conclusion. This issue is now being considered by the Basle Committee on Banking Supervision and the International Organization of Securities Commissions. A full review of the adequacy of current arrangements, with proposals for possible improvements, will be considered at the next G-7 Summit in Lyon.

The G-10 countries are also engaged in a critical reassessment of how best to deal with sovereign liquidity crises. Progress in this area could further strengthen our capacity to deal with future financial crises. Nevertheless, any decisions in this area will need to carefully balance a number of economic and legal considerations. My hope is that we will be in a position to reach some firm conclusions by next spring.

Finally, in Halifax, Leaders recognized that there have been important deficiencies in the treatment of the human rights and refugee dimensions of many crises, including the recent Rwandan situation. In light of this, Leaders recommended that the United Nations and Bretton Woods institutions strengthen their coordination. It is clear that we will need to find a way to respond to the special needs of a post-conflict Bosnia. Over the coming months, Canada will be encouraging these institutions and donor governments to achieve a clearer understanding of how the international community can better respond to the needs of countries afflicted by crises or in post-conflict situations.

Policy Directions for the Fund

While it is generally accepted that the IMF must remain the central institution for international surveillance, there are differences as to what this means in practice. In Canada's view, it will require the Fund to make concerted efforts to enhance its surveillance activities in countries that could potentially trigger systemic problems.

It also means that the Fund needs to more strongly encourage member countries to provide standardized and more timely economic and financial data. Such data are essential to help markets work better and, as such, offer the single best means of averting future financial crises. For this reason, Canada supports the consensus reached in the Executive Board on minimum reporting standards, and the refinement of a more demanding set of publication standards for countries with current or prospective access to international capital markets.

As with financial market regulation, the best possible information should be available to all participants. I see no reason why the data that a country provides the Fund should be any different from the data it makes available to the market. In line with this, I would encourage the Executive Board to continue to work to promote a more pro-active role for the Fund in the monitoring of data publication practices of member countries.

Admittedly, even with these changes in place, the possibility of a crisis exists. This raises the question of appropriate mechanisms to respond to crisis situations and the adequacy of the resources at the Fund's disposal. At the Halifax Summit, Canada and its G-7 partners urged the establishment of a new IMF procedure -- an "Emergency Financing Mechanism" -- which would provide faster access to Fund resources with strong conditionality and larger up-front disbursements in crisis situations. The recent agreement by the Fund Board to pursue such a procedure is a welcome development.

The related issue of the Fund capacity to mobilize additional resources though new borrowing arrangements is also receiving attention. A doubling of the resources currently available under the General Arrangements to Borrow now appears to be broadly accepted as appropriate. In the coming months, we look forward to discussions with other members as to how this can best be achieved. For our part, Canada sees an advantage in keeping the current GAB intact and exploring the modalities of a complementary arrangement with other shareholder governments.

Let me also underline the importance that I attach to the continued financing of the Enhanced Structural Adjustment Facility (ESAF). It is essential that the Fund retain its capacity to provide concessional assistance to low-income countries pursuing strong adjustment programs. For this reason, I support the proposal to make ESAF both permanent and self-sustaining. In this context, let me reiterate my strong support for the proposal to use a modest portion of the IMF's gold reserves for this purpose. This is the simplest and most direct way of resolving the current impasse.

Conclusion

In conclusion, let me re-emphasize the critical role that the IMF must continue to play in the smooth operation of the international monetary system. Our discussions today will help define that role. I have every confidence that, together, we can ensure that the Fund will continue to have the tools to respond to its future challenges with flexibility and imagination.